Global Probe Focusing on 2001 Practices

Federal investigators probing Global Crossing Ltd. for possible wrongdoing are sharpening their focus on the first half of 2001 -- a period when employees took questionable steps to fend off financial collapse and top executives cashed out shares in a final binge.

Internal documents and e-mails obtained by The Times show that by May 2001, the telecommunications company was dangerously close to violating a key bank requirement. Had such a violation occurred, Global Crossing’s banks could have demanded repayment of more than $2 billion in loans, triggering a default on $3.8 billion in notes.

In turn, Global Crossing could have been forced into Bankruptcy Court months before its Chapter 11 filing Jan. 28. At a minimum, the default would have restricted or reduced Global Crossing’s access to credit and probably would have driven down its credit rating and stock price.

To avert the potential crisis, Global Crossing employees used suspect accounting to boost the company’s adjusted EBITDA, or adjusted earnings before interest, taxes, depreciation and amortization, according to the e-mails and interviews with former employees. Increasing that figure helped keep the firm in compliance with a bank formula that measured the company’s adjusted EBITDA against its total debt.

The practices call into question top executives’ sales of more than $147 million in Global Crossing stock in the first half of 2001, before shares began a tumble from which they never recovered.

In May 2001 alone, when Global Crossing shares closed as high as $15.80, five executives or directors cashed out 11.5 million shares. Chairman Gary Winnick topped the list of sellers by cashing in more than $124 million of stock. On Jan. 28, the day Global Crossing sought bankruptcy protection, the company’s stock closed at 13 cents.

“You’ve got to question the numbers more than ever in those kinds of circumstances,” said Charles Mulford, an accounting professor at Georgia Institute of Technology.

And that’s just what the FBI, the Securities and Exchange Commission, the Labor Department and a congressional committee are doing. All are investigating Global Crossing, which took on more than $10 billion in debt to build a worldwide network of fiber-optic cables to carry data at the speed of light.

Founded in 1997, Bermuda-based Global Crossing grew quickly through acquisitions and made a name for itself with its posh Beverly Hills offices and a share price that peaked above $61. But the company endured a parade of five CEOs, spent lavishly and posted cumulative net losses of more than $7 billion by the end of 2001.

Although much attention has been paid to the fiber-optic capacity swaps Global Crossing made with other telecommunications operators, other, smaller actions taken during the second quarter of 2001 illustrate how desperate the company was to stay afloat.

For instance, internal accounting documents show Global Crossing reclassified an 11-year rental agreement on the company’s Madison, N.J., office building from an operating lease to a capital lease.

Most standard office leases don’t meet the required accounting criteria to be classified as anything but operating leases, accounting experts said. In fact, companies typically try to avoid capitalizing leases because doing so adds interest expense and depreciation and shows up as a liability on the books.

For Global Crossing, however, the switch did one critical thing: It increased the company’s EBITDA. That’s because the lease change -- made retroactive to Jan. 1, 2001 -- converted six months of ordinary rent expenses into interest and depreciation expenses that remain outside the EBITDA calculation. The move effectively boosted what Global Crossing called “recurring adjusted EBITDA” by $1.38 million, plus an additional amount for six months’ worth of depreciation, in the second quarter.

The move had a small effect on EBITDA -- less than 1% -- but tiny amounts can make all the difference in bank covenants.

“It immediately smacks of an attempted manipulation of the financial results,” said Carr Conway, a forensic accountant with Denver-based Dickerson Financial Investigation Group Inc. “If you enter into a lease transaction, you make the determination at the inception of the lease. You don’t change it mid-stream.”

Mulford, the accounting professor, called the lease change “a dramatic and cavalier step.”

Global Crossing declined to answer questions about the Madison lease or its classification and would not discuss what steps it took to comply with its bank covenants for the quarters ended March 31 and June 30, 2001. The company also declined to make available individuals named in this story who still work for Global Crossing. The others mentioned by name either declined to comment or could not be reached last week.

A spokeswoman for J.P. Morgan Chase & Co., the lead lender on Global Crossing’s bank debt, declined to discuss the covenants.

It’s not exactly clear what would have happened if Global Crossing had busted the debt-to-adjusted EBITDA covenant. Once the banks were notified, they could have given the company a waiver, tightened financial requirements, added other conditions or collateral -- or called the loans, forcing the company into bankruptcy.

“We don’t know if the banks would in fact have waived the covenant, and they might have, but it’s their decision to make,” Mulford said.

Ultimately, Global Crossing’s lenders did force the company into bankruptcy, after granting a temporary waiver of the covenants in late 2001.

But a string of internal e-mails sent among finance executives and others in mid-May 2001 reveal how anxious the company was to avoid such a showdown with its lenders. In fact, the executives discussed steps that might bring the company’s books into compliance with covenants before Global Crossing filed financial statements with the banks.

In a May 12, 2001, e-mail from Chief Financial Officer Dan Cohrs titled “debt covenants and capacity sales,” he wrote that current projections for adjusted EBITDA indicate “that we will be tight on our bank covenant as we go through this year.” He added that the first-quarter results “seriously changed the outlook” and stressed to the recipients, “we need to make our numbers.”

That note was sent to then-President David Walsh and Tom Casey, who was chief executive of Global Crossing at the time. Several employees in the company’s finance departments also received copies. Four days later, Hank Millner, head of Global Crossing’s structured finance department, sent an e-mail to the top financial executives and the general counsel warning of “the very serious impact” if first-quarter numbers forced the company out of compliance with the banks.

Millner first urged certain divisions to forward to him updated figures for capital lease obligations and inter-company loans.

“There are just a few levers that we can pull to improve the ratio of debt/EBITDA,” he wrote. Among other things, Millner suggested “where possible, classifying capital leases as operating leases.”

The suggestion from Millner showed the company’s willingness to reclassify existing leases to help out with the covenants, but it is unclear why he was suggesting the reverse of what ultimately happened with the Madison lease, which was changed from an operating lease to a capital lease.

In testimony this month before the House Energy and Commerce Committee’s oversight and investigations panel, CFO Cohrs said Millner’s e-mail was based on “incorrect and imprecise and preliminary estimates that, in fact, did not forecast a violation of loan covenants.” He added that Global Crossing certified that its debt-to-adjusted EBITDA ratio was 3.54 at the end of the first quarter of 2001, well below the maximum allowable ratio of 4.75.

Still, by May 21, five days after Millner’s missive about the covenants, Global Crossing employees were trading e-mails discussing how to convert the Madison operating lease into a capital lease.

At one point, Ripal Patel, a Global Crossing accounting manager, asked another accounting manager, Bernard Calissendorff, to discuss the accounting entries required to change the lease.

In a reply dated May 22, Calissendorff wrote: “I ran the numbers per the file you sent me. Hypothetically, it’s simply an amortization schedule. In effect what was previously recorded as rent expense is now recorded as depreciation and interest expense.”

Then he added, “Do you know who made the decision to capitalize this lease, it doesn’t make sense.”

A subsequent string of e-mails show accounting employees trying to adjust the value of the land and other numbers so the lease would qualify to be capitalized.

On June 1, Ken Dorward, senior manager for financial operations, wrote to department colleagues Scott Sabbagh, Kirk Rossi and Patel: “We are booking the balance sheet side of the Madison capital lease, but there is one hitch. When we spoke about the land portion in relation to the comps you came up with, we basically said land is a small portion of the overall value when dealing with commercial property. However, the tax bill valuation has the land split at 44% of total.”

“I need some evidence that the land value is 25% or less of the total fair value of the property to get the best accounting treatment. Can we come up with something?”

A June 11 printout from Global Crossing’s computerized accounting system, obtained by The Times, included the capitalized Madison lease.

In a letter to the company’s general counsel a month later, Roy Olofson, then a vice president of finance, suggested the company investigate several accounting moves, including the “capitalization of the operating lease for the Madison, New Jersey office complex in May, 2001.” Olofson, who later lost his job at the company, also cited capacity swaps and other items.

The e-mails discussing the lease change indicate that the company not only violated generally accepted accounting principles, or GAAP, “but they violated GAAP in three separate places for just one transaction,” maintained a former employee in Global Crossing’s finance department.

Specifically, that employee said, the company failed to comply with GAAP in valuing the land as a percentage of the total property, in valuing the overall property, and by understating the company’s incremental borrowing rate.

Inflating EBITDA may have postponed the company’s violation of the debt covenant and bought it time for a possible turnaround. “But then if you link it to the personal stock sales,” Mulford said, “then the whole thing starts to stink.”