Nortel accounting worker testifies about 'road maps' to profit

Share

Former Nortel Networks Corp. chief executive officer Frank Dunn felt it would be "awkward" if the telecom giant recorded an internal profit that triggered executive bonuses while it publicly reported losses based on different accounting rules.

Brian Harrison, Nortel's former director of planning and analysis, testified Monday that Mr. Dunn suggested in a conversation early in 2003 that it would look odd if the company reported a loss under generally accepted accounting principles (GAAP) but paid bonuses to top management for meeting internal non-GAAP profit targets.

"The gist of it was that it would be awkward if there was a pro forma [internal]profit, which would trigger a bonus, but an external or GAAP loss," Mr. Harrison told an Ontario court.

"I would say that sort of optically having a public loss and at the same time paying bonuses would be optically odd. … Awkward optics was how I understood it."

After the conversation, Mr. Harrison said he prepared accounting models for the executive team to show how Nortel could report a GAAP profit in the first and second quarters of 2003 by using accounting reserves to boost the bottom line.

Mr. Harrison was the first witness to testify at the fraud trial of Mr. Dunn, former chief financial officer Douglas Beatty, and former controller Michael Gollogly. The men are accused of manipulating Nortel's financial statements in 2002 and 2003 to trigger a special "return to profitability" bonus created by the company's board.

During his testimony in the Ontario Superior Court in Toronto, Mr. Harrison confirmed that he prepared a series of internal "road maps" for Mr. Beatty and other executives that included estimates of increasingly large accounting reserves Nortel would need to use as income in the quarters to reach profitability.

On notes he made as he prepared one of his estimates, Mr. Harrison scrawled the words "rock vs. hard place" in the margin.

The provisions were amounts recorded as reserves in prior years for anticipated future costs, such as settlements of lawsuits. But if the reserved amounts turned out not to be needed, they could be reversed and recorded as income down the road. Crown attorney Robert Hubbard has previously alleged that the provisions were used improperly and arbitrarily to enable Nortel to record a profit when they did not meet proper accounting tests for triggering their use.

In the first quarter of 2003, for example, Nortel released $80-million (U.S.) of head office, non-operating accounting reserves, transforming a loss for the quarter into a $54-million profit and triggering the payout of $73-million worth of bonuses. In the second quarter of 2003, Nortel reported a profit after recording more than $380-million in gains from accounting provisions.

Mr. Harrison testified his model "road maps" were not given to Nortel's board of directors. Asked why not, he replied it wasn't customary within the company because they were management documents used for internal planning.

Mr. Harrison also testified Monday that he wrote an e-mail in 2001 in which he explained that a new expense facing the company could be "offset" by recording a similar amount as income from accounting reserves. In the e-mail, he referred to the reserves as "Doug's cookie jar."

He said the reference was to head office, non-operating accounting reserves that were under the direction of Mr. Beatty, who was Nortel's controller at the time.

Mr. Harrison told the court the "cookie jar" phrase wasn't commonly used at Nortel, but he was directly quoting his boss, a former CFO at Nortel, when he wrote the e-mail.

Asked if it was typical for Nortel to use non-operating reserves to adjust its profits, Mr. Harrison said: "I certainly had a sense there was hardness on the balance sheet." He said "hardness" meant there was potential to use reserves to increase profits.

The trial continues Tuesday.