Former Nortel Networks Corp. chief executive Frank Dunn "did not understand" the role of the external auditors from Deloitte & Touche as they probed issues related to the company's accounting in 2003, a senior Deloitte partner testified Wednesday.
Donald Hathway, who was the lead audit partner assigned to the Nortel file in 2003, told the Toronto fraud trial of Mr. Dunn and two other former Nortel executives that after almost a year of working daily with Nortel staff at the company's head office, he concluded that neither management nor the board's audit committee understood his role.
Mr. Hathway was assigned to head the Nortel audit team in January, 2003, and said he and Deloitte audit partner John Cawthorne quickly found themselves being pressured by Mr. Dunn to help Nortel find strategies to deal with its accounting issues.
"He had lectured John Cawthorne and I on more than one occasion about the need to be creative and come up with solutions … It indicated to me that he did not understand our role as independent auditors," Mr. Hathway testified Wednesday in Ontario Superior Court.
He said the relationship with the Nortel board's audit committee, led by former bank executive John Cleghorn, also grew strained and needed to be "reset" by late 2003.
"The audit committee seemed more interested in getting things done by a certain schedule than they did getting them done right," Mr. Hathway testified. "I was surprised by that, because my view of their function was to oversee the integrity of the financial reporting process."
He said he was criticized by Mr. Cleghorn for taking too long to review issues related to the press release announcing first-quarter financial results in 2003, and was "severely criticized" for expressing reservations about offering an assurance on the company's third-quarter financial statements that year.
Mr. Hathway testified he felt Nortel had a "macho" culture, and that many of its senior executives had never worked anywhere else, so "hadn't seen how other companies do things."
"I think that type of culture was problematic," he said.
By November, 2003, Mr. Hathway was removed as lead audit partner on the file after spending his brief tenure raising red flags about Nortel's use of accounting reserves in 2003. He instead became a senior technical adviser to the audit team.
He said his supervisor told him he was being replaced because he "didn't communicate with the audit committee."
Mr. Hathway said he first discovered in the summer of 2003 – just six months after being assigned to lead the Nortel audit – that senior executives at the company were unhappy with his work.
At the time, Mr. Hathway was pressing the company to launch a comprehensive review of the accounting reserves it was carrying on its balance sheet – a review that later led to a controversial restatement of the company's books in the fall of 2003.
Those reserves have since become the focal point of the fraud trial of Mr. Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly. The three are accused of manipulating the reserves in 2003 to push the company to profitability and trigger "return to profitability" bonuses for themselves.
All three have denied the charges and have said the use of accounting reserves was approved by Deloitte & Touche auditors.
Mr. Hathway testified that he was shown the results of Deloitte client-survey interviews conducted in July, 2003, with Mr. Beatty and Mr. Gollogly.
In the interview summary, Mr. Gollogly reportedly complained that Deloitte's two new lead audit partners – Mr. Hathway and Mr. Cawthorne – were "night and day" compared with Deloitte partners previously assigned to Nortel, and were "turning the audit on its head."
"Gollogly described Don and John as 'inflexible,' " the interview summary said. "Don and John are not in 'solution mode.' "
In a separate client-satisfaction interview with Deloitte, Mr. Beatty reportedly told the firm that he felt Mr. Hathway didn't have any "skin in the game," suggesting that because Mr. Hathway was new to the file, he felt he could reverse decisions previously approved by others at Deloitte.
"He's not going to jeopardize his career, and thus Nortel is getting very tough stances taken by their auditors," the interview summary quotes Mr. Beatty as saying.
Mr. Beatty also noted in his interview that the audit committee of Nortel's board was considering replacing Deloitte as the company's auditor, and would almost certainly do so if the balance sheet review under way in July, 2003, were to eventually turn into a restatement.
Nortel did not, however, replace Deloitte, despite moving ahead with a restatement later that year. Mr. Hathway testified Wednesday that the suggestion by Mr. Beatty "was not something I was too concerned about."