Investors were misled, SEC says

After a three-year investigation, U.S. regulators said yesterday they will pursue four former executives at Nortel Networks Corp., including former chief executive officer Frank Dunn, for allegedly masterminding a "fraudulent" accounting scheme.

The U.S. Securities and Exchange Commission filed civil fraud charges yesterday against Mr. Dunn, former chief financial officer Douglas Beatty, former controller Michael Gollogly and ex-assistant controller MaryAnne Pahapill in the U.S. District Court for the Southern District of New York.

The charges are related to a bookkeeping crisis that has rocked the communications equipment maker and its investors in recent years. After the technology bubble burst in 2000, the SEC alleges, the executives manipulated the books in a variety of ways in the following years in order to mask Nortel's woes, meet Wall Street's expectations, and later collect bonuses.

"Investors were misled for extended periods of time about the health and stability of Nortel's operations," Christopher Conte, an associate director of the SEC's division of enforcement, said in a statement. "Further, these defendants all received significant compensation, in some cases in the millions of dollars, while they were manipulating Nortel's financial results."

The SEC charges came the same day its Canadian counterpart, the Ontario Securities Commission, said it will hold a hearing on May 1 into allegations involving Mr. Beatty, Mr. Dunn, and Mr. Gollogly. The OSC is focusing on the same time period as the SEC -- 2000 to 2003 -- and alleges the defendants used improper accounting policies.

None of the allegations have been proven in court. A lawyer for Mr. Gollogly didn't return a call. A lawyer for Mr. Beatty declined to comment. Ms. Pahapill, who now uses her maiden name Poland, declined to comment via a spokesman for Toronto-Dominion Bank. She took a leave of absence yesterday from the bank, where she worked as vice-president of finance.

In separate statements, Mr. Dunn said he looked forward to the OSC hearing, but was disappointed in the SEC charges.

"I am looking forward to the opportunity that this open and transparent process will give for the truth to finally come out about the events of 2000 and 2003," Mr. Dunn said in his statement.

He added in a later statement that "I think it would have been appropriate, under the circumstances, if the authorities in the United States had deferred to the Ontario Securities Commission in what is really a Canadian matter, and had acknowledged that the Canadian authorities are fully capable of addressing these important issues." He added: "I hope that, so that the issues can now be fully and fairly explored, they will be dealt with in a hearing in Canada."

The Toronto-based company has spent the past four years trying to unravel its accounting tangle. Less than two weeks ago, Nortel said it would again have to restate results for the fourth time in as many years.

Nortel issued its first restatement at the end of 2003. When the need for another restatement came to light in March, 2004, Nortel put Mr. Dunn, Mr. Beatty and Mr. Gollogly on leave and then fired them a month later. Seven other Nortel finance employees were dismissed later that year. Ms. Pahapill, along with William Kerr, were named Nortel's permanent controller and CFO, respectively, in April, 2004. Ms. Pahapill and Mr. Kerr left in 2005 after Nortel named banking executive Peter Currie as CFO.

While the earlier restatements led to a plunge in Nortel's share price and frightened customers, observers said the latest development shouldn't do further damage to the company.

"It's water under the bridge," said Paul Sagawa, an analyst at Sanford C. Bernstein & Co. LLC.

"I don't think it changes [things]in terms of where Nortel is, what their competitive position is, and what they need to do to make things right again."

Jay Barta, a Nortel spokesman, declined to comment except to say the company continues to co-operate with the OSC. The SEC said its probe is also continuing.

The SEC, which started its investigation nearly three years ago, said it's seeking a permanent injunction, civil monetary penalties, officer and director bars, and disgorgement with prejudgment interest against all four defendants.

The company also confirmed yesterday that a criminal investigation by the U.S. Attorney's Office in Dallas is pending. And while the RCMP has not laid criminal charges in the Nortel case, a spokeswoman confirmed the force's elite Integrated Market Enforcement Branch, which handles white-collar securities crimes, is continuing to work on the file.

"It's still under investigation," Sergeant Michele Paradis said.

The SEC's complaint contains a more detailed account of similar allegations to Nortel's own internal reviews on the accounting crisis. The SEC outlined how the former executives allegedly pulled forward $1-billion (U.S.) in revenue in 2000 as demand slumped for telecom equipment. A few years later, the former executives used reserves to post a profit in the first two quarters of 2003, triggering bonus payments. Mr. Dunn, for example, allegedly received a bonus of $3.6-million in 2003.