1Nortel Networks

Synopsis

Nortel Networks is one of the world’s most leading company in

communication technology. Nortel has been in existence since the invention
of the telephone. In the past they have had many different names over the
years, like Northern Electric, Northern Telecom, and Bell Canada Enterprises.

Today they produce next-generation products for network service provider

and enterprise networks, support multimedia and business-critical
applications. Technologies designed by Nortel are used to help eliminate
barriers to efficiency speed. Nortel’s technologies are used to power the
globe’s top 25 service provider’s networks, serve as the foundations of world
economies and financial centers.

During the late 1990s, 75 percent of the Internet traffic in North America was
being carried by Nortel equipment. Nortel’s rapid growth was part due to
acquisitions of other companies.

The Scandal

By 2001, the internet bubble burst which caused a massive change of fortune
for the company. Nortel had lost more then 50 percent of its sales, which
resulted in a loss of $27.3 billion US. This massive loss of revenue proved
hard for Nortel to regain from. In order to regain the lost image of Nortel, the
company created a false image of profitability, to give observers and
stockholders confidence in the company. By changing their record books,
Nortel violated various GAAPS which would increase the stock prices and
allow a fast recovery from the ‘tech bubble.’ In March 2004, Nortel warned
that it would delay filing its audited financial statements for 2003 and would
likely make more financial restatements, sending the stock plunging. The
U.S. Securities and Exchange Commission and the Ontario Securities
Commission began investigations in April 2004 of Nortel's earnings
restatements. The investigation had uncovered shocking truths about
Nortel’s financial statements.

Nortel had engaged in accounting fraud from 2000 to 2003 to close gaps
between its true market performance, its internal profit targets and the Wall
Street expectations. From late 2000 through January 2001, Nortel made
changes to its revenue recognition policies that were not in compliance with
the U.S. GAAP.
The changes were made to fraudulently accelerate revenue into 2000 to
meet its publicly announced revenue targets for the fourth quarter of 2000
and for that year. These actions did not comply with the Objectivity Principle,
the accounting practices by Nortel weren’t based on facts; Revenue
Recognition Convention, revenue earned by Nortel was written as a loss so
that the cash can be used for the next quarter; Time Period Concept, Nortel
violated this GAAP by re-arranging revenue in the quarters of the fiscal year;
Consistency Principle, Nortel violated this GAAP by not using the same
accounting methods from 2000 to 2004; Full Disclosure Principle, this GAAP
had been the major violation Nortel had done. Nortel had not disclosed to its
investors that it had actually been in a loss rather then profit.

Nortel also selectively reversed certain revenue entries during the 2000 year-
end closing process when its acceleration efforts pulled in more revenue than
necessary to meet its targets. These actions inflated Nortel's fourth quarter
and fiscal year 2000 revenues by approximately $1.4 billion. Nortel had
illegally established and maintained, over $400 million in excess cash
reserves when it announced its fiscal year 2002 financial results.

In the first and second quarters of 2003, Nortel again illegally released
approximately $500 million in excess reserves to boost its earnings and
engineered a false return to profitability. These efforts turned Nortel's first
quarter 2003 loss into a reported profit under GAAP, and largely erased its
second quarter loss while generating a profit.

Changes

These violations of the GAAP had a major affect on Nortel’s financial health. It
had caused the market capitalization of Nortel to drop from $398 billion to
less then $5 billion. The stock had crashed from $124 to $0.47. More then
60,000 employees were laid off, and many people lost their retirement
savings and investments. Many members of senior management were forced
to resign or were fired for financial irregularities. Nortel was forced to agree
to SEC’s requirement of not violating the antifraud requirements, reporting,
books and records and internal control provisions of the federal laws and by
paying a $35 million civil penalty.

Nortel was also forced to report to the Commission's staff on its progress in
implementing corrective measures and resolving an outstanding material
weakness over its revenue recognition procedures. Nortel's Board of Directors
launched an independent investigation which later uncovered the improper
accounting. The company introduced a complete corporate renewal, which
would take measures to insure that financial irregularities do not occur again
and GAAP are not being violated. The scandal will continue to haunt the
company for many years, in order to regain the trust of the market Nortel has
today hired an independent auditor, KPMG for checking its books.