Nortel executives lied about financials, says prosecutor

Published: January 13th, 2012

On the eve of the criminal trial of three senior former Nortel Networks Corp. executives, the prosecution has dropped five of the seven charges but left the most serious allegation: That the three men fraudulently misstated the financial results of the troubled company.

Prosecutor Robert Hubbard told an Ontario Superior Court judge Thursday that he will proceed with two charges of fraud each against former CEO Frank Dunn (pictured), chief financial officer Douglas Beatty and controller Michael Gollogly. One charge is fraud against the public, the other fraud against Nortel. The accused could only be convicted of one count — a fraud against the public would automatically include the corporation.

Hubbard said the Crown’s case is simple: “The books were cooked” between 2000 and April 2004 as part of a scheme to entitle them to bonuses.

“In doing so the accused defrauded the public” (shareholders) and Nortel, he said.

Related story: Ciena taking next steps after Nortel metro acquisition

The trial is scheduled to start Monday and is expected to last for several months.

Dunn was in the public gallery during Thursday’s pre-trial hearing, which was originally called to hear complaints by defence that the Crown hasn’t given enough details of the alleged offences to properly prepare for the trial.

But in replying Hubbard gave Justice Frank Marrocco an early outline of his case — which he said the defence already has — and in doing so illustrated the gap between the two sides at trial.

Where the defence lawyers complained about the four million documents the prosecution has built its case on and vagueness of the allegations, Hubbard reduced the prosecution to seven transactions or quarterly financial statements issued between 2002 and 2003 and a later restatement of the financials.
 
By approving the restatement the accused admitted the books were out almost $1 billion, Hubbard said he will try to show. The public reason why the financials were wrong was that matters were not recorded properly, Hubbard said, but he will try to show that wasn’t true.

That restatement was represented to the public as a comprehensive review of Nortel’s numbers, which was a lie, Hubbard alleged.

Hubbard said he will call evidence of an internal Sept. 2002 report to executives stating that $303 million in accrued liabilities were wrongly on the company’s books.

The prosecution will try to show $189 million of that was manipulated by the accused, he said, and either they knew about it or were indifferent.

“This is not about transactions,” he said. “This is a case of knowledge.”

Related story: Nortel patent auction may have hit government snag

In fact, he added, within weeks of the first restatement of Nortel’s financial results there had to be a second restatement of the numbers.
 
The original financials were not an error, he said he will try to prove. “It’s not the transactions that are false but certifying that the financial statements are true.”

 The practice of misusing accruals in the financial results to turn losses into profits wasn’t invented by the accused, the prosecutor added. In fact, he said, he will show it was deeply ingrained at Nortel. But the accused knew about it when financial statements were approved.

There was an indication of how tough a fight this trial will be when Hubbard alleged that “the books were cooked” and murmurs of protest arose from defence lawyers David Porter (representing Dunn), Gregory Lafontaine (representing Beatty) and Brian Greenspan (representing Gollogly).

After a lunch break Hubbard told the judge he’d avoid the phrase in favour of “cookie jar accounting.”

“Our position is the accounting (for the financials) was done properly and honestly,” Porter replied.  

Porter and Greenspan led the attack on the prosecution, complaining Hubbard’s refusal to detail what transactions were allegedly fraudulent is unfair. Despite months of talks with the prosecution, Porter said, it was only today that defence learned that one item wouldn’t be part of the trial.

“This case has been shifting endlessly, and (this) must stop,” he said.

Justice Marrocco said he’d give his ruling Monday afternoon on whether the Crown has to re-do the charges to add more detail. That might delay Hubbard’s opening statement, scheduled to begin after the decision.
 
The trial begins one of the closing chapters of the spectacular collapse of what was once the country’s biggest IT firms. Then, after the collapse of the tech bubble in 2000, it slowly, excruciatingly, became one of the biggest failures as it had to repeatedly restate its financial results.

In the middle, Nortel said Dunn, Beatty and Gollogly were fired for cause in April, 2004. Already in the middle of examining its accounting practices for 2000, 2001 and 2002, the company said it was now including a review of 2003.

In 2007 the trio and an assistant controller were charged by Canadian and U.S. regulators.

Meanwhile, amid the restatement of financial results, Nortel’s sales were falling as customers lost faith in the company.

In January, 2009 it filed for bankruptcy protection having lost more than $7 billion since 2005.

Since then it has been selling assets, most notably last year when a consortium of IT companies bid US$4.5 billion for Nortel’s intellectual property including wireless patents. LM Ericsson paid US$1.13 billion for its CDMA carrier equipment divison, Ciena Corp. picked up Nortel Networks’ metro Ethernet and optical switching lines in 2010 for US$769 million, while Avaya Inc. paid US$915 million for Nortel’s enterprise division, which makes switches, routers, firewalls, virtual private networking (VPNs), unified communications, private branch exchanges (PBXs), phones and key systems.


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