Finance Committee on June 18th, 2009

[The Chair, Conservative, James Rajotte]

I call this meeting to order, the 38th meeting of the Standing Committee on Finance.

Pursuant to Standing Order 108(2), we are continuing our study on measures to enhance credit availability and the stability of the Canadian financial system. We are focusing on Nortel.

We have two panels here this morning, colleagues. First, we have a panel from Nortel Networks Corporation represented by the president and CEO, Mike Zafirovski, and Counsel Derek Tay from 9 a.m. to 10 a.m. From 10 a.m. to 11 a.m., we have persons representing pensioners for an hour as well.

I remind colleagues and all those interested in these hearings that the committee did adopt a motion on June 2 dealing with employment stock options, Mr. Mulcair's motion. There will be a report back to the committee by the Department of Finance in July, I believe. This is to deal with our study on credit availability and dealing with the pension issue, which is a subset of that study.

For the first hour this morning we have the president and CEO. Mr. Zafirovski, I understand you have a ten-minute opening statement and then we will go to questions from members.

Please begin.

[Mike S. Zafirovski, President and Chief Executive Officer, Nortel Networks Corporation]

Thank you, Mr. Chairman.

Good morning, honourable members.

I do appreciate the importance of the request to be here with you today. I do take your own inquiry very seriously, and I look forward to a very transparent and open discussion.

I believe I have ten minutes of opening comments. I'll try to be as transparent and direct as I know how, and I will try to address most of the issues. I do look forward to a quite robust discussion after that.

Before we get into the details, let me just say that not a day goes by when I do not think about the implications of our difficult decisions, which have hit both former and current employees. Nortel is a company with a very historic past, and I take this history very seriously.

When I came to Nortel three and a half years ago, many people said it was a mission impossible; but I, and many within Nortel, believed Nortel was a great global icon that could in fact be fixed. We did set a very ambitious agenda for the company, and together the employees made tremendous progress on multiple fronts. We fixed our accounting and legal issues, we improved the quality of our products, and we improved our cost structure. But most important—and this is specifically for the Ottawa-based centre for R and D—we went from legacy technologies to new technologies. We made significant investments, multi-hundreds of millions of dollars of investments, in technologies such as fourth-generation wireless and 4800 gig optical unified communications.

Just a year ago at an investor meeting in Toronto, we were very proud and had lots of enthusiasm in discussing how we had planned to finish the transformation and about the real prospects for sustainable growth going forward. Then, frankly, we hit a wall. The global financial crisis and recession compounded our challenges and impacted our ability to complete a transformation.

On January 14 we filed for protection from our creditors in Canada, the U.S., and parts of Europe. We did not take this decision lightly, but it was authorized unanimously by our board, after thorough consultation with advisers and extensive consideration of the alternatives.

Nortel today is not completely or solely under the control of Nortel management and the board. Now we have the active involvement of the court-appointed monitor and several creditor committees.

It is not where we want to be. We'll be the first ones to say that. But rest assured, we are pursuing maximized value for Nortel and are trying to preserve as many jobs as possible with the same passion I had when I came to this company three and a half years ago.

We are trying to run the company based on three principles. First is not to lose the customer. It's very important to give confidence to our customers that we are here to stay in business. Second is to operate in the mode of reality and to see the world the way it is, not the way we wish it were—but also, in that same world, to work with a level of optimism. Third, time is of the essence.

Nortel employees have done a tremendous job under very challenging conditions stabilizing our business and delivering outstanding service to our customers. Again, I cannot tell you how much I appreciate the support of not only our employees but also of companies and our suppliers during this period.

Let me move to the matters we are here today to discuss. I do realize the sensitivity of these compensation decisions. One thing that Nortel confirmed right from day one was that we would continue to fulfill all obligations to existing employees. This was a combination of continuing to pay base wages—we did freeze salaries for 2009—and also allowing vacation to accrue, and we continue to pay medical and health care benefits.

At the time of filing, we also believed it was very important to continue our annual incentive plan, and also to have some sort of a retention program for the most important employees. I'll just make a couple of comments here on both of these.

First of all, there's the annual incentive plan. It's available to virtually all Nortel employees—95% plus. It's an ordinary course of business to give incentives, and this plan has been in place for many years. It's very much an industry standard. We do view the incentive plan as very much part of the wages we pay to our employees.

The decision regarding the 2009 annual incentive plan was developed by management, with input from the Mercer consulting group and very active discussions and negotiations with the creditor committees and the monitor. It's based on achieving three very important targets. The first target is to maintain the revenues of the business. The second is for us to be able to fulfill very high customer performance matrices. The third is to preserve the cash balance.

In addition, since we filed, all equity base compensation programs have been terminated. As you also may know, prior equity awards have been cancelled. Therefore we no longer have the ability to compensate our employees with equity awards, which traditionally make up a very significant part of the compensations for management and the employees.

Now to our retention programs. Let me just make a couple of comments about the employee incentive program and the overall employee retention program.

In this company's situation and in a highly competitive industry, retaining key employees and preventing unwanted levels of attrition are critical to preserve the value and to maximize the assets for a company's stakeholders. We have two programs. One is a key employee retention program, and this is for 900 non-executive employees. So this is a rather large number of employees, unprecedented, but we thought this was very consistent with the significant challenges facing the company. In addition, for 92 of the more senior employees, we have our key employee incentive program, and this program is based on achieving very specific incentive targets. Executives who are participating in this program are required to waive their rights under previous change of control programs.

I personally chose not to participate in the key employee incentive and the key employee retention programs. I have also waived the rights to my change of control provisions.

With respect to severance, this is a most difficult issue. It has weighed on me greatly. Most importantly, the decision not to pay severance was not taken lightly. We have a great level of appreciation for the employees. They're highly skilled. And frankly, although I have been with the company only three and a half years, I have felt as a Nortel employee from the day I joined the company. However, in light of the economic reality of the company's constrained cash resources, particularly in Canada, and the fact that in the legal environment severance payments have equal weight with all other provisions for other creditors, we did not have a choice but to follow the legal jurisdiction. This was an extremely difficult decision. It was not taken lightly by management or the board of directors. It was made after extensive consultation with financial advisors and the monitor.

Let me move on to pension-related matters. I do think it's important to summarize that all moneys of Canadian registered pension plans belong to employees themselves. They're not available to the company or to the creditors. We'll continue to make both regular and special contributions to the pension plans, and we continue to make payments to our employees on a scheduled basis.

I know there has been lots of discussion in the press with respect to reducing the commuted value paid to employees who are getting out of the plans. Prior to filing, Nortel had said we've been paying commuted values at 100% based on exception to legislation, but starting in January 2009 we reduced the commuted value to approximately 86%, which is based on the estimated deficit shown in the last-filed valuations of December 31, 2006.

Unfortunately, since those last-filed valuations, the deficits have grown as a result of the well-reported declines of the equity markets, and we consulted with actuarial advisors and believe that the deficit is currently close to 69%. We asked for approval to go to 69%. This was approved, but I do think it's very important to highlight that the reduction was not designed to prejudice anyone but rather meant to ensure equal treatment of members and former members.

Let me just wrap up on two things. First of all, on my compensation, I do realize this is a very visible and explosive issue. For all the executives, myself included, we do try to follow a 50th percentile of the market for executives in the high-tech industry.

For executives, particularly at higher levels, most of the elements of the compensation program are at risk, meaning they are linked to individual corporate performance as well as to the stock price. For example, 88% of my compensation in 2008 was based at risk.

There is a significant difference between what's reported as compensation on the proxy statements versus the actual amounts received. For example, in 2009 the cash compensation was $1.29 million, which was 12% of the total intended compensation for that year. No bonuses were paid in 2008. As I have indicated, we have cancelled all equity awards--both the historical, and we're not giving any equity awards in 2009.

There have also been comments on pension benefits. For me, it is based on five years of active employment. I've been with the company for three and a half years. Assuming I'm with the company for five years, that pension payment is not guaranteed. It will be the same as all other unfunded pension programs. It will become an unsecured claim.

What I can guarantee to you is that where we're driving, with the utmost passion and commitment, is to optimize the value of Nortel and at the same time preserve the greatest number of jobs in this environment. I cannot overemphasize the strong appreciation for the employees and the empathy for the current situation. One of the most significant motivations for management, the board, and me as we're working around the clock is to optimize the value of the Nortel assets. The better the job we do, it is going to result in a higher recovery value for employees, pensioners, and all the other creditors.

I thank you for the opportunity to be here. I look forward to your comments and your questions.

Thank you.

[The Chair, Conservative, James Rajotte]

Thank you very much, Mr. Zafirovski, for your opening statement.

We'll go to questions from members. The first round is seven minutes.

We'll start with Mr. Pacetti, please.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Thank you, Mr. Chairman.

Thank you, Mr. Zafirovski, for appearing.

I'm sort of caught in a dilemma, because there are a lot of issues that we'd like to cover and that I'd like to cover. I'm trying to look at this from a balanced perspective. I requested that you appear because I don't think it's fair to hear just one side of the story. There are three sides to every story, as we all know. I would have preferred to have you speak after we hear the second panel, because I think it is in your best interests to speak afterwards.

I'm not going to try to play the part of an employee or former employee. We are conducting a study on the stability of our financial market, so that's the other angle I'd like to also address. How do we prevent this from happening again?

My time is limited. I only have seven minutes.

I know that certain members had already formed their opinions. They have taken sides and ignored the facts. You now have the opportunity to give us the facts.

The first question is going to be asked in a more overall global manner: how do we avoid this happening again? How could this come to a point where.... You said yourself that of the three criteria of Nortel, one is to keep their customers, but how are you going to keep your customers if you can't keep your employees or former employees happy?

You also said you want to operate in the real world. We are now operating in the real world. Things have changed. I understand they are changing more rapidly than you would like them to, but you're not government; you're a company. You have to be able to change--and change quite rapidly. You can't expect government to change, yet we saw in Obama's statement yesterday that people have to react in a more transparent fashion. Corporations have to report. They have to act in a transparent fashion.

You have an obligation. There are people out there who are living in the real world, the real world meaning that if you've promised them, after 20 or 30 years of service, and they are relying on a paycheque at the end of the month.... Whether that paycheque is $100 or $1,000 is not the question. The question is, if they are relying on it, if they have been promised that, and if they are at the end of their working career, we have to do something about that. There needs to be protection there.

Your third point was that time is of the essence. Well, when you're making a couple of million bucks, yes, sure, you have commitments as well, but when you're only making a couple of hundred bucks and you're trying to find money to pay your mortgage payment and make your credit card payments, what do I say to those people? Because that's what we're going to hear in the next hour. We can go around and pretend this is not happening, but that's really the question we are going to have.

Now, I'm not sure how you're going to answer that. You've answered some of the questions in your opening statement. The problem is that we are going to get the second panel, and they're going to come up with their version, and we are going to have difficulty reconciling both.

I'm trying to take a neutral and very transparent view of this. You're going to get pressure from other MPs who have already taken sides. The Liberal Party position has always been one of the centre, so we will try to address both. I will give you a couple of minutes, but again, we have seven minutes. Could you address some of those points?

[Mike S. Zafirovski]

First of all, I thank you for the question.

I do think it's important to understand where the company was back in 2005 and 2006. I can assure you, there's been a level of a commitment and passion from the employees, customers, and suppliers to try to rectify lots of issues that were with the company at that point in time. We really believe we're making the right things. I mean, there's a significant investment. About 60% of our R and D used to be in legacy products, but we've completely transformed that; it's only 20%, and for the last three years we've made significant investments to really be at the leading edge of communications.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

In answer to my first question, in order for this not to reoccur, the business plans of corporations have to be much better and not make commitments they can't deliver on, unless their plan is going to actually materialize.

[Mike S. Zafirovski]

That's an excellent point. We've tried to be very transparent from day one.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

Or are we making promises we can never keep?

[Mike S. Zafirovski]

We've tried from day one to articulate the challenges for the company, which were rather significant. We also had very significant assets and tried to articulate what we were trying to do to restore a formerly great company. We really thought we were there in the middle of last year. A number of board members personally invested amounts to buy Nortel stock. I've been in business for 34 years and I've never bought a share from a company. There used to be equity programs. A year ago we put in $500,000, including my three boys, who put some of their college savings in there.

First of all, we really believed what we were saying. You can look back and criticize some of those decisions, but there's not a lack of commitment and passion in making the investments for the future. When the world changed upside down, then we were very transparent internally, and made a painful decision at this point in time, particularly in the pension programs. They are not touchable, if you will, by the company or the creditors. We continue to make all payments, including special payments in the program. The reason we're trying to optimize the value—

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

We can almost say thank God that those pension payments are not touchable, but the problem is the deficit or the lack of money.

[The Chair, Conservative, James Rajotte]

You have one minute, Mr. Pacetti.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

You stated in your opening comments that you stopped paying severance. How did you come to that conclusion? How did you just all of a sudden realize that you should stop paying severance?

That goes back to the way Nortel treats its former employees. You're going to have difficulty keeping your current employees if that's how you treat your former employees, I would think.

[Mike S. Zafirovski]

I fully agree with that statement. Mr. Tay can confirm the very heated discussions we had on what's possible. At times you want to do something that simply the circumstances do not allow. That fact of life is painful for me to understand and finally accept.

[Massimo Pacetti, Liberal, Saint-Léonard—Saint-Michel, QC]

I'm going to wrap it up there, because you're going to get questions from the other members and I may get a chance again. But it's just because then you're going to have to rationalize why there are rumours of amounts of anywhere from $7.3 million to $23 million being paid to employees in bonuses. You did have an opportunity to make a choice.

[The Chair, Conservative, James Rajotte]

Thank you, Mr. Pacetti.

You have time for just a brief response, sir.

[Mike S. Zafirovski]

The annual incentive plan is a part of wages. We continue to make the payment. We do have a retention plan in place for 980 employees. It's a significant number, which we thought was absolutely imperative to stabilize the company and to actually give us the best chance to increase the value that would be available for all the stakeholders.

[The Chair, Conservative, James Rajotte]

Thank you.

We'll go to Monsieur Laforest pour sept minutes.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Thank you, Mr. Chair.

Good morning, Mr. Zafirovski. A few of your comments startled me. You claim that you have the support of your employees. I find it odd for you to make such an assertion. How can your employees support you when they are seeing former employees, current pensioners who are in the situation of possibly losing their pensions or only able to draw a tiny amount from their savings?

I find that very odd, but what is even more bizarre is that you received a $9.7-million bonus last year. It is appalling to hear such things, that is the least that can be said. You also said that the room is hot. Perhaps it is hot, but you are feeling the heat because some of the people here do not necessarily support you.

How do you feel? You claim to have a lot of compassion for employees. Above and beyond the compassion, what specific and effective measures are you taking to restore confidence and support these people? In Quebec, 3,000 Nortel retirees are living in uncertainty.

[Mike S. Zafirovski]

Thank you for that question.

The decision on January 14 was the most painful and agonizing of my 34 years in business. It was very hard to come to the realization that to continue with the company as is would provide an even greater risk and potential for liquidation, which we certainly did not want to face.

My comment with respect to the employees is that of appreciation for their work, which has been above and beyond any expectations, and their professionalism in serving customers. The last nine months were actually a multi-year high in delivering for our customers and providing stability for the business, which is the best thing you can do in this environment.

The comment and the conversation is that for 2008, the $9 million amount that you mentioned--and obviously for other executives--was based on stocks and options that today are worthless. As a result of filing for CCAA, that's no longer in place, but it has been a very difficult and agonizing decision. It's been very difficult and agonizing to see what has been happening with our employees.

The only thing I can tell you is that we are working around the clock. We have lots of support and professional pride from the existing employees to be able to optimize the value of the business, which is the only and the best thing you can do for current and for former employees.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

Let us talk exclusively about the pension plan. I presume that for a company the size of Nortel, a pension plan is governed by rules of prudence when making investments. Do you have these types of rules, for example rules on investing a maximum percentage of 10% or 15% in high-risk stocks or riskier products?

Percentage-wise, how much was invested in commercial paper? Only one single agency in Canada, the DBRS, had given commercial paper a grade, and concluded that it was very risky. What is the proportion of commercial paper purchased as investments under the pension plan? I believe that it must have been a major factor in the collapse of the value of your pension plan.

[Mike S. Zafirovski]

I have a couple of comments on the pension plan.

For a large corporation, our pension assets have been managed rather conservatively. You can have a different view with 20-20 hindsight, but 50% of our pension assets were in equities, the stock market, and 50% in fixed income. Most companies of this size, particularly in North America, have a higher percentage in equities. So that's one. We're also good on making all payments to the pension plan, including special payments.

Back in 2006, when I arrived, the pension deficit was actually very significant through returns to the marketplace and special payments. The deficit was down to well below $1 billion on a global basis. A company with our balance sheets, with an unprecedented decline in the capital markets in the second half of last year and the first part of this year, produced very significant deficits. In terms of looking back--from our trustees, the boards--we had managed that business in quite a balanced fashion. One thing you have to admit is that the environment over the last couple of quarters has frankly been unprecedented.

[The Chair, Conservative, James Rajotte]

Fine.

Mr. Laforest, you have 30 seconds.

[Jean-Yves Laforest, Bloc, Saint-Maurice—Champlain, QC]

There are other pension plans that performed very well, and that were able to avert the kind of collapse you experienced. You tell us that you received good assessments. Nonetheless, mistakes were made. I would like you to tell us exactly which mistakes were made.

[The Chair, Conservative, James Rajotte]

Very briefly, Mr. Zafirovski.

[Mike S. Zafirovski]

A very quick comment.

We have 50% of our pension plan in equities and 50% in fixed income. For the last three years on balance we've performed pretty well compared to benchmarks. I'll be happy to follow up with more specifics on that.