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[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

 
                   THE EFFECTS OF THE GLOBAL CROSSING 
                   BANKRUPTCY ON INVESTORS, MARKETS, 
                             AND EMPLOYEES
=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                      OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION
                               __________

                             MARCH 21, 2002
                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 107-63

                      U.S. GOVERNMENT PRINTING OFFICE
78-601                        WASHINGTON : 2002
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001

                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa                 JOHN J. LaFALCE, New York
MARGE ROUKEMA, New Jersey, Vice      BARNEY FRANK, Massachusetts
    Chair                            PAUL E. KANJORSKI, Pennsylvania
DOUG BEREUTER, Nebraska              MAXINE WATERS, California
RICHARD H. BAKER, Louisiana          CAROLYN B. MALONEY, New York
SPENCER BACHUS, Alabama              LUIS V. GUTIERREZ, Illinois
MICHAEL N. CASTLE, Delaware          NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York              MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California          GARY L. ACKERMAN, New York
FRANK D. LUCAS, Oklahoma             KEN BENTSEN, Texas
ROBERT W. NEY, Texas                 JAMES H. MALONEY, Connecticut
BOB BARR, Georgia                    DARLENE HOOLEY, Oregon
SUE W. KELLY, New York               JULIA CARSON, Indiana
RON PAUL, Texas                      BRAD SHERMAN, California
PAUL E. GILLMOR, Ohio                MAX SANDLIN, Texas
CHRISTOPHER COX, California          GREGORY W. MEEKS, New York
DAVE WELDON, Florida                 BARBARA LEE, California
JIM RYUN, Kansas                     FRANK MASCARA, Pennsylvania
BOB RILEY, Alabama                   JAY INSLEE, Washington
STEVEN C. LaTOURETTE, Ohio           JANICE D. SCHAKOWSKY, Illinois
DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      CHARLES A. GONZALEZ, Texas
DOUG OSE, California                 STEPHANIE TUBBS JONES, Ohio
JUDY BIGGERT, Illinois               MICHAEL E. CAPUANO, Massachusetts
MARK GREEN, Wisconsin                HAROLD E. FORD Jr., Tennessee
PATRICK J. TOOMEY, Pennsylvania      RUBEN HINOJOSA, Texas
CHRISTOPHER SHAYS, Connecticut       KEN LUCAS, Kentucky
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
GARY G. MILLER, California           WILLIAM LACY CLAY, Missouri
ERIC CANTOR, Virginia                STEVE ISRAEL, New York
FELIX J. GRUCCI, Jr., New York       MIKE ROSS, Arizona
MELISSA A. HART, Pennsylvania         
SHELLEY MOORE CAPITO, West Virginia  BERNARD SANDERS, Vermont
MIKE FERGUSON, New Jersey
MIKE ROGERS, Michigan
PATRICK J. TIBERI, Ohio

             Terry Haines, Chief Counsel and Staff Director
                                 ------                                

              Subcommittee on Oversight and Investigations

                     SUE W. KELLY, New York, Chair

RON PAUL, Ohio, Vice Chairman        LUIS V. GUTIERREZ, Illinois
PETER T. KING, New York              KEN BENTSEN, Texas
ROBERT W. NEY, Texas                 JAY INSLEE, Washington
CHRISTOPHER COX, California          JANICE D. SCHAKOWSKY, Illinois
DAVE WELDON, Florida                 DENNIS MOORE, Kansas
WALTER B. JONES, North Carolina      MICHAEL CAPUANO, Massachusetts
JOHN B. SHADEGG, Arizona             RONNIE SHOWS, Mississippi
VITO FOSSELLA, New York              JOSEPH CROWLEY, New York
ERIC CANTOR, Virginia                WILLIAM LACY CLAY, Missouri
PATRICK J. TIBERI, Ohio

                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    March 21, 2002...............................................     1
Appendix:
    March 21, 2002...............................................    49

                               WITNESSES
                        Thursday, March 21, 2002

Cleland, Scott C., CEO, Precursor Group..........................    39
Cohrs, Dan J., Ph.D., Executive Vice President and Chief 
  Financial Officer, Global Crossing.............................    12
Legere, John J., Chief Executive Officer, Global Crossing........    10
McGrath, Andrew, President, Cable & Wireless Service Providers 
  PLC............................................................    17
McNamara, Will, Director, Energy Industry Analysis, SCIENTECH, 
  Inc............................................................    40
Mohebbi, Afshin, President and Chief Operating Officer, Qwest 
  Communications International, Inc..............................    14
Morrissey, John M., Deputy Chief Accountant, U.S. Securities and 
  Exchange Commission............................................    37
Salisbury, Michael H., Executive Vice President and General 
  Counsel, WorldCom, Inc.........................................    16

                                APPENDIX

Prepared statements:
    Kelly, Hon. Sue W............................................    50
    Oxley, Hon. Michael G........................................    69
    Clay, Hon. William Lacy......................................    71
    Jones, Hon. Stephanie T......................................    72
    Slaughter, Hon. Louise.......................................    73
    Cleland, Scott C.............................................   145
    Legere, John J., and Dan J. Cohrs, joint statement...........    74
    McGrath, Andrew..............................................   126
    McNamara, Will...............................................   160
    Mohebbi, Afshin..............................................   104
    Morrissey, John M............................................   132
    Salisbury, Michael H.........................................   118

              Additional Material Submitted for the Record

Kelly, Hon. Sue W.:
    EITF Abstracts, Issue 00-11..................................    63
    EITF Abstracts, Issue 00-13..................................    66
    Financial Accounting Series, FASB Interpretation #43.........    52
Legere, John J., and Dan J. Cohrs:
    Ralph C. Ferrera, clarification letter to Hon. Sue W. Kelly..   103
    Written response to questions from Hon. Sue W. Kelly.........    93
McGrath, Andrew:
    Written response to questions from Hon. Sue W. Kelly.........   128
Mohebbi, Afshin:
    Written response to questions from Hon. Sue W. Kelly.........   110
Salisbury, Michael H.:
    Written response to questions from Hon. Sue W. Kelly.........   123

                   THE EFFECTS OF THE GLOBAL CROSSING 
                   BANKRUPTCY ON INVESTORS, MARKETS, 
                             AND EMPLOYEES

                              ----------                              

                        THURSDAY, MARCH 21, 2002

             U.S. House of Representatives,
      Subcommittee on Oversight and Investigations,
                           Committee on Financial Services,
                                                    Washington, DC.
    The subcommittee met, pursuant to call, at 10:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Sue W. Kelly, 
[chairwoman of the subcommittee], presiding.
    Present: Chairwoman Kelly; Representatives LaFalce, Tiberi, 
Oxley, Jones, Capuano and Clay.
    Also present: Representatives Slaughter and Baker.
    Chairwoman Kelly. Good morning. This hearing of the 
Oversight and Investigations Subcommittee of the House 
Financial Services Committee will come to order.
    I want to thank all Members of Congress who are present 
today, and without objection, all Members present will 
participate fully in the hearing. Their opening statements and 
their questions will be made part of the official hearing 
record. In the interest of ensuring proper subcommittee 
consideration of H.R. 3763, The Corporate and Auditor 
Accountability, Responsibility, and Transparency Act, known as 
CARTA, we are here today to examine the status of the 
telecommunications industry.
    We will hear from the executives of the companies, from the 
industry experts, and from an accounting expert at the 
Securities and Exchange Commission. Global Crossing's 
bankruptcy in January marked the fourth largest bankruptcy in 
the history of the United States.
    It serves as an ominous warning to the financial and 
business community and has had far-reaching consequences. While 
the overall downturn in the telcom industry was a factor in the 
collapse, the fall of Global Crossing raises serious questions 
about current accounting practices, disclosure requirements, 
and corporate management.
    Just yesterday we learned that Global Crossing did not 
disclose a complex communications deal, several months before 
the company filed for bankruptcy in January. Experts called the 
lack of disclosure a serious lapse by management.
    An estimated 500,000 jobs have been lost in the telecom 
industry. Global Crossing's bankruptcy resulted in the loss of 
an estimated 9,000 jobs, and has caused real harm to investor 
confidence.
    It has had an impact on my home State of New York. 
Statewide, Global Crossing has eliminated hundreds of local 
jobs, and the New York State Pension Fund lost $63 million as a 
result of the collapse.
    How did a company that was perceived by all conventional 
measures as healthy, fall so far so fast? By all accounts, 
Global Crossing was a winner, but now we know that it was 
actually a financial time bomb.
    Did some top executives know that the clock was ticking and 
that time was running out? One thing is certain. We do know 
that the bomb was tossed right in the lap of employees and 
investors who didn't have a clue that the company was going 
under.
    The collapse of Global Crossing calls into question, how 
much confidence employees, investors, and the public should 
have in financial information that's released by companies, 
particularly the pro forma financial projections. Since these 
pro forma statements are not required to use Generally Accepted 
Accounting Principles, known as GAAP Principals or GAAP 
Accounting, a company such as Global Crossing can massage the 
numbers on these pro forma financial statements, or, in other 
words, these pro forma statements can provide an easy 
opportunity to cook the books.
    In the case of Global Crossing, the company's pro forma 
statements may have misinformed investors and employees as to 
the profitability and performance of the company. In an 
examination of Global Crossing's filings submitted last spring 
with the SEC, the company reported an additional $531 million 
in earnings in the pro forma statement, pumping up earnings by 
nearly 50 percent as the result of controversial swaps 
activities.
    However, the $531 million was not included in the company's 
GAAP-compliant statement of earnings. Why not? Because under 
present required disclosure regulations, it didn't exist. It 
wasn't required to exist.
    In addition, we need to examine the way in which companies 
report their swaps of indefeasible rights of use known as IRUs. 
It appears that swaps are being used as a quick and easy way to 
inflate earnings, and make a company look more profitable than 
it really is.
    Investors deserve accurate information and in some cases, 
they appear not to be getting it. We need to know how the SEC 
views these IRUs, since some have alleged that this accounting 
practice has misled investors and the companies' employees as 
to the true profitability of the corporations.
    Other issues raised by the collapse of Global Crossing 
include corporate governance and responsibility, including 
blackout periods imposed on employee 401K plans. At the highest 
levels of Global Crossing, top executives were selling stock 
and pocketing millions before the company's collapse. Former 
CEO Gary Winnick, sold stock worth $734 million before the 
company collapsed, while this winter, employees of his company 
watched their savings, investments, and severance packages 
disappear.
    The purpose of this hearing is to take an honest look at 
the issues surrounding this collapse. The ultimate goal is to 
protect workers and investors and prevent this from happening 
in the future through new legislation, if it's necessary.
    Accounting methods, financial disclosure, and transparency 
and corporate governance are matters that the Full Committee is 
deliberating right now. I believe that CARTA provides a 
comprehensive solution to our concerns and will restore 
investor and employee confidence in company disclosures.
    I would like to note for the record that we invited the 
President of the Communications Workers of America to testify, 
however, he was unable to join us due to scheduling problems. 
In addition, we also invited the American Institute of 
Certified Public Accountants to testify, but they were also 
unable to accept the invitation.
    [The prepared statement of Hon. Sue W. Kelly can be found 
on page 50 in the appendix.]
    Chairwoman Kelly. Unfortunately, my friend, the Ranking 
Member, Mr. Gutierrez, is unable to join us today, so I will 
now recognize the Ranking Member for the Full Committee, 
Congressman LaFalce, for his opening statement. Mr. LaFalce.
    Mr. LaFalce. Thank you very much. First of all, I am 
delighted that you are having this hearing today. I think it's 
very, very important, and I am pleased we have such 
distinguished witnesses.
    Once again, investigation into the companies, most 
particularly Global Crossing's conduct, by the Securities and 
Exchange Commission and by the Justice Department have raised 
the specter of another major United States company that may 
have been engaged in very deceptive accounting practices.
    While we do not yet know for certain if Global Crossing 
engaged in fraudulent accounting practices, there are certainly 
very serious questions as to whether it engaged in practices 
that had far more to do with meeting analysts' earnings 
estimates than with economic substance.
    While its ultimate failure may have had to do primarily 
with its underlying business model, and also--and very 
importantly--excess industry capacity, Global Crossing may well 
have succeeded in keeping its share price inflated much longer 
than was justified, based upon its true value.
    Global Crossing may not be alone within the world of 
companies or within the world of telecommunications companies. 
The Financial Services Committee is currently considering 
legislation aimed at correcting the systemic weaknesses that 
have become all to apparent in our financial reporting system.
    Mrs. Kelly has mentioned one of them, CARTA. That's been 
introduced by the Chairman and co-sponsored by many individuals 
in this subcommittee. There is another approach, too. While 
there's nothing wrong with the CARTA approach, in my judgment, 
as far as it goes, I just don't think it goes nearly far 
enough, and so I've introduced a bill, CIPA, The Comprehensive 
Investor Protection Act, and it, too, has been co-sponsored by 
a great many Members of our subcommittee and others within the 
House.
    Some of the witnesses in our past hearings have warned that 
we should not overreact to the collapse of Enron and some other 
companies. Well, I don't think we should overreact to anything, 
but I don't think we should under-react, either.
    The failure of Global Crossing, Enron, and so forth, is a 
powerful reminder that this is not just about the foibles of 
one or two companies, but it's about fundamental weaknesses 
that afflict our financial reporting system. The safegaurds 
intended to protect investors have been overwhelmed by the 
temptation for companies to sometimes cheat, but more often, 
overstate or obscure their financial disclosure to improve 
short-term results, to improve market capitalization, to meet 
analyst or investor expectations or analyst hype.
    If we are to break out of this cycle of improprieties, I 
believe that we must fundamentally do a number of things. We 
must alter the relationship of the auditor to its client, 
making sure that everybody realizes that the auditor's 
responsibility is a fiduciary responsibility to the public.
    We must strengthen corporate governance. I just think that 
the line between the boards of directors and the offices 
sometimes has been blurred, and boards of directors too often 
become passive puppets of officers--not always, to be sure, but 
too often. This is especially true with respect to audit 
committees, and we must provide meaningful oversight to both 
the accounting profession and the securities industry analysts.
    I've introduced a bill, as I've said, that seeks to do 
exactly that. I look forward to working with the Members of our 
subcommittee as we seek to learn the facts of the failure of 
Global Crossing and its management practices, its accounting 
practices, as I look forward to hearing today from other 
participants within the telecommunications industry to gain 
their perspective. And I hope that we can create a legislative 
response that will not simply follow the lead of either the 
Chairman or the Ranking Member, but a legislative response that 
will take each issue, issue-by-issue, and attempt to come up 
with a response that is the best way to deal with a particular 
issue, regardless of which side of the aisle it originated on. 
I thank the Chair.
    Chairwoman Kelly. Thank you very much, Mr. LaFalce.
    We turn now to the Chairman of the full Committee on 
Financial Services, Mr. Oxley.
    Mr. Oxley. Thank you, Madam Chairwoman, for this timely 
and, we hope, illuminating hearing today. It seems that each 
day brings us new allegations about the use or misuse of 
complex accounting practices that hide the information needed 
by the markets to assess a company's health.
    When this happens to a healthy company during a period of 
growth, the company can work its way through it, but when the 
company is already experiencing a severe downturn in its 
business and then has its accounting question, as was the case 
with Global Crossing, it can be devastating.
    There are two sets of victims who get burned in this cycle: 
Investors suddenly receive new and damaging information about 
the company, and then lose confidence in it, and worse yet, the 
employees then lose their jobs and their pensions when the 
businesses turn bad and the capital markets freeze, because the 
good news they had about the company was not necessarily true.
    While the Enron bankruptcy first brought these issues to 
our attention, it appears that Global Crossing, which has also 
declared bankruptcy, and other telecom companies accounted for 
key activities in a way that raises serious concerns. Employees 
and investors need to know whether they engage in swaps of 
capacity that had a legitimate business purpose or did not, and 
whether they were accounted for properly or in a way that just 
pumped up their projected cash flow and stock prices.
    Global Crossing entered into these capacity swaps with a 
number of companies, including Qwest, Cable and Wireless, and 
WorldCom at a time when the entire telecom world was 
experiencing an excess of capacity. We need to understand how 
the industry's overall problems intersected with the use of 
those swaps.
    I want to thank the CEO and CFO of Global Crossing and 
executives of Qwest, WorldCom and Cable and Wireless for 
agreeing to appear before us today to explain these issues to 
the subcommittee and to the American people. It is only by 
investigating these practices that we can help investors to 
base their decision upon a company's real financial condition, 
not just a projection released without an objective opinion by 
an independent party.
    Just as important to my way of thinking is the desire to 
protect shareholders and employees from the kinds of activities 
that are often characterized as sweetheart deals that might 
have had an adverse impact on shareholder's value. Some of 
these practices include special treatments for loans, bonuses 
and pension payouts.
    We need to discuss the propriety of 401K blackout periods 
wherein some employees are precluded from selling stock for 
specified periods of time. This hearing will be of enormous 
assistance in assuring that H.R. 3763, The Corporate and 
Auditing Accountability, Responsibility, and Transparency Act 
of 2002, or CARTA, is successful and effective.
    In order for our Nation's economy to remain on sound 
footing and to continue its recovery and anticipated growth, it 
is vital for the American investor to have access to the most 
recent, meaningful, and accurate information possible. Good 
corporate governance is necessary for such an environment to 
exist, and that is one of the things we are seeking to 
accomplish by the introduction and implementation of the CARTA 
legislation.
    Madam Chairwoman, we were pleased to have testimony 
yesterday from the Chairman of the SEC, who indicated very 
strongly, his support of our legislation and for a new way of 
looking at things in this modern world, particularly in the 
telecommunications sector. And for that, I think all of us can 
learn a great deal, not only from Mr. Pitt's testimony, but 
certainly from our witnesses today. And I thank you for the 
opportunity, and I yield back.
    [The prepared statement of Hon. Michael G. Oxley can be 
found on page 69 in the appendix.]
    Chairwoman Kelly. Thank you very much, Mr. Chairman.
    We turn now to Mrs. Jones.
    Mrs. Jones. Thank you. To Chairwoman Kelly; Vice Chairman 
Paul; Full Committee Chairman, Mr. Oxley; Ranking Member, Mr. 
LaFalce; and Members of the subcommittee, the witnesses who 
have come here this morning, thank you for coming.
    In the wake of Global Crossing we have seen firsthand, the 
effects of poor corporate governance, perhaps, and financial 
irresponsibility, perhaps. The issues have been complicated, at 
best. The misdirection, finger-pointing, and complexity of 
personalities and accounting involved in the situation have 
made the root issues difficult to parse.
    However, when the Gordian Knot has been tied by the Globals 
of the world, I think that it's best that we get back to basics 
and move forward to evaluate our position as a Nation with 
regard to corporate responsibility, governance, and ethics.
    Let me first address those directly responsible for the 
well being of those least able to protect themselves. At a 
basic level, it is the role of the board of directors of any 
company to protect and act in the best interest of the 
shareholders. Protecting shareholders is a task simple enough 
to speak of, but seemingly infinite in its difficulty to 
perform.
    Shareholders have no choice but to trust the board as 
fiduciary agents to act in their best interest, and it is 
because of this dependence that we must carefully evaluate what 
led to the down fall of Global Crossing. Second, we must 
examine the role that Global's corporate auditors had in 
effecting the company's downward spiral.
    Is it more than a coincidence that Global Crossing and 
Enron were both audited by Andersen? Perhaps. But we are sure 
that both Enron and Global shared the same fate in Chapter 11 
bankruptcy.
    The notion of true auditor independence is at issue, and, 
specific to this hearing, how big of a factor it was in Global 
Crossing's demise, we hope to learn today.
    Finally, I would like to acknowledge the employees of 
Global, who have often been overlooked in the media storm 
surrounding its once proud employer. I received several letters 
in my Congressional office from many of my constituents saying, 
why isn't Global getting the same attention as Enron? To each 
of my constituents who wrote to me, today we're going to 
address that issue.
    Over 9,000 people lost their jobs as a result of the Global 
bankruptcy, most of which were unaware of the accounting 
improprieties that may have cost the company its life. The 
reach of the Global Crossing debacle into the 
telecommunications sector was deep: By some estimates over 
500,000 jobs and $2 trillion in market capitalization in the 
sector was lost as a direct result of Global Crossing's 
bankruptcy.
    This is reason enough why we must continue to scrutinize 
what happened to Global Crossing so that it will never happen 
again. Madam Chairwoman, I am pleased that you are hosting this 
hearing today. I thank everyone who has come out to testify, 
and I trust that we will get to the bottom of many of the 
issues that have been raised by both corporate leaders, by 
shareholders, by auditors, and by the general public. I yield 
the balance of my time; thank you very much.
    [The prepared statement of Hon. Stephanie T. Jones can be 
found on page 72 in the appendix.]
    Chairwoman Kelly. Thank you very much, Mrs. Jones.
    We turn to Mr. Tiberi. You have no opening statement at 
this time? Thank you, Mr. Tiberi.
    We turn to Mr. Capuano.
    Mr. Capuano. Thank you, Madam Chairwoman. I have no opening 
statement, because anything I said would probably be 
unprintable, based on this issue.
    Chairwoman Kelly. Thank you, Mr. Capuano.
    We turn to Mr. Baker.
    Mr. Baker. Thank you, Madam Chairwoman. I especially want 
to express your appreciation for your courtesy, not being a 
Member of the subcommittee, to allow my participation this 
morning.
    I'll be very brief, but, I hope, to a specific point. I 
first want to express my appreciation for the gentlemen's 
appearance here today in helping the subcommittee to understand 
the mechanics of how this reporting difficulty occurred, and 
hopefully leading us to some resolution. It appears, 
preliminarily, that although there was compliance with the 
letter of the law, the letters weren't necessarily in an order 
that spelled anything.
    In my review of the pro forma financials, even after the 
July 1999 1043 revisions, it appears that compliance, 
technically, with the warning statement, ``Read at Your Own 
Risk,'' sort of like a Surgeon General's warning, that if 
anyone wanted to get to the details of the content of corporate 
structure, you would go primarily to the pro forma, because 
there appeared to be more information than as to the GAAP 
standards.
    It does indicate to me, at least, preliminarily, that the 
metrics included increasingly greater amounts of cash receipts 
for future sales and services that were not provided at the 
time of the revenue being reported, on the belief that those 
sales would eventually close.
    In my simple calculation, that's called counting your 
chickens before they hatch, but there may be reasons for that 
conduct. Clearly, there is extraordinary pressure from Wall 
Street for corporations to meet quarterly expectations for cash 
revenues and the adjusted EBITDA, as it's called, and I can 
understand the pressure to generate a report that indicates 
that the cash is coming or is in the bank.
    However, the definitions that were utilized, whether it's 
cash, cash receipts, adjusted EBITDA, are not apparently 
consistent from one telecom company to another in the 
methodology by which these quantities are measured or reported.
    For example, a cash receipt in this instance would have 
been for, I believe, the sale of broad band capacity for 
portions of the network not yet complete. Madam Chairwoman, let 
me make that point. If I'm understanding the reports properly, 
they booked revenue in the current quarter for sale of broad 
band capacity for a portion of the network which was not yet 
constructed. I think that is something that needs to be 
thoroughly discussed.
    And, further, the company would incur substantial out-of-
pocket expenses to fulfill these obligations at a later time, 
but that deduction was not taken in adjusted EBITDA. It appears 
that some of the transactions were actually swaps and not cash 
revenues, or, stated another way, money round tripped between 
parties that did not add value.
    All of this apparently is within the context of the law, as 
I understand it, under the preliminary cover of legitimate 
business purpose, which is not a regulatory not statutory 
definition, but an accounting convention.
    I think we need help in examining legitimate business 
purpose. It appears that the reporting, although consistent 
with rule and regulation, would lead a person to come to 
conclusions about cash adequacy that were entirely 
inappropriate in relation to the actual cash standing at the 
time of the report.
    Madam Chairwoman, I don't have sufficient time to examine 
all of these questions this morning, and I would ask your 
further diligence, Madam Chairwoman, if I could perhaps provide 
more clarity with my questions in a written comment for the 
Chair to consider forwarding at the appropriate time, and I 
thank you for your courtesies.
    Chairwoman Kelly. With unanimous consent.
    Mr. Baker, you had mentioned that you were not a Member of 
the subcommittee, but you are a Member of the full Financial 
Services Committee, and, as such, you are welcome here at this 
panel.
    We turn now to Mr. Clay. Have you an opening statement, Mr. 
Clay?
    Mr. Clay. Madam Chairwoman, at this time, I will forego an 
opening statement, and wish to hear from the panel and have 
questions for them, thank you.
    Chairwoman Kelly. Thank you very much.
    Ms. Slaughter.
    Ms. Slaughter. Madam Chairwoman, I thank you very much for 
allowing me to be here this morning. As you know, I'm not a 
Member of this subcommittee, and you are very gracious in 
allowing me to come. I appreciate the opportunity to submit my 
statement for the record.
    And my interest in this hearing stems from the fact that 
thousands of people from my district have been affected by 
Global Crossing's bankruptcy filing. Actually, all the people 
in my district have been affected by it, because the economic 
displacement has the possibility of being quite profound.
    Global Crossing's North American headquarters were located 
in Rochester, New York, and I hope they still are. They owned 
Frontier Communications which had an outgrowth from the 
Rochester Telephone Company, which had given wonderful service 
to the people of Rochester area for over 100 years. And then 
their 13,000 workers were taken over by Global Crossing with 
220 workers.
    Now, as I said, the effect is devastating, and came as 
quite a surprise, as we had every indication in Rochester that 
Global was doing well, and, indeed, was planning to consolidate 
and move, and had gotten from the local IDA some $400,000 to 
help expedite that, on the grounds that they would immediately 
hire 72 new workers.
    The bankruptcy came as a surprise to a lot of people 
because, indeed, the company still had adequate assets 
according to most people that I've spoken to, to continue. As a 
matter of fact, one of the first things that struck us as 
strange was that the offer for Global Crossing of $750 million 
was going--I think that was something like 69 percent ownership 
of that company, which claimed to have assets of $22 billion.
    On March 9th, we hosted a public forum in Rochester, and 
over 250 people came to talk about their experiences, and it 
was heartbreaking. I'd like to quote from an article I 
received, written by a former employee, who summarizes the 
general sentiment at the forum:
    ``Many former employees have been economically devastated 
as the result of corporate greed and the mismanagement of 
Global Crossing. People spent their life savings, they've had 
to cash in their deflated--since the stock market plummeted--
retirement 401K plans, just to survive the last few months, 
after Global Crossing abruptly ceased their promised severance 
payments.
    ``Some former employees are forced to file bankruptcy 
themselves, while others may lose their homes, have had to 
drastically change their lifestyles, and are barely 
surviving.'' Again, another impact on my community is that many 
of those extraordinarily talented and gifted people may have to 
leave our community altogether, because they are not able to 
find jobs that they can take care of their family.
    According to the press reports, there appears to be 
striking parallels between the cases of Enron and Global 
Crossing, including a lack of auditor independence, 
questionable executive mismanagement, misleading accounting 
methods, and questions on the accessibility of employees' 401K 
accounts before the bankruptcy filing.
    And unlike the small shareholders and company workers, 
current and former top executives walked away the winners. This 
hearing begins the process of Congress asking the tough 
questions on how this occurred. Where did the system break down 
and allow this to happen?
    Hearings like this will serve as a wakeup call to Congress, 
and, we hope, to corporate America, particularly those who are 
organized in Bermuda, that these types of business practices 
and bankruptcies can be neither sustained nor tolerated.
    Additionally, current law must change to better protect the 
workers and investors, and, across the board, investors are now 
skiddish about relying on auditors' reports and analyst 
recommendations and that is a tragedy.
    I certainly look forward to listening to the witnesses' 
views, their experience, and their suggestions on how Congress 
can take effective action, and I thank you again, Madam 
Chairwoman.
    [The prepared statement of Hon. Louise Slaughter can be 
found on page 73 in the appendix.]
    Chairwoman Kelly. We thank you.
    If there are no further opening statements, I will 
introduce our distinguished panel of leaders of the 
telecommunications industry. We sincerely appreciate the effort 
that it took for you to prepare testimony on this difficult 
issue, and to travel here today. Mr. McGrath, you came from 
England, and I think you get our award for the longest traveled 
visitor to get here today, and for that, you get a free glass 
of water. I thank you all for making the effort.
    Our panel consists of Mr. John Legere, the Chief Executive 
Officer; and Mr. Dan Cohrs, the Executive Vice President and 
Chief Financial Officer of Global Crossing, Ltd. Next, we have 
Mr. Afshin Mohebbi. I'm pronouncing that wrong. Mr. Mohebbi, is 
that correct?
    Mr. Mohebbi. Yes.
    Chairwoman Kelly. Thank you, Afshin Mohebbi, the President 
and Chief Operating Officer of Qwest Communications 
International; Mr. Michael Salsbury, Executive Vice President 
and General Counsel of WorldCom, Incorporated, and, Mr. 
Salsbury, we welcome you; and finally, Mr. Andrew McGrath, 
President of Service Providers Channel, Cable and Wireless 
Global.
    We welcome you all here today, and we are looking forward 
to your testimony, and we thank you for appearing here. We 
begin with you, Mr. Legere.
    Mr. LaFalce. Madam Chairwoman, a parliamentary inquiry.
    Chairwoman Kelly. Yes, sir?
    Mr. LaFalce. It is my understanding--not that it is 
necessary to tell the witnesses, but it won't hurt--the laws of 
perjury that obtain when you are asked to stand and be sworn in 
are the same, even though you're not asked to stand and be 
sworn in. The mere fact that you're testifying before Congress 
makes you fully subject to all the laws of perjury; is that 
correct, Madam Chairwoman?
    Chairwoman Kelly. That is correct.
    Mr. LaFalce. Thank you, Madam Chairwoman.
    Chairwoman Kelly. You are still liable for your statements 
in front of this subcommittee, even though we are not swearing 
you in as witnesses. We all look forward to listening to your 
views on these important issues we touched on in our opening 
statements, and without objection, your written statements and 
any attachments will be made part of the record.
    You will each now be recognized for 5 minutes for a summary 
of your testimony. There are lights in front of you and they 
indicate the amount of time you have. The green light signifies 
that you're in your first of the 4 minutes. The yellow light 
will turn on when you have 1 minute remaining; the red light 
will turn on when your time has expired. If possible, I would 
like to ask you to keep your summaries within the 5-minute 
sequence, so that people can ask questions.
    And we'll begin with you, Mr. Legere.

 STATEMENT OF JOHN J. LEGERE, CHIEF EXECUTIVE OFFICER, GLOBAL 
                       CROSSING, LIMITED

    Mr. Legere. Good morning, Chairwoman Kelly and Members of 
the subcommittee. We prepared a longer statement, which I 
understand will be filed for the record. Now, this is my first 
appearance before a Congressional subcommittee, and I'm honored 
to contribute to your effort to take a serious look and a 
substantive look at the difficult financial issues facing the 
telecommunications industry.
    Our difficulties at Global Crossing and the measures we are 
taking as we continue our restructuring in bankruptcy, is a 
microcosm of an industry under tremendous economic pressure. 
I'm accompanied here today by Dan Cohrs, Global Crossing's 
Chief Financial Officer, and Ralph Ferrara, who is our outside 
counsel.
    In response to the questions posed in your letter of 
invitation, we would like to respond to the three issues you 
raised. Dan Cohrs will respond to the first two of your 
questions, and I would like to provide a brief overview of 
Global Crossing and our efforts to rebuild our company.
    My written statement amplifies on these remarks to respond 
to your final question, and to address steps that can be taken 
to enhance investor confidence in the accounting for and 
disclosure of financial information in the telecommunications 
industry.
    Now, it's all too easy to dismiss Global Crossing's 
bankruptcy as the failure of yet another dot.com company or to 
attribute its collapse to fancy or misleading accounting. The 
media in this post-Enron environment, continue to focus on 
these issues.
    The reality is that thousands of our employees continue to 
operate the real Global Crossing. Today, Global Crossing has 
over 85,000 customers, corporations, governments, associations, 
and organizations in over 200 cities in 27 countries who 
transmit voice and data over our global network.
    Every day our employees keep coming to work, keep helping 
the customers keep the data moving, and keep their spirits 
high. I want to take this opportunity to thank them publicly 
and to thank our thousands of loyal customers who have 
supported us through this challenging time.
    A few facts about what Global Crossing really does: We 
transmit over $5 trillion U.S. dollars in financial 
transactions every business day. We connect over 7,000 
financial institutions and hundreds of scientific research 
centers across the globe.
    The Global Crossing network carries CNBC's video between 
Ft. Lee and London, over our high-capacity sub-sea fiber optic 
cables, something previously only satellites could do. NBC 
transported hundreds of hours of Winter Olympic news broadcasts 
to its affiliate stations across America over our network.
    Because of our network, customers in KB Toy Stores can 
charge their purchases five times faster, and diplomats in over 
240 British Embassies and Consulates can correspond with their 
colleagues, 24/7, reliably and securely. Many people who will 
see these hearings on television and reported on the nightly 
news shows, will be watching signals transmitted over our 
network.
    Now, our pride in what we have accomplished is, of course, 
offset by tremendous disappointment. Although our network 
infrastructure is unique and unparalleled in the industry, 
building it came at a very high price, in excess of $15 billion 
U.S. dollars.
    Global Crossing, like many other telecommunications 
companies, built aggressively as the forecasts of industry 
analysts, financial analysts, and technology experts predicted 
that our world would soon be one where classrooms would reside 
on computer desktops; movies would flow electronically on 
demand; and millions of people would be able to communicate 
through millions of personal channels.
    And though we continue to believe that people will one day 
be able to take advantage of this expansive infrastructure, the 
demand simply hasn't materialized as quickly as predicted. In 
what became a very volatile environment for the entire 
telecommunications industry, our company simply could not cut 
costs back fast enough to accommodate the sudden changes.
    We need to take a more realistic approach. Part of what 
we're doing through the Chapter 11 bankruptcy process and 
through a continued series of painful cost reductions, is to 
restructure our balance sheet and realign our operations.
    Since my arrival 6 months ago, my prime focus has been to 
realize the true potential of our company. With our 
restructuring now well underway, and despite the necessary and 
often painful actions we have had to take, my belief is that we 
will come back stronger than ever.
    You asked for our views on H.R. 3763. We believe it 
provides a useful framework for discussions on auditing 
accountability, and we have offered several specific 
suggestions in our written testimony.
    While our company and our industry continue the 
challenging, critical process of building the new business 
model in the more realistic context, we fully support the 
efforts of this subcommittee to develop, in parallel, ways of 
encouraging financial accountability that will enhance investor 
confidence in financial reporting in the telecommunications 
industry.
    We have an opportunity, working together with you, with the 
SEC, with the accounting industry, and with our 
telecommunications industry colleagues here today, to improve 
the way we communicate. Whether this is through reformed 
accounting principles or clearer and more timely reporting 
practices, we support and intend to be the market leader, not 
only in how we run our business, but also in how we report on 
what we're doing. I'm confident, with our joint efforts, this 
industry, and Global Crossing, in particular, will once again 
be in a position to contribute strongly to this great Nation's 
prosperity. Thank you very much.
    [The prepared joint statement of John J. Legere and Dan J. 
Cohrs, Ph.D., can be found on page 74 in the appendix.]
    Chairwoman Kelly. We turn to you, Mr. Cohrs. Do you have a 
statement?

STATEMENT OF DAN J. COHRS, Ph.D., EXECUTIVE VICE PRESIDENT AND 
       CHIEF FINANCIAL OFFICER, GLOBAL CROSSING, LIMITED

    Mr. Cohrs. Yes, ma'am, if I may. Good morning, Chairwoman 
Kelly and Members of the subcommittee and also the Full 
Committee. John Legere has asked that I briefly address the 
accounting issues raised in your invitation to appear here.
    Our industry and the accounting profession have struggled 
with how to adapt historic concepts of accounting for leases 
and real estate to purchases and sales of fiber optic capacity. 
Global Crossing settled upon an accounting model that our 
independent accountants advised was most appropriate to our 
business.
    The accounting for the majority of our revenue, which is 
derived from providing voice and data services to our 85,000 
customers, is not controversial. The accounting for the 
company's sales to other carriers of fiber optic capacity on 
its network raises the issue of the proper accounting for 
transactions known as sales of IRUs.
    An IRU, which is an indefeasible right of use, is a 
contract like a lease, granting the right to use a fixed amount 
of capacity for a specified period. IRUs have been used in the 
telecom business for many years.
    Typically, the sale of an IRU involves an up-front cash 
payment of the full contract amount. However, revenue from the 
sale of an IRU is recorded only over the life of the lease. For 
example, for a 20-year lease for $20 million of capacity, only 
$1 million is recorded as GAAP revenue in the income statement 
for the first year and each year thereafter.
    The other $19 million of cash paid up front on the contract 
is not recorded as revenue, but is recorded on Global 
Crossing's GAAP balance sheet as a liability called deferred 
revenue. Although Global Crossing has the cash in its bank 
account and the cash is non-refundable, it earns the revenue 
only over the 20-year life of the lease.
    Not surprisingly, banks and investment analysts who need to 
assess the company's ability to service its debt were 
interested in our cash flow, including the amount of cash 
collected through IRU sales, which was shown as deferred 
revenue. The cash entering the deferred revenue account was not 
reflected in GAAP revenue or earnings.
    To present a clearer picture of cash flow, two measures--
cash revenue and adjusted earnings before interest, taxes, 
depreciation and amortization, which we called adjusted 
EBITDA--were reported to the market to supplement our GAAP 
revenue and earnings. These measures included the cash from IRU 
sales; they were clearly defined, and we believe they were well 
understood by the marketplace.
    Some questions have been raised about the quality of the 
company's disclosure respecting cash revenues and adjusted 
EBITDA. We are confident that Global Crossing fully and fairly 
disclosed the meaning of these terms in its press releases and 
SEC filings, and we believe that the additional information 
provided by these measures was useful to investors.
    The focus of virtually all the attention to Global 
Crossing's accounting model has been directed at how the 
company accounted for the relatively simultaneous purchase and 
sale of IRUs to the same counterparty. As the Global Crossing 
network grew, we and other carriers understood that it was 
sometimes cheaper and faster to buy capacity from another 
carrier than to build it ourselves.
    In our case, we needed additional capacity on certain 
routes, redundant capacity to provide backup for potential 
network problems, and extensions of our network into new 
markets where building would not have been economic. 
Accordingly, we purchased IRUs for cash, as well as sold IRUs 
for cash, sometimes with the same counterparty.
    These were two, independent transactions, each evaluated on 
its own merits. Nonetheless, due to the proximity in time of 
the two transactions, the question has been presented of 
whether revenue should be recognized on these sales with the 
purchases recorded as capital expenditures, rather than simply 
netting the sale and purchase amounts.
    According to the accounting model that was developed and 
approved by our independent accountants, revenue and capital 
expenditures should be recognized on the two transactions, if, 
first, there was a valid business purpose for the asset we 
bought, and, second, the assets bought and sold embodied 
different risks and rewards of ownership.
    In our case, the second test can be satisfied if the rights 
to the capacity sold had the risk profile of an operating lease 
and the rights to the capacity purchased had the risk profile 
of a capital lease. Today, some have raised questions as to 
whether the process we conducted adequately established the 
valid business purpose for our purchase of assets; that is, did 
we satisfy the first test? And that is the crux of the 
controversy.
    It's the subject of a detailed review by our Board of 
Directors and its independent counsel. The SEC and our 
independent accountants are also reviewing these transactions.
    As we conduct these reviews, it's critically important to 
consider only the facts and circumstances that existed at the 
time the transactions were closed, not use hindsight. We now 
know that since the second quarter of 2001, the astounding 
deflation in the demand for fiber optic capacity has devastated 
our industry.
    As demand waned in the industry, there was less need for 
both the capacity that we had built and for the capacity that 
we had purchased. These difficulties have also been experienced 
by others in our industry.
    We hope to have fully considered conclusions on these 
matters in the very near future, and I'll be pleased to respond 
to any of your questions, thank you.
    Chairwoman Kelly. Thank you very much, Mr. Cohrs.
    We turn to you, Mr. Mohebbi.

  STATEMENT OF AFSHIN MOHEBBI, PRESIDENT AND CHIEF OPERATING 
          OFFICER, QWEST COMMUNICATIONS INTERNATIONAL

    Mr. Mohebbi. Thank you, Madam Chairwoman, and Members of 
the subcommittee. My name is Afshin Mohebbi, President and 
Chief Operating Officer of Qwest Communications International, 
Incorporated. I want to thank you for inviting me to appear 
today at your hearing.
    Permit me to tell you a little bit about Qwest. Qwest is 
the fourth largest local telephone company in the United States 
with 25 million customers. We provide local services in a 14-
state area that covers nearly 40 percent of the land mass of 
the United States. We have about 60,000 employees and annual 
revenue of more than $19 billion.
    About 80 percent of our revenues, and more than 90 percent 
of our profits come from our local phone service. We also 
provide data and long distance services to businesses in 27 
cities outside our 14-State local area, and we are the Nation's 
fourth largest long distance company.
    In addition, we have about half a million high-speed 
internet service customers, more than a million wireless 
customers, and a large Yellow Pages business, and a product 
line that ranges from the most basic telephone service to the 
most sophisticated internet and data technologies available.
    We're also very proud that we just completed one of the 
most technically trouble-free Olympics in history in Salt Lake 
City, where Qwest was one of the primary providers of 
communications services to the Olympics event.
    Qwest has a state-of-the-art, worldwide fiber optic network 
in the United States, Asia, and Latin America and through its 
related company KPN Qwest in Europe. In addition to its fiber 
optics network, Qwest has 16 web-hosting centers that safeguard 
the critical data of banks, corporations, healthcare providers, 
and Government agencies, among others. Qwest does business with 
60 percent of the Fortune 1000 companies around the world.
    Qwest's strategy in building its domestic network was to 
provide facilities for our own use, as well as constructing 
facilities for sale. Conduit, fiber, and capacity sales have 
paid for substantial portions of the cost of building our U.S. 
network.
    As we completed our domestic network, we began to expand 
overseas. We made decisions whether to build or buy these 
international facilities. Based upon the analysis of time and 
cost, we purchased facilities to connect our network to Europe, 
Asia, and Latin America.
    It was in this context that we entered into IRU 
transactions with a number of companies, including Global 
Crossing. The IRUs Qwest sold to Global Crossing were 
principally on domestic routes we built to sell. The IRUs that 
Qwest purchased from Global Crossing enabled us, quickly and 
cost-efficiently, to build our network internationally to 
locations that we could not otherwise serve.
    An IRU is an indefeasible right of use, which is the 
exclusive right to use a specific amount of capacity or fiber 
for a specific period of time, usually 20 years or more. An 
indefeasible right is one that cannot be revoked or voided. 
IRUs are for specific point-to-point assets. IRUs are not 
services and are generally asset sales.
    Once sold, they belong to the customer and cannot be moved 
without the consent of the customer. An IRU allows the 
purchaser to carry voice, data, video, or other traffic on that 
specific fiber or channel asset.
    In some cases, Qwest enters into two transactions that 
occur at about the same time: One, to sell IRUs to companies; 
and, second, to acquire optical capacity from such companies. 
The agreements for the sale of such optical capacity are 
separate legal agreements that are enforceable, regardless of 
whether the other company performs under the separate purchase 
contract.
    In accounting for the purchase and sale of IRUs, Qwest 
complies with Generally Accepted Accounting Principles known as 
GAAP. Qwest's auditors review our IRU transactions in the 
context of reviewing our financial statements each quarter.
    When Qwest sells IRUs, the customer receives the exclusive 
rights to a specific asset, and the risks and rewards of 
ownership passes to the buyer. Under the relevant accounting 
rules, Qwest recognizes revenue when Qwest delivers the asset, 
the buyer accepts it, and Qwest receives adequate consideration 
for those assets.
    Where the purchase and sale transactions occur at about the 
same time, Qwest applies the more restrictive rule for revenue 
recognition on what the accountants called a non-monetary 
transaction. The revenues attributable to IRU sales that 
occurred at the same time as purchases of an IRU in 2000 and 
2001, were approximately 2 percent in 2000 and 3.5 percent of 
total reported revenues of Qwest, respectively.
    Qwest publicly disclosed the network expansion plans and 
the nature, size, and the accounting treatment of the IRU 
transactions undertaken to further that strategic objective. In 
various press releases and filings with the Securities and 
Exchange Commission, Qwest made appropriate disclosure of the 
existence of the IRU transactions and the way Qwest accounted 
for them.
    In conclusion, as part of our business strategy to build a 
worldwide fiber optic network, we bought and we sold IRUs. When 
appropriate and in compliance with GAAP, we recognized revenue 
as well as costs from these transactions, when we entered into 
them, and although IRUs were not a material component of our 
revenues in the last 2 years, we publicly disclosed them and 
how we accounted for them.
    We're proud of the state-of-the-art network we have built 
and the services it enables us to provide, and I will be glad 
to answer any questions that you may wish to ask. Thank you for 
the opportunity.
    [The prepared statement of Afshin Mohebbi can be found on 
page 104 in the appendix.]
    Chairwoman Kelly. Thank you very much, Mr. Mohebbi.
    And we now turn to Mr. Salsbury.

STATEMENT OF MICHAEL H. SALSBURY, EXECUTIVE VICE PRESIDENT AND 
                GENERAL COUNSEL, WORLDCOM, INC.

    Mr. Salsbury. Thank you, and good morning. My name is 
Michael Salsbury, and I am the General Counsel of WorldCom, 
Incorporated. The questions and issues that the subcommittee 
seeks to address in this hearing, how accounting standards and 
Federal policies may have contributed to the problems 
experienced by Global Crossing and the industry are valid and 
important.
    There has been a lot of press recently about swap 
transactions, whereby carriers record revenue from selling 
capacity that is not likely to be used, in return for a 
purchase of capacity that is not used and is capitalized rather 
than expensed. WorldCom does not participate in such 
transactions.
    WorldCom sells IRUs and occasionally purchases them where 
needed, but in all cases, accounts for them appropriately. To 
put this into perspective, during 2001, WorldCom recorded 
recurring revenues of approximately $23 million out of total 
2001 revenues for WorldCom of $35.2 billion from the sale of 
IRUs.
    During December 2001, WorldCom entered into two IRU 
transactions with Asia Global Crossing--not Global Crossing. 
WorldCom purchased needed capacity on AGC's East Asia Crossing 
Cable and AGC purchased capacity on WorldCom's Australia-Japan 
Cable.
    Each transaction was for $20 million over a 10-year term. 
Because neither lease has yet become operational, WorldCom has 
not yet recognized either transaction on its P&L. As each IRU 
becomes operational, WorldCom will recognize approximately one-
half million dollars per quarter in revenue and in operating 
expense over a 10-year period. Again, to place this into 
perspective, our 2001 revenues were $35.2 billion.
    The subcommittee also asked to what extent certain factors 
served as a trigger for industry problems. WorldCom does not 
use unique accounting standards and does not issue pro forma 
revenue projections.
    As many companies do, WorldCom issues pro forma profit and 
loss statements in conjunction with our regular financial 
statements to show the effect of acquisitions or of revenue 
from consolidated entities. WorldCom believes such statements 
assist investors in understanding the impact of certain 
transactions.
    It has become fashionable recently to blame the large 
number of failures in competitive sectors of the 
telecommunications industry on bad planning. These claims, 
which generally emanate from the monopoly sectors of the 
industry and their pundits, but occasionally also from 
regulators, suggest that new entrants invested too much in new 
facilities and mis-forecast the demand for telecom services.
    There may well have been invalid assumptions by new 
entrants, but they related more to the expectation that Federal 
regulators would fairly and vigorously enforce the 
telecommunications and antitrust laws than to assumptions about 
consumer demand. By repeatedly favoring monopoly interests and 
undermining competition, these regulators increased the costs 
for new entrants, which led directly to higher prices and lower 
consumer demand for local telephone services and high-speed 
data services such as DSL.
    The current problems in the competitive sectors of the 
telecommunications industry were not caused primarily or even 
significantly by accounting issues or assumptions about 
capacity utilization; rather, those problems resulted directly 
from the unrelenting efforts of the Bell Companies to retain 
their monopoly power, and the fundamental failure of the FCC 
and the DOJ to properly and effectively implement and enforce 
the law.
    In WorldCom's view, those failures have destroyed far more 
market capitalization and robbed far more value from 
shareholders' investments than any accounting issues. Thank 
you.
    [The prepared statement of Michael H. Salsbury can be found 
on page 118 in the appendix.]
    Chairwoman Kelly. Thank you very much, Mr. Salsbury.
    Mr. McGrath.

   STATEMENT OF ANDREW McGRATH, PRESIDENT, SERVICE PROVIDERS 
                CHANNEL, CABLE & WIRELESS GLOBAL

    Mr. McGrath. Good morning, Chairwoman Kelly, Congressman 
LaFalce, and Members of the subcommittee. My name is Andrew 
McGrath, and I am the President of Cable & Wireless's Service 
Providers Division. Cable & Wireless is a global provider of 
telecommunications services, headquartered in the United 
Kingdom.
    Cable & Wireless, with annual revenues of $11 billion, 
provides services ranging from local telephone services to 
internet backbone and web-hosting services in more than 70 
countries. Cable & Wireless has been in business for over 100 
years. It is well financed and has no net debt.
    We are proud to have a substantial presence in the United 
States, where we provide IP and data services and solutions to 
business customers. I have been with Cable & Wireless since 
1991, and currently head the Global group within Cable & 
Wireless that provides a broad range of services to carriers, 
ISPs and content owners.
    I hold an engineering degree from Surrey University in the 
United Kingdom, and an MBA from London Business School. I have 
been invited to appear today to address the subcommittee's 
inquiry regarding telecommunications capacity transactions, 
typically called Indefeasible Rights of Use, or IRUs.
    The nature of the telecommunications industry makes it 
essential for carriers to contract with each other to provide 
services to their respective customers. It is not always cost-
effective for a carrier to build all aspects of its global 
network for its own exclusive use.
    It has been a long-established industry practice for 
carriers to interconnect with other carriers and to purchase 
network capacity from other carriers, either through leases or 
IRUs. Cable & Wireless has undertaken IRU purchases for the 
purpose of obtaining the network capacity necessary to support 
its customer requirements.
    Our internal governance policies are designed to ensure 
that, in each case, our acquisition of capacity serves a 
legitimate commercial need. Cable & Wireless has also sold 
network capacity to other carriers.
    These IRU sales are a very small part of Cable & Wireless' 
business. At their peak, in the year ending March 31, 2001, 
such sales accounted for less than 5 percent of Cable & 
Wireless' revenues and have since declined as carriers have 
largely completed their network build-out programs.
    In building its global network, Cable & Wireless has 
purchased capacity from several operators. A small proportion 
of these transactions has been with Global Crossing. As always, 
the network capacity we obtained through these transactions 
served specific commercial needs.
    Cable & Wireless states its accounts in accordance with 
Generally Accepted Accounting Principles--GAAP--as adopted in 
the United Kingdom, as it must do as a U.K. public limited 
company. As an additional disclosure, Cable & Wireless 
separately reports the amount of its IRU sales.
    Our accounting policies with regard to the treatment of 
such transactions are disclosed as part of our financial 
statements and are readily available to the public. Because 
Cable & Wireless ADRs--American Depository Receipts--trade on 
the New York Stock Exchange, it also discloses its financial 
results in SEC Form 20-F.
    For these purposes, Cable & Wireless states its results, 
including IRU transactions in accordance with U.S. GAAP. A 
reconciliation of the net income under U.K. GAAP and that under 
U.S. GAAP is disclosed as part of our financial statements and 
is also readily available to the public.
    Thank you for the opportunity to appear today. I welcome 
any questions from the Members of the subcommittee.
    [The prepared statement of Andrew McGrath can be found on 
page 126 in the appendix.]
    Chairwoman Kelly. We thank you, Mr. McGrath.
    One of the issues that I'm most concerned about here is the 
issue of the pro forma financial statements by 
telecommunications companies. I'd like the entire panel to 
respond to my first question, and I'd appreciate it then, if 
you will, answer my followup questions.
    I'd like to know how common pro forma financial statements 
are in your industry, and we will begin with anyone who wants 
to start the answer, but I'm going to ask each one of you to 
answer that. Mr. Cohrs, Mr. Legere?
    Mr. Cohrs. Yes, Ms. Chairman. My understanding is that in 
the industry, the use of pro forma statements is relatively 
common for the purposes of explaining the impacts of merger and 
acquisition activities, so that the presentation of pro forma 
statements can provide an apples-to-apples comparison from one 
period to the next when a significant number of companies have 
been either bought or sold by the company. And, in fact, I know 
that Global Crossing has used that to provide fair comparisons 
between one quarter and the next.
    I believe that your question probably refers to the use of 
measures like cash revenue and adjusted EBITDA, which are pro 
forma measures, and those measures became common as the 
industry of selling fiber optic capacity developed. It's a new 
industry.
    I indicated in my opening remarks that there's a big 
divergence between the cash coming into the company and what's 
reflected in the GAAP statements, that is, in my example, $20 
million IRU sale only is recorded as $1 million of revenue, 
even though the cash is in the bank and non-refundable. And so 
in our case, we adopted the practice of using pro forma 
measures to supplement our GAAP reporting so that we were 
showing investors the full picture of cash in addition to the 
GAAP picture.
    Now, that practice was adopted by a number of other 
companies who went public after Global Crossing. Global 
Crossing was essentially the pioneer among publicly traded 
companies in the sub-sea business, and therefore, I believe we 
were the first to use those particular measures, and they were 
adopted by others in the industry after that.
    Chairwoman Kelly. Mr. Mohebbi.
    Mr. Mohebbi. Madam Chairwoman, in terms of Qwest, the 
primary reporting vehicle that we have is GAAP revenues and 
GAAP accounting. However, Qwest is a company that was created 
as a result of six acquisitions, so sometimes as a supplement 
to our GAAP reporting, we provide, for the purposes of the 
investors who have specifically asked for it, pro forma numbers 
as a supplement, but our purpose, our main purpose of reporting 
and way or reporting our results are GAAP financials.
    Chairwoman Kelly. Mr. Salsbury.
    Mr. Salsbury. I think I would sort of reiterate what the 
others have said.
    Chairwoman Kelly. Well, the others said two different 
things, sir, I'm sorry.
    Mr. Salsbury. Right. As I said in my testimony, our primary 
method of conveying our financial results is GAAP accounting 
and our regularly reported financial statements. Occasionally, 
as noted earlier, I think by Mr. Cohrs, we have obviously had 
acquisitions, and it's useful to supplement our financial 
statements with pro formas showing the effect of acquisitions 
over time, so that you have an apples-to-applies comparison.
    Most companies, not just in telecommunications, do this. I 
certainly have been reading about occasions where companies 
have not done this. I was reading the paper this morning, and 
that's been criticized, because it gives a misleading--looks 
like companies are growing faster, when you don't show the 
effect of acquisitions.
    We also have an investment in Embratel in Brazil, and it's 
not a consolidated entity, but it's often useful to show, with 
a pro forma statement to our investors, the effects of--a pro 
forma statement, with Embratel and without. So those are the 
two examples I'm aware of. I'm not an accountant, and I don't 
pretend to know every single instance that the company may have 
used them, but we do not use pro forma revenue statements.
    Chairwoman Kelly. Thank you.
    Mr. McGrath.
    Mr. McGrath. Cable & Wireless provides a full disclosure of 
its accounts, consistent with U.K. GAAP. In addition, we 
provide separate disclosure of all IRU transactions. Our 
accounts are audited by KPMG, who have always provided an 
unqualified, clean audit report.
    We find that with that level of disclosure, that we don't 
need to provide pro forma statements, and we haven't done so.
    Chairwoman Kelly. Thank you. Mr. McGrath, you were saying 
that you do not file pro forma statements; is that correct?
    Mr. McGrath. That is correct.
    Chairwoman Kelly. Just for clarification, could you all 
just answer with a simple yes or no, did all of your companies 
file pro forma statements last year.
    Mr. Salsbury.
    Mr. Salsbury. I don't know the answer.
    Chairwoman Kelly. Mr. Mohebbi.
    Mr. Mohebbi. I believe we did, but I'm not sure of it.
    Chairwoman Kelly. Mr. Cohrs.
    Mr. Cohrs. Yes, we did.
    Chairwoman Kelly. Do you all know if you all used the same 
methodology, if you filed pro forma statements?
    Mr. Cohrs.
    Mr. Cohrs. I just can't speak to any other companies' 
statements. I haven't studied them, so I just don't know the 
answer to your question.
    Chairwoman Kelly. Do any of the rest of you know the 
answer?
    Mr. McGrath. No, ma'am.
    Chairwoman Kelly. So you don't know if there is a 
consistent methodology in preparing a pro forma; is that 
correct? I'd like an answer from the three of you, since Mr. 
McGrath doesn't have a background in the pro formas.
    Mr. Cohrs. Well, if I may respond?
    Chairwoman Kelly. Yes, Mr. Cohrs.
    Mr. Cohrs. The objective of a pro forma statement can serve 
various purposes. For example, if the pro forma statement is 
designed to normalize for the results of merger and acquisition 
activity, then the methodology, I believe, is relatively 
consistent across companies, because it's an attempt to show 
apples-to-apples comparison, as if that merger had not 
happened.
    In the case of measures like cash revenue and adjusted 
EBITDA, as I said, I just don't know the details of other 
companies' disclosures, and so I'm just not aware if there are 
any differences. I believe that the measures are, you know, 
relatively similar, but I'm just not aware if there are 
differences in reports from other companies.
    Chairwoman Kelly. Mr. Mohebbi, do you have any knowledge of 
that?
    Mr. Mohebbi. Madam Chairwoman, I certainly have no 
knowledge of how other companies, obviously, report on the pro 
forma basis, so I cannot say that there is a uniform or a non-
uniform way. I do know that in some cases, again, as an 
appendix or a supplement to our GAAP reporting, which is our 
primary reporting of revenues, profits, and activities 
financially, we have provided pro forma to show the investors 
the differences between before and after acquisitions, but I 
can't give you an answer on an industrywide basis or multi-
company look.
    Chairwoman Kelly. Mr. Salsbury, is it safe to assume that 
your answer would be similar?
    Mr. Salsbury. Yes.
    Chairwoman Kelly. I guess the nature of my question is, the 
investing public will look at a pro forma and try to make some 
sense out of it. And if the pro formas are not based on the 
same types of procedures, the same type of methodology, it 
would be very difficult, if you wanted to invest in the 
industry itself, to determine between companies, which company 
had a better pro forma, if there is no structure that's a solid 
methodology underneath each one of the pro forma statements. 
Would that be a correct statement? And you can just answer 
quickly by saying yes or no.
    Mr. Legere.
    Mr. Legere. I think inherent in your statement is that the 
answer would have to be yes. I mean, when we were reviewing 
H.R. 3763 and looking at some of the things that the industry 
could benefit from, one item is that at times when an industry 
is going through revolutionary change, as opposed to an 
evolutionary process, sometimes accounting or information 
disclosure could use some assistance from an otherwise staid 
set of rules.
    And, you know, in the period we're talking about, this may 
have been an environment where some governing body could have 
enhanced the ability for the industry to have consistency in 
understanding so that this transparency that you speak to could 
be attained.
    Certainly we look to our individual sets of auditors to 
provide us guidance from an industry expertise standpoint, but 
looking forward, I think we would all benefit from some 
knowledge about industry standards, things that we could apply 
to ensure that our information would be consistently viewed.
    Chairwoman Kelly. OK, thank you. I am out of time. I am 
turning now to Mr. LaFalce.
    Mr. LaFalce. Thank you very much, Madam Chairwoman. Mr. 
Legere, first of all, thank you for coming to my office before 
the meeting. I'm sorry we didn't have more of an opportunity to 
discuss the issues.
    I have the honor of representing over 90,000 in Monroe 
County and all of the almost 45,000 people in Orleans County, 
most of whom are serviced by Global Crossing, formerly 
Frontier, formerly Rochester Telephone. In this morning's 
Rochester Democrat and Chronicle, Mr. Legere, there's an 
article on the business page, entitled ``Ex-Frontier Group to 
Bid on Global.''
    It is written by Richard Mullins, and it says ``A Rochester 
group of former Frontier executives wants to buy a major part 
of the now-bankrupt Global Crossing. Leading the group is 
Anthony Casara, the former President of Frontier's Carrier 
Services Division. Also involved is Louis Massaro, the former 
Chief Financial Officer of Frontier. `The group knows the 
business, the customer requirements, the infrastructure, and we 
understand how to realize its underlying potential with the 
right strategy,' said Casera. `I believe there isn't a 
management team better suited for this opportunity than the 
team who originally built Frontier's North American business.' 
''
    Mr. Legere, as the ranking Democrat of the Financial 
Services Committee, I just want you to know that I strongly 
endorse, support, the effort by this local group of Rochester 
businessmen to repurchase that portion of Global Crossing. And 
I know that this is a business judgment that you, under the 
auspices of the Bankruptcy Court, will have to make, but I hope 
that our judgments will coincide. Fair enough?
    Mr. Legere. Congressman, we know these individuals. They're 
fine telecommunications people, and at this point in time, as 
part of the Chapter 11 restructuring process, we are engaged in 
period of time where any interested bidder can come forward 
through our advisors, the Blackstone Group, and make a proposal 
that they believe can maximize the return to all constituents 
who have a piece of the estate. And we look forward to seeing 
their proposal, along with, right now, over 40 interested 
parties that have gone to the point of non-disclosures to look 
further at the company. So, we certainly look forward to it.
    Mr. LaFalce. I appreciate that there are 40 bidders. I also 
appreciate the fact that these individuals are from Western New 
York; they're from Monroe County, in particular. They are the 
ones who originally built Frontier's North American business; 
they are the ones who are most likely best suited to enhance 
the future prospects for the company, its employees, the 
community in which it exists, and I think that that should be 
given great, great weight.
    Now, Mr. Legere, I have about 20 questions, and I'm not 
going to be able to get through more than a few of them. And so 
I am going to submit them to you in writing, and ask you to 
respond for the record to each of them. Would you be willing to 
do that?
    Mr. Legere. Anything that can be provided to our counsel, 
I'll be glad to do that.
    Mr. LaFalce. We will do that.
    Chairwoman Kelly. If the gentleman will yield.
    Mr. LaFalce. Yes.
    Chairwoman Kelly. Its my intention to hold the record open 
for 30 days. There are Members who are unable to be here today, 
and we will hold the record open for written questions and 
written answers to be inserted into the record, thank you.
    Mr. LaFalce. I thank the Chairlady for that.
    Sir, it's my understanding that the auditor was hired by 
Global Crossing to become the Executive Vice President for 
Finance; is that correct?
    Mr. Legere. Joseph Perone, who is currently our controller 
of the company is a former Andersen employee; that's correct.
    Mr. LaFalce. OK, well, did the Audit Committee ever think 
that this might compromise the independence of the audit to 
have the CFO, the former partner in charge of the audit from 
the auditing firm?
    Mr. Legere. This hiring took place before I arrived, but it 
is my understanding that those were considered by the Audit 
Committee.
    Mr. LaFalce. OK, well, do we know if the Audit Committee 
ever spoke with the auditor out of the presence of the 
corporate officers? Do we know that?
    Mr. Legere. I'll defer to Mr. Cohrs, who was there.
    Mr. Cohrs. Yes, Congressman, our Audit Committee had the 
practice, at each Audit Committee meeting, which were held 
regularly, of asking the senior executives to leave the room 
and to speak privately with the auditors.
    Mr. LaFalce. For 5 minutes? Was this done regularly? Was it 
done in-depth? Did they spend a half a day going over the 
various books, or was this just a pro forma thing?
    Mr. Cohrs. Well, since I wasn't in the room, I actually 
don't know the content of the conversations, but that was the 
purpose of asking me to leave the room.
    Mr. LaFalce. About how long did these meetings usually 
last, when you weren't in the room?
    Mr. Cohrs. It was done regularly.
    Mr. LaFalce. But about how long did they last?
    Mr. Cohrs. I would say that they lasted anywhere from 10 
minutes to an hour. And they were done regularly at every 
meeting of the Audit Committee.
    Mr. LaFalce. OK. My point is, very often the Audit 
Committee--that's a superficial meeting. Let me go on to two 
other areas, securities analysts and attorneys:
    When representatives of Global Crossing met with securities 
analysts, did they ever ask you or your colleagues about these 
swap transactions or your pro forma presentations? Did they 
have any questions about them?
    And who were these security analysts, especially those that 
were hyping the Global Crossing stock?
    Mr. Cohrs. Yes, Congressman, we had regular contact with 
securities analysts, and since the beginning of the company, 
there were----
    Mr. LaFalce. Did they ever question the swap transactions 
or your pro forma presentations?
    Mr. Cohrs. We had discussions about swap transactions, so-
called swap transactions, which were----
    Mr. LaFalce. Did they ever challenge the so-called swap 
transactions?
    Mr. Cohrs. They asked questions about the transactions, and 
we explained to them, actually, an explanation which is very 
much the same as was in my opening remarks, which was that 
these were independent transactions, separately negotiated, and 
that the proper accounting for the transactions was not to 
account for them as swaps. And we explained the economic reason 
for buying the assets and for selling the assets. We did have 
those discussions with securities analysts.
    Mr. LaFalce. Well, I'm going to be going into the economic 
reasons for buying and selling at considerably greater length. 
I can't do it now; I don't have time. But I'm going to question 
the so-called economic rationale.
    What was the role of your outside counsel in reviewing your 
public disclosure, outside a formal capital-raising scenario, 
and did they look at your 10K before it was filed? Did they 
look at your 10Qs?
    Mr. Cohrs. Our outside counsel reviewed all of our filings, 
and they reviewed our earnings releases, as well as all of our 
SEC filings, and all of the filings that we made in the process 
of the public securities offerings that we did. Those filings 
were reviewed by our outside counsel and by our outside 
auditors at some length.
    Mr. LaFalce. Let me just tell you what I'm getting at right 
now. I think it's imperative that we look at the propriety of 
the actions of corporate officers, who I have a lot of 
questions about, because so often their salary is based upon 
their stock options--or their compensation is based upon their 
stock options, and, therefore, they have a tremendous interest 
in enhanced market capitalization.
    The same thing is true with respect to the audit 
committees, and then the accounting firms have their own 
conflicts. And the primary focus has been placed upon the 
auditing profession, but I think we need to put much greater 
focus, too, on the securities industry and the quality of their 
analysis.
    Most investors don't look to what's said by corporate 
presidents--they expect puffery--or even the boards of 
directors or even the accountants. And most investors don't 
look at your statements, your 10Ks, your 10Qs, your financials, 
your pro formas; they look to the recommendations of the 
securities analysts.
    And so I really think we need to focus in on them more, 
because I think that sometimes there's an awful lot to be seen 
that wasn't seen and conveyed by the securities industry. And 
also there's a fiduciary responsibility on the part of 
attorneys, too, and attorneys hired by a firm should not be in 
the business of giving firms advice and counsel that the firm 
wants to hear, but they should be in the business of giving 
companies the advice and counsel that they need to hear. And I 
don't know that that has been done.
    My time has expired, Madam Chairwoman. I appreciate that. I 
will submit the balance of my questions in writing.
    Chairwoman Kelly. Thank you very much, Mr. LaFalce.
    We go to the Committee Chairman, Mr. Oxley.
    Mr. Oxley. Thank you, Madam Chairwoman.
    Mr. Legere and Mr. Cohrs, in his letter to the Global 
General Counsel on August 6th, Mr. Roy Olafson asserted, among 
other things in his letter, that the terms that the company 
used do not really mean what you said that they mean; that 
there were amounts included in the cash flow definitions that 
shouldn't have been included, and that although Asia Global 
Crossing was a global subsidiary, it defined and calculated its 
cash flow differently.
    Can both of you address the points made in Mr. Olafson's 
letter?
    Mr. Cohrs. Yes, Congressman, the first question had to do 
with an allegation that the measures that we reported were 
somehow not what we claimed them to be. The pro forma measures, 
the cash flow and adjusted EBITDA, were very precisely defined 
in every one of our filings. Our press releases and our SEC 
filings defined exactly what these terms meant.
    In fact, the origin of cash revenue and adjusted EBITDA was 
in our loan covenants. The bankers who were lending money to 
the company designed the loan covenants using adjusted EBITDA, 
and so these were very well understood by the banking community 
as representations of cash flow. The definitions were precise 
and they were well understood by the banking community and by 
the securities analyst community.
    Mr. Oxley. So, there was really full disclosure--from your 
perspective, there was full disclosure and transparency going 
forward with that issue?
    Mr. Cohrs. We believe there was.
    Mr. Oxley. Let me ask you also, in this complaint, Mr. 
Olafson referred to swaps of about $100 million in capacity 
between Qwest and Global in each of the first two quarters of 
2001, but that each company accounted for the transactions 
differently, despite having the same outside auditor.
    It's not clear from your quarterly statements if that is 
true. Did the swaps actually happen?
    Mr. Cohrs. We did transactions with Qwest and, you know, we 
had transactions, capacity transactions, with Qwest. We 
accounted for them in the manner I described in my remarks, and 
I just couldn't comment on any accounting practices at Qwest.
    I would say that the accounting treatment for any 
transaction depends on the facts and circumstances of that 
transaction, and accounting treatments can differ, based on 
different facts and circumstances, but I certainly couldn't 
comment on how Qwest did any accounting.
    Mr. Oxley. Mr. Mohebbi, would you care to comment on that?
    Mr. Mohebbi. Congressman Oxley, again, we did transactions 
with Global Crossing in 2001. The specific amount is not 
exactly $100 million, as you indicated. However, the 
transaction involved Qwest buying capacity, international 
capacity that we needed to build our business strategy, which 
was to expand our international network.
    And we had a number of bids from, if I'm not mistaken, 
three different providers, and Global Crossing's terms and 
conditions for those purchases were deemed to be the best, and 
we purchased those assets from Global Crossing.
    Mr. Oxley. Do you recall who the other bidders were?
    Mr. Mohebbi. I don't exactly recall, but I believe that 
there were a number of providers in this particular transaction 
who I believe were in Asia, and I believe that there are a 
number of providers in Asia that have the capacity where we 
wanted it, and we received bids from them. But I don't remember 
the specific names, Congressman.
    Mr. Oxley. Was that a common practice, to bid that out and 
to have a competitive arrangement for that capacity?
    Mr. Mohebbi. As an internal process in Qwest, again, as we 
are buying capacity, part of the process is to look at the 
market-based pricing and see what other providers have as 
price. So that's one of the conditions in the process for 
reviewing what the winning proposal looks like, Congressman.
    Mr. Oxley. Are you able to supply for the subcommittee at a 
later date, the identification of the other bidders?
    Mr. Mohebbi. I will be certainly happy to go back to our 
files and look at the information that we had on those 
transactions.
    Mr. Oxley. I would appreciate that.
    Let me ask actually all of you on the panel, in Mr. 
Legere's testimony, he said that the IRUs did not play a 
significant role in Global Crossing's problems, but have the 
revelations about the cash flow presentations of a number of 
telecom companies has that led to a loss of confidence by the 
investing public? Or what has happened with the overall 
perception of stock in the telecom sector, and has this led to 
a lack of support and confidence in that sector by the 
investing public? Anybody?
    Mr. Salsbury. Congressman, let me just take a crack at it. 
I do believe that the--as I mentioned in my testimony--that 
some of the policies that have been followed by the FCC and the 
Department of Justice clearly have had a negative impact on the 
results of companies in the competitive sector. And I think 
that has led, with a combination of other events like the 
downturn in the economy last year, and so forth, to having poor 
results. And I think that has led to the sector somewhat being 
out of favor. I think accounting issues are a relatively small 
part of it.
    Mr. Legere. Congressman, if I could just add that I think 
there is a cause-and-effect situation. I'd just like to go back 
to some of my initial comments. The bankruptcy of Global 
Crossing is not the reason for the loss of 9,000 jobs. The 
500,000 jobs that have been lost in the industry are indicative 
of an industry that has for a period of time, going across the 
board, pretty significant declines in market capitalization, 
because many companies in the sector found themselves over-
capitalized, needing to reduce costs significantly, just to 
survive. So the restructuring that Global Crossing has gone 
through, which unfortunately led to a Chapter 11 restructuring, 
is similar to what the entire industry has gone through, and, I 
believe, you know, needs to go through in order to prepare 
itself for, hopefully, the return to normalcy of the industry.
    But certainly that has been a period of shareholder 
concern, not only about the situations of reporting, but about 
the industry and the ability to make returns on the significant 
amount of capital that has been put into the industry over the 
last several years.
    Mr. Oxley. So it is--at least the perception by the layman 
would be--and I think you touched on it--that over-capacity in 
that sector really caused the downturn and the ultimate loss of 
confidence in the market; is that correct?
    Mr. Legere. Well, it's important to note that the 
perception of over-capacity is just as damaging in customer 
purchases as real over-capacity, because, in effect, carriers 
who are larger purchasers of capacity, will delay purchases in 
anticipation of huge amounts of increase in capacity, which 
generally will lead to significant price declines.
    So we have, at least as a minimum, a perception of an over-
capacity of supply, globally. There are differing opinions, 
including this morning's USA Today, which are presenting 
information that suggests that the capacity and the supply of 
fiber optic capacity may not be as over-supplied as perceived.
    But, I think we did have a time in the industry where 
demand was suppressed, because of a perception, at a minimum, 
of over-capacity, and, therefore, the value of the investments 
made by many players in capacity was, and still is, suppressed.
    Mr. Oxley. And do other witnesses share that same view, 
from the other companies?
    Mr. McGrath. Yeah, I think, from my perspective in Cable & 
Wireless, I think that one of the visible signs that the 
industry is becoming extremely competitive is that companies 
start to fail and exit the market.
    I think that's a very visible sign which is seen by 
shareholders, and it will affect confidence. It's a visible 
sign that there has been potentially over-supply, real or 
perceived; that the shareholders will see that and will demand 
increased scrutiny and be more conservative about investing in 
the sector. I think the simple answer to your question is yes.
    Mr. Oxley. And that's not necessarily a bad thing; is it?
    Mr. McGrath. I think increased scrutiny, greater 
understanding in detail and the reality of business plans being 
understood is probably a good thing.
    Mr. Oxley. I think that's been shared, Madam Chairwoman, by 
other witnesses that we've had in Mr. Baker's subcommittee as 
well as yours, that perhaps after all of this, we will have 
learned some valuable lessons in the marketplace, and that, 
indeed, markets can be very punishing, perhaps even more so 
than the Government as we work our way through some of these 
difficult problems. I thank the Chairlady for her indulgence, 
and I yield back.
    Chairwoman Kelly. Thank you, Mr. Chairman.
    Mrs. Jones.
    Mrs. Jones. Thank you, Madam Chairwoman. There are so many 
questions I want to ask that 5 minutes won't allow me, but let 
me try and get started.
    Mr. Legere, in an article around the time of the filing of 
the bankruptcy of Global Crossing, you're quoted as saying: 
``Ours is a balance sheet issue, not an operational one. 
Today's actions are intended to directly address this issue. 
Even with financial uncertainty, we've recently experienced 
that customers have continued to choose our network over many 
others.'' And it goes on and on and on.
    But, I want to go back to ``ours is a balance sheet issue, 
not an operational one.'' Would you be a little more specific 
and tell me what you meant?
    Mr. Legere. I'd be glad to. When I became the chief 
executive on October 3rd, I immediately started a process of 
refocusing the company, lowering its cost structure, and 
significantly preparing it to do what every family in American 
needs to do, which is live on existing means.
    We have over $3 billion in service revenue, and I had 
prepared the company to start to generate enough cash to 
service its operating capital expenditures. The issue we have 
is, we were paying between $2 and $3 million a day on interest 
to service our debt. And that debt burden was just too large 
for us to be able to, as a young company, to be able to create 
the underpinnings of an organization and operations to support 
that debt.
    Mrs. Jones. Thank you. Now, however, the debt was not so 
large as for them to pay you. How much did you receive to 
become the CEO of Global Crossing?
    Mr. Legere. I think my salary is public information.
    Mrs. Jones. I asked you, what did you receive, sir?
    Mr. Legere. My salary is $1.1 million a year.
    Mrs. Jones. And you received a signing bonus, also, sir?
    Mr. Legere. I had a $3.5 million signing bonus.
    Mrs. Jones. And in another article, there is a young lady 
by the name of--let me see if I can find her name real quickly. 
I just had it cleared--ah-hah--oh, here she goes--a Ms. Hinton 
said that: I was required to take--her severance pay in spread-
out payments, rather than a lump sum. Note that all of her 
medical benefits were terminated, all of her 401K retirement 
plan was held for more than 30 days. Is that a correct 
statement, sir?
    Mr. Legere. I'm not familiar with the situation.
    Mrs. Jones. Well, assume its a correct statement for 
purposes of this question. The employees of Global Crossing 
weren't able to receive a lump sum payment to pay their debts. 
They weren't able to receive any medical benefits, but what did 
you tell me your salary was, again, sir?
    Mr. Legere. My salary is $1.1 million.
    Mrs. Jones. And you got a signing bonus of how much?
    Mr. Legere. $3.5 million.
    Mrs. Jones. And if Ms. Hinton made $79,000 a year, how many 
Ms. Hintons could you have paid or could your company have 
helped with the $3.5 million bonus that you received, sir?
    Mr. Legere. Well, first of all, you know----
    Mrs. Jones. My question is, how many Ms. Hintons could you 
have helped if you had paid----
    Mr. Legere.----tremendous--for the issues----
    Mrs. Jones. Hold on a second. I asked a question.
    Mr. Legere. And I also----
    Mrs. Jones.----and you give the answer.
    Mr. Legere. I also believe that my pay----
    Mrs. Jones. Sir, Mr. Legere, stay with me, sir. My question 
is, how many Mrs. Hintons could you have helped or paid if they 
made $79,000 a year, with your $3.5 million bonus?
    Mr. Legere. As a rule, I don't do math in public.
    Mrs. Jones. Well, as a rule, would you pull out a 
calculator and do it for me, please?
    Mr. Legere. Well, I don't----
    Mrs. Jones. I mean, I don't want--I'm trying to be real 
clear in my questions, and I'm not looking for smart answers, 
sir. You're here to help Congress come up with some decisions 
about how they handled this situation, Mr. Legere.
    Mr. Legere. I understand.
    Mrs. Jones. And I do not appreciate the quirk.
    Mr. Legere. I certainly understand as well----
    Mrs. Jones. And I hope you will apologize.
    Mr. Legere.----That there's a difficulty in trying to 
understand the complexities of a Chief Executive Officer in a 
turnaround situation of a major telecommunications company. To 
believe that anyone would have those skills is an 
understatement of the complexity of the task that we face.
    Mrs. Jones. Mr. Legere, I don't believe that's what I said. 
I merely asked you, how many Ms. Hintons could you have helped 
with your $3.5 million, and seeing how you don't choose to do 
my math, let me proceed.
    Is Arthur Andersen still your auditor, sir?
    Mr. Legere. Yes, they are.
    Mrs. Jones. And you've chosen to stick with them, even 
amidst all that's been going on; is that a fair statement?
    Mr. Legere. Yes, we have.
    Mrs. Jones. Can you give me a statement as to how much 
information is provided to your Audit Committee from Arthur 
Andersen, and are they serving also as consultants in addition 
to auditors?
    Mr. Legere. I'll defer to Mr. Cohrs on that question.
    Mr. Cohrs. Well, on your first question, Congresswoman, we 
provide all of the information that we need to provide to the 
auditor and all the information that they request. And so they 
have full access to any information that they need to do their 
audit.
    The second question is, have we used Arthur Andersen as 
consultants? Yes, we have.
    Mrs. Jones. But are you using them currently as a 
consultant, sir?
    Mr. Cohrs. We have some consulting engagements. For 
example, Arthur Andersen has helped us collect the information 
required, which is a massive amount of information, to prepare 
our bankruptcy filings.
    Mrs. Jones. Are they still your auditors, sir?
    Mr. Cohrs. Yes, they remain our auditors today.
    Mrs. Jones. Are you aware, Mr. Legere--I'm going to go back 
to him--that of the question in the industry with regard to the 
impropriety, ethically, of having auditors as both accountants 
and consultants? And I'm going to terminate in this area, Madam 
Chairwoman, if you'll allow me.
    Mr. Legere. I don't believe there is any impropriety 
associated with the roles that Andersen is playing in our 
company.
    Mrs. Jones. That wasn't the questions. I said, are you 
aware, sir, in the industry, the concern about an auditor 
serving both as an auditor and as a consultant?
    Mr. Legere. I'm aware of it from the standpoint that I 
reviewed H.R. 3763 and understand that it's one of the issues 
that is potentially going to be addressed, so, in that sense, I 
do understand.
    Mrs. Jones. And you just did tell me, sir, that you have 
all these great qualifications to be a CEO, and so forth, in 
the industry, and that's why you were paid $3.5 million?
    Mr. Legere. The pay was decided by the Compensation 
Committee with outside experts; the Committee offered me to 
take on the role.
    Mrs. Jones. The point I'm trying to make to you, sir, is, 
right now, in these United States, there are investors and 
shareholders, and employees out here who are concerned about 
auditors serving both as auditors and consultants, but that 
doesn't appear to be an issue for your company; is that a fair 
statement, Mr. Legere?
    Mr. Legere. In my understanding, I don't believe there's 
anything improper in the roles that our auditors are playing 
inside of our company.
    Mr. Oxley. [Presiding] The time of the gentlelady has 
expired. The gentleman from Massachusetts, Mr. Capuano.
    Mr. Capuano. Thank you, Mr. Chairman.
    Mr. Legere or Mr. Cohrs, whoever is appropriate to answer, 
has your company ever received a qualified audit?
    Mr. Cohrs. I'm sorry, Congressman, are you referring to a 
qualified audit?
    Mr. Capuano. Has your audit ever come back with a 
qualification?
    Mr. Cohrs. No, it has not.
    Mr. Capuano. Has it ever had a disclaimer?
    Mr. Cohrs. No, it hasn't.
    Mr. Capuano. Has it ever had an adverse opinion of any 
kind?
    Mr. Cohrs. No, our audit opinions have been unqualified.
    Mr. Capuano. Thank you. Mr. Mohebbi, relative to Qwest, 
have you ever had a qualified report?
    Mr. Mohebbi. I'm not aware of one, Congressman.
    Mr. Capuano. Have you ever had a disclaimer of any kind or 
an adverse opinion of any kind.
    Mr. Mohebbi. I'm not aware of one.
    Mr. Capuano. OK, Mr. Salsbury, has your company ever had an 
adverse report, a disclaimer, or a qualification?
    Mr. Salsbury. Not to my knowledge.
    Mr. Capuano. Mr. McGrath, you earlier said that you had not 
qualifications of any kind. I would take all of you and suggest 
to you that Enron also never had a qualification or a 
disclaimer or an adverse report, so, therefore, when you tell 
me you have clean audit reports, at this point in time with 
your auditors, it doesn't mean anything to me, and I would just 
suggest that it doesn't mean much to the general public as 
well.
    Mr. McGrath, I would also suggest that--I don't know 
exactly the makeup of your company, but I know very well that 
the auditing rules and accounting rules in England are much 
more strict than we have in the United States, and for whatever 
businesses you do here, keep your eyes open; use your English 
requirements as opposed to your American requirements; you'll 
be safer and we won't have to call you back here at a future 
time.
    Mr. McGrath. Thank you.
    Mr. Capuano. I guess it's not a real surprise that my 
understanding is that four of the five companies sitting in 
front of us have the same auditor and the same auditing 
company, and it is no surprise at all to me that Global 
Crossing has retained Arthur Andersen. When they were here, 
they did a very good job defending their relationship with you, 
so, therefore, I'm not surprised at all that the camaraderie is 
a two-way street.
    But I'm going to tell you that I don't have a whole lot of 
questions, because, honestly, I don't like the answers I'm 
getting. I don't think we're going to get the answers, I don't 
think. I think this is the greatest forum. I think the SEC and 
the appropriate legal jurisdictions will be the ones who will 
ask tougher questions and will get the appropriate answers, and 
I will have to trust them at this point in time.
    But I've got to tell you, from where I sit, the whole thing 
you're talking about is nothing more than a much more fancy 
and, you know, certainly larger Ponzi scheme, nothing new. You 
bought something you didn't need with money you didn't have, 
and sold it to somebody who didn't need it and didn't have any 
money, and you hid the bookings.
    Gee, never heard that before. You're just doing it with a 
lot bigger money, nice, fancy technical terms, because you're 
in a new business. But the result is the same. The result is 
the same.
    And that's why earlier I didn't have a whole lot of opening 
statements. I don't appreciate the way you do your business. I 
do appreciate the businesses you do. I find it unfortunate, to 
be perfectly honest, for the American public and for the entire 
business community, that we have to be sitting here having 
these hearings.
    I don't like doing them. I don't like overreacting to 
individuals in the business community that do these kinds of 
things. And I'm not going to sit here and blame any one of you 
individually. I'll leave that to the appropriate people as 
well, including your shareholders, who may or may not come 
after you.
    But I will tell you that what you have done or what your 
companies have done or what your predecessors have done, no 
matter how you measure it, and no matter what you have said 
here today on the record, we all know in our hearts what you 
have done. I hope--I don't think--I'm sure you're not 
embarrassed. I'm not sure you're not repentant, and it's not 
for me to make you so.
    But I will tell that that's why I'm not asking questions 
today, because I don't expect to get answers that are going to 
be clear and concise. I don't expect to get answers that are 
going to do anything to help the employees that you have hurt, 
the shareholders that you have hurt, and I don't see any way 
that we can take steps to reconstitute the trust the American 
people once had in the American business community.
    It will take time, and these kinds of auditing procedures, 
this kind of greed, absolute, unfettered greed, I don't think 
it's good for America. And I'm sorry that you or your 
predecessors did it, and I'm terribly sorry that your auditors 
allowed you to do it.
    Mr. Oxley. The gentleman's time has expired.
    The gentlelady from New York, Ms. Slaughter.
    Ms. Slaughter. I thank you, Mr. Oxley.
    Mr. Legere, I can appreciate the difficulty that you face 
in trying to reconstitute a company, but I want to add on to 
what my colleague, John LaFalce, said, and to make a plea to 
let my people go in Rochester, and look favorably, if you can, 
to trying to reconstitute Frontier. The 13,000 jobs there mean 
the world to us.
    Mostly I want to talk about some things that I've read in 
the papers that I'm really dying to talk to you about. First 
there's a piece from the New York Times on February 19th which 
says ``Mr. Perone authored a memo dated February 10, 1999, 
before his hiring by Global Crossing, in which he recommended 
how to best account for capacity swaps. The suggestions 
contained in the memo were to keep the contracts 60 days apart, 
apparently to avoid suspicion that the deals were reached 
merely to help each party meet its quarterly financial 
objectives, and to require each party to submit separate cash 
payments, apparently to create the look of a valid deal.''
    To the untrained eye, gentlemen, that looks like you were 
trying to fool the public. Actually, I think that Global 
Crossing did decide that this was a pretty smart fellow over 
there at Andersen, and frankly, you decided to hire him for the 
company, perhaps to overlook this or look it over. I understand 
that he did have several relatives that he was also able to 
contribute.
    What was the intent, other than fooling the investors and 
Wall Street, to have that kind of a system put together, which 
basically said that this will make it look all right?
    Mr. Cohrs. Congresswoman, there are a number of memos, as I 
described in my testimony. The accounting for the transactions 
that we're talking about, any IRU transaction, whether they are 
relatively simultaneous or whether they are stand-alone IRU 
transactions, there are very difficult accounting questions.
    We were struggling to adapt accounting rules that were 
originally applied in real estate and the leasing industry, 
because those were the only accounting standards available. And 
so our industry--the entire industry, as well as the entire 
accounting profession--was struggling to understand the right 
way to account for these transactions.
    I described in my opening remarks that the GAAP treatment 
that's used now bears no relationship to the cash flow of the 
company. Now, for example, there was a meeting sponsored by 
Arthur Andersen, in which Global Crossing participated, in 
which all of the major accounting firms, the SEC, the FASB, at 
least one law firm, and participants from the industry met to 
try to develop the correct accounting for these transactions.
    So that's the environment that we----
    Ms. Slaughter. But, Mr. Cohrs, what I read here, what I 
understood from this, is that you were not looking for correct 
accounting procedures.
    Mr. Cohrs. Well, if I could----
    Ms. Slaughter. But you were looking for a way that if you 
didn't--that your revenue appears to have come from 
bookkeeping, right?
    Mr. Cohrs. Well, if I could just finish.
    Ms. Slaughter. All right.
    Mr. Cohrs. In that context, the accounting memos that were 
developed by Arthur Andersen were extensive, going through a 
great deal of accounting theory on how these transactions 
should be developed, and a particular accounting model was 
developed that we applied.
    And we were advised that that was proper GAAP accounting. 
But in addition----
    Ms. Slaughter. But when it says that it is being done to 
avoid suspicion, wouldn't that make you feel a little peculiar 
about it?
    Mr. Cohrs. Congresswoman, we applied the accounting to the 
best of our ability. In addition to applying the accounting, in 
our press releases, when we did these transactions that were 
relatively simultaneous, we disclosed the transactions. We 
described the transactions that we were doing. We can provide 
you with the earnings releases that we issued in the first, 
second, and third quarter of 2001.
    Ms. Slaughter. In which you never made a profit; isn't that 
true?
    Mr. Cohrs. Well, as I said, we disclosed these transactions 
in those releases. In those releases----
    Ms. Slaughter. Because that was the only transaction----
    Mr. Cohrs.----We also----
    Ms. Slaughter.----That you had, were the swaps. Let me go 
on.
    Mr. Cohrs. No, that's----
    Ms. Slaughter. I don't want to use my time up here.
    Mr. Cohrs. They were a small number of the transactions 
that we had, to correct the facts.
    Ms. Slaughter. Let me just comment on this, because this is 
another statement. ``Instead of a stampede of customers to fill 
up the fiber optic highways, the industry found itself with too 
many vacant lanes, way too many. What had once seemed a 
brilliant idea, carriers buying and selling future access on 
the networks to meet expected demand, became a swap meet unto 
itself with its own peculiar bookkeeping,'' which reiterates, 
again, what you were saying.
    But their own peculiar bookkeeping and the fact that Arthur 
Andersen was so close with what you were doing that you hired 
the man who authored it, I think is really a matter of some 
suspicion.
    There are a couple of other things here that I want to 
comment on: One is that in an August, 2001, letter Mr. Olafson 
said that Global Crossing's Chief Financial Officer, Daniel J. 
Cohrs, had sent an e-mail message to Thomas Casey, who was 
chief executive, and to other high-ranking executives, 
expressing concern about a news release that Qwest had issued, 
giving the details of the IRU agreements, because Mr. Cohrs was 
worried that the Qwest statement would draw unwanted attention 
to Global Crossing's IRUs, Mr. Olafson said. Would you comment 
on that? You may not have had an opportunity to comment on that 
since it was printed.
    Mr. Legere. I'll comment on it, Dan. I think the most 
important thing was----
    Ms. Slaughter. I was asking Mr. Cohrs, since he was the 
author of the memo.
    Mr. Legere. Well, I think that since it refers to Mr. 
Cohrs, if I could make one quick comment?
    Ms. Slaughter. Certainly, Mr. Legere.
    Mr. Legere. And that is that, as was mentioned before, the 
SEC is doing a very detailed investigation of all the items 
that you spoke about. Our Board is doing the same, and we very 
much look forward to participating in those. I think the 
information that we can jointly share is the output, which will 
answer a lot of these questions, including most of what was 
written in Mr. Olafson's letter.
    Ms. Slaughter. All right, well, let me just close with 
reiterating what Ms. Tubbs Jones said, and that is that it's 
very real, the pain in Rochester. I've talked to people who 
have had to put their homes up for sale, people who have no 
jobs, brilliant people who had very high positions in your 
company who are looking to see if they can run filling stations 
or something for a little while until they can tide themselves 
over; people who have lost their healthcare; people who are 
terrified of the future, young people, and scared that they're 
going to have to move and start all over again and look at 
something else.
    Then there are the other people. The people who worked 
forever for Rochester Telephone, going out in the dreadful 
weather at night, going up those poles, making sure that the 
phone service worked. They are going; they have great concern 
about their pensions. And in that regard, I want to say that we 
are very much concerned that Global has not turned over the 
pensions to Citizens Communication. That, in itself, would 
moderate a great deal, I think, some of the fear of the workers 
up there.
    But those who were let go who were promised severance and 
didn't get it, I don't think, unless you've had an opportunity 
to talk to them or look into their faces, that you could ever 
gauge the depth of the pain. These were people who liked your 
company, Mr. Legere. These were people who invested everything 
they had in it. Many of them left good jobs, enticed over 
because they thought that they saw the future.
    Suddenly, 4 years later, it's all over, and they are left 
in an economy that's pretty bad, with very little hope, and 
it's devastating. So, let me say again to you, if there is an 
opportunity for us to back up and reconstitute Frontier, please 
give us every consideration to let us do it.
    Rochester's economy really needs it, and we ask you most 
sincerely to give that your utmost attention and to let that 
survive, so that these people can again have a job and a decent 
wage.
    Mr. Oxley. The Congresswoman's time has expired.
    Mr. Legere. We feel the pain more than I think you 
understand. It's a very horrible thing that we've had to do to 
try to do something that I believe is in the best interests of 
Rochester, which is to save this company, save the jobs that 
exist, and hopefully get back to a time when we can grow jobs 
and bring new jobs back into Rochester.
    Ms. Slaughter. We do want you to save those jobs; they're 
very important to us. Thank you.
    Mr. Oxley. The gentleman from Washington State.
    Mr. Clay. Mr. Legere, one of the great outrages in the 
Enron collapse was the decision by management to black out 
their employees' ability to sell their stock while the 
executives retained their ability to sell their stock as the 
company was collapsing.
    I've been told--and I'll just ask you--that there was a 
similar blackout for almost a month in your situation from 
December 14th to January 18th, while your employees were 
essentially blocked out, shackled, not allowed to sell their 
stock, and executives were allowed to sell theirs.
    Regardless of what was happening in the market at that 
time, was that the case, and if so, how would you justify 
blacking out, locking down, your employees during that 
situation, particularly in light of the fact that the world 
came to know what happened to the Enron employees, even before 
you ordered that lockdown?
    Mr. Legere. I appreciate the opportunity to address this, 
and I'll start, and then ask Mr. Cohrs for some specifics.
    What you're referring to is a lockdown period of our 401K 
plan, and it was locked down for everyone who participates, 
regular employees, as well as executives. It was announced 
first to the employees on October 2nd, and it was part of a 
move from Putnam to Fidelity as the manager of the plan.
    Between October 2nd and the time from December to January 
when it was shut down, they were notified multiple times. And 
just for the record, one of the major differences here is on 
October 5th, our stock was trading at 83 cents. On October 9th, 
our stock was trading at 38 cents.
    When the plan closed down on December 18th, approximately, 
the stock was trading at 67 cents. When it reopened in the 
middle of January with plenty of time to continue to sell, the 
stock was trading at 54 cents, so we're dealing with a very 
different scenario from the standpoint of what happened during 
the period of time. It was a planned, scheduled change between 
Putnam and Fidelity. It was announced many times in the time 
period going up to it, so it does have the similarities in that 
there was a blackout, but that's where the similarities cease 
to exist.
    Mr. Cohrs. If I could just add, Congressman, the reason for 
the blackout period, as it's called, as Mr. Legere said, was 
the transition from one provider to the other. That was 
necessary because we had multiple 401K plans because of the 
acquisitions we had done.
    So we had multiple plans with different levels of service, 
and we were in the process of consolidating those plans so that 
we could actually provide better service in the plans. And it's 
just necessary when you change providers to freeze the activity 
so that all the data can be transferred over. But as Mr. Legere 
said, this was announced 2\1/2\ months before the blackout 
period began.
    Mr. Clay. And the executives who held stock themselves were 
free to sell their stock outside the 401K during that time; is 
that the situation?
    Mr. Legere. All 401K participants were blacked out at the 
same time. All shareholders could sell under the rules, and 
executives who were not subject to a blackout period or a 
period of time that's normal for officers, could trade.
    Mr. Clay. Well, do you think it makes sense to allow 
executives, in that context, to be able to sell their stock 
while the company's falling apart, and lock down the employees 
who are in the 401K? Do you think that should be the rules of 
engagement, if you will?
    Mr. Legere. I don't have the data, but maybe it would be 
important to look. During the blackout period of the 401K, I 
don't believe any people were trading shares outside of the 
program, either.
    Mr. Clay. That's one thing we'll appreciate. I want to ask 
about swaps. And this has been a eye-opener for me, and, I 
think, for a lot of Americans. There is an old movie called 
``The Flim-Flam Man,'' and it starred George C. Scott.
    And why he didn't use swaps, I don't know, because to me, 
this has enormous potential for abuse, where you essentially 
buy an asset, spread out the cost over many years, with a 
counterparty and then sell it and take the revenue in 1 year, 
just has tremendous potential for abuse, it seems to me.
    Now, I'm told that in your situation there was substantial 
swapping with other parties or counterparties, even though 
there was excess capacity pretty well known in the industry at 
that time. Tell us, to the extent you can, what economic 
rationale there was for those, and tell us, to the extent there 
was, if you will, simply a transfer by both parties, of a 
potential stream of revenue to something you book immediately 
as a stream of revenue?
    Mr. Legere. If I could start, Congressman, I think the 
important difference between what you've described and what was 
taking place here is the notion almost sounds as if you're 
dealing with people sitting in empty rooms who are walking out, 
buying something, holding on to it, and then selling it to 
another.
    We've constructed a 101,000 route-mile network that 
connects 27 countries and over 200 cities in the world. And it 
was through the process of building and acquiring the routes on 
this network, which is not just to sell capacity, but to serve 
enterprise customers advance data requirements. That's the 
requirement that drove us to looking to capacity that we would 
require to finish that network.
    And when you have 101,000 route-miles of network, you also 
are a logical place for people who need to buy things from 
someone, to come to, because you have the broadest reach. And, 
Dan, if you want to add----
    Mr. Cohrs. If I could just address the accounting points 
that you mentioned, Congressman, it is quite often repeated 
improperly in the newspapers that these transactions generated 
revenue and spread the costs out over many years. That is 
simply not true.
    As I explained in my opening remarks, an IRU transaction 
has the revenue recognized over the life of the lease, and the 
cost is amortized actually over a shorter period. So, in our 
GAAP accounting, the revenue on a 20-year IRU is only 
recognized, ratably, over 20 years. It is not recognized up 
front.
    The cost of those assets is depreciated, just like any 
other asset that we would buy or build, generally over a 
shorter period, generally 12 to 15 years. And so the 
amortization of our cost on these transactions is actually much 
faster than the rate at which we booked the revenue.
    The confusion comes because we also reported as a 
supplemental report, the number we called cash revenue. In 
addition to the GAAP revenue that I just described, we reported 
cash revenue because the cash was collected up front, and we 
felt it was important to our investors and our lenders and the 
markets as a whole to give both views, the GAAP view, of 
course, which we were required and which is the proper GAAP 
accounting, but also the view that more closely corresponded to 
the cash coming into the company.
    I'd just like to say and repeat that it is not true that 
these transactions generated up-front revenue with costs 
amortized over a long period of time. It's actually almost the 
opposite.
    Mr. Oxley. [Presiding.] The gentleman's time has expired.
    Mr. Clay. Thank you.
    Mr. Oxley. Let me thank this panel for your participation. 
As the subcommittee Chair indicated, the record will remain 
open for 30 days for written questions from the Members, and 
they will be forthcoming. Again, gentlemen, we thank you for 
your participation, and this panel is dismissed.
    Chairwoman Kelly. [Presiding] I would like to thank the 
second panel for joining us today. And our second panel is 
going to discuss the accounting principles involved in the 
company's filings and disclosures, the state of the industry, 
and how some of the energy companies also tread into the 
telecom world and were caught in the vortex.
    For our second panel, we welcome John Morrissey, Deputy 
Chief Accountant for the Securities and Exchange Commission; 
Scott Cleland, CEO of the Precursor Group; and a noted 
telecommunications industry analyst, Will McNamara, Director of 
Energy Industry Analysis for SCIENTECH, Incorporated.
    I want to thank each of you for testifying here before us 
today, and I welcome you on behalf of the Full Committee. 
Without objection, your written statements and any attachments 
that you have, will be made part of the record.
    You will each now be recognized for a 5-minute summary of 
your testimony. Your full written testimony, as I said, will be 
a part of the record. We begin with you, Mr. Morrissey.

 STATEMENT OF JOHN M. MORRISSEY, DEPUTY CHIEF ACCOUNTANT, U.S. 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Morrissey. Congresswoman Kelly, Congressman LaFalce, 
and Members of the subcommittee. I'm John Morrissey, Deputy 
Chief Accountant at the United States Securities and Exchange 
Commission. Thank you for the opportunity to testify today on 
behalf of the Commission concerning several accounting issues 
affecting the telecommunications industry.
    As the subcommittee has requested, my testimony will 
address the accounting by providers of indefeasible rights of 
use of telecommunications network capacity, the accounting for 
non-monetary transactions, including swaps, and the reporting 
of pro forma financial information. My written testimony 
addresses those matters in more detail, and I ask that it be 
included in the record.
    As Global Crossing has disclosed, the SEC is investigating 
certain issues associated with the company's accounting and 
disclosure practices. The Commission appreciates the 
subcommittee's recognition of the non-public nature of its 
investigation. The Commission also asks that, in light of its 
ongoing investigation, the subcommittee understand our 
reluctance to address specific issues related to compliance 
with Federal securities laws at this time. You can be assured 
that the Commission staff is thoroughly investigating 
allegations of financial reporting improprieties.
    Confidence in our markets begins with the quality and 
transparency of financial information available to help 
investors decide whether and when to invest their hard-earned 
dollars. The goal of the Federal securities laws is to promote 
honest and efficient markets and informed investment decisions 
through full and fair disclosure of all material facts.
    Transparency in financial reporting, that is, the extent to 
which financial information about a company is visible and 
understandable to investors and other market participants, 
plays a fundamental role in making our markets the most 
efficient, liquid, and resilient in the world.
    The SEC's responsibility is to ensure that the financial 
markets are transparent and hospitable to all investors. 
Congress wisely ingrained in the Federal securities laws the 
philosophy that investors have the right to be fully informed 
of all material factors and to use markets that are free from 
fraudulent, deceptive, and manipulative conduct.
    Telecommunications service providers often sell access to 
the networks on the basis of an Indefeasible Right of Use, or 
an IRU. Accounting for such capacity sales raises a number of 
issues that can become quite complex.
    Perhaps the most important and basic accounting issue is 
when to recognize revenue from an IRU sale. My written 
testimony provides more detailed information on some of the 
considerations that go into this evaluation, and I will not 
repeat them here. However, I will note that the specific terms 
of the network capacity agreements between a provider and a 
purchaser can have a significant impact on how and when to 
recognize income from such sales under Generally Accepted 
Accounting Principles.
    For example, network capacity purchase agreements that 
qualify to be accounted for as leases could result in up-front 
revenue recognition, provided that certain criteria are met. 
Alternatively, network capacity purchase agreements that are 
not leases must be accounted for as service contracts, which 
typically requires that the related revenue be recognize into 
income over time as the access to the capacity is provided.
    Several recent articles in the financial press have focused 
on the business practices of telecommunications companies 
swapping network capacity. These articles raise a number of 
legitimate questions about the accounting for network capacity 
swap transactions, which is discussed in my written statement.
    While I cannot comment on specific companies or specific 
transactions, I assure you that if any financial reporting 
improprieties or violations of Federal securities laws have 
occurred, the Commission staff will not hesitate to seek 
appropriate remedies to protect investors.
    Furthermore, recent press articles have focused on the use 
of pro forma financial information in Global Crossing's and 
others' earnings releases. While pro forma financial 
information can serve useful purposes, the Commission is 
concerned that pro forma financial information, under certain 
circumstances, can mislead investors if it obscures GAAP 
results.
    On December 4, 2001, the Commission issued cautionary 
advice that companies and their advisors should consider when 
releasing pro forma financial information. The cautionary 
advice is part of our ongoing commitment to improve the 
quality, timeliness, and accessibility of publicly available 
financial information.
    At the same time, the Commission is focusing on ways in 
which our current periodic reporting and disclosure system can 
be updated to fill the void that pro forma statements may be 
attempting to fill.
    Thank you for the opportunity to appear today. I am happy 
to try to respond to any questions that the Members of the 
subcommittee may have.
    [The prepared statement of John M. Morrissey can be found 
on page 132 in the appendix.]
    Chairwoman Kelly. I thank you very much, Mr. Morrissey.
    Mr. Cleland.

  STATEMENT OF SCOTT C. CLELAND, CHIEF EXECUTIVE OFFICER, THE 
                        PRECURSOR GROUP

    Mr. Cleland. Yes, thank you for the honor of testifying 
today, Chairwoman Kelly. I'm Scott Cleland, founder and CEO of 
the Precursor Group, an independent, research broker/dealer 
that provides telecom-tech investment research to institutional 
investors. I will try to provide the subcommittee with a 
broader, big-picture perspective today.
    Global Crossing's bankruptcy is not unique; it's part of a 
broader telecom spiral, debt spiral in the sector. And we 
believe that the recession was not the cause of many of these 
telecom bankruptcies; it was only the trigger.
    Nor is the cause what Federal Reserve Chairman Alan 
Greenspan called irrational exuberance. I surmise that the 
causes were the rational manipulation of the capital market 
system and the irrational economics of the telecom-internet 
sector, which created and burst the NASDAQ market bubble.
    I suspect there is some rational manipulation going on 
here. Global Crossing's bankruptcy is a wakeup call to us all.
    First, we must improve our clearly inadequate investment 
research system that can't even expose a trillion-dollar fib. 
Investors depend on investment research for an objective 
assessment of the facts and due diligence on a company. 
However, they were not informed that the single most important 
trend buttressing Global Crossing's business model and that of 
most all the data traffic models, was hugely overstated and 
inflated for years.
    The conventional wisdom, repeated by almost everyone for a 
few years, was, from 1997 to 2001, that the data traffic growth 
was exploding; that it was doubling every 3 to 4 months. But 
that is an 800 to 1600 percent annual growth rate through 1996 
to 2001.
    Unfortunately, it simply wasn't true. The actual growth 
rate was closer to 100 to 200 percent. Now, if you can see the 
chart that we brought with us, you can see then that roughly 14 
companies, predicated on this exploding data thesis, that their 
market capitalization increased during that period by over a 
trillion dollars. That's the T-world, over a trillion dollars, 
and then it fell by over a trillion dollars as the bubble burst 
and the hype on data traffic was exposed.
    But more troubling than that is that this is not an 
isolated incident. It appears that there may be a pattern of 
misrepresentation in the telecom-internet sector.
    In addition to this trillion-dollar data traffic fib, U.S. 
investors lost almost another trillion dollars of shareholder 
wealth on the internet dot.com investment thesis, where 
everybody thought or everybody was told that the virtual 
economy was purported to obsolete the old economy.
    Now, second, I think it's pretty obvious from this that we 
do not have a well-functioning market. If these kinds of 
misrepresentations can go largely unchallenged in the system of 
investor protections, the system simply does not produce what 
investors need--trustworthy audits and investor research.
    Effectively, the Big Five auditors function as a cartel 
where it's hard for investors to find a pure audit company that 
would best serve investor interest. Effectively, Wall Street 
functions as an investment banking cartel, where it is hard for 
investors to get objective investment research that's free of 
investment banking bias, that may be better at discovering the 
problems behind a Global Crossing.
    In response, the Precursor Group, along with Argus Research 
and Egan-Jones, we're forming the Investor Side Research 
Association, and our mission is to increase the investor and 
pensioner trust in the U.S. capital market system through the 
promotion and use of investment research that is aligned with 
investor interests.
    We're currently recruiting additional members, and 
recruiting organizations that support our mission, and our 
website will be www.investorsideresearch.org.
    Now, third, we believe we must make our capital market 
system much less prone to manipulation. Growth or story stocks 
like Global Crossing have become very prone to manipulation, 
and, moreover, the options compensation culture that we have 
created for company management now, can perversely incent the 
management of publicly-traded companies to engage in very high 
risk behavior that this hearing is about today.
    It's the one-way nature of options that's the problem. It 
is that they only have something to gain on the way up, but in 
a down market or if there is a problem, they have nothing to 
lose on the way down, and, therefore, they can use the balance 
sheet as a piggy bank, as a way to goose the stock.
    So, like a car, we believe that this system is badly out of 
alignment, which can allow it to dangerously veer off the road. 
And our capital market system is badly out of alignment, 
essentially leaving investors and pensioners potentially 
wounded in the ditch. It's skewed toward company interests over 
investor interest, and the system is skewed toward equity 
markets over credit markets.
    In conclusion, I'm testifying today to try and bring the 
overall problem into better perspective. We believe there's no 
easy solution, however, the Government can improve the 
inadequate research investment system to prevent future 
trillion-dollar fibs. It can discourage the rational 
manipulation of the capital markets by better protecting 
investor interest, and it can also undo the irrational 
economics that led to the telecom and the internet debacle. 
Thank you very much again, Madam Chairwoman, for the 
opportunity to testify.
    [The prepared statement of Scott C. Cleland can be found on 
page 145 in the appendix.]
    Chairwoman Kelly. Thank you, Mr. Cleland.
    Mr. McNamara.

STATEMENT OF WILL McNAMARA, DIRECTOR, ENERGY INDUSTRY ANALYSIS, 
                        SCIENTECH, INC.

    Mr. McNamara. Thank you, Chairwoman Kelly and Members of 
the subcommittee. I thank you for the opportunity to appear 
before you today. My name is Will McNamara, and I'm Director of 
Energy Industry Analysis for Scientech, an energy consulting 
firm focused on energy trends, both domestically and 
internationally.
    The purpose of my testimony today is to discuss the recent 
trend of energy companies that may have expanded into the 
telecom sector through significant investments, and may have 
incurred financial or accounting problems as a result of the 
downturn in the telecom sector.
    Deregulation of both the energy and the telecom sectors 
enabled the convergence between the two. An argument could be 
made and was often made that it was a strategic move for energy 
companies and electric utilities to expand into telecom, based 
on the following conditions:
    Most of the companies already had the trenches in which to 
lay fiber optic cable. In addition, pushing voice and data 
files seemed similar to electricity distribution.
    There were great expectations for the growth of dot.com 
companies, and energy companies traditionally have low-growth 
prospects, and many were looking for other revenue-drivers. 
Companies such as Enron Corporation and Williams Companies led 
the movement by buying or constructing many miles of fiber 
optic capacity. However, the prognosis for energy companies 
that expanded into telecom is virtually the same for the pure-
plate telecom companies.
    What we are witnessing is that demand was greatly 
overestimated; there was a glut of capacity or a perceived glut 
of capacity; there were heavy debt loads for telecom units and 
diminished opportunities for sales.
    To provide you with some specific examples of energy 
companies that moved into telecom and suffered the 
consequences, I provide the following data: Enron Corporation, 
former CEO of Enron, Jeffrey Skilling, had previously 
anticipated a $450 billion worldwide market for band-width 
trading by 2005, and specifically evaluated the valuation of 
Enron's own broad band unit at $35 billion.
    However, in the second quarter of 2001, Enron reported a 
$102 million loss in its broad band unit, and by the third 
quarter of 2001, although the company had stopped separating 
telecom earnings, the company also reported that losses had 
continued. In addition, Enron acknowledged that its sales 
prospects for the telecom sector had dried up.
    Williams Company, based on Tulsa, Oklahoma, had spun off 
its telecom unit, Williams Communications, but in March of 
2002, said it could face a loss due to a stock-backing 
arrangement between the two companies. Williams Communications 
has about $5.16 billion in debt, currently.
    Houston-based Dynergy, Inc., lost $31 million in telecom 
during the first 6 months of 2001. The company says it won't 
make any money from telecom for a year or more.
    Butte, Montana, Montana Power, and Touch America, as it is 
now known, is the extreme example of an electric utility 
transforming into a pure-plate telecom company. The move has 
been met with financial losses, a lawsuit from shareholders, 
and community backlash due to rate increases that occurred as a 
result of the transformation.
    Moreover, expansion into telecom has not been a successful 
strategy for energy companies thus far, although some companies 
maintain that their telecom investments will prove financially 
lucrative in the long term.
    The degree of current financial impact on energy companies 
that moved into telecom depends on the extent of their 
investment. In terms of recommendations, energy companies will 
need to manage their own financial risk exposure to the telecom 
sector as most are currently doing.
    To protect investors and enable analysts to have accurate 
financial data about energy companies, the SEC is widely 
working to revise financial disclosure and accounting rules, 
along with potential legislation supported by this 
subcommittee.
    I thank you for the opportunity to appear before you. I 
have gone into much greater detail in my written testimony, and 
I welcome the opportunity to address any of your questions. 
Thank you.
    [The prepared statement of Will McNamara can be found on 
page 160 in the appendix.]
    Chairwoman Kelly. I thank you, Mr. McNamara.
    I want to get back to the issue of the pro forma financial 
statements by the telecommunications companies. Mr. Morrissey, 
in your testimony you discuss that there is the new SEC 
guidance on pro forma financial statements. I wonder if you'd 
be willing to discuss what the SEC is planning to do in the 
future to address your concerns about those statements?
    Mr. Morrissey. I'd be happy to. First of all, the 
Commission is very concerned about the misuse of pro forma 
financial information. This concern is translated into 
tangible, substantive action on a number of different fronts:
    On one front, we recently issued cautionary advice on the 
use of pro forma financial information. This cautionary advice 
acknowledges that pro forma information, when properly 
presented, can provide very useful and meaningful information 
to investors to help them understand what's going on.
    But it also reminded individuals and preparers that the 
anti-fraud provisions of the Federal securities laws apply to a 
company issuing pro forma financial information. In addition, 
we offered some guidance in order to help avoid misleading 
investors in terms of preparation of this pro forma financial 
information.
    For example, we said that they need to clearly disclose the 
basis of the presentation. They need to not omit material 
information that is meaningful to investors. They need to do it 
in plain English, so people can understand what the deviations 
are from GAAP, and, I think, very importantly, companies need 
to compare that information to GAAP-reported numbers, so that 
investors can be able to understand where the numbers come 
from, and have that basis of comparison.
    And I think this has all been very well received within the 
community, the investment community and investors. Some 
information I received is that companies have welcomed this 
because if their desire is to present more meaningful 
information, to try to explain their results, they also want it 
to be perceived as being credible. And this is a way for them 
to comply with these guidelines and give it the type of 
credibility that, theoretically, they're looking for.
    Second, on the other front, the Commission has been very 
active in also pursuing violations of the securities laws with 
respect to material misrepresentation. We recently brought a 
case against Trump Hotels, in which there is evidence to show 
that there was misleading financial information, pro forma 
financial information being disclosed, and we went after them 
and we prosecuted them and we brought that case.
    So I think that one of the things that we've seen is that 
the new cautionary advice is now out there. It's being digested 
by preparers of financial information, and I think we're 
already seeing benefits from that now.
    Where do we go from here? We need to, I think, wait and see 
a little bit to see how the improvement goes.
    Chairwoman Kelly. Thank you.
    Mr. Cleland.
    Mr. Cleland. Yes, could I add a point? The problem with pro 
forma is, it tends to be--it can be--not all times--it can be 
spin. And when it's put out, it is designed to then go to the 
investor relations department, to the public relations 
department as their press releases, where they may have had a 
GAAP accounting loss, however, on a pro forma basis, they're 
showing an improving financial situation.
    And they know that by putting the pro forma first, in 
advance of the GAAP, that the headline will be, you know, 
``Company Beats Expectations,'' or ``Company Showing Improving 
Results.'' And by baring the GAAP at the end, the perception of 
the public, through the media and through Wall Street, which 
loves the pro forma--and they'll talk about the pro forma, pro 
forma, pro forma--they don't get an accurate picture of what 
the real financial situation is that can be compared to other 
companies, because that's what GAAP is all about, is to know, 
should I invest in Company A, Company B, or in Bond A or Bond 
B?
    You need to have a common language, and that's what GAAP 
accounting is. And so the trouble is that pro forma contributes 
to a perception game that can mislead investors.
    Chairwoman Kelly. Mr. Cleland, there are statements on the 
pro forma statements that are caveats. It seems to me that Mr. 
Morrissey--and, Mr. Morrissey, you may join in answering here--
there may be a need for a stronger statement or for a pro forma 
to carry something that says very clearly, up front--Mr. Baker 
talked about the Surgeon General's terse warning on every pack 
of cigarettes. Well, maybe there should be--my question to you 
really is, should there be a terse warning, large type, up 
front, on every one of these pro forma statements, so that 
everybody gets it, and the perception is, this is--what the 
company is saying, this is not an audited statement.
    I know that you do require some things, but perhaps we need 
to take a look at how that's working. Mr. Cleland, Mr. 
Morrissey, would you want to jump in there?
    Mr. Cleland. Where I jump in is that the problem isn't 
necessarily with one individual piece of the system; it's how 
the system behaves together, in the sense that the pro forma, 
by itself, might be innocuous, and the way investor relations 
may decide to put it out, it may be innocuous by itself. But it 
is the system that comes together, where everybody has an 
interest to say the good stuff about the stock and not the bad 
stuff about the stock.
    And so what you get is the perception created. And we all 
know that the average investor reads the headlines and reads 
the first paragraph, or that's what we take away. We hear the 
radio announcement or the TV announcement, which is just the 
best stuff, and all of the other stuff just tends to fritter 
away. So, 99 percent of the perception is the good stuff, and 
you have to go digging for the bad stuff.
    Chairwoman Kelly. Mr. Cleland, let me just follow up on 
that for 1 minute, and then I'd like to have Mr. Morrissey kind 
of jump in on that original question. But, in recent years, the 
telecom industry has really just gone right straight up in 
terms of markets and so forth.
    My interest in asking you this question is, whether or not 
there was any kind of a Government action, any kind of a 
Government policy that made this an arc rather than a continued 
curve up? I'm wondering if this was policy or if this was 
something that was driven by the companies themselves?
    Mr. Cleland. Well, it's a very good question, and when you 
look at the result on that chart, you see that the NASDAQ, 
which everybody thought was a bubble and went up, it went up 
287 percent. And these data traffic stocks went up 1800 
percent, so there is something extraordinary going on in that 
segment, and that segment helped drive that NASDAQ up 287 
percent.
    Now, the bubble that we all talk about was driven largely 
by telcom and tech. There was this culture of what I call 
rational manipulation of a system. It may not be any one 
individual, but they all said the same thing and they all knew 
they all benefited from hyping the traffic growth. That was the 
essence of it.
    But there was also a Government problem in the sense that 
the Government created a set of irrational economics. Number 
one, you know, the Government commercialized essentially a not-
for-profit peering system, so the entire industry structure of 
internet data traffic is not profitable.
    On top of that, the Government massively subsidized data at 
the expense of voice, billions of dollars every year. And what 
it did is, it added more cost to the telecom voice system and 
subsidized data, so it created this kind of free-lunch 
atmosphere.
    Then you had the Telecom Act come in and said that 
everybody should build out these new data networks, and the 
problem was that this is a capital-intensive business where if 
you add risk, all the people that own the debt freak out and 
they don't want to necessarily be invested in it. So the 
Telecom Act essentially took an industry where capital was 
welcome and changed it into an industry where capital wasn't 
welcome.
    And then the other thing that Government policymakers did 
is, they added the internet tax moratorium, which gave the 
perception that the internet was special. Essentially, if we 
transacted business over the internet, we didn't have to pay a 
tax, but if I did it over the phone or if we did it in person, 
the exact same purchase would be taxed, and so we created this 
unreal tax haven.
    So all four of those things, the Government policy tended 
to inflate the bubble, and the market looked at the Government 
and the Government was the main cheerleader. So this is a dual 
problem.
    Chairwoman Kelly. Would either Mr. Morrissey or Mr. 
McNamara like to get in here? Now, Mr. Morrissey, I said I'd 
come back to you, so let's start with you.
    Mr. Morrissey. I guess I'd like to respond to your original 
suggestion and say I think that it has a lot of merit. It's a 
good idea to have a statement that may say something to the 
effect that these statements do not represent full financial 
information in accordance with Generally Accepted Accounting 
Principles and should be read in conjunction with financial 
statements prepared in accordance with Generally Accepted 
Accounting Principles. I think that idea has a lot of merit, 
and I appreciate the suggestion.
    One of the tensions you have, though, in reporting 
information, is that, we desire to have material information 
reach the market as quickly as possible. And one of the issues 
you have is that you may have some financial information that's 
of interest to investors, but not yet have prepared your 
financial information, financial statements in their entirety.
    So the question is, do you withhold that information until 
the financial statements are ready, or do you go and do them at 
different times? And that's just one of the tension issues that 
needs to be addressed as we try to work through these different 
types of issues with respect to pro forma earnings releases.
    Chairwoman Kelly. Mr. McNamara.
    Mr. McNamara. I would add that we spoke earlier about 
methodologies that companies use for pro forma accounting, and 
how often they vary from company to company and may not be 
disclosed to the public. So along with the disclaimer 
recommendation, which I think has a lot of merit, I think that 
the methodologies that companies use for their pro forma 
accounting projections should also be disclosed in the line of 
greater transparency. Certainly that is something that the SEC 
appears to be moving toward.
    Chairwoman Kelly. Do you want to respond to that, Mr. 
Morrissey? Are you moving toward that?
    Mr. Morrissey. As I said, with respect to pro forma, we had 
this recent initiative. It is something that we're watching 
very closely. We're hoping to see a significant shift in the 
market reaction to the issuance of pro forma information, in 
conjunction with the guidelines that we have established. And 
we have to watch and see the progress that's being made.
    Chairwoman Kelly. I would like now to just kind of go to 
swaps, the swaps issue. In July of 1999, the FASB mandated that 
the companies could not recognize all revenue earned from the 
new swaps in the current year. That was a change.
    And they required then that the contract be amortized over 
its life. How did that affect the telecommunications companies' 
financial projections? And this is for all of you.
    Mr. Morrissey. Do you want me to go first? Basically what 
was occurring within the industry and with an interpretation of 
the accounting literature was that it was progressing, 
evolving, and becoming more refined. And the statement that I 
believe you're referring to added clarification as to what type 
of lease these IRUs should be accounted under.
    And what that statement said is that basically they have to 
be accounted for under the literature that applies to real 
estate transactions. Associated with real estate transactions 
are a whole series of criteria that you have to meet in order 
to recognize the revenue up front on one of these types of IRU 
transactions.
    And my understanding is that when that statement came out, 
it effectively presented a significant hurdle that was very 
difficult to overcome for many of these types of transactions 
that had been recorded in the past with up-front revenue 
recognition. So my understanding is that, from an industry 
perspective, it had a significant impact, and that it reduced 
companies' ability to recognize the revenue up front.
    Chairwoman Kelly. Thank you.
    Mr. Cleland.
    Mr. Cleland. You know, the problem here is that you have a 
set of irrational economics in the industry. You have this 
extraordinary hype and expectations that were created. When you 
have, you know, 1800 percent increase in the market 
capitalization of 14 companies, you've created an unreal 
circumstance.
    Then you have a culture which has a lot riding on keeping 
that stock up, because the options culture is one way; they 
want it to have momentum and to go up. And so what it does, it 
created enormous pressure, and investors wanted that money 
created. So, investors, the investment bankers, the auditors, 
the lawyers, everybody, had an interest in making sure that 
this bubble didn't get burst.
    And so in that context of an unreal world and overextended 
expectations, I think people looked to the accountants and 
said, you know, how can we, within the rules, make this look 
the best possible? And what I think is important is, lots of 
times people can address the letter of the law, but not address 
the spirit of the law, and they'll say, well, I did this right; 
I did this right; and I did this right; there isn't anything 
wrong. When doing the three of those things together, you add 
them up, and it is a clear, obvious misrepresentation of the 
circumstance.
    So we need to step back and look at these things in context 
to see whether or not there was rational manipulation or 
misrepresentation going on.
    Chairwoman Kelly. Mr. McNamara.
    Mr. McNamara. I would just add that I think Mr. Cleland's 
assessment is accurate. There is a parallel between the 
telecom's use of IRUs and the energy industry's use of the 
mark-to-market technique, although they're vastly different and 
involve different businesses and different commodities.
    What essentially would be the same is that the pressure is 
to inflate current earnings on the basis of transactions that 
may not materialize until down the line. And so as changes 
regarding rules governing pro forma accounting emerge, it would 
be helpful to look at both industries.
    Chairwoman Kelly. Mr. McNamara, you have delivered some 
really interesting testimony today. Any subsequent figures and 
facts that you can bring to flesh that out, the subcommittee 
would appreciate, because I think you've had some very 
interesting testimony.
    I'm going to ask you just a couple of very straightforward 
questions, and basically I'm concerned that companies over-
valued earnings. And I'm concerned that investors really didn't 
get a clear picture here. And it seems to me your testimony is 
saying that, and all I want to know is, if my perception is a 
correct one? And you can just answer that yes or no, and you 
can just start down the line and give me a quick answer.
    Mr. McNamara. I would say that the answer is yes, but I 
would say that both pro forma and real-time financial earnings 
are important, and why not offer both to investors and 
analysts, and they can choose which one they want to follow.
    Chairwoman Kelly. Mr. Cleland.
    Mr. Cleland. I think you can have as quick a disclosure and 
as complete a disclosure, and then you want to have a system 
that has people that are looking out for investors, either 
auditors that are pure audit companies or investor-side 
research, because we have a systemic problem here where the 
system is no longer working for investors. That's how Enron, 
Global Crossing, the bubble, happened. It is that the system 
got out of alignment and then it always wanted to go up.
    And the thing is, markets don't always go up; they have ups 
and downs; they have corrections and whatever, but this system 
is out of alignment, and it will continue to veer off into the 
ditch until you figure out a way to let the free market and 
competitive use of ideas flourish. Because if somebody would 
have stood up and said there's a problem with Enron early on, 
and because they're paid by the system to find those things, or 
if, you know, if somebody was paid to find those things with 
Global Crossing and the telecom debacle, you would have 
identified those things. But the system didn't pay for capital 
preservation; it paid for stock promotion. It's a problem.
    Chairwoman Kelly. Mr. Morrissey.
    Mr. Morrissey. I guess the way I would answer the question 
is, at the Securities and Exchange Commission, we fully expect 
companies to comply with the Federal securities laws and comply 
with Generally Accepted Accounting Principles, and to reflect 
transactions based upon their substance.
    And that to the extent that mere compliance with the 
technicalities of the literature does not present a fair 
picture of what's happening, they have an obligation to 
disclose what really is going on in management's discussion and 
analysis, so that investors have a clear understanding of 
really what is happening.
    If that is not occurring, they're going to have a serious 
problem with my fellow colleagues in the Division of 
Enforcement, and we expect that from all investors.
    Chairwoman Kelly. All right, thank you. I have a few more 
questions, but I'm going to submit those in writing.
    This has been a relatively long hearing. The Chair notes 
that some Members will have, in all probability, additional 
questions for this panel, and they will submit them in writing, 
so without objection, the hearing record is going to remain 
open for 30 days for the Members to submit written questions to 
these witnesses and to place their responses in the record.
    We thank you very much for your patience in waiting through 
the first panel, and for your subsequent testimony here. This 
second panel is excused with our great appreciation for your 
time.
    I want to briefly thank the Members who are here and other 
Members of this subcommittee who have shown a great deal of 
interest in this topic, and I also want to thank especially the 
staff that we have, my staff, and the staff on the Financial 
Services Committee. They have been terrific in making this 
hearing possible, and with that, this hearing is adjourned.
    [Whereupon, at 12:40 p.m., the hearing was adjourned.]
                            A P P E N D I X

                             March 21, 2002

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