Deloitte & Touche LLP has taken knocks when it comes to Nortel Networks Corp., but new documents filed by U.S. regulators show the outside auditor helped uncover the alleged accounting fraud.
The U.S. Securities and Exchange Commission alleges that former top Nortel executives repeatedly misled, withheld information and ignored advice from its number crunchers, and that Deloitte eventually set off the alarm bells that led to the unravelling of the scheme.
Nortel's accounting scandal, discovered in 2004, led to a plunge in the company's shares from which it has yet to recover. Deloitte is among the parties that have been sued by investors over the crisis, but little has been said about the auditor's role until this week.
The allegations were contained in a complaint released by the SEC after it filed civil fraud charges on Monday against former Nortel executives Frank Dunn, Douglas Beatty, Michael Gollogly and MaryAnne Pahapill (who now uses her maiden name Poland). The first three executives also face a hearing by the Ontario Securities Commission, which alleges they used improper accounting policies.
None of the allegations have been proven in court. Mr. Dunn wouldn't discuss the SEC's allegations. He plans to comment further along in the OSC's process.
Mr. Dunn, Nortel's chief executive officer until he was fired with Mr. Gollogly and Mr. Beatty in April, 2004, said he wants the truth to come out. “The only way that's going to come out is when you get to sit in a room and see the facts presented,” Mr. Dunn said. “That's important. Then I'll answer questions.
“I would love this process to go at a very quick pace,” he added, referring to the OSC hearing that starts in May. “I've had three years of doing nothing, and I want to put the issue on the table.”
Lawyers for Mr. Beatty and Mr. Gollogly didn't return calls. Ms. Pahapill couldn't be reached for comment. A Deloitte spokesman said it would be “inappropriate” to comment on a continuing investigation. Nortel declined to comment.
Nortel's accounting saga began in 2000, when demand for telecommunications gear slumped. Despite the changing market, Nortel did not back away from its full-year revenue forecast and began looking for ways to achieve that target.
Controller Mr. Beatty and assistant controller Ms. Pahapill started considering bringing back so-called “bill and hold” transactions, which allow revenue to be booked even though it hasn't yet been delivered. They asked Deloitte for information on “bill and hold” rules in October, 2000, the SEC alleges.
Deloitte presented a set of charts regarding “bill and hold” transactions to the two executives on Nov. 2, 2000. But Mr. Beatty and Ms. Pahapill disregarded that advice and Deloitte's request to include it when they distributed their own charts to some Nortel accounting and finance employees, the SEC alleges.
“Indeed, prior to Nov. 7, 2000, Deloitte had reviewed the charts and warned Pahapill that the guidance was too brief and did not give the intended users sufficient information to always make the correct assessment of the appropriate accounting,” the SEC alleges in its complaint.
The outcome was that Nortel was allegedly able to pull forward more than $1-billion (U.S.) in revenue in 2000 to meet its targets. Mr. Dunn provided Deloitte with a letter that the SEC alleges included false statements about 2000 results, including that they complied with U.S. generally accepted accounting principles (GAAP). A few years later, the SEC alleges, another accounting scheme emerged. In the first quarter of 2003, CEO Mr. Dunn, chief financial officer Mr. Beatty and Mr. Gollogly directed the release of “reserves” (liabilities) in order to post a profit, triggering bonus payments, the SEC alleges.
In March, 2003, Deloitte found out about the release of some of the reserves, and asked Nortel for supporting documentation. It didn't come, and Deloitte learned similar releases were planned for the second quarter, the SEC alleges. Concerned, Deloitte allegedly asked Nortel in July, 2003, to keep some of the reserves until it produced backup documents. “Nortel's plan thus was thwarted and Nortel instead reported a U.S. GAAP loss for the quarter though it showed a pro forma profit necessary to pay [return to profitability]bonuses that quarter,” the SEC alleges.
On July 24, 2003, Deloitte told Nortel's audit committee that there was a “reportable condition” concerning accounting weaknesses, the SEC said. Nortel's top management, including Mr. Dunn and Mr. Beatty, wrapped up a restatement in December, 2003, that didn't address the “revenue recognition fraud” from 2000 or all of the improper use of reserves, the SEC alleges.
Deloitte was replaced this year by KPMG LLP. Nortel said the change wasn't the result of a disagreement.
Even though Deloitte allegedly picked up on the accounting irregularities, David Sharp, an associate professor at the Richard Ivey School of Business, says he would be worried if he were the firm. “How far should Deloitte have questioned it in those early days?” he said. “It's always a very tough judgment call.”