Investing

Catch and release

RCMP's markets teams have been a failure. Why Canada's fraud cops can't get their men.

Former Nortel CEO Frank Dunn, accompanied by his wife Nancy, leave provincial court in Newmarket in 2008. There has yet to be a trial. (Photo: David Cooper/Toronto Star/GetStock)

A warm spring day promises a brighter future. But sitting in a Toronto courtroom in April, Frank Dunn could expect only more waiting and uncertainty. Sporting a natty wristwatch, grey pinstriped suit and greyer hair, he looked like the senior executive he once was. In walked an old colleague; Douglas Beatty and Dunn exchanged pleasantries. But apart from banter about recent hockey trades, there wasn’t much to say. So they listened as a dozen lawyers debated whether records of conversations the two men had had with another group of lawyers years earlier could be used against them at their looming fraud trial.

Although Dunn now lives in relative obscurity, many Canadians will remember him as the executive who oversaw a crucial period in Nortel Networks’ long march to oblivion. Dunn’s promotion in 2001 from chief financial officer (the position Beatty assumed soon after) to CEO violated the adage that finance specialists should always be on tap but never on top. However, he took over at a desperate moment: Nortel was losing billions of dollars every quarter, and its shares had plunged in value. Undaunted, Dunn told reporters that he’d promptly restore the company to profitability. “We’re in really good shape,” he insisted.

Dunn’s legal troubles began after he was accused of making Nortel seem in better shape than it actually was. In 2003 and again in 2006, the company massively restated previous years’ financial results. An internal investigation concluded that top executives “changed our accounting policies several times,” aiming to manipulate revenues and earnings. Dunn, Beatty and controller Michael Gollogly were fired. Securities regulators launched actions against them. A mushroom cloud of litigation blossomed. Ultimately, the men were arrested, charged with criminal offences and released on bail. The defendants deny the allegations, which have not been tested in court.

If Dunn seeks solace, he need recall only one thing: his opponents regularly get their butts kicked in court.

The evidence against the Nortel defendants was gathered by an Integrated Market Enforcement Team, one of 10 elite groups assembled to tackle complex, high-profile fraud cases of this very sort—and to do it quickly to boot. In eight years, the teams scored victories in a series of small-time swindles, and secured multiple convictions connected to Norbourg Financial Group, a manifestly fraudulent mutual fund company. But thus far, they’ve charged only 42 people, of whom only 10 have been convicted. Last year, the IMETs’ first major corporate fraud case—involving Royal Group Technologies, a plastics and building-supplies manufacturer—ended with an Ontario judge taking the unusual step of formally vindicating all of the accused. Margaret Franklin, current chair of the CFA Institute (which issues accreditations to financial professionals) offers a bleak assessment: “Not enough cases. Not enough charges. And certainly not enough convictions. If you think about the decade that this covers, it’s hard to believe.”

Placed in an international context, these results seem bush league. The United States’ Corporate Fraud Task Force was established in 2002 on logic nearly identical to the IMETs’. According to its last published report, it convicted nearly 1,300 corporate fraudsters, including more than 200 CEOs, 120 vice-presidents and 50 CFOs. (It was replaced with another agency, the Financial Fraud Enforcement Task Force, in 2009.) American proceedings unfold at a blistering pace: in less than two years, a single U.S. attorney’s office charged 47 people with insider trading offences. Most of them have already been convicted at trial or pleaded guilty. Nevertheless, U.S. authorities have been criticized for failing to prosecute individuals popularly believed to bear responsibility for the recent financial crisis.

The U.K. enforcement record also puts the IMETs to shame. Several years ago, Britain’s Serious Fraud Office hired former Manhattan prosecutor Jessica de Grazia to conduct a review. She concluded that the SFO had taken far longer to prosecute cases than two similar American bodies, and had obtained limited results. De Grazia’s scathing report spurred change. “When I became director, our conviction rate was far too low, with an average five-year conviction rate of 61%,” sniffed incoming head Richard Alderman in the SFO’s most recent annual report. Alderman boasted he’d raised the rate to 91%.

The conviction rate that left the SFO so embarrassed would be a striking improvement for the IMETs. Spencer Lanthier, who serves on a variety of boards, recently asserted during a speech in Toronto that, despite recent advances in regulation and enforcement, large frauds still unfold in Canada largely with impunity. He claimed this country has “the weakest standards of enforcement in the G8.” Other critics routinely call for speedier investigations, more charges and more serious punishments. Even IMET superintendent Dean Buzza concedes that his units haven’t lived up to expectations. “We overpromised and underachieved,” he says.

Skeptics doubt the Nortel file, arguably the most important fraud case of the past decade, will change perceptions. “What’s going to happen?” asks Al Rosen, a veteran forensic accountant who has investigated many frauds. “I suspect it’s going to get screwed up.”

The IMET initiative started out promisingly enough. Shortly after 5 a.m. on Feb. 2, 2005, an aging hulk of a Winnebago pulled up conspicuously in front of the headquarters of Scotiabank on King Street in downtown Toronto. This was no elderly tourist couple from Wisconsin who’d taken a wrong turn; it was a mobile police command post. Over the subsequent hours, a host of police cruisers and SUVs parked nearby. Three Toronto IMETs were mustering for the biggest raid in Bay Street’s history.

They pounced around 9 a.m. As curious pedestrians and workers in neighbouring office towers gawked, two dozen police officers and civilian support personnel lugged equipment into the building. IMET members “were quite proud to be part of that operation,” recalls Craig Hannaford, a retired RCMP officer who led the Toronto teams at the time. “People saw [that raid] as a positive thing in terms of doing our job on Bay Street.” Within hours, the teams obtained passwords and were rifling through Scotiabank’s computer systems in search of documents relating to Royal Group, which the bank numbered among its clients.

Canadians had seldom before witnessed such drama in white-collar cases. Nor had they seen anything like the IMETs. Launched in 2003, they were to be the SWAT units of the capital markets—crack, tightly knit groups of financial investigators, legal advisers, forensic accountants and other specialists. Federal solicitor-general Wayne Easter promised they would “help catch corporate criminals who may have previously evaded the law.” Although primarily arms of the RCMP, IMETs would receive support and funding from the Public Prosecution Service of Canada and the federal finance, justice and public safety departments. Each team was to pursue a new high-profile case every year. Today, there are four teams in Toronto, and two each in Calgary, Montreal and Vancouver. There’s also a “Quick Start” team at the Ottawa headquarters that can be deployed nationwide. The groups comprise about 150 investigators in total, and consume around $40 million a year.

IMETs were a response to a crisis of confidence born of notorious American frauds like Enron and WorldCom. “The question was asked: If we had a similar corporate scandal in Canada, would the RCMP have the capability to investigate effectively?” says Hannaford, who retired in 2006. “The answer was no.” The same could be said of uniquely Canadian scandals where fraud was suspected (notably Bre-X and Livent) and where the investigations dragged on for years. The Scotiabank raid heralded a new era of tougher enforcement, with Royal Group the first major target.

The case stemmed from events that happened years earlier. In 1997, a company controlled by Royal Group founder Vic De Zen and his associates purchased an undeveloped parcel of land across the road from Royal Group’s suburban Toronto headquarters for $114,000 per acre. Hours after the deal closed, at De Zen’s direction, the company sold the land to Royal Group for $150,000 per acre. Investigators surmised that the executives set prices at both sides of the transaction, enabling them to pocket millions from the company’s treasury.

In mid-2008, following an IMET investigation, the Crown laid charges against De Zen and five other Royal Group executives. That same day, charges came down on Dunn and other Nortel defendants. With two high-profile cases beginning simultaneously, some cheered that the IMETs had finally hit their stride.

But any such impression evaporated after the Royal Group trial wrapped up last year. On Dec. 10, Vic De Zen and fellow former executives attended an Oshawa courtroom to hear the final arguments in their fraud trial. Under normal circumstances, they might have waited several weeks to learn the verdict. But these were not normal circumstances: Justice Richard Blouin had heard enough. He deemed the case against the defendants so flimsy that he thought it unfair to make them wait. He announced that he found “overwhelming evidence” no fraud had been committed. De Zen received his vindication enthusiastically, hugging lawyers and family members.

Such a stinging rebuke from the bench populates prosecutors’ darkest nightmares. What’s more, apart from a single document, the Crown had supplied every scrap of evidence and called every witness Blouin relied on when he concluded that there was no proof of an intent to defraud. He accepted that when De Zen’s company purchased the property, he honestly believed Royal Group didn’t need the land. Blouin also acquitted the five co-defendants on other fraud charges. The IMETs’ Scotiabank raid ended in farce. (The Crown is appealing.)

In explaining the IMETs’ embarrassing performance, critics point to factors both external and internal. For starters, corporate frauds are generally complex and require highly specialized skills to investigate and prosecute. One of the biggest challenges for any such investigative body is getting—and keeping—the right people. “Within our own shop, it takes six or seven years to take someone with a basic financial understanding and work with them on cases,” Rosen says. “Eventually, they develop a smell for stink. My best people have been around for 10 years plus.”

Few last that long at the IMETs. Early recruits were asked to commit to five years’ service. Yet, at last report, only 13% of RCMP-affiliated members and 17% of civilian members had five years’ tenure. Internal RCMP politics are partly to blame: for cops, promotion often means moving to a different division within the service. The private sector also beckons, with salaries the units simply can’t match. For example, an IMET inspector might earn $100,000; even a securities commission will offer twice that.

The quality of leadership has been questioned as well. Nick Le Pan, a former superintendent of financial institutions, was retained to report on IMETs’ progress and, in a report issued in 2007, he noted that staff often laboured under a “lack of clear direction.” Indeed, according to an earlier report, shortly after the program’s inception, the director was required to be away for six months of language training. And senior IMET officials rarely fulfil their own five-year vows: just four years in, all four of the original officers-in-charge had moved on.

This lack of direction seems to extend to the organization’s objectives. “It’s not apparent to me what they consider success,” complains Franklin of the CFA Institute. She’s not alone. Asked by what metrics the IMETs should be judged, superintendent Buzza struggles. “That is probably the most difficult question anybody could face,” he says. He embarks on a lengthy discourse on why the IMETs’ original mandate—to pursue large cases fast—could not be met. Pressed, eventually he settles on one criterion: “My deliverables are to make sure that we don’t let things fall through the cracks. If I can’t do a file because I haven’t got the resources, I want to make sure somebody else is going to be addressing it.”

This seems less ambitious than one might expect from Canada’s premier fraud cops.

But there’s a deeper issue in Canadian courts’ expectations of how corporate executives should behave. You can detect it in Judge Blouin’s decision on Royal Group. He acknowledged that De Zen dominated the company through a management structure that gave him “unfettered power to transact significant contracts on behalf of the corporation.” But whereas other courts at other times have regarded such behaviour as amounting to fraud on shareholders, he appeared to brush it off as no great mischief. “Almost every witness who was asked about the issue of corporate governance supported the view that a ‘sea change’ occurred in North America around 2002 with the passage of the Sarbanes-Oxley Act in the United States,” he wrote in his decision. “Therefore, to view events in [Royal Group’s] life in 1996, for example, through a corporate governance lens 10 years later, distorts the historical record.”

In the face of such thinking, convicting executives is a challenging task. Even the IMETs’ most vociferous critics concede the point. “Getting convictions is much, much harder” than it once was, Rosen reports. “In that sense, I can’t help but sympathize in the extreme.”

Buzza, a veteran of the RCMP’s commercial crimes unit who assumed command of the IMETs in 2008, complains that it’s unfair to compare the IMETs’ results to those seen in foreign jurisdictions. “Why can’t we do things the Americans do?” he asks. “Well, we have different tools.” The U.S. bestows its prosecutors with considerable power. They lead investigations from start to finish. The grand jury process can compel third parties to testify and provide evidence. By contrast, IMETs work more or less independently from prosecutors and cannot compel testimony from anyone they haven’t charged. Various rules governing confidentiality and constitutional rights often effectively prevent provincial securities commissions and other bodies from sharing information with IMETs. “And when you can’t do those types of things, you’re left with a very intensive document search,” Buzza says.

Such searches can be nightmarish. IMETs cannot simply cherry-pick the 50 pages of “smoking gun” evidence that support their case; Canadian courts demand that prosecutors hand over to the defence virtually every document handled during the investigation. In complex cases, that can be the equivalent of thousands—even tens of thousands—of banker’s boxes brimming with paper. (IMETs typically store them digitally.) However, simply handing these over to the defence is not enough: it all has to be organized, indexed and searchable. This places a considerable logistical burden on investigators. Adds Buzza, “If you’re going to go after the biggest companies in Canada, you can expect that by the time you get to court, you’re going to be up against a legal team with a lot of resources at its fingertips.”

Major fraud investigations are gruelling. “You go into one of these, and that’s likely the case you’re going to be working on for three or four years,” says Hannaford. “You’re going to be buried in documents. You’ve got to learn what’s happened and synthesize all that information to conduct interviews of fairly sophisticated people. Everybody’s lawyered up.” (Following the Nortel restatements, Dunn appeared at internal meetings with four lawyers in tow. Beatty brought six.)

Even when convictions are secured, punishments meted out to white-collar offenders here are substantially lighter than elsewhere. In fact, Canada’s parole rules make the whole exercise resemble a game of catch-and-release; the IMETs can only watch as their targets gain freedom. “Vincent Lacroix gets sentenced to 13 years,” Buzza says of the chief Norbourg fraudster. “He’s out after 13 months. Bernie Madoff gets sentenced to 150 years, and for all intents and purposes, he will never leave prison.” Recent changes to Canadian legislation suggest the future holds slightly stricter punishments. Enron-style jail terms, though, are simply not on offer.

But if it’s convictions Canadians crave, that’s not Buzza’s objective. He points out that under Canadian law, police must remain at arm’s length from the prosecutorial system, merely providing Crown counsel with the facts. He notes that he could boost IMETs’ conviction rate by taking on only slam-dunk cases, but argues that would be inappropriate. Victims seeking restitution will also be disappointed. “My role is not to get your life savings back,” he explains. “Restitution is under the purview of the criminal justice system.”

Buzza argues that the IMETs are misunderstood, and that most of their successes remain unrecognized. “There’s a common belief right now that IMET has done seven or eight files, when in reality we’ve done over 1,300 investigations,” he says. “We’re working in an assistant capacity, helping the FBI or the SEC on many international files. We help out European police.” IMETs also execute so-called “knock-and-talks”—a euphemism for visiting groups or individuals suspected of malfeasance to let them know they’re being watched.

Hannaford, now a corporate fraud and integrity consultant, suggests that given the RCMP’s rigid structure, it might be better to put the IMETs under the auspices of the securities commissions. For one thing, the regulators have more flexibility on compensation, which would help the IMETs retain talent.
But in his view, the teams have already made an important contribution. “People have to realize that before IMETs came along, there was virtually zero capacity for law enforcement in Canada to tackle these big cases,” he says. “The fact that Nortel and Royal Group were investigated at all raises the level of deterrence. Royal Group didn’t go so well in court, but that’s the way it is.”

Frank Dunn, Doug Beatty and Michael Gollogly are currently scheduled to stand trial in January. The IMETs have much riding on the outcome. “I don’t think the RCMP had ever seen a commercial crime case like Nortel,” says Hannaford, “where there were millions and millions of documents provided.” In fact, IMET collected 23 million pages of evidence. The sheer volume has already created problems in pretrial wrangling. Last year, the defence complained that the assortment of PDFs, spreadsheets, graphical and text documents the prosecution handed over was nearly impossible to navigate. Justice Cary Boswell agreed and forced the Crown to remedy the problem.

Things didn’t go well at the April hearing, either. Crown Attorney Sandy Tse attempted to persuade Judge Ian Nordheimer that memos describing 2004 interviews with the defendants should be treated as normal business records and admitted as evidence. The judge disagreed. Dissatisfied, the Crown returned to court in late June, asking to call as witnesses some of the defendants’ own lawyers who were present at the 2004 interviews. Nordheimer has yet to rule on this.

The trial is one of the few remaining chapters of Nortel’s sorry saga yet to be written. In a quintessentially Canadian outcome, many have been blamed for the corporation’s demise, but few held accountable. Given the IMETs’ record and the vagaries of Canada’s legal system, popular desires for an official reckoning will likely not be satiated for a long time. Or at all. Dunn may find himself still in court years from now, with hair greyer still, waiting, like everyone else, for answers.