Opinion ID: 3061983
Heading Depth: 2
Heading Rank: 2

Heading: The Defendant’s Stock Sales

Text: -6- At approximately the time Mr. Nacchio was receiving these internal reports regarding IRU sales and recurring revenue and assuring investors that the company was on track to meet its public guidance, he was selling over a million shares of Qwest stock. This occurred a few months before the company was forced to lower its guidance by a billion dollars, the amount previously estimated by Qwest’s financial officers, and the stock lost half its value. These sales are the basis of the government’s charge that Mr. Nacchio was trading on inside information. Mr. Nacchio claims, however, that a full understanding of the context of his sales proves otherwise. Like many highly-paid CEOs at the time, Mr. Nacchio received a substantial portion of his compensation in stock options rather than in cash. Options are a common part of CEO salaries because they provide incentives to perform. Option compensation also provides cash-flow advantages to the company, because a company expends no cash when it grants them, and, at one time, a company did not need to account for the cost until the option was exercised. See Share-Based Payment, Statement of Fin. Accounting Standards No. 123 (Fin. Accounting Standards Bd. 2004); Kevin J. Murphy, Explaining Executive Compensation: Managerial Power versus the Perceived Cost of Stock Options, 69 U. Chi. L. Rev. 847, 859–60 (2002); Fischer Black & Myron Scholes, The Pricing of Options and Corporate Liabilities, 81 J. Pol. Econ. 637 (1973). -7- Among Mr. Nacchio’s holdings as of October 2000 were options for $7.4 million in Qwest stock, with an expiration date of June 2003. One way that a corporate official can dispose of stock without liability for insider trading is to do so pursuant to a fixed sales plan. Under SEC rules, if a person has no material inside information when he “[a]dopt[s] a written plan for trading securities,” and that plan sets fixed rules for when he will buy and sell shares in the future, then his trades are not “on the basis of” inside information even if he later does acquire inside information. 17 C.F.R. § 240.10b5-1(c). Qwest’s general counsel, Drake Tempest, was required to approve each stock sales plan entered into by each Qwest officer; doing so required a determination that the officer was not in possession of material nonpublic information at the time he entered into the plan. Except for sales according to a fixed sales plan, Qwest policy only permitted officers to sell stock during short “trading windows” each quarter immediately after quarterly earnings were announced. App. 1879. In October 2000, Mr. Nacchio announced that he would exercise options and sell approximately one million shares each quarter. This would enable him to exercise his $7.4 million in options before their expiration date, while spreading his sales out over time to avoid the risk of a stock drop that comes when too many shares are sold at once. Mr. Nacchio did not actually enter into a formal trading plan in October, but he did so—briefly—in February 2001, which was approved by Tempest. He cancelled the plan less than a month later, when Qwest’s stock -8- fell below $38 per share. At that time, he stated, “I would expect to return to my prior practice of making sales in quarterly trading windows, or, in, appropriate circumstances consider entering into a new daily sales program if I believe the stock price is more realistic.” App. 4803. He now points to this decision as evidence that, rather than having knowledge of an impending revenue shortfall with attendant decline in stock price, he believed the stock price would remain above $38. The second-quarter trading window began on April 26, 2001, with Qwest’s stock at $39 per share. Between then and May 15, Nacchio sold 1,255,000 shares of Qwest as the share price hovered between $37 and $42. His rate of sales in those weeks was about four times his average rate from 1998 to 2000, but only slightly more than the million shares per quarter he had declared his intention to sell in his October 2000 announcement. At the end of the May trading window, Mr. Nacchio entered into a second automatic sales plan, approved by Tempest, to sell 10,000 shares a day as long as the stock price was at least $38 per share. On May 29, 2001, Qwest’s stock price dropped below $38, where it has remained since. Mr. Nacchio sold no more shares after that, and finished the year with more vested options than he had owned at the beginning. He made no attempt to sell any of the Qwest stock (other than options) he held in his personal account, nor that owned by his family.