Three Former Nortel Bigwigs Arrested On Fraud Charges

The Royal Canadian Mounted Police in Toronto arrested ex-CEO Frank Dunn, ex-CFO Douglas Beatty and former corporate controller Michael Gollogly, who were each hit with seven counts of fraud.

The RCMP said the charges include "fraud affecting public market; falsification of books and documents; and false prospectus, pertaining to allegations of criminal activity within Nortel Networks during 2002 and 2003."

The men pleaded innocent and were released on bail.

The U.S. Securities and Exchange Commission and the Ontario Securities Commission separately began investigating the former employees in 2003 after Nortel (based in Toronto with U.S. headquarters in Richardson, Texas) repeatedly restated financial earnings. The SEC filed a civil complaint against the former executives in March 2007.

The SEC said that in all, Nortel went into 2000 with more than $1 billion in revenues through its "improper" use of bill and hold transactions.

The SEC complaint went on to note that beginning in February 2001, Nortel suffered serious losses when it finally lowered its guidance to account for its business losses. As Nortel's business plummeted throughout the remainder of 2001, the company began a restructuring that resulted in cutting its workforce by two-thirds (approximately 60,000) and had significant write-downs of assets. As part of the reorganization, Dunn became Nortel's president and CEO. The SEC said that by the summer of 2002, Dunn publicly announced that he expected Nortel to return to profitability by the second quarter of 2003. That's when more even more trouble was heaped on the company.

"Assisted by defendants Beatty (then CFO) and Gollogly (then controller), Dunn then embarked on a second scheme—the manipulation of Nortel's reserves—to manage Nortel's publicly reported earnings, create the false appearance that his leadership and business acumen was responsible for Nortel's profitability, and to pay bonuses to these three defendants and other Nortel executives."

In April 2004, Nortel terminated Dunn "for cause," and Beatty and Gollogly were also fired. The company was forced to restate financial results back to 2001. The moves panicked Wall Street, and investors dumped shares, which plummeted from more than a hundred dollars to just pennies.

The Toronto Star characterized the scandal as "one of the most spectacular stock market disasters in Canadian history, in which investors lost roughly $300 billion."

"The fraudulent conduct at issue here was egregious and long-running," stated said Linda Thomsen, director of the Commission's Division of Enforcement in the SEC suit. "Each of the defendants betrayed Nortel's investors and their misconduct gave rise to billions of dollars in shareholder losses. The action we take today sends a strong message that officers of U.S.-filing foreign corporations will be held to the same standards of accountability that are required of all participants in the U.S. financial markets."

After facing shareholder lawsuits, Nortel agreed to settle two class-action lawsuits for $2.47 billion in February 2006. Also in 2006, Dunn, Beatty and Gollogly filed suit against Nortel in Ontario Superior Court asserting claims of wrongful dismissal that among other things caused Dunn "mental distress" and sought compensatory, aggravated and punitive damages.

In October 2007, Nortel reached a settlement on all issues with the SEC's investigation of the company's previous accounting practices, and agreed to pay a civil penalty of (US)$35 million. Nortel also said it would provide the SEC with quarterly written reports detailing its progress in implementing its remediation plan.

"This is the latest in a series of checkpoints in Nortel's turnaround, including settlement with the Ontario Securities Commission, the resolution of the shareholder class actions," the company said in a statement.

As far as the arrests of the three men this week, Nortel issued a statement saying that the company has "not been charged and was not the target of this investigation. The company has fully cooperated with the RCMP and will continue to do so. This is in relation to former executives of the company who were dismissed for cause in 2004."

"Nortel is rebuilding a great Canadian company while upholding the highest standards of integrity and ethics. Incredible progress has been made in the last few years, and today a new Nortel is emerging under the leadership of a new management team."