COURT FILE NO.: 10-00145

DATE: 20130114

ONTARIO

SUPERIOR COURT OF JUSTICE

BETWEEN:

HER MAJESTY THE QUEEN

– and –

FRANK A. DUNN, DOUGLAS C. BEATTY AND MICHAEL J. GOLLOGLY

Defendants

Robert Hubbard, Amanda Rubaszek & David Friesen, for the Crown

David M. Porter, John Dent, Sarit Batner, Harry Underwood & Andrew Matheson, for the Defendant, Frank A. Dunn,

Gregory Lafontaine &, Lori Anne Thomas, for the Defendant, Douglas C. Beatty

Sharon Lavine & Robin McKechney, for the Defendant, Michael J. Gollogly

HEARD: January 12, 16, 17, 18, 19, 20, 30, 31, February 1, 2, 3, 6, 7, 8, 9, 13, 14, 15, 16, 17, 21, 22, 27, 28, 29, March 5, 6, 26, 27, 28, April 2, 3, 4, 5, 10, 11, 17, 18, 30, May 1, 2, 3, 10, 14, 22, 23, 24, 28, 29, June 4, 5, 12, 13, 14, 19, 20, 21, 22, 25 & 26, September 27, 28, October 2, 3, 2012

Contents

Nortel’s Circumstances during the time-frame of this indictment 7

The law of fraud as it applies to the allegations against the accused in this case. 9

Materiality. 11

SAB 99 and Mr. Dunn, Mr. Beatty and Mr. Gollogly. 13

The presumption of innocence, reasonable doubt, R. v. W.(D.), [1991] 1 S.C.R. 742. 13

Business Records. 14

Should the evidence of some of the Nortel and Deloitte’s employees be viewed with caution?. 14

A few basic accounting principles. 18

More generally. 21

Considerations concerning the set-up and use of accrued expenses/liabilities. 21

Nortel specific circumstances. 21

Deloitte’s historical relationship with Nortel 21

Target setting and Nortel’s culture. 22

The employment of Mr. Dunn, Mr. Beatty and Mr. Gollogly at Nortel 23

Mr. Frank Dunn. 23

Mr. Douglas Beatty. 24

Mr. Michael Gollogly. 25

Mr. Dunn, Mr. Beatty and Mr. Gollogly. 25

Nortel was a complex corporate organization. 26

The Financial Results of Nortel Networks Corporation. 27

Nortel’s Consolidation Close Process. 27

Excess accrued liabilities & Nortel’s policy of Conservatism.. 30

The accused knew there were excess liabilities on the balance sheet 33

Unsupported and excessive accrued liabilities on the balance sheet 33

Nortel’s Pro Forma earnings calculations. 34

Pro Forma earnings and Bonus Thresholds. 35

Nortel’s Re-statement of previously-published financial statements. 35

The First restatement 37

A short chronology. 37

Who was Responsible. 37

Nortel Restatements are complex. 37

How the Restatements came about 37

The Comprehensive Balance Sheet Review.. 39

Was the Comprehensive Balance Sheet Review Comprehensive?. 41

The results of the second restatement 43

Inferences concerning Nortel’s restated financial results for Q1 03 and Q2 03. 47

Q4 02-the 4th quarter of 2002. 48

The participation of Mr. Dunn and Mr. Beatty. 51

The specific late entry accrued expenses/liabilities solicited by Mr. Harrison. 52

The solicitation of late entries from Karen Sledge. 52

Late entry Fringe and Vacation accrued liability balances. 52

Fringe Benefit Accrued Liability Balances. 52

Vacation Expenses. 54

Soliciting accrued expenses in Asia. 54

The solicitation of additional accruals from Ken Crosson. 56

Excess and obsolete inventory. 56

Use of Mr. Crosson’s $30 million as an offset 58

The JDS Uniphase Corporation transactions. 58

Perot Systems. 61

The solicitation of additional accruals from Jim Kinney for the period Q4 02. 62

Mr. Gollogly’s knowledge generally. 64

360 Networks. 65

The manipulation of Nortel’s pro forma earnings before taxes to get a bonus. 66

Did the late entry accrual expenses/liabilities misrepresent Nortel’s US GAAP financial results for Q4 02? 66

Susan Shaw’s 2002 Summary of Accrued Liabilities. 67

Corporate. 70

Non-Op. 71

Q4 2002 Conclusion. 72

Q1 03 & Q2 03. 74

The release of $361 million in Q1 03 and $372 million in Q2 03. 74

The Crown’s Chart – “operations” Ex. 42E.. 75

The PWC release – $19 million-originally released Q1 03. 76

The Genuity release – $23 million originally released Q1 03. 77

The Optical Warranty release – $8 million released in Q2 03. 78

Conclusion. 79

The release of $80 million in Non-op accrued liability balances and the entitlement to a bonus. 79

The effect of the $80 million on earnings. 85

Conclusion concerning the Bonus Payments & earnings. 85

The materiality of the release of $80 million of Non-op accrued liability balances. 86

Conclusion. 89

Susan Shaw’s list of $189 million Non-op accrued liabilities. 89

Should the $189 million have been dealt with in Q4 02?. 93

The knowledge of Mr. Dunn, Mr. Beatty and Mr. Gollogly. 94

The accrued liability balance for the Degree of Difficulty bonus – $25 million. 95

The accrued liability balance for the General Provision $10 million. 96

The $142 million in accrued liabilities which Nortel wished to release in Q2 03. 98

Conclusion. 99

The use of Outlooks and Roadmaps in 2003. 100

The Arris Proposal 105

Deloitte’s interest in forecasting. 105

The 2003 Outlooks and Roadmaps tracked proposed releases. 107

The February 19, 2003 teleconference. 107

The June 6, 2003 Outlook and the surrounding events. 111

The release of the $4 million Siemens accrued liability balance. 113

The Restricted Stock Unit Bonus Plan. 115

Conclusion. 116

The draft letters Mr. Gollogly prepared for the Board of Directors and the Audit Committee in July 2003 117

Mr. Gollogly’s draft letter to the Chairman of the Board of Directors, the Chairman of the Audit Committee and the Chairman of the Joint Leadership Resources Committee. 120

Conclusion. 121

Mr. Gollogly’s draft letter to Mr. Beatty. 121

The “now infamous intercompany out of balance provision”. 122

Mr. Gollogly’s reference to the unsupported accrued liability balances. 123

Mr. Gollogly’s reference to the forecasted Q3 03 loss. 125

Mr. Gollogly’s concern about Nortel’s internal controls. 125

Conclusion. 125

The language in the 2003 press releases and the notes to the first restatement 126

The Crown’s criticism of the Q3 03 financial results. 129

Preservation of the integrity of the Q3 03 General Ledger 131

Conclusion. 132

Conclusion. 132

The excess and unsupported accrued liabilities. 132

Q4 2002(Q4 02) 133

The $80 million in Non-op Accrued liability balances released to the Q1 03 profit and loss statement 134

The Return to Profitability Bonus. 134

The Restricted Stock Unit Bonus. 134

The $80 million generally. 135

The attempt to release the $142 Million. 136

Nortel’s published financial results for Q3 03. 136

The Comprehensive Balance Sheet Review.. 136

The Q1 & Q2 03 accrued liability balance releases. 138

Verdict 139

MARROCCO J.:

[1] The defendants are charged with two counts of fraud.

[2] The first count alleges that, between January 1, 2000 and April 28, 2004, the three accused did, by deceit falsehood or other fraudulent means, defraud the public by deliberately misrepresenting the financial results of Nortel Networks Corporation.

[3] The second alleges that, between January 1, 2000 and April 28, 2004, the three accused did, by deceit falsehood or other fraudulent means, defraud Nortel Networks Corporation by deliberately misrepresenting the financial results of Nortel Networks Corporation.

[4] In both counts, it is alleged that the extent of the fraud exceeded $5,000.

[5] For the sake of completeness, I make two observations: first, the events captured by this indictment concern matters which occurred between 2000 and 2004. Nortel did not commence Companies Creditors Arrangement Act proceedings until January 14, 2009. The evidence in this proceeding did not describe events linked to the commencement of those proceedings. Second, Nortel Networks Corporation’s shares traded publicly on the New York and Toronto Stock Exchanges. It ceased trading publicly on January 14, 2009.

Nortel’s Circumstances during the time-frame of this indictment

[6] All allegations of criminal conduct are made within a factual fabric or context. A true appreciation of the nature of the alleged criminal conduct is impossible without a description of that fabric or context.

[7] Part of the factual context for this matter is set out in Exhibit 251D. Exhibit 251D was received in evidence as a business record of Deloitte & Touche.

[8] Nortel Networks Corporation (“Nortel”) was in the business of providing data, wireless and optical networking products and services to telecommunications carriers and enterprise customers around the world. Between 1998 and 2001, Nortel Networks Corporation and its predecessor, Nortel Networks Limited, undertook a total of twenty-two acquisitions for an aggregate purchase price of $29 billion. These acquisitions were undertaken during a period of both strong economic growth in 1999 and 2000 and rapid infrastructure build-out by the telecommunications industry.

[9] By 2001, the telecommunications industry began to experience a slowdown attributed to excess capacity created as a result of the build-out, the consolidation of service providers within the industry and lower capital spending by industry participants. As a result, there was a dramatic and significant reduction in the demand for Nortel’s products and services.

[10] In response to the industry and economic downturn in 2001, Nortel attempted to streamline its operations. Nortel reduced its overall workforce from approximately 94,002 to approximately 52,000 and incurred severance and termination charges in excess of $3.3 billion. Nortel discontinued aspects of its operations and divested itself of investments. Nortel recorded a write down of $12.4 billion for goodwill and other intangible assets in the quarter ending June 30, 2001.

[11] In 2002, Nortel reduced its workforce to 37,000 as at December 31, 2002. Nortel experienced a write down of its goodwill in its Optical business of approximately $595 million and, on December 13, 2002, Nortel pledged substantially all of its assets in favor of certain lenders.

[12] Nortel experienced net income losses of $197 million in 1999, $2.9 billion in 2000, $27.4 billion in 2001 and $3.6 billion in 2002.

[13] The equity of Nortel’s shareholders shrank from $28.7 billion in 2000 to $1.9 billion in 2002.

[14] The circumstances had become so dire at Nortel that, when a quarterly result was announced, the auditors had to take a view of the next twelve months from the date of the quarterly report and opine on the likelihood of Nortel continuing as a going concern.

[15] Nortel Networks was publicly-traded on the New York Stock Exchange. The New York Stock Exchange ran on Nortel equipment. Nortel’s decline was so severe that the closing share price for the company’s common shares in September 2002 fell below the minimum for continual listing on the New York Stock Exchange. The Chairman of Nortel’s Board was advised that Nortel might be de-listed although, in fact, this did not occur.

[16] The compelling but rather sterile economic reality described above was put into more human terms by Mr. Bruce Richmond, who testified as a Crown witness. During the time-frame of the indictment, Mr. Richmond was the Vice-Chair and Deputy Chief Executive of Deloitte & Touche LLP (Canada). He is a chartered accountant; he is a Fellow of the Institute of Chartered Accountants since 1997, a designation conferred on approximately 2% of the Institute’s members.

[17] During the time-frame set out in the indictment, Mr. Richmond was responsible for overall management of Deloitte’s clients across the entire Deloitte organization, which comprised sixty-seven offices with $1.4 billion in revenues.

[18] Mr. Richmond was professionally associated with Nortel through Deloitte & Touche from the late 1970’s.

[19] Through the time-frame described in the indictment, Mr. Richmond served as the Deloitte & Touche Senior Advisory Partner to Nortel. Specifically, Mr. Richmond had been the Senior Advisory Partner at Nortel since 1992. In addition to Nortel, Mr. Richmond also served as the Advisory Partner to approximately a dozen of Canada’s major corporations.

[20] I accept Mr. Richmond’s entire evidence in this matter without qualification.

[21] As Advisory Partner, Mr. Richmond had two primary responsibilities; first, to interface with the directors, particularly members of the Audit Committee, as well as the CEO and the CFO; second, to be a sounding board for the Deloitte partners conducting Nortel audits and reviews.

[22] Mr. Richmond attended virtually all Audit Committee meetings.

[23] Mr. Richmond described Nortel as a major client in the same category as Canadian banks and other major Canadian corporations. Mr. Richmond indicated that approximately twenty companies in Canada would be described as major clients.

[24] Mr. Richmond described Nortel’s situation during the time period set out in the indictment as follows: “Nortel was descending down a very slippery path at a very fast rate… The notion of where the bottom was going to be was not understood at that point in time by anybody… One day a client existed the next day it was out of business… The team was clearly on red alert in terms of what they were facing… ….endeavoring to the best of our collective ability, and I’m talking Nortel folk and I’m talking Deloitte folk, to put your arms around a situation that frankly, having had 20 years in the profession and having been the lead client guy and the senior client service guy for the largest firms in the country, this was a situation that we had never seen before”.

[25] Later on in his evidence, Mr. Richmond said: “in the years 2001, 2002, the company was fighting for its very survival…”

[26] Mr. Richmond indicated that the free-fall that Nortel was experiencing resulted in a situation where Nortel could be comfortable with the value of an asset on one day and next day be convinced that the asset was severely diminished in value.

[27] As a result of that situation, Nortel’s Audit Committee and Board of Directors were in Mr. Richmond’s words: “focused like a laser beam in terms of ensuring from their perspective in the discharge of their responsibilities that the Corporation was doing whatever was required to ensure that they had identified and appropriately quantified provisioning in connection with any exposure of the Corporation”.

[28] Nortel’s Audit Committee and Board of Directors had succeeded in communicating this concern about providing for every risk to senior management and the field.

[29] Nortel’s first re-statement re-stated more than $900 million in excess accrued liabilities into previously-published Nortel financial statements. I am satisfied that one of the underlying reasons for the presence of these excess accrued liability balances was the determination of Nortel’s Audit Committee, auditors, senior management and field staff to provide for every risk and, thereby, avoid unpleasant surprises.

The law of fraud as it applies to the allegations against the accused in this case

[30] It is the Crown’s position that the accused told lies and that the lies put investors at risk of economic deprivation. It is also the Crown’s position that the accused told lies which put Nortel itself at risk of economic deprivation. The lies, according to the indictment, are found in the deliberate misrepresentation of Nortel Networks Corporation`s financial results.

[31] The offence of fraud is set out in the Criminal Code, RSC 1985, C. C-46 s. 380 in the following terms:

380. (1) Every one who, by deceit, falsehood or other fraudulent means, whether or not it is a false pretense within the meaning of this Act, defrauds the public or any person, whether ascertained or not, of any property, money or valuable security or any service,

(a) is guilty of an indictable offence and liable to a term of imprisonment not exceeding 10 years, where the subject matter of the offence is a testamentary instrument or the value of the subject matter of the offence exceeds $5000.

[32] At the outset of the trial, the Crown provided the court with a factum setting out the general principles of the law of fraud, as well as helpful references to s. 397(1)(a) of the Criminal Code. That factum was quite helpful and I have attempted to apply those principles in this case.

[33] In R. v. Zlatic (1993), 79 C.C.C. (3d) 466 (S.C.C.) at para. 26, the court stated that the actus reus of fraud will be established by proof of: (i) the prohibited act, be it an act of deceit, a falsehood or some other fraudulent means; and (ii) deprivation caused by the prohibited act, which may consist in actual loss or the placing of the victim’s pecuniary interests at risk.

[34] The court, in R. v. Zlatic, at para. 26, held that the mens rea for fraud was established by proof of: (i) subjective knowledge of the prohibited act; and, (ii) subjective knowledge that the prohibited act could have as a consequence the deprivation of another (which deprivation may consist in knowledge that the victim’s pecuniary interests are put at risk).

[35] Finally, the court stated that, where proof of these two elements was established, the accused was guilty if he or she actually intended the prohibited consequence or was reckless concerning the consequences (see: R. v. Zlatic (supra), at para. 27).

[36] In R. v. Eizenga 2011 ONCA 113 [2011] O.J. No. 524, at para. 81, the Court of Appeal emphasized that a subjective intent to mislead was not an essential element of fraud.

[37] In R. v. Theroux (1993), 79 C.C.C. (3d) 449, at paras. 16-17 (S.C.C.), McLachlin J. [as she then was] defined the actus reus for the offence of fraud as requiring two elements: a dishonest act and deprivation.

[38] McLachlin J. indicated that deprivation was established if it was proven that the dishonest act caused detriment, prejudice or risk of prejudice to the economic interests of the victim.

[39] In R. v. Theroux, McLachlin J. [as she then was] defined the mens rea requirement for the offence of fraud.

[40] McLachlin J. stated that the mens rea of fraud was established by proof of subjective awareness that one was undertaking the prohibited act, i.e. the deceit, falsehood or other dishonest act, and that the prohibited act could cause deprivation in the sense of depriving the proposed victim of property or putting the proposed victim’s property at risk.

[41] McLachlin J. also stated that the fact that an accused person may have hoped that the deprivation would not take place or may have felt that there was nothing wrong with what he or she was doing was not a defence (see: R v Theroux, at para. 22).

[42] Later on, McLachlin J. stated, at para. 29: “the accused must have subjective awareness at the very least that his or her conduct will put the property or economic expectations of others at risk”.

[43] This case deals with false financial results. Where the omission or misstatement complained of is not material to those financial results, it stands to reason that it will be difficult to prove that there was any risk of prejudice to the economic interests of the public.

[44] The public are not defined in the indictment in count one. Obviously, the public can be divided into different groups or segments. I am satisfied that a fair interpretation of the public in this case is the investing public.

[45] In count two, the victim is defined; namely, Nortel Networks Corporation.

[46] As indicated earlier, the Crown advances the proposition that, in this fraud case, the accused told lies. McLachlin J. specifically commented in R. v. Theroux, at para.29: “But in cases like the present one, where the accused tells a lie knowing that others will act on it and thereby puts their property at risk, the inference of subjective knowledge that the property of another would be at risk is clear”.

[47] In R. v. Drabinsky, 2011 ONCA 582 [2011] O.J. No. 4022, one of the charges in the indictment was that the accused in that case had provided false financial information to persons who invested in an IPO. In that case, at para. 80, the Ontario Court of Appeal stated: “the Crown had to prove the appellants knew that the financial statements contained misrepresentations and that they were material to the decision to invest in the IPO”.

[48] The matter before me is different; there is no IPO. In this case, the defendants are, in count one, facing a charge of defrauding the public by deliberately misrepresenting the financial results of Nortel Networks Corporation. Accordingly, if one applies the same conclusion that the Court of Appeal expressed in R. v. Drabinsky, supra, the conclusion in this case must be that the Crown has to prove that the accused knew that Nortel’s financial statements contained misrepresentations that were material to the decision of a member of the investing public to buy, hold or sell Nortel publicly-traded securities.

[49] With respect to count two, the essence of the matter seems to be that the misrepresentation of Nortel’s financial results created the economic risk that Nortel Networks Corporation would pay money to the defendants that ought not to be paid to them.

Materiality

[50] In R. v. Drabinsky, at para. 83, the Court of Appeal commented on the notion of materiality. The court said that materiality in the context of that case was a fair inference from the nature of the misrepresentations, the documents in which they appeared and the context in which those documents were used.

[51] At paras. 81 & 82, the Court of Appeal, in R. v. Drabinsky, upheld the trial judge’s decision that the misrepresentations in the financial statement relied on in support of the IPO were material to the decision to purchase shares through the IPO.

[52] The materiality of a misstatement or omission is, therefore, important. In its opening, as part of a Glossary of Terms, the Crown provided a definition of materiality. In the context of financial statements, an omission or misstatement is material according to this glossary if “the judgment of a reasonable person relying on the statements would have been changed or influenced by the inclusion or correction of the item”.

[53] The Crown offered expert evidence on various aspects of the accounting issues of concern in this proceeding. This evidence was received on consent in the form of a written report from Asset Risk Advisory Inc. The Asset Risk Advisory Inc. Report was prepared by Mr. Robert Chambers, who is a lawyer, a chartered accountant, a certified fraud Examiner and a Fellow of the Institute of Chartered Accountants of Ontario.

[54] At paragraph 31 of his report, which was appended to his affidavit, Mr. Chambers made the following observation about materiality: “According to FASB, materiality is the quality of being important. The omission or misstatement of an item in a financial report is material if, in the light of surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item.”

[55] Mr. Chambers referred the reader of his report to SEC Staff Accounting Bulletin 99 (“SAB 99”) for guidance in determining materiality. SAB 99 was published in 1999 – the same year that Nortel’s world began to unravel.

[56] In SAB 99, SEC made it clear that exclusive reliance on dollar thresholds cannot be used as a substitute for a full analysis of all relevant considerations when determining materiality.

[57] SAB 99 states that, among the considerations that may render material a quantitatively small misstatement of a financial statement item, are:

• Whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate;

• Whether the misstatement masks a change in earnings or other trends;

• Whether the misstatement hides a failure to meet analysts' consensus expectations for the enterprise;

• Whether the misstatement changes a loss into income or vice versa;

• Whether the misstatement concerns a segment or other portion of the registrant's business that has been identified as playing a significant role in the registrant's operations or profitability;

• Whether the misstatement affects the registrant's compliance with regulatory requirements;

• Whether the misstatement affects the registrant's compliance with loan covenants or other contractual requirements;

• Whether the misstatement has the effect of increasing management's compensation – for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation; and,

• Whether the misstatement involves concealment of an unlawful transaction.

[58] Apart from Mr. Chambers’ general statements, no expert evidence concerning materiality was offered in this case. Representatives of Deloitte performed a materiality analysis, which was admitted as a business record and to which reference will be made.

[59] Count number one alleges a fraud upon the public. Nortel was publicly-traded. I am satisfied that the public in this case includes the investing public. Persons who own publicly-traded Nortel securities are included in the term “public”. Persons who are thinking of purchasing publicly-traded Nortel securities are included in the term “public”. I accept and intend to apply the notion of materiality that is described in Mr. Chambers’ report. A misrepresented financial result is material if, in light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable member of the investing public would have been changed or influenced by the correction of the item. The omission of a financial result is material if, in light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable member of the investing public would have been changed or influenced by the disclosure of the item.

SAB 99 and Mr. Dunn, Mr. Beatty and Mr. Gollogly

[60] Mr. Gollogly was aware of SAB 99. Mr. Gollogly sent a memo to selected Nortel employees dealing with SAB 99 on March 3, 2003. His memo attached SAB 99 itself. Mr. Gollogly made a presentation to Nortel’s Audit Committee on April 23, 2003, in which he explained the concept of materiality. Mr. Beatty and Mr. Dunn were normally in attendance at Audit Committee meetings.

[61] I am satisfied that Mr. Dunn and Mr. Beatty were present when Mr. Gollogly made this presentation to the Audit Committee.

[62] Mr. Beatty was aware of SAB 99. On April 19, 2003, Mr. Beatty sent an e-mail to Mr. Gollogly which stated: “would you please email me the charts (if possible) for SAB 99 that speak to the need to disclose, particularly if management comp’n is achieved etc. – probably useful to have the SAB 99 text as well for Monday a.m.”

[63] Mr. Dunn was Nortel’s CEO during the time with which we are concerned. Prior to that, he was Nortel’s CFO and, prior to that, he was Nortel’s Corporate Controller.

[64] Mr. Dunn, Mr. Beatty and Mr. Gollogly were senior officers of a corporation publicly- traded on the New York Stock Exchange with annual revenues of approximately $10 billion per year during the time frame of the indictment.

[65] I am satisfied that Mr. Dunn, Mr. Beatty and Mr. Gollogly were aware of the specifics of SAB 99, the importance of determining whether items of financial information were materially important and, finally, the importance of making the appropriate disclosure to the public.

The presumption of innocence, reasonable doubt, [R. v. W.(D.), [1991] 1 S.C.R. 742](https://www.canlii.org/en/ca/scc/doc/1991/1991canlii93/1991canlii93.html)

[66] I have instructed myself on the presumption of innocence, the burden of proof and reasonable doubt. In a criminal case, the accused is presumed to be innocent unless and until the Crown has proved his/her guilt beyond a reasonable doubt. It is not the responsibility of any accused under our law to establish or to demonstrate or to prove his innocence. If the Crown should fail to prove guilt in respect of a particular crime beyond a reasonable doubt, then the accused is not guilty of that crime. To put the matter somewhat differently, in order to find an accused guilty of a particular offence, the Crown must prove each and every one of the essential elements of that offence beyond a reasonable doubt. If I should entertain a reasonable doubt about the proof of one or more of those essential elements, then I must find the accused not guilty of that offence.

[67] A reasonable doubt is not a far-fetched or frivolous doubt. It is not some fanciful doubt. It is not a doubt based upon sympathy or prejudice. Rather, it is an honest and fair doubt based on reason and common sense. It is doubt that logically arises from the evidence or lack of evidence. It is not enough that I believe that Mr. Dunn, Mr. Beatty or Mr. Gollogly is probably or likely guilty of count one or count two of this indictment. In those circumstances, I must find any or all of them not guilty because Crown counsel has failed to satisfy me of guilt beyond a reasonable doubt. Proof of probable guilt or likely guilt is not proof of guilt beyond a reasonable doubt. I should also remember, however, that it is virtually impossible to prove anything with absolute certainty. Crown counsel is not required to do so. Absolute certainty is a standard of proof that is impossibly high.

[68] If, based on all the evidence, I am sure that Mr. Dunn, Mr. Beatty or Mr. Gollogly committed the offence described in either count one or count two in the indictment, I should find Mr. Dunn, Mr. Beatty or Mr. Gollogly guilty of such offence since I would have been satisfied of guilt beyond a reasonable doubt. If, at the end of the case based on all the evidence, I am not sure that Mr. Dunn, Mr. Beatty or Mr. Gollogly committed either count one or count two in this indictment, I should find Mr. Dunn, Mr. Beatty or Mr. Gollogly not guilty of such offence. If, after a full consideration of all the evidence admissible against any one of defendants, there remains in my mind a reasonable doubt concerning the guilt of such defendant, then the Crown has failed to meet the standard of proof which the law requires, the presumption of innocence prevails and it is my duty to acquit. On the other hand, if, after a full and careful consideration of all the evidence, I am left with no reasonable doubt concerning the guilt of Mr. Dunn or Mr. Beatty or Mr. Gollogly on either or both counts in the indictment, the presumption of innocence has been displaced and it is my duty to convict.

[69] Reasonable doubt applies to issues of credibility. I am not required to firmly believe or disbelieve any witness or set of witnesses. I must ask myself whether, on the basis of the evidence which I do accept, I am convinced beyond a reasonable doubt by that evidence of the guilt of one or more of the accused )see: R. v. W.(D.), [1991] 1 S.C.R. 742, at para. 28).

Business Records

[70] During the course of this trial, the Crown and the defence tendered hundreds of documents. These documents were received as business records. As such, they are capable of proving the facts contained within them. However, I am not bound to accept the business records as proof of facts contained within them.

Should the evidence of some of the Nortel and Deloitte’s employees be viewed with caution?

[71] The Crown indicated that several of the witnesses listed in the Appendix to its submissions were accomplices. The Crown indicated that these witnesses sought to minimize their involvement or distance themselves from wrongdoing and that this took the form of acquiescing quickly with defence suggestions on cross-examination.

[72] Leading questions were asked on cross-examination and it is correct that, on many occasions, witnesses accepted the suggestions contained in those questions.

[73] At the same time, the Crown submits that there was strong confirmatory evidence of aspects of the testimony of these witnesses in the documents which were tendered. The witnesses in respect of whom the Crown urges caution played a role, according to the Crown, in the planning, analysis and use of accrued liability balances to meet earnings targets. Without the co-operation of these witnesses, the Crown submits the three accused would not have been able to shift Nortel from a profit to a loss in Q4 02 (the fourth quarter of 2002) and engineer profits in Q1 03, Q2 03 and Q3 03 (the first quarter of 2003 etc.).

[74] This is perhaps an appropriate place to observe that there is nothing about the background of any of these witnesses which makes them inherently “unsavory”. The evidence has disclosed that regulatory proceedings against the defendants are in abeyance pending the outcome of this matter. The evidence has not disclosed that any of the witnesses listed in the Crown’s Appendix are facing criminal charges themselves. There is no suggestion in the evidence that any of these witnesses are the subject of outstanding regulatory proceedings.

[75] The Crown submits that there was a long-standing culture of Conservatism at Nortel and many of the witnesses who are chartered accountants or certified management accountants had to know that accrued liability balances therefore existed and were being used to meet earnings targets. The Crown submits that compliant employees assisted the accused in misrepresenting the financial results of Nortel Networks Corporation.

[76] I am satisfied that, during the time-frame of the indictment, there was at Nortel a culture of Conservatism, in the accounting sense of that term. I am satisfied that this culture existed for in excess of twenty years. It has to be remembered, however, that, until 1999, the SEC and the Ontario Securities Commission had not prohibited the practice of releasing accrued liability balances to bridge the gap between a company’s actual performance and a previously announced financial target. Coincidentally, it was in the same year, 1999, that Nortel began experiencing significant losses.

[77] Finally, one has to remember that Nortel’s culture concerning the recording of accrued liability balances was slow to change because for fiscal 2000, 2001 2002 Nortel reported losses in the billions and, as a result, the Board of Directors, Nortel’s auditors and its senior management were preoccupied with survival.

[78] The accused called no defence. All of the witnesses who testified were called by the Crown.

[79] The ten witnesses listed in the Crown’s Appendix gave evidence which was capable of both inculpating and exculpating the accused. As well, this is not a case in which it is relatively straightforward to delineate evidence which implicates any one or all of the accused in either of the offences set out in the indictment.

[80] With respect to those portions of the evidence which, in my view, are exculpatory, the question is whether such evidence alone or in combination with other evidence leaves me with a reasonable doubt (see: R. v. Rowe, 2011 ONCA 753, 2011 OJ No. 5382 (Ont. CA), at para. 42).

[81] With respect to those portions of the evidence which implicate the accused, I have to decide whether the credit of these witnesses is such that I should caution myself about accepting, in the absence of confirmatory evidence, testimony from them which implicates any one or more of the three accused.

[82] As indicated earlier, the Crown suggested that these witnesses were accomplices and that their evidence implicating the accused should be viewed with caution in the absence of confirmatory evidence.

[83] I propose now to consider a few highlights of the testimony of the witnesses named by the Crown.

[84] Mr. Brian Harrison was, during the time-frame of the indictment, the Vice-President of Performance Management and, later, when the position of Vice-President Performance Management was eliminated, Nortel’s Director of Financial Planning and Analysis. Mr. Harrison was directly involved in the process of soliciting accruals during Q4 02. It is the Crown’s view that he actively assisted in changing a Q4 02 pro forma gain before taxes into a loss before taxes. Mr. Harrison was a CMA or certified management accountant during the time-frame of the indictment. He no longer has that designation for reasons which were not disclosed. He was interviewed many times by different police forces and regulatory authorities. At one point, he was told that he was a target of the investigation into the matters described in this indictment. Prior to actually testifying, he was told by the police and the Crown that he was no longer considered a target of the investigation into these matters.

[85] In my view, I should exercise some caution before accepting unconfirmed evidence from Mr. Harrison which I think implicates any of the accused in this matter

[86] Linda Mezon, Nortel’s Assistant Corporate Controller for a portion of the time-frame described in this indictment, indicated she was not aware of the fact that there was a point in time in Q4 02 when Mr. Harrison’s Outlook (forecast) suggested positive pro forma earnings before taxes of $73 million. Ms. Mezon also played a central role in the JDS offset in the fourth quarter of 2002 (Q4 02). While I will discuss this in more detail later, it is sufficient to say that the JDS offset resulted in expenses being reduced to reflect a reduction in revenue at a late point in Nortel’s close of the books for Q4 02.

[87] Even if I were to disbelieve Ms. Mezon concerning what she knew about Nortel’s preliminary pro forma earnings before taxes during the early part of the Q4 02 close, this would not make her a witness, whose testimony implicating any or all of the accused, should be viewed with caution in the absence of confirmatory evidence. It simply means that she knew something which she claimed not to know. While this could affect her credibility, it does not make her a Vetrovec witness (see: R. v. Winmill (1999), 131 C.C.C. (3d) 380 (Ont. C.A.), at para. 113). Similarly, her participation in the JDS offset does not make her a witness whose evidence implicating the accused ought to be viewed with caution unless confirmed by other evidence. It simply means that, with the knowledge and consent of her superiors and Nortel’s auditors, she accepted an entry to offset the loss of revenue caused by the accounting for the JDS transaction. This conduct does not make her a witness whose evidence implicating the accused I should be cautious about accepting in the absence of confirmatory evidence.

[88] Helen Verity was the Director of Consolidations for Nortel from 2001 – 2003. She received Outlooks or forecasts during the Q4 02 close process. Her handwriting is on some of them. Ms. Verity testified that she was not aware of the skepticism which greeted Mr. Harrison’s assertion that Nortel’s pro forma earnings before taxes were positive in Q4 02. While this may be a credibility issue as far as Ms. Verity’s concerned, it does not make her a Vetrovec witness (see: R. v. Winmill, supra, at para. 113).

[89] Mr. Crosson was a long-standing Nortel employee who, during the material time, was the Vice-President of Global Operations. Mr. Ken Crosson, despite the fact that he was satisfied with the original financial results he submitted to Nortel headquarters in Brampton during the Q4 02 close, came up with additional accrued liability balances upon request. These additional balances resulted in increases in expenses and a corresponding decrease in earnings. This clearly assisted Mr. Harrison, who was canvassing for accrued liability expenses/liabilities which, by definition, would decrease earnings.

[90] Mr. Crosson, in my view, was responding to requests from his superiors, but I am not satisfied that he responded in an inappropriate way. He indicated in his estimation there was some flexibility concerning excess and obsolete accrued liability balances relating to inventory. While his responses arguably were not entirely consistent with United States Generally Accepted Accounting Principles (“US GAAP”) and while that may be a concern for securities regulators, the accrual balances which he agreed to increase could be changed without distorting Nortel’s underlying financial reality.

[91] I am not satisfied that Mr. Crosson’s conduct changes his character as a witness such that I ought to be cautious, in the absence of confirmatory evidence, about accepting inculpatory evidence from him.

[92] Mr. Glenn Morita was the Director of Finance for the Europe Middle East Asia Region during the time-frame of the indictment. Mr. Morita was also satisfied with his original financial results submitted to Nortel headquarters in Brampton during the Q4 02 close but, nevertheless, located additional accrued liability balances upon request from Mr. Harrison. The fact that Mr. Morita provided additional accrued liability balances which he thought were genuine does not change Mr. Morita’s character as a witness such that, in the absence of confirmatory evidence, caution should be exercised before accepting evidence from him implicating any or all of the accused.

[93] Mr. Jim Kinney was, during the time-frame in the indictment, Vice-President Finance of Wireless, which was a business unit within Nortel. Mr. Kinney and his group worked very hard to meet their Q4 02 target. Despite this, Mr. Kinney submitted additional accrued liability balances that moved him off target in Q4 02. He testified that he was not concerned because he had been requested by his superiors to find additional accruals and that is what he did.

[94] I do not find that Mr. Kinney’s behavior in this regard changes his character as a witness and that I should, therefore, be cautious in the absence of confirmatory evidence about accepting evidence from him implicating any or all of the accused.

[95] Ms. Karen Sledge was the U.S. Controller during the Q4 02 close. She became Assistant Corporate Controller in 2003 where she remained until 2005. When she was Assistant Corporate Controller Ms. Sledge reported to Mr. Gollogly until he was suspended in March 2004. Ms. Sledge changed the Fringe accrued liability balance as a result of repeated calls from Mr. Gollogly and others. Ms. Sledge was not comfortable with making this change and mentioned it to the representatives of the Wilmer Cutler Pickering law firm. Wilmer Cutler Pickering, about one year later, were conducting, at the request of Nortel’s Audit Committee, an independent review of the circumstances leading to Nortel’s re-statement of previously-published financial results. Her conduct does not change her character as a witness such that I should, in the absence of confirmatory evidence, exercise caution before accepting inculpatory evidence from her.

A few basic accounting principles

[96] Mr. Robert Chambers, the Crown’s expert, provided some basic accounting principles in his report.

[97] A general principle underlying US GAAP is that expenses are to be matched with revenues as long as it is reasonable to do so. When work or a product makes its contribution to revenue, expenses associated with that work or product are recognized even if those expenses cannot be known with precision. This matching principle is applied through accrual accounting. In such a situation, the accrued expenses are estimated.

[98] An accrued expense is an expense that has been incurred but not yet paid. An accrued liability is an obligation disclosed on the balance sheet that is not yet payable.

[99] Recording an accrued expense reduces income on the profit and loss statement and, simultaneously, results in the recording of an accrued liability on the balance sheet.

[100] Once the accrued liability is recorded on the balance sheet of a publicly-traded corporation like Nortel, the corporation is required to assess that accrued liability balance at the end of each financial quarter to determine whether something has occurred within that quarter which requires a change (i.e., an increase or decrease) in the estimate of the liability.

[101] If an event has occurred within that quarter which requires a change in the estimate of the accrued liability balance, then the accrued liability balance should be either increased or decreased in that quarter. This is sometimes referred to as a “change in estimate”.

[102] If an accrued liability balance is increased as a result of the change in estimate, earnings are negatively affected.

[103] If an accrued liability balance is decreased as a result of a change in estimate, earnings are positively affected.

[104] In Nortel speak, the event which required a change in the estimate of the accrued liability balance was called a triggering event or a trigger. Put simply, trigger was a word used to denote an event or some other situation that drove a change in an accrued liability balance.

[105] When the accrued expense becomes certain and is paid, the earnings of the corporation can be favorably affected. The following example, borrowed and slightly-amended from the Crown’s expert evidence, illustrates this.

[106] Assume that, as a result of a contract into which it has entered, a publicly-traded corporation is involved in litigation at the close of its fiscal year ending December 31, 2002 and assume that an unfavorable outcome is probable. Management does not know the exact amount it will have to pay, but its reasonable estimate is that the judgment against it will be for not less than $3 million and not more than $9 million. If no amount within that range appears to be a better estimate than any other, Financial Accounting Standards No. 5 (“FAS 5”) requires that an expense of $3 million be recorded at December 31, 2002, i.e., the expense estimate at the lowest end of the estimated range of appropriate exposures.

[107] Recording this expense on the profit and loss statement will have a $3 million negative impact on earnings for the period ending December 31, 2002. Recording this accrued expense also results in an accrued liability of $3 million being recorded on the balance sheet.

[108] In the example above, if the company thought that $4 million was the best estimate of its liability, then it would record $4 million as an expense/liability despite the fact that it was not at the lowest end of the range of appropriate liabilities. It is only when no amount within the acceptable range is a better estimate than any other that the lowest amount in the range must be chosen.

[109] Assume, for simplicity’s sake, that the company settles the litigation for $2 million in the third quarter of 2003 and pays the plaintiff in that quarter. At the end of the third quarter of 2003, the company should eliminate the accrued liability of $3 million. $2 million of the liability was used to pay the plaintiff so the remaining balance is $1 million. This remaining $1 million excess is removed from the balance sheet and $1 million is recorded on the profit and loss statement as a positive impact on earnings. This is sometimes referred to as a “releasing” the accrued liability balance to the profit and loss statement or “releasing the accrual” or a “releasing the $1million”. Sometimes it is referred to as “reversing the accrual”.

[110] In some of the documentation received in evidence, accrued liabilities were referred to as “provisions”. Setting up accrued expense/liability was sometimes referred to as “provisioning”.

[111] There is a timing issue in the example. US GAAP, specifically SEC Bulletin 14, requires the elimination of the accrued liability and the recording of the $1 million positive impact on earnings in the quarter when the event precipitating the conversion of the liability occurred. In this example, it is the third quarter of 2003 because the precipitating event is the settlement of the litigation.

[112] In the example, if the accrued liability balance was not adjusted in the third quarter of 2003, then an “error” has occurred. In the third quarter 2003, accrued liability balances would be $3 million greater than they should be and earnings would be $1 million lower than they should be.

[113] An accrued liability can be falsely stated on the balance sheet if any one of three things happens:

• first, if, contrary to US GAAP, the liability is fictitious;

• second, if, contrary to US GAAP, an artificially-high number is used to estimate the liability when it is first set up;

• third, if an event occurs within a quarter which calls for a change (i.e., an increase or decrease) in the estimate of the accrued liability and, contrary to US GAAP, a change in estimate does not occur. From that point on, accrued liabilities will be either overstated or understated on the balance sheet.

[114] When there are excess accrued liability balances on the balance sheet, an opportunity is created to tailor earnings by arbitrarily “releasing the accrual” to positively impact earnings in the quarter where you want to increase earnings. The motive for tailoring earnings is often to meet a previously-publicized financial target. Such behavior is contrary to US GAAP. The financial results in the tailored quarter are misrepresented. Whether the misrepresentation is material is a separate consideration.

[115] Returning to the example, if the corporation did not release the $1 million in Q3 02 but, instead, left it on the balance sheet for a rainy day, the corporation would be said to have a “cookie jar” of $1 million on its balance sheet.

[116] A corporation can also tailor earnings by lowering them if, contrary to US GAAP, it creates an accrued expense/liability which is completely false or artificially high. The false or artificially-high expense negatively affects earnings and results in earnings being misrepresented on the corporation’s profit and loss statement. Recording the false or artificially-high expense automatically results in the recording of a false or artificially-high accrued liability. When this happens, the corporation’s financial results are misrepresented. Whether the misrepresentation is material is a separate consideration.

[117] Finally, a corporation has to account for impairment of its assets even if there is uncertainty concerning the recognition of revenue or the incurring of an expense and uncertainty concerning how much money is involved.

[118] The Financial Accounting Standards Board issued the Statement of Financial Accounting Standards No. 5 (“FAS 5”) in March 1975 to assist in accounting for uncertainties related to the occurrence of future events, commonly known as accounting for contingencies.

[119] Nortel was required to record an expense related to a material contingency if information available prior to the issuance of its financial statements indicated that it was probable that an asset had been impaired or a liability had been incurred at the date of the financial statements and the amount of the impairment or loss could be reasonably estimated. The evidence established that, during Nortel’s decline, assets thought secure became impaired overnight. The evidence established that great uncertainty existed in 2001 and 2002 concerning the extent to which Nortel’s assets had become impaired.

More generally

[120] First, when estimating and recording accrued expenses/liabilities, considerable discretion is accorded to management and, correspondingly, considerable judgment is required.

[121] Second, Mr. Richmond testified that, while the basic concepts of accrual accounting were straightforward, their application could be quite complex. He testified that, between 2000 and 2005, the operating mechanics of accrual accounting did not change, the regulatory environment changed. To this, I would add sometimes reasonable differ; sometimes interpretations and applications of basic principles change.

Considerations concerning the set-up and use of accrued expenses/liabilities

[122] Mr. Richmond explained that there are two considerations. The first is ensuring that your provisioning for expenses is appropriate at any point in time; that is, that you had identified every risk for which you should provide. The second consideration requires, if necessary, reducing accrued liability balances should they turn out, at any point in time, to be overstated.

[123] It was Mr. Richmond’s view that there had been a practice in corporate Canada and corporate America in the late 1990s to prepare financial statements in a professional, thorough and comprehensive way, but also in a way that made sure there was flexibility in the accrued liability levels of the corporation so that, at the end of a quarter if a CEO found himself slightly short of the market’s expectations of profitability, he or she might release accrued liabilities from the balance sheet and, thereby, positively impact earnings in order to meet the corporation’s publicly-stated targets.

[124] Mr. Richmond commented that this practice was ended by the SEC and the Ontario Securities Commission in 1999. The result of the change, according to Mr. Richmond, was that it was still permitted to provision in a prudent way, but not appropriate after the results of the corporation had been determined to go in and use “magic” to change numbers arbitrarily to comply with previously-publicized targets.

[125] Mr. Richmond described this change in 1999 as “a huge deal”. Mr. Richmond gave examples of corporations such as Microsoft, which had experienced difficulty with regulators because they failed to appreciate this change in the environment.

Nortel specific circumstances

Deloitte’s historical relationship with Nortel

[126] The scope of Deloitte’s involvement with Nortel is an important part of the context of this matter. It is difficult to get a full appreciation of the total number of Deloitte & Touche partners and associates who worked on the Nortel file. Mr. Richmond indicated that younger partners, managers and senior accountants worked on the Nortel file full-time. In terms of billings, Nortel was a major client of Deloitte.

[127] Evidence in this proceeding indicated that external auditing fees for 2003 were approved by the Nortel Audit Committee in the amount of $19 million.

[128] Some Deloitte’s auditors including the lead audit partner had their offices in Brampton at Nortel headquarters.

[129] Deloitte had been Nortel’s auditors for approximately one hundred years.

[130] I am satisfied that Nortel was a significant Deloitte & Touche client. I am satisfied that Deloitte & Touche were embedded in one form or another in all aspects of Nortel’s operations. The evidence is replete with communications between Nortel staff and Deloitte staff. Many of the witnesses testified that, when Deloitte asked for information, it was provided. This assertion is amply borne out by the documentary record.

Target setting and Nortel’s culture

[131] Mr. Peter Dans testified in this matter. Mr. Dans worked at Nortel from 1990 to 2007. Mr. Dans served in a strategic planning role from 2001 to 2003. Specifically, Mr. Dans was assigned to the Global Planning and Reporting Group.

[132] Mr. Dans has a degree in engineering. He has an MBA; he is also a CMA – that is, a certified management accountant.

[133] Mr. Dans described the setting of targets. He testified that Nortel, whose fiscal year was the calendar year, started working on its budget in August. In August 2003, Mr. Dans prepared budgets and potential targets for each of the business units for fiscal 2004. The initial targets came from the Global Planning and Reporting Group. They produced a target for revenue and profitability which was essentially in the form of a profit and loss statement. Mr. Dans then reviewed these initial targets with the accused Douglas Beatty and it was Mr. Dans’ understanding that Mr. Beatty reviewed the target with the accused Frank Dunn.

[134] The targets were sent to the Presidents and financial Vice-Presidents of the various business units so that they could provide their view on achieving their proposed target.

[135] Mr. Dunn and the Presidents of the business units would hold a final meeting and set the budget targets for the year.

[136] Mr. Dans further testified that there were times during the year when targets were updated. Mr. Dans indicated that Mr. Dunn and Mr. Beatty set what were called “stretch targets”. This was a target that would be harder to achieve. It might be as much as 5% better than the budget. While Mr. Dans only had direct knowledge of this process for the fiscal year 2003, it was his impression that the target setting process employed in 2003 had not changed from earlier years.

[137] Hitting the target was an important part of Nortel’s culture. Mr. Kinney offered the observation that one negotiated targets which allowed one to succeed rather than fail.

[138] Mr. Gollogly described the attitude at Nortel in an e-mail, dated July 31, 2003: “... General approach is to sandbag good news and close hard to the forecast”.

[139] E-mails were received as business records in this trial.

[140] Mr. Glenn Morita is a chartered accountant. He was the Director of Finance for the Europe Middle East Asia Region. Mr. Morita similarly expressed himself in an e-mail to a colleague, dated January 8, 2004. Mr. Morita testified and confirmed the implication in his e-mail.

[141] The inference I draw is that the Nortel business units made a very determined effort to meet their targets.

The employment of Mr. Dunn, Mr. Beatty and Mr. Gollogly at Nortel

[142] Mr. Richmond and other witnesses were able to provide some history and context to the employment at Nortel of all three accused. This evidence could not be elicited from the accused because they did not testify.

Mr. Frank Dunn

[143] Specifically, Mr. Richmond testified that Mr. Dunn, a certified management accountant by training, joined Nortel out of university. Mr. Richmond, although aware of Mr. Dunn, only began to deal with him when Mr. Dunn became Corporate Controller (1992-1993). When Mr. Dunn was Nortel’s Controller, Mr. Richmond met with him both individually and at Audit Committee meetings.

[144] Mr. Richmond indicated that, after Mr. Dunn became Nortel’s CFO, their dealings became more frequent. Mr. Richmond was present at Audit Committee meetings when Mr. Dunn, as CFO, made presentations and commented on issues.

[145] Mr. Richmond pointed out that, when Mr. Dunn was the CFO of Nortel, he was the CFO of a corporation with the largest capitalization value of any corporation in Canada.

[146] Mr. Dunn became the CEO of Nortel in the fall of 2001. Mr. Richmond continued to deal with Mr. Dunn after that time.

[147] Mr. Richmond testified that Mr. Dunn was technically competent as far as accounting skills were concerned. Mr. Brian Harrison indicated that Mr. Dunn was knowledgeable concerning accounting principles. Mr. Harrison also testified that Mr. Dunn was very interested in details; he described him as detail-oriented. In a similar vein, Ms. Helen Verity, a chartered accountant herself, testified that she worked with Mr. Dunn and Mr. Beatty at different times during her career at Nortel. Ms. Verity described Mr. Dunn as “a very smart man” with a good grasp of accounting principles. Mr. Ken Crosson testified that he had known Mr. Dunn for twenty-five years at Nortel and offered the opinion that Mr. Dunn was “very familiar with numbers, very efficient with numbers. Understood – – he – – he understood numbers”. Mr. Crosson also indicated that, on the occasions when he and Mr. Dunn discussed accounting issues, Mr. Dunn was able to “understand it completely”.

[148] I accept the assessments of Mr. Dunn offered by Mr. Richmond, Mr. Harrison, Ms. Verity and Mr. Crosson. They had years to observe Mr. Dunn and their evidence in this regard did not appear to be contentious.

[149] Mr. Lynton R. Wilson also testified. Mr. Wilson was the Chairman, President and CEO of BCE Inc. and, as a result, joined the Board of Nortel in 1991. Mr. Wilson was a member of the Board of Directors throughout the period described in the indictment. He was the Chair of the Board of Directors of Nortel for most of the period set out in the indictment. Mr. Wilson was, therefore, personally familiar with the period described in the indictment.

[150] Mr. Wilson is an Officer of the Order of Canada and a Companion of the Order of the Business Hall Of Fame. During his career, Mr. Wilson served as CEO and as a director of a number of major Canadian corporations.

[151] I accept Mr. Wilson’s evidence without qualification.

[152] Mr. Wilson became the Chair of Nortel’s Board in 2001. He testified that Mr. Dunn was asked to take on the role of CEO at Nortel in the fall of 2001 at a difficult time. At that time with reference to Nortel, Mr. Wilson stated, “the ship was listing pretty badly…”

[153] It was Mr. Wilson’s opinion that it was a credit to Mr. Dunn’s leadership that he was able “to keep the ship afloat” after he became CEO in 2001.

Mr. Douglas Beatty

[154] The evidence established that Mr. Beatty was a C.A., who became the CFO of Nortel on July 17, 2002. Thus, Mr. Beatty’s first quarter as CFO was Q3 2002. Prior to being CFO, Mr. Beatty was the Corporate Controller. Mr. Beatty succeeded Mr. Dunn as Corporate Controller.

[155] Mr. Richmond testified that he felt it was part of his responsibility to assess Mr. Beatty’s ability to be CFO. Mr. Richmond indicated that it never occurred to him to suggest to the Chair of the Board or the Chair of the Audit Committee that Mr. Beatty did not possess the technical and other expertise to carry out his responsibilities. To the contrary, Mr. Richmond testified that he recommended Mr. Beatty to the Board for the position of CFO.

[156] Mr. Brian Harrison testified and I accept his evidence that Mr. Beatty was knowledgeable concerning accounting principles. Ms. Helen Verity also confirmed that Mr. Beatty was “a good accountant”. Mr. Ken Crosson testified that he was in contact with Mr. Beatty on at least a weekly basis. He testified that Mr. Beatty was a very knowledgeable and efficient accountant.

[157] I accept the evidence of Mr. Richmond, Mr. Harrison, Ms. Verity and Mr. Crosson concerning Mr. Beatty’s background and accounting acumen.

Mr. Michael Gollogly

[158] The evidence established that Mr. Gollogly is a C.A., who became Nortel’s Corporate Controller on July 25, 2002, eight days after Mr. Beatty became CFO. July 25 was in the third quarter of 2002. The fourth quarter of 2002 (October 1-December 31) figured quite prominently in the evidence in this case.

[159] At an earlier point in his career, Mr. Gollogly had been Nortel’s Assistant Controller (the late 1990s). He moved from Assistant Controller to senior executive positions with Nortel in France, Asia and England and then returned to the Brampton head office in July 2002 as Controller.

[160] Quite significantly, immediately upon assuming his position, Mr. Gollogly made a better understanding of Nortel’s Balance Sheet a priority for him and his staff.

[161] Exhibit 42 TT demonstrates that, in January 2003, Mr. Gollogly began Balance Sheet Reviews for all units and statutory entities within Nortel.

[162] Mr. Richmond was of the view that Mr. Gollogly was technically competent as far as his accounting skills were concerned. Mr. Harrison and Ms. Verity both indicated that Mr. Gollogly was knowledgeable concerning accounting principles.

[163] In addition, Mr. Gollogly prepared draft letters and made presentations to the Audit Committee of Nortel staff which demonstrated that he was quite knowledgeable concerning accounting principles of interest in this proceeding.

[164] I accept Mr. Richmond’s, and Ms. Verity’s assessment of Mr. Gollogly’s accounting ability.

Mr. Dunn, Mr. Beatty and Mr. Gollogly

[165] The three defendants were, from Q3 02 (the 3rd quarter of 2002), the three senior managers of the Corporation.

[166] I am satisfied that all three of the defendants were knowledgeable and experienced accountants who had the principal responsibility for Nortel’s financial statements and records.

[167] I am satisfied that they were, by reason of their training, their access to forecasts and their long association with Nortel, interested in and well-acquainted with all aspects of Nortel’s financial affairs.

[168] I am satisfied that all three accused were aware of financial information which materially affected Nortel’s financial results.

Nortel was a complex corporate organization

[169] Nortel, itself, is part of the fabric in context of this case. Because we are dealing with the consolidated financial statements, there is a tendency to think of Nortel as a single entity. This is not precise.

[170] Mr. Richmond testified that Nortel operated in at least sixty countries in the world. He stated that the organizational chart included dozens of separate entities operating in geographies all over the world. He pointed out that, every time you had a subsidiary Nortel Corporation, generally speaking, you had to conduct an audit.

[171] Mr. Richmond described Nortel as a large, complex organization with a large and complex audit-processing team. He estimated that there were hundreds of people involved in Nortel auditing.

[172] This fact is important because it means that the financial information which the Regions were forwarding to corporate headquarters each quarter was financial information which had been produced by entities which, themselves, had been audited.

[173] Mr. Donald Hathway was Deloitte’s Lead Audit Partner on the Nortel audit commencing in the spring of 2003. He was the DeLoitte person in charge of the conduct of the actual audit. Mr. Hathway stated that Nortel had a matrix organization. He said that responsibility for particular General Ledger accounts was divided between geographic entities and line of business entities. He said that responsibility for particular accounts was not always clear because of the complicated nature of the organization. Mr. Hathway testified that there were financial decisions made at the business level which were not controlled by Regional Controllers and for which Regional Controllers would have no responsibility.

[174] Mr. James Kinney testified. Mr. Kinney is a Certified Management Accountant. He started at Nortel in 1980 and continued there until 2004. From August 2002, he was the Vice-President Finance for the Wireless Business Group. Mr. Kinney indicated that, from a business perspective, Nortel was divided by both Business Lines and Regions. Mr. Kinney also indicated that the Business Lines, in turn, were divided by technologies and products. The products were also divided by Regions. Each Line of Business had a President; each Region had a President. Each Line of Business had Vice-President Finance and each Region had Vice-President Finance.

[175] Mr. Kinney testified that the Regions were also responsible for the contractual liabilities that went with the customer. Contractual liabilities were 40% of Nortel’s total liabilities. Contracts would be understood by the responsible person in the Regional organization and would have been set-up through the Regional organization. Knowledge about the documentation of the contract and knowledge concerning the customer resided with individuals within the Regional organization.

[176] Finally, it was Mr. Kinney’s view that ownership of the balance sheet resided in many sections of Nortel but, primarily, in the Regions. This aspect of Mr. Kinney’s evidence was not contentious and I accept it.

[177] I am satisfied that Nortel’s business organization worldwide was composed of dozens of separate corporations operating in geographies everywhere and that it was internally a complex entity.

The Financial Results of Nortel Networks Corporation

[178] Because the essence of these charges is that the defendants deliberately misrepresented the financial results of Nortel Networks Corporation, it is necessary to make some comments about Nortel’s financial results and Nortel’s decisions to re-state some of those results.

[179] Nortel’s fiscal year ended on December 31. Nortel reported its financial results in accordance with US GAAP and Canadian Generally Accepted Accounting Principles (“Canadian GAAP”). The primary financial statements were prepared in accordance with US GAAP.

[180] Mr. Robert Chambers, the Crown’s expert on accounting matters, stated that US GAAP is the common set of United States accounting principles, standards and procedures that companies use to compile their financial statements. It is a combination of standards set by the Financial Accounting Standards Board Statements of Financial Accounting Standards, the Accounting Principles Board Opinions and Accounting Research Bulletins, the American Institute of Certified Public Accountants Statement of Position, the Financial Accounting Standards Board Emerging Issue Task Force, SEC Staff Accounting Bulletins, as well as other rules of the SEC.

[181] Mr. Chambers indicated that there were thousands of standards set by these various standards-setting agencies.

[182] The evidence in the trial concerned compliance with US GAAP; compliance with Canadian GAAP was not an issue.

Nortel’s Consolidation Close Process

[183] Nortel had an accelerated closing process, which meant that financial results had to be reported publicly within less than four weeks. It is the General Ledger which is being closed. Nortel reported quarterly so the closing process occurred quarterly. Nortel reported annual results so the General Ledger was closed annually.

[184] Ms. Helen Verity, the Director of Consolidations, indicated that the Consolidation Close meant that Nortel consolidated its results.

[185] Ms. Verity indicated that there were stages of consolidation. Each business unit closed its General Ledger. Ms. Verity referred to the Regional General Ledger as a sub-ledger. Sometimes, the sub-ledger was referred to as Advance 2. Each business unit may have had more than one entity for which it was responsible so each business unit had to consolidate those entries before it could close its sub-ledger. Mr. Morita testified that the sub-ledgers (Advance 2) had to close within three to five days of the end of the fiscal quarter.

[186] Backup for sub-ledger entries remained in the Regions. The Regions had their own management sign-off and they had their own auditors. The same was true for entries coming from Corporate Services.

[187] After Day 4, late entries that were not material would not be considered. Despite this rule, if one of Ms. Verity’s counterparts from the Regions called and wanted to book a late entry, there would be a discussion about the entry. If the entry was a re-classification between the business units, she would refuse to book the entry. If an entry was significant, Ms. Verity would tell Ms. Mezon, who approved late entries, to expect it.

[188] Mr. Dans testified that an Outlook was prepared every time a consolidation took place and Mr. Dans pointed out that consolidations took place every day and sometimes more than once a day during the first days of a close as results came into corporate headquarters in Brampton Ontario. The Outlook prepared by Mr. Dans during the closing of the books was a snapshot of Nortel’s financial results at that moment. The word “Outlook” denoted more than one document. One type of Outlook was a forecast. Forecasts were prepared throughout the quarter.

[189] After the sub-ledgers were closed, draft financial statements were produced according to the number of adjustments and entries which occurred. Mr. Dans indicated that the draft financial statements were available to the Controller and the CFO upon request.

[190] The corporate headquarters General Ledger was referred to as Advance 1. When the last entry was made into that General Ledger, numbers were final.

[191] Ms. Verity testified that management wanted to have a line of sight to the results earlier than waiting for the consolidated results and so, on Day 4 of the close, a draft of the results would be run. It is important to remember that the close process contemplates repeated drafts being produced after the sub-ledgers had been closed. Draft results can change due to entries from corporate headquarters. Mr. McMillan, Nortel’s Director of Consolidations, indicated that, by Day Four or Day Five of the close process, corporate in Brampton would get their first complete view of the regional financial information. At this point, according to Mr. McMillan, they did not have a complete view from a corporate perspective.

[192] The evidence established that there were up to twenty draft financial statements produced over the close. Each draft statement was numbered.

[193] Results can change due to entries to the General Ledger from corporate headquarters or late entries from the Regions. Corporate headquarters was not subject to the same deadlines as the Regions.

[194] There were two headquarters units which submitted entries to the General Ledger. These units were called Corporate and Non-op. Corporate was a consolidation of the various corporate functions such as real estate, human resources etc.; Non-op was a catchall – a collection of everything that was left over.

[195] Releases of accrued liability balances to the profit and loss statement from Corporate and Non-op could be entered in the General Ledger after the Regions had closed their sub-ledgers.

[196] The Assistant Corporate Controller, Linda Mezon, advised whether an entry from the Regions was appropriate for the General Ledger. Ms. Mezon would advise Helen Verity that an entry was appropriate and Ms. Verity would sign the entry so that it could be recorded in the General Ledger.

[197] Ms. Verity testified that she was responsible for managing the time-lines associated with the close process. Ms. Verity testified that there was a well-established close schedule. It was distributed by e-mail prior to the close and one of her responsibilities was to hold people accountable to that schedule. It was her responsibility to work with Nortel people to resolve timing issues.

[198] Ms. Verity was responsible for resolving posting issues that arose during the close process; she reviewed profit and loss statements and balance sheets; she prepared binders and provided information to the Investor Relations Group within Nortel.

[199] Ms. Verity indicated that an entry was significant if it was significant to the profit and loss statement or the balance sheet. An entry was significant if it was not a “net to zero” or a re-classification entry. This distinction was made because dealing with such items would slow down the close process. At the same time, management cared about trying to get things right and so the compromise was that after Day 4 of the close, entries that changed the consolidated results for external reporting purposes or changed the profit and loss statement would be processed. Ms. Mezon said even small items which met those criteria could be processed.

[200] Ms. Verity indicated that Fringe was the last entry of the close because, if you made another entry to the General Ledger, it might affect the Fringe. Typically, when all entries had been finalized, the business units released any Fringe accrued liabilities to the profit and loss statement.

[201] The binders for which Ms. Verity was responsible contained a consolidation package which was an XL-based profit and loss statement and balance sheet.

[202] The consolidation package was available to everyone at head office in her group; it was available to the auditors and it was available to Linda Mezon, the Assistant Corporate Controller.

[203] There was a Frank Dunn binder which was prepared for the purpose of giving Mr. Dunn a summary of the close. Douglas Beatty and Michael Gollogly and the Assistant Controller and several others received copies of this binder.

[204] Mr. McMillan indicated that the executive package binder included financial statements prepared by Corporate Consolidations and detailed schedules.

[205] The external auditors, according to Ms. Verity, had access to all of the close process material, including the Frank Dunn binder. Mr. Dans indicated that Deloitte & Touche had special access to and a special binder for late entries. The Late Journal Entry Binder contained a copy of the late entries and a copy of the backup for those entries. Deloitte and Touche received regular profit and loss statement updates during the close process.

[206] Ms. Verity indicated that there were regularly-scheduled update meetings during the close; there was also a Controller’s meeting and a CFO meeting. At the Controller’s meeting, there would be a discussion of entries outside the close process which remained outstanding. At the CFO meeting, the results were discussed with the CFO.

Excess accrued liabilities & Nortel’s policy of Conservatism

[207] Nortel had a long-standing corporate policy concerning estimates of liabilities. Nortel Corporate Policy 300.33 provided that any anticipated decline in the value of Nortel assets and any anticipated liabilities must be provided for in accordance with the accounting concept of Conservatism.

[208] On February 27, 2003, following a review of Nortel’s accounting policies including Corporate Policy 300.33, Deloitte & Touche reported to the Audit Committee that they considered Policy 300.33 to be an appropriate accounting policy.

[209] Mr. Chambers discussed Conservatism.

[210] The accounting concept of Conservatism is a characteristic of financial accounting. It is referenced in paragraph 17 of Accounting Principles Board Statement No. 4, as follows: “Conservatism. Frequently assets and liabilities are measured in the context of significant uncertainties historically; managers, investors, and accountants have generally preferred that possible errors in measurement be in the direction of understatement rather than overstatement of net income and net assets. This has led to the convention of Conservatism…”

[211] It is also referenced in paragraph 35 of Accounting Principles Board Statement No. 4, as follows: “Conservatism. The uncertainties that surround the preparation of financial statements are reflected in a general tendency toward early recognition of unfavorable events and minimization of the amount of net assets and net income”.

[212] As indicated earlier, the Financial Accounting Standards Board issued Financial Accounting Standard 5 ( FAS 5), which provides that where there is a range of accrued liabilities and no estimate within the range is better than any other, the lowest estimate in the range must be used. Significantly, paragraph 84 of provides that FAS 5 is not inconsistent with the accounting concept of Conservatism.

[213] Mr. Richmond testified that Nortel had, for twenty years prior to the events described in the indictment, a Conservative accounting culture within the context of the rules.

[214] Mr. Richmond stated that because of the precipitous descent that Nortel went through, those in the field took it upon themselves to identify as many risks as they could and to put an estimate of those risks at the conservative end of the range.

[215] Mr. Richmond elaborated that, when an organization is experiencing the “free fall” that Nortel was experiencing, a customer that one day might appear sound may very well be in financial peril the next day. As a result, Mr. Richmond stated that it was his experience at Nortel that, in preparing Nortel’s financial statements, there was an overarching desire by the directors and the executive management team to ensure that they did the best job possible to prepare the financial statements to adequately account for risks.

[216] Mr. Richmond testified that Nortel was operating in an atmosphere of doubt about the value of its assets and the operative principle was “if in doubt provide for it”.

[217] It struck Mr. Richmond as reasonable and unsurprising that Nortel employees and Deloitte professional staff defaulted to a position that was at the conservative end of the range when recording an accrued expense and liability estimating a particular risk. Mr. Richmond testified that this was something he personally embraced and that it was appropriate in Nortel’s set of circumstances “to provide at the reasonably hard end of that conservative range”. He also testified that the identification of the range involved considerable judgment.

[218] More generally, Mr. Richmond said that the essential concern was whether Nortel would stabilize before it hit the ground.

[219] Mr. Richmond indicated that the critical issue, during the time period described in the indictment, was “making sure that you have the cash to operate the enterprise”. Mr. Richmond indicated that cash was a critical issue in terms of everything Nortel did. I infer from this that Nortel’s cash position was material to its financial results.

[220] There was no suggestion in the evidence that Nortel’s financial results misrepresented its cash reserves, its cash flow generally or its cash flow in its various business units.

[221] Mr. Richmond stated that the data, upon which risk management decisions were made, changed very rapidly and, therefore, management’s estimates quantifying risk went up and down.

[222] Mr. Richmond indicated that the Audit Committee’s preference was for Nortel to be at the conservative end of the acceptable range of risk. He described making sure that adequate provisions had been taken against the risk that assets had lost their value as an overarching paramount focus of Deloitte and Nortel in 2001 and 2002. According to Mr. Richmond, management and Deloitte’s were both told by the Audit Committee concerning the corporation’s exposure to risks to “make sure there are no surprises”.

[223] Mr. Wilson, the Chair of the Board of Nortel, gave similar evidence. He referred specifically to a briefing the Board received in January 2003 concerning an accrued expense/liability of $50 million taken in respect of a claim by a company known as 360 Networks. Mr. Wilson did not recall the details of the briefing concerning the taking of the provision, but he recalled that Mr. Cleghorn, the Chair of the Audit Committee during the time period of the indictment, asked at the Board meeting if $50 million was sufficient because the claim against Nortel was for $100 million.

[224] Similar evidence was provided by Mr. Cleghorn. Prior to serving as Chair of the Nortel Audit Committee, Mr. Cleghorn was the Chairman and CEO and a Director of the Royal Bank of Canada. He was also Chairman of the Board of the Canadian Pacific Railway until 2012. He, like Mr. Richmond, is a Fellow of the Institute of Chartered Accountants of Ontario.

[225] I accept Mr. Cleghorn’s evidence without qualification.

[226] Mr. Cleghorn described participating at the Audit Committee meeting in 2001 where Nortel management advised that it was necessary to write off $19 billion. Mr. Cleghorn testified that his first thought when he heard this was “did they get it all?” Mr. Cleghorn testified that, during the period described in the indictment, the auditors were regularly asked if they were satisfied with management’s estimates of liabilities.

[227] Mr. Gollogly expressed a somewhat similar view in an e-mail, dated October 13, 2003. In this e-mail, Mr. Gollogly proposed a draft for the Note to the Financial Statements explaining why it was necessary for Nortel to re-state earlier financial statements. While Mr. Gollogly’s proposed draft was not used, I note that he attributed the overstatement of accruals and the failure to draw down accruals in the correct fiscal period to “the high level of Conservatism used to identify Nortel Networks financial exposure during our period of realignment and our significant workforce reductions…”

[228] A more extreme view was articulated by Mr. Michael McMillan in his evidence. Mr. McMillan joined Nortel in 1997. Mr. McMillan had an M.B.A. from the University of Manitoba. During the timeframe of the indictment Mr. McMillan was Nortel’s Director of Consolidations. It was Mr. McMillan’s evidence that accrued liabilities were booked on a worst-case scenario basis rather than a best estimate basis. Mr. Peter Dans, to whom reference will be made later, testified that he was aware of accruals being booked on a conservative basis “which may have been the worst-case scenario sometimes”.

[229] During the time period described in the indictment, Nortel lost billions. I do not find it unusual that sensible people confronted with that reality would think that the worst-case scenario was the best estimate of the risks to Nortel’s assets. I also do not find it unusual that sensible people confronted with Nortel’s reality would be slow to decrease accrued liabilities already on the balance sheet.

[230] I am satisfied that throughout the time period described in the indictment accrued liabilities at Nortel were estimated at the high-end of the range of estimates and sometimes on a worst-case scenario basis. According to the evidence a risk can be provided for on a worst-case scenario basis provided that it is the judgment of the person estimating the risk that the worst-case scenario is the best estimate of that risk.

[231] One of the risks created by Nortel’s situation was that excess accrued liability balances would find their way onto Nortel’s balance sheet. This reality created a possibility of using accrued liability balances to meet financial targets. Exhibit 5, tab 242 provides an example of how ingrained this problem was by 2004. This document is an e-mail string. Mr. Glenn Morita, one of the authors of some of the e-mails in the string, in an e-mail, dated January 8, 2004, wrote: “sounds like you Aussies are like squirrels (not sure if you have them Down Under) secretly storing your nuts for a rainy day”. Mr. Morita testified that he was frustrated when he sent the e-mail because his Australian counterpart was covering an expense with the release of an accrued liability balance. Mr. Morita said he was frustrated because Nortel had just gone through a Comprehensive Balance Sheet Review and his Region, which included Australia, thought that it had cleaned up the problem, but it turned out that they had not. There are other references in emails to digging up “opportunities” and having “flexibility”.

[232] Nortel’s Conservatism concerning the recording of accrued liabilities and expenses was likely in effect for twenty years. It was ingrained in Nortel’s culture.

[233] This policy of Conservatism was memorialized in Nortel Corporate Policy number 300.33. This policy had been reviewed by Deloitte in 2003 and found to be an appropriate corporate accounting policy. This policy, which had become a Nortel cultural norm, resulted in the excess accrued liability balances found on Nortel’s consolidated balance sheet during the Comprehensive Balance Sheet Review in 2003.

The accused knew there were excess liabilities on the balance sheet

[234] I am satisfied beyond a reasonable doubt that all three accused, by virtue of their long experience with Nortel and their positions of responsibility, well-understood how the men and women in the field were implementing Nortel’s policy of Conservatism.

[235] I am satisfied, based on the evidence adduced at this trial, that none of the accused initiated this policy.

[236] I am satisfied beyond a reasonable doubt that they knew that the policy of Conservatism had created excess accrued liabilities and, therefore, they knew that these excess liabilities could be released to assist in meeting financial targets.

[237] I also find that the enormous losses suffered by Nortel in these years created a situation in which senior management, Nortel’s Board of directors and Nortel’s auditors were quite reasonably concentrating on doing all things necessary to make sure that Nortel had sufficient cash reserves to survive and continue in business. I am satisfied that non cash impacting excess accrued liabilities on the balance sheet were not a priority.

[238] I am satisfied, on the evidence, that Mr. Gollogly, virtually from the time he took over as Corporate Controller, turned his attention to Nortel’s balance sheet. I am also satisfied, on the evidence, that neither Mr. Dunn nor Mr. Beatty, his immediate superiors, did anything to impede his efforts.

Unsupported and excessive accrued liabilities on the balance sheet

[239] The evidence persuades me that accruals were present on Nortel’s consolidated balance sheet which could not be supported by documentation. However, I decline to draw the inference that these accruals never existed. It seems more logical to me that the downsizing of Nortel, which involved the closing of offices, the selling of real estate and, undoubtedly, the storage of documents, created a situation in which supporting documentation for some of Nortel’s accrued liability balances could not be located. Further, the loss of employees (two out of every three worldwide) created a situation in which the institutional memory concerning the unsupported accruals no longer existed within the company. I am satisfied that these were the reasons why unsupported accrued liabilities were present on Nortel’s consolidated balance sheet.

[240] Also, the evidence does establish and, I so find, that excessive accrued liabilities existed because accrued liabilities were not released when they should have been and because accrued liabilities were not adjusted when they should have been.

[241] Mr. Dunn and Mr. Beatty took part in the analyst calls which generated a 2002 Accrued Liability Report by Ms. Susan Shaw. Ms. Shaw, a chartered accountant in Nortel’s Corporate Consolidations Group, reported to Mr. Gollogly. Ms. Shaw advised both Mr. Gollogly and Mr. Harrison that there were unsupported liabilities on Nortel’s balance sheet.

[242] I am satisfied that all three accused knew that there were unsupported and excessive accrued liabilities on Nortel’s balance sheet.

Nortel’s Pro Forma earnings calculations

[243] The evidence disclosed that securities regulators encouraged Nortel and other publicly- listed companies to refrain from reporting non-GAAP measures commencing Q1 2003 (Q1 03). Prior to Q1 2003, Nortel had reported “pro forma” financial results.

[244] As a result of this regulatory change in attitude, as of fiscal 2003, pro forma earnings calculations at Nortel became an internal measure only. This meant that, commencing in Q1 03, Nortel no longer published pro forma financial results.

[245] Pro forma financial results were calculated using a formula generated internally at Nortel. This formula changed from year-to-year. The 2002 pro forma formula was not the same as the formula used in 2003.

[246] Despite this change, certain Nortel bonus plans, which are important for our purposes, continued to be triggered by Nortel’s 2002 formula for calculating pro forma earnings.

[247] The pro forma calculation of earnings differed from the calculation of earnings according to US GAAP. The pro forma formula for calculating earnings excluded items, including significant cost items, which were included in US GAAP earnings calculations. The items excluded were non-operational in nature. For example, pro forma earnings calculations excluded gains from buying back bonds. According to Mr. Harrison, the items included in pro forma earnings calculations were, themselves, calculated in accordance with US GAAP. Mr. Harrison’s evidence in this regard was not questioned and I accept this aspect of his evidence.

[248] For the sake of completeness, the method of calculating pro forma earnings that was used in 2002 excluded charges which were included in the 2003 method of calculating pro forma earnings. In other words, the 2002 formula resulted in higher pro forma earnings.

[249] The difference between pro forma earnings calculations and US GAAP earnings calculations was also referenced in a glossary of terms filed in this proceeding which contained a definition of “pro forma”. The definition provided, in part, that pro forma financial statements consisted of information which Nortel management believed was meaningful to investors.

[250] Nortel published Q4 02 pro forma financial results in its January 24, 2003 press release announcing financial results for Q4 02. Nortel did not publish pro forma financial statements for Q4 02.

[251] In 2003, Nortel did not publish pro forma earnings calculations at all.

Pro Forma earnings and Bonus Thresholds

[252] Mr. Cleghorn testified that, in the summer of 2002, Nortel employees were being approached by the competition. By this time, many employees at Nortel had been laid off or fired, sales were declining and the auditors considered Nortel to be a high-risk audit. Employees with stock options found that the options were worthless. In an effort to prevent valuable employees from leaving the company, Mr. Cleghorn testified that the Board adopted a Return to Profitability Bonus Plan.

[253] The Return to Profitability Bonus Plan was announced in November 2002. It provided eligible employees with a special bonus if Nortel achieved profitability for any quarter in the period from Q4 2002 through to and including Q4 2003.

[254] Profitability for the purpose of this bonus plan was based on pro forma earnings from continuing operations; it also included an accrual for the cost of the bonus in such period. In other words, there had to be sufficient pro forma earnings before taxes from operations to pay for the bonus. Senior executives would be paid in three tranches.

[255] Pro forma earnings (loss) before taxes was an internal Nortel calculation and metric. This meant that Nortel could change the calculation and this happened in 2003. The Board of Directors, however, in a minute from the 2:50 p.m. Board meeting of April 24, 2003, decided that, for greater certainty concerning the bonus calculations, Nortel’s 2002 formula for calculating pro forma earnings before taxes would continue to be used for the purpose of calculating whether the Return to Profitability Bonus and the Restricted Stock Unit Bonus were earned. This is significant because it meant that, although Nortel changed the way in which it calculated pro forma earnings in 2003, this change did not affect the pro forma calculation of earnings for the purpose of determining whether Restricted Stock Unit and Return to Profitability Bonus targets had been met.

[256] Entitlement to bonuses is an issue in this trial. The bonus payment issue was not made simpler by the fact that Mr. Dans, who did the bonus calculations, erroneously used Nortel’s 2003 pro forma income formula in some of his calculations. Mr. Dans agreed that profitability was more easily achieved under the 2002 formula than the 2003 formula.

Nortel’s Re-statement of previously-published financial statements

[257] The evidence established that Nortel, on two occasions, restated financial statements which it had previously published.

[258] Neither restatement affected Nortel’s cash position. Nortel’s cash position was critical to its survival.

[259] Mr. Chambers, the Crown’s expert, explained in his report when a restatement of previously-published financial information is necessary. Mr. Chambers indicated that, if a misstatement has occurred in a publicly-traded corporation’s published financial results, a restatement of the prior year’s financial statements is required if the misstatement is material in the prior year or if a correction in the current year, i.e., when the misstatement is discovered, materially overstates or understates earnings in the current year.

[260] Mr. Chambers also offered expert evidence on the reasons why financial statements are restated. Mr. Chambers stated in his report that Restatements occur because the earlier financial statements contain errors:

• due to the misapplication of US GAAP;

• mathematical mistakes;

• incorrect facts;

• fraud due to the manipulation of accounting records, misrepresentation, or the intentional misapplication of US GAAP;

• changes in accounting principles; and,

• stock splits.

[261] Mr. Chambers stated that the majority of Restatements are attributable to internal company errors.

[262] Mr. Hathway, the lead auditor for Deloitte on the Nortel file in 2003, explained when it is necessary to restate prior published financial results so that accrued liability balances can be re-profiled to the appropriate financial periods when they should have been released to the profit and loss statement.

[263] Mr. Hathway testified that, where there is an error in the financial statements due to an overstatement of accrued liabilities, there are two choices:

• if the overstatement of an accrued liability balance is not material to either the balance sheet or the profit and loss statement in the current quarter or the quarter in which it should have been released, then it can be, with the appropriate disclosure, released to the profit and loss statement in the quarter in which the error is discovered; and,

• if the overstatement is material to the results in the quarter in which the error is discovered or to the results in the quarter in which it should have been released to the profit and loss statement, then there must be a Restatement of the earlier financial statements to push the excess accrued liability balance back to the period when it should have been released.

[264] Mr. Richmond testified that Restatements in both Canada and the United States are infrequent. He said that for an organization to restate a previously-published financial result is not something that is well-embraced by the organization. Mr. Richmond’s evidence is consistent with evidence heard in the trial to the effect that Mr. Beatty told Mr. Cleghorn that a restatement was never a good idea.

The First restatement

A short chronology

[265] Nortel’s first decision to restate financial statements for 2000, 2001, 2002, Q1 2003 and Q2 2003 was announced on October 23, 2003.

[266] This restatement essentially restated excessive accrued balances on Nortel’s balance sheet back to the quarters when they should have been released to the profit and loss statement.

[267] The restated financial statements resulting from the first Restatement were released to the public on December 23, 2003 approximately two months after the announcement of the first Restatement.

Who was Responsible

[268] Ms. Sledge, indicated that she personally dealt with both Douglas Beatty and Michael Gollogly in connection with the first Restatement and that, from her perspective, both Douglas Beatty and Michael Gollogly were in charge of the first Restatement. Ms. Sledge’s evidence in this regard is consistent with the positions held by Douglas Beatty and Michael Gollogly during the first Restatement; namely CFO and Controller. I accept this portion of Ms. Sledge’s evidence; although I am satisfied Ms. Sledge, a certified public accountant and Nortel’s Assistant Corporate Controller from 2003-2005, also had a major role in the first restatement.

Nortel Restatements are complex

[269] Mr. Michael McMillan testified that, due to the significant number of corporate entities involved worldwide, the restatement process was complex. I accept Mr. McMillan’s evidence that the restatement process for Nortel was a complex one.

How the Restatements came about

[270] Mr. Richmond described the situation at Nortel when consideration was being given for the first time to restating financial statements from earlier periods. The immediate cause of this discussion was the release to the profit and loss statement in Q2 03 (the second quarter of 2003) of approximately $142 million in accrued liabilities which could no longer be supported. The release of this $142 million would have had a positive effect on earnings. These balances had been released during preparation of one of the preliminary drafts of Nortel’s Q2 03 financial statements during the Q2 03 close process described earlier.

[271] Mr. Gollogly made Mr. Hathaway, Deloitte’s lead Nortel audit partner, specifically aware of the $142 million and asked Mr. Hathway for Deloitte’s view. Mr. Hathway objected to the release of these balances, with the result that the release of these balances was reversed in the next preliminary draft of the financial statements and the $142 million in accrued liability balances was returned to Nortel’s balance sheet where they always been.

[272] No profit and loss statement containing the $142 million was ever published.

[273] It was Mr. Richmond’s evidence that Mr. Dunn maintained that the $142 million was the total number of unsupported liabilities on Nortel’s consolidated balance sheet. It was Mr. Dunn’s view that the $142 million should remain released to the profit and loss statement of Q2 03 and that there should be appropriate disclosure of this fact in the press release publishing Nortel’s Q2 03 financial results. Mr. Dunn maintained that his view should be respected because not only was he the CEO, but he had been, prior to that, Nortel’s CFO and Corporate Controller.

[274] This is perhaps an appropriate time to observe the obvious. Mr. Dunn was spectacularly wrong; the first restatement identified in excess of $900 million of accrued liabilities that could no longer remain on Nortel’s consolidated balance sheet.

[275] Mr. Richmond indicated that Mr. Dunn also resisted the idea of a comprehensive balance sheet review due to the workload demands it would place on a group of busy people. This observation attributed to Mr. Dunn seems reasonable to me because, by this time in 2003, Nortel’s employees had been reduced by two-thirds.

[276] Mr. Richmond indicated that, if Mr. Dunn had been correct, the restatement might have been a simple as booking the $142 million back into 2002 because, in 2002, Nortel suffered total losses of $3.7 billion. Thus, the effect of restating the $142 million into 2002 would only have been to reduce that loss to $3.5 billion approximately, which would have been an immaterial change to Nortel’s financial statements for 2002.

[277] Mr. Richmond indicated that it was Deloitte’s position that Nortel had to comprehensively review its balance sheet so that the true extent of the accrued liability problem would be known and that, only when that had occurred, could consideration be given to the correct accounting treatment of the $142 million in unsupported accrued liability balances that everyone already knew was on Nortel’s consolidated balance sheet.

[278] Mr. Richmond indicated that it was Deloitte’s view that it was appropriate to “park” the $142 million on the balance sheet until the comprehensive review of the balance sheet was completed. It was Mr. Richmond’s view and Deloitte’s view that leaving the $142 million on Nortel’s balance sheet did not misrepresent Nortel’s financial results. Mr. Richmond explained that Nortel had more than $5 billion in liabilities on its balance sheet in Q2 03 and that, in Deloitte’s view, the $142 million was not material to that total. Mr. Chambers, the Crown’s expert, offered no opinion to the contrary.

[279] I accept Mr. Richmond’s evidence in this regard and I agree with his conclusion.

[280] Mr. Richmond further explained that Nortel’s profit and loss statement for Q2 03 revealed that it was, at long last, at break-even and that, therefore, the release of the $142 million to the profit and loss statement in Q2 03 would have been material to that statement and, therefore, could not be permitted.

[281] I agree with this conclusion as well.

[282] Finally, Mr. Richmond pointed out that Deloitte’s was not satisfied that the $142 million represented the entire extent of the problem.

[283] Mr. Richmond indicated that this discussion between Deloitte and Mr. Dunn went on for a period of time.

[284] Nortel’s second-quarter concluded on June 30, 2003. Mr. Richmond indicated that, sometime in the first two weeks of July 2003, he had a meeting with Mr. Dunn which resolved the matter as follows:

• The $142 million in accrued liabilities, released to the profit and loss statement in Q2 03 and returned to Nortel’s balance sheet after Deloitte’s objected, would remain on Nortel’s balance sheet;

• Nortel would comprehensively review its balance sheet;

• The fact that a comprehensive balance sheet review was taking place would be disclosed in Nortel’s public financial filings for Q2 03. Mr. Richmond did not suggest that this aspect of the discussion was contentious.

The Comprehensive Balance Sheet Review

[285] Ms. Karen Sledge testified that she participated in the Comprehensive Balance Sheet Review which began at the end of July 2003. During this process, she was part of the team reviewing all of the different accounts from the different regions and business units. She said, as the balance sheet review proceeded, it became clear that that there was more and more on the balance sheet that needed to be corrected. She said that the numbers were increasing every time they looked at the accounts.

[286] It was Ms. Sledge’s evidence that, at some point during the Balance Sheet Review process, those involved realized that there would need to be a restatement of prior years’ financial results. Her evidence in this regard is also consistent with Mr. Richmond’s evidence that, as the Comprehensive Balance Sheet Review progressed, the quantum of excess accrued liabilities increased. Mr. Richmond indicated that, as a practical matter, the error with respect to accrued liabilities was so large that a Restatement was inevitable.

[287] I accept this aspect of Ms. Sledge’s evidence.

[288] Mr. McMillan testified that there was a timing sensitivity associated with the first Restatement. Specifically, he said that all of the people involved in the restatement wanted to make sure that it was completed within the normal reporting lines so that the appropriate filings with the SEC and the Ontario Securities Commission would not be delayed. Mr. McMillan said that the need to report in a timely manner made the first Restatement a demanding exercise.

[289] It was Mr. McMillan’s view that “at the end of it I felt that we had done a good job of it and we had managed it within the timeframe”. Mr. McMillan also indicated that he was quite surprised that it was necessary to restate Nortel’s earlier financial results a second time. I accept Mr. McMillan’s evidence concerning timeliness.

[290] Mr. Richmond also testified that there was pressure to complete the Comprehensive Balance Sheet Review in a timely manner. Mr. Richmond indicated that there was an agreement among the Board, senior management and Deloitte to complete the review “as rapidly as was humanly possible”.

[291] It was Mr. McMillan’s view that the Comprehensive Balance Sheet Review and first Restatement was driven by Karen Sledge and Michael Gollogly. He said that these were the two people to whom he regularly reported. McMillan’s evidence is not contentious and I accept it. Ms. Sledge work was obviously satisfactory; she remained in Nortel’s employ until 2010.

[292] Mr. Peter Dans testified that there was a “focus on getting the Restatement correct and there was, you know, high level of review that was going to be associated with that to try and ensure that the Restatement was done correctly”.

[293] Mr. Richmond said that it was his observation, as the balance sheet review progressed, that “there were some really tired folk, both at Nortel and our firm in terms of trying to make that happen”.

[294] Mr. Richmond indicated that the Comprehensive Balance Sheet Review exercise was so intense that, at one point, he spoke to the Chairman of the Audit Committee and suggested that Nortel should provide an opportunity for those Nortel and Deloitte employees and partners involved in the Comprehensive Balance Sheet Review to enjoy a long weekend.

[295] The time pressure was so intense that Mr. Gollogly wrote in his diary “get it done versus get it right” which was a play on the theme for the restatement which was “do it once and do it right”.

[296] Mr. Hathway recounted being present when Mr. Gollogly suggested to Mr. Dunn that the restatement might not be finished in time for Nortel’s next public filing; Mr. Hathway indicated that Mr. Dunn was adamant that a delay was unacceptable.

[297] Mr. Richmond indicated that, in his view, the Deloitte Nortel engagement team, led by Don Hathway and John Cawthorne, was as close to workaholics as he had ever seen; he said their behaviour was matched by the individuals working for Mr. Gollogly.

[298] Ms. Karen Sledge testified that she remembered one evening where she, Mr. Hathway and Mr. Gollogly were up the entire night resolving balance sheet review issues affecting Nortel’s operations in Asia.

[299] Mr. Hathway was interviewed by the R.C.M.P. in connection with this matter on November 14, 2005. By this time, he was well-aware of the results of the Wilmer Cutler Pickering independent inquiry on behalf of the Audit Committee concerning the causes of the need to restate Nortel’s previously-published financial statements. By this time, Mr. Dunn, Mr. Beatty and Mr. Gollogly had been accused of wrongdoing in that report and, as a result, fired for cause.

[300] During the course of that interview, Mr. Hathway was asked by Sgt. Bone if he felt a conscientious effort had been made during the first balance sheet review. Mr. Hathway said he thought the Nortel side had done a conscientious job. When asked why he thought that, he said “the extent of the work they did, the amount of documentation they tried to go back and find, they did, seemed to me they made a real effort to get behind these items and find out what the real story was, when we asked questions about it, if we were not satisfied with what they gave us initially we would tell them to follow up and it seemed to me they were making a real concerted effort to get you know to respond to our questions and to get the answers…”

[301] Mr. Hathway confirmed that his answers in the R.C.M.P. interview reflected his thinking, not only at the time of the Comprehensive Balance Sheet Review, but also at the time of his RCMP interview in November 2005.

[302] During the course of the R.C.M.P. interview, Mr. Hathway recounted a conversation with Mr. Gollogly at the time when it became clear that there would be a restatement. Apparently, Mr. Gollogly asked Mr. Hathway if he, that is Mr. Gollogly, should resign. Mr. Gollogly thought he should resign because he was the Corporate Controller and should accept responsibility for the fact that the Audit Committee found it necessary to restate previously-published financial results. Mr. Hathway told Mr. Gollogly that he did not think he should resign. When asked during the R.C.M.P. interview why he gave Mr. Gollogly that advice, Mr. Hathway said, “my view was Mike was trying to get the numbers right…” Mr. Hathway was asked during his interview if his opinion had changed and he said, “I am not sure my opinion’s changed”.

Was the Comprehensive Balance Sheet Review Comprehensive?

[303] The Crown suggested all three accused misinformed the public by saying that the first restatement represented a comprehensive review engaged in for the purpose of correcting past accounting errors.

[304] The Crown maintains that the first restatement was not comprehensive. The Crown suggested that the scope of the first restatement was too narrow.

[305] The Crown suggested that, because Nortel and Deloitte staff worked so hard, the first restatement was under-resourced.

[306] The Crown submits that the first restatement understated the extent of the errors on the balance sheet and argues this is demonstrated by the fact that there was a second restatement.

[307] Mr. Wilson, whose evidence I accept, testified that the impact of the restatement of $900 million in accrued liability balances identified during the Comprehensive Balance Sheet Review was favorable to shareholders. The $900 million represented expenses on the balance sheet that did not have to be recognized. Shareholders’ equity was increased by $900 million.

[308] Mr. Wilson described the first restatement as a restatement of over-providing; amounts were brought back which added to the shareholders investment in the company.

[309] The Crown has never suggested that the $900 million in accrued liability balances ought not to have been restated.

[310] I accept the evidence of Mr. Richmond, Ms. Sledge, Mr. McMillan and others attesting to the effort that went into the first restatement. No witness testified or suggested that Mr. Beatty or Mr. Gollogly interfered with the first restatement. Mr. Hathway remained convinced, after the release of the Wilmer Cutler Pickering Review and after the investigation into this matter had begun, that “Mike was trying to get the numbers right”.

[311] I propose to separately consider why there was a second restatement and the inferences to be drawn from that restatement.

[312] I am satisfied the Comprehensive Balance Sheet Review was, in a word, comprehensive.

[313] I am not satisfied that the scope of the first Comprehensive Balance Sheet Review (a review of all accrued liability balances in excess of $100,000 and a review of all accrued liability balances released to the profit and loss statement equal to or in excess of $2 million) was too narrow in scope.

[314] It became apparent in the late summer that a restatement would likely be necessary. The scope of the Comprehensive Balance Sheet Review was approved by Nortel’s auditors and Nortel’s Audit Committee. Nortel’s Audit Committee and auditors knew that the decision to restate earlier published financial statements would attract regulatory interest. It was to satisfy regulators that Nortel’s Audit Committee hired Wilmer Cutler Pickering to conduct an independent review of the circumstances leading to the decision to restate. I am satisfied that, without the benefit of hindsight, Nortel’s auditors and Nortel’s Audit Committee thought that these parameters were reasonable.

[315] I am not satisfied that the first restatement was under-resourced. Deloitte was free to add staff as they saw fit. Mr. Richmond did not hesitate to recommend that Nortel staff and Deloitte staff be compelled to take a long weekend. I have no doubt he would have recommended that Nortel find additional staff for the Comprehensive Balance Sheet Review if it had come to his attention that the project, which he had insisted upon, was being compromised because it was under-resourced on the Nortel side. The Comprehensive Balance Sheet Review did, in fact, reveal that approximately $900 million in accrued liability balances needed to be restated.

[316] I am not satisfied that the original balance sheet review was too narrow in scope

[317] I am satisfied that there was intense pressure to complete the Comprehensive Balance Sheet Review as quickly as possible. I do not attribute this imperative to the accused alone. I accept the evidence of Mr. Richmond that there was an agreement among the Board, senior management and Deloitte that the Comprehensive Balance Sheet Review should be completed “as rapidly as was humanly possible”. I am satisfied that this imperative existed because Nortel wanted to put the balance sheet review and a restatement, if there was indeed going to be one, behind them as quickly as possible and because the accused and Nortel’s Audit Committee wanted to make their appropriate filings with the SEC and the Ontario Securities Commission within normal reporting lines.

[318] I am not satisfied, on the evidence, including the evidence specifically referred to, that the first restatement was not comprehensive because timelines were short.

[319] I am not persuaded that any or all of the three accused insisted upon an unreasonably short timeline in an effort to make certain that the first restatement failed to uncover the true extent of the accrued liability problem on Nortel’s balance sheet.

[320] I attach no importance to the fact that Mr. Beatty told Mr. Cleghorn, the chair of the Audit Committee, that he, that is Mr. Beatty, viewed a restatement as a last resort or that a restatement was a last resort. Mr. Beatty’s statement proves that his attitude toward a restatement was consistent with what Mr. Richmond described as the attitude of corporations generally.

[321] The restatement of these accrued liability balances had no cash impact on Nortel’s cash reserves. Maintaining sufficient cash reserves to keep Nortel functioning was the most pressing responsibility of Nortel senior management, Audit Committee and Board of Directors. In fact, neither the first restatement nor the second restatement had an effect on Nortel’s critically important cash reserves.

[322] Mr. Richmond testified that Nortel lost $3.5 billion in 2000, $27 billion in 2001 and $3.7 billion in 2002. It was his view that the $900 million in excess accrued liability balances was not material to Nortel’s financial statements in those years. Mr. Chambers did not offer a contrary opinion.

[323] Mr. Chambers did not offer any opinion concerning the comprehensive balance sheet review or the first restatement.

[324] I am not satisfied beyond a reasonable doubt that Nortel’s original financial statements for 2000, 2001, 2002, Q1 03 and Q2 03 were materially misstated. I am not satisfied that Nortel’s original financial statements for those fiscal years materially misrepresented Nortel’s financial results. I am not satisfied beyond a reasonable doubt that Nortel’s financial statements published after the first restatement materially misrepresented Nortel’s financial results.

[325] I am satisfied that Nortel’s original financial statements for the years 2000, 2001, 2002, Q1 03 and Q2 03 properly reflected Nortel’s financial reality.

The results of the second restatement

[326] The Crown relied upon the fact of and results from the second restatement as proof that the first restatement was not comprehensive.

[327] Mr. Richmond indicated that, when it became clear in October 1993 that there were $900 million in excess accrued liability balances to be restated, he suggested that the directors retain independent attorneys to review the circumstances which led to both the recording of excess accrued liability balances on Nortel’s consolidated balance sheet and the decision to restate previously-published financial statements for fiscal 2000, 2001, 2002, Q1 2003 and Q2 2003.

[328] The independent attorneys chosen were from the U.S. firm of Wilmer Cutler Pickering.

[329] The Summary of Findings and Recommended Measures resulting from the WCP Review (“WCP Summary”) was received in evidence for contextual purposes and not as proof of the facts or conclusions contained within it.

[330] The WCP Summary is contextual in the sense that it affected conduct which was the subject of evidence in these proceedings. For example, it precipitated the decision by the Board of Directors to restate for a second time. It also precipitated the decision by the Board of Directors to terminate all three defendants for cause. Finally, Mr. Hathway repeatedly asserted during his testimony that Deloitte’s attitude toward Nortel would have been different had Deloitte known about the matters disclosed in the WCP Summary.

[331] The WCP Summary recorded the conclusion that the defendants and other persons employed in the former finance management of Nortel carried out accounting practices relating to the recording and release of provisions that were not in compliance with US GAAP in at least Q3 2002 and Q4 2002 and Q1 2003 and Q2 2003.

[332] The WCP Summary concluded that the dollar value of the individual provisions recorded and released was relatively small and that the aggregate value of the provisions made the difference between a profit and a reported loss on a pro forma basis in Q4 2002 and the difference between a loss and a reported profit on a pro forma basis in Q1 2003 and Q2 2003.

[333] Nortel did not publish pro forma results in Q1 03 or Q2 03.

[334] The WCP Summary concluded that these practices were undertaken to meet internally imposed pro forma earnings targets.

[335] The WCP Summary concluded that the conduct in question caused Nortel to pay bonuses to all employees and senior management under bonus plans tied to pro forma profitability.

[336] The WCP Summary recorded that the work of Nortel’s external auditor, Deloitte & Touche LLP, was not examined, although several current and former audit partners were interviewed.

[337] With respect to the Q3 2003 and Q4 2003, the WCP Summary concluded that no evidence emerged to suggest an attempt to release provisions strategically in those quarters. However, given the significant volume of accrued liability balance releases in those quarters, it recommended a review of releases down to a low threshold.

[338] In addition, the WCP Summary recorded a series of recommendations intended to prevent a recurrence of the conduct uncovered by the WCP Review.

[339] I do not wish to imply that I disagree with the Wilmer Cutler Pickering conclusions. I have no opinion about their conclusions. Forming an opinion about their conclusions would confuse my task with theirs, fail to take into account differences in the evidence we considered and fail to take into account my standard of proof and whatever standard they used. Wilmer Cutler Pickering was answering a question: what were the facts and circumstances leading to the need to restate Nortel’s previously-published financial statements for the relevant periods (i.e., 2000, 2001, 2002, Q1 03 & Q2 03)? I am trying to determine beyond a reasonable doubt whether Nortel’s financial results were deliberately misrepresented during the time-frame of the indictment.

[340] Mr. Richmond stated that, on or about March 5, 2004, he found out that Wilmer Cutler Pickering intended to recommend that Nortel restate its prior financial results yet again. Mr. Richmond briefed the Chairman of the Board and the Chairman of the Audit Committee. Mr. Richmond’s briefing led to a March 10, 2004 Board meeting attended by representatives of the Wilmer Cutler Pickering firm and, following the Board meeting, a press release, dated March 10, 2004.

[341] The March 10, 2004 press release announced that Nortel Networks would delay filing its 2003 annual reports. The press release indicated that Nortel was re-examining the establishment, timing of, support for and release to income of certain accrued liabilities in prior periods. The press release indicated that Nortel suspected that it would have to revise both its previously announced consolidated results for the fiscal year ending December 31, 2003 and its consolidated results for one or more earlier quarterly periods.

[342] Mr. Richmond testified that, when Nortel publicly-stated that it was going from the first Restatement to a Second Restatement, the level of interest in its affairs was intense. He stated that everyone from the Ontario Securities Commission to the SEC was looking over the collective shoulder of Nortel and Deloitte. He said that there was a mandate to get the Second Restatement right in an environment where there was significant litigation going on in the marketplace. He described it as a “high-stakes game”.

[343] Mr. Hathway indicated that the parameters for the second restatement were chosen as a result of the findings of the Wilmer Cutler Pickering independent review. He testified that the Wilmer Cutler Pickering Review revealed information which suggested that aspects of the prior accounting were not correct and raised the potential of earnings management. It was Mr. Hathway’s view that these findings eroded confidence in senior management and resulted in a second restatement.

[344] Mr. Hathway accepted the Wilmer Cutler Pickering conclusions and, based on those conclusions, testified that the first restatement was not comprehensive. As indicated earlier, I do not accept Mr. Hathway’s conclusion.

[345] I am satisfied that, once the Audit Committee received the Wilmer Cutler Pickering Review, it was necessary in response to that information to restate for a second time.

[346] The evidence established that this second review of Nortel’s previously-published financial results considered issues related to revenue recognition, as well as the release of accrued liability balances. Thus, it not only dealt directly with Nortel’s consolidated balance sheets, but also directly with the revenue side of its consolidated profit and loss statements.

[347] The thresholds for the first and second restatement were not the same. The first restatement reviewed all accrued liability balances in excess of $100,000; the second restatement reviewed all accrued liability balances in excess of $10,000. The first restatement reviewed all releases of accrued liability balances to income in excess of $2 million; the second restatement reviewed all releases of accrued liability balances to income in excess of $100,000.

[348] The Second Restatement of Nortel’s previously-published financial results was released January 11, 2005.

[349] A press release, dated January 11, 2005, announced the restatement of Nortel’s consolidated financial results for the fiscal years ended December 31, 2001 and 2002. It also released a revision of Nortel’s previously-announced results for the 2003 fiscal year.

[350] The various press releases were admitted into evidence as business records. The press releases were also attached to Nortel’s filings with the SEC. SEC filings were received as business records.

[351] The January 11, 2005 press release announced that the restated financial results reflected substantial revenue adjustments. The adjustments in revenue, according to the press release, had to be made because there had been accounting errors in Nortel’s previously-released consolidated financial results related to revenue recognition. The press release announced that Wilmer Cutler Pickering would be conducting a further independent review of the circumstances that led to the erroneous recognition of revenue.

[352] The causes of the substantial revenue recognition adjustments reflected in the Second Restatement were not developed in the evidence offered in this case.

[353] This aspect of the January 11, 2005 press release is consistent with the evidence of Ms. Karen Sledge, whose evidence in this regard I accept, that the first Restatement focused primarily on the accrued liabilities on the balance sheet, while the Second Restatement had a much broader scope.

[354] The Crown’s expert, Mr. Chambers, indicated that, as a general rule, expenses are to be matched with revenues as long as it is reasonable to do so. Accordingly, the logical inference is that, if revenues are re-profiled or restated from one financial quarter to another, the expenses associated with earning those revenues will be similarly re-profiled or restated.

[355] The first restatement was published December 23, 2003; the second restatement was announced March 10, 2004. The reason for the proximity of these two announcements was disclosed in the evidence.

[356] Mr. Richmond recommended to the Board that it not file the restated financial statements until Wilmer Cutler Pickering had completed their independent review. Mr. Richmond testified that there was no legal or regulatory requirement to file the restated financial statements on or about December 23, 2003. It was Mr. Richmond’s view that, now that the first restatement was completed, the restated financial statements could be put to one side until Wilmer Cutler Pickering provided their advice, which was expected by mid-February 2004.

[357] The Board, for its own reasons, decided to publish the restated financial statements without waiting. Mr. Richmond conferred with the Wilmer Cutler Pickering firm, who advised that, at that point in December 2003, they knew of no reason why the restated financial statements could not be published. Accordingly, the statements were published.

[358] A short time later, Wilmer Cutler Pickering advised, among other things, that the accused had engaged in earnings management and that there should be a review of Nortel’s previously- published financial results.

[359] Neither the first or second restatement affected Nortel’s critically-important cash reserves. The Wilmer Cutler Pickering review did not suggest that Nortel’s cash reserves had been misrepresented in Nortel’s original financial statements or in the first restatement of those financial statements.

[360] The first restatement of previously published financial results differed from the 2nd restatement because the thresholds for the 2nd restatement were lower and because the 2nd restatement considered errors in revenue recognition as well as accrued liabilities.

Inferences concerning Nortel’s restated financial results for Q1 03 and Q2 03

[361] During Q1 03, Nortel’s financial results were affected by the release of $361 million in accrued liability balances to income. These releases affected Nortel’s balance sheet and profit and loss statement for Q1 03. The first restatement restated $111 million of these balances. The second restatement restated a further $106 million of these balances.

[362] During Q2 03, Nortel’s financial results were affected by the release of $372 million in accrued liability balances to income. These releases affected Nortel’s balance sheet and profit and loss statement for Q2 03. The first restatement restated $105 million of these balances. The second restatement restated a further $105 million of these balances.

[363] The Crown submits that this indicates that the original Q1 03 and Q2 03 releases were not in the “normal course” and that, therefore, Nortel’s financial results were misrepresented in the original financial statements and the first restatement of those financial statements. The Crown argued that the effect of the two restatements was to demonstrate that approximately 2/3 of the accrued liability balances released during Q1 03 and Q2 03 were wrongly released in those periods. The Crown submits that this supports its argument that the Comprehensive Balance Sheet Review was misrepresented as comprehensive and that the resulting financial statements misrepresented Nortel’s financial results.

[364] In my view, this is an incomplete interpretation of the restatement process. The restatement process had the effect of restating releases of accrued liability balances in two directions:

• releases of accrued liability balances to income came out of the profit and loss statements for Q1 03 and Q2 03 into which they had erroneously been released. These releases were restated to the profit and loss statements for the quarters into which they should have been released;

• releases of accrued liability balances came into the profit and loss statements for Q1 03 and Q2 03, if those quarters were the quarters into which those balances should have been released.

[365] The Crown’s interpretation only takes into account the accrued liability balances removed from income and, as a result, is incomplete.

[366] One of the late entry accruals provided by Mr. Morita, the PRC securitization release, was restated from Q4 02 to Q1 03. Although a small amount, $1.8 million, it is an example of a release that was restated into Q1 03. The fact that this release into Q1 03 was randomly reflected in the evidence illustrates that it is reasonable to conclude that other releases were restated into Q1 03. The evidence does not permit an analysis of the net effect on a quarter-by-quarter basis of the restating of accrued liability balances.

[367] Mr. Chambers did not offer the opinion that this “one way analysis” was valid.

[368] The reason for releasing specific balances undermines the suggestion that the 3 accused are responsible for the Q1 03 and Q2 03 balances that were restated.

[369] The evidence demonstrated that at least one release was restated out of Q1 03 because Deloitte disagreed with itself. An example of this seemingly odd conclusion is the Genuity release ($23 million) which is discussed elsewhere in these reasons.

[370] The PWC accrued liability release ($19 million), also discussed elsewhere, was restated out of Q1 03 on the basis of the legal opinion which was produced in April 2004 after the accused had been dismissed from their positions.

[371] The fact that the results of the first restatement were tested undermines that portion of the argument which suggests that the first restatement misrepresented Nortel’s financial results.

[372] Mr. Dans testified that he was involved with Deloitte when they performed a trending analysis to validate the results of the first restatement. He stated that each of the leadership categories presented to Deloitte & Touche the results of the restatement and explained the trends that resulted from the restatement to validate those trends from a business perspective. He described it as a “validation exercise.”

[373] No evidence suggested that this trending analysis indicated that the results of the first restatement could not be validated from a business perspective. No evidence suggested Mr Dans was mistaken about the validation exercise. The trending analysis was not produced. I accept this aspect of Mr. Dans’ evidence.

[374] The restatement of individual accrued liability balances occurred for a variety of reasons. It is not safe to generalize. The specifics of each restated balance have to be looked at in order to see what inferences they support. The first restatement was validated. No expert offered an opinion concerning the Comprehensive Balance Sheet Review and the first restatement.

[375] As indicated earlier, I am satisfied that the first restatement of previously published financial results differed from the 2nd restatement because the thresholds for the 2nd restatement were lower and because the 2nd restatement considered errors in revenue recognition as well as accrued liabilities.

[376] I am not satisfied, by the evidence, that the first restatement of accrued liability balances released in Q1 03 and Q2 03 demonstrates that the 3 accused misrepresented Nortel’s original financial results. I am not satisfied, by the evidence, that the 2nd restatement of accrued liability balances demonstrates that the 3 accused misrepresented Nortel’s financial results as first restated.

Q4 02-the 4th quarter of 2002

[377] Q4 02 was the subject of considerable evidence. The Crown argued that the accused attempted to manage earnings in Q4 02 and, in so doing, deliberately turned a pro forma profit into a pro forma loss.

[378] The Crown submitted that the solicitation of late accrued expenses/liabilities wrongly converted a pro forma gain before taxes into a pro forma loss before taxes in Q4 02.

[379] Mr. Harrison described how his solicitation of late entry accrued expenses and liabilities for fiscal Q4 02 came about.

[380] As indicated earlier, after the business unit sub-ledgers had been closed and the business unit financial results submitted to corporate headquarters, Mr. Harrison frequently prepared an Outlook document to give management a hint of the consolidated financial results. This Outlook document was a snapshot of the results from the general ledger.

[381] At a daily status update meeting, Mr. Harrison shared his latest Outlook snapshot. Mr. Harrison also commented on what entries were still to be made.

[382] Typically, the Assistant Corporate Controller, Linda Mezon, the Controller, Michael Gollogly, Mr. Harrison and someone from his staff would be in attendance.

[383] Mr. Harrison identified one of these snapshots, dated January 6, 2003, which indicated that Nortel’s pro forma gain before taxes was $73 million. Mr. Harrison testified that, when he announced this result at the January 6 status meeting, there was surprise. He testified that showing a profit in Q4 02 seemed out of context. He described the feeling at the meeting was that the result did not make sense.

[384] Skepticism concerning Mr. Harrison’s calculation of a pro forma gain before taxes of $73 million was justified. Nortel’s pro forma income calculations excluded gains on the buyback of bonds. Mr. Harrison erroneously included $59 million in gains from one such bond transaction in his January 6 Outlook calculations. Mr. Harrison had overstated Nortel’s pro forma net gain before taxes by this amount.

[385] Mr. Harrison corrected his error two days later. By this time, Mr. Harrison had solicited the late entry accrued expenses/liabilities of which the Crown now complains.

[386] Mr. Harrison testified that, as a result of the skepticism concerning his calculation, he agreed to make calls to senior finance individuals in each of the business units and the Regions to see if they had accrued expenses/liabilities which they had failed to record.

[387] Mr. Harrison had no clear recollection of any particular person asking him to make these calls; he said the idea that he would do that came from the meeting. Mr. Harrison testified he had never before made a call of this nature.

[388] Mr. Harrison testified that he made these phone calls and told each of the individuals to whom he spoke that Nortel’s results were very favorable and asked each of the individuals if they had any accrued expenses they needed to cover.

[389] Mr. Harrison’s calls resulted in the various business units booking approximately $176 million worth of accrued expenses/liabilities.

[390] Mr. Harrison created a list of the individual accrued expenses which he had solicited and testified that $137 million of this total came from Non-op which Mr. Harrison stated was under the “purview of the Controller”. Mr. Harrison, elsewhere on the same list, indicated that $126 million in additional accrued expenses came from Non-op. The reason for this discrepancy is not clear.

[391] Two days later, January 8, 2003, Mr. Harrison’s Outlook, or snapshot at the daily status meeting, suggested that Nortel was going to have a pro forma loss before taxes of $73 million, rather than a pro forma gain of $73 million.

[392] Mr. Harrison indicated that, if he had not made the calls, the $176 million in accrued expenses would not have been booked and that Nortel’s pro forma and US GAAP results would have not reflected the $176 million in negative impacts represented by the late entry accrued expenses/liabilities.

[393] Mr. Harrison confirmed that if, the Q4 2002 results had reflected a pro forma gain before taxes, most of Nortel’s employees would have been entitled to all or part of a Return to Profitability Bonus.

[394] The payment of this bonus in Q4 2002 was awkward from Nortel’s point of view because, in Q4 2002, Nortel experienced a loss calculated according to US GAAP of $248 million. This result had to be publicly reported. Bonus payments were payable if net pro forma income was positive after allowing for the cost of the bonus. The bonus was payable regardless of the fact that that there was a US GAAP loss.

[395] The awkwardness, to which I refer results from the fact that Nortel would have publicly reported a US GAAP loss and, at the same time, publicly reported that it was paying its employees a bonus. The evidence disclosed that it was well-known that other publicly-traded corporations had been criticized for precisely this behavior.

[396] The three accused representing Nortel senior management were motivated to avoid such a situation.

[397] Additional accrued expenses/liabilities which were all that Mr. Harrison was soliciting would have a negative impact on pro forma earnings. Sufficient additional accrued expenses /liabilities could, therefore, turn a pro forma gain before taxes into a pro forma loss before taxes. If Nortel reported a pro forma loss before taxes in its press release announcing Q4 02 financial results, then no bonus would be payable.

[398] Reporting a pro forma loss before taxes in Q4 02 was expected. Mr. Dunn had publicly predicted pro forma gains before taxes in Q2 03 or the second quarter of 2003.

[399] Mr. Beatty had expressed himself to Mr. Harrison on a related issue. In a conversation in Q3 02 or the third quarter of 2002, according to Mr. Harrison, Mr. Beatty stated that “The Street” would not reward Nortel for only one quarter of positive earnings. Mr. Harrison said that he understood the objective was constant positive results.

[400] It is not contrary to the criminal law to attempt to manage the affairs of a corporation to achieve a financial target. The question is whether, in attempting to achieve the targeted result, those responsible for preparation of the corporation’s financial results cause the financial statements to misrepresent the corporation’s financial results.

[401] Accordingly, the question becomes did the late entry accrued expenses/liabilities cause a misrepresentation of Nortel’s financial results?

[402] Before considering the additional accrued liability balances which resulted from Mr. Harrison’s solicitation, I propose to discuss the participation of Mr. Dunn, Mr. Beatty and Mr. Gollogly in the solicitation of additional accrued expenses.

The participation of Mr. Dunn and Mr. Beatty

[403] Nortel was a multibillion-dollar year business, international in scope and publicly- traded. It was also financially at risk. When Nortel announced a quarterly result, the auditors had to take a view of the next twelve months from the date of the quarterly report and opine on whether Nortel would be able to continue in business as a going concern.

[404] It is not logical and I decline to draw the inference that matters affecting Nortel’s pro forma and US GAAP earnings escaped the attention of Nortel’s CFO and CEO. Both Mr. Dunn and Mr. Beatty were accomplished accountants. Mr. Dunn, in particular, was described as very intelligent with a mind for detail. The evidence disclosed that on a trip to China, as one would expect, he made arrangements to be kept informed of the final 2002 financial results. Mr Dunn told Mr. Wilson that Nortel was profitable on operations in Q4 02 but the quarter was going to be negative due to accruals including 360 Networks.

[405] Exhibit 1, tab 30 was received as a business record. It is, therefore, capable of proving the facts contained in it. One of the facts contained in the business record is that Mr. Beatty discussed with Mr. Dunn the $30 million increase in Optical’s excess and obsolete inventory accrued liability balance. The increase in this balance came about as a result of Mr. Harrison’s solicitation of additional accrued expenses. Thus, the evidence is that Mr. Dunn was informed by Mr. Beatty of Optical’s response to Mr. Harrison’s communication.

[406] Nortel’s Board of Directors decided to pay a Return to Profitability Bonus based on Nortel’s 2002 formula for calculating pro forma gains (losses) before taxes. The bonus was created, in part, at Mr. Dunn suggestion because Nortel’s competitors were attempting to hire away Nortel employees. It stands to reason that conclusions concerning whether the bonus was payable or not would be brought to Mr. Dunn’s attention.

[407] Mr. Beatty, as Nortel’s CFO, would obviously be preoccupied with Nortel’s financial results.

[408] Mr. Gollogly was Nortel’s Controller. Mr. Gollogly was at the meeting on January 6, 2003 when Mr. Harrison announced that his calculations indicated that Nortel was pro forma positive by $73 million at that point in time. It was at the same meeting that it was decided that Mr. Harrison would call around and solicit late entries.

[409] I am satisfied that all three accused knew that Mr. Harrison was soliciting additional late entry accrued expenses/liabilities for fiscal Q4 02.

The specific late entry accrued expenses/liabilities solicited by Mr. Harrison

The solicitation of late entries from Karen Sledge

Late entry Fringe and Vacation accrued liability balances

[410] Karen Sledge offered some testimony concerning the solicitation of additional accrued expenses in connection with Fringe and Vacation benefits during the close of the books for Q4 02.

[411] Ms. Sledge is a CPA, which is the American designation which corresponds to our C.A. In Q4 2002, Ms. Sledge was responsible for accrued liability balances for vacations, holidays and termination benefits. Ms. Sledge indicated that she took on this responsibility in 2002, which was also the first year that she had U.S. Controller responsibilities.

Fringe Benefit Accrued Liability Balances

[412] In September or October 2002, Ms. Sledge and her team made a forecast that they did not have enough expenses accrued to cover medical costs in the U.S. throughout the fourth quarter of 2002.

[413] Ms. Sledge indicated that an additional $13 million should be added to the Fringe accrued liability balance. This was done in October 2002. This increase in the accrued liability balance negatively affected Nortel’s Q4 02 results by $13 million.

[414] This conclusion was based on a review of medical costs associated with recently- terminated employees which demonstrated that recently-terminated employees took greater advantage of medical benefits than active employees. Apparently, terminated employees in 2002 spent approximately 141% of active employees’ expenditures. Terminations in 2002 were 6% higher than originally estimated. Medical costs rose between 18 and 20% in 2002, resulting in significantly higher prescription drug costs.

[415] On December 20, 2002, only two months after the original forecast, Ms. Sledge’s staff indicated that they had overestimated this accrued liability balance by $7.3 million. This meant that, on December 20, 2002, Ms. Sledge and her team thought that a release to the profit and loss statement in the amount of $7.3 million would reduce the Fringe accrued liability balance to the appropriate level. This meant that the $7.3 million would positively affect Nortel’s Q4 02 results by $7.3 million.

[416] On January 3, 2003, two weeks later, Ms. Sledge advanced a new position, namely that the Fringe accrued liability balance should be reduced by $37 million. This meant that the Fringe accrued liability balance had been overestimated by $37 million. This meant that Q4 02 results would be positively affected by $37 million. A journal entry recording this $37 million reduction was made on January 4, 2003.

[417] Ms. Sledge received two or three telephone calls from Mr. Gollogly on January 5 or 6, 2003, as well as a call from Mary Cross, her immediate supervisor, expressing concern about the $37 million release.

[418] According to Ms. Sledge, Mr. Gollogly asked her to take a look at her decision to release this $37 million and Ms. Sledge initially responded that she thought the decision to release the accrued liability was correct. Ms. Sledge indicated that Mr. Gollogly became more emphatic about the need for her to reconsider the release with each call.

[419] Ms. Sledge said that she then increased the Fringe accrued liability balance by $11 million. A journal entry recording this $11 million increase was made on January 13, 2003. This, in effect, reduced the $37 million positive impact on earnings by $11 million. Ms. Sledge testified that, without these calls, she would not have increased the Fringe accrued liability balance.

[420] Ms. Sledge based her decision to increase the Fringe accrued liability balance by $11 million on invoices that had been incurred but not yet received from medical institutions. A trending analysis was done on these invoices and this analysis indicated the invoices would ultimately come in higher than expected.

[421] Ms. Sledge said that she asked her own team to consider whether the $11 million increase was justified. Their verification of the increase was communicated to Ms. Sledge on January 13, 2003. Accordingly, the Fringe accrued liability balance was adjusted upwards by $11 million at that time.

[422] Ms. Sledge indicated that she then asked her staff to determine why their initial forecast had suggested a $13 million increase in the Fringe accrued liability balance was necessary and then their subsequent forecast recommended a $37 million reduction in the accrued liability balance. Ms. Sledge’s staff discovered a $19 million double counting error was, in part, responsible. In addition, Ms. Sledge’s staff discovered that four months of employee severance notifications and their corresponding medical expenses had been overlooked in their original calculations.

[423] It is clear from Exhibit 58A, tab 8 that Deloitte & Touche audited Ms. Sledge’s decision to increase the Fringe accrual by $11 million. It appears that Deloitte did this on January 17, 2003. Deloitte concluded that the Fringe accrued liability balance should be increased, but only by $8.7 million and a downward adjustment of $2.3 million, representing the difference between $11 million and $8.7 million, was made in Q1 03.

[424] Nortel published its Q4 02 results on January 23, 2003.

[425] Ms. Sledge testified that the accrual increase was restated during the Second Restatement. Deloitte restated the $11 million increase because the increase was “not based on sufficient and/or appropriate evidence to support the accrual”.

Vacation Expenses

[426] Ms. Sledge testified that she was also responsible for accrued liability balances for vacation expenses. She said that, after she had submitted her figures, she was asked by her supervisor, Mary Cross, and by Mr. Gollogly if she had any other accrued expenses/liabilities to record in Q4 02.

[427] Ms. Sledge knew that there had been a $9 million release of vacation accrued liability balances to the profit and loss statement. Ms. Sledge reversed the release of this $9 million to the profit and loss statement. She did so by increasing the percentage factor that Nortel used in establishing vacation liability. Specifically, she increased the percentage factor from 75% to 85%.

[428] Ms. Sledge’s increase in the percentage factor used in establishing vacation liability and the supporting documentation were specifically brought to the attention of Deloitte & Touche.

[429] In an e-mail to Deloitte explaining the decision, Ms. Sledge that prior to 1998, the U.S. had used 100% as a vacation factor and Canada 75%. In September 1998, after a survey of North American employers to determine the average vacation days on hand, a decision was made to use 75% as a factor across North America. Due to unusual circumstances at Nortel in 2002, which Ms. Sledge partially identified as layoffs, management churn and employees not taking time off out of fear that they would be laid off, the consensus was reached that Nortel North American employees had not taken vacation and, therefore, a factor of 85% factor was more appropriate than 75%.

[430] Ms. Sledge indicated in her e-mail that a North American survey and analysis was scheduled for June-July 2003 and that further adjustments could be made upon receipt of the survey results and analysis.

[431] The North American survey was conducted in May 2003, which suggested a range of percentages varying from 77% to 89%.

[432] The $9 million increase in the vacation accrued liability balance was restated in the second restatement. The reason given for restating this $9 million increase was that the results of the survey were not available at the end of Q4 02.

[433] The restatement set the appropriate percentage at 85% for Q2 03 and Q3 03, which was the period when the study was available. The restatement set the appropriate percentage factor at 77% for Q4 03.

Soliciting accrued expenses in Asia

[434] Glenn Morita joined Nortel in 1997 and became a chartered accountant in 1998. Commencing in 2000, he was stationed in what Nortel termed the Asia Region. His title was Director of Finance.

[435] Asia Region was very large; it included China, India, Pakistan, Australia, New Zealand, Taiwan and Japan.

[436] When Mr. Morita first arrived in Asia Region, he reported to Mr. Gollogly. Mr. Morita knew Mr. Gollogly prior to being stationed in Asia because both of them were stationed in Brampton for a time.

[437] While in Asia Region, Mr. Morita was responsible for end of year, budgeting, forecasting and financial reporting. Mr. Morita said that he was also responsible for passing information along to the Corporate Consolidation Group in Brampton headed by Mr. Harrison.

[438] Mr. Morita indicated that, during the quarterly close of the general ledger, it was his responsibility to make sure that partial almost complete deals were properly documented so that Asia Region could book the revenues and the appropriate expenses associated with those revenues. Mr. Morita also indicated that, sometimes, it was possible to proceed more quickly with part of a project and, thereby, trigger a release of an accrued liability balance to income.

[439] During the course of his cross-examination, Mr. Morita indicated that accrued expenses booked in Asia were not readily visible in North America, with the result that Corporate in Brampton depended upon Asia Region to tell them about potential accrued liability releases to the profit and loss statement.

[440] Mr. Morita indicated that he had received a request to look for potential accrued expenses/liabilities that had been missed at the original close of the Asia Region sub-ledger. Mr. Morita said the request came from Mr. Gollogly and his team. He recalled the request specifically as being one to survey the Region and all the Regional Financial Primes for risk areas that they might want to cover off.

[441] Mr. Morita said that he spent the day making calls around the Region asking if there were accrued expenses/liabilities which people wanted to book to the general ledger.

[442] Mr. Morita pointed out that, at the time he was making these calls in January, the books in Asia Region had already been closed and Asia Region had already submitted its final Q4 02 figures to corporate headquarters in Brampton.

[443] Mr. Morita booked three additional items totaling $4.8 million. He said that these were not large items; they were not material at the corporate consolidations level. Mr. Morita indicated that because he was sending these three items so late in the process, he thought the entries would be refused because they were not material to the results. Mr. Morita testified that he sent the information along to demonstrate that he had cooperated with the request from Mr. Gollogly and his team. He indicated that he had no backup for these accruals when he sent them along. Back up was obtained later.

[444] The $4.8 million in accrued expenses was, in fact, booked to the General Ledger on January 8, 2003. Mr. Morita agreed on cross-examination with the suggestion that he viewed this process as an opportunity to make things more accurate; to go back and to double-check for opportunities to cover off risk.

[445] It appears that one of these items (the PRC securitization release) was restated from the Q4 02 profit and loss statement to the Q1 2003 profit and loss statement. The reason for this restatement appears to be that it was part of a Securitization Review.

[446] Mr. Morita indicated that the $4.8 million in additional accrued expenses, which he submitted, were given to him by his contacts in the various countries. He indicated that the three accrued expenses which he submitted were genuine and verifiable. Mr. Morita indicated that he went through each expense with the individual submitting the expense. It was his view that, if he had not booked these accrued expenses in Q4 02, they would have been booked in a subsequent quarter. Mr. Morita was firm that he would not have engaged in this process if he thought he was doing something wrong or incorrect.

[447] Mr. Morita indicated that, from his perspective, whether it was proper to set-up an accrued expense or release an accrued liability balance to the profit and loss statement depended upon whether the set-up or release could be justified.

[448] Mr. Morita indicated that, from his perspective, while it was not proper to release accrued expenses to the profit and loss statement to meet targets, the appropriate release of accrued liabilities to the profit and loss statement could, in fact, assist in meeting targets.

The solicitation of additional accruals from Ken Crosson

Excess and obsolete inventory

[449] Mr. Crosson joined Nortel in 1975 after obtaining an MBA from York University. From 2000 to 2003, he was the Vice-President of Global Operation; he was located in Raleigh, North Carolina. Mr. Crosson had between twelve and seventeen people reporting to him. Mr. Crosson reported to the accused Douglas Beatty. He was terminated by Nortel in 2003 for matters apparently unrelated to this case.

[450] Global Operations was a single supply chain that supplied product to various lines of business. Mr. Crosson was responsible for the financial management of the supply chain in the manufacturing of Nortel’s products. Mr. Crosson was responsible for efficiently managing inventory; this was one of his two prime responsibilities.

[451] Mr. Crosson indicated that gross inventory was valued at $2 billion and that there was an accrued liability balance for inventory for $1 billion approximately. In Mr. Crosson’s words, half the inventory “was provided for”. The risk with respect inventory was that it was excess or obsolete; i.e., not sold within the appropriate period of time or unusable.

[452] Mr. Crosson pointed out that excess inventory on the books of Nortel’s contract manufacturers was, in many cases, Nortel’s responsibility and had to be provided for. According to Mr. Crosson, determining who was responsible for what was a contentious matter among Nortel and its contract manufacturers. Finally, Mr. Crosson indicated that the Optical business unit had an inventory problem. Specifically, Optical’s exposure on account of excess and obsolete inventory was more than $500 million or approximately ½ of the total accrued liability balance on account of excess and obsolete inventory.

[453] The precise amount of the inventory accrued liability balance was determined by an algorithm or formula. Obsolete inventory was not usable and so the accrued liability for it was 100% of its value on Nortel’s books. Excess inventory was inventory calculated on a percentage basis based on whether the inventory was six-months-old, nine-months-old or one-year-old. The algorithm made these calculations.

[454] Mr. Crosson testified that determining the level of excess inventory involved judgment and forecasting. Forecasting is important because, if orders do not come in and revenues are not as anticipated, then there will be a calculation suggesting that excess inventory is greater than originally anticipated and the accrued liability balance for excess inventory will have to be increased. Optical was particularly vulnerable in this regard.

[455] The accrued liability balance for excess and obsolete inventory was also affected by various attempts to dispose of the inventory. For example, Nortel approached manufacturers of similar items and offered its excess or obsolete inventory to them at a significant discount. Mr. Crosson testified that Deloitte & Touche took an active interest in auditing these excess or obsolete inventory mitigation programs.

[456] Mr. Crosson indicated that the Optical business unit had not reached “the bottom” and so there was always the risk that the accrued liability balance on account of Optical’s inventory was not sufficient. Specifically, the possibility was that, when the algorithm was applied to Optical’s inventory, it would indicate that the accrued liability balance for Optical’s inventory must increase.

[457] Mr. Crosson indicated that running the algorithm for all of Nortel’s inventory required time; specifically, it required you to input the age of the inventory and then run the algorithm. It was not something that could be done instantaneously. Accordingly, a decision was reached in late 2002 to postpone re-evaluating the inventory and focus on disposing of it.

[458] Mr. Crosson indicated that he submitted his financial information for Q4 02 on time that is by January 5, 2003. Mr. Crosson indicated that he was satisfied that his financial information was accurate. Mr. Crosson indicated that, prior to submitting his financial information, he gave consideration to increasing the accrued liability balance on account of excess and obsolete inventory by $50 million. His evidence in this regard is confirmed by an Outlook outlining a potential $50 million increase in the accrued liability balance for excess and obsolete inventory, dated December 19, 2002.

[459] Mr. Crosson ultimately decided not to make this adjustment to the excess and obsolete inventory balance in Q4 02.

[460] Mr. Crosson testified that he received a telephone call from Brian Harrison on January 6 or 7, 2003 asking him if he could justify increasing his inventory accrued liability balance. Specifically, the request was, if required, could Mr. Crosson justify increasing his inventory accrued liability balance for Optical by $30-$35 million. Mr. Crosson indicated that he had never before received such a communication. Mr. Crosson indicated to Mr. Harrison that, based on Optical’s history and the fact that he did not see a bottom for Optical, such an increase could be justified.

[461] Mr. Crosson would not have increased the accrued liability balance for Optical’s inventory had he not received Mr. Harrison’s call.

[462] Increasing Optical’s accrued liability balance had the effect of reducing its income because it meant increasing Optical’s expenses on its profit and loss statement, thereby negatively affecting Optical’s net income. A similar effect would be felt on Nortel’s consolidated profit and loss statement.

[463] Subsequent to agreeing to this increase, Mr. Crosson testified that he was then asked to agree to a reduction of this increase from $35 million to $30 million. Mr. Crosson indicated that he was unconcerned about the reduction.

[464] Mr. Crosson indicated that, after the reduction, the backup documentation was changed to support a $30 million increase in the excess and obsolete inventory accrued liability balance rather than a $35 million increase.

[465] Interestingly, one of the business records introduced was an e-mail from Mr. Beatty to Mr. Gollogly and others indicating that Mr. Dunn did not agree with the $30 million increase in the accrued liability balance for Optical’s inventory.

Use of Mr. Crosson’s $30 million as an offset

[466] The tale of Mr. Crosson’s $30 million increase in the excess and obsolete inventory accrued liability balance contained an unexpected twist.

The JDS Uniphase Corporation transactions

[467] Nortel purchased a plant from JDS Uniphase which was located in Switzerland and, as well, purchased related assets in New York State.

[468] The purchase price ($2.8 billion) had two components – cash and Nortel shares. A portion of the Nortel shares (500,000 shares) amounted to future consideration for the purchase of these assets. Specifically, if Nortel purchased 16.9% of its component needs from JDS in the years 2001, 2002 and 2003, then Nortel would not have to issue 500,000 shares of its stock to JDS. In other words, this portion of the purchase price was deferred and could potentially amount to a purchase price discount.

[469] At the time of the transaction in 2001, advice was received from Deloitte & Touche concerning how this deferral of the purchase price should be treated in the years 2001, 2002 and 2003. Specifically, Deloitte’s advice was that Nortel positively impact net income by approximately $40 million per quarter. Nortel followed this advice. Each quarter, commencing immediately after the purchase, $40 million in positive impacts to income was automatically posted to the General Ledger. Consistent with this decision $40 million in positive impacts had been posted in Q4 02.

[470] On November 8, 2002, Nortel sold these assets to an arm’s length company.

[471] Deloitte gave Nortel the opinion that the $40 million in positive impacts to Q4 02 net income had to be reduced by $25 million. Nortel accepted Deloitte’s opinion.

[472] Due to the fact that the resolution of this matter was not straightforward, the decision to reduce the $40 million positive impact for Q4 02 by $25 million was not made until January 21, 2003. This was two days before Nortel intended to publish its Q4 02 results.

[473] Rather than revise Nortel’s financial statements for Q4 02, a decision was made to find a fully offsetting entry. Specifically, the accrued liability balance for Optical’s excess and obsolete inventory was reduced by $25 million.

[474] From the Crown’s perspective, the changes in the accrued liability balance for Optical’s excess and obsolete inventory are suspicious in the extreme. First, Mr. Crosson increases the accrued liability balance for excess and obsolete inventory by $35 million in response to Mr. Harrison’s request. The $35 million increase is reduced to $30 million. Then it is reduced to $5 million so that Nortel’s financial statements will not have to be changed two days before they were to be published.

[475] Ms. Linda Mezon testified in these proceedings. Ms. Mezon joined Nortel in Brampton in May 2001 as Assistant Corporate Controller. At this point in time, Mr. Beatty was the Controller. She left Nortel in 2003.

[476] Ms. Mezon is both a CPA (the American equivalent of the Canadian CA) and a C.A. Ms. Mezon is also an MBA. She was a member for eight years of the Accounting Standards Board, which is responsible for setting accounting standards in Canada for public companies, private entities, not-for-profit organizations and government entities.

[477] Ms. Mezon testified that she had a good solid working knowledge of both Canadian and United States GAAP.

[478] Ms. Mezon indicated that, after the decision was made to reduce Nortel’s revenue by $25 million on January 21, she, Mr. Gollogly and Helen Verity had a conversation about finding an offset. The reason they were looking for an offset was because it was January 21, 2003 and the press release describing Nortel’s financial results was due to be released on January 23, 2003. Finding an offset would mean that the financial statements which already been prepared would not have to be changed.

[479] Ms. Mezon indicated that it was not her job to find the actual offset and so she went home. The next morning she found out that the offset was a $25 million reduction of Mr. Crosson’s $30 million increase in the excess and obsolete inventory accrued liability balance. Ms. Mezon testified that, as soon as she found out about this, she contacted Mr. Crosson and confirmed that he was content with the reduction.

[480] Ms. Mezon explained her own thinking which was quite helpful. She thought that the total accrued liability balance for excessive and obsolete inventory exceeded $1 billion and so she asked herself whether the $25 million reduction would materially misstate the balance sheet and she concluded that it would not. Ms. Mezon indicated that she knew that excessive and obsolete inventory had been discussed many times with Deloitte & Touche. She described excessive and obsolete inventory as “a very difficult area because in this business, you know the demand had ramped up very quickly, and the demand had fallen off very quickly, particularly, for instance, in Optical, which was—it was very difficult the forecast”.

[481] She said that she concluded that the $25 million reduction was not material. She said that, although she talked to Mr. Gollogly about the offset, she felt the decision was really her responsibility because she was the “GAAP expert”.

[482] Ms. Mezon testified that she made Deloitte & Touche specifically aware of the offset.

[483] Deloitte specifically reviewed the offset and concluded that the $25 million release was a release associated with inventory classed as a deferred asset which had already been provided for. Accordingly, there was no impact on the inventory line in Nortel’s consolidated balance sheet from the $25 million reduction. This conclusion is recorded in Exhibit 156; a Deloitte’s working paper, at Tickmark I. Deloitte’s working papers were admitted into evidence as business records. The author of this particular working paper was not called as a witness. No witness, including the Crown’s expert Mr. Robert Chambers, suggested this conclusion was wrong.

[484] As far as the offsetting entry is concerned, Ms. Mezon understood the transaction concerning which she was testifying and took responsibility for her decisions. The decision to reduce the excess and obsolete inventory balance to offset the unexpected revenue decline was reasonably taken. Mr. Crosson was consulted; it is true, only after the decision was taken. However, Mr. Crosson was consulted before Nortel’s financial statements for Q4 02 were finalized. The auditors were made aware of the downward adjustment and signed off on the financial statements for an “accounting reason” that was not challenged.

[485] There is one other aspect of this matter and that is the difficulty with drawing general conclusions about an item which has been restated.

[486] The Q4 02 accounting for this transaction was reviewed when Nortel sold these assets to an arm’s length purchaser. At a meeting of Nortel’s Audit Committee on January 9, 2003, Deloitte & Touche confirmed that they were of the opinion that the accounting advice which they gave in 2001 remained appropriate.

[487] During the second restatement, Deloitte changed its opinion concerning the treatment of the entire transaction.

[488] Deloitte’s new approach calculated that the deferral of the purchase price was worth approximately $500 million. Accordingly, Deloitte decided that the appropriate accounting treatment was to reduce the purchase price by $500 million. This reduction in the purchase price meant that $319 million in positive revenue impacts, which had resulted from the $40 million revenue entry in each quarter after the sale, had to be eliminated. As a result, revenue in 2001 and 2002 was collectively reduced by $319 million as a result of Deloitte changing its mind. I infer from Mr. Chambers report that any expenses associated with earning this $319 million would also have to be restated.

[489] Deloitte gave two opinions endorsing the accounting treatment of this transaction. The first opinion was given in 2001 and the second confirming opinion was given to the Audit Committee in 2003. In October 2004, during the second restatement, Deloitte changed its opinion, resulting in a reduction in Nortel revenues.

[490] The Crown argues that the accused, in restating previously-published financial statements, have admitted that accrued expenses/liabilities should not have been recorded in the quarters in which they were recorded, that they were not properly released in the quarters when they should have been released and that, therefore, Nortel’s financial statements are not US GAAP compliant. The Crown argues that the fact that there was a restatement proves that Nortel’s financial results were misrepresented from 2000 to May 2003 and the only question is whether the accused knew this when those results were published.

[491] It would be wrong to conclude in a criminal case such as this that the $319 million reduction in revenue means that Nortel’s original financial statements misstated its revenue in 2001 in 2002 by $319 million. Describing the original JDS entries as false or wrong inaccurately characterizes what occurred and could easily lead to the false conclusion that something inappropriate happened when the original accounting was done. A consideration of the details of this transaction illustrates why it is impossible to draw the inference which the Crown urges from the fact that accounting entries are restated. The accounting for this transaction was changed because Deloitte changed its mind. A consideration of the specifics of this restatement of the JDS Uniphase transaction makes it clear that it is dangerous to generalize about items that are restated.

[492] When the facts of this specific restatement are known, it is clear that the accused could not have known that the original treatment of the $500 million purchase price discount was an error or wrong or false. Such words are not appropriate when describing the fact that Deloitte changed its mind.

Perot Systems

[493] Mr. Crosson found a second accrued expense/liability – Perot Systems.

[494] In March 1996, Perot Systems and Nortel Networks Corporation combined to jointly pursue certain identified business opportunities. In 1997, there were significant performance defaults by Nortel. Nortel Networks Corporation and Perot Systems settled their dispute over these defaults in August 1998 upon the following terms:

• Nortel paid $2 million to Perot Systems;

• Nortel agreed to provide Perot Systems with $5 million in product credits;

• Nortel agreed to award Perot Systems a total of $75 million in business over five years ending August 1, 2003.

[495] From 1998 to the end of December 2002, Nortel had provided Perot Systems with approximately $48 million worth of business. By the close of Q4 2002, Nortel had identified the fact that it still had to provide $27 million worth of work by August 2003 to meet its settlement obligations. Nortel received legal advice in November 2002 to the effect that Perot Systems had a legal right to invoice them for the $27 million difference.

[496] Nortel was looking for an opportunity to establish a more permanent relationship with Perot Systems. Nortel wanted to continue to do business with Perot Systems and Perot Systems wanted to continue to do business with Nortel. Nortel did not want to receive an invoice for $27 million. Both sides wanted to avoid litigation.

[497] When Mr. Crosson submitted his Q4 2002 results, he did not provide for or set up an accrued expense/liability to reflect the risk of unsuccessful litigation with Perot systems. Mr. Crosson did not believe there was sufficient risk. Mr. Crosson knew that Nortel was struggling and was not going to create an expense if he did not believe the $27 million risk warranted it. Mr. Crosson agreed that he knew, on January 2, 2003, about a potential exposure under the Perot Systems Settlement Agreement.

[498] After Mr. Harrison’s telephone call, there was an accrued liability balance entry made in the general ledger for Q4 2002 increasing accrued expenses and accrued liabilities by $27 million on account of Perot Systems.

[499] Mr. Crosson indicated that he would not have suggested the $27 million increase unless he thought it could be justified. Mr. Crosson indicated that any late entry increase in accrued liability balances would have to be supported to the satisfaction of Deloitte & Touche.

[500] Mr. Crosson said initially when he submitted his financial information, he did not submit the Excess and Obsolete Inventory accrued liability balance increase and the Perot Systems Perot systems accrued liability balance increase because the accrued expenses/liabilities which he submitted were within a range with which he could live. He felt he could also support a higher number and, therefore, felt that increases of these two accrued liability balances were supportable. Mr. Crosson also testified that the material that he submitted in support of these increases was genuine.

The solicitation of additional accruals from Jim Kinney for the period Q4 02

[501] Mr. Kinney was trained as a certified management accountant. He started at Nortel in 1980 and worked there continuously until 2004. Commencing in August 2002, he was the Vice-President Finance for Wireless, one of Nortel’s business units. He succeeded Michael Gollogly in that position. As the VP Finance for Wireless, Mr. Kinney reported to the accused, Douglas Beatty. There were various Financial Primes within Wireless and those persons reported to Mr. Kinney.

[502] As Vice-President Finance for Wireless, Mr. Kinney was responsible for the consolidation of its global financial performance, financial planning and analysis, liaison with the other line organizations, sales proposals and budgeting.

[503] Mr. Kinney indicated that, in October 2002, he had a phone conversation with the defendant, Michael Gollogly. Mr. Gollogly advised Mr. Kinney that there were issues with the Wireless balance sheet and acknowledged some responsibility for their existence. Mr. Gollogly instructed Mr. Kinney to clean up the balance sheet. Mr. Gollogly was not specific about the items which were problematic. Mr. Kinney said that Mr. Gollogly, as Controller, was instructing him to get a thorough understanding of what was on the balance sheet, why it was there and, most importantly, whether it should stay on the balance sheet.

[504] Mr. Kinney said that the balance sheet cleanup at Nortel began in earnest in December 2002 with a conference call among himself, people on his staff, Karen Sledge, in her role as U.S. controller, and Mary Cross, in her role as Controller for North America. It was agreed that Wireless would review its balance sheet quarter by quarter, region by region and entity by entity. The purpose of the review, according to Mr. Kenny, was to determine whether accrued liability balances should remain on the balance sheet.

[505] Mr. Kinney said he had no contact with Douglas Beatty or Frank Dunn about the balance sheet cleanup that he was undertaking.

[506] Mr. Kinney explained the difficulty he faced trying to clean up the Wireless balance sheet. Whether liabilities remained on the balance sheet came down to a judgment call based on the representation of the individual who was responsible for the specific accrued liability balances on the Wireless balance sheet. The tricky part, according to Mr. Kinney, arose because many of the liabilities had to do with liquidated damages or potential customer claims. These items were, therefore, self-determined. Within the sales organization, the decision was dependent upon internal representation that there was a liability and that the liability needed to remain on the balance sheet.

[507] Mr. Kinney said that he viewed the passage of time as the failsafe mechanism. The longer something was on the balance sheet without a claim the more confident he became that it could be taken off the balance sheet. Mr. Kinney said that, in his judgment, an accrued liability balance could be released to the profit and loss statement if there was a high degree of certainty, if not virtual certainty, that the liability no longer existed. Mr. Kinney said he followed the practice of allowing a cooling-off period when he thought an accrued liability balance could be released to the profit and loss statement. Specifically, he waited one extra quarter to make sure that an unexpected exposure did not present itself.

[508] Mr. Kinney also followed the practice of seeking customer representation that the liability was gone and used receipt of that representation as the event which triggered removal of the liability balance.

[509] Mr. Kinney testified that, until July 31, 2003, he thought that balance sheet reconciliation was sufficient justification to remove an accrued liability from the balance sheet. According to Mr. Kinney, when he heard a presentation by Mr. Gollogly which indicated that this was not a sufficient justification, it was “a game changer”. The evidence disclosed that Mr. Kinney was not alone in this misconception.

[510] This is perhaps an appropriate place to remark on the fact that Mr. Beatty is a chartered accountant like Mr. Gollogly. I am satisfied that he understood when accrued liabilities could be released to the profit and loss statement. Mr. Kinney recounted that Mr. Beatty explained to him that a change in estimate was a proper way of releasing an accrued liability to the profit and loss statement. Mr. Kinney testified that Mr. Beatty provided him with a reference to the section of the accountants’ handbook dealing with the proprietary of accrued liability balance sheet releases.

[511] Mr. Kinney testified that, for Q4 2002, the Wireless “stretch target” contribution to pro forma earnings before taxes was $70 million. He agreed that, on January 7, 2003, his submitted numbers had reached that target. Mr. Kinney testified that he received a telephone call from either Brian Harrison or Michael Gollogly. Mr. Kinney was not the only one on this telephone call. He believed there were other Vice Presidents of Finance on the call. They were told that Nortel had a favorable variance to its anticipated earnings and that, as a result, they were being asked to go back and make certain that adequate provision had been made.

[512] Mr. Kinney indicated that he would not have attempted to find and book increases to Nortel’s accrued liability balances without the phone call from Mr. Harrison or Mr. Gollogly.

[513] Mr. Kinney solicited Wireless for possible increases in the accrued liability balances and received two responses upon which he acted. The first related to an inventory issue involving a customer in China and the second dealt with an increased risk as a result of Nortel’s relationship with France Telecom.

[514] The result of Mr. Kinney’s efforts was that he submitted accrued liability balance increases of $12 million. This $12 million increase in the accrued liability balances for Wireless was not restated.

[515] Coincidentally, Wireless revenue was reduced by a further $8 million because, during the closing of the General Ledger, $8.9 million was removed from Mr. Kinney’s revenue calculations by Nortel corporate headquarters.

[516] As a result of searching for and booking the $12 million in accrued liability balance increases and the $8.9 million revenue reversal, Wireless missed its stretch target by $19 million.

[517] Mr. Kinney indicated that he was concerned about the reaction of the President of Wireless because Wireless had missed its target. He also indicated that he was not concerned about the reaction of senior management because senior management set the target and, therefore, could dispense with the target.

Mr. Gollogly’s knowledge generally

[518] Because Mr. Kinney took over from Mr. Gollogly and because Mr. Gollogly instructed Mr. Kinney to clean up the Wireless balance sheet, this is an appropriate place to comment on Mr. Gollogly’s knowledge concerning Nortel’s financial results.

[519] Mr. Kinney said that, when he took over as VP Finance for Wireless, he recognized that the balance sheet for Wireless was not well understood within Wireless. After he took over as VP Finance for Wireless, Mr. Kinney recognized that there were significant excess accrued liability balances on the Wireless balance sheet. He also thought that there were accrued expenses/ liabilities which were not well understood. Mr. Kinney testified that he thought that there were $180 million in excess accrued expenses/liabilities on the Wireless financial statements at the end of Q2 02.

[520] Mr. Kinney also observed that Wireless used the balance sheet as a means by which to meet its earnings targets. This practice was not peculiar to Wireless. Mr. Gollogly said as much in an e-mail (Exhibit 3, tab 140), dated July 31, 2003. Specifically, he said in the e-mail: “I think we need to reinforce the importance of forecasting. It seems like a throwaway comment, but if we ‘cleanup’ the balance sheet, the LC’s ability to deliver earnings based partly on discretionary elements pretty much goes away. So they will need an incremental level of precision in their forecasting. I do not think the company is ready for this since the general approach is to sandbag good news and close ‘hard’ to the forecast. But if we cannot move the numbers one way or the other, we may get much more surprised than currently”.

[521] I am satisfied beyond a reasonable doubt that Mr. Gollogly knew that there were excess accrued liabilities on Nortel’s balance sheet.

[522] I am also satisfied that Mr. Gollogly was determined to do something about this after he became Corporate Controller. I say this because one of his first acts was to begin balance sheet reviews. His instruction to Mr. Kinney is telling, not only in terms of his knowledge, but also his intent to remove these excess accrued liabilities. I am not persuaded that he understood the extent of the problem.

[523] Although slightly out of context, it is perhaps appropriate to point out here that Mr. Richmond testified that the $900 million in excess accrued liabilities identified in the Comprehensive Balance Sheet Review were not material, in his opinion, to Nortel’s financial results in fiscal 2001 and 2002 due primarily to the $33 billion in losses that Nortel experienced in those years. Mr. Chambers did not offer a contrary opinion.

360 Networks

[524] The largest late entry accrued expense/liability in Q4 02 was $50 million. This accrual was in relation to 360 Networks litigation. This entry was reviewed during the second restatement. Deloitte’s conclusion was “accrual was appropriate based primarily on in-house legal representation”. Accordingly, this entry was never restated.

[525] Reference has been made elsewhere to Nortel’s preoccupation with providing for every possible risk. With respect to this accrued expense/liability, Mr. Cleghorn, the Chair of the Audit Committee, recalled this matter. Specifically, he recalled that, at a January 2003 Audit Committee meeting, he sought specific assurances $50 million was a sufficient accrued liability balance for this risk because the 360 Networks claim was for $100 million.

[526] Mr. Cleghorn’s evidence was entirely consistent with other evidence to the effect that it was part of Nortel’s culture to provide for every possible risk in order to ensure that there were no surprises.

[527] There is no issue about the appropriateness of this late accrued expense/liability entry which comprised $50 million of the $176 million in late entries.

[528] I accept the evidence of Ms. Sledge, Mr. Morita, Mr. Crosson, Ms. Mezon and Mr. Kinney concerning the solicitation of late entry accrued expenses/liabilities.

[529] Nortel’s press release of January 23, 2003 also announced a pro forma net loss for Q4 02 of $62 million. This was the only report of a pro forma financial result. Q4 02 was the last time Nortel ever announced pro forma results. Pro forma financial results for Q4 02 were never restated. Deloitte published no opinion concerning pro forma results because it was not retained to do so.

[530] I am satisfied that the negative impacts of the $59 million revenue error which Mr. Harrison made in his January 6 calculation and $50 million late entry accrued liability for 360 Networks, the appropriateness of which has never been challenged, were more than sufficient to create a pro forma loss in Q4 02. I am satisfied that it was Mr. Harrison’s snapshot on January 6, 2003 of a pro forma gain before taxes of $73 million which misrepresented Nortel’s pro forma Q4 02 financial result.

[531] I am not satisfied that the reported pro forma loss of $62 million misrepresented Nortel’s Q4 02 financial results.

The manipulation of Nortel’s pro forma earnings before taxes to get a bonus

[532] The Crown alleges that the accused manipulated Nortel’s pro forma earnings before taxes calculation in order to get a bonus. I reject this submission elsewhere in these reasons.

Did the late entry accrual expenses/liabilities misrepresent Nortel’s US GAAP financial results for Q4 02?

[533] Nortel’s press release, on January 23, 2003, announced its financial results for Q4 02. Nortel reported a net loss calculated according to US GAAP of $248 million.

[534] Nortel’s Q4 02 financial statements were restated twice.

[535] Exhibit 85B also records that, after the second restatement, Nortel reported a net loss calculated according to US GAAP of $294 million for Q4 02.

[536] I am not satisfied the difference is a misrepresentation. No witness offered such an opinion.

[537] In addition, in Q4 02, Nortel originally reported total revenue of approximately $2.5 billion. After the second restatement, Nortel reported total revenue of approximately $2.6 billion.

[538] In Q4 02, Nortel originally reported a gross margin of 39%. The second restatement reported a gross margin of 42%. Mr. Harrison indicated that it was his experience with Nortel that it typically reported gross margins in the range of 40%. No witness suggested that the difference in reported gross margins was important.

[539] Nortel’s press release of January 23, 2003 announced that it was “net cash positive” in Q4 02. The evidence did not suggest that this assertion was a misrepresentation. This was a critically- important piece of information for investors because the evidence indicates that maintaining sufficient cash reserves was a fundamental concern for Nortel’s Board of Directors, Audit Committee, senior management and Auditors and fundamental for Nortel’s survival.

[540] Nortel’s original financial statements for Q4 02 indicated that Nortel had outstanding approximately 4.3 billion shares. The evidence did not suggest that this assertion was a misrepresentation.

[541] I am satisfied that the late entry accrued expenses/liabilities did not result in a misrepresentation of Nortel’s US GAAP financial results for Q4 02.

[542] I am not satisfied that Nortel’s original published US GAAP financial results misrepresented Nortel’s actual financial results.

Susan Shaw’s 2002 Summary of Accrued Liabilities

[543] Susan Shaw prepared a compilation dealing with accrued liabilities and presented it to Mr. Gollogly in Q4 02. Her compilation indicated that $303 million in accrued liabilities were no longer required and available for release.

[544] It is the Crown’s position that, despite knowing that there were millions of dollars in excess accruals on the balance sheet, none of the accused advised Nortel’s Audit Committee or Deloitte about this situation.

[545] It is also the Crown’s position that the accused did not initiate a comprehensive review of Nortel’s balance sheet or initiate a restatement of its previously-published financial information.

[546] Ms. Shaw brought her findings to the attention of her superiors, Helen Verity and Linda Mezon. Susan Shaw reported her findings to Mr. Gollogly. Ms. Mezon testified that she brought Ms. Shaw’s report to the attention of Mr. Beatty.

[547] Ms. Shaw’s compilation informed Mr. Gollogly and Mr. Beatty that $303 million in accrued liability balances were no longer required and available for release. It also told Mr. Gollogly, who as Corporate Controller was responsible for Non-op, that $66 million of the no longer required accrued liability balances were Non-op accrued liability balances.

[548] On November 6, 2002, Ms. Shaw sent an e-mail to Mr. Gollogly’s assistant attaching an XL spreadsheet entitled “Acc Liab Q3 for FD”. I am satisfied that FD refers to the accused Frank Dunn.

[549] Mr. Dunn was financially trained and described as an intelligent detail-oriented person. Given Nortel’s precarious position, I am satisfied that financial information of any importance was brought to his attention. I am satisfied that Ms. Shaw’s compilation would have been considered important because it had been generated in response to questions from outside financial analysts.

[550] I am satisfied, therefore, that Mr. Gollogly, Mr. Beatty and Mr. Dunn were aware that Ms. Shaw believed that there were $303 million in accrued liability balances which were no longer required and were available for release.

[551] Some context is helpful in assessing the Crown’s position.

[552] Susan Shaw is a chartered accountant. She joined Nortel in 1988 and, in 2002; she was transferred to the Corporate Consolidations Group where she reported to Helen Verity, who was the Director of that group.

[553] During a call with securities analysts in July 2002, one of the analysts asked Douglas Beatty about Nortel’s accrued current liabilities. The analyst pointed out that Nortel’s accrued current liabilities exceeded $5 billion and had been increasing over the last few quarters.

[554] The first problem raised by the question was that if the $5 billion was all cash impacting, then Nortel would not have enough cash to pay all those liabilities. As indicated many times these reasons cash was a critical issue in terms of anything and everything Nortel did.

[555] The second problem with the question was that Nortel’s business had been declining in the previous quarters and yet the liabilities did not seem to be trending downward.

[556] As a result of this question, the Assistant Corporate Controller, Linda Mezon, asked Helen Verity to look into the matter. Specifically, Linda Mezon wanted to know which provisions would require payment and, therefore, have an impact on cash. In addition, Ms. Mezon wanted to know when the accrued liability balances would be cleared to the profit and loss statement.

[557] Helen Verity asked the various finance vice presidents throughout Nortel, in an e-mail dated August 2, 2002, to follow up on the question. Ms. Verity assigned the task of compiling the information provided to Ms. Shaw.

[558] Ms. Shaw described the process she followed in preparing her compilation as iterative. The various business units were provided with their liability balances at Q2 2002 (June 30, 2002) and asked whether those liabilities were going to be cash impacting. In addition, they were asked whether all of the accrued liability balances were correct or whether some were greater than necessary. The business units were also asked whether those that were required were going to be utilized within 2002.

[559] There was a template which was provided to the units and Ms. Shaw was in communication with the various business units about the information provided when they returned the completed template; she was also in communication with Helen Verity and Linda Mezon to make sure that she was collecting the information that they wanted.

[560] Ms. Shaw emphasized that, while the business units were being asked for information, they were not being asked to justify their numbers.

[561] Ms. Shaw also indicated that the information which the units were providing was not designed to provide the basis for a determination of what accrued liabilities should be released to income.

[562] Finally, Ms. Shaw indicated that 50% of her work concerned contractual liabilities because they composed 40% of the total liabilities on Nortel’s consolidated balance sheet. Given that Nortel’s total liabilities exceeded $5 billion, contractual liabilities exceeded $2 billion.

[563] I am satisfied that the primary purpose, from Ms. Shaw’s point of view, was to determine the cash impact of Nortel’s accrued liabilities as at Q2 2002.

[564] One of the pieces of information which Ms. Shaw uncovered was that, in the opinion of the various business units, there was a total of $303 million in accrued liabilities which were no longer required and available for release.

[565] Ms. Shaw’s Summary of Accrued Liabilities was not kept a secret. E-mail evidence was introduced which indicated that senior accountants of Deloitte & Touche were aware of her work.

[566] The $303 million in excess accrued liabilities was broken down into categories.

[567] Two thirds of this total is contractual liabilities. A contractual liability was an accrued liability that arose out of a promise to perform that Nortel had made in agreeing to supply a product or service. Put simply, when the total revenue which Nortel was to receive from the contract to supply a product or perform a service was recognized, the cost of providing that product or service for the life of the contract also had to be estimated and recognized.

[568] Of the remaining one-third of these accrued liabilities, which were no longer required and available for release (approximately $100 million), $66 million was attributed to Non-op, which was a non-operating unit under the control of Nortel’s Corporate Controller, Michael Gollogly. Mr. Gollogly had only recently (July 25, 2002) assumed this position when Ms. Shaw presented him with her final compilation in October 2002.

[569] To put the $66 million in excess accrued liabilities in context, it should be remembered that Ms. Shaw’s report also identified the fact that Non-op had, at the end of Q2 2002, total accrued liabilities of $315 million. In other words, at the end of Q2 2002, $249 million in accrued liabilities were, according to Ms. Shaw, required by Non-op and $66 million were not required.

[570] In addition, it should be remembered that Ms. Shaw was consolidating results being provided to her. She was not determining which specific accrued liability balances were required and which specific accrued liability balances were no longer required.

[571] On September 16, 2002, Ms. Shaw met with Linda Mezon to explain the results of her consolidation so that Linda Mezon could meet with Michael Gollogly and provide him with a progress report.

[572] On October 2, 2002, Mr. Gollogly was formally briefed by Ms. Shaw and others on the final results of her consolidation. Ms. Shaw indicated that, during the meeting, Mr. Gollogly was concerned to know the persons who had provided the information contained in her compilation. It was her impression that Mr. Gollogly was attempting to acquire a level of confidence about the financial information in her report.

[573] It is important to remember that the numbers in Ms. Shaw’s report were those available for the period ending Q2 2002, i.e., June 30, 2002. The numbers in this report were never updated.

[574] Mr. Richmond provided some assistance on the implication of Ms. Shaw’s report. Mr. Richmond was not shown the report and, given his position and responsibilities as Senior Advisory Partner in the Nortel/ Deloitte’s relationship, there is no reason why he should have been shown the report. Suffice to say, Deloitte was aware of Ms. Shaw’s report and documentary evidence suggested that a person within Deloitte was to liaise with Ms. Shaw while she was preparing her compilation. This person was never identified in the evidence.

[575] Mr. Richmond said his reading of Ms. Shaw’s report suggested to him that she had performed “some sort of analysis and concluded that there were $303 million of provisions that were so-called no longer required”. Mr. Richmond stated that there would be a need to review whether that was an accurate statement. He said it would have to be reviewed carefully with many different people to find out whether $303 million was the correct number. After that had been done, consideration would be given to the appropriate way of returning the $303 million to Nortel’s profit and loss account.

[576] I am satisfied that, while Ms. Shaw’s report would require follow-up, it would not support, as the Crown suggested, a restatement of Nortel’s previously-published financial statements. Mr. Richmond testified that restatements are a serious matter. Obviously, an unverified internal compilation could not provide the basis for the restatement of previously-published financial results.

[577] Mr. Michael McMillan was asked, in 2004, to follow-up on Ms. Shaw’s report. The purpose of this project was, in part, to find out what happened to the reserves that had been identified by Ms. Shaw’s October 2002 report as no longer required and available for release

[578] Prior to preparing his report, Mr. McMillan met with Ms. Shaw, reviewed her original mandate and located the templates upon which she relied. Mr. McMillan requested the business units to locate all documentation which they had used to satisfy Linda Mezon’s original e-mail requesting information.

[579] Mr. McMillan developed a template for the business units to use in determining what happened to the forecasted balances. Mr. McMillan consolidated the submissions from the various business units and reviewed his report with Deloitte & Touche.

[580] Mr. McMillan reported on March 26, 2004. Mr. McMillan provided a copy of his report and an explanation to the law firm of Wilmer Cutler Pickering which, along with Huron Consulting LLP, was reviewing on behalf of the Audit Committee the reasons why Nortel had to restate some of its prior published financial statements.

[581] By March 26, 2004, the accused had been virtually suspended. There was no suggestion that they played any role in the preparation of Mr. McMillan’s report.

[582] As far as Corporate and Non-op were concerned, Mr. McMillan came to the following conclusions:

Corporate

• the forecasted releases were mainly specific and traceable; only $1 million was unidentified;

• $7 million in forecasted real estate releases were, subsequent to Ms. Shaw’s Compilation, found to be supportable accrued liability balances and not released; $1 million of this balance was used.

• $1 million release dealing with a supplier bankruptcy was determined to be valid and released in Q4 2002;

• $4 million out of $15 million accrued on account of asset shrinkage was released in Q4 02 and the remainder was reclassified;

• $5 million which had been accrued on account of late terminations was released in Q1 2003;

• $5 million accrued as a specific Controller’s provision was not released in 2002 or 2003; this accrual was re-profiled during the Second Restatement;

• $1 million accrued on account of annual report printing was released in Q3 2002 and this was found to be a valid release;

• $28 million accrued on account of dispute resolution was released in Q3 02 and this was determined to be a valid release;

Non-Op

• $20 million on account of Intercompany Out Of Balance was released in Q3 2002 and reversed to Q4 2001 in the First Restatement;

• $20 million could not be linked to a specific balance and was, therefore, categorized as unidentified.

[583] Mr. McMillan indicated that a portion of the forecasted releases in the original study were not linked to specific provisions and, for that reason, it was necessary to go back to the business units to determine whether the forecast was in relation to a specific provision or a basket of provisions.

[584] Mr. McMillan determined that $222 million of the $303 million was released in Q3 2002 and Q4 2002. Specifically, he determined that $146 million in releases occurred in Q3 2002; $76 million in releases occurred in Q4 2002. No witness testified that the release of this $222 million was material to Nortel’s 2002 financial results.

[585] As originally calculated Nortel lost $1.8 billion in Q3 02 and $250 million in Q4 02. Nortel lost approximately $3.6 billion in fiscal 2002. These releases to income were not material to Q3 02, Q4 02 or fiscal 2002 financial results.

[586] In addition to carrying out the specific task of preparing this accrued liability analysis, Ms. Shaw had ongoing responsibilities for reporting on the status of accrued liabilities in Corporate and Non-op. As a result, she was able to confirm that $20 million of the $66 million was released in Q3 2002 to Nortel’s profit and loss statement. This $20 million would have favorably impacted earnings. I attach no significance in terms of the accuracy of Nortel’s financial statements to the release of these excess provisions in Q3 2002 because Nortel lost $1.8 billion in Q3 2002.

[587] Mr. McMillan determined that $10 million in releases occurred in Q1 2003 and $14 million in releases occurred in Q2 2003. No further evidence was led concerning these releases and I am unable to determine whether they were released in the normal course of business or otherwise.

[588] Mr. McMillan concluded that $57 million in releases were either not released or so vaguely described in Ms. Shaw’s report that they could not be identified.

[589] Ms. Shaw testified that she thought Mr. McMillan’s conclusions concerning her report were accurate.

[590] The release of this $303 million in accrued liabilities would not be cash impacting but would favorably impact earnings by $303 million. The entire $303 million would not be material to Nortel’s 2002 balance sheet or profit and loss statement. In 2002, Nortel had approximately $5.2 billion in liabilities on its consolidated balance sheet. Nortel’s consolidated profit and loss statement for 2002 reported losses of $3.6 billion.

Q4 2002 Conclusion

[591] I am satisfied that Mr. Gollogly did not accept Mr. Harrison’s assertion on January 6, 2003 that Nortel’s pro forma gain before taxes on that date was $73 million.

[592] I am satisfied that Mr. Gollogly was quite right to be skeptical about this result because Mr. Harrison had made a $59 million error on the revenue side in his January 6 calculation.

[593] I am satisfied that Mr. Harrison and Mr. Gollogly, with the knowledge and consent of Mr. Dunn and Mr. Beatty, were attempting to manage Nortel’s financial results in this quarter for the following reasons:

• First, the Wireless business unit, for which Mr. Kinney was the Vice-President Finance, had achieved its stretch target of $70 million. It is not logical that Mr. Kinney would be asked to go over his results to see if he had made any errors or if there were risks for which he wanted to provide unless the intention was to negatively manage the pro forma gain which Mr. Harrison had reported;

• Second, all of the persons solicited by Mr. Harrison or Mr. Gollogly were only asked to provide additional accrued expenses/liabilities. They were not asked if there were any positive impacts to income which they had erroneously failed to report.

[594] However, it is clear that Mr. Harrison erroneously included $59 million in his revenue calculation. It is also clear that the 360 Networks’ late entry accrued liability expense/liability of $50 million is unchallenged. These two required adjustments (totaling $109 million) turn Mr. Harrison’s forecasted earnings before taxes into a loss.

[595] In the same vein, if I consider Mr. Harrison’s erroneously calculated pro forma gain of $73 million as a starting point and then account for the negative impacts of the $59 million revenue error and the $176 million in late entries of accrued expenses/liabilities, the pro forma loss before taxes should have been greater than the $62 million which Nortel reported in its January 23, 2003 press release. Accordingly, there must have been positive impacts to Nortel’s pro forma gain (loss) which are not clear from the evidence. In short, there must have been other changes to Nortel’s pro forma calculations which are not apparent from the evidence.

[596] I am not satisfied Nortel’s pro forma financial results for Q4 02 were correctly reflected in Mr. Harrison’s January 6 Outlook calculation.

[597] I am not satisfied that Nortel had pro forma earnings before taxes in Q4 02.

[598] The evidence does not establish that Nortel’s published Q4 02 pro forma $62 million loss misrepresented Nortel’s Q4 02 financial results.

[599] When I consider all the evidence, including the evidence to which I have made specific reference, I am not satisfied beyond a reasonable doubt that the accruals solicited by Mr. Harrison and recorded in Q4 02 resulted in a misrepresentation of Nortel’s US GAAP financial results for Q4 02 or fiscal 2002.

[600] I am not satisfied that Nortel’s financial results for Q4 02 were misrepresented due to the solicitation of late entry accrued liability expenses/balances.

[601] I am satisfied that $222 million of the $303 million identified by Ms. Shaw in 2002 as provisions no longer required and available for release were, in fact, released in Q3 02 and Q4 02. I am also satisfied that a portion of the $57 million identified as unreleased was so noted because it could not be identified and, therefore it cannot be determined whether those unsupported provisions were released or not in 2002 or 2003.

[602] I am not persuaded that the release of these accrued liability balances in Q3 02 and Q4 02 materially misrepresented Nortel’s financial results in those periods or for the fiscal year 2002.

[603] The circumstances surrounding the $10 million released in Q1 2003 and the $14 million, released in Q2 2003 were not disclosed in the evidence. I am not satisfied that those releases misrepresented Nortel’s financial results in Q1 03 or Q2 03.

[604] I am not satisfied beyond a reasonable doubt that the manner in which Nortel dealt with the $303 million in accrued liability balances identified by Susan Shaw as no longer required and available for release in her October 2002 compilation misrepresented Nortel’s financial results in Q4 02, fiscal 2002, Q1 03 or Q2 03.

Q1 03 & Q2 03

The release of $361 million in Q1 03 and $372 million in Q2 03

[605] Quantitatively, Nortel released $361 million in accrued liability balances to its profit and loss statement in Q1 03. The Crown contends that, in its original filings, the accused, on behalf of Nortel, falsely represented that these accruals were in the normal course.

[606] Included in the $361 million and accrued liability balance releases were $80 million in accrued liability balance releases relating to Non-op. The Crown contends this $80 million was improperly released and, further, that the motive for the improper $80 million release was the desire on the part of the accused to qualify for a bonus and to meet previously-published financial targets.

[607] Mr. Cleghorn, the Chair of the Audit Committee, testified that he thought that, apart from the $80 million, the balance of the $361 million in releases was in the normal course.

[608] The first restatement reviewed the release of these accrued liability balances and determined that $111 million of these balances should be restated. The Crown contends that this underestimated the extent of the problem because, during the second restatement, an additional $106 million was identified and re-profiled or restated.

[609] The Crown contends that the combined effect was that $218 million was restated and that this demonstrates, along with other evidence, that the $361 million was not in the normal course and that the first restatement was not comprehensive.

[610] Quantitatively, Nortel released $372 million in accrued liability balances to its profit and loss statement in Q2 03. The Crown contends that, in its original filings, the accused, on behalf of Nortel, falsely represented that these accruals were in the normal course.

[611] The first restatement reviewed the release of these accrued liability balances and determined that $105 million of these balances should be restated. The Crown contends that this underestimated the extent of the problem because, during the second restatement, an additional $105 million was identified and restated.

[612] The Crown contends that the combined effect was that $210 million was restated and that this demonstrates, along with other evidence, that the $372 million was not in the normal course and that the second restatement was not comprehensive.

[613] The Crown’s expert did not express an opinion consistent with the Crown’s contention.

[614] The Crown attempted to demonstrate the financial effect of the $361 million in Q1 03 and the $372 million in Q2 03 by means of a chart which it constructed and which was received as Exhibit 42E. Mr. Harrison confirmed the entries in the Exhibit reproduced the entries in his Outlooks. Mr. Chambers expressed no opinion concerning this chart.

The Crown’s Chart – “operations” Ex. 42E

[615] It is necessary to make an observation about Exhibit 42E in order to avoid its misapplication in this trial.

[616] The Crown introduced this chart which it had prepared; the chart was based on Mr. Harrison’s Outlooks and Roadmaps (forecasts). Mr. Harrison confirmed that the entries in the Exhibit reproduced entries in his Outlooks.

[617] There is a column in the chart marked “Operations”. I attach no weight to this column. To the extent that the Operations column was intended to describe positive or negative net income from the actual operations of the business units, I find it to be unreliable.

[618] Mr. Harrison indicated Operations for him was something that he tracked. It was a metric he created; it was a metric to show the earnings, excluding the positive impact of the release of accrued liabilities to the profit and loss statement.

[619] The evidence established that, in order to calculate net income from a business unit’s operations or its normalized results for a particular quarter, one had to eliminate both the positive impacts of releasing accrued liability balances to the profit and loss statement in that quarter and the negative impacts of setting up accrued expenses/ liabilities in that quarter.

[620] An example of this calculation for the Wireless business unit is found in Exhibit 42G. The analysis starts with the actual results for the period Q4 02; that is $46 million. According to Exhibit 42G, Wireless set up $196 million worth of accrued expenses/liabilities in Q4 02 which had a negative impact on its net income of $196 million. According to the Exhibit, Wireless released $181 million in accrued liabilities in Q4 02 to its profit and loss statement which had a positive effect on its net income of $181 million. To determine Wireless’ “normalized results”, both of these impacts must be eliminated. The net effect of this calculation is that net income is increased by $15 million.

[621] Accordingly, as described in Exhibit 42G, the normalized result for Wireless in Q4 02 is $60 million approximately.

[622] A comparison with Mr. Harrison’s calculation reveals why this aspect of the Crown’s chart is unreliable. Mr. Harrison’s calculation only involved eliminating the positive impact of the release of $181 million. Mr. Harrison confusingly called this metric which he had created “Operations”. Applying Mr. Harrison’s methodology leads to a net loss in his “Operations” metric of $135 million.

[623] Confusing Mr. Harrison’s metric with the normalized results for the Wireless business unit leads to the erroneous conclusion that Wireless lost $135 million on account of its Operations when, in fact, Wireless enjoyed a $60 million gain on operations.

[624] To the extent that the Operations column in the Crown’s chart was intended to describe positive or negative net income from actual operations, it is unreliable. I attach no weight to Mr. Harrison’s Operations metric. Mr. Harrison’s Operations metric does not accurately establish operational losses at any time during the time-frame of the indictment.

[625] The evidence established that, in Q1 03, Nortel’s set-up $1.1 billion in accrued liability balances and released $361 million in accrued liability balances to the Q1 03 profit and loss statement.

[626] The evidence established that, in Q2 03, Nortel set up $1.2 billion in accrued liability balances and released $372 million in accrued liability balances to the Q2 03 profit and loss statement.

[627] This activity with respect to accrued liability balances was fully-disclosed to Nortel’s Audit Committee by Mr. Gollogly.

[628] I propose now to comment on certain specific releases which were disclosed in the evidence.

The PWC release – $19 million-originally released Q1 03

[629] This release was specifically referred to in the Wilmer Cutler Pickering Review. It was part of a list of fourteen items listed in the review that the authors said required further study. Each of these items was, according to Mr. Kerr, analyzed from cradle-to-grave. According to Mr. Kerr, this meant an analysis of the accrued liability balance from the moment it was established. Any activity in the accrued liability balance was specifically considered.

[630] This accrued liability balance was released to the profit and loss statement in Q1 03. Accordingly, it is part of the $361 million in accrued liability balances in Q1 03 which the Crown maintained were not in the normal course. The PWC release was not restated in the first restatement. It was specifically identified in the Wilmer Cutler Pickering review. It was then analyzed from cradle-to-grave during the second restatement.

[631] Some context is helpful in considering this accrued liability balance.

[632] In April 2000, Nortel outsourced certain services to PWC. In 2002, Nortel decided to bring these services in-house. An accrued liability balance in the amount of $19 million was set up to account for certain disputed invoices between Nortel and PWC.

[633] The repatriation of the services was substantially completed in December 2002. The Final Close of the Disengagement Agreement between Nortel and PWC occurred on January 17, 2003.

[634] Nortel originally released the $19 million PWC accrued liability balance to its profit and loss statement in Q1 03, the quarter in which the Disengagement Agreement closed.

[635] On April 13, 2004, Nortel received legal advice from its senior counsel. This advice was to the effect that closings of the disengagement agreement for all locations, other than those in France, were completed before December 31, 2002. It was counsel’s opinion that no claims against Nortel could originate from the French locations, despite the fact that the closing of the disengagement agreement with respect to locations in France did not take place until January 17, 2003.

[636] Upon receiving this legal opinion in April 2004, Deloitte decided that the $19 million accrued liability balance should be restated from Q1 03 to Q4 02. Deloitte was also of the view that the legal opinion of April 13, 2004 did not represent new information and, as a result, the failure to originally release the $19 million accrued liability in Q4 02 was classified as an error.

[637] The $19 million was restated to Nortel’s Q4 02 profit and loss statement.

[638] As can be seen from the details of this release, the original set-up of the release properly recorded an accrued liability.

[639] I am not satisfied that the release in Q1 03, as opposed to Q4 02, can fairly be classified as false. I am not persuaded that the failure to restate this accrued liability balance release in the first restatement demonstrates that the first restatement was not comprehensive or a continuation of the fraud alleged in this indictment. I am satisfied that the release in Q1 03 is exactly what Deloitte said it was: namely, an error. Furthermore, it was an error that is understandable once the facts are known.

[640] Finally, it has not been demonstrated that the accused were, in any sense, responsible for this error or the failure to consider the error in the first restatement.

The Genuity release – $23 million originally released Q1 03

[641] This is another accrued liability that was originally released in Q1 03. It was part of the $361 million in total releases for that quarter. It was not restated during the first restatement.

[642] It was also identified by Wilmer Cutler Pickering as a release which should be reviewed and, as such, was subject to “cradle-to-grave” reconsideration.

[643] Some context is helpful in considering this accrued liability balance.

[644] Nortel had several claims against Genuity, totaling approximately $156 million. Genuity alleged that Nortel was liable for substantial claims arising out of their business relationship. Specifically, Genuity alleged that Nortel had supplied defective equipment, had resiled from a guarantee and, finally, that Nortel was liable to Genuity for contributions to a joint development and marketing fund.

[645] Genuity filed a petition for re-organization under the US Bankruptcy Code in November 2002. At the same time, Genuity proposed to sell all of its assets free and clear of pre-existing claims to an arm’s length third-party purchaser.

[646] The arm’s length purchaser received permission to purchase Genuity’s assets in Q1 03 and the $19 million accrued liability balance was released to Nortel’s profit and loss statement.

[647] Nortel’s counsel advised that part of Genuity’s claim was well-founded in its opinion. Nortel and Genuity reached a settlement at the end of Q2 03. Nortel’s counsel was of the view that the settlement would not be approved by the Bankruptcy Court because they believed it would be opposed by others interested in Genuity’s bankruptcy. However, there was no opposition to the settlement and the Bankruptcy Court approved the settlement in Q3 03.

[648] During the second restatement, the release was reviewed. The opinion of the Deloitte reviewers was that the Q1 03 release was appropriate. However, the U.S. National Office of Deloitte & Touche overruled the Deloitte reviewers and required that this conclusion be changed. Deloitte’s U.S. national office required that the $23 million release in Q1 03 be classified as an error on the basis that the release should have occurred in Q2 03 instead of Q1 03.

[649] This release also undermines the position taken by the Crown with respect to the Q1 03 and Q2 03 releases. The Genuity release reveals that the $23 million released in Q1 03 was restated into Q2 03. The Crown’s submission is undermined because it only takes into account releases that were restated out of Q2 03; it ignores the releases that were restated into Q2 03. This same observation applies to Q1 03. The Crown’s submission does not take into account those releases restated into Q1 03.

[650] Finally, the specifics of this accrued liability balance indicate that it was restated because Deloitte, in essence, disagreed with itself.

[651] There is no evidence that would permit me to conclude that any or all of the accused were responsible for this error or for the failure to restate it in the first restatement.

The Optical Warranty release – $8 million released in Q2 03

[652] In Q1 2001, the Optical Warranty accrued liability balance became underfunded by $21 million. Adjustments were made to the balance in 2001 and 2002. These adjustments reflected changes in the standard costs for the Optical Network Repair Group. The problem was that customers were using the warranty at a higher rate than had been used to calculate the accrued liability balance. In other words, the accrued liability balance on account of the Optical Warranty was not adequate.

[653] However, during the first half of 2002, it was discovered that the Optical Network Repair Group’s standard costs, which were used to record warranty usage, were overstated by about 64% in 2001. This problem was corrected in Q2 02. This meant that the accrued liability balance for Optical Warranty was overfunded; however, the accrued liability balance remained overfunded because of the Optical Networks management team did not have confidence in its data.

[654] By Q2 03, there was twelve months’ usage data available. Accordingly, the accrued liability balance for the Optical Warranty was reduced by $8 million in Q2 03.

[655] The $8 million reduction in the Optical Warranty accrued liability balance was reviewed and confirmed during the first restatement. It was the opinion of Deloitte during the first restatement that the $8 million change was due to a change in estimate.

[656] The $8 million with which we are concerned was considered again during the second restatement because it was specifically mentioned in the Wilmer Cutler Pickering review.

[657] In April 2004 during the second restatement, the decision that the $8 million was released to income as a result of a change in estimate and, therefore, in accordance with US GAAP. The release was confirmed again.

[658] However, for reasons that are not clear, the matter was reviewed yet again in October 2004. This time it was decided that the Optical Warranty model that was used in arriving at the decision to release $8 million to the profit and loss statement was, itself, inherently flawed. The model was inherently flawed because it had not been revised to reflect the significant changes that had taken place in the Optical business unit’s environment in 2001 and 2002. Accordingly, a New Warranty Model was developed. This new model was applied retroactively to 1999.

[659] Accordingly, the $8 million Q2 03 release was determined to be an error. In addition, the new Warranty Model was applied to all changes in the Optical Warranty accrued liability balance from 1999 to 2003. The changes which had taken place in the Optical Warranty accrued liability balance from 1999 to 2003, based on the old model, were determined to be errors as well.

[660] A consideration of the specific details surrounding the restatement of this accrued liability balance leads to the conclusion that the decision to restate was taken based on a New Warranty Model which did not exist in Q2 03. The new model did not exist when the accused were employed at Nortel.

[661] The evidence does not demonstrate that the accused had any role in the decision to release this accrued liability balance in Q2 03 or any knowledge that the old warranty model was flawed.

Conclusion

[662] The specific releases to which I have referred demonstrate that the decision to restate on account of an error can be the same thing as saying that there was a decision to restate on account of a difference of opinion.. Clearly new information can affect the decision to restate. Arguably hindsight can be a factor in the decision to restate.

[663] I agree with the Crown that the fact that accrued liability balances were restated is capable of supporting an inference that financial results were misrepresented, but I am not persuaded by the evidence which I have heard that I should draw such an inference in this case.

[664] As a result, I cannot give effect to the Crown’s submissions concerning the inferences I should draw from the fact that original Q1 03 and Q2 03 accrued liability balance releases were restated.

[665] I am not satisfied beyond a reasonable doubt that the three accused misrepresented Nortel’s Q1 03 and Q2 03 financial results by releasing to income $361 million and $372 million respectively in accrued liability balances. Further I am not satisfied that the original release to income of $361 million and $372 million misrepresented Nortel’s financial results.

The release of $80 million in Non-op accrued liability balances and the entitlement to a bonus

[666] There was no triggering event in Q1 03 that would have justified the release of this $80 million in accrued liability balances to Nortel’s profit and loss statements for Q1 03. This fact was well-known to everyone.

[667] The Crown alleges that the release of this $80 million in Non-Op accrued liabilities to the profit and loss statement in Q1 03 had the effect of changing pro forma losses in Q1 into a profit which resulted in substantial Return to Profitability and Restricted Stock Unit bonuses being paid to all three defendants in May 2003.

[668] Put differently, it is the Crown’s position that, without the release of this $80 million, the profit targets required for the payment of these bonuses would not have been met and none of the accused would have been entitled to a bonus.

[669] It is the Crown’s position that Mr. Hathway was misled when he was informed by either Mr. Gollogly or Mr. Beatty that the Return to Profitability Bonus would have been paid even without the release of the $80 million.

[670] The Crown also alleges that the three accused failed to disclose the fact that there was a direct connection between the $80 million release of accrued liabilities and the payment of these bonuses. Specifically, the release of the $80 million offset the liability ($73 million) associated with paying the Return to Profitability Bonus.

[671] The Crown takes the position that the disclosure in the April 24, 2003 release made it appear as though these two events were unrelated. Specifically, the press release in the Crown’s view failed to draw a direct connection between the $80 million release and the payment of the bonuses (i.e., it did not say that the $73 million RTP Bonus was payable because of the release of the $80 million) nor did the press release mention that the $80 million was related to other excess accrued liabilities; namely $109 million in unsupported accrued liabilities which remained on Nortel’s consolidated balance sheet.

[672] It is also the Crown’s position that Nortel’s SEC filings for Q1 03 obfuscated the nature of the $80 million release.

[673] The Crown also alleges that the release of this $80 million improperly reduced US GAAP losses.

[674] It is the Crown’s position that the improper release of this $80 million resulted in the publication of financial statements which misrepresented Nortel’s financial results.

[675] It is the Crown’s position that even if, based on the Second Restatement financial statements, the bonus milestones would have been met at some point in 2003, the timing of those payments would have been different in the sense that the payments would have been made in different quarters of 2003. The Crown maintains Nortel was at risk when the bonuses were paid based on false results and it does not matter that the bonuses would have been payable later in 2003 based on the restated results for that year.

[676] I have no difficulty in accepting the fact that all three accused knew what targets had to be hit before they were entitled to the Return to Profitability Bonus and the Restricted Stock Unit Bonus. I attach no significance to that fact; it is simply rational economic behavior. The inference is easily drawn from the access that all three accused had access to Outlooks (forecasts), as well as their positions in the company. The evidence was, for example, that Mr. Dunn played a role in deciding the milestones for the Return to Profitability Bonus.

[677] Releasing the $80 million in accrued liabilities to the profit and loss statement was specifically considered by Deloitte & Touche in an internal memo, which appears to have been produced to the Crown on December 23, 2011.

[678] Counsel for Deloitte indicated in the letter producing the memo that it had been previously produced to “other regulators”. Counsel for Deloitte indicated in the letter producing the memo that it was a “desk file”, which apparently means it was never finalized and incorporated into Deloitte’s audit working papers. I infer this information was provided to explain the late production.

[679] Apparently, after the draft memo was turned over to the unidentified regulators, Deloitte was asked a series of questions by one or more of these regulators which they answered. The questions and answers were also turned over to the Crown on December 23, 2011 and produced in this trial as business records of Deloitte & Touche.

[680] The trial in this matter commenced in January 2012. The authors of the memo, Diana De Acetis, Peter Chant and Chris Allen, were not called as witnesses.

[681] It is trite that business records are capable of proving the facts contained within them. I am not required to find that these business records or any other business records prove the facts contained in them. However, I found this business record to be particularly helpful, despite the fact that it was a “desk file.”

[682] The draft memo to the Nortel Networks Corporation file of Deloitte & Touche LLP was primarily written by Diana De Acetis. However, during the course of the drafting of the memo, Ms. De Acetis received significant content and input from two other Deloitte accountants, namely, Peter Chant and Chris Allen. Tony Ciciretto assisted by providing information to Ms. De Acetis, but was not otherwise directly involved in the memo’s preparation. In addition, according to the memo’s introduction, Don Hathway, John Cawthorne and others reviewed the memo. It appears from Exhibit 11 tab 42 that Mr. Hathway also provided information to Ms. De Acetis, Mr. Chant and Mr. Allen prior to the preparation of the memo.

[683] When Ms. De Acetis prepared this memo, she was a senior manager in Deloitte’s Complex Accounting and Transaction Expertise Group. As a member of that group, Ms. De Acetis had provided technical assistance and advice to members of the Nortel engagement team in respect of a number of issues which had arisen during the course of the quarterly reviews in Q1 and Q2 2003.

[684] Ms. De Acetis reported to Peter Chant. Mr. Chant was a partner and practice group leader of the Complex Accounting and Transaction Expertise Group. Mr. Chant was not a member of the engagement team that performed Deloitte’s audits or quarterly reviews at Nortel in Q1 and Q2 2003. However, like Ms. De Acetis, he provided technical assistance and advice to members of that engagement team from time to time in respect of a number of issues that arose in connection with the Q1 and Q2 2003 quarterly reviews.

[685] Chris Allen was a partner at Deloitte, who worked on the Nortel engagement during the Q1 and Q2 2003 reviews. Mr. Allen was a senior member of the Deloitte engagement team for Nortel.

[686] Tony Ciciretto was, during the Q1 and Q2 2003 reviews, responsible for supervising Deloitte’s review work in respect of Nortel’s Corporate Analysis and Consolidations Group in Brampton. Mr. Ciciretto’s name appears on very many e-mails which were received in evidence as business records. I infer from the documentation that Mr. Ciciretto was a senior member of the Nortel engagement team. Mr. Ciciretto was not called as a witness.

[687] According to the information provided to the Crown by Deloitte, the memo was created because, in April 2003 during the course of performing its review work, Deloitte’s engagement team noted that Nortel had released $80 million in accrued liabilities. Deloitte’s engagement team identified a number of documentation and support issues with respect to these accrued liabilities. In late June or early July 2003, Deloitte’s engagement team became aware that Nortel intended to release in its financial results for Q2 03 a number of additional accrued liability balances which were no longer required on Nortel’s balance sheet. Once again, the engagement team identified documentation and support issues. Based on Deloitte’s advice, Nortel did not release these accrued liabilities to the profit and loss statement.

[688] As a result of these documentation and support issues, Diana De Acetis was asked to conduct a review of Nortel’s release of the $80 million in accrued liability balances to the profit and loss statement in Q1 2003 to determine whether these releases were appropriate under US GAAP. I should add here that, in terms of topic and timing, this is an extremely pertinent inquiry.

[689] According to the information provided to the Crown, Ms. De Acetis obtained background information from Mr. Ciciretto and other members of the Deloitte engagement team for Nortel. Ms. De Acetis prepared an initial draft of the memo in July 2003 and then received comments from Chris Allen and others. Further drafts were generated during July and August. In September, Ms. De Acetis received further comments from Peter Chant. By late September or early October 2003, work on the preparation of the draft memo itself was halted.

[690] The draft memo bears the date of July 15, 2003. At this point according to the evidence, it was clear to Deloitte that Nortel had unsupported accrued liabilities on its balance sheet and that a Comprehensive Balance Sheet Review was required.

[691] The draft memo identified six corporate level provisions totaling $80 million, which Nortel determined in Q1 2003 were no longer required or which could not otherwise be justified on its balance sheet at their current balances. In addition to itemizing these accrued liability balances, the memo set out when the accrued liabilities were recorded, the reason for initially recording them and the reasons and support for their reversal in Q1 2003.

[692] The memo concluded that $6 million worth of releases resulted from a change in estimate triggered in Q1 2003. Therefore, the release of this $6 million was entirely in accordance with US GAAP.

[693] The memo concluded that the remaining five accrued liability balances totaling $74 million could not be supported. Of this amount, two of the balances, EDSN ($9 million) and Capital Tax ($10 million), had been recognized as errors in the year in which they were created, that is 2002, and so their release in Q1 2003 was considered to be the correction of an error.

[694] The memo concluded that the remaining three accrued liability balances released to the profit and loss statement in Q1 2003; namely, Intercompany Out Of Balance ($35 million), QST ($5 million) and Short Close ($15 million) were errors, although the memo specifies that a portion of the Short Close release in Q1 2003 was in accordance with US GAAP.

[695] The memo then spends three pages analyzing whether the releases were material to the Q1 2003 financial statements. The analysis references Staff Accounting Bulletin 99 of the SEC, which has been referred to repeatedly during this trial, as the foundation for a materiality analysis. No materiality expert testified during the trial. The Crown’s expert did not comment on the materiality analysis in this memo.

[696] The memo concluded that “the reversal of the provisions was not considered on a qualitative and quantitative basis to be material to Nortel’s financial statements for Q1 2003…”

[697] One of the tests for materiality which is set out in Staff Accounting Bulletin 99 is whether the misstatement “changes a loss into income or vice versa”. Accordingly, the memo re-calculates Nortel’s net income for Q1 2003, excluding the effects of the release of the $80 million in accrued liability balances to the profit and loss statement. The memo concludes, after making the appropriate accounting adjustments that Nortel would have had net income of $2.2 million without the benefit of the release of the $80 million to income. The memo concludes that this net income of $2.2 million would have been earned after allowing for payment of the Return to Profitability Bonus and the Success Plan Bonus. The Success Plan Bonus was the performance-based bonus for a large portion of employees. Accordingly, the release of the $80 million did not turn a loss into a profit.

[698] More specifically, the memo concludes, in an Appendix, that the Return to Profitability Bonus target is achieved whether the $80 million in accrued liability balances is released to the profit and loss statement or not.

[699] The memo also concludes that the Success Plan Bonus earnings, revenue and cash flow targets are met whether the $80 million in accrued liability balances is released to the profit and loss statement or not.

[700] Thus, the memo concludes that the thresholds for these two bonuses would have been met whether or not the $80 million in accrued liability balances is released to the profit and loss statement.

[701] The memo, which was received as Exhibit 251D, is quite thorough. It analyzes six specific accrued liabilities totaling $80 million and it calculates the financial state of affairs relevant for our purposes that would have existed had the $80 million remained on the balance sheet of Nortel instead of being incorporated into its profit and loss statement.

[702] Mr. Harrison testified that he did not calculate the Return to Profitability Bonus plan target in the same fashion as Deloitte & Touche. His evidence in this regard was not particularly helpful.

[703] A review of the minutes of the Human Resources Committee of the Board of Directors of Nortel Networks Corporation, known in Nortel speak as the Joint Leadership Resources Committee (“JLRC”), demonstrates that the bonus target for the Return to Profitability Bonus is to be calculated using Nortel’s method in 2002 of calculating pro forma gains before taxes.

[704] The only issue is whether Deloitte’s calculation is consistent with that definition. The lack of similarity between Mr. Harrison’s method of calculating the target for the Return to Profitability Bonus and Deloitte’s method is of no assistance.

[705] Deloitte’s calculation is contained in one of the Appendices to the memo. The only way to describe this Appendix is by the document number, DT 601338. The Appendix has two purposes: its first stated purpose is to evaluate the effects of the release to income of $80 million of accrued liability balances in Q1 03 on Nortel’s ability to achieve the Return to Profitability Bonus and Success Plan Bonus thresholds. In this memo, the release of accrued liability balances to the profit and loss statement is described as the “reversal of provisions”. The second stated purpose is to evaluate the effects of the reversal of these provisions reported on net income for Q1 03.

[706] As a result, this Appendix addresses two important issues in this trial.

[707] The first calculation concludes that the Return to Profitability Bonus target is met with and without the release of the $80 million. The calculation is plainly set out. It starts with Nortel’s loss from continuing operations as reported and then adjusts for the pro forma items that are called for by the 2002 definition of pro forma income; namely, the amortization of acquired technology, stock compensation expense, special charges, and gains on the buyback of bonds. It then adjusts for the cost of the bonuses and arrives at positive pro forma gains before taxes of $161 million. It then adjusts or subtracts the $80 million with which we are concerned and it concludes that the Return to Profitability Bonus target is met.

[708] Mr. Dans testified about this calculation, although I found his evidence to be vague. He agreed with the adjustment for the amortization of acquired technology, stock compensation, special charges and gains on the buyback of bonds. To the extent that he said that Deloitte, in this Appendix, did not adjust for the cost of the Return to Profitability Bonus, he was in error. If I misunderstood Mr. Dans’ evidence, it does not matter because the Deloitte calculation did adjust for the cost of the bonus.

[709] Deloitte included in its calculation two positive adjustments totaling $28 million. Mr. Dans did not agree with these adjustments. It does not matter. Assuming Mr. Dans is correct, pro forma gains before taxes are $133 million. If I had to decide this matter, I would prefer the Deloitte analysis in the Appendix to Mr. Dans’ conclusory statement.

[710] The Appendix then considers the Success Bonus Plan which had three targets: an earnings target, a revenue target and a cash flow targets. Deloitte, in this memo, concluded that all three targets were met with or without regard to the $80 million with which we are concerned.

[711] I observe here that the Restricted Stock Unit Bonus Plan, with which we were also concerned in this trial, is not referred to in this memo. It was never suggested that a threshold for this bonus plan was achieved in Q1 03.

The effect of the $80 million on earnings

[712] The appendix then considers the effect of the $80 million with which we are concerned on reported earnings. It concludes that Nortel achieved positive earnings with or without the $80 million. This calculation appears on document DT 601339. Mr. Dans did not comment on this calculation.

[713] Apart from the calculation’s conclusion, the analysis contains a note dealing with foreign tax credits. The note reveals that the authors of this memo participated in a conference call with a person identified as John Van Oglrop. The purpose of the call was to obtain clarification about certain foreign tax credits. It appears that a foreign tax credit, which had been recorded as a recoverable asset, had been written off in Q1 2003 and it should have been written off in 2002. This meant that the accrued liability balance for foreign tax credits was overstated by $20 million in Q1 2003 and understated in 2002. The note is interesting because it demonstrates the thoroughness with which the authors of this desk memo approached their task.

Conclusion concerning the Bonus Payments & earnings

[714] I am satisfied that the Return to Profitability Bonus was payable in Q1 2003 with or without the release of $80 million in Non-op accrued liability balances. I am satisfied that the Success Plan Bonus was payable with or without the release of $80 million in Non-Op accrued liability balances. The Restricted Stock Unit Bonus Plan was not an issue in Q1 03.

[715] I am satisfied that Nortel achieved net US GAAP income in Q1 03 with or without the $80 million.

[716] I am satisfied that Mr. Hathway was not misled when he was told by either Mr. Beatty or Mr. Gollogly that the Return to Profitability Bonus would have been paid with or without the release of the $80 million in Non-op accrued liability balances.

[717] I am not satisfied that the accused used Non-op “cookie jar” accrued liability balances to manage earnings and permit the payment of a bonus in Q1 03.

[718] I am not satisfied that the inclusion of the $80 million with which we are concerned in Nortel’s profit and loss statement for Q1 03 misrepresented Nortel’s financial results.

The materiality of the release of $80 million of Non-op accrued liability balances

[719] Ms. De Acetis, Mr. Chant and Mr. Allen considered whether the $80 million in Non-op accrued liability balances, which were released to Nortel’s profit and loss statement in Q1 03, were material to the Q1 03 financial statements.

[720] Notwithstanding the fact that this is entitled a draft memo, the materiality analysis is instructive.

[721] The memo concluded that, from a quantitative perspective, the $80 million was material because the materiality threshold used for Deloitte’s Q1 03 audit review was $14 million. These authors noted that the $14 million threshold was calculated in accordance with the stated policy of the Deloitte & Touche firm.

[722] The authors then considered whether the $80 million was material from a qualitative perspective.

[723] Staff Accounting Bulletin 99 of the SEC mandates both a quantitative and qualitative analysis prior to a materiality determination.

[724] No materiality expert was called during the trial.

[725]