Nortel Back on the Rocks
HE WAS SUPPOSED to be the solution - a dose of humility for a company that flew too close to the sun, and fell. Methodical and low-key, yet deeply driven, Frank Dunn spent a quarter-century climbing the corporate ladder at Canada's flagship telecommunications company, attaining the exalted position of chief financial officer. But when he replaced the beleaguered John Roth as chief executive of NORTEL NETWORKS CORP. in November 2001, the celebrations were muted: by then, questions were swirling about Nortel's financial reporting methods. More than a few analysts noted that Dunn had been holding the purse strings as the company's stock crashed a year earlier.
"There was a ton of criticism, by our shop and others, about Nortel's accounting when Dunn was financial chief," recalls Al Rosen, a Toronto-based forensic accountant whose firm advises pension and mutual funds on Canadian companies. Among the complaints: the company appeared to have sweetened its quarterly results by recording revenues not yet received from clients - a practice Rosen says should have raised alarms on Nortel's board of directors. "There were good, positive reasons for keeping [Dunn] around," he adds. "But you don't keep him around without some very strong oversight."
The point? While it's easy to blame Nortel's latest, arguably most damaging, scandal on Dunn and two other executives who were sacked last week, anyone wishing to learn from this debacle must surely look past the executive suite, to the directors of the company and the rules within which they operate. If reports of questionable accounting were circulating when Frank Dunn was CFO, why did the Nortel board promote him? Where was the board's audit committee when the irregularities first emerged? And if there's nothing forcing boards to keep their managers in line, what does that say about Canada as an investment environment?
Those were among the troubling questions after the telecommunications equipment manufacturer yet again dashed hopes of investors, who had brief visions of Nortel returning to the colossus that once dominated Canada's corporate landscape, commanding as much as $124.50 per share. In the hours after Dunn's dismissal, a worldwide sell-off ensued, shearing 31 per cent, or $9.7 billion, from Nortel's stock value and prompting speculation of takeover bids by multinational telecoms (by week's end, none had materialized). Tech stocks, pension funds, mutual funds and mom-and-pop portfolios all took hits as investors succumbed to the jitters, creating a trough of uncertainty that swept through Canadian markets. And it may be a while before the cloud lifts. After already restating results from previous years, Nortel now estimates that its 2003 profit of US$732 million will likely be cut in half, yet cannot say when it will produce a reliable set of numbers. "It's just scary," says Bill Mackenzie, president of Fairvest Corp., which monitors corporate governance for institutional investors. "You have all these restatements, and now everybody's waiting for the other shoe to drop."
As ever, most analysts who watch the company's operations seem unruffled, pointing to its still-strong fundamentals and successful forays into new technologies. Nortel remains the largest telecommunications equipment maker on the continent with 35,000 employees worldwide and a market capitalization of $23 billion, and has recently scored large contracts in the emerging fields of wireless broadband and voice-over-the-Internet systems. "Some of these victories suggest the company's doing quite well," says Blaik Kirby, senior vice-president of Adventis management consultants, who specialize in the information and communications sector. "This is a major bump in Nortel's road to recovery. But I don't think it's a harbinger of more bad news to come."
Maybe not for analysts. But with the U.S. Securities and Exchange Commission and the Ontario Securities Commission both investigating Nortel's accounting practices, and the RCMP making "informal" inquiries, the company is sure to become a lightning rod for demands of more rigorous corporate governance in the coming months. The lavish bonuses it offered to executives for returning the company to profitability in 2003, quarter by quarter, are already attracting attention from critics who believe they encourage executives to manipulate results. "It's just not appropriate to be giving large amounts of money to executives based on a company's performance over the course of 12 weeks," says David Beatty, managing director of the Canadian Coalition for Good Governance, a watchdog group for publicly traded companies. "You need performance incentives. But the horizon has to be something more reasonable, like three years."
Then there's the nagging question of oversight: while Nortel's board may have uncovered accounting irregularities with its own audit this year, Rosen wonders how it could have missed them when they first occurred - by all appearances as early as 2000. "Maybe they did give very explicit directions to clean up the damn mess," he says, "and [Dunn] chose not to do it." The directors are keeping their counsel, saying only that Dunn and his lieutenants were fired "for cause" and that the decision relates to the ongoing audit. Lynton (Red) Wilson, Nortel's chairman, said the moves were necessary to restore "confidence in the company's leadership and financial reporting."
Still, it was hard to miss the symbolism in the board's choice to succeed Dunn - a former admiral who commanded the U.S. Sixth Fleet during the 1991 Gulf War and once served as vice-chairman of the Joint Chief's of Staff. William Owens, 63, has been a director of Nortel for more than two years, and promised to make financial accountability the company's "watchword." His appointment sent a reassuring message to investors, suggesting a restoration of honour and discipline to a firm that evidently lost its bearings. But then, that's what the company and many analysts said about Dunn. And in a sea of financial uncertainty, with precious few officers left on the bridge, this is one ship that won't be easy to turn around.
Maclean's May 10, 2004