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Nortel used reserves to meet profit targets, court told

A Nortel employee testified that he was asked to make a new reserve for excessive and obsolete inventory of $35-million (U.S.) for the fourth quarter of 2002.


Nortel Networks Corp.'s largest operating division routinely used accounting reserves that were held on its books to meet its profit targets, a Toronto court heard Tuesday.

Jim Kinney, former vice-president of finance in Nortel's wireless division, told the fraud trial of three former Nortel executives that there was a common practice in the wireless division to fill in budget gaps by releasing income from old accounting reserves.

He said he discovered the practice when he joined the division in 2002 and was told it had $180-million (U.S.) of reserves being carried on its books that were out of date and no longer needed.

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"I think it was clearly obvious since coming into wireless in August, 2002, that the balance sheet release [of reserves]was a means to meet your earnings target," he testified.

Indeed, Mr. Kinney said it was a "game changer" a year later when staff were told accounting reserves could no longer be used as they had been.

Nortel had launched a review of its use of accounting reserves – which would later lead to a restatement of the company's books – and executives prepared a presentation for staff on July 31, 2003, saying a "balance sheet review" was not a proper justification to trigger the use of accounting reserves, according to a staff presentation submitted at the trial.

Instead, employees were told that accounting rules said reserves could only be released when there was a proper business "trigger" in that quarter, like the conclusion of a lawsuit or the completion of a contract.

Mr. Kinney testified the presentation called into question what had become standard accounting treatment throughout all of Nortel's divisions. Employees had often released reserves to bolster income using the justification that the reserves had been subject to a review and were not deemed to be needed any longer.

"I'd go as far as to say the entire corporation from A to Z that had anything to do with a balance sheet was doing it wrong," he testified.

"This was a significant change from previous methodologies that had, quite frankly, permeated the entire organization."

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Mr. Kinney is testifying at the fraud trial of former Nortel chief executive officer Frank Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly. The men are accused of manipulating Nortel's reserves to trigger a profit at the company in 2003 and earn a special "return to profitability" bonus for executives.

Lawyers for the accused have denied the allegations and have argued the reserves were legitimate and were approved by auditors from Deloitte & Touche.

In court Tuesday, Crown attorney David Friesen showed Mr. Kinney an e-mail he had written in August, 2003 – after the company had launched its project to review all reserves on its books. In the e-mail, Mr. Kinney told another Nortel employee he was concerned about a suggestion that had been made that the division had "flexibility" to meet its targets by releasing reserves from the balance sheet.

Mr. Kinney said he wrote the e-mail because he was concerned "old habits die hard."

"When did you lose that flexibility?" Mr. Friesen asked.

"July 31," Mr. Kinney replied, referring to the date of the staff presentation on the use of accounting reserves.

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"Before that you had it?" Mr. Friesen asked.

"That is correct," Mr. Kinney replied.

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