Not to be lost in the recent accusations of accounting fraud involving former top management of Nortel is the fog that company’s financial statements continue to produce.
With its fourth restatement announced two weeks ago —the fourth in four years— Nortel landed firmly in the record books. No publicly traded company has ever had as many restatements in this period of time. Nortel changes its financial statements more often than some people change their hair styles. News of the latest re-do may well prompt investors to ask if the company is really in the telecom business or whether it has gone into the accounting restatement business. After all, the newest restatement will restate financial results that have themselves been the subject of previous restatements. Which begs the larger question: Has Nortel reached the point where it is reasonable to conclude that this once world class manufacturer of technology equipment is metaphysically incapable of producing accurate and reliable numbers to guide investors and company stakeholders? Evidence leans in that direction.
In January 2005, William Owens, Nortel’s then CEO, pronounced that with the release of the company’s restated financials for 2001, 2002 and 2003, a task which he claimed had been “monumental,” “we have a solid foundation on which to move forward with our business.” Then, under its new CEO, Mike Zafirovski, there was a further restatement in March of 2006. One would have thought that no stone would have been left unturned during the three previous reviews, and certainly the one conducted last March —the first to be carried out under Mr. Zafirovski’s tenure— to ensure that every possible contingency was fully considered in order to avoid just this kind of embarrassment.
By the way, the same Form 52 certifications under which the SEC is charging Nortel’s former CEO and CFO were signed by the current CEO and CFO on a regular basis. The period to be restated includes quarterly statements for 2006 and the annual results for 2005 to which both Mr. Zafirovski, as Nortel’s CEO, and CFO Peter Currie, attested as to their accuracy under the provisions of Sarbanes-Oxley. I would not want to be the CEO or the CFO who had to explain that one, since the whole purpose of this part of the legislation is to ensure the precision of financial statements and to avoid Enron-type cases where a CEO could claim to be taken by surprise by their inaccuracy.
One of the most underreported facts about Nortel was the astonishing revelation contained in its most recent annual report that the company’s auditors discovered five material deficiencies in its accounting control system. It boasts in its latest statements that it now has only one such deficiency. Nortel’s own auditors define a material deficiency as:
…a significant deficiency, or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected.
The auditors go on to note:
In our opinion, management’s assessment that Nortel did not maintain effective internal control over financial reporting as of December 31, 2005, is fairly stated….
Yikes! It’s hard to know whether fraud or just plain incompetency was the biggest threat to Nortel’s investors.
All of this brings us to corporate governance —not the ivory tower theory of corporate governance or a society columnist’s celebrity view of corporate governance, but the idea that directors will actually direct and protect investors. That kind of corporate governance.
During the time of Nortel’s major losses and irregularities, it had one of the top paid boards in Canada. The company boasted big name trophy directors. Several had financial and accounting backgrounds. Some sat on the boards of major banks. The fact that three Nortel directors sat on a committee reviewing board standards for Canada’s publicly traded companies, including Nortel’s then CEO John Roth and Guylaine Saucier, who chaired the panel, is something to file under the corporate governance category of Ripley’s Believe It or Not. (I raised a number of criticisms about this committee and its membership in my op-ed columns in The Globe and Mail at the time, which was prior to Nortel’s disaster coming to light.) Yet these directors not only presided over a series of embarrassing scandals and financial mishaps, but as Nortel’s auditors have stated, they failed to ensure adequate internal controls were in place. Several continue to serve on the boards of prominent Canadian companies today.
It might seem odd that failure is so well rewarded in the boardroom. But in the culture that too often prevails in the world of the corporate director, underperformance is rarely seen as an unaccommodating vice, and adherence to the rules of the club, of which thou shall not rock the boat heads the list, is typically viewed as a most admired virtue.
Fast forward to the current board. Under its governance, two restatements have already taken place in as many years. Hundreds of other large and complex companies routinely provide accurate financial statements to the investing public. They do not require repeated do-overs. Yet Nortel has become a serial re-stater of financial results. And the board appears to have hit the mute button regarding this latest fiasco, just as its predecessors did for too long. There are no statements of explanation from Nortel’s audit committee. Its well paid non-executive chairman is silent. And the board itself seems unable to issue a reassuring word. It gives the impression that Nortel’s directors see nothing out of the ordinary in this latest announcement –which is, perhaps more than anything, symbolic of the problem.
Instead, Nortel’s current board seems bent on following in the steps of its predecessors, who are remembered for a governance legacy that produced financial scandal and investor mistrust, huge sums being doled out to a former CEO who left the company in tatters, and a compromised system of financial controls whose effects continue to reverberate among investors.
Nortel was once filled with innovators and highly motivated employees. But with its inability to get out from under the cloud that has long followed its missteps and blunders, the time has come for investors to seriously consider whether the assets of the company would be better off in new hands. Here, the emphasis is on a board that is visible, engaged and capable of instilling confidence on the part of all the stakeholders needed for success –not clamping shut when crisis strikes.
Nortel needs a lot more than another accounting restatement. With its history so steeped in scandal and its present still darkened by constant financial backpedaling, it needs to think through whether Nortel can go on being Nortel.
Despite RIM’s co-CEO Jim Balsillie’s valiant efforts to twist himself into a pretzel and downplay the significance of RIM’s stock options and backdating fiasco, a sampling of which follows below…
“A heartbeat ago, it was just Mike and me and a half-dozen others where we shared an office and had the metal desk.”
“Was I trained in these governance matters? No.”
“Mike and I have voluntarily put US$5-million each
into this to cover costs, so it’s a bit of our Warren Buffett kind of moment.”
“I haven’t read the Canadian rules handbook for 20 years.”
“So did we do backdating? Yeah. We did backdating. Did we do it knowingly to line our pockets? No. No. Did we do it recklessly? No.”
…there are important corporate governance concerns connected with RIM’s internal report on the company’s stock options fiasco. The most basic questions: Where was the board, what did it know and what did it do about it?
The report fails to explore what role, if any, RIM’s directors had in approving backdating of options for the co-CEOs. We know the report claims Balsillie, Lazaridis and Kavelman engaged in the manipulation of grant dates for their subordinates. How did the dates get rejiggered for the benefit of top management? The report is silent.
The report gives no details as to the dollar value of options that have been backdated or for whom or when the dates were contrived. Perhaps the company can at least confirm that there was not backdating in the period immediately following the terrorist attacks on America which eventually led to a steep drop in shares on all North American exchanges.
A further question: Why was this so-called management initiated review commenced “at the initiative of Dennis Kavelman, the Company’s Chief Financial Officer, with the support of Jim Balsillie, the co-Chief Executive Officer of the Company, and the executive management team amidst the heightened public awareness and concern regarding stock option granting practices by publicly-traded companies?” Why did the audit committee or the board’s compensation committee not take the appropriate action to initiate the review? Was the board even aware of the media coverage regarding stock options in the United States? As in many things involving RIM, the board seemed not entirely on top of things.
Having decided to investigate, why did the audit committee permit members of the board’s compensation committee to participate in the investigation? More important, since top management was involved in backdating and knew it, at what stage in the probe was this disclosed to the committee? And why did it take seven months for this information to be put into the hands of investors?
As for the board’s role in receiving backdated options, the report found:
“Certain of the Company’s outside Directors also received an in-the-money benefit from the Company’s options granting practices. Such amounts currently appear to be immaterial. As the selection of grant dates used on grants made to outside directors was not apparent to those directors, they were unaware that they were receiving grants with dating issues.”
If the probe determined the amount of such benefits was “immaterial,” the exact amount must be known. Why does the report hide that figure? Why not put it out and let the investing public decide whether it is “immaterial”? The report claims the directors were unaware of the dating issues associated with their options. They didn’t fall out of the sky, so who approved them?
RIM’s board wanted the world to think it was in control over stock option decisions. As it stated in the most recent company proxy filing:
The Stock Option Plan is administered by the Board of Directors and the Compensation Committee. Each of the Board of Directors and the Compensation Committee has full and complete authority to interpret the Stock Option Plan.
Yet the report finds to the contrary:
The Review revealed that until after the commencement of the Review in August 2006, all stock option grants, except grants to RIM’s co-CEOs, were made by or under the authority of co-CEO Jim Balsillie or his delegate in accordance with an apparent delegation of such authority by RIM’s Board. For a number of years after the Company’s initial public offering in 1997, Mr. Balsillie was directly involved in approving grants, including grants that have been found to have been accounted for incorrectly. Mr. Balsillie’s direct involvement in approving grants diminished over time, as more responsibility for approving certain grants was delegated, without explicit conditions or documentation, to the Company’s Chief Financial Officer, Dennis Kavelman, and to other employees. Mr. Kavelman and other, less senior, personnel were also involved in the granting of options that have been found to have been accounted for incorrectly.
Note the phrase “apparent delegation of such authority by the board.” There appears to be no basis for this so-called delegation, which begs the question: Was the board so disconnected and disengaged from stock option concerns and compensation matters that it had no idea what kind of decisions were being made and by whom? Surely it must have known huge numbers of options were being granted. Did it ever wonder how option dates were being set and how much that might be costing shareholders? The board appears to have been merely a passive bystander in these events.
It seems to me that since certain directors received backdated stock options, and the board itself played an overly passive role in the company’s governance and control, an investigating committee of two audit committee directors was not in the best position to objectively detail the failures that led to these problems. The report assigns no blame or responsibility to the board or its committees for the failures and improprieties that occurred, nor is there any critical statement made about its actions. This is in stark contrast to the report of Enron’s special board committee which examined that company’s debacle, and placed considerable responsibility at the boardroom door.
Some might think it’s a little too cozy for the board to be investigating its own actions given that one of the committee’s members, James Estill, has been on RIM’s board since 1997 and has served with other directors on the compensation and audit committees for the past ten years. Clearly, he would be a key part of any weaknesses detected in corporate governance and board oversight, as would be his colleagues on RIM’s board with whom he has served for the past decade.
The report does make the following reference, which is enough to send chills up the spine of any serious investor:
The Special Committee determined that the Company failed to maintain adequate internal and accounting controls with respect to the issuance of options in compliance with the Company’s stock option plan…
But again, the committee assigns no responsibility for this failure. It speaks in the passive tense about the Company. Is the “Company” referring to top management or the board? Was the audit committee at fault? Mr. Estill is a member of the audit committee. It does get complicated when people are wearing several hats and trying to tap dance at the same time.
There are many questions the board does not seem to want to answer. But the riddle is: Is it even able to? This appears to be a board that doesn’t really know how often it meets.
During interviews this week, were he compared himself to Warren Buffet in terms of philanthropic generosity, co-CEO Balsillie, claimed repeatedly that the board generally has just four meetings a year. Prior to stepping down from the position a few days ago, Mr. Balsillie served as board chair from the IPO in 1997. The number of meetings he claims is well below the frequency recommended for the boards of publicly traded companies. More to the point, however, the statement is at odds with RIM’s latest proxy release, which claims the board met formally a total of 11 times. This is another discrepancy the company should explain. Keep in mind, investors were for the past several years provided with the following assurance in the company’s proxy statement:
The Company believes that it has a sound governance structure in place for both management and the Board of Directors.
As it turns out, RIM’s former board chair confirmed in a whirlwind of media interviews after the report’s release that the company was less attentive to these matters than it needed to be. We detailed RIM’s serious corporate governance shortcomings some months ago at Finlay ON Governance at a time when few seemed to see any problem. Clearly, as these findings and RIM”s own proposed changes reveal, RIM did not have a well evolved corporate governance culture. It didn’t have one because management called the shots and dominated the affairs of the company. I see little to suggest that will change given the disingenuous nature of the spin that has been put out to explain why the company’s governance practices fell into the appalling and costly state they did. RIM has had the level of board involvement and governance practices the founders wanted. I doubt if real change is on their agenda, given Jim Balsillie’s expectations of “just four meetings a year that last two or three hours.”
What all this comes down to is an incomplete report that skated over key questions, failed to provide necessary details and turned a blind eye to the board’s own role in the debacle that involved weak controls and absent compensation committee landlords.
The kids have marked their own exam. Perhaps now we can have some adults conduct the real investigation and get to the bottom of what happened, why it happened and what should be done about it.
Dealing in the field of corporate governance for a few decades now, I’ve read more than my share of self-serving corporate documents. Sometimes you’d think these things were written at a service station in between fill-ups. But the report of the internal committee reviewing RIM’s stock options irregularities is in a category by itself —so full of holes it’s hard to keep a grasp on it long enough to read it.
Among key questions that remain unanswered:
Exactly how much did top management and directors receive in options that were improperly accounted for or issued through backdating?
How, when and by what authority were these options approved?
What precisely was the options granting approval process for RIM’s co-CEOs and how and by whom were the dates for those options set?
Who set the option dates for RIM’s independent directors who also received backdated benefits, according to the report?
If improper gain was not the motive, what caused this quarter-billion dollar fiasco? Was it just good luck with bad advice?
Since it was determined that top management, including the co-CEOs and CFO, backdated options for certain personnel, and somebody apparently backdated options for the so-called C-group, why did it take seven months for this to be revealed? Why didn’t the co-CEOs just admit what they had done so that the information would be in the hands of investors earlier rather than later? Mr. Balsillie says these blunders occurred “on (his) watch.” He says he takes responsibility. Wouldn’t earlier disclosure have been more consistent with that spirit? That would have been leadership, not just spin.
It might be worthwhile to consider how this internal investigation came about. It was prompted by “the heightened public awareness and concern regarding stock option granting practices by publicly-traded companies.” Taking such action in the face of almost certain regulatory investigation is not exactly an act of altruism.
The list of accommodating oversights and failed questions goes on and on.
The report tries to explain away the backdating by saying an “informal” approach was taken to the granting of stock options. The use of other people’s money and the term “informal” should never occur in the same room.
Management, the company would have us believe, did not fully appreciate the accounting implications of their actions. Apple tried that line for Steve Jobs in its internal review and apparently got away with it. To see if it will work at RIM, we first need to do a check. Do we have the right Mr. Balsillie about whom it is claimed did not possess an understanding of the accounting implications of his actions? This is not Mr. Balsillie the medieval studies major at Yale or Mr. Balsillie the shoe salesman at Gap. This is Jim Balsillie who has two business degrees, including an MBA from Harvard. He is also a chartered accountant who, the company’s website boasts, has received the highest designation from the Institute of Chartered Accountants. No, I don’t think the Steve Jobs defense will work here.
What about RIM’s CFO, Dennis Kavelman? He was also involved in options backdating and received certain options whose dates had been favorably adjusted. The report does not disclose who specifically approved those dates. Are we to believe he, too, was unaware of the accounting implications? Mr. Kavelman is also a chartered accountant who has worked in that profession. The credentials of these accounting trained executives seemed to elude the internal investigation team. I guess it was too difficult to connect the dots where accountants actually might be expected to know something about accounting rules.
If you accept the report’s conclusion that there was no intentional wrongdoing and only honest mistakes were made, you would also have to believe that the two co-CEOs and the CFO had no idea of the significance of the Form 52 documents they were regularly required to sign under U.S. securities laws attesting to the accuracy of company financial statements. The certification by CEOs and CFOs was a direct result of the Enron-era scandals in which too many chief executives thought they could invoke the I-had-no idea-that-was-wrong defense made popular by Ken Lay, Jeff Skilling, Bernie Ebbers, Martha Stewart and a long line of similar actors. The fact that Messrs. Balsillie, Lazaridis and Kavelman were affixing their signatures to these important securities forms during the period in which they had all participated in the alteration of option dates boggles the mind.
Finally, there is some indication from previous company statements that certain records had to be recovered and “forensic imaging” was employed. In other cases, the report claims the necessary documents do not exist. Were records destroyed or deleted? The report itself offers no clarification and it should. Was there a failure on the part of the audit committee or top management to insist upon a proper policy of document retention? The uncovering of efforts to destroy records during the course of an investigation is something that always sends up red flags to regulators and justice investigators in the United States. We will see what happens here.
We’ll have more to say about the role of RIM’s board, and the staggering failures in oversight and control that led to this costly embarrassment for the company and its investors.
The Centre for Corporate & Public Governance has a statement at its website concerning the most recent revelations of stock option irregularities at RIM. Company chiefs may be caught up not so much in a Catch-22 as a Catch-52, since that is the form U.S. securities laws require that CEOs and CFOs sign attesting to the accuracy of financial statements and disclosure. Both co-CEOs Jim Balsillie and Mike Lazaridis, and CFO Dennis Kavelman, routinely certified the results of RIM’s quarterly statements and annual filings.
In our previous comments on this company, we predicted there would be more surprises. But it is still hard to believe that there was such a prevalent culture of ignorance at the top management and board levels about proper disclosure and accounting of stock options. Yet that’s what the internal report is claiming. That may be a rather generous interpretation.
Finlay On Governance will have more on this breaking story in upcoming posts.
Former Hewlett-Packard director Thomas Perkins laments the rise of what he calls “compliance” boards filled with checklist directors who do not understand the business of the company they oversee and whose primary focus is ensuring that they live up to the letter of the law. He favors the “guidance” board, which he sees disappearing. Mr Perkins seems to believe that only the latter have any interest in understanding the businesses of the companies they direct or are capable of adding real value.
This is just one more rather poorly disguised attack on Sarbanes-Oxley legislation, which enshrined generally accepted minimum requirements that any board must follow if directors are truly assuming the responsibility of directing. No doubt about it, many directors don’t like the idea of rules in the boardroom and prefer the cushy, clubby old days when directors didn’t have to answer for their actions. The drive for change and higher standards of compliance and accountability that seem to bother people like Mr. Perkins came about after many decades of scandals where boards were given to regularly claiming they had no idea about the problems facing the company, usually because they were so disengaged from its affairs that the staff in the mail room were better informed than the directors in the boardroom. SOX sought to change that culture. I supported its enactment in submissions to Congressional committees at the time and remain committed to its groundbreaking role in raising governance standards and upholding public confidence in capitalism. Wise directors know they have a job on their hands to restore the image of a much disparaged institution and are working hard to bring the boardroom into the 21st century. They do not view, and none should be tolerated who see, compliance and creativity as mutually exclusive.
Directors do not hold office simply to advise the CEO and provide moral support; they are there to supervise top management. Of course, an exchange of views and experiences between directors and management is always important in the boardroom and good directors support CEOs in a number of ways. But the real issue is not what Mr. Perkins calls “plug to plug” directors. It is that in too many cases in the past, directors were little more than ornaments that only came to light when the CEO plugged them in –and much of the rest of the time they were left completely in the dark. Those were neither “guidance” nor “compliance” directors; they were disengaged directors. There are too many still in business today. Changing that culture is what lies behind the move to reform the boardroom.
How or if Mr. Perkins fits into this new world is something he can decide for himself. Personally, I thought the HP merger with Compaq was a disaster and I put that position on the record during the time of Walter Hewlett’s campaign opposing it. I find little evidence to suggest that HP’s shareholders were well served by that corporate marriage.
I agree that we don’t want directors who see their job as one purely of lawyering and bean counting. Directors of vision are always essential and should be encouraged, and, in my view, they are no more rare today than they were in the decades that preceded SOX. But the suggestion that keeping companies honest and accountable has reached such a burdensome level that it impairs the ability of directors, or relieves them of the duty, to understand their business and contribute significant value at various levels is…well, rubbish.
Sorry to be so blunt, Mr. Perkins, because I was rather looking forward to a spin on your new $100 million yacht, which I’ve been hearing so much about. I think I could have offered some sound guidance.
Thank goodness Goldman Sachs paid its co-presidents $106 million between them for their first year on the job. It works out to $53 million each. If only everything in life could be as fair as the directors who made this even-handed award.
I say thank goodness because it is close to a sub-atomic physical certainty that if they had paid these fellows, say, $43 million each, they would have made a sad clown face. At $33 million, they would have thrown a hissy fit. And at a mere $22 million, they both would have sunk into a deep depression and probably spent the next several months in their pajamas all day long.
The sums being awarded on Wall Street are like candy being handed out by children in a candy store. They have no connection to reality and do not know when to stop. You can see the same culture at work in the huge amounts (and fees) going into private equity deals where there seems to be no restraint either. You can hear it in the constant talk, driven by fund managers and investment bankers, about how the world is awash in money with no limits as to the size or number of deals. Most people have no problem with compensating CEOs and top management well. And Goldman Sachs has performed in a stellar fashion. In a market such as this, it would take some concerted effort to not do extremely well. It is a question of proportion and sound judgment that is at issue.
We have discussed previously Goldman Sachs’s bonuses here.
Some of us have seen this picture before. It is the kind of misguided thinking that leads certain people to believe that the laws of economics and physics have been suspended. It generally occurs just before a major economic downturn and a sudden plunge back into reality. Little children know about it. They understand that when the cartoon character goes off the ledge and seems to be hanging in mid-air, he will surely fall to earth with a thud as soon as he looks down. It’s just one of the immutable laws you learn as you grow up.
If kids and cartoon characters understand about reality, why don’t CEOs and compensation committees?
