A case of Enronitis may now be spreading to Qwest Communications International Inc. Last year, the Denver telecom giant saw its stock slide 64%, to $14.13, after it came under fire for its accounting practices. This year, Qwest’s shares slid an additional 31%, to $9.71 on Mar. 8, amid growing liquidity concerns and downgrades from the major credit-rating firms. Then, on Mar. 11, Qwest disclosed that the Securities and Exchange Commission had opened an informal inquiry into its accounting practices.

Qwest may end up having to explain more than just its accounting. A BusinessWeek review of insider stock sales found that Qwest’s top execs were selling stock at the time its critics allege accounting improprieties may have occurred at the company. CEO Joseph P Nacchio sold 2 million shares of Qwest stock in the first half of last year, realizing $74.6 million. And on May 2, 2001, Qwest founder Philip F Anschutz sold roughly 10 million shares for $408 million, according to SEC filings.

The sales have angered Qwest employees. In early March, workers filed two lawsuits, claiming they were encouraged to keep their retirement savings in company stock even as top execs sold hundreds of millions of dollars in shares. "Senior management had a fiduciary duty to employee stock plans, and here they are urging employees to invest while selling off their own stock," says Joseph Whatley, one of the attorneys who has brought suit against Qwest’s senior management.

Anschutz isn’t commenting. Nor is Credit Suisse First Boston, which in 2000 acquired Donaldson, Lufkin & Jenrette Inc., the investment bank that structured Anschutz’s stock sale through a Cayman Islands subsidiary. That transaction represented only 3.3% of Anschutz’s 301 million-share stake in Qwest. A spokesman for Qwest says that Nacchio sold shares to diversify his holdings and still has options on 20 million shares.

The timing of the sales may be critical because they occurred just before Qwest’s stock nose-dived. The company’s shares held up better than the rest of the telecom industry during the first half of last year, largely because Nacchio insisted that Qwest could outpace its rivals in revenue and earnings growth. But in the second half, the company stumbled. On Sept. 10, Nacchio conceded that Qwest would not meet its revenue and growth targets for the year and for 2002.

The SEC’s investigation involves accounting practices Qwest used that made its financial performance look good through the middle of last year. One area the SEC is examining is Qwest’s sales of capacity on its network. Qwest, like many telecoms, sold slices of capacity on its network—known as indefeasible rights of use (IRUs)—to other phone companies while buying IRUs from other service providers. Such sales can be legitimate if, for example, Qwest needed capacity between San Francisco and Seattle and AT&T needed capacity between New York and Boston.

But capacity sales also can be used to inflate revenues and profits. A sale of an IRU is counted as revenue, while a purchase is counted as a capital investment. If two companies, for example, sell each other IRUs valued at $100 million, both companies can book revenues of $100 million today, but they spread the cost of the $100 million purchase over the life of the contract, typically 20 or 25 years. The result is that a company’s financial statements look good today, although no net cash has changed hands.

What the SEC is investigating is whether Qwest, Global Crossing Limited, and others sold each other network capacity to inflate their financial statements, without any real business purpose. In the first six months of 2001, Qwest sold $857 million worth of network capacity to other telecom players. It also bought $450 million in capacity from some of those same companies. The sales helped Qwest’s revenues rise 12%, to $10.3 billion, for that time period. Without those transactions Qwest’s revenues would have grown only 7.5%, to $9.4 billion.

Qwest’s transactions were first examined as part of the SEC’s ongoing investigation into Global Crossing, the former telecom highflier now in bankruptcy. According to a whistle-blower lawsuit filed by former Global Crossing employee Roy Olofson, Qwest and Global Crossing exchanged about $200 million worth of network capacity in the first and second quarters of 2001. And Global Crossing Chairman Gary Winnick entered into a $123 million stock sale in the same month that Anschutz sold—May of 2001. It may all be a coincidence, but there were certainly a lot of shares being sold at a curious time.

By Ronald Grover and Christopher Palmeri in Los Angeles and Peter Elstrom in New York in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc