Feds Play the Queen of Hearts

Former Qwest (NYSE: Q  ) CEO Joe Nacchio, the subject of a three-year-long federal investigation, was indicted by a Denver grand jury on 42 counts of insider trading Tuesday.

According to a Reuters report, the indictment says Nacchio in August 2000 began receiving warnings about "material, nonpublic financial risks" facing Qwest that could hinder its ability to meet financial targets. And, further, that he stepped up stock sales in January 2001 as he became aware of more troubling news. All told, the feds accuse Nacchio of more than $100 million in ill-gotten gains. Which isn't much different from what it says on Nacchio's entry for the "Shareholders' Most Wanted" card deck. Nacchio is listed as the queen of hearts. (Funny, I know. Wouldn't Martha Stewart have been better in that role?)

Inside the hype
The feds allege that Nacchio knew Qwest's business was deteriorating when he sold. We're not yet privy to the evidence, so it's impossible to make a complete judgment. But if you believe the feds' case -- that Nacchio had some prior knowledge -- company communications don't begin to inspire any more confidence in his innocence.

Take this press release from September 2000. In it, Nacchio raises revenue guidance for both 2000 and 2001 based on the "strength of the business." Ironically, 22 months later, Qwest would announce its need to restate earnings for 2000 and 2001.

Two things make this release and its proclamations really interesting. First, it falls during the time the feds believe the deception began. Second, there are no other releases like it. And the three that get closest might be best described as hype, if you're to buy the feds' case. For example, this one from June 20, 2001, is merely a rebuttal to a Morgan Stanley (NYSE: MWD  ) report that questioned Qwest's projected earnings growth and capital needs. Interestingly, the Morgan Stanley criticism came just a day after Nacchio and his team reaffirmed 2001 guidance, and 60 days before the first of three downward revisions during the Nacchio rein.

To be fair, Qwest stock fell roughly $10 per stub between Sept. 7, 2000 -- the date of the release raising guidance -- and the first day of trading in 2001. But by Jan, 25, the stock would recover all but $2 per share of that loss. We don't know exactly when Nacchio sold shares because his Form 4 filings -- which list transactions for buying and selling stock -- weren't required to be filed electronically until April 2003. (His transactions are all paper records stored away at Securities and Exchange Commission headquarters in Washington, D.C.)

It's also worth noting that Reuters names three former Qwest executives as cooperating in the case against Nacchio, including former chief financial officer Robin Szeliga, former chief legal officer Drake Tempest, and former president Afshin Mohebbi.

Don't wait up for me, Bernie
So, at least from this Fool's view, it doesn't look good for Nacchio. And those seeking jailhouse justice a la Bernie Ebbers, the former CEO of WorldCom, may take heart. The Wall Street Journal reports that federal prosecutors are seeking more than $100 million in restitution and that, if Nacchio is convicted, each insider trading charge could bring 10 years in prison and a $1 million fine.

For his defense, Nacchio will likely bring forth the specter of secret national security contracts that led him to believe the company was doing far better than it really was.

I'm not sure I buy it. But a jury? We'll see. For now, though, you can count the queen of hearts as bitterly broken.

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Fool contributor Tim Beyers learned Wednesday that Nacchio was visiting his hometown of Denver. So that's what that smell was. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. You can find out what's in his portfolio by checking Tim's Fool profile. The Motley Fool has an ironclad disclosure policy.

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