No one's happier with the market's rejection of pro forma accounting than Nortel (NT) executives. Of course, with a $50 million annual bonus pool you'd be smiling too.

Last Thursday, the Brampton, Ontario-based, phone gearmaker posted a first-quarter profit.

Investors were surprised. They were surprised again, if less agreeably, when a look at the numbers showed that the profit came from businesses Nortel is getting out of. Then they were surprised a third time when the company said that passing the profit milestone had triggered a rash of bonus payments contributing to Nortel's latest quarterly operating loss.

Now Wall Street wonders if the future might hold more unpleasant surprises for investors. Some observers question how Nortel can justify the incentive payments, pointing to a regulatory filing that lays out a pro forma profitability standard that the company doesn't appear to have met in the latest quarter. (Conveniently, Nortel said in its earnings report that it will no longer report pro forma numbers.) The questions loom large because senior executives stand to rake in much bigger bonuses if the company stays profitable for the rest of the year.

Nortel declined several requests for comment, and analysts who have been briefed by the company say it calls the executive bonus payout immaterial. But not everyone is convinced.

Lehman Brothers analyst Steve Levy, who was one of the first to put an asterisk on Nortel's profit claims, said after a briefing with Nortel bigwigs, "We still have questions about how they measure profits which trigger the bonus." (Levy has a neutral rating on the stock and his firm has no banking ties to the company.)

Diving In

There's no question that Nortel made money last quarter. The question is whether those profits should trigger the bonus payments.

A look at regulatory filings suggests not. The return-to-profit bonus plan was first mentioned in a quarterly

Securities and Exchange Commission

filing last fall. According to that document, Nortel profits are defined as "pro forma earnings from continuing operations."

Pro forma earnings have clearly outstayed their welcome on Wall Street, what with regulators trying to stamp out nonstandard accounting and promotional communications. In keeping with that sentiment, Nortel said in Thursday's release that it was done with pro forma numbers. That said, the apparent intent of the Nortel filing is clear: To spur bonus payments, the company must generate a profit from ongoing operations.

But on Thursday Nortel emphasized it had reached profitability even though its continuing operations produced a loss of $136 million, or 3 cents a share. The first quarter reached the black only thanks to a $190 million contribution from discontinued operations. The decision to pay bonuses based on a profit that didn't come from the main business struck some observers as odd.

"The definition of profitability needs to be clear up front," says Bruce Ellig, author of

The Complete Guide to Executive Compensation

. "It can't change from GAAP one time to pro forma the next without good reason. If it appears to be a way to put money into an executive's pockets, then shareholders might have a problem with that."

Cashing In

While passing the profit milestone triggered a one-time cash bonus for all 36,000 Nortel workers, senior executives stand to do better by far. They'll get two much larger bonuses this year if the company maintains its newfound profitability, according to a federal filing.

About 30 unnamed senior executives who received 20% of their potential bonus in the first quarter will get another 40% in the second quarter and 40% at year-end, should the company stay profitable. The cut for CEO Frank Dunn will be $5 million, according to one person familiar with the agreement.

The bonus would be quite a reversal for Dunn. He and his fellow executives received no bonuses last year due to Nortel's horrid performance. Dunn had to make do with his $825,000 salary and his 750,000 new stock options.

Generally speaking, Ellig says shareholders are "owed some degree of confidence in their executives. There needs to be some sense that executives share the pain as well as the gain with shareholders. If by sticking with rules means executives are getting millions, that doesn't bother me. But if they are changing the ground rules and lowering the targets as they go, that presents a problem."

What's probably more interesting, from a Wall Street perspective, is just how quickly the benefits of the company's endless cost-cutting -- a two-year-long effort that has eliminated tens of thousands of jobs -- were neutralized in the latest quarter by the generous executive incentives.

Indeed, in a perfectly apt twist, the company ate up the quarter's would-be profits by paying out $80 million toward bonuses and stock compensation.

On a conference call with analysts, CEO Dunn declined to say whether the bonuses would continue to offset the cost savings from the firings for the rest of the year. Some analysts said the savings generated by years of steep cuts will likely exceed the bonus payout over the rest of the year.

Still, $50 million's a lot of money. To help put the bonus pool in perspective, it's worth noting that the company last booked a quarterly profit in the fourth quarter of 1999. Back then, net income amounted to $172 million -- on $6.6 billion in sales, or three times the company's current revenue level. has a revenue-sharing relationship with under which it receives a portion of the revenue from Amazon purchases by customers directed there from