Lead prosecutor Robert Hubbard told court on Tuesday that under the direction of then-CEO Frank Dunn, the use of financial reserves to bulk up flagging balance sheets was widespread at Nortel — not confined to the men who face charges.
"In terms of this cookie-jar approach to accounting, it had a long history at Nortel, it wasn't just the accused who were involved in it," Hubbard said during the second day of what is expected to be a lengthy trial.
Hubbard likened the alleged scheme overseen by Dunn to a game of Sudoku, in which he knew what would trigger bonuses tied to a return to profitability and manipulated numbers to get there.
Hubbard said the former leaders of what was once Canada's biggest company — but has since been broken up and sold off — were orchestrating an "earnings management scheme" through which they held back millions of dollars of "out of balance" money so it could be reported at a later date of their choosing.
Dunn, who was Nortel's chief financial officer before he became its chief executive officer, former CFO Douglas Beatty and former controller Michael Gollogly are accused of manipulating Nortel's books and defrauding the company of $5 million. All have pleaded not guilty to the charges.
The Crown has a list of 27 witnesses it plans to call, including former employees whom it has warned the judge may have acted as accomplices.
Several employees, including Gollogly — as well as the company's external auditors — had raised concerns about using the fund to shore up income, but in the end signed off on the scheme, Hubbard said.
Prosecutors allege management misled the company's board of directors by presenting underwhelming outlooks, Hubbard said. Those were later surpassed by adding money not earned during the reporting period in order to impress the directors with the illusion of improving results and have them agree to trigger the bonuses, he added.
Meanwhile, the company's divisions were doing the same thing to management.
"At the end of the day, everybody's sandbagging everybody," Hubbard said of the alleged scheme.
"Sometimes the accused are sandbagged by their (operating divisions) ... because everybody's doing this cookie-jar accounting."
The Crown's case centres on the first two quarters of 2003, when it says accruals were used to make the numbers appear more positive. The turnaround to a profit in those quarters was followed by a financial restatement at the end of the year that revealed the company's books were off by more than half a billion dollars in the first half of 2003.
"What changed between April and May and December when they restated it? The Crown's answer is nothing. They knew it was inappropriate when they stated it at the time," Hubbard said.
Those consecutive profitable quarters had been preceded by a loss in the fourth quarter of 2002, during which the Crown holds the accused turned an unexpected profit into a loss because the return to profit came too early to trigger a bonus.
Hubbard referred to several internal documents to illustrate the alleged culture of corporate fraud at the company.
One set related to the company's second-quarter results suggested the company used $372 million in previous accruals to turn what Dunn allegedly said was a loss he was "embarrassed and ashamed" about into a profit.
The problem was that because so many of the company's divisions were using their own cash reserves to boost results, that by the third draft of its results, that profit came in at more than $100 million more than anticipated, leaving the company with what Hubbard called "an embarrassment of riches."
The accused then backed away from their contribution to the bottom line, leaving the company with a $35 million profit — the exact target required to trigger bonuses.
Hubbard said he plans to prove the executives were not simply guilty of poor accounting, using several instances in which very specific amounts of money were manipulated to achieve desired results.
He went on to cite internal documents that he said showed the accused knew what were considered appropriate accounting practices.
He pointed to a handwritten memo by controller Gollogly that noted problems with the release of those quarterly results including "deliberate accruals to outlook," "margin management" and "inadequate documentation" or sloppy record keeping.
Hubbard noted that the company's external auditors, Deloitte and Touche, pushed back to a degree about releasing the results that included the accruals, but ultimately the firm gave the go ahead. Hubbard said he will submit evidence that suggests the accounting firm "should have said no."
The court will hear evidence that Deloitte and Gollogly argued over the inclusion of an $80 million accrual in the first quarter.
"But the fact that Deloitte acquiesces, doesn't make it right," Hubbard said.
Hubbard has said he expects his opening arguments to last into Wednesday, when he will present exhibits.
Defence opening arguments are expected later Wednesday. The trial could last longer than six months.
The Nortel accounting scandal of 2002-2003 produced one of the most spectacular stock market flameouts of a Canadian company, dragging down the share price of what had been Canada's premier technology firm from a peak of $124.50 in 2000 to penny-stock status.
Nortel's stock has since been delisted and is worthless.
The company filed for bankruptcy protection in 2009 in the United States, Canada and Europe amid mounting losses, falling sales, big debts and a legacy of legal issues.
Thousands of Canadians lost their jobs when Nortel folded, though thousands of positions were also rescued when other tech giants bought up Nortel's assets.
The company has sold almost all its operating businesses to various buyers for more than $3 billion.
At its peak during the 1999-2000 technology boom, Nortel went through several years of rapid expansion and diversification funded by debt and stock sales. It briefly became the world's largest supplier of telecom equipment.