Price wars, a weak economy and excess network capacity have wreaked havoc in the telecommunications and networking industry. Now, to add to that misery, US investigators want several telecoms companies to open their books and bare their accounting practices to scrutiny. And at the centre of the controversy is the telecom industry’s auditor of choice, the once-mighty Arthur Andersen.
The main problems in the US stem from probes by the Securities and Exchange Commission (SEC), which looked into accounting issues at several telecommunications companies, including Global Crossing, WorldCom and Qwest, which were all audited by Andersen.
Andersen has confirmed that it has received requests for information about the three companies from the SEC. However, a spokesperson for the firm has emphasised that Andersen was believed not to be a focus of the SEC’s investigation into the accounting practices of the telecom companies.
And, he added: “Andersen auditors conducted their audits properly and in accordance with SEC and professional guidelines at all times.”
Andersen was popular with companies in the telecoms industry because of the aggressive accounting practices it developed specifically for the telcos. These include so-called capacity swaps, in which telecom companies allegedly swapped network capacity with others – a technique, say critics, which was solely used to inflate revenue. But Andersen has vigorously defended its treatment of the swaps and has said its white paper on the subject was developed in consultation with others in the accounting field and with the involvement of the SEC.
Executives from the three companies were grilled about swaps when they appeared before a committee of US congressmen. Not only did the executives claim the swaps were properly accounted for in their financial statements, they said revenues garnered from them were insignificant in the big picture.
The politicians were unimpressed. “It appears swaps are being used as a quick and easy way to inflate earnings and make a company look more profitable than it really is,” said representative Sue Kelly, chair of the panel conducting the hearing. She noted also that swaps were not required to be reported in certain earnings statements.
For its part, the SEC is on the record as saying that swaps are not the only focus of its investigation. Steve Cutler, the SEC’s director of enforcement, said the agency’s top policing priority is accounting-related complaints. “Those will get the hardest look,” he said.
In general terms, the SEC probe of the companies relates to questions about how they booked sales, classified the assets of companies they bought and accounted for debts they could not collect.
Tales of potential accounting issues among telecommunications companies have become almost a daily occurrence since high-speed network builder, Global Crossing, which was $12.5bn in debt, filed for Chapter 11 bankruptcy protection in January. It has since commenced restructuring on the understanding that two Asian companies, Hutchison Whampoa and Singapore Technologies Telemedia, would chip in $750m for a controlling stake.
It was in the aftermath of the Global Crossing bankruptcy filing that capacity swaps came to light. A former Global Crossing employee charged in a letter to the SEC that the company improperly inflated revenue using a practice known as “round tripping”, in which one telecom company swaps capacity with another and both book revenue.
Network operators such as Qwest and WorldCom, the second-largest long-distance company in the US, have also struggled as wholesale prices for their capacity have plunged and business customers have cut back on technology spending as the economy weakened. WorldCom has seen its share price drop more than 90% this year to less than $2 after news that the SEC was investigating both its accounting practice and a series of large loans to its then CEO Bernard Ebbers. Ebbers, who stood down in April, has repeatedly said there was no problem with the loans and he intended to pay them back even if he had to liquidate some of his assets.
In mid-May, WorldCom joined some 300 other companies in firing Andersen as its auditors. It gave no reason for the change to KPMG. Global Crossing and Qwest both remain with Andersen.
However, Qwest recently dismissed Andersen from performing non-auditing services, such as consulting. Qwest, which has said its accounting principles met SEC requirements, is under scrutiny on a couple of fronts. One relates to how it recognised revenue and accounted for sales of optical capacity.
A second relates to the company’s sale of telecommunications equipment to customers who either purchased internet services from Qwest or received financing from it.
Separately, Qwest is facing regulators in several US states, which have begun reviews of confidential agreements the company made with competitors.
The regulators are trying to determine whether the pacts favoured competitors who agreed not to oppose Qwest’s efforts to regain long-distance business in its 14 western states region.
Jonathan Hamilton, an analyst at Public Accounting Report, has no doubt that swaps are a technique for generating revenue that isn’t there. “Three to five years ago, the telecoms companies were all meeting analyst projections, but when they stopped doing that, that’s when the questions began,” he says. “This should have been a red alert for people. Swaps on face value are not unethical – yet these swaps are phantom revenue.” Hamilton believes there will now be a total transformation of the telecoms industry, ending in consolidation.
Gartner analyst Jay Pultz disagrees. He says the worst is over for the sector. “When the smoke clears a few carriers will have suffered serious damage, but most will survive,” he says. “In fact, some consolidation will make the survivors stronger, depending on the carrier and the segment.”
Andersen, however, is unlikely to be stronger after the smoke clears.