The much-anticipated judgment in R v. Dunn, in which the former CEO, CFO, and Controller of Nortel Networks were prosecuted for fraud in association with inaccuracies in Nortel’s reported financial results, was released on January 12. All three were acquitted.
The use of the Criminal Code (in this case, s. 380, which defines the offence of fraud) to pursue alleged wrongdoing in publicly-listed corporations is relatively rare in Canada, particularly for a business of Nortel’s historic significance (it was, in recent memory, the largest company in the country by market capitalization, a fact noted by Justice Marrocco in his judgment). The lengthy reasons will be considered by lawyers and commentators for their impact on future prosecutions of this type. Predictors may be disappointed, however. The decision in R v. Dunn is a classic example of judicial economy – it is fact-specific, composed with care, and hues closely to the mundane but complex accounting principles governing Nortel’s financials.
Section 380(1) of the Criminal Code sets out the offence of fraud as an act of deceit or falsehood (or some other fraudulent means) causing a deprivation of “any property, money, or valuable security or any service”. The mental element of the offence requires subjective knowledge of the false or deceitful act and subjective knowledge that the consequent deprivation might arise. If these elements are established, the accused is guilty if they intend the deprivation, or are reckless as to its occurrence.
Section 380 was augmented in 2004 with the addition of an offence against the public markets, encapsulated in s. 380(2). This part of the Code was not at issue in this case.
The Crown focused on the presence of excess accrued liability on Nortel’s books. Certain of these liabilities were unsupported by documentation, and were not released to Nortel’s profit and loss statements until the latter quarters of 2003 and thereafter. Much public embarrassment was visited on Nortel at that time, as the company restated its second quarter financials twice. The second restatement was, in the Crown’s contention, a major piece of evidence that the original financials and the first restatement were materially inaccurate. The Crown argued that the two restatements demonstrated that approximately two thirds of Nortel’s first-quarter and second-quarter (2003) accrued liabilities were incorrectly stated. The contention was that accrued liabilities were “unparked” from the balance sheet at beneficial times for the accused.
The Crown alleged that the accused were motivated by the desire to obtain a bonus. In the course of Nortel’s difficulties, certain retention bonuses were put in place to persuade key people not to jump ship. The Court deflated this argument (and hence the deprivation element of the offence) by finding that the bonuses would have been payable regardless of when certain releases to P&L of accrued liabilities were made. The Crown advanced no alternative motive for the offence.
The Court accepted evidence that all three individuals were learned in the accounting practices of Nortel and understood the applicable provisions of US GAAP. All three accused were aware of the accrued liability problem. However, the extent of the issue, being that upwards of $900 million in excessive accrued liabilities existed at a time on the balance sheet, was accepted by the Court as being outside everyone’s comprehension, including Nortel’s auditors and many of the key employees involved in the company’s accounting functions.
Nortel, and the accused, are presented in the judgment as having taken the accrued liability problem seriously. Between the restatements, Nortel undertook (at the advice and direction of its auditors) a comprehensive review of its balance sheet to identify, as best as possible, the full extent of the issue. This activity was conducted against a backdrop of low earnings and a falling share price – the Court noted that Nortel was, at all material times, fighting for its very survival.
The Court demonstrated a high degree of commercial sensibility in its judgment: the missing documentation is accepted as being the unfortunate but unavoidable product of large-scale downsizing in a flagging corporation. The importance of maintaining enough cash to avoid a liquidity event – something that was in evidence as being Nortel’s priority – is treated sympathetically. It was important to stave off insolvency, such that the time of key people was, quite reasonably, precious. Most importantly, the Court parsed the difference between the first and second restatements (being a different threshold of review of the 2003 financial statements, combined with differing opinions among Nortel’s professionals and advisors) effectively and decisively. The Court observed a culture of conservatism at Nortel which generally served to benefit the company’s accounting, but operated to prevent genuine accrued liabilities from being released to profit and loss at the optimum times. It was an unfortunate problem, but certainly not the worst of Nortel’s worries at the time.
The Court’s findings of fact were numerous, but the acquittal rests heavily on the Court’s belief that the accused did not unjustly benefit from the misstatements and worked diligently to resolve the problems Nortel was facing. As there was an acquittal, issues of sentencing were not explored.
No defence witnesses were called. The Court accepted almost all the evidence from the Crown’s witnesses as being reliable and of value. In other circumstances, an acquittal in the face of only good evidence from the Crown would raise eyebrows. R v. Dunn is notable for the fact that the evidence presented could, to paraphrase the Court, just as easily implicate the accused as be exculpatory. The decision may not illuminate corporate criminal legal practice, but it serves as an example of how reasonable doubt is a justifiably high standard.