Mark Evans, Financial Post
So Nortel Networks Corp.'s books were apparently cooked after all. The burning questions are what exactly happened, who fudged the numbers and what were their motivations.
Until Nortel says otherwise, the responsibility for the accounting fiasco lies at the feet of the three executives fired “for cause” in April — chief executive Frank Dunn, chief financial officer Doug Beatty and controller Michael Gollogly.
According to unidentified sources cited by The Wall Street Journal, the company's board has “determined the company inaccurately employed an accounting manoeuvre to make it look profitable, when in fact it wasn't.”
The “manoeuvre” in question has to do with complex accounting rules involving things such as writedowns for assets and bad loans. Nortel had billions of dollars in play from acquisitions and equipment deals done during the telecom boom from 1997 to 2000.
If the Journal story is accurate, it confirms speculation that has been bandied about since Nortel's accounting problems evolved from a minor problem into a financial disaster in late-April.
So what prompted the financial massage? One argument is the short-tempered Mr. Dunn was hell-bent on wrapping up the company's extensive restructuring by returning the firm to profitability last year at a time when the telecom equipment industry was still in a deep slump.
Mr. Dunn could have made it clear to senior executives it was paramount Nortel post profits –the sooner, the better. With firm marching orders, these executives and their staffs may have decided to play it fast and loose with accounting rules, which can be more art than science. A few numbers get shuffled here and, voila, profits.
This, in turn, triggered a company-wide bonus plan in early 2003, and everyone went home happy. Mr. Dunn looked like a hero for nurturing Nortel back to health, while he and thousands of his employees received some major walking-around money.
If this scenario materializes, are Mr. Dunn, Mr. Beatty and Mr. Gollogly on the hook? Do they bear responsibility for ensuring the accuracy and legitimacy of the company's accounting systems? In a world obsessed with the Sarbanes-Oxley Act, they have to take the blame if they signed off on the books.
A more sinister prospect is Nortel's books were deliberately torqued — driven by a bonus scheme the board — which includes new CEO Bill Owens — put in place to motivate people who had watched tens of thousands of their co-workers eliminated through layoffs, office and plant closures and asset sales.
With more than $140-million of bonuses within reach — slightly more than what ex-CEO John Roth made in 2000 — it is easy to understand how avarice may have come into play. Given the enormous wealth that executives received during the dot-com and telecom booms, it is possible many people within Nortel believed their bonuses were entirely justified.
(Nortel said yesterday it intends to recover any bonuses paid to executives found guilty of wrongdoing.)
If all it took was a little number fudging here and there, who was really going to get hurt? Employees would be rewarded, while investors would be happy if Nortel shares bounced back a little bit. It seemed so simple and, more important, lucrative.
So far, Nortel is not providing specific details.
As investors showed yesterday, Nortel will — for the most part — be valued on its business prospects as the telecom equipment industry appears to have its first year of growth since 2000. Nortel is well positioned to capitalize on demand for equipment to run Internet and wireless networks.
This week, Nortel investors have been swamped with new information. They have been told: the company will provide an update next month on the impact of the restated results, which cover the periods between 2001 and 2003; preliminary first and second-quarter results will be disclosed in August; and the board will claw back unwarranted bonuses.
All of this suggests the investigation by the company's independent audit committee, which started its work in November with advice from a major law firm in Washington with connections to the U.S. Securities and Exchange Commission, is close to completing its work.
It may not have all the answers yet but the committee, headed by ex-Royal Bank of Canada chairman John Cleghorn, probably has enough information to ascertain what roughly happened.
What has become abundantly clear is the committee believes Mr. Dunn, Mr. Beatty and Mr. Gollogly had the ultimate responsibility for making sure Nortel's accounting systems were accurate. It may be they were ignorant of what was happening within the ranks but there are no excuses these days in the post-WorldCom/Enron world.
A major issue going forward that Nortel will have to address is the class-action lawsuits being launched. If the books were manipulated, some analysts believe the company could cough up as much as US$500-million in settlements. It is entirely possible Nortel may be making settlements or defending itself for the next two to three years.
As Mr. Owens battles to restore Nortel's credibility, he will also have to deal with the fact the fallout of the company's accounting problems will not vanish any time soon. It could be some time before Nortel can start with a clean slate but at least you get the feeling the healing process is underway — even if it is embarrassing, painful and expensive.