Academic journal article Brigham Young University Law Review

Insider Trading and Soft Information: U.S. V. Nacchio

Academic journal article Brigham Young University Law Review

Insider Trading and Soft Information: U.S. V. Nacchio

Article excerpt


Joseph Nacchio, former CEO of Qwest, is currently serving a sixyear sentence for insider trading. Nacchio was convicted of insider trading after he exercised his Qwest stock options at the same time he received information that Qwest's 2001 earnings were in danger of falling nearly one billion dollars short of projected revenue estimates. Nacchio's case is unique because it demonstrates the importance of following proper procedure when introducing expert testimony in a criminal trial under the Daubert standard, as well as the difficulty of determining "materiality" in an insider trading case based on "soft" information.

The Tenth Circuit's decision in Nacchio II is problematic for two reasons: first, the court conflated the requirements of Rule 16 disclosures and the Daubert standard for qualifying experts by creating an onerous burden on defendants attempting to admit expert testimony at the early stages of trial. Additionally, Nacchio ITs stringent "soft" information requirement may discourage companies from disclosing accurate or ambitious revenue projections to the public given the potential liability for insider trading if internal documents question the accuracy of those projections. Investors may thus be left with less information to inform their investment decisions.


A. Qwest's 2001 Earnings Estimates

In September 2000, Qwest made public its 2001 earnings projections. Qwest CEO Nacchio1 announced the company's projected total revenue would be in the range of $21.3 to $21.7 billion.2 Qwest also prepared internal targets higher than the projections announced publicly.3

Qwest officials soon became concerned that the public projections were too high. Qwest executives, including Nacchio, received a "risk estimate" forecasting a potential shortfall in 2001 earnings. The memo indicated earnings could end up nearly $900 million below die public projections. This shortfall was based on Qwest's faUure to account for changes in revenue streams. Specifically, Qwest had traditionally counted on revenues from longterm leases of space on Qwest's network known as "indefeasible rights of use" ("IRUs"). Qwest collected the lease payment at the beginning of the lease, and thus, IRU sales produced one-time revenue rather than a perpetual stream of income. As the public projections failed to account for these revenue streams drying up, the risk estimate indicated Qwest would have to make an "aggressive pivot" or "shift" from IRUs to other consistent streams of revenue to meet projections.4 Nacchio further understood that a slow start to 2001 could have a "snowball effect" on the rest of the year's earnings.5 Nacchio acknowledged this reality when he told his sales staff that "something big" had to happen by April or earnings would fall short of estimates.6

Qwest met its projected earnings in the first two quarters of 2001. However, in early April, Qwest's executive vice president informed Nacchio that the IRU market was drying up. In late April 2001, Nacchio discussed Qwest's earnings estimates with investors. Nacchio told investors the company was "still confirming" company projections. When asked to break down the company's revenue streams into recurring streams and one-time transactions, Nacchio refused.7 When further pressed about how Qwest planned to meet its revenue projections, Nacchio merely responded that "Qwest had better products and better management."8

B. Nacchio's Stock Sales

Nacchio, as is common for corporate executives, received a substantial portion of his salary in stock options.9 In October 2000, Nacchio announced that he planned to exercise his options and sell one million shares of Qwest stock per quarter. However, Nacchio did not enter into a fixed sales plan until February 2001. After Qwest stock dropped below $38 a share less than a month later, Nacchio cancelled his fixed sales plan and determined he would sell, as he traditionally had done, during quarterly trading windows. …

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