Report details Nortel accounting misdeeds

The former management and employees of Nortel Networks manipulated the company’s accounting in order to postpone the payment of bonuses in late 2002 and to meet earnings targets in early 2003, according to an independent review conducted by the law firm Wilmer, Cutler, Pickering, Hale & Dorr and released Tuesday by Nortel.

The practice began when analysis of Nortel’s finances, directed by former Chief Financial Officer Doug Beatty in August 2002, revealed about $303 million in incorrect "provisions," or accounting entries. Generally accepted accounting practices require companies to disclose the provisions when they are discovered or restate previous quarters. Instead, the CFO and controller allowed finance employees to distribute those provisions over the following several quarters, the report said, using them to "close the gap" between a business unit’s earnings and the EBT ("earnings before taxes") targets instituted by former CEO Frank Dunn.

"Dunn and others stretched the judgment inherent in the provisioning process to create a flexible tool to achieve EBT targets," the report said. "They viewed provisioning as a ‘gray area.’ They became comfortable with the concept that the value of a provision could be reasonably set at virtually any number within a wide range and that a provision release could be justified in a number of quarters."

In mid-2002, Nortel’s board followed management’s recommendation in creating "return to profitability" (RTP) bonuses, a one-time payment to all employees as a reward for the company’s first pro forma profitable quarter. In addition, 43 top executives were eligible to receive bonuses for Nortel’s first, second and fourth straight quarter of profits.

When initial accounting indicated to management that Nortel would achieve pro forma profits in the fourth quarter of 2002, a particularly tough year for the company, the Wilmer Cutler report said, "Frank Dunn…understood that profitability had been attained from an operational standpoint but determined that it was unwise to report profitability and pay bonuses in the fourth quarter because performance for the rest of the year had been poor. He determined that provisions should be taken to cause a loss for the quarter." As a result, no employee bonuses were paid that quarter.

Later, in the first quarter of 2003, Nortel used a total of $361 million in provisions to report a pro forma profit for the quarter and award RTP bonuses to employees, though the company was actually operating at a loss. The company did the same in the second quarter of 2003.

Nortel has since fired its CEO and CFO along with other employees and demanded the return of bonuses paid to the CEO, CFO, controller and seven senior finance employees. Twelve senior officers, including the four presidents of Nortel’s business units, the four presidents of its regions and the president of global operations, have agreed to repay Nortel the entire amount of their RTP bonuses.

The company released an audited restatement of its 2003 financial results this week.