U.S. SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 20333 / October 15, 2007
Accounting and Auditing Enforcement Release No. 2740 / October 15, 2007
SEC v. Nortel Networks Corporation and Nortel Networks Limited, Civil Action No. 07-CV-8851 (S.D.N.Y.)
Nortel Networks Pays $35 Million to Settle Financial Fraud ChargesThe Securities and Exchange Commission today filed civil fraud charges in the U.S. District Court for the Southern District of New York against Nortel Networks Corporation and its principal operating subsidiary Nortel Networks Limited (Nortel) alleging that Nortel engaged in accounting fraud from 2000 through 2003 to close gaps between its true performance, its internal targets and Wall Street expectations. Nortel is a Canadian manufacturer of telecommunications equipment.
Without admitting or denying the Commission's charges, Nortel has agreed to settle the Commission's action by consenting to be permanently enjoined from violating the antifraud, reporting, books and records and internal control provisions of the federal securities laws - namely, Section 17(a) of the Securities Act of 1933, Sections 10(b), 13(a), 13(b)(2)(A), 13(b)(2)(B) and 13(b)(5) of the Securities Exchange Act of 1934, and Exchange Act Rules 10b-5, 12b-20, 13a-1 and 13a-13. Nortel also has agreed to pay a $35 million civil penalty, which the Commission will seek to place in a Fair Fund for distribution to affected shareholders, and to report periodically to the Commission's staff on its progress in implementing remedial measures and resolving an outstanding material weakness over its revenue recognition procedures.
According to the Commission's complaint, from late 2000 through January 2001, Nortel made changes to its revenue recognition policies that were not in conformity with U.S. Generally Accepted Accounting Principles (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. The complaint alleges that 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, the complaint alleges, inflated Nortel's fourth quarter and fiscal year 2000 revenues by approximately $1.4 billion.
The complaint further alleges that Nortel had improperly established, and was improperly maintaining, over $400 million in excess reserves by the time it announced its fiscal year 2002 financial results. According to the complaint, these reserve manipulations erased Nortel's fourth quarter 2002 pro forma profit and allowed it to report a loss instead so that Nortel would not show a profit earlier than it had previously forecast to the market. The complaint alleges that in the first and second quarters of 2003, Nortel improperly released approximately $500 million in excess reserves to boost its earnings and fabricate a return to profitability. These efforts turned Nortel's first quarter 2003 loss into a reported profit under US GAAP, and largely erased its second quarter loss while generating a pro forma profit. According to the complaint, in both quarters Nortel's inflated earnings allowed it to pay tens of millions of dollars in so-called "return to profitability" bonuses, largely to a select group of senior managers.
In settling the matter, the Commission acknowledges Nortel's substantial remedial efforts and cooperation.
The Commission previously announced the filing of civil fraud charges in U.S. District Court against Nortel's former CEO Frank Dunn, former CFO Douglas Beatty, former Controller Michael Gollogly and former Assistant Controller MaryAnne Pahapill (a.k.a. Mary Anne Poland) for their roles in Nortel's accounting fraud. See Litigation Release No. 20036 (March 12, 2007) / Accounting and Auditing Enforcement Release No. 2576 (March 12, 2007). The Commission subsequently amended its complaint to bring charges against Douglas Hamilton, Craig Johnson, James Kinney and Kenneth Taylor, the former vice presidents of finance of Nortel's business units. See Litigation Release No. 20275 (September 12, 2007) / Accounting and Auditing Enforcement Release No. 2676 (September 12, 2007).