Filter
Top Products
Nortel posted significant losses in 2001 and 2002 and downsized its work force by nearly two-thirds. The remaining employees were asked to
undertake significant additional responsibilities with no increase in pay and no bonuses. The Company’s former senior corporate management
asserted, at the start of the inquiry, that the Company’s downturn, and concomitant downsizing of operations and workforce, led to a loss of
documentation and a decline in financial discipline. Those factors, in their view, were primarily responsible for the significant excess
provisions on the balance sheet as of June 30, 2003, which resulted in the First Restatement. While that downturn surely played a part in the
circumstances leading to the First Restatement, the root causes ran far deeper.
When Frank Dunn became CFO in 1999, and then CEO in 2001, he drove senior management in his finance organization to achieve EBT
targets that he set with his senior management team. The provisioning practices adopted by Dunn and other finance employees to achieve
internal EBT targets were not in compliance with U.S. GAAP, particularly Statement of Financial Accounting Standards Number 5 (“SFAS
5”). SFAS 5, which governs accounting for contingencies, requires, among other things, a probability analysis for each risk before a provision
can be recorded. It also requires that a triggering event — such as resolution of the exposure or a change in estimate — occur in the quarter to
warrant the release of a provision. Dunn and other finance employees recognized that provisioning activity — how much to reserve for a
particular exposure and when that reserve should be released — inherently involved application of significant judgment under U.S. GAAP.
Dunn and others stretched the judgment inherent in the provisioning process to create a flexible tool to achieve EBT targets. They viewed
provisioning as “a gray area.” They became comfortable with the concept that the value of a provision could be reasonably set at virtually any
number within a wide range and that a provision release could be justified in a number of quarters after the quarter in which the exposure,
which formed the basis for the provision, was resolved. Dunn and others exercised their judgment strategically to achieve EBT targets.
Third quarter, 2002
.
At the direction of then-CFO Doug Beatty, a company-wide analysis of accrued liabilities on the balance sheet was
launched in early August 2002. The CFO and the Controller, Michael Gollogly, learned that this analysis showed approximately $303M in
provisions that were no longer required and were available for release. The CFO and the Controller, each a corporate officer, knew, or ought to
have known, that excess provisions, if retained on the balance sheet, would cause the Company’s financial statements to be inaccurate and that
U.S. GAAP would have required either that such provisions be released in that period and properly disclosed, or that prior period financial
statements be restated. Instead, they permitted finance employees in the business units and in the regions to release excess accruals into income
over the following several quarters. They acted in contravention of U.S. GAAP by failing to correct the Company’s financial statements to
account for the significant excess accrued liabilities. Neither the CFO nor the Controller advised the Audit Committee and/or the Board of
Directors that significant excess provisions on the balance sheet had been identified and that the Company’s financial statements might be
inaccurate, nor did either suggest such information should be disclosed in the Company’s financial statements.
As a result of this company-wide review, senior finance employees recognized that their respective business unit or region had excess
provisions on Nortel’s balance sheet, and directed other finance employees to track these excess provisions. Nortel finance employees had their
own distinct term for a provision on the balance sheet that was no longer needed — it was “hard.” Each business unit developed, in varying
levels of detail and over varying periods of time, internal “hardness” schedules that identified provisions that were no longer required and were
available for release. Finance employees treated provisions identified on these schedules as a pool from which releases could be made to “close
the gap” between actual EBT and EBT targets in subsequent quarters.
117