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'Offset' of lost income not a material sum, Nortel trial hears

A sign is pictured outside Nortel's Carling Campus in Ottawa August 10, 2009. Nortel Networks said on Monday its chief executive, Mike Zafirovski, will step down immediately and its board will shrink from nine directors to three as the bankrupt telecom equipment maker works to sell off all of its major assets. REUTERS/Blair Gable (CANADA BUSINESS SCI TECH)


An accounting entry made at Nortel Networks Corp. in early 2003 to "offset" lost income from an unrelated business deal was not a material sum of money and was reviewed and approved by Nortel's auditors, a lawyer for former chief executive officer Frank Dunn suggested Wednesday.

Lawyer David Porter, who is representing Mr. Dunn at his Toronto fraud trial, cross-examined Nortel's former assistant controller Linda Mezon about her earlier testimony that Nortel decided to reverse $25.5-million of reserves for obsolete inventory in order to offset an unrelated loss of $25.5-million in income from a business deal involving JDS Uniphase.

Mr. Porter asked Ms. Mezon during cross-examination on Wednesday if she were comfortable with the decision to make an offsetting accounting entry in light of the fact that a $25-million change was not a material amount within the company's total $1-billion reserve for obsolete inventory.

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She replied she was comfortable with the decision, and said the employee responsible for the inventory reserve, Ken Crosson, told her he could provide documentation to support the change.

The Crown has alleged the offsetting inventory entry was an "inappropriate and arbitrary" accounting decision made only to ensure the company would meet a predetermined level of income for the fourth quarter.

In testimony Tuesday, Ms. Mezon said the decision about the offset was made late in the day on Jan. 21, 2003, after the JDS accounting change was finalized. She said the company wanted to keep its bottom line numbers the same for the fourth quarter of 2002 so it wouldn't have to rewrite its earnings media release, which had been prepared and was scheduled for release within two days.

During his cross-examination, Mr. Porter noted that the company's auditors at Deloitte & Touche reviewed the change to the inventory reserve and approved it.

"You were certain to make sure Deloitte & Touche were aware of the offsetting entries at the time they occurred," Mr. Porter said.

Ms. Mezon agreed. She also agreed with Mr. Porter's suggestion the inventory provision had been under review at the time, so it was not surprising it might be adjusted.

Ms. Mezon is testifying at the fraud trial of Mr. Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly. The three men are accused of manipulating Nortel's accounting reserves in 2002 and 2003 to push the company to profitability and trigger special "return to profitability" bonuses for themselves.

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Lawyers for the accused deny the allegations and say the accounting treatment was believed to be appropriate at the time and was approved by auditors.

During his cross-examination, Mr. Porter showed Ms. Mezon numerous internal Deloitte & Touche working papers showing the auditors discussed issues involving use of the company's reversal of accounting reserves in 2002 and during the first half of 2003.

He also painted a picture of the stressful environment facing the company at the time, noting there were periods in 2002 when Nortel was unsure it could meet its payroll obligations. Staff members were distracted by numerous other more pressing accounting problems beyond the use of accounting reserves, he said.

"In your position you were experiencing complex accounting issues at a great pace in a stressed environment and a diminished work force," Mr. Porter noted.

Ms. Mezon agreed.

She left Nortel in June, 2003, and later became chief accountant at Royal Bank of Canada.

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Real Estate Reporter

Janet McFarland is the real estate reporter for The Globe and Mail’s Report on Business, with a focus on residential real estate trends. She joined Report on Business in 1995, and has specialized in reporting on corporate governance, executive compensation, pension policy, business law, securities regulation and enforcement of white-collar crime. More

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