Recent article: Nortel brings in legal muscle

The biggest cloud now hanging over Nortel Networks Corp. is what will happen to chief executive Frank Dunn.

This is a legitimate question in the wake of Nortel's decision Monday to put CFO Doug Beatty and controller Michael Gollogly on paid leave — a move that surprised investors and caused Nortel shares to tumble 19%, eliminating much of the lustre the telecom equipment maker has gained in recent months.

At the heart of Mr. Dunn's future is the “independent” review being conducted by an audit committee headed up by former Royal Bank of Canada CEO John Cleghorn, which is looking into the company's financial statements for the past four years.

If the audit committee discovers serious financial problems, they will have to dig into what role Mr. Dunn played. After all, he was Nortel's chief financial officer from 1999 to 2001 before he became CEO.

If the audit committee finds relatively minor issues — something that several analysts speculated yesterday — then one has to question why Nortel's board and Mr. Dunn felt it was necessary to make Mr. Beatty and Mr. Gollogly walk the plank. Even if both executives are welcomed back into the fold, their reputations have certainly been impaired. More serious is the possibility that Nortel made a serious strategic error that may have prompted investors to panic for no good reason.

“I don't know how you put these guys back on the payroll after the crap that has unfolded, unless you are trying to protect Dunn,” said forensic and investigative accountant Al Rosen. “How did he get appointed CEO in the first place? Why hasn't he told these guys to clean up the damn mess?”

Nortel hasn't said very much. But we do know the five-member audit committee, which includes Mr. Cleghorn and Air Canada chairman Robert Brown, launched its review last October after Nortel started its own accounting review in July.

As part of the process, the audit committee hired Washington-based Wilmer Cutler Pickering LLP as its advisor. Wilmer Cutler is a large, high-profile firm that, among other things, specializes in securities enforcement. If the audit committee did not believe there was the possibility of something serious emerging, why would it hire a big U.S. law firm? Why wouldn't it hire a local firm such as Torys or McCarthy Tetrault?

According to its Web site, Wilmer Cutler assists “clients in responding to informal inquiries as well as formal SEC … investigations. This includes working with the SEC … staff in the course of its fact-finding. In that context, we present factual, legal, and policy arguments either to persuade the staff not to recommend enforcement proceedings, or to persuade the agency not to authorize such proceedings.”

Wilmer Cutler also says it has worked on SEC enforcement matters involving high-profile insider trading matters and accounting practices.

Heading up the firm's securities practice is William McLucas, who spent eight years as the U.S. Securities and Exchange Commission's director of enforcement. During his tenure, he led the division's staff in a number of investigations and enforcement actions. This included the SEC's case against junk-bond dealer Michael Milken.

In other words, Mr. McLucas is not a lightweight. He is a securities “robo-cop” who clearly liked his job with the SEC. For Nortel to hire Wilmer Cutler and Mr. McLucas's services suggests the audit committee wants to ensure it has the big guns on its side if a major problem comes to light.

This is an important consideration when one remembers that the most valuable asset a person such as Mr. Cleghorn possesses is his reputation. The last thing he wants to suffer through is an accounting scandal on his watch.

“If you were a big boy like John Cleghorn and you think of yourself as a very important person and something bad happens to a company, you want the best,” said an analyst who wished not to be named. “You will go to a Washington-based law firm and get the lead partner who has got experience in such matters that may involve the SEC.”

Anyone looking for quick answers to Nortel's accounting woes will be disappointed. Given developments this week, the role being played by the audit committee and Wilmer Cutler, this is going to be a drawn out process that may not produce any answers for a long, long time.

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