Course:MGMT405 2020W2/Nortel

Background

Nortel, also know as Nortel Networks Corporation, was a public telecommunications and data networking equipment manufacturer. They made multiple purchases of internet companies during the dot-com boom from 1997-2001. They did this to stay competitive in the rapidly growing information technology (IT) market. They peaked as a company in 2000 when their stock made up 35% of the Toronto TSE 300 index value. They were a top 10 most valuable company in the world and employed roughly 94,000 people globally. However, Nortel was involved in an accounting scandal that would ultimately lead to their demise. In 2009, they filed for bankruptcy protection resulting in the largest corporate failure in Canadian history. Key stakeholders such as shareholders, employees and pensioners took the biggest losses while Nortel executives received US$190 million in retention bonuses between 2009-2016. All in all, this was one of the largest corporate scandals to ever occur in Canada.

What Happened?

Nortel's share price performed excellent from 1997-2001 benefitting from the dot-com bubble. Everyone at this time believed internet stocks were the future and would experience massive growth. Individuals and institutions poured money into these companies such as Nortel. This caused the share prices of many of these companies to become very rich as they were anticipating endless massive sales growth. For Nortel, these expectations were not met causing the share price to collapse. Under GAAP, Nortel was not permitted to use the pooling method for acquisitions of companies. The pooling method would treat acquisitions the same way mergers were treated which allowed the acquiring company to not have to account for the expense of the acquisition. Instead, Nortel had to use the purchase method for acquisitions meaning they had to depreciate or amortize the value of the acquired company's assets. Nortel had many acquisitions during the dot-com bubble from 1997-2001 but did not have a single profitable year due to the large reportable expense from acquisitions using the purchase method under GAAP. To combat this, Nortel would focus on and highlight earnings from operations to shareholders and analysts. This would not take into account the corresponding expenses from acquisitions which were mostly made up of goodwill. Using earnings from operations, Nortel would appear profitable and its stakeholders loved this. However, this type of accounting made it possible to acquire companies for nothing which did not make any sense as there should be some type of expenses for performing an acquisition. At the same time, Nortel was promising shareholders 30-40% top line growth. As well, during 2000 Bell which held 39.23% of Nortel's shares decided to sell out of their position. These shares became available to retail investors who bought them all up in a hurry. Later that year, Nortel shares hit a high of $124.50 on the Toronto Stock Exchange. Index funds that tracked the Toronto Stock Exchange largest companies were heavily invested in Nortel as it made up approximately one-third of the TSE 300 index. As mentioned earlier, many internet companies had sky high valuations and were priced for perfection. If they did not meet these massive expectations, their share price would be crushed. That is exactly what happened to Nortel. In October 2020, they missed analyst revenue expectations. In early 2001, Nortel revised revenue guidance for 2021 from 30-35% growth to only 10-15%. This caused the share price to fall below $3. Nortel was hit with many lawsuits as investors questioned Nortel's accounting practices. The SEC claimed Nortel performed fraudulent accounting practices in 2000, 2002 and 2003. Nortel collapsed because of losing confidence of its clients amid a culture of "arrogance and hubris."

Key Players/Who Was Most Responsible?

The Nortel scandal was one that impacted a lot of people. For a huge company such as Nortel, who had about 90,000 employees at its peak, it is possible that several people were involved in the accounting scandal. However, a few people played key roles in the developments that lead up to scandal. These people are:

• John Roth (CEO):

John Roth was the CEO when Nortel went on a purchasing spree of smaller companies during the dot-com boom between 1997-2001. During the course of the purchasing spree, Nortel failed to align the acquired companies with its own strategy. Nortel tried to acquire companies without the processes or culture necessary to integrate them. This lack of culture and processes needed to run the newly acquired businesses caused Nortel to suffer consistent losses. In addition, John Roth would oversee an independent investigation carried out on Nortel's accounting. This independent investigation turned out to yield inaccurate results and resulted in the firing of key executive personnel at a key point int the company's history.

• Frank Dunn (CEO)
• Douglas Beatty (CFO)
• Michael Gollogly (Financial Controller)

The three persons listed above oversaw the activities of the company from 2001 to 2004. Frank Dunn took over from John Roth as CEO. He was previously employed in the company as the CFO. Frank Dunn also took over the responsibilities of CFO for a brief period after Terry Hungle resigns as Chief Financial Officer of Nortel after it was revealed that he bought and sold company stock within his retirement plan. These three men have been held accountable for the misgivings of the company because they were supposed to be in charge of the company. Amidst numerous accounting scandals and revenue restatements, the top executives listed above were charged with steadying the ship or at least reporting financial activity according to the guidelines stated by GAAP. In addition, Frank Dunn, Douglas Beatty, and Michael Gollogly allegedly inflated Nortel stocks to gain about $12.8 million in bonus payments for themselves -- $9.7 million in 2003 and $3.1 million in 2001 -- after showing an inaccurate return to profitability. This goes to show, that the top executives of Nortel at the time benefitted from the false representation of financial statements and the defrauding of investors.

• Bill Owens (CEO) & The Nortel board of directors

Bill Owens was the CEO who succeeded Frank Dunn. Bill Owens was appointed to the board of directors position in 2002. After Frank Dunn was terminated, Bill Owens became the new CEO of Nortel. Bill Owens brought a sense of stability to Nortel after the recent accounting scandals that the company had been involved in. However, Bill was essentially an independent director when he joined the company and had very little knowledge about its business or industry. Still, Bill Owens was charged with steadying the ship and setting the company up for future success. Bill Owens, however, was not able to set up the company for future success as there were numerous complaints from customers about Nortel's disregard for customer concerns.

The board of directors went on to appoint numerous CEOs until 2011 when the company sold the last of its assets. One example of tyhese CEOs was Mike Zafirovski, who was formally the CEO of Motorola and had great credentials for the role. None of appointed CEOs stopped the company from consistent restatements of revenues years after they had been originally stated. From 2001 to 2006, Nortel’s board and senior management were more focused on dealing with restatements and investigations than trying to satisfy customers’ needs and commercialize new products. This caused the company to continue to suffer financial losses as well as a loss of faith from investors. With profits drying up, Nortel executives tried to find creative ways to appear profitable to the public.

Key Stakeholders And Stakeholder Groups/How Were They Impacted?

Employees

At its peak in 2000, Nortel employed over 90,000 employees. By 2002, the workforce was reduced to just 35,000 meaning 55,000 employees lost their jobs in those two years. After the restructuring, there was a brief return to profitability in 2003. However, over the next six years, Nortel would steadily cut jobs throughout the company including 1,900 in 2006 and 2,900 in 2007 and 2008 before finally closing its doors in 2009. In January 2009, the vote to declare bankruptcy won by a landslide and Nortel quickly filed and began selling off parts of the business to companies like Ciena and Ericsson, Blackberry and Apple. Luckily, these companies ended up retaining most of the employees that still worked for Nortel. Because Nortel's assets were acquired at such a discounted price, the companies took time to integrate them into their business. However, many employees still lost their jobs if the companies felt that their position was made redundant.

Pensioner Saga

Shortly after the bankruptcy filing, ex-employees became increasingly concerned about the company's pension plan and the funds that they were promised. Meetings were held but the future was uncertain for Nortel pensioners. By 2011, the pension fund had been draining and pensioners' cheques were cut, along with health insurance benefits. Since 2011, the pension fund has been managed by Morneau Shepell on behalf of the Government of Ontario and one thing became clear: defined benefit pension plans are not always guaranteed.

The pensioners (including 20,000 Canadian) started a lengthy legal battle in order to get as much of the money as possible. Additionally, around US$1.6B was incurred in court proceedings that determined how to divvy up Nortel's assets between Canadian, American, and European creditors. This figure was met with harsh criticism, as it decreased the amount of money that the pensioners would receive in the future. Claimants felt that the $1.6B in legal fees was unreasonable and Ontario Superior Court judge Frank Newbould stated "there were far too many lawyers in court in both Toronto and Delaware". Additionally, pensioners felt that it was unfair that lawyers, consultants (etc) were paid 100 cents to the dollar while they were not. Finally, in 2016, the claimants reached a settlement that would allocate the Ontario pensioners 57% of the funds they were originally promised, which was seen as a reasonable compromise. Pensioners outside of Ontario, however, were not necessarily given the same guarantee. By summer 2018, over $4B was sent out to around 15,000 Canadian creditors (including pensioners), as well as $1.8B and $1.1B in the U.S. and U.K. respectively. Although these figures seem large, pensioners only received 45.5 and 41.5 cents to the dollar in Canada and the U.S. respectively, falling short of the 57% they were guaranteed in 2016.

During the lengthy court proceedings of Nortel's insolvency case since 2011, pensioners mainly survived on a $380M advance from the Pension Benefits Guarantee Fund (PBGF), which acts as a sort of pension insurance for Ontario citizens. In 2018, however, the PGBF, along with the Financial Services Commission of Ontario, claimed that over $200M was repayable to the fund (from the pensioners). According to the PGBF, the pensioners received much more than what was originally estimated by the fund. The original estimates were much higher than the money that was actually received from the insolvency proceeds. This move by the Commission throws another wrench in the road for Nortel pensioners who have been fighting to get the money they're entitled to for about a decade.

Shareholders

Nortel shareholders suffered huge losses from 2000 to the eventual bankruptcy in 2009. Prior to John Roth being brought in in 1997, the company was still called Northern Telecom Inc. Roth saw that the company was not taking full advantage of the internet boom, and thus decided to change the name in 1998 to Nortel Networks Corp., in order to communicate the shift in focus to the shareholders. Pursuing an aggressive buyout strategy in order to acquire as many internet/tech startups as possible made them extremely popular on the various stock exchanges. Nortel was certainly a large player during what is referred to as the "Dot-Com Bubble", which saw the NASDAQ rise from around 1,000 to well over 5,000 in the five year span between 1995 and 2000, and then back down just over 1,000 in 2002. In the year 2000 alone, the company spent an overwhelming $19.7B on acquisitions, which were largely paid for using treasury shares rather than cash. Most of the companies that were acquired were developing patented, cutting-edge technology, but had little to no sales. Later, during the insolvency proceedings, over 6,000 of these patents would be sold to companies such as Microsoft, Apple, and Blackberry for around $4.5B.

Nortel shares reached their peak on July 26, 2000, when shares closed at $124.50. By October of the same year, stock prices had already taken a $24.60 hit. Shockingly, by June 2002, after many of the accounting scandals were made public, and Nortel's earnings per shares had been drastically overstated, Nortel shares were worth a measly $3. Although there was a short return to profitability in 2003, the stock essentially flatlined until the eventual insolvency in 2009. When the company was delisted on January 14, 2009, shares were worth 39 cents.

Bankruptcy Case

The Nortel case is currently no longer under investigation in 2021. As well, Nortel is no longer a company. The Nortel bankruptcy case lasted roughly 8 years, making it the sixth-longest bankruptcy case in history. In 2016, a settlement was reached over the $7.3 billion raised in the bankruptcy liquidation of Nortel. Over the years, over $2B was accumulated in legal fees, and dished out to law firms who constantly got held up in court due to the complex structure of the business and its creditors. $4 billion was to be given to the creditors, former employees, retirees, and bondholders. This number falls short of the original $7.3B raised from the sale of assets shortly after filing in 2009. This means that most creditors (including pensioners) only ever saw a fraction of the money they were originally entitled to. Justice Newbould, who was heavily involved in the Nortel bankruptcy proceeding, remarked in 2017 that it was regrettable that the "case wasn't settled sooner without the added expense and delay caused by the litigation".

Where Is The Company Now?/Where Are The Key Players Now?

Where is the company now?

When Nortel filed for bankruptcy in January of 2009 they put together an executive retention plan in hopes of rebuilding the company. Unfortunately, due to their fractured image and the economic conditions at the time it was decided in June of 2009 that Nortel would dismantle and liquidate all of it's business units and any remaining assets. Due to Nortel's innovation in the telecommunications industry and their large volume of acquisitions during the dot-com boom they had a lot of valuable assets that were soon to be auctioned off. Coming off the end of a recession many of the large tech companies were buzzing to acquire these assets for a fraction of what they were worth. The first auction was won by Ericsson who bid $1.1 billion USD for Nortel's CDMA and LTE assets and technology which would be used by the Swedish company to serve wireless customers in the North American Market. Ericsson also prevailed as the highest bidder for Nortel's GSM business for $103 million and Nortel's share of LG Electronics totalling $103 million and $242 million. Avaya purchased Nortel's enterprise solutions unit for $900 million. The next purchase was made by tech company Ciena for Nortel's ethernet network at a price of $769 million consisting of cash and convertible notes. The final piece that was sold off was 6,000 patents that Nortel held. These were sold to a consortium including Microsoft, Apple Inc., Research in Motion, Sony, EMC Corp, and Ericsson at a price of $4.5 billion USD. Ultimately, Nortel was completely dismantled with every asset being sold to the highest bidder. Nortel was an industry leader following in the footsteps of it's forefather Alexander Graham Bell who created the telephone. Many of Nortel's innovations live on today in some of the largest tech companies in the world. They had a major impact in shaping the way North America and much of the world communicates. Perhaps Nortel was too focused on innovation and investment instead of focusing of profit.

Where are the key players now?

John Roth (CEO 1997 - 2001): John Roth retired as CEO of Nortel after it's stock crashed in 2001. It was reported that Roth cashed in over $100 million USD in the year 2000 while all this was happening. Roth has been retired and no doubt living comfortably with his significant life's earnings. However, he has had to protect those earnings as there have been many lawsuits against him by former Nortel employees looking for a share.

Frank Dunn (CFO 1999 - 2001, CEO 2001 - 2004): Succeeding John Roth and his time as CEO, Frank Dunn began his term as CEO of Nortel at a very unstable time. Share price was down significantly and earnings were not promising. During Dunn's time as CEO it appeared Nortel might be turning things around. That was until he and several other executives were fired amidst an accounting scandal. A few years later the SEC laid charges on Dunn and three other executives alleging they participated in accounting fraud to bridge gaps in Nortel's performance. Frank Dunn was arrested in 2008 and set to face trail but the charges were later dropped and allegations withdrawn. It is important to note that Douglas Beatty and Michael Gollogy were also fired in relation to the 2004 accounting scandal. Like Dunn, Beatty and Gollogy had their careers derailed due to the allegations made by the SEC after an investigation into Nortel's financial reporting. Also like Dunn, the charges were dropped and allegations withdrawn.

Bill Owens (CEO 2004 - 2005): Owens was selected as CEO of Nortel following Frank Dunn's termination. Owens, a retired US admiral, had been on Nortel's board for two years prior. He was brought on as CEO to add stability and structure to the company. His time as CEO was short as he quit the following year and was replaced by Mike Zafirovski.