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Nortel used reserves to post loss instead of profitable 'blip,' trial hears

The Crown alleges Nortel executives used accounting reserves to manipulate the company's financial reports in order to receive 'back to profitability' bonuses.


Nortel Networks Corp. unexpectedly earned a profit of as much as $168-million (U.S.) in the final quarter of 2002, but the gain turned into a loss of $62-million after the company booked a series of adjustments before the results were disclosed to shareholders.

The Toronto fraud trial of three former Nortel executives heard evidence Monday about the closing process for completing Nortel's books at the end of 2002, and about the wild swings in the company's profitability as employees worked on financial statements in early 2003.

Helen Verity, a former Nortel accounting employee responsible for consolidating the company's operating numbers to create financial statements, identified a series of internal financial statements that were created from Jan. 5, 2003, onward, showing the fourth-quarter results changing dramatically over several days.

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A first draft on Jan. 5, for example, showed a preliminary loss of $42-million for the fourth quarter, which was far better than a $100-million loss forecast to the board of directors only two weeks earlier.

By Jan. 6, the results showed a profit of $73-million.

By Jan. 7, the internal report showed Nortel had earned a profit of $168-million in the fourth quarter, but the report also listed a series of new accounting reserves proposed for creation that would lower the profit to a loss of $28-million.

By Jan. 8, internal reports listed $212-million of new reserves that would transform the profit into a loss of $71-million. The company would ultimately report a loss of $62-million for the period following more tweaking of the numbers.

The Crown has contended Nortel's senior management decided to arbitrarily create more than $200-million of new accounting reserves to transform a profit to a loss in the fourth quarter of 2002 because they felt the fourth-quarter results were a "blip" that could not be sustained. The company's new "return to profitability" bonus plan for executives would only pay out at the maximum level if the company had consecutive quarters of profitability.

The Crown alleges the senior executives instead used some of the new reserves created at the end of 2002 to push the company from a loss to a profit in the first and second quarters of 2003, triggering their bonus payouts at that time.

Many of the reserves created at the end of 2002 were unwound when Nortel did two later restatements of its books to correct past errors.

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Former Nortel chief executive officer Frank Dunn, former chief financial officer Douglas Beatty, and former controller Michael Gollogly are charged with fraud in connection with the alleged manipulations.

The men have denied all the allegations and their lawyers have suggested the new accounting reserves created at the end of 2002 were legitimate reserves that needed to be booked at the time.

In testimony on Monday, Ms. Verity said the final adjustment for the fourth-quarter financial statements was made Jan. 21, 2003, which was "very late" in the period.

Late that day, Ms. Verity testified, assistant controller Linda Mezon asked Ms. Verity's group to reduce a newly created reserve for excess and obsolete inventory from $30-million to $4.5-million by booking a $25.5-million reversal.

At the same time, Ms. Verity was asked to record a new $25.5-million cost related to a business transaction with JDS Uniphase Corp. "I was annoyed I was still booking entries this late," she testified.

When she signed the approval for the entry, she added a note saying that it was done at Ms. Mezon's request, Ms. Verity said.

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The Crown has previously alleged that Nortel discovered an error related to JDS late in the closing process, so it arbitrarily reduced the unrelated inventory charge by the identical amount to offset the cost and keep the bottom line at the same level.

On Jan. 23, 2003, two days after the final changes were recorded, Nortel issued its press release announcing its fourth-quarter financial results.

Ms. Verity also testified that she asked each quarter in 2002 about a list of accounting reserves the company was carrying on its books that had been identified as no longer supportable and available to be released.

She said she asked Ms. Mezon if anything was going to happen with the out-of-date reserves, but each quarter nothing changed. "Linda was aware of when these accruals had been set up. She was aware that they had been sitting there for a while. And I reminded her of that," Ms. Verity said.

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About the Author
Real Estate Reporter

Janet McFarland is the real estate reporter for The Globe and Mail’s Report on Business, with a focus on residential real estate trends. She joined Report on Business in 1995, and has specialized in reporting on corporate governance, executive compensation, pension policy, business law, securities regulation and enforcement of white-collar crime. More

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