By now, there are few who have not heard the results in the criminal trial of Joe Nacchio, the former chief executive of Qwest. On Thursday, the jury returned a verdict of guilty on 19 counts of insider trading, all from trades during April and May 2001, when, the jury believed, Nacchio knew Qwest might not make its numbers yet reaffirmed the earnings guidance to the market.
The reaction to the verdict has ranged from sadness to relief to vindication. But the message from this trial goes well beyond the consequences to a single CEO and its impact on this particular community.
This country has perhaps the most innovative and entrepreneurial set of businesses in the world. These businesses need funding, and the U.S. has perhaps the most vibrant financial markets in the world.
The U.S. is one of the few (maybe the only) countries where companies with nothing more than a good story can come to the market, persuade investors to buy their shares, and, with the funds, go off and develop their innovative ideas. Many fail, but the ones that survive are the industry leaders. For every WebVan that collapsed during the dot-com boom, an eBay or Amazon survived and flourished.
But the markets in this country thrive because investors believe that the game is not rigged. Investors mostly have the same chance to strike it rich or lose it all. It is not the case that people on the inside, people in the know, get to use their unique knowledge to profit at the expense of others.
The collapse of Enron, WorldCom and even Qwest caused investors to lose faith in the U.S. financial markets. Some of those companies turned out to be houses of cards, their financial statements containing loads of inaccurate information. With corporate officers in these companies cashing out and retirees losing their investments, the perception was that the game was rigged.
Congress reacted by adopting a farsighted piece of legislation called Sarbanes-Oxley, or SOX. The act forced companies to get their financial-reporting obligations in order. As a result, companies, including Qwest, began restating their financial statements in large numbers, with 2006 setting a record. In effect, these restatements were an admission that the numbers previously disclosed were wrong.
SOX has generated a deluge of complaints. Why not? It’s expensive to accurately put together financial statements. But with the costs come benefits. Investor confidence in the U.S. financial markets has returned with a vengeance, with the Dow Jones last week hitting a record high and Nasdaq hitting a six-year high.
What does this have to do with Joe Nacchio? As the jury verdict tells us, he knew that Qwest was having trouble meeting its numbers. Instead of telling the market, he did the opposite, reaffirming the financial guidance and creating the impression that everything was fine.
The behavior no doubt kept Qwest share prices higher than they ought to have been. Nacchio took the opportunity to sell more than a million shares, generating more than $50 million in gross proceeds. In other words, the game was rigged. He was benefiting from his own misleading disclosure.
SOX was meant to restore investor confidence. So does the trial and conviction of Joe Nacchio. It is a reminder to investors in the United States that a rigged game won’t be tolerated.
Jay Brown is a professor of law at the University of Denver. Brown and his students address corporate governance issues in a blog, theracetothebottom.org.
