The former U.S. controller for Nortel Networks Corp. said she changed two key accounting entries after she had already finalized her year-end results for 2002 because she got phone calls from her head office bosses – including controller Michael Gollogly – seeking last-minute amendments.
Karen Sledge testified Tuesday at the Toronto fraud trial of Mr. Gollogly and two other former Nortel executives – chief executive officer Frank Dunn and chief financial officer Douglas Beatty – to recount her actions during a controversial period at Nortel when the company was closing its books for the fourth quarter of 2002.
The Crown has contended Nortel arbitrarily transformed a profit to a loss in the fourth quarter because a profit would not conform with its earlier forecasts of a loss for the period, and because it would not have helped executives trigger their special “return to profitability” bonuses at that time.
The Crown alleges the accused executives used new accounting reserves set up at the end of 2002 to help reap a profit and trigger the bonuses in the first and second quarters of 2003.
The trial has previously heard testimony from an accounting employee, Brian Harrison, who testified the company found itself with an unexpected profit at the end of the fourth quarter of 2002, and said he was told to contact people in various divisions globally to find new accounting reserves that could be created. Mr. Harrison testified he had never been asked to do that previously, and the new reserves had the effect of decreasing Nortel’s profits for the quarter.
On Wednesday, Ms. Sledge testified she had completed and submitted the U.S. division’s fourth-quarter financial results by Jan. 5 when she received a phone call from Mr. Gollogly either later that day or the next day.
She said Mr. Gollogly was concerned about the release of a $37-million (U.S.) reserve for employee medical benefits because he had not expected it to occur. The release had an impact on the company’s bottom line, boosting profits for the period, she said.
She said Mr. Gollogly ultimately called her two or three times asking her to check if the number was correct.
“He was most emphatic that we had most likely gotten the entry wrong, and I needed to correct it – and make sure I wouldn’t correct it in the next quarter [of 2003]” Ms. Sledge said.
“So if there was any doubt, I needed to fix it that week.”
In the meantime, Ms. Sledge testified she also got a phone call from the company’s North American controller, Mary Cross, who was her direct boss, asking her about changing the $37-million release. Ms. Cross also asked if she had any other new liabilities she could create reserves for, which would have the effect of lowering profits, Ms. Sledge testified.
As a result of the phone calls, she said the U.S. division lowered the release for the medical reserve by $11-million, putting the amount back into reserves and reducing profits as a result.
She testified she also reversed a $9.2-million release related to vacation accruals for employees as a result of the phone calls with Mr. Gollogly and Ms. Cross.
“Without the call from Mr. Gollogly or Ms. Cross, would you have changed anything,” Crown attorney Robert Hubbard asked.
“No,” Ms. Sledge replied.
Ms. Sledge said she and her staff also wrote justifications to explain the reversals to the company’s auditors.
She said one of her employees continued to examine the medical reserve issue even after the change was made, and sent her an analysis on Jan. 23 saying the original $37-million amount was still valid. By this point the changes had already gone through, however.
She said she contacted Mr. Harrison at the head office to tell him about it, and that he said there was no way to correct the change for the fourth quarter. He said the $11-million that had not been released would have to be spread out and released over the next four quarters instead.
“From an accounting point of view, was that the proper treatment,” Mr. Hubbard asked.
Ms. Sledge said it was not. She said, however, that is what happened over the next four quarters.
She said both the medical release amount and the vacation amount were subsequently restated when the company did a second restatement of its books in January, 2005.
Under cross-examination by David Porter, a lawyer representing Mr. Dunn, Ms. Sledge confirmed she had provided signed certifications each quarter, including the fourth quarter of 2002, saying that the financial statements she had submitted were correct.
Asked if the certification was true in that period, Ms. Sledge replied that it was.
“To the best of my knowledge, yes. In that language. Yes,” she said without further elaboration.
Mr. Porter asked if she understood the certifications were important, and would be relied upon by more senior executives at the company for their own certifications of the financial statements. Ms. Sledge replied that she did.
The cross-examination will continue Wednesday afternoon.