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Lead Nortel auditor Don Hathway says he was no t privy to internal "roadmaps" the company used to plan how profit targets could be met through the use of accounting reserves.NATHAN DENETTE

Nortel Networks Corp. controller Michael Gollogly was prepared to resign after he found out his boss had booked three accounting entries, without consultation, that had the effect of transforming a small loss to a profit in the second quarter of 2003, an Ontario court heard Tuesday.

The fraud trial of three former Nortel executives – including Mr. Gollogly and former chief financial officer Douglas Beatty – heard testimony from a Nortel auditor, Donald Hathway.

He said Mr. Gollogly called him at home on a Sunday in July, 2003, to tell him he was upset to discover Mr. Beatty had made three entries totalling $20-million (U.S.) while Mr. Gollogly was out of the office the previous Friday.

Mr. Hathway, then the lead audit partner from Deloitte & Touche overseeing the Nortel audit, said he met the next day with Mr. Gollogly at Nortel's head office in Brampton, Ont. He testified that Mr. Gollogly told him "he was going to see Mr. Beatty and demand these entries be reversed and if they wouldn't be reversed, he was prepared to resign."

Asked by Crown attorney Robert Hubbard what he thought of that news, Mr. Hathway replied, "I did think it was a gutsy move by Mr. Gollogly to essentially put his job on the line."

The three entries were reversed later that day after Mr. Gollogly's protest, and Nortel ended up reporting a $14-million net loss for the second quarter. Mr. Hathway said the mood in the executive offices grew tenser, however, and both Mr. Beatty and chief executive officer Frank Dunn were unhappy with Mr. Gollogly.

"There was a time after that where Mr. Beatty and Mr. Gollogly were not getting along very well, and that extended to Mr. Dunn as well," Mr. Hathway testified. "So communication, for a period of time, was not the best."

All three former executives are on trial for allegedly manipulating Nortel's accounting reserves to push the company to profitability in 2003 and trigger special "return to profitability" bonuses for themselves.

The men have denied the allegations and have argued Deloitte & Touche approved their use of accounting reserves.

Mr. Hathway testified earlier Tuesday that he did not know the company was preparing internal "road maps" in 2003 that outlined how profit targets could be met by using the company's accounting reserves, and said the news was troubling when he learned of it during a later investigation.

The trial has previously heard Nortel first started creating the road maps in 2003, at a time when it had publicly forecast it expected to return to profitability after years of large losses.

One road map forecast shown to Mr. Hathway in court suggested hundreds of millions of dollars of accounting reserves might have to be released in quarters in 2003 to move the company into profitability.

Mr. Hathway testified he was first shown the documents in 2004 after a U.S. law firm was hired to conduct an independent investigation of Nortel's accounting problems. "What we saw in 2004 was very concerning, and I think would have changed a lot of stuff had we known about it in 2003," he said.

Mr. Hathway also said he did not know at the time that the use of $80-million (U.S.) of head office non-operating reserves released in the first quarter of 2003 made the difference in terms of triggering bonus payments for Nortel's executives.

He added that he asked Mr. Beatty and Mr. Gollogly about the bonuses before the first-quarter results were released, and was told they would have been paid with or without the use of the $80-million of reserves.

He said he nevertheless insisted to management and the board that the impact of the $80-million be disclosed to shareholders in the press release for the first quarter of 2003. He told Mr. Beatty his audit firm would "not be associated" with the regulatory filings for the first-quarter statements unless the impact of the use of reserves was disclosed.

Mr. Hathway testified that at an audit committee meeting, chairman John Cleghorn "chastised" him for delaying the preparation of the press release over his concerns and for "taking up too much of Mr. Dunn's time" on the matter.

Mr. Cleghorn is expected to testify next week.

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