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How Nacchio sicced the NYSE on Morgan Stanley

Qwest Communications International ex-CEO Joe Nacchio never much liked unpleasant questions about his company from Wall Street analysts.

Qwest Communications International ex-CEO Joe Nacchio never much liked unpleasant questions about his company from Wall Street analysts.

By Justin Schack
October 2002
Institutional Investor Magazine

Qwest Communications International ex-CEO Joe Nacchio never much liked unpleasant questions about his company from Wall Street analysts. Forget about negative research reports.

So when Morgan Stanley decided to downgrade Qwest in June 2001, Nacchio -- who was forced to resign from the faltering company this June -- went all out to silence analyst Simon Flannery. First, Nacchio tried to get Morgan Stanley chairman and CEO Phil Purcell to quash the research report. When that failed, Qwest retaliated.

A note made public by a House subcommittee last month, written by then­Qwest CFO Robin Szeliga shortly after the downgrade, said, "Quietly close Morgan Stanley out of company," and specified investment banking and other business that Qwest would withhold from the firm.

But Nacchio went further. II has learned that late last year Nacchio urged New York Stock Exchange chairman Dick Grasso to investigate Nacchio's claims that Flannery and Morgan Stanley had sold Qwest shares short and had downgraded the company to profit from the sales. The NYSE, according to sources, conducted an approximately five-month-long probe that finally exonerated Morgan Stanley and Flannery in August. The analyst's insights were, of course, on target: Qwest shares have plunged from about $40 in mid-2001 to less than $3 amid federal investigations of its accounting practices.

The story begins in spring 2001, when telecom specialist Flannery, aided by accounting analyst Trevor Harris, began to question whether Qwest was relying too much on one-time accounting benefits to provide a rate of earnings growth that was unsustainable (see "The 2002 All-America Research Team," page 69). Before issuing the report, Flannery called the company for answers to questions he had, but he did not receive any.

But according to people familiar with the matter, Nacchio called Purcell three times in the days immediately before the June 19, 2001, publication of the report, which downgraded Qwest from outperform to neutral. The Qwest CEO complained that the report was inaccurate, and he asked Purcell to delay it and to replace Flannery as the analyst assigned to Qwest.

Purcell held fast. Flannery's report created a huge buzz on Wall Street. It prompted Nacchio to conduct a now-infamous June 20, 2001, conference call with investors and other analysts, in which he said that the Morgan Stanley analysts "aren't the sharpest knives in the drawer" and pledged to never talk with them again.

Late last year, say people familiar with the matter, Nacchio approached NYSE chairman Grasso with the short-selling allegations, which triggered an investigation. Last spring NYSE enforcement officials deposed Flannery and other analysts involved in preparing the report.

Sources say that in the depositions, which lasted several hours each, NYSE officials asked whether the analysts had positions in Qwest shares, how they came to pursue their line of inquiry about Qwest's accounting, how they drew their conclusions and what they thought of reports by other analysts -- including those by former Salomon telecom czar Jack Grubman -- that defended the company against Morgan Stanley's assertions. The Big Board followed these depositions by requesting documents from Morgan Stanley. Not until August, after Nacchio had resigned in disgrace, did the exchange notify Morgan Stanley that it had found no cause to take action.

Regulatory sources say that as a self-regulatory organization governing its member firms, the NYSE was obligated to look into the allegations. An NYSE spokesman declined to comment specifically on the matter, citing exchange policy regarding pending or completed investigations. The exchange spokesman said, "We investigate alleged violations of our rules and the federal securities laws without regard to who is being investigated. We simply focus on the suspected violation itself."

Qwest was one of the biggest listings coups in the history of the NYSE, which gets one third of its revenues from listings fees. Delighted to lure a high-flying technology company at a time when the Big Board was perceived as an information age laggard, NYSE chairman Grasso personally called on Nacchio to recruit Qwest from the rival Nasdaq Stock Market, and he gave the company a highly coveted single-letter ticker symbol ("Q"). In the days leading up to Qwest's January 4, 2000, transfer from Nasdaq, the exchange took out ads in The Wall Street Journal and elsewhere, promising a big surprise to ring in the millennium. Nacchio, accompanied by his father, attended the bell-ringing ceremony in black tie.

Spokespeople for Nacchio and Qwest declined to comment. Flannery, whom money managers selected as the top Telecommunications Services/Wireline analyst in this magazine's annual research rankings (see page 106), and a Morgan Stanley spokeswoman also declined to comment on the investigation.

"Simon is very even-keeled," says an associate. "He said, 'If they want to ask questions, fine.' But people at the firm were pretty angry. And I think deep down he was very disappointed. Here he was making a controversial call that alienates a big fee generator, at a time when there's all this concern about conflicts of interest. And he gets investigated for it? I mean, it's outrageous."