Former Nortel Networks Corp. audit committee chairman John Cleghorn said he did not know Nortel senior staff had prepared an internal outlook in March, 2003, showing how they could earn payouts on their bonuses by the end of June that year.
Mr. Cleghorn, the former chief executive officer of Royal Bank of Canada who joined Nortel’s board in 2001, testified Thursday at the Toronto fraud trial of three former Nortel executives, explaining he did not learn about a number of accounting decisions made by management during a controversial period in 2003 until the board’s independent investigators told them about the events in 2004.
Mr. Cleghorn testified he did not know, for example, that Nortel had initially turned a profit in the fourth quarter of 2002 after years of large losses, nor that staff members had put out a call to the operating divisions to look for new accounting reserves to be booked in the period that ultimately had the effect of turning the profit into a loss.
And he said he did not know staff had done modeling in March, 2003, to figure out how to reach profit thresholds to trigger executive bonus payouts by the end of the second quarter that year.
Asked by Crown attorney David Friesen if he would have wanted to see such a document, Mr. Cleghorn said he would.
“I’d ask the question, ‘What did that mean?’ But it wasn’t shown to us.”
He also testified Nortel often had surprises at the end of its quarterly periods because it did “not have robust systems” for tracking its financial status from the general ledger to quickly prepare draft financial statements.
“The company had not been razor sharp,” he noted.
Mr. Cleghorn said, however, that there were plans to upgrade the systems and it couldn’t be made a priority at a time when the company was facing so many other major challenges.
He said it a was a “pleasant surprise” to learn Nortel had turned a profit in the first quarter of 2003, and said he was not concerned at the time that Nortel had reached the target after reversing $80-million of head office, non-operating accounting reserves to boost income by that amount.
“It sounded to me like there was a clean-up going on of the balance sheet, words to that effect,” he said.
Asked if he knew whether there were appropriate “triggers” to justify releasing the reserves, he said he assumed there were.
“I don’t recall a discussion that they did not have triggers, because not having a trigger is not according to GAAP [Generally Accepted Accounting Principles],” Mr. Cleghorn said. “The auditors were not hung up about these numbers being recorded in the results.”
The release of the reserves had become a central issue in the case. Former Nortel chief executive Frank Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly are accused of manipulating the reserves in 2003 to push Nortel to profitability and trigger special “return to profitability” bonus payouts for themselves.
The men have denied the allegations and have said they believed all the accounting decisions were appropriate at the time and were approved by Nortel’s auditors.
Mr. Cleghorn also testified Thursday there was some tension between auditors from Deloitte & Touche and Nortel’s senior executives after the fourth quarter of 2002 and again after the first quarter of 2003, with both sides complaining they had not had enough time and co-operation to do their work.
Mr. Cleghorn had been named chairman of Nortel’s audit committee in 2002, and said he told both sides they needed to “get their act together” and start earlier in the process to address issues of concern.
He added he wanted to be sure the auditors were getting the information they needed.
“We operated with a rule that if the auditors weren’t happy, we weren’t happy. So we weren’t going to release any statements if the auditors weren’t satisfied.”
In testimony last week, former Deloitte auditor Donald Hathway said he felt “chastised” by Mr. Cleghorn after the first quarter of 2003 for using up too much of Mr. Dunn’s times on concerns about disclosure in Nortel’s earnings press release.
Mr. Hathway also said he felt the board and Mr. Dunn did not understand the role of independent auditors.
Mr. Cleghorn’s testimony will continue Friday.