Shockingly Nortel’s Frank Dunn not Found Guilty in Canada

In February 2004 I was invited to a Nortel analyst day. The Canadian telecom giant had great news to share about their worldwide sales – especially in China. CEO Frank Dunn was the primary speaker at the conference and explained just how well the company was doing. Thereafter, I met with division head after division head and the story kept getting better. The stated sales increases seemed too good to be true and it turns out they were – helping to batter the company’s share price over a number of years once news was released that the books were cooked.

Nortel’s senior management had large financial incentives to turn the company around quickly and they fraudulently recognized revenue at times which violated GAAP accounting standards in order to pay less bonuses than needed and to ensure they had reserve earnings needed to make the numbers in future quarters which allowed them to receive performance-oriented bonuses.

On March 12, 2007 the US DOJ said as much in a complaint against former execs Frank A. Dunn, Douglas C. Beatty, Michael J. Gollogly and MaryAnne E. Pahapill. “The fraudulent conduct at issue here was egregious and long-running. Each of the defendants betrayed Nortel’s investors and their misconduct gave rise to billions of dollars in shareholder losses,” said Linda Thomsen, Director of the Commission’s Division of Enforcement. “The action we take today sends a strong message that officers of U.S.-filing foreign corporations will be held to the same standards of accountability that are required of all participants in the U.S. financial markets.”

Asa result of this incident, the loss of trust between Nortel execs and the public markets, customers, media and analyst community coupled with the company overpaying for acquisitions during the dotcom and telecom bubbles combined with competition from ZTE and Huawei eventually forced this Canadian telecom icon to declare bankruptcy.

This is why I read with some surprise that an Ontario Superior Court judge dismissed the case against these same former Nortel Networks execs. The judge, Frank Marrocco said he was “not satisfied” the financials were misrepresented.

Greg Draper, who heads investigative and forensic services at chartered accountancy and business consulting firm MNP, says that the burden of proof was difficult to meet in this case.

“To prove that there was not just intention to do the conduct, moving the money and making the financial statements that were made, but to do it with a criminal purpose to defraud shareholders and the corporation is difficult to prove,” he said.

In his judgment, Marrocco said the decision to only release $80 million in excess accruals when it had $189 million to boost numbers during the company’s first quarter of 2003 were not out of the ordinary.

This policy did not lead to misrepresenting Nortel’s “financial results to the investing public or Nortel’s audit committee or Nortel’s board of directors,” he wrote.

Marrocco concluded the company’s statements were restated twice in one quarter to reflect differences of opinion in accounting practices, not as an effort to cover up fraud.

Although the judge found that genuine accrued liabilities were not released when they should have been nor adjusted when they should have been, he was “not satisfied that any or all of the accused understood the extent of the excess accrued liabilities on Nortel’s balance sheet.” Furthermore, the amount was immaterial to the finances of such a large company, and even if they were not released, the executives would’ve received their profit bonuses anyway, Marrocco told the court.

At trial, Dunn’s lawyer said his client approved the accounting at the telecom equipment maker but should not be held responsible if the figures given to him were inaccurate. At the time, Dunn was preoccupied with trying to save the company and trusted that the balance sheets were correct when he approved them, argued the defense.

“I am satisfied that non-cash impacting excess accrued liabilities on the balance sheet were not a priority,” the judge wrote in his decision.

Dunn made the following statement as a result:

For a very long time, integrity has been the foundation of Nortel Networks’ corporate governance and business practices. The documentary evidence and testimony re-affirmed this core value that I witnessed over my 28 years with the company,” he said. “I am looking forward to turning the page on this chapter of my life.

At one point Nortel had almost 100,000 employees. While Dunn and the other managers are no doubt happy right now, many ex-Nortel staffers may feel like they have just been cheated out of seeing justice served to a management team which helped kill an industry icon.

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