Chapter V: The Bust of the Bandwidth Bubble

Years before the Bandwidth Bubble had begun to take shape, data had surfaced that indicated something major was amiss. In 1998 an AT&T Labs Internet researcher named Andrew M. Odlyzko published a paper debunking the widely held view that Internet traffic was doubling every three months. Odlyzko explained that the implications of this rapid traffic doubling would imply that by 2001 Internet traffic would have grown by a factor of seventeen million. The amount of Bandwidth, Odlyzko calculated, would require every Internet user on Earth to stream video twenty-four hours a day. Clearly, that wasn’t the trajectory.

“[Doubling every three months] was an extremely convenient myth,” said Odlyzko. “Every entrepreneur who was getting financing could quote it.” In contrast, Odlyzko’s analysis suggested Internet usage was doubling only once a year.

Odlyzko’s inconvenient truth was either unnoticed or, more likely, ignored.

As the Boom reached its height, the twentieth century was coming to an end. Are you old enough to remember the Y2K hysteria and how computers everywhere could fail or run afoul because of a software glitch as midnight turned to January 1, 2000? Hindsight now shows this proved to be a creepy distraction from the signs that a Bandwidth Bubble was forming.

I was an executive eyewitness to the Y2K obsession forcing our company and customers to be prepared with a solution. Crowe named me the executive on duty in Level 3’s network control center on December 31, 1999. The world of business and government had deep fears that infrastructure of all types would malfunction precisely as that day, and that century, would end. Air traffic control systems, railways, shipping, power grids, the stock market, communications networks, and pretty much everything else that depended on computers would break. The fear was the entire world would come to a halt, and the path to returning to normal would be uncertain.

When computer software was written in the 1960s through 1990s, not much thought was given to the date convention. Most software used the last two digits of the year instead of the full year. For example, ’93 was used instead of 1993. The Y2K fear was that software wouldn’t know what to do when ’99 turned to ’00. Did ’00 mean 2000, or did it mean 1900? Would computers continue to function, or would they malfunction?

Gobs of money were spent on consultants before New Year’s Eve. The scope was so vast and much of the software so archaic that no company could know if ticking time bombs were embedded in their software.

So I spent New Year’s Eve in our Boulder, Colorado, control center, unsure of what we would do if problems arose. As the clock struck midnight, we watched with high anticipation. Nothing happened on the Level 3 network. US corporations spent an estimated $100 billion responding to this nail-biter, including technical adjustments and consultants who helped fan the flames with media support. When nothing of significance transpired, we were all left wondering whether the money spent had saved us from disaster or if we had been victims of a financial con job.

At around 2:00 a.m., I went to a colleague’s house in Boulder to catch the tail end of our company’s New Year’s Eve celebration. Almost every guest was from Level 3. I recall the atmosphere—partying was hard while anxiety was thick in the room. Y2K was not the source of the anxiety. It was the sense that along with the end of the century, the Bandwidth Boom was kaput.

The third event foreshadowing the collapse was the 9/11 terrorist attack on the World Trade Center’s Twin Towers. This moment, the desperate images I saw unfold of the destruction, desperation, and murder of innocent lives will forever be linked to the Bandwidth Boom’s inglorious dismount.

The new decade had begun with Level 3 experiencing more than its share of dysfunction. The solution: engage a corporate shrink. In our case our coach was a husband-and-wife team branded as the Woodstone Consulting Company of Steamboat, Colorado. The consultancy focused on “streamlining business relationships, eliminating barriers, and attaining higher performance.”

Woodstone recommended retreats, which began with the entire executive team. The idea was to make us a stronger and more cohesive leadership unit. One for all and all for one. I know we needed help, though in hindsight, I don’t know that Woodstone ended up as our solution or panacea.

After a series of sessions that involved the senior executive team, each executive hosted sessions for our own teams. Mine was September 10–12, 2001. My team and I arrived on Monday, September 10, and had an afternoon session and a dinner at the Woodstone Ranch.

The next morning was 9/11. I walked into the hotel lobby coffee shop and saw all eyes fixated on the TV.

“What happened?” I asked my colleague.

As he tried to articulate an answer, the second 767 crashed into the World Trade Center South Tower. I recall the TV newsperson trying to imagine how this could be an accident. “Perhaps the smoke from the first tower caused the second plane to lose its course,” the news anchor said in a tone that made it clear the news reporter knew that explanation was nonsensical.

Still, we left and drove to the Woodstone Ranch, where we watched more TV, as everyone everywhere did, numb from the horror of watching the world’s two tallest buildings collapse floor by floor in a massive cloud of smoke and fire. Watching this, you just knew there could be thousands of people trapped inside the Twin Towers, which together claimed to house upward of seventy-five thousand to one hundred thousand office workers on any given day. Now these people might have been pulverized by the implosion. We felt shock in our stomachs, called our families to check on their well-being, and headed to our homes immediately.

The stock market was gut-punched too. Both NYSE and Nasdaq did not open on Tuesday September 11 and remained closed until the following Monday. The markets fell by 15 percent by the end of that first trading week.

The effect of this event, and the resulting disruption to the financial markets, perhaps masked the turmoil that was already in play for the fiber gladiators.

“Unfortunately, we see a slowdown in business as a result of the shock of Sept. 11, which hopefully is a short-term reaction to the attacks,” an industry executive speculated, being correct about the slowdown but wrong about the cause.

With abundant clarity, the Boom times were over.

In late 2001 the New York Times foreshadowed the historic nature of the Bandwidth disaster.

[R]ecent telecom failures and those still likely to occur . . . represent one of the most spectacular investment debacles ever. Bigger than the South Sea bubble. Bigger than tulipmania. Bigger than the dot-bomb. The flameout of the telecommunications sector, when it is over, will wind up costing investors hundreds of billions of dollars.

The New York Times followed this coverage in early 2002 with “The Fiber Optic Fantasy Slips Away.”

Only a few years ago, the dream of striking it rich by transmitting Internet data and telephone calls across continents and under oceans, through endless ribbons of fiber optic cable, captivated one company after another. But rarely in economic history have so many people with so much money got it so wrong.

Instead of a stampede of customers to fill up these fiber optic highways, the industry found itself with too many vacant lanes—way too many.

In March 2002 the New York Times remained relentless, publishing “Telecom, Tangled in Its Own Web.”

Thanks to a star-quality cast, the Enron wreck has been riveting theater. Greedy executives concocting transactions to inflate company earnings, grasping Wall Street bankers eager to assist, pliant accountants and analysts looking the other way—Broadway’s finest could not have come up with a better script.

Yet while all eyes remain on Enron, a tragedy of identical plot but with far more damaging implications has been playing out on another stage. Unlike Enron’s saga, this drama is not about a single, rogue company operating to enrich its executives. [Instead,] this tale is about an entire industry—telecommunications—that rose to a value of $2 trillion based on dubious promises by Wall Street and company executives of an explosive growth in demand for telecommunications services. When that demand failed to materialize, the companies were left with mountains of debt and little revenue.

Since the telecom sector peaked in the spring of 2000, some $1.4 trillion in investor wealth has evaporated. Almost 400,000 jobs in the telecommunications sector have vanished as well . . . many companies in the industry are still operating on the edge.

Some analysts were on to the folly: “All the companies in the emerging telecom area are candidates for restructuring given the over leveraged balance sheets.”

He nailed it. Most of the multibillion-dollar fiber companies ended up declaring bankruptcy, and those that didn’t barely escaped the fate. Not one sailed through unscathed.

WorldCom—Bernie Ebbers#

When we last left the WorldCom story, the company was in a 2001 free fall. Ebbers was forced to back out of WorldCom’s $115 billion acquisition of Sprint and followed up with the acquisition of Intermedia—a deal his vice chairman, Sidgmore, called the “stupidest deal of all time.” The drop in WorldCom’s stock drove Ebbers into deep personal debt. Moreover, rumors were swirling that accounting misbehavior was taking place inside WorldCom. The Bandwidth Boom was over; the wide breadth and vast depth of the Bust, which was on the cusp of being revealed, was beyond anyone’s imagination.

In March 2002 the SEC opened an investigation into WorldCom. The New York Times reported,

The government appears to be looking into many of the business practices that helped WorldCom emerge from obscurity the last 15 years by acquiring dozens of companies, most notably MCI Communications.

[The SEC inquiry includes] a 24-point bill of particulars, asking for a trove of documents from as far back as January 1999 . . . [and indicating the SEC] appears to be taking an interest in WorldCom’s acquisitive streak . . . [requiring] all WorldCom’s documents concerning its accounting for goodwill—the accounting term for the difference of the purchase price in an acquisition and the assessed value of the acquired company’s assets. Writing off goodwill in a one-time charge can be perfectly acceptable, even required, under accounting rules. But such a charge could also enable a company improperly to avoid a long-term drag on its earnings.

An analyst helping to sound the alarm added, “I’ve been following this industry for 12 years, and I have never seen an SEC request like this. Nothing good can come of it. WorldCom was always an entrepreneurial company. If you’re being entrepreneurial, you’re shooting from the hip, you’re taking risks, and maybe you take a few too many risks with your accounting.”

Forbes, seeing a financial and human disaster for the ages unfolding, summoned none other than the legendary journalist and author of The Right Stuff to call 911 in its article titled “The Rise and Fall of Bernie Ebbers.”

Memo to Tom Wolfe: It’s time to start writing up the epic story of the Great Telecom Debacle. The fall of Bernard Ebbers provides the climax for Act III, in which the hero pays for his hubris and is subjected to the ritualized humiliation of a company press release thanking him for his services.

“Tom Wolfe, The Bear has now arrived. Glad you missed this memo. I’ll take it from here,” is my unsent 2024 memo to Wolfe.

The news of the SEC investigation drove WorldCom’s stock price to below $5 a share, pushing its Market Value below $7 billion. Just two and a half years prior, WorldCom was valued at over $100 billion. Now WorldCom’s debt of $37 billion was looking larger than the entire value of the company.

WorldCom also came clean on the full extent of the personal loans provided to Ebbers. At WorldCom’s peak value, Ebbers had assets valued at $1.3 billion. However, he sold only a tiny fraction of his WorldCom shares. “I was one of the founders of the company. I was extremely proud of WorldCom, and I did not want to send a message to the shareholders that when the stock was struggling, that the CEO didn’t believe in it,” Ebbers explained.

Ebbers took out $400 million of bank loans, collateralized by his boat and yacht company, his timber operation, a sprawling 164,000-acre ranch in Canada, his luxury yacht, Aquasition, and his ten million shares of WorldCom stock. With WorldCom’s stock price trending toward $0, Ebbers’s assets were worth far less than the loan. He was bankrupt.

Ebbers claimed his board discouraged him from selling his stock and instead suggested that the company loan him the money to pay back the bank. Years later, a congressional panel asked John Sidgmore and Bert Roberts to defend the loans to Ebbers. They each meekly responded, “[If I] had to vote for it again, I wouldn’t do it.”

On the last Friday in April 2002, the board probed Ebbers, trying to understand the steep decline in the stock price and the ramifications of the SEC probe. Ebbers offered to resign. The board deliberated over the weekend, and Ebbers turned in his resignation on Monday.

Ebbers’s departure was respectful. The board agreed to pay him $1.5 million a year for as long as he lived. Ebbers would retain the title of chairman emeritus and would be entitled to use the WorldCom plane for thirty hours a year.

Forbes continued,

Everyone knew WorldCom and its chief executive were in trouble, but the sudden fact of his demise was shocking nonetheless.

WorldCom was the emblematic telecom firm of the go-go 1990s, and Ebbers was the visionary who stitched it together like Frankenstein’s monster from pieces of the many firms he acquired over the past two decades. His departure today will serve future business historians as [the event that marked] the formal end of the telecom frenzy.

In May the Economist jumped in with “Yesterday’s Man.”

In his cowboy boots and Stetson hat, Bernie Ebbers made a splendid cover for any magazine that wanted to be abreast of the telecoms revolution of the late 1990s. His background, too, had just the sort of mix of hard grind, modest intellectual prowess, and sporting vim that America likes in its hero-bosses. Born in Canada, he worked as a milkman by day and a bouncer by night. He dropped out of college twice, eventually graduating with a degree in physical education from Mississippi College . . .

With this perfect pedigree, Mr. Ebbers coupled a talent for deft deal-making and cosmic quantities of chutzpah . . . he gobbled up more than 75 companies to become a brand-new telecoms giant.

The press, for whom a takeover battle makes far more exciting copy than the humdrum daily business of minding the shop, happily collaborates. And the smoke and mirrors of acquisition accounting offers plenty of scope for creative rearrangement of the balance sheet.

No wonder that, at the peak of the telecoms frenzy, Mr. Ebbers was the subject of as much admiring prose . . . Forbes listed him as the 174th richest American. Time Magazine included him in its cyber-elite. George Gilder, an Internet guru, [declared] “It’s all over. Bernard Ebbers of WorldCom has won.”

The same month, Time magazine piled on with “The Rise and Fall of Bernie Ebbers.”

A transplanted Canadian, Ebbers, 60, teaches Sunday school at his Baptist church each week, serves meals to the homeless at Frank’s Famous Biscuits in downtown Jackson, Miss., lives modestly in a prefab home, and wears jeans and boots to the office.

Right now, though, it’s hard to find a friend of Bernie outside Mississippi.

WorldCom, like much of the U.S. telecom industry, looks as broken as a coin phone in a bus station. And so, sadly, does the executive image of Ebbers.

“I feel like crying,” Ebbers [said] after his resignation last week. “But I am 1,000 percent convinced in my heart that this is a temporary thing.”

The thing Ebbers was referring to was anything but temporary.

What Forbes, the Economist, and Time magazine hadn’t acknowledged in its condescending recap of media coverage of the WorldCom/Ebbers downdraft and scandal was its own failure to scoop other media in shining a light on Ebbers and the implausibility of WorldCom’s numbers.

WorldCom’s board, seeking to recover, named Vice Chairman John Sidgmore to replace Ebbers.Sidgmore claimed to have quit WorldCom in 1999, after Ebbers embarrassed him by pulling out of a deal to acquire Nextel on the day it was to be executed. Sidgmore told Keller, the former Wall Street Journal reporter turned CEO headhunter, that WorldCom’s board later pleaded with him to come back. Eventually he would replace Ebbers as CEO.

“They gave me $12 million to come back, but that wasn’t why I agreed,” Sidgmore told Keller at the time. “I’m already very wealthy and didn’t need their twelve million bucks. I love UUNET. I didn’t want UUNET and its employees to get hurt.” Sidgmore told Keller he had no sooner returned when two accountants showed up at his office one day and told him they had discovered a massive fraud of $4 billion. “I felt like someone had punched me in the stomach,” Sidgmore told Keller. “And as the next couple of months went by and more accounting fraud was uncovered by our accountants, I had to keep upping the number making public statements and the fraud was reaching into the billions. I had no choice in the end but to put the company into bankruptcy.” We first met Sidgmore in The Inventors when he was hired to be CEO of Internet pioneer UUNET. Sidgmore sold to MFS, only to see Crowe sell MFS to WorldCom less than a year later, a transaction that made Sidgmore an extremely wealthy man and WorldCom’s Vice Chairman. I teased that Sidgmore would come to regret selling UUNET. Here’s why.

When he accepted the CEO position, Sidgmore did not yet know what he was up against, so his first move was to declare a bankruptcy filing would not be necessary. “In the reasonable, foreseeable future, we don’t see any scenario under which we are going to run out of cash or go into bankruptcy. This is a real company that makes real money.” Boy, was he wrong!

Sidgmore, at first, felt comforted by having WorldCom CFO Scott D. Sullivan by his side. Both analysts and WorldCom executives viewed Sullivan as the brains behind WorldCom’s ascent, as captured by the Wall Street Journal.

Many Wall Street professionals thought Scott Sullivan was one of the best CFOs around. He was seen as the key to WorldCom’s financial credibility, known for having instant answers to even the most obscure financial questions—and being willing to have substantive discussions about them.

. . . Sullivan . . . acted as a sort of straight man and tempering influence for Ebbers. . . . Mr. Ebbers had the charisma and the vision; Sullivan had the answers. Ebbers did the talking, but often what he said was “We’ll have to ask Scott.”

Sullivan had offers from six of the top eight accounting firms when he graduated from college in 1983. KPMG was his choice, and he did well during his four years with the firm. He left to join a company acquired by Ebbers in 1992. Within two years Sullivan was named CFO and was already emerging as the loyal hand of Ebbers. The wonder boy was only in his early thirties.

The New York Times referred to Sullivan as the “whiz kid,” quoting an analyst, “[Sullivan] was the most credible C.F.O. in the entire industry. He knew the minutiae of the numbers and he could go all the way up to the big picture.”

I had a different view of Sullivan, stemming from an encounter I had with him in 1997. Within days of completing the MFS acquisition, most of the MFS executive team parted ways. My expertise in MFS’s network business made me uniquely valuable, so they retained me. I was assigned to run network planning for WorldCom’s local networks, reporting to former MFS executive Ron Beaumont, who was named president of the network organization.

Soon thereafter WorldCom discovered a fatal flaw with its acquisition of MFS. To justify the high purchase price, WorldCom assumed it would achieve major cost savings by routing its long-distance traffic through MFS’s local network.Long-distance telephone companies paid local telephone companies to originate and terminate phone calls. The per-minute termination rate was artificially high because of historical reasons tied to the breakup of AT&T. These high access rates were the mechanism for using long-distance revenue to subsidize phone companies so that local phone service would be affordable to most Americans.

In 1997 access rates were set at approximately 2.5 cents a minute, and this expense category was WorldCom’s biggest cost. If they could cut this in half, their stock would soar, and they had a plan to do just that: acquire MFS!

MFS was leading the charge in bringing competition to local phone service. Local competition required local phone companies to exchange phone calls with one another. If MFS’s customer needed to call Verizon’s customer, MFS would hand off a call to Verizon, and Verizon, in turn, would deliver it to the customer. The reverse of this was also true, as Verizon’s customers would need to call MFS as well.

Although the technology of exchanging local calls was identical to exchanging long-distance calls, the price was far lower—about 0.5 cents a minute instead of 2.5 cents a minute.

WorldCom’s plan was to gain synergies through the MFS acquisition by routing its long-distance traffic through MFS’s local trunks. This would save 50 to 75 percent of the fees it was paying the local telephone companies to terminate its long-distance traffic. If successful, WorldCom would save tens of millions of dollars per month. Though the network technology allowed for this, the regulatory laws did not. It was illegal.

This was unwelcome news for Ebbers and Sullivan as a gigantic portion of WorldCom’s promised synergies went belly-up. WorldCom, in its Boom times rush to buy MFS, discovered this restriction after the acquisition was consummated.

Ebbers and Sullivan could have come clean with Wall Street investors by telling them they made a costly and regrettable error. They knew this would cause WorldCom’s stock price to crater and their reputations as Wall Street’s Batman and Robin Dynamic Duo would be shattered. So they searched for a “better” option.

The resourceful Sullivan conceived of a creative accounting solution. His plan was to treat the planned savings as a write-off associated with the acquisition.When a company is acquired, the price paid for the company is reflected in the acquirer’s balance sheet using the accounting standard referred to as purchase price allocation. WorldCom used this process to modestly inflate the cost of the acquisitions so as to be able to hide from the income statement expenses that WorldCom would incur after the acquisition was completed. The logic was that this “savings” would have been available to WorldCom, but they simply couldn’t realize the savings immediately. So Sullivan decided to treat the cost savings as an intangible asset, which they would write-off over a twenty-year period. In doing so WorldCom would realize the savings on the income statement, thereby inflating near-term profits. Wall Street would be deceived into thinking that the promised synergy targets were being met.

Note the cash to pay the access charges would be unchanged. Only the accounting treatment would alter. As long as Wall Street didn’t dig too much, WorldCom’s near-death experience would be avoided.

To implement this revised plan, WorldCom needed an expert to collaborate with its accounting firm, the famed Arthur Andersen, to provide context for the write-off. Sullivan asked me to be this expert. I explained the scheme wasn’t permitted by regulators, and to me, the accounting treatment seemed suspect. Sullivan viewed these as technicalities. He explained that WorldCom was the only account assigned to the Andersen partner, who, not surprisingly, lived in WorldCom’s hometown of Jackson.

“You’re overthinking this,” Sullivan tried to assure me. “Andersen just needs some color.”

I overthought it some more. After a sleepless night or two, I decided to tell Sullivan no. I didn’t realize it at the time, but my alternative might have involved sleepless nights in a jail cell.

“No problem” was Sullivan’s reaction. “We will get someone else to do it.”Bill LaPerch recalled a similar event. “When MCI was acquired by WorldCom, I was running operations for MCI. I had a $860 million budget, which included paying network access expenses. When the budget was redone by the WorldCom geniuses, my budget was reduced to $200 million, with the reduction the result of WorldCom deciding to capitalize access cost. I was just a dumb ops guy, so I was not involved with the accounting aspect here, but something smelled rotten in Denmark. I left WorldCom three months after the MCI merger was consummated.”

I knew that I compromised my career at WorldCom. That was okay. I didn’t want to move to Jackson, and I didn’t want to work for people I didn’t trust. I resigned, leaving $500,000 of unvested stock options behind. I watched as WorldCom’s stock price doubled, wondering if I made the right decision.

In 2002, a few weeks after Sidgmore began his turnaround with Sullivan at his side, the massive fraud of WorldCom was revealed. I felt vindicated and lucky that I didn’t get sucked in.

In the weeks before Sidgmore took the helm of WorldCom, a small band of WorldCom accountants conducted an internal, covert, and unsanctioned investigation. The leader of this effort would be credited with unmasking the biggest corporate accounting fraud in business history. Within a year her contributions would be applauded on the world stage.

Every year since 1927, Time magazine names its Person of the Year. The first winner was Charles Lindbergh, who flew the first solo transatlantic flight. Martin Luther King Jr. was recognized in 1963, and Ayatollah Khomeini in 1979. Taylor Swift was honored in 2023.

In 2002 a WorldCom employee was named Time magazine’s Person of the Year. The recipient wasn’t Bernie Ebbers or Scott Sullivan. Instead, WorldCom’s internal audit director, Cynthia Cooper, was recognized for her relentless pursuit of Sullivan’s cooking of the WorldCom books.Cooper was one of three whistleblowers named by Time magazine as their 2002 Persons of the Year. Sherron Watkins of Enron and Coleen Rowley of the FBI were the other two.

Cynthia Cooper launched WorldCom’s internal audit team in 1994.The internal audit function provides independent assurance that a company’s risk management, governance, and internal controls are operating effectively.In 1991 Cynthia Cooper had a two-year-old daughter and a failing marriage, which prompted her to move to her childhood home of Clinton, Mississippi. She needed a job to pay the bills, so she jumped at the opportunity to be a $12-an-hour contract employee for WorldCom. In 1993 she married Lance Cooper, a high school classmate who was smitten with her. To convince her bosses of the need for an internal audit, she invited Ebbers and Sullivan to a meeting. Her plan was to show how internal audits could improve profitability.

When Ebbers didn’t show up on time to the meeting, Cooper was determined to wait for him. He showed up thirty minutes later wearing a sweatsuit and smoking a cigar. “What in the hell is the purpose of this meeting?” Ebbers asked Cooper. Unflustered, Cooper gave her presentation. She claimed her newly created internal audit group could find millions of dollars in wasteful operations with the use of internal controls. Ebbers was the last person to leave the meeting.

Cooper led internal audit for the next eight years with Sullivan as her boss’s boss.

In March 2002 the head of WorldCom’s wireless business met with Cooper. He explained that he had set aside $400 million of reserves from the third quarter of 2001, which he intended to tap into to bolster weaker quarters. The $400 million was booked as a reserve to account for the likelihood that some customers would not pay their bills. In practice, the manipulation of reserves was commonly used to smooth out performance. It served as a safety net to be used on rainy days.

The executive told Cooper that he discovered the $400 million reserve was being depleted by Sullivan’s office to boost WorldCom’s income. Cooper brought the matter to the Audit Committee of WorldCom’s board. On March 6 the Audit Committee discussed the topic with Cooper and Sullivan, leading Sullivan to back off from using the reserve.

The following day Sullivan tracked down Cooper by first calling her house and receiving Cooper’s mobile phone number from her husband. Cooper took Sullivan’s call from a salon and, with highlights and tinfoil in her hair, listened as Sullivan lambasted her for pursuing the issue.

The combination of Sullivan’s scolding and the SEC inquiry drove Cooper and her audit team to launch a quiet but intense search for wrongdoings.

In May, Cooper’s audit team received an email from a Texas-based WorldCom accountant who tracked capital accounts. Attached to his email was a local Texas newspaper article pertaining to a former employee who had been fired after he raised questions about a minor accounting matter involving capital expenditures. “This is worth looking into from an audit perspective” was his message to Cooper.

Cooper’s team continued their discreet probe into WorldCom’s accounting system.Capital expenditures had already surfaced as a focal area of Cooper’s probe. Her team discovered $2 billion of capital expenditures that were booked in the first three quarters of 2001 that lacked authorization. When Cooper’s team probed, they were told it was for “prepaid capacity.” When they asked what this meant, they were redirected to David Myers, WorldCom’s controller.

Cooper followed up by asking the Texas accountant to explain “prepaid capacity.” He was cryptic while citing the source of the entries as being Buford Yates, WorldCom’s director of general accounting.

On May 28 an accountant on Cooper’s team stumbled across an accounting entry for $500 million in computer expenses with no supporting documentation.

The audit team was reaching a conclusion that operating costs were being masked as capital expenditures. By doing so near-term profits were being vastly inflated. The capital expenditures would be spread across many years, and as they were depreciated, they would affect net income but not the important measure of profitability.

Cooper’s team included Myers in an email in which they asked for explanations of prepaid capacity. Myers replied that his staff did not have time to support internal audit inquiries. By early June they found $2 billion of questionable accounting entries. Many involved expenses being booked as capital expenditures to erroneously inflate profitability.

On June 11 Sullivan called Cooper. He asked her to swing by his office. As the meeting was ending, Cooper casually asked one of her auditors to share with Sullivan what he was working on. This was preorchestrated, designed to gauge Sullivan’s reaction to the audit they were performing. Sullivan urged them to delay the audit until after the third quarter, suggesting he was already intending on cleaning up some problems. Cooper said the audit would continue.

Alarmed by Sullivan’s response, Cooper reached out to WorldCom’s Audit Committee chair, Max E. Bobbitt, the former President of Alltel, who redirected Cooper to KPMG, the recently hired public accounting firm that was supporting the SEC probe. KPMG urged Cooper to validate her findings.

On June 17 Cooper asked the director of management reporting for documentation to support the capital entries. She confirmed she made the entries without any support for them. Next, Cooper stopped by WorldCom’s director of general accounting. He was unfamiliar and pointed to WorldCom’s controller, who acknowledged there wasn’t support for the entries.

On June 20 Cooper and her team met with WorldCom’s Audit Committee. Sullivan defended the entries but asked for the weekend to prepare a full justification. On June 24 the Audit Committee told Sullivan he had until the end of the day to resign.David Meyers, WorldCom’s controller, was also given a day to resign. Unlike Sullivan, he did.

When Sullivan chose not to resign, he was fired. He was only forty years old.

On June 24 WorldCom disclosed that it had inflated its earnings by $3.8 billion over the previous three quarters. The SEC immediately filed a civil fraud lawsuit, and trading of WorldCom’s stock was halted.

Sidgmore released a statement: “Our senior management team is shocked by these discoveries . . . I have committed to driving fundamental change at WorldCom, and this matter will not deter the management team from fulfilling our plans.”

Arthur Andersen, the world’s most prestigious accounting firm, also issued a statement suggesting they, too, were misled: “It is of great concern that important information about line costs was withheld from Andersen auditors by the chief financial officer of WorldCom. . . . Our work for WorldCom complied with SEC and professional standards at all times.”

At first, WorldCom’s collapse was tied primarily to its failed acquisition of Sprint. The Washington Post wrote,

The MCI deal was the culmination of a relentless growththrough-acquisition strategy that finally hit a wall two years ago, when the government blocked Ebbers’ boldest acquisition ever, WorldCom’s $129 billion purchase of Sprint Corp. It forced him to do something he had never done before: make money by running what he already owned rather than buying something new.

It proved beyond him. And that is how WorldCom, a global company sprung from the unlikely soil of small-town Mississippi, apparently came face-to-face with an unpalatable choice. It could admit to Wall Street that it was losing money, staggering under the debts that came with its many purchases and its miscalculations about long-distance telephone service and the Internet. Or it could cook the books and keep showing profit.

WorldCom used the acquisitions to distort future profits by creating capital reserves to offset expenses. This allowed them to show a predictable increase in operating profits in the quarters that followed the acquisitions. So long as the acquisition gravy train continued to run, the fictional story of synergy achievement would persist.

“The kiboshing of the Sprint merger was, for all intents and purposes, the end of WorldCom,” an accounting expert said. “When you have companies that have to make acquisitions to survive, once the music stops, the dance is over.”

Further investigation revealed that the scope was far greater and the period during which the fraud was being committed was far longer. The number kept growing until finally $11 billion was restated over a period that began in 1997. This coincided with my turning down Sullivan’s request to help with a suspicious write-off, which also prompted me to leave WorldCom.

Congress launched an investigation, suggesting Ebbers would be implicated for his Gold Rush antics. “Ebbers was aware that hundreds of millions of dollars had been moved from expenses to capital accounts” was Sullivan’s account, according to a spokesman for the House Energy and Commerce Committee, as told to the New York Times. “This is the first evidence we have seen showing that the muddy little footprints may lead back to Bernie Ebbers’ doorstep.”

On July 8, 2002, the Congressional hearing featured Ebbers, Sullivan, Salomon analyst Jack Grubman, and an Arthur Andersen partner.

In Ebbers’s opening statement, he declared his innocence while exercising his Fifth Amendment rights.

When all of the activities at WorldCom are fully aired and when I get the opportunity, and I’m very much looking forward to it, to explain my actions in a setting that will not compromise my ability to defend myself . . . I believe that no one will conclude that I engaged in any criminal or fraudulent conduct during my tenure at WorldCom. Until that time, however, I must respectfully decline to answer questions . . . on the basis of my Fifth Amendment privilege.

Sullivan was brief and to the point when pleading the Fifth: “I have no prepared statement. Based upon the advice of counsel I respectfully will not answer questions based on my Fifth Amendment right.”

The Andersen partner cited his willingness to cooperate with the investigation while denying wrongdoing.

Let me state clearly, and without any qualifications, that prior to June 21st, 2002, when Andersen was first contacted about this matter, neither I, nor any-to my knowledge, nor any of my team members had any inkling that the [fraudulent accounting entries] had been made.

The Andersen partner blamed management.

The fundamental premise of financial reporting is that the financial statements of a company . . . are the responsibility of the company’s management, not its outside auditors.

. . . In performing our work we relied on the integrity and professionalism of WorldCom senior management. . . .

If the reports are true that Sullivan and others . . . improperly [misstated] the company’s actual performance, I’m deeply troubled.

Grubman started by expressing his joy for being asked to testify to the committee. He, too, claimed he was misled by management.

I appreciate your invitation to appear before this committee today and I voluntarily did so. I want to commend you and everybody on this committee for acting quickly to try to find out what went wrong here.

. . . WorldCom is a company that I believed in wholeheartedly for a long time. It fit my long held, honestly held investment thesis that the newer, more nimbler companies would create value. It evolved into a company that had an unparalleled array of global network assets and a huge customer base after its merger with MCI.

As far as the topic of this hearing today, the fraud at WorldCom, of course, it influenced our analysis. . . . If the public statements are fraudulent, I and other analysts have flawed information to go on. If we had a truer picture of WorldCom’s financial results earlier, no doubt our opinion would have changed.

He acknowledged the inherent conflict of interests within investment banking firms while defending his integrity.

As far as investment banking conflicts with analysts . . . in full-service firms that research is a product used by the bank. If a research analyst has stature and credibility with investors and happens to have a favorable view of a company, that will help get banking business. If, on the other hand, you have an unfavorable view, that will hurt.

In all instances, the life blood of an analyst’s reputation and credibility is integrity and honestly held research and opinions with investors and that is something that I have always practiced.

Grubman estimated that his firm received $80 million in fees from WorldCom but denied any connection between these payments and his compensation.

Grubman was asked about spinning, a practice where investment banks allocated lucrative IPO shares to CEOs as a reward for their business. Grubman answered,

I’m trying to think if I can answer that specifically yes or no. I just don’t recall, because that’s not something that I would be involved with, so I can’t recall. I’m not saying no, I’m not saying yes. I just can’t recall. . . . My company is a big company, so therefore I cannot say definitively one way or the other if what you’re saying is true or not.

A panel member barked, “For an analyst, brilliant as you are, you have a terrible recollection.”

Back at WorldCom, the company filed for Chapter 11 bankruptcy protection on July 21, 2002. Eleven days later, the US government began moving on the company’s executives, with the FBI making its first arrests of CFO Sullivan and his controller David Meyers. Each was charged with securities fraud and conspiracy. Sullivan was hit with seven counts of fraud charges and was released on a $10 million bond. Charges of bank fraud and making false statements were added in April 2003.

In March 2004 Sullivan changed his plea from not guilty to guilty. In the hearing he admitted to falsifying WorldCom’s financials even though he knew “it was wrong” and told the judge, “I deeply regret my actions.” Sullivan implicated “management at the highest level.” He agreed to direct the $13 million in proceeds from the sale of his Boca Raton house to a restitution fund administered by the government.

On the same day as Sullivan’s March 2004 hearing, the government filed an indictment against Ebbers, charging him with securities fraud, conspiracy to commit securities fraud, and making false filings with the SEC. Sullivan would be the star witness. The trial was set for early 2005.

In June 2004, as part of his cooperation deal with federal prosecutors, Sullivan pleaded guilty to one count of conspiracy to commit securities fraud. He faced five years in prison and a $5,000 fine, with sentencing delayed pending the outcome of his cooperation.

On January 25, 2005, opening statements were made in Ebbers’s New York City trial to a twelve-person jury: “When he said hit the numbers, it was a command to commit fraud,” Assistant US Attorney David Anders told jurors. “Bernie Ebbers lied not once, not twice, but again and again and again. He made sure that the people who worked for him, lied for him.”

Ebbers’s personal motives were tied to the $400 million personal loans he owed to his company. If the stock price collapsed, Ebbers would be unable to pay these loans. He’d be bankrupt.

“He lied in an effort to inflate WorldCom’s stock price and to avoid personal financial ruin,” said Anders.

So he conspired, claimed Anders, with several other WorldCom executives to conceal WorldCom’s deteriorating financial condition. “Ebbers knew that WorldCom’s books had been cooked,” Anders said. “He knew because he told people who worked for him to do it.”

Reid H. Weingarten, Ebbers’s attorney, punched back, attacking the credibility of Sullivan, pointing out he was “very capable of deception, that is, he’s a liar.” Weingarten pointed out to jurors that Ebbers hadn’t sold his WorldCom shares, which countered the claim that Ebbers knew the stock was inflated. “There are a zillion documents in this case and there ain’t one smoking gun,” Weingarten told the jurors.

WorldCom’s controller, Meyers, indicted and under arrest, agreed to cooperate with the government in its fraud case. Meyers was among the first witnesses called by the prosecution.

In February 2005 Meyers testified in the US District Court in Manhattan that, starting when he became controller in 1997, he and Sullivan had agreed to make various adjustments to WorldCom’s books. Some of these adjustments were appropriate, and some “could be considered gray,” Meyers testified.

But Meyers’s most damning testimony pertained to false entries that were made at Sullivan’s direction in the third quarter of 2000. Meyers testified that Ebbers approached him in the hallway following the release of third-quarter results, telling him, “I’m sorry that you were asked to do what you were asked to do. You should not have been put in that position.” Meyers added, “[Ebbers] gave me his word that we would never have to do that again.” This, along with other Meyers’s testimony, rebutted Ebbers’s defense that Sullivan alone was to blame.

Meyers also added credence that the $400 million in loans to Ebbers were Ebbers’s motive for committing fraud. Meyers recounted a 2001 meeting when Ebbers pushed finance managers to cut costs and turn around the business: “[Ebbers] said, ‘I’m sure all of you guys are aware of my personal situation.’ Bernie told them if WorldCom’s stock price dropped below a certain point, banks would start calling in his loans, ‘and everything I’ve worked for since I’ve joined WorldCom would basically be wiped out.’”

In cross-examination Meyers acknowledged that he and Sullivan had hidden their transgressions from Ebbers “to some degree.” When asked why he agreed to cooperate with the prosecution, Meyers said, “I hope not to serve any prison time.”

Next on the stand were WorldCom’s director of management reporting, Betty L. Vinson, and another accountant, Troy Normand, on Meyers’s team. They told similar stories. “Scott said that Bernie didn’t want to lower the third-quarter expectations so that we needed to make the entry,” testified Vinson. Both Vinson and Normand pushed back, the latter telling Sullivan that he didn’t want to follow directions to hide certain operating expenses and that he “was scared, and I didn’t want to put myself in a position of going to jail for him or the company.” Both threatened to quit, with Vinson’s draft resignation being presented as evidence. “The actions proposed regarding quarter-close entries have necessitated this action,” Vinson wrote. “I feel that upper management has forced my decision surrounding my resignation.”

Vinson said Ebbers received a budget report in the first quarter of 2001 that showed both WorldCom’s true line costs and the lower number that was reported to the public, which again indicated that Ebbers was aware of the fraud.

On February 7 Sullivan, the star witness for the prosecution, took the stand. He testified, “[Ebbers] was very hands-on, very detailed. . . . he has a good grasp of accounting concepts.” Sullivan also described his tight relationship with Ebbers, saying that he was in Ebbers’s office seven to ten times every day, that the two executives ate lunch together most days, and that they traveled together worldwide.

Sullivan recounted when he urged Ebbers to cut the growth estimates given to Wall Street. Ebbers insisted they wait until the fourth quarter. Sullivan recalled Ebbers saying, “Scott, we can’t issue an earnings warning to the marketplace until we tell them what we’re going to do about it. . . . We have to stick with our guidance for the third quarter. We have to hit our numbers.” Sullivan said he explained to Ebbers that the only way to meet Wall Street targets was to lower the company’s reserves while booking revenue that was not collectible, emphasizing there was no business justification for making these adjustments. “I told Bernie, ‘This isn’t right. This is the only way we can get the numbers to market expectations,’” Sullivan said. He added Ebbers replied, “‘We have to hit our numbers.’” Sullivan said he took Ebbers’s words to mean that Sullivan’s team should make the accounting adjustments.

This adjustment, Sullivan recalled, was what led to Vinson’s threat to resign. Sullivan said he sent a handwritten note to Ebbers that read, “In the future, it will be up to the operations of our company to hit our earnings targets and not up to the accounting department.” Sullivan claimed he met with Ebbers to discuss the note, and Ebbers told him, “We shouldn’t be making these adjustments, we need to improve operations.” The note was not produced as evidence.

WorldCom lowered guidance in November 2000. However, the situation continued to deteriorate, making it clear by January 2001 that the company would fall short of its revised forecast. When told of this, Sullivan said Ebbers replied, “‘We can’t lower our guidance [again]. We just announced new guidance on Nov. 1. Get to work on it.’”

Sullivan described how he first depleted tax reserves to artificially reduce expenses. Next, he reclassified line costs from an expense to a capital expenditure. In total, $771 million in expenses were removed from the first quarter of 2001 results. Sullivan claimed that he explained this to Ebbers at a steakhouse in Washington in March 2001.

The prosecution played a voicemail that Sullivan left for Ebbers in late June 2001. In the voicemail Sullivan said revenue growth “keeps getting worse and worse,” and reported financials “already have accounting fluff in it.” Sullivan also flagged low margin equipment sales, which were used to bolster revenue but added to the challenge of achieving ongoing growth. “We’re going to dig ourselves into a huge hole because it disguises what’s going on,” Sullivan said. “It’s the worst kind of revenue that you can have.”

The prosecution introduced as evidence an early 2002 videotape of an Ebbers interview with CNBC. “We’re ahead of where we thought we would be,” Ebbers told CNBC viewers. “We have been a sound financial company. We have been very conservative in our accounting.” He also said the dividend the company was paying on the MCI tracking stock wasn’t in any danger.

Also put into evidence was a long handwritten note from Sullivan to Ebbers that preceded the interview. The memo expressed concerns about WorldCom’s financial well-being.

Sullivan also discussed Ebbers’s $400 million loan, claiming Ebbers told him the banks were demanding more collateral for loans secured by Ebbers’s WorldCom shares. Sullivan recounted that Ebbers said in a meeting with the accountants, “[I]f our stock goes down below $12, I’m wiped out.”

Sullivan also told of Verizon’s interest in potentially acquiring WorldCom in August 2001. Verizon CEO Ivan Seidenberg expressed interest in completing the acquisition by Labor Day, Sullivan testified, adding that he voiced concern to Ebbers that Verizon would discover, during its due diligence examination of WorldCom’s finances, that the company was manipulating its accounting statements. According to Sullivan, Ebbers responded, “You’re right. This probably isn’t a good time to be talking to Verizon anyhow, because our stock price isn’t where it should be.”

Sullivan claimed Ebbers blocked information about accounting adjustments from being shared with WorldCom’s board. He cited a specific example in which Ron Beaumont, WorldCom’s COO, presented details on these adjustments in the June 2001 board meeting. After the meeting, one of the directors asked Sullivan, “You’re not really going to do that, are you?” Sullivan shared this with Ebbers.

“Bernie told us to keep the presentations at a higher level, that our jobs were on the line,” Sullivan told the courtroom. “And he told Ron Beaumont not to get into the ‘close-the-gap’ [revenue adjustments] items.”

Under cross-examination, Weingarten emphasized that the prosecution’s star witness, Sullivan, had a track record of lying. “If you believe something is in your interest, you are willing and able to lie to accomplish it, isn’t that right?” Weingarten pressed Sullivan. More specifically, Weingarten raised the June 2002 board meeting in which Sullivan denied wrongdoing. “You looked at those 12 (board members) and lied your head off, didn’t you?”

Sullivan’s response to both those questions and others was to acknowledge he lied.

Weingarten also probed whether Sullivan had witnesses to his claims that he kept Ebbers informed of the accounting misrepresentations. “It was Bernie and I,” Sullivan replied. “Those conversations were always Bernie and I. There was never anyone else in these conversations.”

When pressed by Weingarten about committing the fraud, Sullivan acknowledged, “I knew it was wrong, I knew it was against the law, but I thought we were going to get through it. I have no excuse for what I did.”

Soon after Sullivan’s testimony, the prosecutors rested their case.

The first witness called by the defense was whistleblower Cooper. She recounted Sullivan’s role in the cover-up, including how he aggressively sought to suppress her discoveries. She testified that when Sullivan blocked her from sharing her findings with the Audit Committee, she appealed to Ebbers. “Tell the audit committee what you need to tell them” was Ebbers’s response. Her testimony seemed consistent with the defense’s claim that Sullivan, not Ebbers, was to blame.

Weingarten also used Cooper to describe the complexity of the fraud. “It was a spider web of transactions, and it was not easy to trace,” she testified.

WorldCom chairman Bert Roberts testified that he spoke with Sullivan in the summer of 2002. “I asked Scott [Sullivan] if Bernie [Ebbers] knew, and Scott’s answer to me was that Bernie did not know of the journal entries.”

On February 28 Ebbers took the stand. As expected, he claimed Sullivan kept him in the dark. “He’s never told me he made an entry that wasn’t right,” Ebbers testified. “If he had, we wouldn’t be here today.”

Ebbers was asked about the dinner with Sullivan in Washington. He acknowledged having dinner in Washington around that time but didn’t recall who was with him. “I don’t recall a conversation about capitalizing line costs,” he testified.

Ebbers denied apologizing to Myers for cooking the books, testifying, “I didn’t have anything to apologize for.”

Ebbers painted a picture of his interactions with Sullivan that was a stark contrast to Sullivan’s account. Ebbers said he wasn’t close to Sullivan and rarely met with him alone. “You talked to Mr. Sullivan several times a day?” Anders asked. “Oh no,” responded Ebbers, “I don’t ever remember speaking to him three to four times a day.” Ebbers’s characterization was they spoke three to four times a week.

Ebbers likened his CEO job to his experience as a basketball coach. “I believe that a coach’s job is to get the best players that he can, or she can, and get them to play together, sometimes massaging egos.” This philosophy implied that Sullivan was largely autonomous in his management of accounting.

Ebbers explained his reaction when he was told by WorldCom’s attorney of the accounting problem: “I was shocked. I couldn’t believe it. Never thought anything like that had gone on, never—I mean, I put those people in place, I trusted them, and I just had no earthly idea that anything like that would have occurred.”

Ebbers testified that he didn’t take accounting courses during college. “The closest thing I ever had to an accounting course is a preliminary course in economics,” he told Weingarten. Under cross-examination, the prosecution was able to establish that Ebbers was aware of accounting write-offs.

Anders: You are familiar with what a write-off is, correct?

Ebbers: Yes.

Anders: For example, you took a $4 billion write-off for research and development after the MCI deal, right?

Ebbers: I don’t recall the number, but there was a write-off.

Anders: Do you recall that initially you and others had wanted to write off $7 billion, correct?

Ebbers: There was initially a larger number. I don’t recall the relationship with the 7 to the 4.

Anders: Do you recall there was a large number and then you were forced to bring it down to a smaller number, right?

Ebbers: Yes.

Anders: That’s an example of a write-off that you were aware of, right?

Ebbers: Yes, yes.

Anders was also able to corner Ebbers into admitting he signed SEC quarterly financial filings (10-Ks) that contained false statements.

Anders: You would agree that you now know that there were false statements in the 10-Ks you signed, right?

Ebbers: I don’t know that there were false statements in there.

Anders: We have talked about these line cost transfers, right?

Ebbers: Right.

Anders: They are not reflected in those 10-Ks, right?

Ebbers: I don’t believe they are.

Anders: So you would agree that the line cost numbers are wrong in the 10-K, right?

Ebbers: If it’s reported in there that way, yes.

Anders: As we talked about, the line cost number flows all the way down the income statement, right?

Ebbers: Yes.

Anders: To net income, right?

Ebbers: Right.

Anders: Earnings per share?

Ebbers: Right.

Anders: So if the line cost transfers aren’t in there, then the 10-K is wrong, right?

Ebbers: Yes.

Anders resurfaced several instances in which Ebbers received reports showing that monthly line costs fluctuated wildly. Ebbers conceded that the swings should have been a red flag but added, “I just didn’t see it.”

“WorldCom reduced its line costs through adjustments by over $2 billion and you had no idea?” Anders asked.

“I did not,” answered Ebbers.

The prosecution delivered their closing comments on March 2. “Money, power, and pressure corrupted Bernard J. Ebbers and motivated him to commit fraud,” Anders told the jurors. “He lied and concealed a fraud of more than $5 billion. WorldCom had truly become WorldCon. Ebbers . . . was the leader of WorldCom and the leader of that con.”

The prosecutor told the jury, “He lied right to your face. The ‘Aw Shucks’ defense insults your intelligence.”

Weingarten countered Ebbers’s crucial mistake was delegating financial responsibility to the wrong man, Sullivan. “Ignorance of Sullivan’s wrongdoing isn’t criminal.” He claimed Sullivan lied and Meyers exaggerated in both cases to reduce their sentences. Weingarten mocked Sullivan’s claims that he was in constant communication with Ebbers but never with others present. The prosecutor’s case, Weingarten claimed, was “Ninety-eight percent Sullivan, two percent Myers.”

Weingarten also emphasized that Ebbers bought stock after he left WorldCom. “With his remaining available cash, he buys more WorldCom stock,” Weingarten told jurors. “The only conclusion you can come to is that [Ebbers] didn’t have a clue the books were cooked.”

Jury deliberations began on March 5. In the first vote, ten jurors favored conviction, and two voted for acquittal. As they discussed, two of the for-conviction votes shifted to supporting acquittal, resulting in a tighter eight for conviction to four against. On the eighth day of deliberations, one of the four holdouts changed their vote. The other three followed twenty minutes later.

On March 15 Ebbers was found guilty of all nine counts against him, including conspiracy and securities fraud. He faced life in prison.

A bus driver from Manhattan and one of the four holdouts focused on the judge’s instruction that “in order to find the defendant guilty, it would suffice to determine that he turned a blind eye to the fraud, even if he did not partake in it directly.”

The bus driver’s conclusion was, “A blind eye is not going to get him an excuse.” He added, “He was the man who was in charge. It’s just kind of hard to sit there and think he didn’t know what was going on.”

A second juror said, “I think Ebbers pretty much hung himself. How could he be up that high in a company that he started, and then he says I didn’t know anything?”

In July Ebbers was sentenced to twenty-five years in prison. He also forfeited most of his remaining wealth. On September 26, 2006, Ebbers surrendered himself to the Federal Bureau of Prisons in Oakdale, Louisiana. After spending thirteen years behind bars, he was released in late 2019 for health reasons and died in February 2020. He lived to be seventy-eight.

Sullivan, who faced 165 years behind bars, received a sentence of five years. The reduced sentence was because, as Anders advocated, Sullivan was a “model cooperator.” Sullivan also forfeited his assets to settle a class action lawsuit. He spent four years in prison and one year in home confinement in a new home in Boca Raton.

Meyers and Yates each received a prison sentence of one year and one day. Vinson was sentenced to five months in prison and five months of house arrest. Normand received three years of probation.

Sidgmore, Beaumont, and Roberts were never charged with any misconduct or wrongdoing over WorldCom’s collapse. Sidgmore died from kidney failure in December 2003, at the young age of fifty-two, only a few months after the FBI arrested Sullivan. The fear of what the FBI might pursue against Sidgmore must have weighed on him. Beaumont left WorldCom when the fraud was uncovered but continued to be an executive in telecom for the next twenty years.

In April 2004 WorldCom emerged from bankruptcy, changing its name to MCI and relocating its corporate headquarters to Ashburn, Virginia.Hewlett-Packard executive Michael D. Capellas became chairman and CEO on December 16, 2002. When WorldCom emerged from bankruptcy, Capellas said, “WorldCom’s turnaround is a tribute to the human spirit and the amazing will of our 50,000 dedicated employees. We are emerging with a new board and management team, a sound financial position, unmatched global assets, a strong customer base and industry-leading service quality. It really is a great day for the company. We come out of bankruptcy with virtually all of our core assets intact. But it’s been a marathon with hurdles.”

The bankruptcy judge required that the former SEC chairperson Richard Breeden remain WorldCom’s court-appointed monitor for an additional two years. The $41 billion debt was reduced to $5.5 billion.Citigroup settled with WorldCom investors for $2.65 billion on May 10, 2004, providing funds for WorldCom to settle with bond holders. Revenue was roughly $20 billion.MCI shares continued to trade under the symbol MCIAV, though its aspiration was to eventually relist on the Nasdaq market. The stock price was $18 a share.

In 2005 Verizon acquired WorldCom for $6.6 billion, prevailing against a hostile counter bid in a battle that involved a WorldCom rival.E. Stanley Kroenke purchased the Douglas Lake Ranch in British Columbia once owned by Ebbers for $68.5 million. Sullivan’s ten-bedroom, twelve-bath Boca Raton mansion sold for $9.7 million in February 2005. Ironically, the other bidder was Qwest.

Global Crossing—Gary Winnick and John Legere#

When we last visited Global Grossing, the Gold Rush was rapidly losing its luster. Chairman Winnick had named his fourth CEO in two years. Thomas J. “Tom” Casey, his new CEO, presented an outlook that was starkly different from that of his predecessor, Leo Hindery. Whereas Hindery advised Winnick to sell as soon as possible, warning Wall Street was about to wake up and realize it was being fooled, Casey told Wall Street that Global Crossing would meet its aggressive 30 percent growth targets. What did Hindery know, and why was Casey painting a different portrait?

As the story played out, I, along with my Level 3 colleagues, was presented a clue to the answer just as the rush for gold was giving way to the panic of the meltdown. The clue came during a visit from my parents on Saturday, September 30, 2000—the last day of the third quarter.

My family was anticipating a fun family weekend. We were all gathered at Boondocks, an amusement park near Boulder, when my mobile phone rang.

“Are you available to do some work over the weekend?” my boss, Level 3 COO Kevin O’Hara, asked. “It’s important.”

O’Hara explained that Level 3 CFO Sureel Choksi received a call from Global Crossing. “They want to sell $40 million of fiber assets to Level 3, and in exchange, they proposed that we buy $40 million of fiber assets from them.” O’Hara said that they are trying to track down Crowe to get his reaction.

Me: “What fiber assets does Global Crossing want to sell to us?”

O’Hara: “They say they will take whatever we want to give them, so long as the assets are valued at $40 million.”

Me: “What fiber assets does Global Crossing want us to buy?”

O’Hara: “They say they will give pretty much whatever $40 million worth of assets we want to buy. They need the transaction signed by midnight today (Saturday), with the details sorted through tomorrow (Sunday).”

Perfect! That sounded like a fine opportunity. Global Crossing needed to pump up their quarterly financial results. We could cherry pick $40 million of valuable assets and, in return, give them $40 million of assets that were of little value to either of us. We would record the transaction in an overtly conservative manner in our accounting statements with full transparency provided to our auditors. “Who cares about the accounting benefit? Let’s create some value out of their desperation,” I thought and sent texts to my team to get them mobilized for a Saturday and Sunday of work.

Late that evening, O’Hara called back. “False alarm. Crowe and Walter Scott do not want to proceed forward.”

O’Hara and Choks tracked down Crowe after his daylong hike in Jackson Hole, Wyoming. Crowe called Scott while O’Hara and Choks remained on the phone. Scott said that no matter how we handled the transaction on our end, it wouldn’t “pass the Wall Street Journal sniff test.” Even if we did the right deal for the right reason with conservative accounting, the headline will be that Global Crossing and Level 3 did a business deal for deceptive accounting reasons.

O’Hara and Choks passed the “not interested” message to Global Crossing. Anticipating an escalation, Crowe instructed O’Hara not to give his mobile number. “An hour or so later, Winnick called me directly, making a forceful attempt to put him in touch with Jim, which I declined,” recalled O’Hara as he reflected on the story in 2024.

Roy Olofson, Global Crossing’s vice president of finance, also knew what Casey was masking.

In May 2001 Olofson expressed concerns to his boss, Dan Cohrs, Global Crossing’s CFO on capacity swap transactions. He used the term “round tripping” to describe the deals, noting the practice enabled both parties involved in the swap to pump up their financials.

Global Crossing was the counterparty to Qwest, and each used the swap to help the other inflate its revenue and profitability. In one deal Global Crossing exchanged $100 million of capacity with Qwest.Others were involved in the accounting scam as well. 360networks bought $150 million in capacity from Global Crossing, while Global Crossing returned the favor by buying $200 million in return. Both these deals were signed just before the end of the first quarter of 2001.Another abuser of these accounting scams was Enron. As Larissa Herda, tw telecom’s CEO, recounted on a entrepreneurship panel at CU Boulder, “Enron came in and met with my CFO, and they presented a scheme.” Enron’s scheme allowed telecom companies to accelerate revenue from long-term Dark Fiber sales to four years despite the lease term being twenty years. “My CFO said to Enron, ‘So after four years you’ve already accounted for all the revenue, so after the four years you’re going to have this kind of revenue drop, what do all these other companies say about that?’ The Enron guy said to my CFO, ‘Well they don’t plan to be around in four years.’ My CFO was aghast and told me this story, and I said we are not selling another circuit to Enron, because something is wrong.”

These reciprocal swap deals were structured such that both Global Crossing and Qwest were able to book $100 million of revenue in the quarter of the transaction (or shortly thereafter). Each party’s balance sheet would reflect a $100 million operating lease to reflect the $100 million obligation owed to the other party for use of the swapped asset. By treating the $100 million as an operating lease, the associated expense would be amortized over the next twenty years. As such, the $100 million in manufactured revenue had minimal offsetting expenses. And profitability in the quarter of the transaction was inflated by $100 million.

To an outside investor, the revenue and profitability results would look impressive, while the change in the balance sheet due to the operating lease would go unnoticed because of the lease’s small size relative to other costs being spent to build out the networks. These transactions would help both parties report strong revenue and profitability growth to their investors. However, no net cash would change hands.

In early August 2001, CFO Cohrs sent an email to his CEO Casey, citing a news story that questioned the use of these reciprocal transactions by Qwest. “The bad news is that this is raising visibility on the swap issue,” Cohrs wrote.

Later in August Cohrs’s deputy, Olofson, formalized his concerns in a five-page letter to James Gorton, Global Crossing’s general counsel. Gorton waited five months before sharing it with Global Crossing’s Audit Committee. Global Crossing’s auditing firm was Arthur Andersen. And Andersen learned of this on the same day Global Crossing filed for Chapter 11. Again, none of this was disclosed to shareholders.

To what extent were Winnick and other Global Crossing executives dumping their stock to in-the-dark investors?

Olofson also expressed concern about Global Crossing’s executive vice president of finance, Joseph Perrone, who was Andersen’s lead audit partner—the outside auditor—on the Global Crossing account before he joined the company in May 2000.

A subsequent congressional investigation also uncovered an August 2000 email from a Global Crossing executive characterizing the value of a capacity swap as “the plug number designed to meet” Wall Street expectations.

Winnick and Casey were directly engaged in these swap transactions. In June 2001 Winnick sent an email to Casey about an Enron swap. “I spoke with [Enron COO] Jeff Skilling and there are three people vying for the business—we’re one of them. They too are looking to do something here by quarter end,” Winnick wrote.

In April 2005 the SEC completed its investigation and reached a settlement agreement with Casey and two others. The SEC cited,

[T]he failure of [Global Crossing] and its senior management to ensure that the company provided complete and accurate disclosure to investors concerning certain significant transactions entered into by the company in the first half of 2001. Because of [Global Crossing]’s inadequate disclosure, investors were not given the opportunity to fairly judge the quality of [Global Crossing]’s financial results. . . .

These significant transactions involved [Global Crossing]’s sales of telecommunications capacity to other carriers that were linked to, and in some cases dependent on, its purchase of capacity from the same carrier. [Global Crossing] referred to these transactions as “reciprocal transactions.” In early 2001, [Global Crossing] was increasingly reliant on the reciprocal transactions as a substantial source of [Global Crossing]’s announced “pro forma” results, i.e., results of operations that were prepared on a basis defined by [Global Crossing], and that were not in accordance with generally accepted accounting principles (“GAAP”). . . . Without these reciprocal transactions, [Global Crossing] would not have met [financial targets].

The SEC concluded,

[Global Crossing] violated Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-13 thereunder, which require issuers . . . to file accurate and not misleading quarterly reports. . . . [Global Crossing] failed to adequately disclose material events, trends, and uncertainties relating to its past and future financial condition and results of operations. . . . As a result, investors did not have the ability to judge the quality of [Global Crossing]’s financial results.

A director in the SEC’s Los Angeles office said, “Global Crossing’s senior executives failed to discharge one of their most important responsibilities—to communicate with investors in a clear and straightforward manner about the company’s business and financial condition.”

Despite these substantive findings, the settlement was favorable to those implicated. Casey and the two others each agreed to pay a $100,000 civil fine. Winnick was not cited for wrongdoing or fined. None faced criminal charges.

Global Crossing paid nothing. John Legere, who became CEO during the investigation, expressed relief: “We’re happy to have reached a settlement with the SEC and that we can put these issues solidly behind us without a finding of fraud or a financial penalty against the company.”

Legere succeeded Casey in October 2001. With Casey lasting only one year in the revolving CEO chair, Legere became the fifth CEO in Global Crossing’s four years of existence.

“Bankruptcy is not a possibility at all,” Legere proclaimed in an interview shortly after he was named CEO. Bankruptcy was declared on January 22, 2002, just three months after Legere’s declaration.

Meanwhile, as CEO Legere took responsibility for saving the business, Winnick was assiduously working on saving Winnick. He had already embarked on a plan to navigate the company through a rapid restructuring in which he would remain at the helm. The complex plan, which was hatched with his new board member and former US ambassador to Singapore, Steven J. Green, almost sort of worked.

With Global Crossing sailing toward bankruptcy in the fall of 2001, the plan Winnick and Green cooked up was for them to invest $25 million to gain a 13.4 percent stake in the Singapore investment firm K1 Ventures. Green would be named as chairman. Both K1 and Singapore Technologies Telemedia (ST Telemedia) were controlled by Temasek Holdings, an investment fund owned by the government of Singapore.Singtel and Singapore Airlines were among Temasek’s other holdings.

Now with K1 aligning Winnick’s financial interests with ST Telemedia, Winnick negotiated with ST Telemedia to purchase a controlling interest in Global Crossing for $750 million.Hutchison Whampoa (Hutchison) was originally a partner in the pre-pack. They pulled out because of regulatory resistance from the US government. This transaction—called a prepackaged (pre-pack) bankruptcy—would be implemented as part of a bankruptcy filing that would result in most debt and all equity being wiped out. The K1 investment and the pre-pack transaction were completed before Global Crossing disclosed the high risk of an impending bankruptcy.

Though Winnick informally disclosed the K1 transaction to his Global Crossing board, he didn’t disclose K1’s relationship to Temasek. Nor did he explain that he was collaborating with another Temasek-controlled entity on a pre-pack bankruptcy buyout. When investigated, Winnick and Temasek denied that the K1 transaction would result in Winnick benefiting from the bankruptcy in ways not available to others. Right . . .

ST Telemedia eventually agreed to buy 61.5 percent of a reorganized Global Crossing for $250 million. This implied the value of Global Crossing as it emerged from bankruptcy to be $600 million, a gigantic haircut relative to the $50 billion valuation a couple of years prior.The $600 million consisted of $400 million in public stock, valued at $10 a share, and $200 million in debt.

Winnick, however, finally met comeuppance. He was forced to resign on December 30, 2002, while bankruptcy was far from being resolved. Winnick would spend the next few years defending himself from questionable accounting, disclosure, and stock selling practices.

In April 2004 Global Crossing emerged from bankruptcy with a cleaned-up balance sheet. Legere continued as CEO.

Amazingly, despite Global Crossing’s seismic collapse, Winnick was able to extract $734 million for himself. However, he faced civil and criminal legal challenges. He was investigated but not charged with insider trading. He settled a lawsuit related to the case for $55 million without admitting guilt.A total of $324 million was paid to settle a lawsuit with shareholders and former employees. In addition to Winnick’s $55 million, an insurance company paid $195 million, and the law firm Simpson Thacher & Bartlett paid $19.5 million.

A former Global Crossing employee and plaintiff characterized the settlement as not even a symbolic victory: “This is not justice. What this man did to the company left whole families devastated. . . . I really feel he should be in a cell with much stronger bars than Martha [Stewart] might get.”The contrast between the treatment of Stewart versus Winnick is impossible to rationalize. In 2001 Stewart avoided a loss of $51,000 when she sold stock worth $228,000 in ImClone Systems a day before ImClone disclosed a negative development. Stewart’s broker learned of the news and shared the inside tip with Stewart, which prompted her to direct her broker to sell. She was convicted of felony charges related to obstruction of justice. Stewart spent five months in prison and five months under house arrest and paid a $30,000 fine.

CNN Money published an article titled “The Emperor of Greed” in 2002, which provided an unflattering summary of Winnick and his inner circle that included Tom Casey and Steven Green.

Winnick and his cronies are arguably the biggest group of greedheads in an era of fabled excess. Not only did Winnick sell off stock at huge profits while investors who jumped in later watched their stakes burn to nothing, but he treated Global Crossing from the get-go as his personal cash cow, earning exorbitant fees from consulting and real estate deals between Global Crossing and his own private investment company.

In all, Winnick cashed in $735 million of stock over four years—including $135 million Global Crossing issued to his private company—while receiving $10 million in salary and bonuses and other payments to the holding company.

Winnick died at the age of seventy-six in his lavish Bel Air home in late 2023. The cause of death was withheld. Perhaps it was remorse.

Notwithstanding the almost constant drama surrounding Winnick, Legere ran Global Crossing successfully for several more years. In 2011 Level 3 purchased Global Crossing for $3.0 billion.The $3 billion price consisted of $1.1 billion in assumed debt, and the remainder was in Level 3 stock. The implied value per Global Crossing share was $23, a 2.3-fold increase compared with the $10 per share value when Global Crossing emerged from bankruptcy. This outcome was a positive one for Legere, and it proved to be a steppingstone for him to become the extraordinarily successful CEO of T-Mobile.

Qwest—Joe Nacchio and Dick Notebaert#

In early 2001, Level 3 needed revenue momentum. Glenn Russo, who led the Intercity Dark Fiber Solutions business unit for my product organization, stumbled across a commercial opportunity that seemed too implausible to be true. “Qwest referred one of its customers to us to buy a nationwide Dark Fiber network,” Russo told me.

“Why wouldn’t the customer just use Qwest’s fibers?” I asked. Russo didn’t know. On the other end of the transaction was Stephanie Copeland, a longtime colleague at both MFS and Level 3 who had recently joined Qwest. Russo pressed Copeland for more information. Citing confidentiality, the only information she offered was that this was a real opportunity for Level 3.

“Are they looking for a swap?” I asked Russo, assuming Qwest must be looking for a quid pro quo.

“No, it’s a straight-up purchase,” he answered. The contract value would be multiple tens of millions with a significant portion paid up front.

The sale closed, leaving us perplexed as to how Calpoint and Qwest were benefiting from the Dark Fiber provided by Level 3.

Our questions were resolved when, in October 2001, the Wall Street Journal published “Qwest Chief Defends Calpoint Contract as Deal Fuels Worries about Revenue.” Calpoint was somehow going to create high-capacity voice and data services for Qwest to offer large enterprise clients. To enable this, Qwest sold Calpoint equipment valued at $300 million and Qwest, in turn, would subsequently lease capacity from Calpoint for approximately $700 million over five years.

The transaction made sense only through an unscrupulous accounting lens. If Qwest used its own fiber, Qwest’s accountants would require that the equipment sold to Calpoint to be amortizing over the twenty-year life of the contract. If, instead, the equipment was installed on Level 3’s Dark Fiber, the accountants would allow the sale to be reflected as upfront revenue. In a sign of the times, Nacchio, who was directly involved in the structuring of the transaction, chose to forgo the cash flow benefits of the fiber sale in order to pump up Qwest’s quarterly financials.

Qwest’s stock was already down significantly from its high of $57 per share. On the Calpoint news, it dropped another 15 percent to a fifty-two-week low of $16.50 a share.

Nacchio tried to rationalize: “The deal, ‘brings more engineering talent, more arms and legs’ while helping Qwest avoid having to alter capital spending and engineering priorities in order to add the new services. There’s been a huge overreaction. I never would have imagined we’d have such a furor.” More accurately, he never imagined he’d be caught with his hand in the cookie jar.

The Wall Street Journal carefully surfaced concerns of accounting manipulation.

Some investors feared that Qwest was using the equipment sale to boost revenue and meet growth targets, while artificially lowering its capital spending by letting Calpoint spend the money to put the capacity into service.

“The market is telling you that there’s a managementcredibility issue here,” said [an investor]. . . . “We don’t believe there’s accounting shenanigans here. They’re not breaking any rules.”

“Everything the company is doing is completely aboveboard and within standard accounting rules,” said Nacchio.

This wasn’t the first time Nacchio played it loose with accounting manipulation. Several years before, U S West, which had, earlier in 1999, entered the merger agreement with Qwest, was purchasing $60 million worth of new computers. Qwest suggested it would be better for U S West to buy the computers through Qwest, allowing Qwest to book the $60 million as revenue. Qwest would treat the computer purchase as capital, thereby boosting both revenue and profit. U S West’s lame duck CEO balked, saying, “[N]o way we will engage in activity like this.” This was the tip of another cook-the-books iceberg.

The pressure continued to build. By the end of 2001, Qwest’s stock dropped to $12. The third-quarter revenue was flat, and the company posted an unexpected third-quarter loss. The Wall Street Journal summarized Nacchio’s challenge: “Probably the most important task facing Qwest is reassuring investors and analysts who say their confidence has been undermined by executive turnover, confusion about complex contracts, and fear that the company’s growth rate was inflated by sales that tended to be one-time in nature.” The turnover included Qwest’s CFO and several senior executives.

In February 2002 the Qwest merger with U S West was finally completed. Nacchio came in hot with his new employees. He sarcastically joked that the new name of the company would combine the first two letters of Qwest’s name with the last three letters of U S West, which formed Qwest. He used the expression “US Worst” to describe the culture of U S West and was quoted as using the word “clowns” to describe U S West employees. When he shut down a remodel of the lobby of a U S West New York City headquarters building, he hung a sign saying, “Excuse our appearance. We’re entrepreneurs. This building was built in a different era, and we save cash by not remodeling.”

Nacchio wasn’t frugal about his travel. Though he was said to have been critical of U S West’s CEO using a $5 million plane for business travel, Nacchio replaced U S West’s Falcon 20 with a $20 million Falcon 50EX. A bigger plane was needed, Nacchio explained, for his frequent trips between his New York home and Qwest’s Denver headquarters.

At the same time, Qwest’s situation was becoming dire. In February Qwest drew down a $4 billion line of bank credit to cover its short-term cash needs.

At an all-hands meeting soon after the merger closed, an employee asked Nacchio why the board hadn’t fired him yet. Nacchio responded that the board “thinks I’m doing a pretty good job.”

The stock was down to $7.49 per share.

In April 2002, one month after the SEC started investigating WorldCom, the shit hit the fan. Qwest announced a $20 to $30 billion charge to reflect a decline in the assets that it had acquired. Moreover, the SEC disclosed that it was conducting a broad inquiry into how Qwest booked revenue for 2000 and 2001. Specifically, the focus of the probe was whether Qwest inflated its revenues by engaging in improper swaps of fiber capacity. The Calpoint transaction was part of the investigation.

In 2001 Qwest reported Bandwidth capacity revenues of $1.01 billion, up from $468 million in 2000. In the same year, Qwest reported purchases of $1.08 billion from other carriers, an eerily similar number to the revenue. Qwest’s Bandwidth capacity revenue expectations for 2002 were only $212 million, a whopping 80 percent drop from 2001.

The accounting for these capacity transactions obfuscated revenue and profitability growth, which, if not properly disclosed, would inflate Qwest’s performance and mislead investors. The SEC’s investigators were drilling down on transactions in which Qwest sold capacity to a customer while simultaneously agreeing to buy a similar amount of capacity from the same customer.

The level of accounting deceit uncovered in these investigations was truly breathtaking. WorldCom’s fraud was the intentional misclassification of expenses as capital to inflate profitability. Qwest’s fraud involved inflating revenue through swap transactions while masking the offsetting costs as capital. Like WorldCom, the magnitude of the fraud was mammoth.The SEC filing disclosed that $684 million of the $1.01 billion in 2001 revenue was associated with swap transactions. Similarly, $863 million of the $1.08 billion purchases were also linked to swaps.

Qwest booked the revenue from these sales up front. Yet the purchase was booked as a capital expense, which meant the cost would be expensed over many years. The pop in revenue was also a direct boost of profit. As it did with WorldCom and Enron, Arthur Andersen advised Qwest on how to carefully structure the transactions to rationalize this accounting treatment.

The obvious question was, how much of this swap activity was designed to inflate the stock price? Were the swaps of meaningful economic value to the parties involved, or was it just a ruse to mislead investors?

Qwest’s annual meeting was in early June 2002. The once-swaggering, defiant Nacchio and his board appeared to be running for cover from shareholders, as this meeting would be held in Dublin, Ohio, the first time Qwest held its meeting outside Denver and its fourteen-state home territory since going public in 1997. Once again, an employee went at the CEO, who once called his new employees from a merger “clowns.”

“I would like for Phil [Anschutz] and the rest of the board to terminate you, Joe,” the employee said. “Investors, creditors, regulators, employees, and pensioners—we have lost confidence in you.”

Later in June Anschutz and Qwest’s board agreed it was time for Nacchio to get the hook and find a new CEO to course-correct Qwest. Anschutz flew to New York and personally delivered the news to Nacchio that he was being replaced, effective immediately. Nacchio received $10.5 million in severance pay and a $1.2 million partial 2001 bonus.

The following month, in July 2002, the US attorney in Denver began a criminal investigation of Qwest and its executives. Trading in Qwest shares was briefly suspended at the opening of the New York Stock Exchange. When the stock was allowed to trade, its price plummeted and closed at a price of $1.77, down eighty-three cents.

Four Qwest executives were indicted on twelve counts in February 2003.Three were members of Qwest’s global business unit: Grant Graham, the CFO; Thomas Hall, a senior vice president; and John Walker, a vice president. The fourth was assistant controller Bryan K. Treadway. The charges stemmed from a $100 million 2001 contract with the Arizona School Facilities Board, where Qwest was accused of improperly booking $34 million in revenue to meet second-quarter financial forecasts and then lying to auditors and regulators by claiming the Arizona school had approved the accelerated equipment order.

Two were acquitted.Treadway and Walker were acquitted. The jury was deadlocked on the other two.The jury was deadlocked on eight of the eleven charges for Graham and on all the charges for Hall. The US attorney used the threat of a second trial to reach plea bargains with the deadlocked pair to gain their cooperation in the investigation of Nacchio.Graham and Hall each agreed to cooperate with the Qwest investigation of Nacchio. Hall pleaded guilty to a misdemeanor count of falsifying documents and was sentenced to a year of probation and fined $5,000. Graham pleaded guilty to a felony count of accessory after the fact to wire fraud with reckless indifference. Graham was sentenced to time served, which referred to the three and a half years on pretrial supervision. No fine or restitution was imposed.

The difficulty in securing convictions for revenue fraud led the US attorney’s office to take a different approach to Nacchio. Prosecutors focused on Nacchio’s stock sales, which occurred while he masked the company’s true financial outlook. In December 2005 Nacchio was charged with forty-two counts of criminal insider trading regarding his sale of $100.8 million worth of Qwest stock in 2001. If convicted, he would face up to ten years in prison on each count.

Nacchio’s trial took place in March and April 2007 and ran for sixteen days over a span of three and a half weeks. Twelve jurors heard the case.

Qwest’s former CFO testified she told Nacchio that the 2001 revenue targets were as much as $1 billion too high, yet Nacchio reassured analysts about Qwest’s financial momentum.

A Qwest sales executive testified he warned Nacchio in late 2000 that his unit, which was responsible for a significant portion of Qwest’s sales, would have a hard time reaching its 2001 revenue target. When that target was raised, the sales executive sent a one-word email to Nacchio and others: “Bullshit.”

Qwest’s president, Afshin Mohebbi, Nacchio’s number two for several years, testified he warned Nacchio repeatedly in writing, in late 2000 and early 2001, about the growing gap between financial targets and the revenue projections coming from Qwest’s business units. Mohebbi called the 2001 targets a huge stretch. Despite the warnings, Nacchio did not change guidance.

Even a Goldman Sachs analyst weighed in, saying he told Nacchio that Qwest had a big credibility issue because it wasn’t fully disclosing one-timers. He characterized some of the one-time deals as bogus swaps between telecom companies, resulting in the booking of phantom revenue.

Nacchio did not testify. Anschutz testified for the defense, attesting to Nacchio’s character.

In the closing arguments, federal prosecutor Colleen Conry claimed Nacchio knowingly and unlawfully concealed Qwest’s growing financial challenges while simultaneously cashing in on his stock options. “This is a case about choices,” the prosecutor said. He “made a choice. He chose not to tell. And he also made a choice to sell.”

Nacchio’s defense attorney offered the following in his closing arguments. “Maybe his business projections didn’t come true. Maybe the same optimism and drive that helped Nacchio build Qwest led him to miscalculate . . . but that is not a crime.”

The jury deliberated for six days. The judge read the verdict one at a time for each of the forty-two counts. “Not guilty” was read for the first count, which was repeated twenty-two times. Nacchio’s son, Michael, began sobbing. The attorneys on both sides knew it was premature to react.

On count twenty-three, the judge read “guilty,” which was the first of twenty “guilty” verdicts. Nacchio was released on a $2 million bond. He locked arms with his wife and son as he walked out of the courtroom.

“Convicted felon Joe Nacchio has a very nice ring to it,” said the United States attorney for Colorado. “I couldn’t be happier that after five and half years, justice has finally been served.” He characterized the proceeding as the largest insider trading case in US history.

In July Nacchio was sentenced to six years in prison. He was also ordered to pay $19 million in fines and forfeit $52 million in ill-gotten gains for illegally selling company stock. The judge denied his request for bail pending the appeal and, in 2010, turned down the appeal for another trial. The US Supreme Court refused to hear his case.

On April 14, 2009, Nacchio and three of his buddies took a three-hour ride to Minersville, Pennsylvania. They listened to a playlist that Nacchio prepared for this special occasion. Nacchio belted out, “You can check out anytime you like, but you can never leave,” as the final song—“Hotel California” by the Eagles—played. He then stepped out of the car and entered the Schuylkill prison facility.Nacchio shared the story in a 2013 interview with the Wall Street Journal for its article titled “Former Qwest CEO Joseph Nacchio: Tales from a White-Collar Prison Sentence.”

Nacchio spent the next five years in prisons, specifically at two low-security facilities in Pennsylvania. The detainment camps had no bars or walls, and inmates were allowed to use email daily.

Nacchio worked out most days, leaving in better shape than when he entered. His prison jobs were laundry and tailoring. His inmate friends had nicknames such as Spoonie, Juice, and Spider.

He remained defiant.

I trust Spoonie and Juice with my back. I wouldn’t trust the guys who worked for me at Qwest.

I can’t wait for the first person to come up to me and say something to me [about the conviction]. I’m going to look them in the eye and say, “You must be confusing me with someone who gives a fuck about your opinion.”

I never broke the law, and I never will.

Nacchio insisted his conviction was government retaliation for rebuffing requests in 2001 from the National Security Agency (NSA) to access his customers’ phone records.

Nacchio doubled down in a 2014 interview with Denver’s CBS affiliate, which published “Defiant Joe Nacchio Lashes Out against Those Who Sent Him to Prison.” He continued to attribute his conviction to his rebuff of the NSA. “I refused to allow Qwest to participate or personally participate in what I believe was an illegal surveillance activity.”

When asked why he wouldn’t apologize to all the people who were harmed by Qwest’s fraud, Nacchio lashed out, “There’s nothing to apologize [for]. . . . The people say to me, ‘Why don’t you apologize?’ What am I apologizing for? Not breaking the law?”

He also had parting words for Anschutz, whom he felt abandoned him. “The only thing Phil really worries about is his money. For example, he’s never even contacted me. So he’s probably too busy counting.”

In December 2005 the Denver Post published an article titled “A Look at Joe Nacchio,” presenting a nuanced perspective of the man. Focusing on his upbringing in “Brooklyn’s gritty neighborhood of Red Hook,” they described his “journey from near Red Hook to [his multimillion-dollar, nine-thousand-square-foot mansion] in nearby Mendham, New Jersey, as a classic American success story.” The Denver Post covered his ascent at AT&T and then reflected on his unraveling.

Nacchio’s big leap at AT&T came after the company sent him to the Massachusetts Institute of Technology’s Sloan Fellows Program, where he earned a master of science degree in management in 1986.

In his early 40s, he was the youngest head of a major AT&T division. He was well-liked and respected, but some feared him. “He can be very cutting in a meeting where he’s in charge. He doesn’t suffer fools easily,” said [a colleague].

. . . Nacchio’s boss for about six years during the 1980s, put it more delicately. “Because he had strong feelings about things, he could get more emotionally involved than others. I counseled him to keep that in check, which he essentially did.”

. . . Contrary to AT&T’s risk-averse culture, Nacchio thrived on taking calculated risks. Nacchio turned around the flagging consumer long-distance unit, a $20 billion enterprise, in the early 1990s.

The Denver Post went on to explain that Nacchio had fired the longtime ad firm that worked with AT&T and ordered up an aggressive new ad campaign from another ad firm that “put its archrival MCI on the run.” What’s more, AT&T numbers were leaked to the press. This, plus Nacchio’s short time in the new role and the public airing of the ad partner’s firing, angered AT&T’s CEO Bob Allen, according to the former corporate communications chief of AT&T, who told the Post. “That convinced Bob that Joe wasn’t ready to run the company,” said the former AT&T executive. “Of course, Bob thought that of practically everyone who worked for him.”

This description of Nacchio reminds me of a younger me. If I had been in Nacchio’s shoes in the early 2000s, I believe I would have stayed decisively on the right side of the line. However, I know firsthand the intensity of the public company CEO seat, including the self-confidence of being able to navigate tough situations and the passion for not wanting to disappoint investors.

Maybe the difference in Nacchio’s outcome and mine is that I had a chance to learn from the mistakes of him and the others. Or maybe it was just a stroke of luck—bad luck for him and good for me.

In the aftermath of the Nacchio debacle, Qwest made a powerful CEO change, handing the reins to Richard “Dick” Notebaert, the hard-nosed former CEO of my first employer, Ameritech. Notebaert brought with him his former no-nonsense CFO at Ameritech, the much accomplished Oren G. Shaffer. The appointment of Notebaert and Shaffer put both outsiders and those inside Qwest on notice that the nonsense days were over. Anschutz, who still owned 18 percent of Qwest, resigned as chairman while remaining on the board.

Notebaert insisted they would not end up in bankruptcy: “We will not be the next shoe to drop. We believe we’re doing the right thing by discussing this issue in a very transparent way.”

With the help of KPMG, which replaced Arthur Andersen, Qwest cleansed its financial statements. When the restatement was completed in October 2003, Qwest disclosed that it understated losses in 2000 and 2001 by $2.5 billion.

With most of the fallout in the rearview mirror, Notebaert turned his attention to the future of Qwest. He decided to take a hostile run at WorldCom. In February 2005 WorldCom decided to sell to Verizon for $6.6 billion instead of selling to Qwest for $7.3 billion. Both bids included stock as a significant part of the payment. WorldCom concluded that, despite the lower headline number, Verizon’s offer was of higher value.

The Verizon-WorldCom merger required regulatory and shareholder approval. During the go-shop period, Notebaert increased his offer to “best and final offer” of $9.7 billion. Forbes covered the offer in its article titled “Qwest’s Last Stand.” Their prediction was that the offer, despite its boldness, wouldn’t change the outcome.

In many ways, the offer is a blockbuster. It tenders $16 per share in cash, includes new financing details and adds assurances that Qwest will close the deal even if WorldCom’s business declines. . . . It’s nearly everything WorldCom’s board asked for when they . . . gave Notebaert a pie-in-the-sky example of what it would take to change their mind.

But it still isn’t enough to seal a deal, and chances are good that Qwest is going home empty-handed.

WorldCom accepted a sweetened offer from Verizon, concluding that Verizon’s new bid, which was still 13 percent lower than Qwest’s, was superior. WorldCom’s board understandably had little confidence in the future performance of Qwest’s stock.

On May 3 Notebaert withdrew Qwest’s bid and gave up. Though Notebaert remained CEO for another two years, the lost battle for WorldCom was indeed Qwest’s last stand. In February 2006 Anschutz, who still owned 17 percent of Qwest, announced he would not seek reelection to the board. In June 2007 Notebaert resigned.

Ed Mueller replaced Notebaert as CEO, which was fitting, as he also succeeded Notebaert at Ameritech. “When Mueller took the helm at Qwest in August 2007, he was charged with leading a financially stable but unwanted company” was how the Denver Post characterized the challenge.

Mueller dabbled with potential acquisitions and considered divesting the legacy Qwest fiber business. In the end he realized he was dealt a losing hand.

Three years after Notebaert’s departure, CenturyLink agreed to acquire Qwest, which enjoyed a Gold Rush value of $100 billion, for $22.4 billion.The $22.4 million purchase price consisted of $10.6 billion CenturyLink stock and $11.8 billion in assumed debt.

WilTel 2—Howard Janzen and Jeff Storey#

When we last left CEO Howard Janzen in mid-2000, he was feeling spunky about WilTel 2. The value hit $15 billion, with Baby Bell SBC as its anchor customer and part owner, and its shiny new Tulsa headquarters was complete. Soon thereafter, the Bubble burst.

By early 2002 Janzen and his WilTel 2 board knew a restructuring was unavoidable, disclosing the likelihood of a Chapter 11 filing. WilTel 2 did not disclose that in January the board awarded the company’s five top executives $13 million in retention bonuses for the purposes of repaying the loans Janzen and others were given in 1999 to buy the now worthless WilTel 2 stock. The “heads we win, tails you lose” outcome was not well received by shareholders when this was later revealed.

The woes of WilTel 2 spilled over to its parent. The Williams Companies delayed its fourth-quarter 2001 earnings release, citing the need to study its debt exposure to WilTel 2. In April 2002 Williams decided a divorce was necessary and distributed its WilTel 2 shares to the shareholders of the Williams Companies. Also in April, Williams paid $753 million to WilTel 2 for network capacity it was leasing from WilTel 2. In return WilTel 2 assumed $753 million in unsecured debt owed to the Williams Companies.The Williams Companies also agreed to take over interest payments on $1.4 billion in WilTel 2 notes that the Williams Companies had previously guaranteed.

The Williams Companies, which was simultaneously hit by the Enron-related collapse in energy trading, was forced to sell pipelines, refineries, and natural gas production leases in an unfavorable market. Williams’s stock dropped 89 percent in 2002.

In the state of Oklahoma, Oklahomans hear a lot of “whoas” from their cowboys. The Williams Companies heard it loudly as its spin-off of WilTel 2 came under scrutiny. The state of Oklahoma opened an investigation into the collapse of WilTel 2, which came only a few months before WilTel 2’s bankruptcy filing. A committee representing unsecured creditors questioned whether the terms of the spin-off were a fraudulent transfer: “More broadly, did the Williams Companies engage in misconduct by spinning off a subsidiary that was over-leveraged and had no reasonable chance to survive as a standalone entity given its capital structure?”

In April WilTel 2 filed for bankruptcy protection. “I’m not happy . . . but I do understand what caused it: the biggest meltdown ever in our industry,” Janzen said. Skirting his own participation in WilTel 2’s failure, Janzen blamed “a debt-laden balance sheet created by Williams . . . that left WilTel 2 ill-equipped to survive the industry’s troubles.” It’s always your daddy’s fault.

“The goal is to come out of it as quickly as possible,” said a WilTel 2 spokesperson. “Our customers won’t be impacted, our employees won’t be impacted, our vendors won’t be impacted. It’s just our holding company.” The reassurances proved to be hollow, as customers, employees, and vendors were all severely affected.

Level 3, navigating through its own challenges, took a run at acquiring WilTel 2 for $1.1 billion. Level 3’s offer was conditioned on WilTel 2 having $450 million of cash on its balance sheet, which reduced the effective purchase price to $675 million.

WilTel 2 said no and instead partnered with Leucadia National, a low-profile publicly traded investment firm that focused on special situations. Leucadia agreed to invest $330 million for a 45 percent ownership stake, of which $150 million was distributed to the holders of bank debt and $180 million was paid to Williams Companies to sever its relationship. WilTel 2 also repurchased its Tulsa headquarters from the Williams Companies for a $150 million obligation. Bond holders would own the remaining 55 percent. Shareholders, including SBC, received nada.

WilTel 2 emerged from bankruptcy in October, rebadging itself as WilTel and debt-free except for its headquarters liability. Jeffrey K. Storey, a WilTel 2 operations executive since 1999, received a battlefield promotion to replace Janzen as CEO.Jeff Storey spent his earlier years at Cox Communications and SBC.

When Leucadia invested the $330 million, it agreed not to make a tender offer to buy the remaining shares until after October 14, 2004. Despite this agreement, it tendered an offer in May 2003, with a simple explanation that its “offer was in the best interests of the company and its shareholders.”

When WilTel’s independent directors requested time to seek other offers, Leucadia withdrew its offer, adding that a sale to a third party would not be realistic because Leucadia would not sell its shares. In August the independent directors agreed to support Leucadia’s offer to buy the remaining shares for $423 million.The $423 million equated to $15.50 per share, a 24 percent gain over the first trading day closing price of $12.51 per share.

In 2005 WilTel reached a settlement with SBC, releasing SBC from its obligations to purchase services from WilTel. The agreement required SBC to make cash payments to WilTel totaling $236 million. Two years later Leucadia struck a deal to merge WilTel into Level 3 for $696 million.Leucadia received $386 million in cash, plus Level 3 shares that were valued at $310.5 million based on Level 3’s stock price of $2.70. Leucadia realized an additional $100 million based on cash held by WilTel at the time of closing and also retained the benefit of payments owned from SBC per the $236 million settlement. Leucadia reported a gain of $180 million on its $753 million investment in WilTel.

Leucadia also retained $4.9 billion of net operating loss carryforwards, which might have added another $500 million or more to the value of this transaction.

Ian Cumming was the CEO of Leucadia and led the WilTel investment. He passed away in 2018 at the age of seventy-seven. His obituary quoted Crain’s New York Business: “While Mr. Cumming’s track record compares very nicely with Mr. Buffett’s, he’s as unknown as the Oracle of Omaha is famous.” The obituary also included a quote from Cumming and his partner Steinberg’s final annual letter to Leucadia investors in 2012: “We have always preferred to make money, rather than headlines.” Well, Cumming made money on his investment in WilTel.

Broadwing#

Broadwing, the new brand of Cincinnati Bell’s business, was in a pickle. The Bandwidth Boom lost its momentum, and flames of the Bust were burning hot. Even after accounting for all the cash flow generated by its legacy business, Cincinnati Bell’s burden of funding its newly acquired Broadwing resulted in an overall cash burn of $39 million in 2002. Broadwing shares traded at below $5, which was 10 percent of the share price at the time of the legacy Broadwing acquisition. Cincinnati Bell’s leaders determined a harsh pivot was necessary and decided to unload the legacy Broadwing business to anyone that would take it.

An entity named C III Capital Partners offered $129 million cash, plus the assumption of $375 million of associated operating liabilities. For this $504 million, C III acquired the competitive fiber business that Cincinnati Bell bought from Broadwing for $3.2 billion just three years prior. Cincinnati Bell gave C III the Broadwing name and wished them luck.

The legacy telephone business was retained and branded, once again, as Cincinnati Bell, and their $3.2 billion nightmare was over.

PSINet—Bill Schrader#

The Bandwidth Boom was a glorious time for PSINet and its CEO, Bill Schrader. The company’s name was on a new NFL stadium, and Schrader was confident a buyer would emerge with $20 billion to buy the business. Even as the Bubble began to burst, Schrader remained an optimist. At PSINet’s holiday party in December 2001, he told employees, “AT&T is going to go down, but PSINet will survive.”

PSINet’s board was alarmed by the $3 billion in debt and Schrader’s relentless focus on expansion. Schrader “was more interested in building the infrastructure than in achieving profitability with what he already had,” shared one of PSINet’s directors.

Despite Schrader’s positive outlook, PSINet was going downhill—and fast. Cash burn increased dramatically as revenue fell short of expectations. PSINet’s stock price was down 95 percent from its peak. Goldman Sachs was retained as an adviser with the hope of raising capital by selling noncore businesses, but there were no diving saves in the PSINet portfolio.

“The risk of bankruptcy can’t be ruled out,” reported an analyst.

The company warned, “Even if [we are] successful [in our restructuring], it is likely that the common stock of the company will have no value.”

In April 2001 PSINet reported fourth-quarter 2000 losses of $3.2 billion and disclosed that it was in default on lease obligations. PSINet’s board asked for and received Schrader’s resignation. Schrader lost most of his $1 billion in PSINet stock by refusing to sell. “When the stock was at $30 he’d say ‘I’m a seller at $75.’ When it went to $60, he said ‘I’m a seller at $100,’” an insider of PSINet revealed.

In May the company reported it would miss the deadline to file its quarterly financial report and would be unable to pay its quarterly dividend of $14.4 million due to preferred shareholders. Later in May, PSINet, its cash blown and unable to pay its bills, filed for bankruptcy.

In February 2002 the assets of PSINet, including customer portfolio, fiber and systems backbone, and intellectual property, were purchased for a paltry $10 million.The $10 million comprised $7 million for the business and $3 million already paid by the buyer for the right to conduct its due diligence. Unlike every other company covered so far in this book, PSINet’s assets do not belong to any of our four consolidators—AT&T, Lumen, Verizon, or Zayo. Instead, another clever entrepreneur, David Schaeffer, the founder and CEO of Cogent Communications, purchased the PSINet assets. Schaeffer was socially quirky and, as I learned as I got to know him, had an IQ of a genius. He bought several other fiber properties at distressed prices and assembled them into a public company worth multiple billion. Nice job, Dave!

Genuity#

In 2001 all seemed to be going well for Genuity. Verizon, which owned 9.5 percent, was expected to buy the rest of Genuity as soon as Verizon received a green light from regulators. Genuity launched its new bundled and branded Black Rocket offering, boasting big name partners such as Cisco and IBM. Genuity expanded into Europe by acquiring a French fiber provider. Then the good times rapidly turned bad.

Within weeks of the French transaction, Genuity announced it was lowering its 2001 revenue outlook, citing a slowdown in corporate purchases. Genuity reduced its workforce by 12 percent but could not have imagined the implosion right around its corner.

In early 2002 Genuity’s relationship with Verizon seemed solid. Genuity was announced as Verizon’s preferred provider of Internet Backbone services. “Over the past two years, Genuity and Verizon have uncovered great opportunities to . . . jointly market and sell Genuity’s innovative services,” declared Verizon CEO, Ivan Seidenberg.

Soon thereafter, Genuity added another billion dollars to its debt capacity, despite the objection of the Verizon representative on Genuity’s board. In July 2002, with three years remaining on the five-year term, Verizon surrendered its option to buy Genuity. In announcing its decision, Verizon sought to reassure the public markets that it would not absorb Genuity’s $3 billion in debt and $4 billion in 2001 losses. The option forfeiture triggered a covenant on Genuity’s debt facility, which set the course for bankruptcy.

Trying to fathom Verizon’s reluctance, one analyst speculated, “It sounds like they’re anticipating that the business is going to continue eating cash and they don’t want to throw good money after bad.”

Genuity claimed to not have had advanced warning of Verizon’s decision. Forbes evidently was tipped off. On the Monday before Verizon’s disclosure, Forbes, in an article titled “Genuity Is Left on the Launching Pad,” poured salt on Genuity’s wounds.

Genuity introduced itself to a puzzled public two years ago with an ad campaign that featured a mysterious-looking black rocket and a very 1990s tagline: “Do you want to change the world?” But the ‘90s, alas, had just ended, and the world had already changed—and not for the better, if you were a tech investor.

Now Genuity and its rocket appear headed for the auction block.

The Verizon announcement ravaged Genuity’s stock, which had already fallen to $2.59 a share. It plunged further to 29 cents. With bankruptcy looming, Genuity searched for a white knight, but time was not on the Verizon castoff’s side.

Just a day before the Verizon announcement, Genuity drew down $723 million of its outstanding line of credit. “This is absolutely coincidental,” said a Genuity spokesperson. “We had absolutely no knowledge of what Verizon was going to do.” Genuity’s behavior suggested otherwise. The credit was drawn down with unusual urgency, with Genuity demanding the banks complete the transfers by noon.

Genuity, in default on its $2 billion line of credit and its $1.15 billion loan from Verizon, filed for bankruptcy in November 2002.

Genuity found a big brother, but this one was not nearly as loving as Genuity was to the French company. Level 3 agreed to buy Genuity’s assets for $242 million. The price was subject to adjustments in Level 3’s favor. By the time the acquisition was completed in June 2003, the purchase price dropped to $60 million in cash, plus $77 million in cash prepayments to vendors.

Genuity, inclusive of BBN, was now owned by Level 3 for a purchase price of less than 5 percent of Genuity’s peak valuation. The ugly yet desperately needed industry process of consolidation was officially underway.

Touch America—Bob Gannon#

In 2000 Montana Power CEO Gannon announced the company would exit the power industry and instead focus on Bandwidth under the brand Touch America. His timing couldn’t have been worse. First, Gannon exited the power business in a down cycle that reversed course soon after the exit. “Electricity prices in Montana doubled, then redoubled, and doubled again,” reported CBS News. PPL, which bought Montana Power’s electric generating plants, sold a third of the power to out-of-state utilities at a huge markup and posted record profits.

In 2001 Bandwidth boinked. By April, Touch America stock dropped to $8 a share, down from $65 the previous spring of 2000. As it dropped, Touch America bought back 6.6 million shares for $204.8 million. These shares soon became worthless. In June 2003 Touch America, then with twenty-one thousand miles of fiber network, declared bankruptcy.

That February CBS News had already aired its segment: “Who Killed Montana Power?”

For nearly 90 years, the Montana Power Company exemplified the very best of American capitalism. It provided cheap, reliable electricity for the people of Montana, excellent benefits for thousands of employees and generous, reliable dividends for its stockholders.

Everyone was happy, except for the corporate officers and their Wall Street investment banking firm who decided there was more money to be made in the more glamorous and profitable world of telecommunications.

The result exemplified the worst of American capitalism.

Goldman Sachs advised Montana Power for seventeen years. In the years leading up to the power divestiture, Goldman bankers made over one hundred visits to Butte.

CBS News questioned whether Montana Power’s directors, the majority of whom were Montanans, “fully appreciated the risks and challenges of the fiber-optic business.” A public service commission member questioned the competency of Touch America’s leadership: “[Montana Power’s Board was] intoxicated by their stock price and Wall Street was telling them, ‘Hey, you’re on a roll.’ These were utility guys. What did they know about the telecommunications business?”

The board considered multiple options. One was to continue to treat the fiber business as a division within Montana Power. The second was to take Touch America public and spin out the shares to Montana Power’s shareholders. At the urging of Goldman Sachs, the board chose the third option—to sell the power assets and transform into Touch America.

Matt Darnell, a Goldman Sachs’s managing director, downplayed his firm’s role: “There were numerous options explored but we certainly supported the thoughtful and deliberative approach the board took.” He added, “The telecommunications industry has taken a turn no one expected.”

Gannon defended himself and his board: “There are a lot of suggestions in watering holes around this state that Goldman was flying around the West looking for a bunch of guys to dupe and that we were a bunch of rubes from Montana who got taken in. That’s the stupidest thing I have ever heard.” To me, this doesn’t sound far-fetched—it rings as an accurate portrayal of the situation. The shoe fits. Gannon was CEO and needed to wear it.

“There’s a lot of second-guessing taking place now,” Gannon said. “But we were the ones sitting in the chair, and we made a decision that was absolutely correct and justified.” I ponder what an incorrect and unjustified decision would have looked like to Gannon and his board. Of all the Boom-and-Bust sagas, Gannon’s Touch America story may be the saddest for the apparent incompetence of its strategic due diligence and execution.

Shareholders agreed and filed a breach of fiduciary duty lawsuit against the company, board, senior executives, and Goldman Sachs. Six of the state’s largest firms collaborated on the suit. “We’re trying to salvage the pension funds of thousands of Montanans who are wrapped up in this company,” explained a former state Supreme Court justice.

The former judge continued, “[Gannon] was tired of what he thought was a stodgy utility stock. He owned an awful lot of shares. And I think he wanted to be the Bill Gates of Montana.” The judge also made clear his view that Goldman Sachs, whose fees were $20 million, shared much of the blame for the Montana Power-Touch America debacle: “The evidence is going to show that the weeks would go by and then there would be memos in which Goldman Sachs would just keep pushing, ‘This has to be done now. No better time than now. The market for this can only get worse.’ [Goldman Sachs] were definitely the driver. They were pushing it all the time,” the former judge noted.

At the height of the Bandwidth Boom, Gannon was praised for his bold makeover and cheered at Touch America’s shareholder meeting. One year later, with the Bandwidth Bust in full force, Gannon was a pariah, scorned for selling out Montana Power shareholders. The fury intensified when the shareholders learned that $5.4 million in change-of-control payments were made to the executive team, $2.2 million of which went to Gannon. In 2001 the company’s headquarters were picketed. Gannon was heckled—and had raspberries thrown at him—by locals as he walked in downtown Butte. He was refused service in downtown Butte restaurants. A banner was hung a few blocks from Touch America’s headquarters that labeled Gannon a “rat bastard” and a “weasel.”Gannon claimed that some or all the assertions in this paragraph did not happen.

“I get pretty emotional about Gannon and his bunch because I think they were motivated by their own greed,” said a retiree. “They saw a golden parachute at the end of this.”

“You can see a company going out of business,” said a woman who lost her job the day before bankruptcy papers were filed. “But when three or four people get rich off it, that’s hard to handle,” said a colleague who was laid off the same day. He added, “At least I know now how companies should not be run, how customers should not be treated.”

The irony of the situation hung in the air. Gannon was raised in Butte, less than a mile from Montana Power’s headquarters. He had a thirty-year career at Montana Power. His father worked for the company. This was not the ending that Gannon had envisioned as his retirement celebration.

In late 2003 Touch America sold its remaining fiber assets to 360networks for a negligible $28 million, bringing an end to both Touch America and Montana Power. Touch America and 360networks sorted through claims with AT&T, Verizon, Qwest, and Sierra Pacific. Each got certain assets to resolve claims.

“It hasn’t worked out the way we had hoped and believed was achievable,” Gannon explained. “There are reasons for that. That is a hard reality.” Indeed it was, and his words were an understatement.

Eight years later I acquired 360networks, which made Zayo the proud owner of most of Touch America’s assets. Separately, I also bought a spare conduit on the route that Touch America jointly built with Sierra Pacific.

360networks—Greg Maffei#

“When Maffei bets, he bets big. He believed in [360], so he bet big,” proclaimed the former head of worldwide sales at Microsoft. Maffei’s wager on 360networks was gigantic. He left Microsoft well into the Boom cycle. In hindsight he was late to the party, as rivals Broadwing, Genuity, Level 3, Qwest, and others had a multiyear head start.

When we last spent time with Maffei, he was maintaining a brave front, telling investors and employees that 360networks would survive the troubled times ahead of it.

360networks’s stock price began its steep decline immediately following its September 2000 peak of $24 per share. By the end of 2000, the stock price was at $10. By March 31 the price dropped to below $5. In June the stock traded for less than 10 cents. Maffei’s $1 billion of paper net worth burned to ashes.

In early June 2001, 360networks disclosed it wouldn’t make a scheduled $11 million interest payment on its $2.8 billion debt. Later in June, just eighteen months after Maffei’s arrival, 360networks filed for bankruptcy.

Maffei reflected, “It’s so easy with 20-20 hindsight to say this was too aggressive, that was too aggressive. The fundamental premise is that the business plans of all of the emerging telecoms were too aggressive, and without access to capital, they weren’t able to complete them.”

He lamented, “I had great timing on leaving Microsoft. I had less good timing on entering telecom. If I’d known it was going to be this volatile, I wouldn’t have come.” The word “understatement” again comes to mind.

When he filed for bankruptcy protection, Maffei expressed optimism for the future of a restructured 360networks. “Almost all of our competitors are in financial distress,” Maffei said in 2002. “We’re more conservatively financed than most of them, and we’ll be the first back into the market.” Maffei, making good on his word, led 360networks rapidly through the bankruptcy process. He sold off or shut down many of the company’s partially completed projects.During bankruptcy, Hibernia Atlantic, which was the name of 360networks’s nearly complete €900 million undersea cable to Europe, was put in receivership. Using his Columbia Ventures Private Equity firm, Kenneth Peterson Jr. of Washington State purchased Hibernia, including 360networks’s Dublin headquarters, for $18 million in 2003. The North Atlantic fiber began carrying traffic in 2005. In 2017 Peterson achieved a great exit when GTT purchased Hibernia Atlantic for $607 million. GTT, which completed dozens of acquisitions, went bankrupt in 2021.

In November 2002 Maffei led 360networks out of bankruptcy. He collaborated with Wilbur Ross, founder of WL Ross & Co., to structure a reorganization plan. Ross invested $30 million and received 10 percent of the new equity and 13 percent of the new bank debt.

Ross explained their logic: “After studying optical fiber network opportunities for more than a year, we have concluded that 360networks presents the most attractive combination of balance sheet strength, network map, technology, proximity to cash flow breakeven, and management talent. We see it as a logical base for the imminent industry consolidation.”

360networks emerged with about $215 million in debt and $50 million in cash.

“Instead of being the most risky player out there, we are arguably the least-risky guy to buy from,” said Maffei, who remained CEO after the restructuring.Jimmy Byrd, who briefly ran Level 3 North America, remained COO.

Maffei wasted no time putting his clean balance sheet to work. One week after emerging from Chapter 11, 360networks announced the $260 million acquisition of a Canadian fiber provider, which added two hundred eighty thousand miles across Canada, as well as seventeen markets the fiber business was serving.After accounting for cash on the acquired company’s balance sheet, the net purchase price was far lower.

“We are very excited about combining these two successfully restructured companies,” Maffei said in a release. “Together we will be Canada’s largest and most complete full-service competitive telecommunications company.”

Two years later 360networks sold most of its Canadian assets to Bell Canada for $201 million. According to Wilbur Ross, 360networks realized a big gain.

In April 2003 Maffei acquired the US Bandwidth business of Dynegy, a Texas power utility, which consisted of sixteen thousand route miles serving sixty-five wholesale customers in forty-four US cities.Dynegy, a Houston, Texas, energy company, followed Enron’s footsteps off a steep cliff. See the Enron Broadband & Dynegy Global Communications section of appendix 3, “More Bandwidth Stories.” “[Their fiber] business will complement our US network footprint,” said Maffei. “The volatility in the telecommunications industry continues to create consolidation opportunities for those with the right assets and financial backing.”

In 2003, 360networks purchased Touch America’s fiber business, which was once valued at over $1 billion, for $28 million. “Touch America’s business enables us to be a leading provider . . . in the western US,” explained Maffei to Photonics Spectra.

A portion of the power company and Touch America assets were sold or returned to AT&T, Level 3, and Qwest. By 2004, 360networks eliminated all its debt and resolved claims associated with its acquisitions.

In July 2005 Maffei became president of Oracle and, less than a year later, became president and CEO of John Malone’s Liberty Media. After these transitions, Maffei retained his position as chairman of 360networks while parsing the day-to-day management to SVP Rick Coma and CFO Chris Mueller. They would run the company for six years. 360networks steadily grew in value in the decade that followed bankruptcy. Kudos to Maffei, Coma, and Mueller for achieving a respectable outcome.

AT&T—C. Michael Armstrong and Ed Whitacre#

In his first three years as the CEO, Armstrong transformed AT&T and, in doing so, shaped the Bandwidth Boom, becoming the largest Cable TV provider with plans to layer voice and Internet services alongside interactive video. AT&T Wireless established itself as the biggest mobile carrier. AT&T’s enterprise offerings were bolstered by its acquisition of Teleport and partnerships to construct new intercity fiber routes. AT&T was positioned to be a global leader considering it also had its partnership with BT. Yet as the Bandwidth Bust loomed, all was far from going as AT&T had planned.

The cable systems that AT&T purchased from TCI were in dire need of upgrades, causing AT&T to spend several billion dollars a year on the overhauls.

Though Cable TV revenue was growing at 10 percent, profitability had declined to 16 percent, which was far below the industry norm of 35 percent. No doubt the gap also exposed the difficulty of a large corporation with a monopoly history competing in an industry dominated by scrappy operators.

Meanwhile, AT&T’s Concert venture with BT was losing $250 million a quarter. AT&T and BT agreed to dissolve Concert in October 2001, causing AT&T to take a $3.5 billion write-off.

All three of AT&T’s intercity joint build partners—Velocita; McLeodUSA, which acquired CapRock; and Touch America—became bankruptcy hot messes.

By October 2000 AT&T’s stock traded at $23 a share, less than half of the share price shortly after Armstrong was named CEO. AT&T’s Market Value declined by $70 billion in less than a year*.* Debt, which was essentially zero when Armstrong assumed the reins, ballooned to $62 billion!

In October 2000 the Wall Street Journal published an article titled “Armstrong’s Vision of Cable Empire at AT&T Unravels on the Ground.” “The sobering conclusion: It may be time to give up on his ambitious plan to reinvent one of the great American business icons by integrating cable, wireless, and long-distance. Those businesses, [Armstrong] says, ‘aren’t necessary for each other.’” Though potentially correct, he destroyed tens of billions before having this epiphany.

AT&T’s board approved a plan—code named “Project Grand Slam”—to split AT&T into four businesses: AT&T Wireless, AT&T Broadband, AT&T Consumer, and AT&T Business.By June 2001 AT&T Wireless stock was $17, reflecting a market valuation of only $19.4 billion. “We have three really strong growth businesses and we have a huge declining business that shrouds all of these businesses,” Armstrong said. “[This is] going to provide a foundation and a path to let these businesses realize their value in the marketplaces.” Armstrong aspired to become the CEO of AT&T Broadband.

The Wall Street Journal reported on the skepticism surrounding the plan: “Some industry observers question whether the breakup is the right move for AT&T, saying the company has execution problems that can’t be solved with tracking stocks and spinoffs.”

An analyst added, “It’s hard to escape the feeling that a corporate funeral took place today. . . . It’s really the end of an icon and no matter how they try to put a positive spin on it, it’s the death of a corporate giant.”

During the Bandwidth Boom, Armstrong went hostile on the Roberts’ family in the AT&T-Comcast battle over MediaOne. With AT&T now vulnerable, Comcast decided to exact some vengeance by launching an unsolicited offer to acquire AT&T Broadband for $58 billion.The $58 billion purchase price consisted of $44.5 billion in stock and $13.5 billion in assumed debt. This was half the price AT&T paid for TCI and MediaOne. The hostile bid, if successful, would make Comcast the largest cable company in the world.

“If Comcast gets away with this one we may see the end of AT&T as we know it,” an investment fund speculated.

Though AT&T’s board initially rejected the offer, claiming the $58 billion “did not reflect the full value of AT&T Broadband,” this was just delaying the inevitable. AT&T and Comcast agreed on a price of $69 billion in December 2001.

In July, with AT&T’s stock price at $10 a share, David W. Dorman, AT&T president and the former CEO of AT&T-BT’s Concert joint venture, replaced Armstrong as AT&T’s CEO. Dorman did his best to show optimism: “We’ve got a lot of wind at our back. . . . We believe we’ve got some very clear opportunities right in front of us [such as the local phone market].” Perhaps the Concert blowup left a blur in his eyes.

AT&T entered 2003 as a fatally wounded animal with no fight remaining in it. After one more year of trying to regain momentum, AT&T sold itself for $20 per share to one of its seven babies, SBC Communications.SBC Communications’ original name was Southwest Bell Communications.

Edward E. Whitacre Jr. began his career as an engineer in the Bell System and was named CEO of SBC, the Baby Bell headquartered in Dallas, in 1995, just as the Renegades of the early fiber build-outs were gaining momentum. During the Boom chaos of the turn of the century, Whitacre and his team, regarded by many in the industry as the sharpest guns among the Bell industry executives, rolled up three of SBC’s siblings: Pacific Telesis Group in 1997, Ameritech in 1999, and BellSouth in 2006. In 1998 the Texas Bell also purchased Connecticut-based independent telephone company Southern New England Telephone, landing SBC close to Verizon’s New York ranch. Things were getting really interesting and aggressive in the land of the Bell Heads.

Then in 2005 Whitacre, whom his executives always referred to as “Mr. Whitacre,” made the move for which he will always be remembered: SBC acquired its former parent, the once almighty AT&T, for the bargain price of $16 billion. Soon thereafter, in early 2006, SBC changed its enigmatic, vestigial branding to the saved, reborn, and still enviably iconic AT&T.

“The AT&T name has a proud and storied heritage, as well as unparalleled recognition around the globe among both businesses and consumers,” Whitacre explained. “No name is better-suited [as] the brand that will lead the industry in delivering the next generation of communications and entertainment services.”

In 2007 Whitacre retired.Ed Whitacre’s retirement didn’t last long. US auto giant General Motors filed for Chapter 11 bankruptcy on June 1, 2009. Eight days later the White House announced that Whitacre would serve as chairman and six months later added the title of CEO. Whitacre, who had to learn the auto business fast, was credited with successfully leading the turnaround of General Motors. Whitacre was then succeeded by telecom veteran Dan Akerson. Instead of gobbling up other fiber properties, AT&T focused its attention on other lines of business, especially mobile and video service. Today, AT&T’s Bandwidth Infrastructure assets are the least robust of the four consolidated US platforms.

XO—Dan Akerson and Teddy Forstmann#

XO was on a tear during the Gold Rush. Rockstar Dan Akerson took over as CEO. Gold Glover Teddy Forstmann pumped in $850 million of fresh capital. The $700 million of fibers purchased on Level 3’s network were soon to be ready for delivery. Then the sledgehammer came crashing down on the Bandwidth industry.

XO, like all telecom companies, was hit hard. As XO was drifting toward bankruptcy, its ability to fulfill its joint build obligations was in question. At Level 3 Crowe directed me to urgently rework the fiber deal with XO to ensure our payments wouldn’t be tied up in the anticipated XO bankruptcy. XO would get less fiber and conduit; we would get fiber on XO’s metro networks, and XO’s overall price for the joint build would be lowered. It took one long and tense month to complete the restructuring with both XO and Level 3 in a desperate state to find a path through the financial crisis.

Crowe hounded me every one of the last ten days to get it done. I told him XO’s terms wouldn’t work for us. Crowe didn’t want the details. He just wanted it finished. I didn’t appreciate the gravity of the situation, as Level 3 was in deeper financial straits than I was privy to.

Toward the end of the negotiations, I was on the phone with XO’s COO. We were going back and forth on one of the details when someone shouted to him, “Tell Caruso I’ll escalate to Crowe if he doesn’t concede this point.” I asked, “Who’s that talking?” After a moment of silence, a response came: “I’m sorry. Akerson briefly jumped in my office and was listening in. He just left.” I’m sure he was listening the whole time, and I doubt he had left.

I’m glad I held out because the details mattered, and we found a middle ground. In the end XO received eighteen fibers on our network, plus the tag-along rights, which were never used, that gave XO the ability to purchase additional fiber associated with Level 3’s future capacity overbuilds.Level 3 also released XO from its obligations to purchase pan-European fiber in Europe. XO was required to put the $700 million payment associated with the U.S. joint build in escrow, assuring Level 3 of payment even if XO declared bankruptcy.

After we executed this deal, I sent an email to Crowe, inviting him to a meal with the two other key Level 3 executives who supported me on the restructuring.John Scarano was the SVP who was my right hand during the negotiation. John Ryan was one of Level 3’s senior attorneys at the time and later was promoted to be Level 3’s general counsel. Crowe jumped on the invite, and we enjoyed a steak and martini dinner together. This was perhaps my warmest moment with Crowe, as we all let down our guards and relaxed, putting aside for one evening our high-anxiety day jobs.

Since I did the original and the reworked deal, I knew the opportunities and vulnerabilities on both sides. As I left Level 3, XO was near the top of my acquisition wish list of fiber properties.

After XO reported losses of $2.1 billion in November 2001, Nasdaq suspended trading. XO’s shares traded over the counter at 8 cents a share. The $10 billion Market Value posted in late 2000 evaporated in full.

Forstmann, with the backing of Akerson, had a plan to protect its $1.5 billion XO investment through a prepackaged bankruptcy. However, the legendary Carl Icahn was working on a different scheme. Forstmann versus Icahn—which heavyweight would win? With the Bear roaming in the background, perhaps both would lose.

AboveNet—Bill LaPerch#

In 1999 I joined Level 3 CEO, Jim Crowe, on a trip to New York to meet with Howard Finkelstein and Silvia Kessel, who were representing Metromedia’s Kluge. Kessel was short, spoke with a pronounced German accent, and proudly displayed an ashtray filled with ashes. Her voice was coarse, which I surmised was the result of chain-smoking cigarettes.

After pleasantries, both parties went silent, waiting for the other to initiate the business conversation. Finally, Jack Grubman, the Salomon banker who brokered the meeting, spoke. As he did it became clear that Grubman told Finkelstein and Kessel that Crowe wanted to meet with them while telling Crowe that Finkelstein requested the meeting. From my seat either one could have been true, or perhaps both fished for the conversation. Crowe and Finkelstein danced around a merger, with Grubman egging it on. Both executives expressed confidence in their business prospects. Neither wanted to show weakness or fear to the other.

Nothing came of this meeting, which was quite fortunate for me because if AboveNet had been acquired by Level 3, Zayo’s 2012 acquisition of AboveNet could not have happened. And I wouldn’t be sitting at my brand spanking new beachside home at the El Dorado Golf and Beach Club in Cabo writing this book.

In 2001 AboveNet faced an existential problem. Nearly every distressed fiber provider was a customer of AboveNet, and these businesses made up the overwhelming majority of AboveNet’s impressive $2 billion revenue backlog. Backed by these customer contracts, AboveNet was well on the way to building the most valuable metro networks in the world.

Then the wobbly status of these customers abruptly destroyed AboveNet’s source of funding.

In January 2001 AboveNet announced that it had obtained a firm commitment for a $350 million credit facility from Citicorp that would fund AboveNet to achieve cash flow sustainability. Six months later AboveNet revealed that Citicorp’s “commitment” was conditioned on AboveNet securing commitments from other lenders in the amount of $287 million. In August a class action lawsuit was filed against CEO Steve Garofalo, who was once lauded for birthing AboveNet by creatively leveraging the available network of sewers below NYC. Now he was being sued for misleading AboveNet’s public investors.

For all these reasons, AboveNet’s stock was trading below $1 per share.

In late 2001 AboveNet was able to close on a $611 million debt facility that included Verizon and Citigroup. The loan bought AboveNet a short reprieve.

Another bomb dropped in April 2002 when AboveNet’s auditor, KPMG, found the company’s internal systems and controls so flawed that they couldn’t be reviewed in accordance with normal accounting procedures. AboveNet issued a statement: “[KPMG] identified issues relating to a number of adjustments that it believes will be necessary . . . and is working to determine the nature and amount of such adjustments.”

Furthermore, KPMG stated that it couldn’t “review the quarterly data that is expected to be included in the Annual Report in accordance with professional standards because AboveNet’s internal control structure and policies and procedures for the preparation of interim financial information did not provide an adequate basis for them to complete such a review.”

As if April wasn’t already bad enough, Verizon and Genuity terminated their fiber-optic agreements with AboveNet.

AboveNet filed for bankruptcy in May 2002.

In September 2003 AboveNet emerged from bankruptcy.During bankruptcy, AboveNet sold valuable real estate assets in the extraordinarily important data center market of Northern Virginia for a combined value of $63 million, which represented steep discounts to the properties’ true values. Craig McCaw, the original backer of XO and an AboveNet shareholder since 1997, partnered with board chair Kluge to each invest $25 million, which gave them a significant ownership stake in AboveNet.

The restructured company emerged with $276.6 million in revenue, $80 million in cash, $83 million in debt, and an estimated Enterprise Value of between $230 million and $330 million—a far cry from the $10 billion value AboveNet enjoyed during the Boom.

The accounting flaws identified by KPMG proved to be insurmountable to reconcile. In fact, it was 2008 before AboveNet filed a quarterly (10-Q) or annual report (10-K) with the SEC. The 2008 filing covered 2006. When this report was filed, Rob Powell of Telecom Ramblings blogged.

[T]his day marks the end of an era, the final curtain has come down on the telecom nuclear winter that began in 2001 in which hundreds of telecom companies went under—from WorldCom on down.

All those assets filtered through bankruptcy court into new ownership, occasionally more than once, but one case always stood out. . . . AboveNet used to be known as Metromedia Fiber Networks and the depth of its collapse is legendary, involving a 5 year SEC investigation.

While AboveNet emerged from bankruptcy in 2003, they have struggled for 5 years now to find out where the money went back in 2000–2002. They have not succeeded and have admitted they likely never will, nor have they managed to produce a 10-Q or a 10-K since then, despite being a public company. In fact, AboveNet didn’t have any quarterly or annual reports on file this century which they hadn’t disavowed.

All the other rubble from the crash (MCI, GX, WilTel, Genuity, etc.) has long been cleaned away or refurbished, but AboveNet was still lying in a coma. Until today.

. . . So maybe they’re back.

Emerging from bankruptcy with a vacant CEO seat, the board needed to find a replacement. William G. “Bill” LaPerch, AboveNet’s operations executive, received a battlefield promotion to CEO and became AboveNet’s fifth CEO in three years. Unlike his predecessors, LaPerch would have a long tenure as CEO.

LaPerch was a longtime telecom operator, making his way up through NYNEX and MCI as a highly regarded operations and engineering executive. He served our country as a captain in the army after graduating from West Point. He earned his MBA from Columbia University while at MCI. In 2000 WorldCom acquired MCI, and LaPerch joined AboveNet to lead operations.

“Before AboveNet, MCI was the highlight of my career,” LaPerch shared with me in 2024 as he reflected on his career journey. “To say I was devastated when WorldCom acquired MCI would be a big understatement. Within a month I knew WorldCom was not for me.” Fifteen members of LaPerch’s MCI team followed him from WorldCom to AboveNet.

LaPerch recalled his first board meeting, which was held at Rockefeller Center soon after he joined. “Everybody had an assigned seat, with mine between two elderly gentlemen. I introduced myself to the guy on my left. He responded, ‘Hi. I’m John Kluge.’ I turned to the unfamiliar man to my right, who introduced himself as David Rockefeller. Red-faced and giggling to myself, I thought I had finally made it to the big time, sitting between two of the richest people in the world.”

During his first year as CEO, LaPerch sold multiple data center assets that, if held, could have been worth many hundreds of millions. “We’re paying pennies on the dollar for the San Jose building’s assets. If we had to go out today and build a building from scratch like this, we would have to deploy $80 million in capital,” an Equinix executive joyfully remarked. LaPerch used the proceeds to expand AboveNet’s fiber network with a focus on connecting AboveNet fiber to as many data centers as possible.

LaPerch’s ten-year execution of the Bandwidth Infrastructure strategy was extraordinarily successful. He captured his focus in his 2006 and 2010 interviews.

We come to work every day prepared to execute on our organic growth strategy.

We go into the top metro markets, and we do two things simultaneously. One, we connect it to the rest of our markets using our wide area network. Two, based on the experience we have in our existing markets, we know that a significant amount of business is going to be focused around the data center infrastructure. So, we establish a fiber ring that hits the key carrier hotels and data centers.

We don’t go out and resell someone’s service.

We are . . . not interested in being a cloud service provider, a CDN provider, or a professional services company.

In early 2009 AboveNet was relisted on the NYSE. In August 2009, as its stock approached $80 per share, AboveNet executed a stock split. This conveyed leadership’s confidence that their business, which was now worth more than $1 billion, would continue its growth in value.

And grow it did. By 2012 AboveNet’s revenue reached $540 million, which was double from when it emerged from bankruptcy. The company achieved a very respectable profitability margin of 45 percent, and cash flow was positive. The stock price continued to rise, again approaching $80 per share, reflecting a 200 percent gain since the 2009 split.

Despite posting exceptional results with perhaps the industry’s best collection of fiber assets, the $1.8 billion valuation placed on AboveNet by the public markets was low relative to its financial performance. Private Equity took notice. In 2011 a Private Equity firm bought the stakes of some of AboveNet’s investors.

LaPerch, no doubt encouraged by bankers and investors, saw the opportunity to take the company private in a management buyout. In doing so they put AboveNet in play and on a collision course with my Zayo journey. The outcome would end up shocking the industry.

Level 3—Jim Crowe#

As the first year of the new decade was upon us, Level 3 realized it was overextended. The decision was made to pull out of Asia, which reduced capital obligations by several hundred million.The Asian undersea assets, which cost roughly $660 million to deploy, were sold to an Asian carrier for $80 million. This released Level 3 from the obligation to complete construction of the undersea network. A year later Level 3 completed its retreat from Asia by also selling—or, more accurately, handing over—its Japan, Hong Kong, Korea, and Taiwan fiber networks to an Asian company named Reach. This reduced Level 3’s capital obligations by $300 million and led to a $500 million write-off. Level 3 took a 2001 write-off of $500 million.

In January 2001 Level 3 posted results for the fourth quarter. “It was another solid quarter and an exceptionally strong year for us,” declared Crowe.

However, Crowe’s positive spin was not aligned with the duress that was hitting the Bandwidth industry. By June 2001 Level 3’s stock price cratered to $5, down 94 percent from its $130 peak in March 2000. The Market Value of Level 3 was $2 billion.Level 3’s $2 billion Market Value implied a value of $8.4 billion, including debt.

Like with AboveNet at the time, Level 3’s revenue was largely associated with customers now in financial freefall. This made the revenue base highly suspect, especially the upfront payments that would be owed for customer contracts for yet-to-be-delivered fiber.

In June the Wall Street Journal published an article titled “How the Fiber Barons Plunged the U.S. into a Telecom Glut.” Capturing the veiled panic of the times, the Wall Street Journal reported, “Now, Level 3 has hit a wall even Crowe may have trouble overcoming. . . . Some acquaintances have noticed that Crowe seems more subdued these days. But in public the executive remains the picture of confidence.”

A saltwater fish tank that was the feature of Crowe’s office suite was emptied to save money. I don’t know what happened to the fish.

Crowe explained how the landscape had shifted, stating only the strong would survive. “A year ago we were in a hothouse environment where every plant, regardless of its strength, prospered. Now, we are outside in the cold world. It is a better environment, as painful as it is.”

Crowe spun the industry turmoil as being advantageous to Level 3’s strategy. “The shake-out that is occurring is good for Level 3 in the long term, although it is awfully hard to convince someone who is sitting in a dentist’s chair being drilled that this is a good thing,” said Crowe. “It hurts.”

Level 3’s plan was to use its stockpile of cash to outlast its rivals. Level 3 reduced its workforce by 20 percent. “[Crowe] stresses that the company still has $4 billion in cash and says it will emerge from the shakeout,” wrote the Wall Street Journal.

In September 2001 Level 3 announced a plan to buy back debt at a discount of 43 percent to 73 percent of its face value. Over the next six months, Level 3 bought back $2.1 billion at a steep discount, lowering the debt load to $6 billion.

At the end of 2001, Level 3 had $2.1 billion in liquidity, which it said was sufficient to get to cash flow breakeven. The markets weren’t buying it. “Level 3’s bonds are trading at about 50 cents on the dollar,” a high-yield telecom research analyst stated. “That’s basically the market telling the company that it has to restructure.”

In January 2002 Level 3 disclosed that if its current rates of sales, cancellations, and disconnects continue, the company may soon violate a “revenue-based financial covenant.” If so, the lenders could force Level 3 into bankruptcy.

The loan covenants specified that Level 3 must have $2.3 billion in annual revenue to stay in compliance. Crowe tasked his team to find an acquisition that met three requirements. First, revenue needed to be at least $1.7 billion to satisfy the debt covenants. Second, the acquisition price needed to be as low as possible, as Level 3 had little cash or debt capacity to spend on acquisitions, and Level 3’s tiny stock price prevented it from being usable as acquisition currency. Third, the acquired company must be classified as a communications services business, as Level 3’s debt covenants counted only revenue of communications businesses.

Crowe needed a diamond in the rough, and the bankers found one, by the name of Howard Diamond.

Diamond was CEO of Corporate Software, the largest reseller of Microsoft Office. His firm would book as revenue the entire cost of the software and return 97 percent of it back to Microsoft.

Corporate Software had a whopping $1.2 billion of revenue but a miniscule profitability of only $18 million. This profile meant Level 3 could acquire a whole lot of revenue for a tiny purchase price. Most importantly, the business was classified as a communications services business.

Level 3 purchased Corporate Software in February for $139 million and, two months later, purchased Software Spectrum, a rival to Corporate Software, for $122 million.

An analyst was blunt in his assessment: “This is creative financial engineering. . . . [T]hey’re buying their way out of the revenue covenant. It’s not immediately clear to me how a business-applications software reseller that’s been around well over 15 years is directly integral to Level 3’s communications business.”

Crowe did his best to provide a strategic angle. “This transaction affords a number of distinct advantages to Level 3. . . . Level 3 already provides a variety of information technology services. . . . This acquisition will enable [us] to attain scale and to leverage [our] customer base, worldwide presence and IT professional relationships.” None of this was true, of course, as the purpose was solely to avoid bankruptcy.

Howard, a true diamond in the rough, wasn’t the only gem Crowe had up his sleeve.Crowe had a backup plan. The renegotiation of the XO-Level 3 Joint Build was structured in a manner that would allow Level 3 to reclaim the conduit and six of the twenty-four fibers without any refund. This would allow Level 3 to accelerate the recognition of over $700 million in revenue and satisfy the debt covenants. The other was the famed Oracle of Omaha, Warren Buffett. Level 3 chairman Walter Scott, who also served as a board member of Buffett’s Berkshire Hathaway, convinced Buffett to invest $100 million alongside $400 million from Legg Mason and Southeastern Asset Management. Forbes’s headline was “When Buffett Buys, a Bottom Must Be Near.”

The fresh investment from extraordinary investors positioned Level 3 to shift from defense to offense. Buffett said, “[L]iquid resources and strong financial backing are scarce and valuable assets in today’s telecommunications world. Level 3 has both.” He added Level 3 “is well equipped to seize important opportunities that are likely to develop in the communications industry.”

The endorsement of Legg Mason was every bit as important. Legg Mason Funds Management beat the Standard & Poor’s 500-stock index for eleven consecutive years, the longest run for a stock-fund manager at that time. Chairman Bill Miller expressed his confidence: “Level 3 is emerging as one of the ultimate leaders, survivors, and consolidators in the industry.” Level 3 stock promptly shot up 66 percent the day of the announcement.

Crowe was ready to go on the offensive. “The company is now able, with this additional capital, to better take advantage of acquisitions and consolidation opportunities in the communications industry today.”

Crowe leaned on James Bond for credibility. Actor Sean Connery was featured in television ads touting Level 3’s glorious vision of a Bandwidthenabled world.

Though bankruptcy in the near term was avoided and 007 was endorsing the company, the stakeholders were not believing the message. Level 3’s bonds traded at 35 cents on the dollar. The stock remained below $2 per share. These implied that both debt and equity investors believed a bankruptcy was very likely.

Much work would be required to get the company healthy and worth more than its debt.

Jack Grubman—Sarbanes–Oxley#

This book would be irresponsibly incomplete without the enthralling story of Salomon Smith Barney analyst Jack Grubman.

The job of a Wall Street analyst is to provide research and analysis on public companies, which typically include recommendations for investors to either buy or sell the stock of the covered companies. Grubman and most analysts specialize in particular industries. In Grubman’s case telecom was his area of focus.

Grubman came up three times in our story. The first time was when he introduced Nacchio to Anschutz. Second was when Grubman proclaimed XO as “the best opportunity ever in telecom history.” Third was when Grubman sat alongside WorldCom’s chairman Sidgmore and CFO Sullivan in front of Congress, testifying that he “always practiced . . . honestly held research and opinions.” In effect, Grubman’s excuse for making his disastrous recommendations was that he was simply one of the all-time worst analysts.

The truth was Grubman’s opinions were not honest and didn’t derive from research expected of an analyst. His opinions were caked in old-fashioned greed. And glowing praise of his Gold Rush darlings made him rich. Eventually, though, he would pay a price.

Grubman grew up an only child. For years Grubman told the story that he came from the working-class South Philly, the home base of singer Frankie Avalon and the neighborhood where the film character Rocky Balboa perfected his boxing. In fact, he grew up in the relatively prosperous middle-class Oxford Circle neighborhood of Philadelphia. In 2000, as the telecom industry began its meltdown, bringing heightened scrutiny by Congress and federal investigators, Grubman, the most prominent and highest-paid telecom analyst on Wall Street, admitted to a BusinessWeek reporter that he had been lying about his education for years. Grubman lied to his first Wall Street employer, PaineWebber, and in subsequent official bios and to the media, claiming that he had graduated from the prestigious Massachusetts Institute of Technology when, in fact, he received his undergraduate degree from Boston University.

He launched his career at AT&T before joining a Wall Street investment banking firm as a telecommunications analyst. The self-professed math genius failed the Series 7 exam, a required test to be an investment analyst, before passing it on his second try.

Grubman became an outspoken critic of AT&T and a loud cheerleader of AT&T’s competitors. His AT&T experience gave him an edge over other analysts, and he carved out a niche by being bullish on the new entrants that attacked AT&T and its Baby Bell offspring.

In 1994 Grubman jumped ship to join Salomon, where he became the leading analyst on Wall Street. In 1997 he was number one in Institutional Investor’s annual rankings. Wall Street insiders referred to him as the “ax,” which informally knighted him as the sector’s most influential analyst.

Grubman covered forty newly formed competitors to the Bell System, whose combined Market Value exceeded $1 trillion. His words fueled dramatic increases in stock prices, and he wasn’t shy in how he characterized his influence. “I’m sculpting the industry,” he proudly exclaimed.

“When Grubman said wonderful things about a company, it was like a narcotic—everybody wanted it” was how a former Salomon stockbroker characterized Grubman’s influence. “He walked around like he was a god. And it was perceived in the industry that he was a god.”

Grubman’s influence led to lucrative engagements for his firm. Salomon collected over $1 billion from the clients covered by Grubman during the late 1990s and early 2000s. To reward him, Salomon paid Grubman $48 million between 1999 and 2001, by far the highest compensation of any Wall Street analyst.

The first time I met Grubman was in early 1999, when I was the group vice president overseeing the network organization for Level 3. I spent an hour with him in our Colorado offices detailing Level 3’s execution plan. Grubman’s focus was on pinpointing how to position Level 3 relative to other clients of his, such as AboveNet, Global Crossing, Qwest, and XO. As we conversed, it wasn’t a substantive explanation that he was seeking. Grubman was searching for nuanced words he could use that would convey differentiation without dissing his other clients.

The next month Level 3 raised $1.4 billion by selling shares at $54 each, with Salomon engaged as Level 3’s Wall Street advisor. On the day this offering was announced, Grubman raised his price target on Level 3 from $54 per share to $70. Four days later, Grubman published a forty-page report titled “Level 3 Communications—Optimizing a Layer of the Telecom Value Chain: The Intel Inside of Telecom.” He touted that Level 3 was “a great play on Bandwidth” and “has a strong management team that is critical for success in this business.” Grubman’s influence was as good as advertised, as Level 3’s shares jumped 34 percent to $72.

The expression “pay-to-play” refers to the linkage between an analyst’s positive report on a client and the analyst’s employer receiving lucrative engagements from that client. Grubman’s positive report on Level 3, timed to coincide with Salomon being hired to support Level 3’s stock offering, reeked of pay-to-play.

“It’s buyer beware—many Wall Street firms have embedded conflicts of interest,” said one analyst at the time.

“Does it look crummy? Yeah, it looks crummy. It’s an appearance problem for the firm, but I don’t know whether it’s anything more than that,” added a professor at New York University’s law school. The laws at the time were unclear.

“Whenever [Grubman] picks up [coverage on] a company, I think the presumption is that there’s a banking deal in the works,” another expert chimed in.

Grubman was unapologetic, noting the sharp jump in Level 3’s stock price: “I guess if anyone was particularly bothered by our report, it didn’t really show in the market.” When later questioned about the inherent conflicts in his pay-to-play antics, Grubman replied with his trademark swagger: “What used to be a conflict is now a synergy. Objective? The other word for it is uninformed.”

WorldCom was the biggest example of Grubman’s outsize influence. In October 1997 the New York Times published “For Salomon, as Adviser, Millions Plus Revenge,” which focused on Grubman’s critical role in WorldCom’s successful acquisition of AT&T’s biggest rival MCI.

The only company with as much to gain from WorldCom’s $30 billion bid for MCI as WorldCom itself may be [Salomon]. . . . WorldCom will pay Salomon $32.5 million in fees if the acquisition is completed.

. . . The job of persuading Wall Street . . . falls to Jack B. Grubman, Salomon’s senior telecommunications analyst. Mr. Grubman, who is renowned for his shoot-from-the-hip opinions and polemical research reports, has become a key deal maker at Salomon. He has known [Ebbers] since 1988, and has been an unflagging advocate of the company’s stock.

McLeodUSA, a Midwest telecom company led by one of Iowa’s wealthiest individuals, Clark McLeod, was another example. Salomon earned over $100 million in fees, including leading the McLeodUSA public offering in 1996 at $24 per share. Two weeks after the IPO, Grubman initiated a buy recommendation with a target of $40. “McLeod represents one of the truly great business models that will be executed in the new era of telecom,” Grubman wrote.

Grubman was caught red-handed in a 2001 email message about Focal Communications. In February he published a research note on Focal reiterating a buy but noting some concerns. When bankers told Grubman that Focal’s executives complained, he emailed the bankers: “If I so much as hear one more f-ing peep out of them, we will put the proper rating in this stock. . . . We lost credibility on [McLeodUSA] and XO because we support pigs like Focal.” Grubman threatened to “put the proper rating” on Focal, which he said every smart institutional investor “feels is going to zero.” On the same day as this email outburst, Grubman reiterated his buy rating, with the stock trading at $15.50 a share. He maintained the buy recommendation for five months, with the shares dropping to $1.24. Soon thereafter Focal went bankrupt.Bob Taylor, a former Ameritech and MFS colleague of mine, was the co-founder and CEO of Focal. In 2000 Taylor resigned and was replaced by Kathleen “Kathy” Perone, a veteran of MFS and Level 3. Focal filed for Chapter 11 bankruptcy in December 2002, completed reorganization in 2003, and was acquired by Broadwing in September 2004 for $189 million.

In April 2001 Grubman published “Don’t Panic—Emerging Telecom Model Is Still Valid.” In it, he recommended seven stocks, including Broadwing, Global Crossing, and AboveNet. By the end of 2001, the basket of stocks lost 58 percent of their value. Soon thereafter all but Level 3 went bankrupt.

The New York Times article titled “Telecom’s Pied Piper: Whose Side Was He On?” focused on the conflict of interest among analysts who were rewarded with bonuses based on the fees the bank received from the companies they covered. Buy recommendations made for happy banking clients. Grubman, “one of Wall Street’s highest-paid analysts,” played the game.

The New York Times identified Grubman’s culpability in the Boom and Bust: “The telecommunications mess stands out for another reason: One man is at its center—Jack Benjamin Grubman. . . . Mr. Grubman lured more investors into securities of nascent and risky telecom companies than perhaps any other individual.”

Eventually, though, investors soured on the companies Grubman covered, and Grubman was exposed as a peddler of worthless stocks. “Even as [Grubman] rallied clients . . . to buy shares of untested telecommunications companies and to hold on to the shares as they lost almost all their value, he was aggressively helping his firm win lucrative stock and bond deals from these same companies,” the New York Times reported.

“Jack Grubman is the king of conflicted analysts,” said a securities lawyer. “He used his picks to generate investment banking business for his firm and abused investor trust in his picks. He personifies the blurring of lines between investment banking and objective analysis.”

Grubman wasn’t alone. The analyst community in general shared in the blame. The New York Times article titled “Pied Piper” cited the questionable metrics that were used to value fiber providers.

Because these companies had neither revenue nor earnings, telecom analysts devised new rationales, new metrics, to justify the purchase of already overpriced stocks. . . .

The most popular method was to value the companies based on the money they had put into their networks—money from investors, not money that the company had earned. . . . [T]elecom shares were promoted by big brokerage firms as good values because they traded at prices that represented four or even five times what they had invested in plant and equipment.

In March 2002 the New York Times article titled “Telecom, Tangled in Its Own Web” tied Wall Street’s pay-to-play behavior as contributing to the meltdown.

At the center of this debacle stand the usual Wall Street enablers. Investment bankers raised money from investors for far more telecom networks than were economically feasible. Brokerage-firm analysts, eager to help their employers win ever more securities offerings, drummed up investor interest in untested companies.

The SEC didn’t buy Grubman’s “I-was-honest-but-incompetent” explanation. In 2003 the SEC filed a complaint against him for providing misleading research. Grubman paid $15 million in fines and was banned for life from the securities industry.

The destruction of the telecom industry led to one of the largest securities regulatory reforms in history. The new law, named the Sarbanes– Oxley Act of 2002, or SOX for short, was created by Sen. Paul Sarbanes and Rep. Michael Oxley. Among SOX’s numerous provisions, it codified Grubman’s behavior as unlawful.SOX also required that executive officers certify that they have reviewed the report, have read and understand it to ensure the report does not contain “untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading,” and that the report fairly represents the company.

SOX makes it clear that signing officers are responsible for creating and maintaining effective internal controls to detect all material information that should be shared within the reporting period, including reporting deficiencies and material weaknesses.

SOX strengthened the independence auditors play in serving a company. An auditor would no longer be allowed to provide a client with non-audit work simultaneously. The lead audit for a company must switch every five years so that the possibility of fraud is decreased. Separation—typically referred to as a Chinese Wall—would be required to prevent bankers from colluding with analysts.

As the mid-2000s neared, the worst of the Bust was behind us. Now it was time to transition to the next phase of the Boom/Bust cycle—the time when savvy investors rummage through the rubble and get their grimy hands on valuable assets for next to nada. The table was set for the phoenix to rise from the ashes.