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House Panel Probes Telecoms

Already answering to angry investors and, in some cases, to federal regulators, telecoms are now being called upon to answer questions about accounting irregularities before a congressional panel.

The U.S. House Financial Services Subcommittee on Oversight and Investigations will hold a hearing Thursday in an attempt to get to the bottom of potential accounting and securities irregularities that appear to be widespread in the industry. Representatives from bankrupt Global Crossing Ltd., Qwest Communications International Inc. and WorldCom Group, are expected to testify.

The subcommittee's hearing is part of a wider probe into the quality of federal accounting regulations, sparked by the massive Enron collapse. Michael G. Oxley (R-Ohio), chairman of the Financial Services Committee, has drafted a bill intended to tighten corporate responsibility and reform the accounting industry.

Specifically, the subcommittee plans to look into allegations of revenue inflation which may have played a role in hiding Global Crossing's distressed state, leading to the fourth largest bankruptcy filing in U.S. history.

Telecoms are notorious for their murky, hard-to-understand accounting practices. Much of the trouble can be traced to the use of a legitimate tool in the telecommunications industry's arsenal: the IRU or Indefeasible Right of Use. An IRU is the right to use a fixed amount of communications capacity, or a certain communications facility, for a defined period of time.

IRUs first came into vogue back in the days of Ma Bell's monopoly, when they allowed competitors to utilize the large undersea cables that were part of AT&T's fief to build out their networks. For instance, a company might purchase an IRU giving it the right to use an OC-48 wavelength (the equivalent of about 32,000 simultaneous telephone calls) for five years, or might purchase two fibers in a network for 20 years. Most IRUs average between 20 and 25 years.

A long-haul carrier might be interested in extending its business into a region it believes will be lucrative but where it has no capacity or facilities. Through an IRU, that firm could lease capacity or a facility in the region, allowing it to enter the market but bypass the costs associated with a buildout.

When a company buys an IRU, it accounts for it as a capitalized asset that depreciates over time. Selling IRUs is more complicated. When a firm sells capacity in a land-based network, the revenue from the sale is general reported in GAAP (Generally Accepted Accounting Principles) financial statements over the term of the IRU. For submarine capacity, GAAP generally requires that the entire amount of the revenue be recorded in the current period.

IRUs became especially popular about five years ago, when a host of new backbone providers burst onto the scene with a need to build their markets quickly.

But IRUs can also be used to inflate revenues. Two firms can sell (or swap) each other IRUs for the same capacity or facility at the same time. Though not always a sign of collusion, this sort of deal, sometimes known as a "hollow swap," could allow the two companies to exchange the same amount of capacity with no real money changing hands. Each side could then record the IRU it sold as revenue and the IRU it purchased as a legitimate capital expense.

Both Global Crossing and Qwest, among others, engaged in trades of tens of millions of dollars of network capacity in the past few years. In one case, Global Crossing acquired capacity in the United States from Qwest, while Qwest acquired about the same amount of capacity from Global Crossing in Asia. In this case, Global Crossing recorded the swap as revenue while Qwest didn't record the revenue. Qwest has told regulators the transaction was not recorded because it had a negligible impact on its 2000 annual revenue of $19 billion.

The panel will also scrutinize a deal between WorldCom and Asia Global Crossing in which WorldCom acquired a 10-year, $20 million IRU from Asia Global Crossing and at the same time sold that company a 10-year, $20 million IRU.

All three companies have said any IRUs they have engaged in were for legitimate business purposes.