ParfumGigi@aol.com

The verdict, says Troy Eid, the U.S. Attorney for Colorado, is justice served. Appointed to office just eight months before the trial began, Eid built a new team almost entirely from scratch to prosecute the case, including recruiting a former Enron prosecutor. "I want to debunk the notion that there is a playbook that Justice developed," Eid says. "We had to make up our own strategy."

_____________________________________________________________

A loss in the first Qwest trial forced the Denver U.S. Attorney's Office to change tactics and learn the virtues of simplicity

Ben Hallman

The American Lawyer

November 8, 2007

Joseph Nacchio is going to prison. Unless an appeals court overturns his conviction, the former chief executive of Qwest Communications International Inc. will serve six years for insider trading -- for dumping Qwest stock shortly before the company disclosed that it had been misstating billions in revenue in its balance sheets.

The verdict, says Troy Eid, the U.S. Attorney for Colorado, is justice served. Appointed to office just eight months before the trial began, Eid built a new team almost entirely from scratch to prosecute the case, including recruiting former Enron Corp. prosecutor Cliff Stricklin.

"[Nacchio's conviction] was a huge win for Denver and this office," Eid says. His choice of words is telling. While the U.S. Department of Justice deserves some credit for the Nacchio conviction -- lawyers from its criminal fraud division worked on the Qwest case -- Eid and Stricklin say that no one from Washington, D.C., came prepared with a master plan for how to try the case. "I want to debunk the notion that there is a playbook that Justice developed," Eid says. "We had to make up our own strategy."

After the Enron scandal, the Justice Department indicted a series of high-profile corporate executives under the auspices of a new body: the Corporate Fraud Task Force. Formed to "investigate and prosecute significant financial crimes," in the department's words, the task force suggests a unified government machine that sweeps up bad actors in a big net and prosecutes them according to a plan drawn up deep within the halls of the Justice Department in Washington. But this impression, promoted by the political side of the Justice Department to show that it maintains control over the 93 U.S. Attorney's Offices, and by defense lawyers who use the imagery to portray the government as a bully with limitless resources, is a far cry from how most high-profile white-collar cases look at ground level.

The reality is that prosecutions, like politics, tend to be intensely local and are subject to the same ambitions, failed ideas and rivalries found in any other human institution. This goes doubly true for the Qwest case, a costly four-year imbroglio for the government that before the Nacchio conviction hadn't resulted in prison time for any of the players charged.

Eid blames William Leone, his predecessor, for mismanaging the case. He says he took over a case that was in "deep trouble," was in "disarray" and was suffering from a "leadership problem." Some defense lawyers are also unhappy about how government managed the Qwest case. They want to know why a group of midlevel Qwest executives tried earlier were charged more aggressively than the CEO.

But the Qwest case also shows how even in an imperfect system, ideas and best practices about how to charge and try big-name corporate crooks percolate through the federal justice system. It shows that the autonomy granted U.S. Attorney's Offices allows them to learn from their own mistakes. In April 2004, after a Denver jury acquitted two midlevel Qwest executives accused of conspiracy and securities fraud and failed to reach a decision on two others, prosecutors changed course at Leone's direction. For the case against Nacchio and two CFOs, who were still under investigation, the new paradigm would be simplify, simplify. Rather than try to pin accounting fraud on the senior Qwest leaders, which would have meant an excruciating in-court review of dozens of smaller transactions, prosecutors opted for a more straightforward case based on the government's assertion that Nacchio knew about his company's dire situation before he dumped $100 million in Qwest shares.

In changing direction, the Qwest team did what other successful white-collar criminal prosecutors in the past few years have done, says Andrew Weissmann, a former head of the Enron Task Force and now a partner at Jenner & Block.

They "streamlined" the case to a single issue: Did the executive lie? That, essentially, was the winning recipe in the trial of Enron's Jeffrey Skilling and Kenneth Lay; in the third-time's-the-charm prosecution of former Cendant Corp. head Walter Forbes in Connecticut; and even in the prosecution of home economics queen Martha Stewart, who was convicted of lying to investigators in the ImClone Systems Inc. case.

In the first Qwest trial, the Denver U.S. Attorney's Office tried the throw-the-book-at-them method and failed. What succeeded in the second trial was a radically different strategy. Call it the single-chapter approach.

In June 2000 Qwest merged with U S WEST Inc., a regional "baby bell" telephone company. According to a Securities and Exchange Commission complaint filed in March 2005, Nacchio, then the chief executive at Qwest, and his deputies, including CFOs Robin Szeliga and Robert Woodruff, had been reporting the sale of equipment and access to the company's fiber optic network -- so-called onetime sales -- as recurring revenue for at least a year.

(Nacchio's lead attorney, Herbert Stern of Stern & Kilcullen in Roseland, New Jersey, did not return phone calls asking for comment.) The executives used this income to artificially inflate future earnings projections, making the company's long-term prospects seem brighter to investors than they actually were, the SEC suit says. Insiders referred to the company's reliance on onetime sales to make budget an "addiction," "heroin" and "cocaine on steroids," according to the complaint. The SEC suit describes Nacchio as the ringleader in the deception. In May 2001, even as other telecoms were struggling, Nacchio told investors to expect 1,517 percent revenue growth -- two to three times the rate of anyone else in the industry.

As with most addicts, Qwest executives, once hooked, found it impossible to quit abusing. And, as with most addicts, the abuse led to burnout. In June 2001 Arthur Andersen LLP, Qwest's outside auditor, told Szeliga, the former chief financial officer, that the audit firm could no longer be associated with Qwest's financial statements without better disclosure of the onetime sales. Nacchio and other senior executives continued to lie to investors for the next two months, the SEC suit alleges, until, in mid-August 2001, the company for the first time disclosed revenue from the onetime sales. This set in motion a barrage of inquiries and, eventually, restatements.

In June 2002 the Justice Department informed Qwest that it had launched an investigation. Nacchio resigned. A month later, Qwest stock, which had traded as high as $64 per share in 2000, hit bottom, dropping to $1.11 a share.

Once Nacchio was gone, Qwest's new chief executive, Richard Notebaert, told government lawyers that the company would cooperate with the Justice Department's investigation, says Qwest counsel Harold Haddon, a partner at Haddon, Morgan, Mueller, Jordan, Mackey & Foreman in Denver. Over the next few years, Haddon and Qwest responded to dozens of questions about specific transactions and turned over internal interviews conducted with Qwest employees in the wake of the accounting disaster. In February 2003 the government indicted former Qwest executives Bryan Treadway, Grant Graham, Thomas Hall and John Walker on charges of conspiracy, securities fraud, aiding and abetting, filing false statements and wire fraud. The indictment, which had been drafted in the Colorado U.S. Attorney's Office with the help of prosecutors from the Justice Department, alleged that the quartet devised a scheme to falsely recognize $33 million in revenue by immediately reporting millions of dollars from an equipment sale to the Arizona School Facilities Board. This was but one of many alleged examples of the "onetime" sales that served to inflate Qwest earnings.

The nine-week trial didn't go well for the prosecution. James Hearty, an Assistant U.S. Attorney who played a minor role in the trial, says the case was "all about criminal intent" -- and the prosecution team, led by Leone, was unable to persuade the jury that the men were criminally culpable. One of the biggest problems for the prosecution was that it couldn't prove that the executives personally benefited financially from the fraud in any way. Trial observers also say the case was simply too complex and that the jury often seemed bored.

"White-collar accounting cases are hard to present in a down-to-earth fashion," says Daniel Sears, an attorney for Graham and also a former federal prosecutor. "The government got bogged down in minutiae. They lost the jury's attention."

After the jury acquitted Treadway and Graham, Hall pled guilty to a misdemeanor charge of falsifying documents, and Walker, the vice president of sales at Qwest, pled guilty to a felony charge of being an accessory after the fact to wire fraud. None of the executives served any time in prison. In post-trial interviews, jurors said they thought the government had gone after the wrong people. "The sentiment that the government threw everything at them and hoped something would stick, that worked against the government with several people," jury foreman George Gerstle told The Wall Street Journal.

So why did Leone go after these four executives for what ultimately was a very small piece of the overall fraud? After the Enron bankruptcy in 2001, the Justice Department announced that it would pursue a strategy of "real-time enforcement" against white-collar criminals, Leone says. Justice wasn't going to spend years building a case. Rather, prosecutors would move rapidly, filing charges while still in the middle of an investigation, Leone says. Also, he says, the department was telling prosecutors to go after white-collar bad guys like they would drug gangs. "Prosecute the midlevel guys," Leone says he was told. "Plead and flip."

He learned the hard way that this is a tougher chore in the white-collar arena. "When you're dealing with a drug conspiracy, everyone involved knows they are participating in criminal conduct," Leone says. "If you can convince the lawyer that you've got the goods, they will plead and flip. In white-collar cases, the power of denial is so much higher. It's much easier to rationalize one's actions."

Prosecutors were hoping that indicting the lower-level executives in a seemingly easy-to-prove case would lead to an indictment of the executives from the 52nd floor of the Qwest building in Denver, where Nacchio and his CFOs worked. Sears says there was nothing wrong with the strategy, per se. "In most white-collar cases, you start with lower-level employees and obtain convictions, or obtain pleas," he says. But the midlevel executives didn't plead, they didn't flip and the government could not convince a jury that they were culpable for the $33 million in fraudulent accounting. Prosecutors were dismayed with the outcome. Former U.S. attorney general John Ashcroft had personally announced the indictment; the defeat registered in Washington, D.C., and in Denver as a black eye for the government, say lawyers familiar with the case.

For the next stage, Leone asked the Justice Department for help. Justice sent Michael Koenig, a prosecutor from the fraud section, to Denver. For two-and-a-half years, beginning in early 2004, he helped Leone build the case against Nacchio and his CFOs. Koenig, now a partner at Greenberg Traurig, declined to discuss the process, but others familiar with the investigation say that Denver prosecutors were initially building a broader accounting fraud case in the same vein as the Arizona case. That case would have looked much like the SEC civil suit, which alleges that senior Qwest executives "engaged in a massive financial fraud that hid from the investing public the true source of the company's revenue and earnings growth."

Haddon, the Qwest lawyer, says the SEC complaint "is a window into what the government was thinking about accounting at the time."

After the Arizona verdict, government thinking changed. Leone, now a partner at Faegre & Benson, says he told his staff to keep it simple and to start at the top. "Complexity was a disadvantage in the first trial," he says.

Denver prosecutors decided to pursue the individuals they felt were responsible for the "culture of corruption" at Qwest, Leone says. Nacchio was enemy number one. By indicting him for insider trading, the government would be able to try Nacchio and his executives in the broader context of the accounting fraud, but on a specific, easier-to-prove charge. The argument: Nacchio knew Qwest's books were cooked, so he sold off his stock before the price dropped through the floor. Evidence included testimony from Qwest officials and memos warning him about the company's shaky financial legs.

Insider trading cases are interesting, and juries understand them, says Sullivan & Cromwell partner Steven Peikin, a former white-collar prosecutor in New York. "They appeal to something basic, that the playing field should be level," Peikin says.

One group that thinks the playing field has been off-kilter in the government's pursuit of Qwest executives is a handful of attorneys who represented Nacchio's underlings in the first Qwest trial. They want to know why their clients were charged with accounting fraud, but the alleged ringleaders of a much larger plot that led to a $3 billion revenue restatement -- Nacchio and his chief financial officers -- were not. After all, Denver prosecutors had spent years building a broader accounting fraud case against Nacchio before they abruptly changed course. "Going after Nacchio for insider trading is like going after Al Capone for tax evasion," says Jeffrey Springer, a partner at Springer & Steinberg. Springer represented Hall, one of the midlevel executives. "If the stock was seriously manipulated," as the slow-moving SEC civil lawsuit maintains, Springer says, "then where is the prosecution?"

Leone didn't get the chance to see the case he built through to the end. He had been acting U.S. Attorney, and though he lobbied for the appointment, President George Bush nominated Eid in his stead, a counsel to former Colorado governor William Owens.

In an hour-long interview in his Denver office, Eid painted a picture of an office that, prior to his arrival, was demoralized and in disarray. The person to blame for this state of affairs, he says, was Leone.

Others echo this message. Prior to Eid's arrival, agents at the Federal Bureau of Investigation had "major doubts about whether the [insider trading] case was winnable," says an official close to the investigation.

When Eid took over, the official says, "things began progressing very smoothly." (An FBI spokesman said agents who worked on the case couldn't comment until the appeals process played itself out. Other prosecutors in the Denver U.S. Attorney's Office declined to talk about this issue on the record.)

Eid also says the Justice Department was frustrated with Leone and his prosecution of the Qwest case. Leone, Eid says, didn't communicate with federal agents who were investigating the case, didn't communicate with other prosecutors working on the case, made "questionable" plea deals with Qwest executives -- and, further, made these deals without first signaling his intentions to others who had worked on the case.

Leone, told of Eid's comments, seemed genuinely shocked: "Really? He said that?" As to the broader issue of what Washington, D.C., thought of the job he was doing, Leone says, "Never once did I get a call from the DOJ saying that there was a problem with the case." Koenig, who worked with Leone on the case for several years, also says he didn't hear criticisms of Leone from within the Justice Department. "I was the one shuttling back and forth between D.C. and Denver," he says. "If anyone would know, it would probably be me."

From the improbably well-appointed U.S. Attorney's Office in Denver, Stricklin, a former Texas state court judge and Enron prosecutor, can pick out several peaks in the nearby Rocky Mountains that he has climbed.

Stricklin took the job in Denver, he says, because it gave him the "leadership role to be able to try a case the way [he] thought it should be tried," he says. For a man who mentions his love of hiking and backpacking on his resume, the mountains were a plus, too.

The Nacchio win has made Stricklin a rising star in the small world of federal prosecutors who have tried high-profile corporate fraud cases.

Current and former government lawyers interviewed for this story say that Stricklin, along with Hearty, the Assistant U.S. Attorney, and Justice Department prosecutors Colleen Conry and Leo Wise, deserves praise for trying a simple, succinct case that led to a long-overdue conviction. "Big kudos to the current crew," says one observer, former Colorado U.S. Attorney Robert Miller, now a partner at Perkins Coie in Denver. "They focused on a theme simple to understand and made it salable."

Though she was technically colead trial counsel with Stricklin, Conry says that "Cliff was the face of the case."

It was a new role for Stricklin. He had assisted in the prosecution of Enron's Richard Causey, Jeffrey Skilling, and Kenneth Lay in Houston and was co-lead prosecutor in the case against five former Enron Broadband Services executives charged with securities fraud and money laundering. But this was his biggest stage.

The prosecution's case boiled down to whether Nacchio traded on his inside knowledge that Qwest was in trouble. The defense argued that Nacchio's stock divestitures were part of a prearranged plan to exercise his stock options and sell before the options expired in 2003. Prosecutors argued that this plan didn't exist anywhere but in Nacchio's head; that in February 2001 Nacchio started selling stock shares at seven times the rate he had specified in an earlier written plan.

Though Stricklin agrees with the indictment against Nacchio that Leone crafted, he says he went into the trial hamstrung by the plea agreements with witnesses. The CFOs pled to deals that spared them prison time, and other witnesses, including Afshin Mohebbi, Qwest's former president, were granted immunity in return for testimony. "That just isn't how it is done," Stricklin says. The deals made his job harder, he says, because jurors might question -- and the defense point out -- the seeming injustice of other executives escaping prison even though they allegedly committed the same crime as Nacchio.

The government wanted what Stricklin calls "conviction moments" that would prove that Nacchio knew that the company was on shaky ground and that he lied to investors. The first of these came courtesy of the defense. A few days into the trial, defense attorney John Richilano, a partner at Richilano & Gilligan in Denver, asked Lee Wolfe, Qwest's former director of investor relations, what Nacchio told him when analysts pressed for more information about the company. Wolfe testified that Nacchio said, "Screw them, go tell them to buy."

Stricklin would seize on Nacchio's disregard for investors in his closing argument. "That gives us almost more insight than any other phrase uttered during the four weeks of testimony," he said. "It about says it all."

Defense lawyers argued that Wolfe had lied on the stand, that Nacchio genuinely believed that Qwest would continue to prosper, that he was distracted by personal problems at home. They said he didn't want to dump his stock, but did so in the mistaken belief that his stock options would expire if he didn't. "An honest mistake in judgment does not rise to the level of criminal intent," his lawyer Stern said in his closing argument.

Another of Stricklin's conviction moments came when Mohebbi testified about memos that he had left on Nacchio's chair in 2000 and 2001, spelling out the company's dire financial straits. Qwest's financial targets for 2001 were a "huge stretch," Mohebbi had written, and the company's dependence on onetime network capacity sales to make up for shortfalls could come back to haunt the Qwest executives. "If we don't crank up recurring growth by April, we got big problems," Mohebbi wrote in another memo in December 2000.

The government used the memos as further evidence that Nacchio was well aware of his company's plight when he sold his stock. A key date, according to the government, was April 24, 2001, when Nacchio reassured analysts and investors that everything was golden at Qwest. By then, he had received months of warnings about the company's deteriorating financial condition and its growing reliance on onetime equipment and capacity sales on its fiber optic network. In her closing argument, Conry played a clip from the recorded call to investors. "He tells them, we've seen nothing to dissuade us [that the company will continue to perform well], and he goes on a selling binge that is unparalleled," she said.

The Denver jury convicted Nacchio of 19 counts of insider trading that occurred after the April 2001 date. (He was cleared of 23 other counts of alleged insider trading that happened earlier.) In post-trial interviews with The Denver Post, jurors said the evidence was clear that Nacchio had been warned many times before this date that the company was in trouble, but that he continued to deceive investors. In July a Denver judge sentenced Nacchio to six years in prison. In August a three-judge panel of the 10th U.S. Circuit Court of Appeals ruled that he could stay free, pending an appeal.

Another branch of the government still seems prepared to go after Nacchio on the old grounds of accounting fraud. The SEC's case, if not settled, will go to trial in 2009 at the earliest. Along with Nacchio, former Qwest CFOs Woodruff and Mohebbi and two top accountants, James Kozlowski and Frank Noyes, face civil charges of securities fraud.

Nacchio is heading to prison, but the road to his conviction surely wasn't what the government imagined when prosecutors announced that they were investigating Qwest more than five years ago. Leone and other prosecutors say that while the system is imperfect, what happened at Qwest shows that prosecutors learn from their mistakes, and from the mistakes of others. How much impact did the lessons learned from other big white-collar cases have on the Qwest case? It is difficult to gauge, but ideas about how to manage prosecutions are shared when prosecutors, like Stricklin, move to different offices; when experienced Justice lawyers like Conry parachute in to help on a case; and when veteran prosecutors tutor new Assistant U.S. Attorneys at the National Advocacy Center in Columbia, South Carolina, the training center for young government lawyers.

However the message has traveled, the idea of simplifying when possible -- in particular, pegging white-collar criminal cases on the question of whether the executive lied to investors -- has clearly caught on. Conry, more than most prosecutors, can appreciate the merits of a trimmed-down case. In 2004 she helped prosecute Richard Scrushy for allegedly directing the accounting fraud at HealthSouth Corp. in Birmingham. In that case, Scrushy was set free despite the testimony of five former chief financial officers who said the former chief executive had bullied and threatened his accounting staff into developing an elaborate scheme to log revenue that didn't exist.

Conry offers the Nacchio indictment -- one crime, 42 counts, seven pages -- as evidence that prosecutors are changing their tactics. In the HealthSouth case, the government had charged Scrushy with 85 counts that covered ten crimes, including mail fraud, money laundering, and conspiracy. "We've all learned that these cases need to be simplified," she says.

Now, if they could only learn to get along. Leone says he hasn't seen Eid since he left the U.S. Attorney's Office. From what he has read in the papers, his opinion is that Stricklin did a nice job, he says, but he doesn't know for sure. "I stayed away from the trial," he says. "If I'm selling a house, I never go back to see what is going on with the carpet."