Investors spanked Nortel ( NT) after the company revealed it is the subject of a federal investigation.

Shares of the telecom-equipment maker fell 3% Monday after the Securities and Exchange Commission said it was formally investigating the company's accounting practices.

Last month, the Canadian networking gearmaker suspended CFO Doug Beatty and Controller Mike Gollogly in the aftermath of a second financial restatement. In October, after initiating an internal audit, Nortel said it would restate its numbers for the past three years to fix some $900 million worth of accounting mistakes.

Then last month, the company said it would restate the previously restated 2003 financial report and asked for an extension to file its annual report with the SEC. Nortel says it is examining the "establishment, timing of, support for and release to income of certain accruals and provisions in prior periods."

Nortel was not more specific about the problem, nor did the company reveal what the SEC's investigation has focused on.

Last month, financial sleuth John Gavin of SEC Insight said an SEC investigation was likely , since the agency had blocked his inquiries into Nortel's books on the basis of a so-called law-enforcement-related exemption. Typically the exemption has been used when a company has been the subject of some sort of investigation.

The company noted that an inability to file its 10-K by March 30 puts it out of compliance with some debt agreements, including indentures covering $1.8 billion of notes issued by its main subsidiary, Nortel Networks, and another $1.8 billion of convertible bonds.

Nortel fans hope the investigation is limited to problems of timing and doesn't suggest any invention of revenue.

Unlike many products that are booked as sales the moment they are delivered, telecom equipment has to be shipped, installed and certified before the proceeds can be recognized. This process can take months if large network systems are involved. The setup usually requires gear suppliers to spread the revenue over several quarters independent from when the actual payments arrive.

Nortel shares doubled in the first two months of 2004 as investors noted the company's progress on its massive restructuring, along with an improving outlook for telecom spending. Indeed, shares throughout the beaten-down networking sector rose as executives spoke of at last turning a corner on a spending rebound. But since then, Nortel has sagged as the redoubled attempts at accountability helped undercut investor confidence.


Softening
Nortel rally subsides


On Monday, Nortel fell 17 cents, to $6.12.

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