Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, September 12, 2007

SEC Charges Additional Defendants in Nortel Fraud Action

The SEC charged four more former officers of Nortel Networks Corporation with engaging in accounting fraud by manipulating reserves to manage Nortel's earnings. The Commission filed an amended complaint in SEC v. Dunn, a case pending in the U.S. District Court for the Southern District of New York, to add as defendants Douglas A. Hamilton, Craig A. Johnson, James B. Kinney and Kenneth R.W. Taylor, who were the former vice presidents of finance for Nortel's Optical, Wireline, Wireless and Enterprise business units, respectively. The Commission's original complaint, among other things, charged three former corporate officers of Nortel — CEO Frank Dunn, CFO Douglas Beatty and Controller Michael Gollogly — with directing the earnings management fraud.

Among other allegations, the amended complaint alleges that Hamilton, Johnson, Kinney and Taylor engaged in the following misconduct:

From the second half of 2002 through January 2003, Hamilton, Johnson, Kinney and Taylor all determined that their business units held tens of millions of dollars in excess reserves. The four finance vice presidents did not immediately release those excess reserves as required under U.S. Generally Accepted Accounting Principles (GAAP), but instead maintained them for earnings management purposes.
In early January 2003, during the 2002 year-end closing process, Hamilton, Johnson, Kinney and Taylor acted on orders received from former executives Dunn, Beatty and Gollogly and improperly established over $44 million in additional excess reserves in order to lower Nortel's consolidated earnings and bring it in line with internal and market expectations. Their efforts helped erase Nortel's pro forma profit for the fourth quarter of 2002 and caused it to report a loss instead.
In the first and second quarters of 2003, Dunn, Beatty and Gollogly directed the improper company-wide release of approximately $500 million of excess reserves specifically to inflate earnings and pay bonuses. These efforts turned Nortel's first quarter 2003 loss into a reported profit under U.S. GAAP, largely erased Nortel's second quarter loss and generated a pro forma profit in the second quarter. The efforts of Hamilton, Johnson, Kinney and Taylor were essential to creating these false results because the four vice presidents improperly released approximately $154 million in reserves in the first quarter of 2003, and approximately $191 million in reserves in the second quarter

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