NOT-GUILTY VERDICT FOR NORTEL

The Ottawa Citizen reports that after a year-long criminal trial, a Canadian Superior Court judge has ruled that Nortel’s top three financial executives are not guilty of accounting fraud. The judge read a summary of his 141-page ruling, touching on the Crown’s main allegations — including that executives had deliberately and inappropriately maintained excess accounting reserves they later used to manipulate earnings and generate executive bonuses — and dismissed them one by one.

The Crown has 30 days in which to appeal the verdict, and the Nortel executives also face a series of civil litigations that have been on hold until the criminal proceedings wrap up, including civil fraud charges laid in 2007 by the U.S. Securities and Exchange Commission.

Lessons Learned 

Although “Fraud Findings” usually highlights proven fraud cases and lessons internal auditors can learn from them, the allegations of financial fraud and misrepresentations of Nortel’s financial results — now dismissed by a Canadian Superior Court judge — also demonstrate several lessons useful to auditors.

First, accounting is not as exact a science as many may think. Judgment is frequently involved in the development of corporate financial statements — despite the existence of numerous accounting policies and regulations. In particular, a key issue in the Nortel trial was the role the executives played in using (or not using) large amounts of accruals to adjust profit/loss balance sheets and trigger performance bonuses. Of course, these decisions were taken in a volatile environment where Nortel executives and its board were facing enormous challenges in managing billions of dollars in losses. Best practice would suggest that specific policies and processes covering the timing and circumstances of the use of accruals (and accounting for them) is both appropriate and necessary, and auditors should be prepared to regularly examine their adequacy as well as the organization’s compliance with such policies and processes.

Internal auditors often face the complex task of differentiating between an honest mistake and deliberate fraud. Applying judgment in an inappropriate manner can be determined to be a crime. In the Nortel case, many accounting irregularities were brought to light, but the prosecution was unable to clearly establish that these irregularities were fraudulent. Several years of investigation by the Royal Canadian Mounted Police and other enforcement officials failed reveal a “smoking gun” conclusively pointing to fraud —despite evidence that Nortel executives had demonstrated to various degrees the three classic elements of fraudulent activity: incentive/benefit, opportunity, and means.

Would the Nortel case have occurred in today’s environment? Would the outcome of this case have been different had it been prosecuted in the United States instead of Canada? Large corporate fraud cases — such as Enron, WorldCom, AIG, Freddie Mac, and Lehmann Brothers — have forced positive changes in the ways in which companies disclose their finances. As a result of the U.S. Sarbanes-Oxley Act of 2002, chief executives are responsible for certifying that their financial statements are accurate, which adds a dimension of accountability. Auditors also have more power to challenge executives when questioning financial filings. In Canada, for example, companies now must report under Financial Reporting Standards.

Some now argue that the current legislation and regulation regime has had a significant deterrent effect on those contemplating the undertaking of corporate financial fraud. Others argue that the byzantine nature of corporate financial management and accounting policies and practices have a dissuasive effect on government regulators — and even auditors — who may be hesitant to undertake the challenges of pursuing potential financial fraud cases. The Nortel case is far from over, however, as civil fraud charges laid by the U.S. Securities and Exchange Commission have yet to be prosecuted. Auditors should not be deterred because they have an important, continuing role to play in all of this — to objectively ask questions and bring forward findings as part of a structured fraud risk assessment, audit planning, and audit engagement program.


Share This Article:    


Accounting Standards
That would be "International Financial Reporting Standards" (for publicly accountable organizations).
Posted By: M. Johnson
2013-02-26 11:49 AM


COMMENT ON THIS ARTICLE

Internal Auditor is pleased to provide you an opportunity to share your thoughts about the articles posted on this site. Some comments may be reprinted elsewhere, online, or offline. We encourage lively, open discussion and only ask that you refrain from personal comments and remarks that are off topic. Internal Auditor reserves the right to edit/remove comments.

Name:

Email:

Subject:

Comment:


To make something bold:
<strong>Text to bold</strong>

To make something italic:
<em>Text to italicize</em>

To make a hyperlink:
<a href="URL">Text to link</a>

 

Subscribe_June 2014 

IIA_AllStar_July2014