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1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 1 TABLE OF CONTENTS PAGE 2 I. NATURE OF THE CASE 1 3 II. JURISDICTION AND VENUE 3 4 III. THE PARTIES 4 5 A. PLAINTIFF 4 6 B. DEFENDANTS 7 7 1. QWEST 7 8 2. THE INDIVIDUAL DEFENDANTS 7 9 3. THE BANK DEFENDANTS 10 10 4. ANDERSEN 13 11 5. DOE DEFENDANTS 14 12 6. AGENT AND CO-ACTORS 14 13 7. UNNAMED PARTICIPANTS 14 14 IV. BACKGROUND OF QWEST AND ITS REPORTED FINANCIAL PERFORMANCE 15 15 A. QWEST’S FORMATION 15 16 B. QWEST’S IPO 15 17 C. QWEST GROWS THROUGH MERGERS AND 18 ACQUISITIONS 15 19 D. QWEST’S FINANCIAL STATEMENTS APPEARED TO SHOW A SUCCESSFUL, GROWING COMPANY 20 WHICH SECURITIES ANALYSTS TOUTED 18 21 1. FINANCIAL STATEMENTS MUST BE PREPARED ACCORDING TO GAAP 19 22 2. QWEST’S REPORTED RESULTS FOR 1999 19 23 3. QWEST’S REPORTED RESULTS FOR 2000 25 24 4. QWEST’S REPORTED RESULTS FOR 2001 31 25 5. QWEST’S REPORTED RESULTS FOR 2002 42 26 V. THE NOTE OFFERINGS 43 27 VI. THE FALSITY OF THE REPRESENTATIONS 43 28 A. IMPROPERLY BOOKED REVENUES FROM COMPLAINT 1 INDEFEASIBLE-RIGHTS-OF-USE TRANSACTIONS WITH OTHER TELECOMMUNICATIONS 2 COMPANIES 44 3 B. QWEST’S REPORTING OF RECIPROCAL TRANSACTIONS VIOLATED GAAP 46 4 1. KMC TELECOM HOLDINGS 48 5 2. CALPOINT 49 6 3. ENRON 50 7 4. GLOBAL CROSSING 51 8 C. INFLATION OF PHONE DIRECTORY SERVICES 9 REVENUE 52 10 D. QWEST DISCLOSES THE FRAUDULENT SCHEME IN JULY 2002 AFTER REVEALING THE SEC 11 INVESTIGATION 53 12 E. QWEST’S STOCK PLUMMETS AS WRONGDOINGS BECOME KNOWN 59 13 VII. DEFENDANTS’ DIRECT PARTICIPATION IN QWEST’S 14 FRAUD 59 15 A. THE INDIVIDUAL DEFENDANTS 59 16 1. THE BOARD OF DIRECTORS 59 17 2. THE AUDIT COMMITTEE 60 18 3. NACCHIO AND ANSCHUTZ 61 19 4. OTHER INDIVIDUAL DEFENDANTS 62 20 B. THE BANK DEFENDANTS 63 21 1. CITIGROUP AND SALOMON 64 22 a. SALOMON MADE SURE IT HAD CLOSE RELATIONSHIPS WITH COMPANIES BY 23 PROVIDING PREFERRED EXECUTIVES WITH STOCK IN IPOs 64 24 b. SALOMON’S JACK GRUBMAN WAS A 25 CHEERLEADER FOR QWEST AND OTHER INVESTMENT BANKING CLIENTS OF HIS 26 FIRM 66 27 28 c. GRUBMAN TOUTS QWEST STOCK COMPLAINT 1 NOTWITHSTANDING HIS KNOWLEDGE OF ADVERSE INFORMATION ABOUT 2 QWEST’S TRUE FINANCIAL CONDITION 67 3 d. LEHMAN, MORGAN SECURITIES AND MERRILL 67 4 e. SALOMON, LEHMAN, MORGAN 5 SECURITIES AND MERRILL MADE MISREPRESENTATIONS AND OMITTED 6 MATERIAL FACTS TO OBTAIN LUCRATIVE FEES FROM QWEST 68 7 2. THE BANK DEFENDANTS LOAN MONEY TO 8 QWEST AND THEN PROTECT THEIR LOANS BY ASSISTING IN QWEST’S NOTE OFFERINGS 70 9 a. THE LOANS 70 10 b. THE NOTE OFFERINGS 70 11 (1) 7.9% NOTE OFFERING 70 12 (2) 7.75% NOTE OFFERING 71 13 (3) 7.25% NOTE OFFERING 71 14 (4) 7% NOTE OFFERING 72 15 C. ANDERSEN 73 16 1. ANDERSEN RECEIVED MILLIONS OF 17 DOLLARS IN FEES BY PROVIDING AUDIT, TAX, AND CONSULTING ADVICE TO QWEST 73 18 2. RESPONSIBILITIES OF AN INDEPENDENT 19 AUDITOR 73 20 3. ANDERSEN KNEW OF THE IMPROPER ACCOUNTING SCHEME 76 21 4. ANDERSEN MADE FALSE REPRESENTATIONS 22 ABOUT QWEST’S FINANCIAL STATEMENTS 78 23 5. ANDERSEN VIOLATED ITS PROFESSIONAL OBLIGATIONS 78 24 VIII. CAUSES OF ACTION 81 25 FIRST CAUSE OF ACTION 26 (VIOLATION OF CALIFORNIA CORPORATIONS CODE § 25400 ET. SEQ.) 81 27 28 SECOND CAUSE OF ACTION (VIOLATION OF CALIFORNIA BUSINESS & PROFESSIONS COMPLAINT 1 CODE §17200 ET SEQ.) 82 2 THIRD CAUSE OF ACTION (FRAUD, DECEIT AND CONCEALMENT) 83 3 FOURTH CAUSE OF ACTION 4 (BREACH OF FIDUCIARY DUTY) 85 5 FIFTH CAUSE OF ACTION (AGAINST ANDERSEN FOR VIOLATIONS OF SECTION 11 6 OF THE SECURITIES ACT) 86 7 SIXTH CAUSE OF ACTION (AGAINST CERTAIN BANK DEFENDANTS FOR 8 VIOLATIONS OF SECTION 11 OF THE SECURITIES ACT) 88 9 SEVENTH CAUSE OF ACTION (AGAINST CERTAIN INDIVIDUAL DEFENDANTS 10 FOR VIOLATIONS OF SECTION 11 OF THE SECURITIES ACT) 90 11 EIGHTH CAUSE OF ACTION (FOR VIOLATIONS OF SECTION 15 OF THE SECURITIES 12 ACT OF 1933) 91 13 IX. PRAYER FOR RELIEF 92 14 JURY DEMAND 94 15 16 17 18 19 20 21 22 23 24 25 26 27 28 COMPLAINT 1 Plaintiff California State Teachers’ Retirement System (“CalSTRS”), as and 2 for its complaint, alleges as follows upon information and belief based, inter alia, 3 upon investigation conducted by Plaintiff and its counsel, except as to those 4 allegations pertaining to Plaintiff personally, which are alleged upon knowledge: 5 I. NATURE OF THE CASE 6 1. This action involves fraudulent conduct by telecommunications 7 company Qwest Communications International Inc. (“Qwest” or the “Company”), 8 its directors and officers, and financial professionals that has caused the pension 9 plan of California’s teachers, Plaintiff CalSTRS, to lose in excess of $150 million 10 invested in Qwest’s equity and debt securities. CalSTRS is the third largest public 11 pension plan in the United States and serves over 715,000 active and retired 12 teachers of California. 13 2. In financial statements, filings with the United States Securities and 14 Exchange Commission (“SEC”), press releases and other public statements, 15 Defendants represented that Qwest was one of the highest revenue producing 16 telecommunications companies in the world, with highly favorable financial 17 results and prospects. Unbeknownst to CalSTRS, however, Defendants were 18 engaged in a scheme to falsely inflate Qwest’s revenues and decrease its expenses 19 so that Qwest would appear more successful than it actually was. The scheme 20 involved, among other things, improperly recognizing revenues from certain 21 multi-year contracts immediately, and recognizing revenues from capacity-swap 22 contracts whose only purpose was to boost revenue. 23 3. This scheme flourished because of the active participation and advice 24 of all Defendants: Qwest itself, the directors and officers who signed the 25 Registration Statements for the Notes purchased by CalSTRS and made other 26 misrepresentations and omissions in public filings and statements and who 27 knowingly participated in the financial fraud alleged herein; Arthur Andersen LLP 28 that aided in the scheme and that certified Qwest’s false financial statements; and 1 COMPLAINT 1 the banking and financial services companies who were directly involved in a 2 knowing scheme to mislead investors. 3 4. On July 28, 2002, Qwest disclosed that for the years 1999-2001, it 4 had improperly accounted for about 220 transactions worth approximately 5 $1.16 billion. These improprieties, which occurred during 1999, 2000, and 2001, 6 primarily involved Qwest improperly recording Indefeasible Rights of Use 7 (referred to as “IRU”) contracts as revenue immediately rather than deferring the 8 revenue over the life of the contract. Since the IRUs gave third companies the 9 right to use Qwest’s capacity or fiber for a period of time, generally twenty years, 10 it was not proper for Qwest to record this revenue immediately. Qwest also 11 entered into “swap” or reciprocal transactions with third parties, such as Global 12 Crossing and Enron, where each bought services or products, that had no business 13 purpose, from the other at inflated prices. Qwest stated that it would be restating 14 its financial statements. 15 5. On October 28, 2002, Qwest made further disclosures in a press 16 release that it would restate $531 million of previously recognized revenue 17 because of improper accounting. Qwest stated that it would treat those past sales 18 of IRUs “for cash as operating leases and recognize the revenue from these assets 19 over the life of the IRUs. The company has concluded that its policies and 20 practices for determining the value of the various elements of the fees earned in 21 connection with the sales of optical capacity assets for cash did not support the 22 accounting treatment. As a result, the company concluded that it should defer the 23 $531 million of revenue previously recognized on such sales over the life of the 24 underlying agreements.” 25 6. Due to Defendants’ misrepresentations and omissions about Qwest’s 26 financial well-being and prospects, CalSTRS purchased Qwest notes and stocks at 27 artificially inflated prices. As Defendants’ fraud that inflated Qwest’s revenues in 28 2 COMPLAINT 1 1999, 2000 and 2001 became known, Qwest’s stock and bond prices fell 2 significantly, ultimately leaving CalSTRS’s investments almost worthless. 3 II. JURISDICTION AND VENUE 4 7. Plaintiff CalSTRS purchased Qwest notes and stock in San Francisco, 5 California. Plaintiff CalSTRS is an agent and instrumentality of the State of 6 California, and therefore, is not a citizen of any state. Moor v. County of Alameda 7 (1973) 411 U.S. 693. 8 8. Each Defendant has sufficient minimum contacts with California, is a 9 citizen of California, or otherwise purposefully avails itself of benefits from 10 California or has property in California so as to render the exercise of jurisdiction 11 over it by the California courts consistent with traditional notions of fair play and 12 substantial justice. 13 9. The amount in controversy exceeds the jurisdictional minimum of this 14 Court. 15 10. This action is not preempted by the federal Securities Litigation 16 Uniform Standards Act of 1998 (“SLUSA”), as this action is not a class action and 17 is brought by a single Plaintiff seeking damages. Furthermore, SLUSA expressly 18 provides that, notwithstanding the other provisions of the Act, a state pension plan 19 such as CalSTRS may maintain a state court action on its own behalf. See 20 15 U.S.C. § 77p(d)(2); 15 U.S.C.
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