Nortel Networks is Canada’s biggest company and it’s usually the biggest winner at our Investor Relations Magazine Canada Awards. This year there was a twist: in the week leading up to our February awards ceremony, Nortel was being seriously mauled by Canada’s business media for, among other things, alleged selective disclosure and misleading investors.
Without going into exhaustive forensic detail, here’s a recap. On January 18 Nortel lowered its 2001 growth outlook and announced 4,000 job cuts. Less than a month later, on February 15, it again revised its forecast downwards and increased the job cuts to 10,000.
The market response was ferocious, sending Nortel’s stock down 33 percent the next day. As for those cheerleaders – the analysts and reporters who propelled Nortel to dizzying heights in the first place – well, the scene was nothing short of a witch-hunt with Nortel CEO John Roth tied to the stake. While the Wall Street Journal and the like dispassionately treated the earnings warning the way they did dozens of other similar warnings that month, Canada’s newspapers made it into front-page blood-letting.
Each day the headlines wrung more out of the story – Nortel executives exercising millions worth of options between the January forecast and the February warning, JDS Uniphase finalizing a plant sale with Nortel for $3 bn in stock right before the price plummeted. The newspapers gleefully reported on class-action shareholder suits, somehow portraying Milberg Weiss as a respected law firm with a legitimate beef.
The coup de grace came the very day of our awards ceremony, when the Globe and Mail came out with this front-page scoop: Roth had shared a gloomy outlook with a select institutional audience days before the earnings warning. On February 12, Roth was on a conference call for clients of RBC Dominion Securities/Dain Rauscher Wessels. He said, in part, that Nortel’s customers were ‘slowing down expenditures of capital like we’ve never witnessed before.’ Though the call was webcast, the wider public wasn’t notified in advance.
Up until then I had been unruffled at the prospect of presenting Nortel its awards that night. This wasn’t the first company to issue an earnings warning, be accused of insider trading and face shareholder lawsuits. It wasn’t the first, and it won’t be the last, to suffer whiplash from momentum players and short-termist analysts suddenly putting on the brakes. But selective disclosure? That gave me pause. A Nortel spokesman trying to shift the blame didn’t help; it was up to RBC to give the public access to the webcast, he said in the Globe, though it’s plainly the company’s responsibility under Reg FD. And while Nortel did post the call on its web site before the ensuing profit warning, it wasn’t available live.
The question is, did Roth reveal material, non-public information in the RBC call? The easy definition of material information is that it’s market-moving – in the UK it’s called ‘price-sensitive’ information. Selective disclosure is usually spotted by tracing a price move to an information leak. This time there was no market movement until after the earnings warning three days later. Several hundred RBC clients who heard the supposed selective disclosure didn’t stampede out of the stock. Nor did the analyst who interviewed Roth change his forecast. Ergo what Roth disclosed wasn’t material.
Nortel still stands accused of being out of touch with its customers and slow to recognize a business crunch. Yet its accusers include many of the 40 out of 45 analysts who had a ‘buy’ or ‘strong buy’ on the company and a consensus estimate in line with the company’s projection right up until the profit warning. The incident highlights how difficult it is to forecast in this market – a phenomenon Nortel itself drew attention to in its January 18 announcement.
With accusations of insider selling, misleading investors and selective disclosure, Nortel was hit by an unlucky triple-whammy. But it didn’t deserve to be pilloried by the press. Nor did it deserve to have the award for best IR by a CEO quietly omitted from our awards gala – it was deservedly won, of course, by John Roth. And by the way, in fairness to the Globe, the paper eventually published an article ‘in defense of John Roth’s disclosure at Nortel.’
Nortel’s disclosure practices are, in general, exemplary, and it fully deserve its accolades. It’s hypocritical for the investment community and financial media to applaud a company for its frank, forward-looking guidance when it’s optimistic, then to crucify it when forecasts don’t pan out.
‘How the mighty have fallen!’ crowed Canada last month. That’s what David said after his best friend, Jonathan, was killed along with his nasty dad, Saul. It’s a phrase used today to describe an evil giant brought down by his own arrogance, even though David’s original point was this: When the world is crumbling, the good guys often get taken down with it.
