Nortel Case Report

10 October 2016

The company also used to be affiliated with AT&T/Western Electric until Western was forced to sell its stake in 1949. In 1976, the company changed its name from Northern Electric to Northern Telecom Limited, and shifted its concentration on digital technology. In 1977, Nortel introduced its DMS line of digital central office telephone switches. Nortel ended its long relationship with AT&T in 1984, a year after deregulation named. Bell Canada Enterprises the parent company to Northern Telecom. In 1998, the company acquired Bay Networks and changed its name to Nortel Networks.

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In the late 90’s, Nortel’s sales of fiber optic network gear was predicted to help their sales, but the market became saturated very quickly. At the height of Nortel’s first 100 years the company amassed for more than a third of the total valuation of all companies listed on the Toronto Stock Exchange (TSX), but once the Internet bubble passed, the company fell into ethical debacle. Nortel Networks Corporation, or formally known as Northern Telecom Limited was one of the largest telecommunications equipment companies in the world prior to its filing for bankruptcy protection on

January 14th, 2009. During times of functionality, they specialized in multinational telecommunications equipment manufacturing. The company is based in Canada out of Mississiauga, Ontario, Canada. Their biggest rival always was Global System Mobile (GSM). Through the early 1990s, the company invested heavily in Code Division Multiple Access (CDMA) in attempt to grow in European and Asian markets. This did not pan out so well as Nortel’s losses amounted to $27. 3 billion by 2001—causing them to lay off two-thirds of the workforce.

From 2000 through 2003 there was a period of fiscal irresponsibility resulting from the work of the company’s administrators. Initially in 2000, they falsified their fourth-quarter earnings by $1 billion to meet market expectations and selectively reversing certain revenue entries. In 2002, administrators discovered $300 million in excess reserves being carried over and swept it under the rug for future benefit in addition to establishing another $151 million in unnecessary reserves. In 2003, administrators directed the release of at least $490 million of excess reserves to boost earning, fabricate profits, and pay bonuses.

Losses turned to profits during this year thanks to the shifty methods taking place. Later in that year, administrators mislead investors as to why Nortel was conducting a purportedly “comprehensive review” of its assets—attributed by restatement $948 million in liabilities. They said restatement was caused solely by internal control mistakes instead of the truth that there was intentional improper handling of reserves which needed to remain hidden. 2 On October 23rd, 2003, the company announced that Nortel would restate its financials for fiscal years 2000, 2001, and 2002.

Shortly after this restatement, the major players of Nortel’s administration that were responsible for all of this were exposed through an independent investigation. In March 2004, The CFO and controller were suspended, in addition to the announcement of further restatements and revisions; they were terminated a month later in April 2004. A restatement in early 2005 showed approximately $3. 4 billion in misstated revenues and another $746 in liabilities. In late 2005, Nortel admitted that restatements were the result of management fraud—beginning the downturn of their stock.

The company ended up restating financials four times over four years, replacing senior management, and instituting a comprehensives remediation program designed to ensure proper accounting and reporting practices. Eventually on October 15th, 2007, Nortel agreed to settle by paying a $35 million civil penalty and admitting to violations of the antifraud, reporting, books and records, and internal control provisions of the federal securities laws. 2 On June 25th, 2009, Nortel’s price dropped to 18. 5 cents a share down from a high of $124. 0 in 2000. The company decided that month that they would discontinue operations and sell off all of its business units. Nortel’s CDMA wireless business and LTE access technology were sold to Ericsson, and Avaya purchased Nortels Enterprise business unit. Major Players in the Scandal: The major players in this scandal were the four members of the senior management: CEO Frank Dunn, CFO Douglas Beatty, controller Michael Gollogly, and assistant controller Maryanne Pahapill. CEO Frank Dunn, who is also a certified management accountant.

Dunn was mainly involved in the improper use of reserves from 2000 to 2003. CFO Douglas Beatty, controller Michael Gollogly, and assistant controller Maryanne Pahapill were also involved in this management fraud. 2 The Royal Canadian Mounted Police in Toronto arrested ex-CEO Frank Dunn, ex-CFO Douglas Beatty, and former corporate controller Michael Gollogly on seven counts of fraud. Including charges “fraud affecting public market; falsification of books and documents; false prospectus, pertaining to allegations of criminal activity within Nortel Networks during 2002 and 2003.

Magnitude of the financial issue: Nortel at its peak was one of the best companies that Canada had ever seen. Just like ENRON and other financial frauds at the time, Nortel appeared to be a shining example of success in the corporate world. Again like ENRON, Nortel grew through a strategy of aggressive expansion and purchasing of smaller companies in order to create a massive conglomerate. During the good times Nortel was the largest technology company and the most valuable company in Canada. Nortel accounted for over one third of the entire aluation of the Toronto Stock Exchange. The Toronto Stock Exchange is the Canadian equivalent of the New York Stock Exchange and holds the most influential stock market in Canada. Nortel employed about 95,000 employees worldwide. About 26,000 of those workers based in Canada alone. Nortel at one point had a market capitalization of almost C$400 billion. Nortel had set up pensions and healthcare protection for its employees. All of these were lost to either the restructuring under Frank Dunne which left about 60,000 employees without jobs or the bankruptcy that followed in 2009.

Canadian government officials and regulators identified how destructive a full failure of Nortel would be on the Canadian economy. The Canadian government through the Export Development Canada project tried to lend money to the falling giant. However the Canadian government could not cover all of Nortel’s debt obligations. Nortel owed about $107 million and the EDC (Export Development Canada) could only supply about $30 million in short term loans. This $107 million interest payment accounted for about 4% of Nortel’s cash and put the company into bankruptcy.

The world financial crisis of 2008 had put too much strain on Nortel and they were forced to begin liquidation. Public auditor: The auditors involved with this case were Deloitte and Touche. In documents from the fraud case, which is still being heard by the Royal court in Canada, Deloitte claims that they were not given proper documentation by Nortel. Deloitte claims that they did not have pertinent information which should have been provided by administrators at Nortel. Deloitte raised concerns to the audit board of Nortel in 2003 when Nortel turned a profit after Frank Dunne’s restructuring of the company.

Deloitte raised awareness of potential fraud and did their duty in that respect. However further investigation conducted has implicated Deloitte in the financial reporting irregularities in Nortel which some have claimed dates back to the time of CEO Roth who held office before Dunne. Information coming out of the case states that even if transactions were deemed suspicious, they still signed off on the verity of the financial reports. Frank Dunne and some of his officers are now charged with fraud by both the SEC and the OSC which regulate the American and Canadian markets respectively.

The case is currently still under review in the Royal court of Canada and civil charges have been brought in the United States. Fraud Triangle Nortel had experienced tremendous growth throughout the 1990s, allowing it to expand operations worldwide. Nortel’s expansion came during the telecommunication and technology bubble of the 1990s that inflated stock prices of companies in those sectors. Frank Dunn had taken over for the previous CEO, John Roth, in November 2001 during the telecommunication bubble bust. Dunn felt pressured to maintain the high stock price because it accounted for over one third of Nortel’s value2.

Nortel management was also incentivized to post profits that produced executive bonuses with over $7. 8million going to Dunn alone. The primary members of the Nortel fraud were able to commit the fraud because, as executive officers and controllers, they were able to go around the internal controls of the company. That allowed them to implement many accounting practices that did not comply with GAAP. Nortel management’s rationalization for these fraudulent practices must have been that they needed to maintain the high stock price in order for the company to continue operating.

Moral Breach and Ethical Issues As a publicly traded company, Nortel had the responsibility of fairly reporting the company’s true financial data to stockholders and potential investors. Dunn, Beatty, Gollogly and Pahapill breached this responsibility by establishing earnings management accounting strategies to manipulate Nortel’s revenues. Nortel management also actively sought to inflate earnings to trigger very large bonuses for key members of management. Perhaps, if these incentives did not exist then there would be less motivation to commit the fraud.

Finally, Nortel’s auditor for over a century, Deloitte and Touche, has come under scrutiny by the defense lawyers in Dunn, Gollogly and Beatty’s civil trial in Canada this year. The defense claims that Deloitte approved of all major accounting adjustments that Dunn and his team had engaged in. Summary of Legal Actions On April 28th, 2004, Dunn and his fraud partners were fired for financial mismanagement2. On March 12th, 2007 the SEC filed civil charges against Dunn, Beatty, Gollogly and Pahapill for repeatedly engaging in accounting fraud to bridge gaps between Nortel’s true performance, its internal targets, and market expectations.

Dunn and Beatty were charged with violating the officer certification agreement that was established by the Sarbanes-Oxley Act. Nortel settled with SEC on October 15, 2007 by consenting to be prescribed from violating the antifraud, reporting, books and records, and internal control provisions of the federal securities laws. Nortel paid $35million to the SEC, and $1million to the Ontario Securities Commission to establish a Fair Fund for affected shareholders. Finally, Canadian authorities arrested and charge Dunn, Beatty and Gollogly with seven counts of fraud.

Their trial began on January 16th, 2012. Current Status: Nortel, once known as the largest telecommunications manufacturer in the world, filed for bankruptcy in 2009. Now three years later, the period of bankruptcy continues as the company discloses their every operating report highlighting each cash receipt and disbursement. When Nortel went bankrupt, executives believed that selling all business assets would be the best and easiest way to fight debt. Recently, Nortel has netted $7. 7 billion from selling its patents and businesses.

As stated on their website, “Nortel remains focused on maximizing value for its stakeholders, including the sale of its remaining assets, resolution of claims, the wind-down of its global operations and entities, resolution of allocation matters with respect to the sale proceeds, and other significant restructuring activities toward the conclusion of the creditor protection proceedings. ” The case for Nortel executives Dunn (ex CEO), Beatty (ex CFO) and Gollogy (ex controller), who were charged with fraud for affecting the public market and falsifying books and documents to earn larger bonuses, is still in trial.

In February, a former Vice President of Nortel testified in court against executives stating that they had asked him to use questionable accounting methods to manipulate the company’s earnings. Although those who committed the crime have been charged, thousands of employees will still be left without pension plans and jobs. Nortel has spent over $20 million on retirement package these past two year, but unfortunately the company will stop the pension plan and disability program payments as it continues to sell away its businesses.

By the end of 2011, Nortel was split into regional entities – Nortel Networks Limited in Canada and Nortel Networks Inc in the United States, causing disagreements over how to split $7. 5 billion that was earned by selling many assets and patents other corporations such as Apple and Microsoft Corp. The following charts, graphs and financial statements analyze Nortel’s current status. Case Study Questions and Solutions: 1. Dunn is a certified management accountant. Based on the facts of the case, which provisions of the IMA’s Statement of Ethical Professional Practice that was discussed in chapter 1 have been violated?

Dunn violates many of the provisions of the IMA’s statement of Ethical Professional Practice they are as follows: 1. Perform professional duties in accordance with law, regulations and technical standards. 2. Provide decision information that is accurate, clear, concise and timely 3. Retain from engaging in any conduct that would prejudice carrying out any duties ethically. 4. Abstain from engaging in or supporting any activity that might discredit the profession. 5. Communicate information fairly and objectively. 6.

Disclose all relevant information, that could reasonably be expected to influence an intended users understanding of the reports analyses or recommendations. 7. Disclose delays or deficiencies in information timeliness processing or internal controls in conformance with organization policy and/or applicable law. He violated these by selective reversal of revenue entries in 2000. Followed by concealing the reserves in 2002, which violated GAAP, and then avoided posting a profit so the company wouldn’t have to pay out bonuses. In 2003 Dunn released the reserves to falsely report a profit, which allowed them to eports a profit a quarter earlier than expected, and to pay out more bonuses to senior management. Also in 2003 he misled the investors about why Nortel had restated its financials in order to avoid uncovering the unethical management techniques him and his team had been using. All of these actions take away Dunn’s integrity and credibility in the field of managerial accounting, which are two of the standards the IMA sets out. Dunn failed to meet his professional code of conduct and his company suffered because of it. 2. What are the responsibilities of an auditor to detect fraud?

How were those responsibilities compromised by the actions of Nortel’s management? It is the auditors responsibility to report fraud if they find it, however in this case the actions of Nortel’s management made it difficult for the auditors to do their job. The false financial statements and hiding of money veiled the problems of the company from the auditors. Once there was a hint of the fraud the auditors found it and perused the trail, taking the ethical route and also following the code of conduct. It was their investigation that brought down the fraudulent executives and forced the company to restate its financials properly.

This would eventually lead to the failure of Nortel. Nortel made materially false and misleading statements and omissions in connection with the quarterly reviews and materially misstated annual audits of financial statements. This caused the auditors to not be able to properly do their job, and review the statements. 3. Describe the incentives that created pressure on Nortel to manage earnings. Considering the role of Nortel’s management in this regard, discuss whether it met its corporate governance obligations as discussed in previous chapters.

The incentives that drove Nortel to manage its earning where greed of the management team, the pressure to deliver bonuses, the pressure to survive an economic downturn, and the pressure to make the company seem like a good investment to both current and potential investors. In an economic climate of intense competition and corporate greed the management at Nortel fell victim to their vices and allowed the pressure to perform to overwhelm their priorities. This caused them to put their own greed and personal ambition before the well being of the company. Nortel did not meet its corporate governance obligations.

It did not follow any internal rules of how to run the business. It ignored any corporate ethics they might have. It lied to stakeholders several times by misstating the financials. They did not follow the professional code of conduct of their careers and also did not follow industry standards. They broke the law. No one inside the company caught the fraud therefore their internal controls where not effective. Each of these immoral acts is a case where corporate governance has failed. 4. The final quote in the case characterizes Nortel’s failure as “just another casualty of capitalism. Do you agree with this statement? Why or why not? How would you characterize the cause of the failure at Nortel? I would argue that Nortel is not just another casualty of capitalism. Nortel did not function in a system of free market capitalism where the government had absolutely no regulation and let the markets function however they wanted. The capitalism system of North America is more of a mixed economy, which combines public and private ownership of companies, and also provides government regulation and intervention to prevent and deal with fraud.

Even in a free market the system is meant to come to an equal balance of supply and demand, which cannot be reached if there is fraud involved since the supply has been inaccurately disclosed by the senior management at Nortel. I would characterize this failure as one of humanity. It was not the economic system that allowed this fraud to take place, but the greed of the people and a social environment that ties success so strongly to wealth. It was the social pressure and the effect of human nature that led to Nortel’s demise. . The case discusses how Nortel’s managers prioritized themselves over the shareholders, which, in part, lead to the company’s failure. What should be a company’s first priority? A company’s first priority should be following their code of ethics. The second priority should be the shareholders, followed by the management and other employees. This hierarchy ensures that all the business that is done with be both moral and legal, meaning there is no room to commit fraud and damage the company.

In this way you are putting the shareholders first, because by providing a stable and healthy company the shareholders will see an investment that will be able to reach its highest potential. 6. Was Nortel’s settlement a fair penalty? Should the SEC have imposed harsher or more lenient sanctions? Should these sanctions have been on the managers, on Nortel as a whole, or both? A fair settlement would offer compensation to all those who were hurt by this fraud. Groups that may have been hurt could be shareholders, employees and customers.

Deciding what is a fair compensation is a little more difficult, however as much of what these people lost as possible should be returned to them. As for the managers who created the problems and took part in the fraud should face a sentence of termination from their company, loss of license (if applicable) and jail time. The company and the individual managers have both failed stakeholders and should both be held accountable. In the case of Nortel specifically the stockholder settlement goes with these guidelines, as for the managers their trial is still ongoing and therefore no sentenced has been given to them yet.

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