(FORTUNE Magazine) – It's hard to imagine somebody less suited to testifying in front of an ornery congressional committee than Joe Nacchio, a man who stood at the center of the telecom boom, ran a company once worth $86 billion, and left it on the brink of insolvency, walking away with $260 million. The people who like him tend to say he is the most competitive person they've ever met. The people who don't like him say more or less the same thing, but occasionally in unprintable language. In a smaller room, in a more social setting, your first impression of Nacchio might be that he is tightly wound, but amid the scale and ceremony of a congressional hearing, his prickliness and general agitation turn into something bigger, a riveting display of defiance.

When I saw him last fall in Washington, D.C., Nacchio, 53, had been out of a job for three months, having been forced out by Qwest's board in the wake of a multibillion-dollar accounting scandal. He had been called to testify before a congressional panel that was trying to determine whether Qwest and another fallen giant, Global Crossing, sold stuff they didn't need to each other and to other telecom companies so that they could boost their revenues and meet Wall Street's quarterly targets--enabling executives to continue making money by selling off their shares to the public.

Gary Winnick, the former chairman of bankrupt Global Crossing, submitted to the expected public tongue-lashing with placid equanimity. He admitted mainly to knowing shockingly little about his own company (from which he personally profited to the tune of $735 million), saying at one point that while he did talk to his CEO on most days, "it wasn't always about business." Qwest's brand-new CFO, Oren Shaffer--part of the present management, which is supposed to be turning the company around--delivered a rambling speech in which he explained that Qwest was erasing $1.5 billion of revenue from Nacchio's tenure because the company had not found the ledger justifying Qwest's accounting for more than a billion dollars in deals.

Nacchio, by contrast, could not keep his mouth from curling into its characteristic sneer. He is a powerful physical presence, with an aging athlete's restless energy and a tendency to look obviously bored or brooding when he does not have the floor. His lawyer, Charles Stillman, often leaned in so close behind him that his head appeared to touch Nacchio's shoulder, seemingly trying to exert a calming influence by mere proximity. Nacchio did not play the game of pretending not to understand his own business. He told the committee bluntly that had he known of any swap designed to artificially boost Qwest's revenues, he would have killed it. He displayed a chart of Qwest's network and challenged the members of the committee: "You can ask me [about] any route, I will tell you the business purpose, I will tell you what budget it was in, and I will tell you at what board meeting we reviewed it," he boomed. "Had I been aware of any proposal for Qwest to purchase capacity solely to induce a contemporaneous sale, to inflate revenues, I would have vetoed it."

It was this whistling-kettle anger that persuaded me to write about Nacchio and Qwest. It was startling, after a procession of mealy-mouthed nabobs, to hear Nacchio's outrage. His readiness to jump out of his skin was a challenge to anyone who doubted him and a dare to the government to make its case.

Six months later, it still has not. In February the Attorney General, John Ashcroft, and the new director of the Securities and Exchange Commission, Bill Donaldson, teamed up for an unusual joint news conference announcing charges against eight mid-level Qwest employees for, as the SEC's complaint put it, their role in "a fraudulent scheme to meet at all costs [Qwest's] predictions of double-digit revenue growth." But it was impossible not to notice that neither the SEC nor the Justice Department had addressed the most striking allegations of bogus nine-figure deals raised in the congressional hearings. Nor had they charged any of Nacchio's inner circle.

That doesn't mean the case is not there to be made. After a review of hundreds of pages of internal Qwest and Global Crossing documents and interviews with current and former Qwest employees, FORTUNE has found compelling evidence of efforts to engineer deals that had no purpose other than to create a false appearance of revenues and profits--and there is evidence that Nacchio knew of the deals as they were happening. His accountants, his outside auditor, and even the audit committee of Qwest's board of directors were concerned about the deals a year or more before they were made known to the public, and told him so.

Eliot Spitzer, the New York State attorney general who has filed a civil suit against Nacchio for taking IPO shares from Qwest bankers but is not investigating Qwest's accounting, compares prosecuting corporate crime in general with his experience working on Mob cases. "You have the trigger guy down the street who committed the crime," Spitzer says. "But how do you prove that the soldier reported it to the capo who reported it to the crime boss?" Whether prosecutors will be able to climb the ladder in a similar way in the Qwest case and other investigations of corporate corruption will be a powerful test of the government's resolve and its ability to rein in the abuses of the past few years.

To understand what happened at Qwest, you should know one piece of telecom history. In the mid-1990s, the Hopeful Years, virtually everyone looking at the industry believed that the expansion of the Internet would lead to insatiable demand for the networks, or "pipes," that would carry huge amounts of data, voice, and video to the living room and desk. Nacchio was the most prominent of a passel of executives from AT&T and other telcos to decamp for what everyone expected would be a powerful new generation of companies that would build those networks: Qwest, Global Crossing, Level 3, Covad, and others. Having left the airless confines of AT&T, where he had reached the executive suite but was denied the top spot, Nacchio became one of the most blustery cheerleaders for the new industry. "I feel like an emerging oil baron in 1859," he told Wired magazine in a 1998 article about Qwest, unfortunately titled "The Future-Proof Telco."

By mid-2000, Nacchio had used Qwest's highflying stock to buy US West, the Denver-based Baby Bell that provided local phone service to 25 million customers in 14 states. That put Nacchio at the head of a truly giant company--but his original vision of a next-generation data company was in big trouble. Qwest's network just wasn't filling up with customers at anywhere near the rate that the new-economy believers had hoped. Shaun Gilmore, a former executive vice president of Qwest, pointed out in an interview that Qwest's network could carry all the voice and data traffic in the U.S.--but the share of the telecom traffic that Qwest's network actually carried during Gilmore's time there never exceeded 4% or 5%. The market had a huge glut of capacity, and most of the "future-proof" network was just sitting idle. By April 2000, according to internal documents, two-thirds of the "IP engineering group" that made data flow on Qwest's network had left or were let go.

Meanwhile, Nacchio was promising investors that Qwest's revenues would increase by 15% a year and its earnings by 20% a year by 2005. To meet his projections, money-losing Qwest would need to add $20 billion in revenue and become one of the world's most profitable companies. He used every technique at his disposal to goad his executives and salespeople to deliver on that. He had a preternatural ability to push the buttons of fear and greed that would make his salespeople "make the numbers"--three words that at Qwest acquired an uncanny power. At a sales conference at the Bellagio casino in Las Vegas, Nacchio threw out tennis balls, each one cut open and stuffed with bills, to a cheering crowd and watched as salespeople with mid-six-figure incomes pushed and dived for the few bucks.

But all that didn't change Qwest's predicament. "The market was collapsing," recounts Nik Nesbitt, a former Qwest senior vice president. "[There were] unreachable demands: 'We need to sell this many millions of dollars in hosting services in the next 90 days,' when the lead time to sell hosting services was 180 days. You'd ask questions, and it was just, 'Don't ask questions. Just go and do it, and if you don't do it, you're not part of the team.'"

Managers were terrified they wouldn't match Nacchio's expectations. In meetings he would pretend not to listen when he was unhappy, then suddenly zero in on what he thought was the weakest point of an executive's presentation, subjecting him to what even a friend describes as a terrifying experience. Down through the hierarchy, Qwest managers believed they had to make their numbers in any way possible. "[Managers would say] 'What can I do? My arm is being twisted. I just gotta do what the boss says,'" recalls Nesbitt. "So it became an 'I just gotta do what the boss says' company."

Qwest managers learned to drive up sales by asking companies that sold equipment to Qwest to buy services in return. Nesbitt says such exchanges were called "guns for whiskey." "The premise," he says, "was, I'm buying a lot of your stuff; we'd like you buy more of our services." It was in this atmosphere that Qwest turned to a new, quick way of making revenues appear on the books: buying and selling capacity to other telecom companies, like Global Crossing, that were in more or less the same fix. By 2000, trading capacity--leasing actual cable in the ground or simply guaranteeing that you'd carry the other telecom company's traffic on your network--was a big part of Qwest's business.

The numbers involved are startling. Despite announcing $2 billion worth of restatements, Qwest has still not released a list of the deals at issue and has no plans to do so. An internal review in March 2002 that outlined two dozen questionable deals included a $134.5 million swap with Tycom, Tyco's network-building subsidiary; $220 million in sales from swaps with Global Crossing; and $242.9 million in revenues from the British company Cable & Wireless in three separate deals. In every case, Qwest spent significant sums leasing capacity and fiber from those companies.

As we've seen, Qwest already had far more capacity than it needed. So why the swaps? Because Qwest execs thought they had found an accounting maneuver that would let the company book paper profits from the deals immediately while writing off the costs over many years. The key here was a white paper produced by the now-defunct Arthur Andersen accounting firm. A senior executive of a rival company calls it the "Rosetta stone for telecom fraud." In Andersen's theory, when Qwest sold 20-year leases of telecom capacity it could immediately book all the revenue. Even better, when it leased capacity from a company like Global Crossing--the magic of the swap--it could stretch the costs over 20 years. When two telecom companies traded leases for each other's networks, both could show big short-term revenues and profits, with little cost--even when, as in some cases, no cash changed hands.

Susan Kalla, an analyst at Friedman Billings Ramsey who predicted the telecom crash, thinks not only that Qwest was involved in deals that it didn't need so that its bottom line would appear better but also that the bogus deals should have been obvious to anybody in charge. "If you were in the industry for five years," says Kalla, "you were probably aware of it. Ten years, certainly aware of it. Fifteen years, complicit in it. Twenty years? Criminal."

Still, even if Nacchio and his team should have been aware of all this, that isn't the same as proof that they were aware of sham deals. It is significant that of all the documents released by Congress, none has Nacchio approving a questionable deal. Billy Tauzin, the Louisiana Congressman who chairs the investigative committee, asked Nacchio if his internal auditor had ever warned him about "overly aggressive accounting." Nacchio answered that he did not recall the issue's having been brought up.

However, a close look at one swap reveals a more troubling story. Interviews with former Qwest employees, and internal records found by congressional investigators, provide evidence that the deal with Global Crossing in the first quarter of 2001 was riddled with problems, that Qwest's financial experts knew that, and that Nacchio was confronted about it and defended the transaction to the chairman of Qwest's audit committee in April 2001.

The idea that outside auditors approved everything that Qwest did during his tenure is a linchpin of the defense that Nacchio has presented (as well as the defense of the new management, who face a huge shareholder lawsuit). That is technically true in the sense that the Andersen accountants leading Qwest's audit team signed off on financial statements. By early 2001, however, Qwest insiders and Andersen auditor Mark Iwan were worried about what the SEC would find if it investigated Qwest. SEC officials had already asked some questions, and as one former Qwest official put it, "everybody thought they were looking to load their guns and come back out and look at revenue recognition."

With that in mind, you can appreciate the importance of what might be the most extraordinary Qwest document dug up by congressional investigators. That document is a printout of an e-mail from Iwan to Tom Stephens, head of Qwest's audit committee, on April 18, 2001, with notes handwritten underneath that Stephens took on the subsequent conversation. The e-mail itself is simple enough: "Tom: I am wondering if we should chat prior to the meeting. There are several items I would like to make you aware of so you can ask the right questions on the call."

When Iwan writes about "asking the right questions," he is talking about questions that Stephens should ask of Qwest's management--Nacchio and CFO Robin Szeliga--on an upcoming conference call. The fact that Iwan found it necessary to prep the head of Qwest's audit committee on how to elicit information from Nacchio and Szeliga is intriguing, but the really juicy stuff is in Stephens's notes.

They indicate that Iwan was seriously worried. "The sky is falling," Stephens writes on one line. More important, among several scrawled notes, one outlines a deal with Global Crossing on which Qwest booked $105 million in revenue. Stephens notes that 10% of Qwest's Ebitda (a commonly used measure of earnings) came from "nonmonetary trades." That's about $200 million, and the difference between Qwest's "making the number" for the quarter and falling short.

And there is one more key line: "This one stinks."

It's lucky that the Global Crossing transaction should be featured so prominently in Stephens's notes, because congressional investigators also managed to dig up a number of e-mails from Global Crossing about the very same deal. And it's a doozy.

So far, nobody at Qwest has admitted that anything was wrong with the deal, in which Qwest swapped capacity on its network in Europe and the U.S. for rights to use Global Crossing's network in Asia. But there is evidence from internal Global Crossing e-mails that its managers regarded this deal as a sham.

On March 13, Global Crossing senior vice president Robin Wright notes in an e-mail that her company is in the process of "building business cases" that would justify a $100 million Qwest deal and other swaps. On March 28, two days before the end of the quarter, Mike Coghill, a Global Crossing engineering executive, sends an e-mail saying his department could find no way to justify a $15 million deal for U.S. domestic capacity with Qwest, let alone the much bigger swap other execs wanted. "We will be factual in our estimation of the value or usefulness of these assets but in good conscience cannot pretend to develop a business case that justifies this transaction," Coghill concludes. Remember, this is the same swap that Stephens and Iwan talk about three weeks later, on April 18. Except that Iwan tells Stephens about his concerns after the deal has already gone through.

There is no way that Stephens could have known about the debate inside Global Crossing--we know about it now thanks to the congressional investigations, which came much later. Unfortunately, we don't have a similarly extensive paper trail from inside Qwest. But given the evidence that Global Crossing execs thought the deal had no justification, the bare, direct words of Stephens's notes point to similar worries inside Qwest--"This one stinks."

That written evidence suggests that Iwan (and after April 18, Stephens) thought that there were big problems with this deal. The $260 million question, of course, is whether Nacchio himself knew it. On that we have no paper trail. But we do have some very good leads.

You'll remember that the reason Iwan got in touch with Tom Stephens on April 18 was that he believed Stephens should bring up these issues with Qwest's management. That's exactly what Stephens did. After his conversation with Iwan, Stephens took the unusual step of inviting Nacchio to make a presentation prior to the April 20, 2001 audit committee meeting. Nacchio's attorney says Nacchio does not recall being in that meeting or any audit committee meeting around that time. However, according to the account one participant in that session gave to FORTUNE, Stephens zeroed in on the problem of big "nonrecurring" revenues--the huge one-time deals exemplified by the Global Crossing swap. He noted that Qwest relied on those deals for a disproportionate part of its Ebitda--exactly the point of his notes from April 18.

Nacchio, according to that person in the meeting, responded that, as Qwest's market matured, there would be less demand for deals like the one with Global Crossing. His take was that they would eventually disappear and be replaced by new revenue from retail customers. That he was aware of the issues and ready to answer Stephens's concerns implies that Nacchio knew the troubling details of the Global Crossing deal before the April 20 meeting. There can be no question that he knew about it afterward: Not only did Stephens ask him about it in front of the audit committee, but another participant recalls that Stephens, still dissatisfied, called Nacchio after the audit committee meeting to confront him one-on-one about the specifics of that deal.

In retrospect, it's clear that those conversations on April 20 were the beginning of the endgame for Nacchio. If he indeed believed that the swaps would take care of themselves, he was stunningly optimistic about his ability to get off what had become a very fast-moving train before it plunged from the collapsed bridge that lay ahead. Amazingly, in the second quarter of 2001--the quarter Tom Stephens found out about the swaps--Qwest relied even more on this sleight of hand. It closed another deal with Global Crossing that let Qwest book more than $100 million in revenue, plus a $134.5 million swap with Tycom. In the third quarter--when Qwest was under increasing pressure from Andersen's Iwan, who was arguing that any further swaps would need to be disclosed and would thus amount to "fiscal suicide"--the predictable finally happened: Qwest missed the numbers that Nacchio had been promising Wall Street, and the stock started its catastrophic slide that has brought the company to $4 a share.

Documents from late 2001 and early 2002 released by congressional investigators indicate that following those April conversations, Stephens made a real effort to understand what was going on at Qwest, finally pushing for the internal investigation that has led to $2 billion in restatements. For now, however, Stephens refuses to explain any further details of his discussions with Nacchio and Qwest's board of directors. Nacchio is gone from the company, but plenty of people both below (dozens of senior managers) and above him (the board of directors, including former chairman Phil Anschutz, who himself sold $1.6 billion in stock at Qwest's height) remain.

Faced with shareholder lawsuits, Qwest has chosen to tell as little of the story of Nacchio's tenure as possible. Current CEO Dick Notebaert refused to be interviewed for this story, and Qwest officials did not respond to a list of questions about Nacchio's tenure. Reached at home, Tom Stephens said that while he'd urged Qwest to comment for this story, he'd been overruled. "Ultimately the whole story will come out," he says. "I'm proud of what I and the board did. It will speak for itself." But as far as explaining the story himself, Stephens said that his hands were tied. "If I were Dick Notebaert," he told me when I finally reached him at home, "you and I would spend a long time together. But I'm not the CEO."

And what about Nacchio, the former CEO? As you've undoubtedly guessed, he too would not cooperate with this story. Through his lawyer and publicist, Nacchio refused to comment on most of the issues raised here. In an e-mailed statement, his lawyer, Charles Stillman, blamed Qwest's problems on the slump in the U.S. economy. "Obviously, [Nacchio] feels it is regrettable that due to a number of circumstances, including the downturn in the economy, the telecommunications industry suffered huge losses and hurt employees of Qwest and its shareholders as well as employees and shareholders of other telecom companies," he wrote. "Based on some accounts I've seen, Mr. Nacchio has been singled out as a scapegoat for the ills that have befallen Qwest. That might be convenient, but it is simply not true."

Nacchio's friends, meanwhile, have argued that it simply wasn't in his character to bend the rules to serve his own interests. "[Joe] is not the kind of person who would consciously cross the line do something that he believed was illegal," argued one who called to plead Nacchio's case. "If a CEO did something illegal so he could sell his stock and make a profit, I think he should go to jail. But Joe always thought that [Qwest] would make it." In his congressional testimony six months ago, Nacchio pointed out that he held 470,000 shares of Qwest. He did not mention that while running the company, he sold more than six million shares. Despite this windfall, contrary to widespread rumors on the Internet, Nacchio is not building a huge new house. He still lives in a relatively modest mansion in Mendham, N.J. As part of his severance agreement, he continues to serve as a consultant to Qwest. He is paid $1.5 million a year.

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