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A tale of toxicity: The real culprit in Nortel’s collapse

In the end, there was no smoking gun. No incriminating e-mails. No damning recordings like the tapes of Enron brokers who, after manufacturing electricity shortages in California, rejoiced eagerly as wild fires threatened power lines.

There were just three hard-pressed Nortel Networks executives and a malleable accounting system. Former CEO Frank Dunn and his financial lieutenants, Douglas Beatty and Michael Gollogly, are now free to continue their lives, acquitted of charges they defrauded investors by toying with Nortel's books to pocket return-to-profit bonuses. Crown prosecutors did not prove beyond a reasonable doubt that the men deliberately planned to defraud investors, Mr. Justice Frank Marrocco concluded. And without proof of criminal intent, there was no case.

Yet Nortel's bookkeeping was not innocent in the sense of candid financial reporting. The year-long trial of the Nortel Three gave a behind-the-scenes look at the company's accounting practices. And what is showed was a fair amount of financial magic – "Ta-dah! This looks nicer" – at work.

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With towering writeoffs and falling revenues, it was easy to move money in and out of the company's reserves, the infamous "cookie jars," to obtain something closer to the desired profit figures. Judge Marrocco dismissed this hocus-pocus, ruling that the amounts were not material for a company of Nortel's size. There was only one exception: The "unsupportable" $80-million in accrued liabilities released in the first quarter of 2003.

But even if these weren't large amounts, the fact this could be done within such discretion is disturbing. There is a fine line between "managing earnings" and manipulating the books. Financial reporting was never intended to be a PR job, nor should it be.

Also troubling was the relationship between Nortel and the company's long-standing auditors, Deloitte & Touche. The lead auditor on Nortel in 2003 was removed from his position and invited to take a back seat after he raised flags and questioned Nortel's use of accounting reserves. Nortel executives had been complaining about his work and his approach to Deloitte.

There were disagreements. There were accounting mistakes. And if Nortel accounting executives drew on reserves in this quarter or that one, it was merely a clumsy attempt to correct errors, concluded Judge Marrocco.

But while this was no fraud, the fact remains that Nortel bosses were eager to smooth out the company's earnings results – an eagerness not unrelated to the company's warped compensation system, which was overly generous and encouraged short-term results. (It was Frank Dunn himself who suggested to Nortel's compensation committee that executives be rewarded with return-to-profit triggered incentives.)

In the go-go years of the telecom boom, every Nortel executive had won the lottery, no one more so than John Roth, who left the company with $130-million and change. The company's board distribution stock options like candies on Halloween night; those long-lasting options came to represent 15 per cent of the shares outstanding. And when the telecom equipment buying frenzy came to halt, the board eased the pain for Nortel executives and managers by reducing the price at which the options could be exercised.

This was the corporate equivalent of reckless endangerment.

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You couldn't say that it was Nortel's rapacious compensation or its aggressive accounting that caused it to sink. When the Internet bubble burst, the equipment manufacturer was overexposed to telecom upstarts that could no longer find financing to buy networks. And despite its head-spinning acquisition spree, Nortel was astonishingly ill-equipped to make inroads in the sounder enterprise market.

Yet this toxic corporate culture ultimately proved fatal to the company – especially when it got mired in the distracting accounting scandal. As CEOs came and went, Nortel was never able to manage a turnaround and extricate itself from controversy.

In the end, there was no smoking gun. Yet four years after the company filed for bankruptcy, as former Nortel employees and retirees are fighting with creditors over the remaining billions, the implosion of Nortel has left a lingering smell as acrid as gunpowder.

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About the Author
Chief Quebec correspondent

Sophie Cousineau is The Globe and Mail’s chief Quebec correspondent. She has been working as a journalist for more than 20 years, and was La Presse’s business columnist prior to joining the Globe in 2012. Ms. Cousineau earned a master’s degree in journalism from the University of Illinois and a bachelor’s degree in economics and political science from McGill University. More

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