POLITICS

Auditors 'uncomfortable' with some Nortel accounting, witness tells fraud trial

01/20/2012 01:06 EST | Updated 03/21/2012 05:12 EDT
TORONTO - External auditors were "uncomfortable" with the way Nortel Networks Corp. released cash from reserves in early 2003, a former employee of the fallen technology giant testified Friday in the trial of three men accused of juggling the books to make the company look artificially profitable.

Brian Harrison, the first witness called by the prosecution in a trial that's expected to last six months, said he had "very little" contact with the audit firm and was not required to send it the planning documents he produced for Nortel.

But the former director of financial planning and analysis said that in one rare meeting he had with outside auditors, during the preparation of first quarter results for 2003, Deloitte & Touche challenged why Nortel would release only $80 million of $189 million in so-called excess accruals — a matter that's a key point in the Crown's case.

"It wasn't smooth," the soft-spoken, snowy-haired witness testified Friday.

"They were questioning the release of some while retaining others."

Excess accruals are provisions for liabilities that had been booked in previous quarters and were no longer needed.

Harrison said he also was "perplexed" about the decision to release the accruals "as we didn't have a trigger in Q1."

Prosecutors contend that under the direction of former CEO Frank Dunn, Nortel employees were encouraged to use reserves of accruals from previous quarters to give the illusion the company had returned to profitability.

Dunn, former CFO Douglas Beatty and ex-controller Michael Gollogly have pleaded not guilty to the charges related to manipulating Nortel's books and defrauding the company of $12.8 million in bonus payments.

The Crown alleges Nortel's senior management released just enough onto their balance sheet to return the company to profitability and trigger millions of dollars of bonuses for senior management.

Defence lawyers argue that the auditors continually reviewed and approved Nortel's books. They haven't had the opportunity yet to cross-examine Harrison who is scheduled to continue his testimony on Jan. 30.

The Nortel trial will take next week off.

That $80 million out of a potential $189 million is key to the Crown's case as it helped thrust Nortel into a $40 million profit and offset the impact of the potential expense of $73 million in profitability bonuses that were to be paid out to employees.

"If you remove the $80 million of releases, then the (before tax) profit of $40 million would be a loss of $40 million," Harrison explained as Hubbard took the court through several of the company's outlooks and income statements.

Harrison said in his planning documents he had recommended releasing half of the accruals, although he admitted he "didn't know if that was the right accounting or not." He also added that his colleague Sue Shaw, who will also be called as a witness, was uncomfortable with their release.

Harrison added that he was bewildered as to how $80 million was concluded to be the amount to release onto earnings during the quarter, as the last figure in planning documents was for $84 million.

The description of where the money came from on the press release sent out that quarter was also "hard to follow" and different from the one the financial planner had seen, Harrison added.

The Crown argues there was nothing to distinguish the $80 million that was released from the $109 million that was held back.

It also maintains the executives held on to that $4 million for use in boosting profits in subsequent quarters because the release of $80 million in the first quarter was enough to spark the bonus plan.

The defence maintains that the $4 million was rightfully set aside to cover any potential additional expenses stemming from a settlement with Siemens, after particularly "rancourous" dealings with the German technology company.

In a later restatement, Nortel admitted the $80 million was wrongly released in the first quarter. The company went on to restate its statements for the first two quarters of 2003, as well as for the full years of 2002, 2001 and 2000.

Dunn, Beatty and Gollogly were fired over the allegations in 2004.

The defence maintains that there was no reason the accused executives would juggle the finances in the first two quarters of 2003 because even after the company's finances were twice restated for the period, data shows they still would have earned the nearly $10 million in bonuses that year.

The crux of the Crown's argument is that the accused were working backward in their accounting, meaning they started with end targets to achieve profitability and then manipulated numbers, through the use of a "cookie jar" of reserves to achieve those goals.

Hubbard questioned Harrison on the company's practice of providing two different profit estimates — outlooks, which were presented to Nortel's board of directors, and roadmaps, which were seen only by senior management.

Harrison said the numbers presented to the board were "typically more conservative," while road maps were "aspirational targets."

The Crown prosecutor presented one such road map for the second quarter of 2003 and asked Harrison how he calculated the route to achieve the end result.

"Fill in the blanks," Harrison replied.

Hubbard showed the court a copy of Harrison's notes from a conference call in early 2003, in which he had penned in a set of accrual amounts that the divisions had agreed could be released onto the income statement. Later, that $99 million worth of accruals appeared as part of the official roadmap.

On that document, Harrison had entered the accruals under the category "balance sheets," but it had been scratched out and termed "other."

"I had a quick conversation with Doug Beatty and he asked me to call it 'other'," he explained.

"I didn't think much of it, I just changed it."

The trial is being presided over by Justice Frank Morrocco.