Once Canada’s Technology Darling, Nortel Now Heads to Court

Only two weeks into the New Year, 2012 is already shaping up to be a watershed year for corporate citizenship in Canada. This week, the Ontario Superior Court of Justice will hear the case of the biggest corporate flameout in Canadian history, starring Nortel Networks Corp [Nortel]. Pre-trial motions started last week in the criminal trial against three former Nortel executives: Frank Dunn, the former chief executive officer; Douglas Beatty, the former chief financial officer; and Michael Gollogly, the former controller.

The charges include fraud affecting a public market, falsifying books and documents and issuing a materially wrong prospectus. The RCMP alleges that their crimes cost shareholders billions of dollars and contributed to the downfall of other Canadian corporations. Media spectacle aside, this case may be a pivotal moment in how the Canadian legal system tackles commercial crimes. Much to the chagrin of former investors and the public at large, these executives may be responsible for the demise of Nortel, but they may not be held accountable for it in the eyes of the law.

Nortel was once an industry leader in optical networking technology. Now, it may be at the centre of one of the biggest financial scandals in Canada – possibly in the world. Frank Dunn took the reigns of Nortel in 2001 following a period in which its stock price plunged and profits dwindled. Essentially, the RCMP charge him with ‘cooking the books,’ so as to make the situation seem less dire and ultimately to assuage the fears of investors. Specifically, they allege that in 2003 and 2006 Nortel egregiously misstated its early earnings. Not only did it force Nortel to ultimately seek creditor protection, but it also cost Canadians billions of dollars.

In terms of the law, this case is remarkable because it underlines how the Canadian legal system really struggles to persecute commercial crime. The RCMP first laid charges against Dunn in 2009; it has taken four years for the case to reach court. One reason for the delay is the nightmarish evidentiary load. For example, in 2009, the RCMP delivered four million documents to the defense as part of its disclosure. Not only is this amount of documents difficult to handle by the courts, but it also makes it difficult for the prosecution to build a case and to come out on top.

As a result of these evidentiary issues surrounding the investigation and prosecution of serious Criminal Code capital market fraud offences, the RCMP, in collaboration with other government parties (e.g. securities regulators), have formed the Integrated Market Enforcement Teams (IMET). IMET is essentially a handful of elite groups tasked to tackle cases of this nature. Since its inception, ten operational IMETs in Canada have charged 42 individuals, of which 10 were ultimately convicted. They have all been on the smaller scale, such as Norbourg Financial Group, a former mutual fund. Nortel is without a doubt IMET’s biggest case.

In our post-Enron and WorldCom world, these low numbers are surprising. Enron and WorldCom were back-to-back scandals in the early 2000s that led to the largest corporate bankruptcy in US history (WorldCom). Further, its highest-ranked employees were swiftly charged, tried, convicted and sentenced to lengthy prison terms. The equivalent of IMET in the US is the United States’ Corporate Fraud Task Force, which was established in 2002. (This group was replaced by another group that carries on the same operations in 2009.) In the last ten years or so, it has convicted nearly 1,300 corporate fraudsters, including 200 CEOs.

The legal structure set up in the US to investigate corporate fraud is not without criticism; it has been criticized for its slow, or lack of, response to the meltdown of the financial markets in 2007. Regardless, one could argue that the US has a much more robust system for punishing commercial crimes than Canada. The question of how Canada would have responded to a Enron-esque scandal was posed to Craig Hannaford, who led a former IMET operation, by Canadian Business magazine: “If we had a similar corporate scandal in Canada, would the RCMP have the capability to investigate effectively?” wondered Hannaford out loud. His answer was simple: no.

Hannaford is not alone in his view of the Canadian system. Al Rosen, a respected forensic accountant, offered a grim prediction: “I suspect it’s going to get screwed up.” There are a number of factors at play. First, the sheer size of the files would overwhelm the operation. There are some 23 million pages of evidence involved in this case. Critics have also pointed to the internal structure of the IMET. It takes years and years of training to meet the demands of the job. Because promotion is often slower and the salaries are lower than those in the private sector, IMET suffers from a low retention rate. There are also complaints that the IMET has poor leadership.

What is most interesting, however, is public perception of corporate crime. One of the IMET’s earlier cases was Royal Group. The judge who heard the case agreed that the executives were to blame. However, Judge Blouin added a further statement: “To view events in [Royal Group’s] life in 1996, for example, through a corporate governance lens 10 years later, distorts the historical record.” Indeed, much has changed between 1996 and 2006 – Enron, WorldCom and the passage of the Sarbanes-Oxley Act in the United States. The growing cynicism toward corporate leadership does not seem like a compelling enough reason to exonerate these fraudsters, though.

Canada has yet to bear witness to a debacle on same scale as Enron or WorldCom. (And one hopes we never do!) This case also comes many years after Nortel’s heyday. Nortel may no longer be part of our national psyche in 2012. Yet Justice Frank Marrocco of the Ontario Superior Court of Justice, who will start hearing the case today, should aim to set the right tone and ultimately send the right message. This may not entail severe punishment for these three executives involved. (The maximum sentence for fraud affecting markets is 14 years imprisonment while falsifying accounts and filing a false prospectus carries a max sentence of 5 and 10 years, respectively).

Rather, it may force our lawmakers to confront this problem and propose a solution. Canada could follow the path blazed by the US: the Sarbanes-Oxley Act of 2002 set new and enhanced standards for publicly traded companies and accounting firms in the wake of Enron’s collapse. As we witnessed with fall of the financial sector in 2007, commercial crime remains a pervasive problem. The case with Nortel provides ample opportunity to address the issue in a meaningful way.