Nortel Network Corp.'s board of directors decided to fire chief executive officer Frank Dunn in 2004 after reviewing a report from investigators that were hired to examine the company's 2003 financial restatement, former chairman Lynton (Red) Wilson said Monday.
Mr. Wilson, a veteran business executive who headed Nortel's board of directors from 2001 to 2005, was the first Nortel director to testify at the long-running fraud trial of three former Nortel executives.
He told a Toronto courtroom Monday that directors had initially thought Nortel's $900-million (U.S.) restatement in October, 2003, was caused by oversized financial reserves being carried on the books due to the company's massive restructuring and downsizing in 2001 and 2002.
Mr. Wilson said it became clear in early 2004 that there were other problems with the accounting that were unrelated to the restructuring provisions.
By April, 2004, the board had already suspended chief financial officer Douglas Beatty and controller Michael Gollogly after Nortel revealed it needed to do a second restatement of its books. When a report by investigators at U.S. law firm Wilmer Cutler Pickering Hale and Dorr LLP was presented to the board, the directors called an all-day meeting to discuss what to do about the findings.
"At the end of the day, the board unanimously decided to replace the three executives," Mr. Wilson said simply.
Due to objections by defence lawyers, Mr. Wilson was not allowed to discuss the specific findings by Wilmer Cutler that led to the dismissals of the three executives. A judge ruled last year that the report's findings could not be submitted as evidence at the trial because they contained conclusions that were not factual evidence.
Mr. Dunn, Mr. Beatty and Mr. Gollogly are accused of fraud for allegedly using accounting reserves to manipulate Nortel's profitability in 2002 and 2003 to trigger bonus payments for themselves. The men have denied all the allegations.
Mr. Wilson also testified that the board created Nortel's now infamous "return to profitability" bonus plan on the recommendation of Mr. Dunn and former human resources head William Donovan.
He said other companies in the telecommunications industry were also facing losses at the time and were creating retention programs to reward key employees for not jumping ship. But Nortel felt it should have a plan that rewarded performance, not just longevity.
"I recall Mr. Donovan and Mr. Dunn suggesting we should base ours on a return to profitability, not simply a program for management to stay with the company," Mr. Wilson testified.
"That sounded to the [board] committee as a more sensible approach, so work was begun at that time."
The program was designed to pay everyone in the company a bonus upon achieving a single quarter of profitability. For top executives, however, a first tranche of payments was available after one quarter of profits, while a second portion was payable after two quarters of profitability, and a third portion after four consecutive quarters of profits.
The program, adopted in late 2002, was later criticized by analysts for providing too much incentive to create a profit in a single quarter to trigger payments. Top executives got their first payouts for the first quarter of 2003 – a period the Crown contends involved manipulation of accounting reserves to reach profitability.
Mr. Wilson testified he did not have concerns at the time about the quality of Nortel's earnings in the first quarter of 2003 – when the bonus was first triggered – despite the fact a large number of accounting reserves had been released in the quarter to achieve profitability.
He said the profits reported to the board in the first quarter were "a pleasant surprise" and had not been anticipated. He said directors believed that the accounting treatment was appropriate and involved reserves that had to be released at the time.
"The main concern of the board was the survival of the company," he said.
"We were relying on management and the auditors to ensure the numbers were in conformity with Canadian and U.S. GAAP [generally accepted accounting principles]. These numbers in terms of the size of the company weren't overwhelming. These were quite small."