Nortel worker acknowledges reserve amount was 'small'

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A new accounting reserve for excess inventory that was proposed at Nortel Networks Corp. in early 2003 was "a drop in the bucket" compared to the company's total inventory provisions, a lawyer for former Nortel chief financial officer Douglas Beatty said Tuesday.

Lawyer Greg Lafontaine told the fraud trial of three former Nortel executives that the company had reserves for excess and obsolete inventory totalling $1.015-billion (U.S.) as of Dec. 31, 2002.

A proposal to create an additional $30-million reserve for excess inventory – later scaled back by $25-million before it was recorded – was not large under the circumstances, Mr. Lafontaine suggested while cross-examining Crown witness Ken Crosson, who was Nortel's former vice-president of global operations.

"So it's a drop in the bucket compared to the larger number," Mr. Lafontaine said.

"It's small, yes," Mr. Crosson agreed.

Mr. Crosson was testifying at the fraud trial of Mr. Beatty, former Nortel chief executive officer Frank Dunn and former controller Michael Gollogly who are accused of arbitrarily manipulating Nortel's accounting reserves in 2002 and 2003 to trigger special "return to profitability" bonuses for executives.

Mr. Crosson testified Monday that he was called by a head office employee in early 2003, after he had already submitted the financial results for his division, and asked to create two new accounting reserves that ultimately totalled $32-million when recorded on Nortel's books.

The new reserves have been a controversial point at the trial because the Crown contends the accused executives created over $200-million of new provisions in the fourth quarter of 2002 to lower the company's profit for the period. Nortel had unexpectedly earned a profit in the quarter, and the Crown contends the executives felt it would not help them to trigger the full amount under the bonus plan at that time.

Instead, the Crown alleges the men used some of the new reserves in the first and second quarters of 2003 to push the company to profitability at that time and trigger their bonus payments.

The accused have denied the allegations and their lawyers have suggested repeatedly during the trial that the provisions created at the end of 2002 were legitimate and were supported by Nortel's outside auditors at Deloitte & Touche.

Mr. Lafontaine suggested to Mr. Crosson on Tuesday that it is difficult to accurately determine provisions for excess inventory.

"The excess [inventory]provision is subject to a great deal of management judgment," he suggested to Mr. Crosson.

Mr. Crosson agreed.

After receiving a request for a new inventory provision, Mr. Crosson initially proposed a $35-million charge, which was then reduced by head office staff to $30-million. It was further reduced to $5-million before it was booked.

The Crown has suggested the amount was reduced because Nortel unexpectedly found an accounting error related to an unrelated business deal, which reduced profit by $25.5-million in the period. As a result, the Crown contends Nortel executives decided they didn't need $25.5-million of planned new inventory provision.

But lawyer David Porter, who is representing Mr. Dunn, showed Mr. Crosson an internal analysis completed in early January, 2003, that suggested the company had too large a provision for excess inventory.

Mr. Porter suggested that analysis was the reason for reducing the provision to $5-million. Mr. Crosson, who did not prepare the analysis, replied he was comfortable at the time with the decision to reduce the reserve to $5-million.

Mr. Lafontaine noted that even if the $25-million had been used, it would have represented just a 1.3 per cent increase in the inventory reserve, which was a tiny amount.

The trial is scheduled to hear Wednesday from another former Nortel employee, Doug Hamilton, who was the former vice-president of Nortel's optical division. He will be the sixth former employee to testify at the trial.