A former financial planning employee at Nortel Networks Corp. said the company released $80-million (U.S.) of accounting reserves in the first quarter of 2003 to reach the profit threshold needed to trigger special "return to profitability" bonuses.
Peter Dans, who worked in Nortel's planning and forecasting division and was responsible for doing bonus plan calculations, told the fraud trial of three former Nortel executives that the company not only needed to post a profit to trigger the special bonus payouts, but it also needed to earn enough profit to also cover the $72-million cost of paying out the bonuses.
Nortel's board had created the return to profitability (RTP) plan in 2002 to encourage executives to strive to turn around the company after it lost billions of dollars in 2001 and 2002. Terms of the program required the company to be profitable enough to cover the cost of the bonus payments without pushing Nortel into a loss for the quarter.
That was accomplished for the first time in the first quarter of 2003 by using $80-million of out-of-date accounting provisions being carried on the company's books under a category known as "non-operating" or head office provisions.
"My understanding of the release of the $80 [million]was that it was being released to essentially offset the cost of the RTP in the quarter, and my view at the time was that I wasn't sure it made sense from an accounting perspective," Mr. Dans testified.
Mr. Dans, who left Nortel in 2007 and is now chief financial officer of health sciences company Nordion Inc., said he knew at the time that it was not appropriate to reverse accounting reserves when there was no business event or "trigger" in the quarter to justify their use.
"They didn't belong in that period," he said. "They were going to create income in that period that didn't relate to an event in that period."
Mr. Dans, who was not part of the executive RTP bonus pool, said he did not raise concerns about the accounting treatment with the company's top executives, but said he spoke with his boss who said the decision to use the reserves would be reviewed by the controller's office and by Nortel's auditors at Deloitte & Touche.
Former chief executive officer Frank Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly are accused of fraudulently manipulating accounting reserves in 2002 and 2003 to trigger the RTP bonuses for themselves.
The men have denied the allegations and say the use of reserves was appropriate and was approved by Deloitte & Touche.
The Crown alleges the three men earned more than $7-million in total from the RTP bonus plan in 2003 and 2004, and a total of almost $13-million including restricted share unit payments and other bonus amounts.
Mr. Dans also testified Monday that Nortel's accounting treatment of reserves changed after June, 2003, when staff were given new instructions about appropriate ways that reserves could be "triggered" and taken into income.
In a June presentation, for example, employees were told that it was not appropriate to book extra large reserves – also known as accruals – using the most conservative estimates.
Mr. Dans said that was a new concept for him at the time.
"My view, from the people I interacted with I was under the impression they were basing their accruals more on conservatism before this date," he said.
Accounting rules discourage the use of conservative estimates in this area because there is a concern that companies could set aside extra large reserves in good years and hold them until a later date when they money is needed to arbitrarily bolster earnings or smooth out losses. The practice has become known as "cookie jar" accounting.
The case is being heard by Mr. Justice Frank Marrocco of the Ontario Superior Court.