Three former top executives of Nortel Networks Corp. were found not guilty of fraud, closing a key chapter in a financial scandal that helped bring down the once-mighty telecommunications giant.
In a ruling Monday, Mr. Justice Frank Marrocco of the Ontario Superior Court found that the accounting manipulations that caused the company to restate its earnings for 2002 and 2003 did not cross the line into criminal behaviour.
For police and prosecutors, the ruling brings an unsuccessful end to what is likely Canada’s biggest corporate fraud case of the past decade. The case focused on allegations that senior Nortel executives had altered accounting reserves to push the company back to profitability, in order to trigger more than $12-million in bonuses and share payments for themselves.
The case hurt Nortel’s reputation at a time when its business was just starting to recover from the technology crash of 2000-2001 and lingered as a management distraction for years; the company filed for creditor protection during the 2009 recession and was liquidated.
Judge Marrocco concluded that Nortel had a 20-year history of setting up inflated accounting reserves that could be used to meet earnings targets, but also said the accounting decisions that formed the basis for the Crown’s case were either not fraudulent or were not material for a company the size of Nortel.
“The burden [of proof] in my view was not met,” Judge Marrocco told the court in acquitting former chief executive officer Frank Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly. All three men all embraced their lawyers after the judge delivered his verdict, and their family members made audible sighs of relief in the quiet courtroom.
Lawyers for the defendants characterized the ruling as a clear vindication of their clients’ actions, following a lengthy and trying ordeal.
In a statement, Mr. Dunn said that “after waiting for almost nine years, I am grateful to have received vindication. I am looking forward to turning the page on this chapter in my life.” His lawyer, David Porter, called the verdict “a fundamental rejection of the Crown’s allegations.”
Mr. Gollogly’s lawyer, Sharon Lavine, described the entire experience as “a very long and difficult road” for her client. “It [takes] an immeasurable emotional toll on someone, as you can imagine,” she said.
Accounting experts said the case is sure to be closely watched by others in the business community for the message it sends about where the line lies between fraud or acceptable use of discretion in accounting.
Forensic accountant Charles Smedmor, who closely followed the Nortel trial, said that despite the verdict, the case will likely deter executives from playing fast and loose, partly because of the effect it has had on the defendants’ lives.
“Their lives have been on hold for 10 years, and they have spent a significant sum on their legal defence and have probably been limited in their ability to earn income during this time. Plus, their reputations have been affected,” he said. “Those factors will make others who might be tempted to skate close to the line, to go the safer route.”
The decision underlines that there is still the duty of management to prepare financial statements that “present fairly the financial position and results of the company,” Mr. Smedmor said. “Nothing in the judge’s decision diminished that duty.”
During the trial, lawyers for the accused said the men believed the accounting decisions they made were appropriate at the time, and that the accounting treatment was approved by Nortel’s auditors from Deloitte & Touche. Judge Marrocco accepted the arguments, noting many times in his ruling that bookkeeping decisions were reviewed and approved by auditors and were adequately disclosed to investors in press releases or notes to the financial statements.
Nonetheless, the judge also said said he believed the accused were attempting to “manage” Nortel’s financial results in both the fourth quarter of 2002 and in 2003, but added that he was not satisfied the changes resulted in material misrepresentations.
He said that except for $80-million of reserves released in the first quarter of 2003, the rest of use of reserves was within “the normal course of business.” And Judge Marrocco said the $80-million release, while clearly “unsupportable” and later reversed during a restatement of Nortel’s books, was properly disclosed in Nortel’s financial statements at the time and was not a material amount.
He concluded Mr. Beatty and Mr. Dunn “were prepared to go to considerable lengths” to use reserves to improve the bottom line in the second quarter of 2003, but said the decision was reversed before the financial statements were completed because Mr. Gollogly challenged it.
In a surprising twist, Judge Marrocco also suggested the two devastating restatements of Nortel’s books in 2003 and 2005 were probably unnecessary in hindsight, although he said he understood why they were done in the context of the time. He said the original statements were arguably correct within a threshold of what was material for a company of that size.
Darren Henderson, an accounting professor at the Richard Ivey School of Business at the University of Western Ontario, said a guilty verdict would have raised the bar for management to justify their accounting judgments. But the acquittal makes it clear that “management manipulation of financial statements is very difficult to prove beyond a reasonable doubt in a court of law,” he said.
It is clear that setting up reserves or provisions is still subject to management discretion, Prof. Henderson said. “The message … is that it is okay to use accounting judgments to achieve desired outcomes, [such as] a certain earnings target.”
Lead Crown attorney Robert Hubbard refused comment before leaving the courtroom, saying he had not yet read the verdict.