SEC Stops Swapping Strategy

A practice used by many telecom carriers — bandwidth swapping –has come
under the Securities & Exchange Commission (SEC) gun, and any company that
participated in the practice may be force to restate its revenues.

According to a report in the Washington Post, the SEC sent the
American Institute of Certified Public Accountants a memo earlier this
month warning them of the new policy.

Not all swapping transactions are banned, the memo said, but any carrier
that stated the swapping as revenue could possibly be forced to restate its
financial results. It warned executives they “should be advised to give
consideration to this matter prior to certifying the financial statements
previously filed with the SEC,” the memo said.

The memo is due notice to chief executive officers and financial officers
for a practice conducted by many carrier’s in the industry. Executives
have come increasingly under the microscope of federal regulators in the
past month, starting with the Enron collapse, which rippled out into SEC
probes of Global Crossing and Qwest Communications and
brought to light financial “irregularities” at WorldCom.

The Sarbanes-Oxley Act of 2002 is the legislative muscle behind the SEC
memo to the telecom industry. The Act requires CEOs and chief financial
officers to sign off on every quarterly revenue report to certify the
“appropriateness of the financial statements and disclosures contained in
the periodic report,” according to Section 302.

For years, companies like Global Crossing, Level 3 and Qwest sold bandwidth
amongst themselves under a practice called indefeasible right of use (IRU)
contracts. First started in the days of the AT&T monopoly in the 1980s, it
let the owning network sell a particular amount of bandwidth over a period
of time — anywhere from one to 20 years.

Most IRU’s are sold in five- and ten-year increments, to be paid out over
the course of the contract. Some carriers, forced with lagging sales in
network capacity, started treating IRU swaps with other carriers as
revenue, and attribute the sale as revenue for the quarter.

That created a problem, especially since the sum total of the deal was
never front-loaded, but paid out piecemeal over the length of the
contract. In some cases, where capacity was swapped on a 1:1 basis, money
never switched hands, but executives still counted the contract as revenue.

The thorny issue
of IRUs
is one the SEC wants to correct, and soon. Forced by Congress
to beef up its investigative scrutiny of telecom companies and prodded by
an Administration facing the largest recession in decades, the agency is
looking for ways to “clean up” the accounting irregularities among companies.

The AICPA, an accounting industry lobbying and trade organization, said
clear accounting practices are necessary, given the abuses of the past
which are coming to light today.

“Investors must have information that is accurate, clear, timely and
relevant,” the organization announced in a statement July 15, after passage
of the Sarbanes-Oxley Act.

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