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Former Nortel Networks chief financial officer Douglas Beatty arrives at the University Avenue Courthouse in Toronto on Jan. 20, 2012.Fernando Morales/The Globe and Mail

One of the most controversial accounting provisions reversed at Nortel Networks Corp. in 2003 was done as part of a careful balance sheet review that was closely monitored by auditors at Deloitte & Touche, a lawyer for former chief executive Frank Dunn told his fraud trial Tuesday.

Lawyer Harry Underwood, a member of Mr. Dunn's legal team, spent Tuesday morning painstakingly cross-examining Don Hathway, Deloitte's former lead audit partner at Nortel, about an accounting reserve Nortel was carrying on its books for inter-company "out of balance" or OOB accounts.

Using an array of internal e-mails and memos, Mr. Underwood attempted to show that Nortel was reversing provisions for the OOB accounts in 2003 as part of an effort to correct its accounting.

The Crown has previously alleged the reserve was one of several being manipulated by Nortel 's top officials in 2003 to push the company from a loss to a profit, triggering special "return to profitability" bonuses for executives.

Mr. Dunn, former chief financial officer Douglas Beatty and former controller Michael Gollogly are charged with fraud over their use of the reserves. The men have denied the allegations, and have said all their actions were appropriate and done with the approval of Deloitte & Touche.

The OOB accounts have been a focus at the long-running fraud trial because Nortel reversed $35-million (U.S.) of the OOB provisions in the first quarter of 2003 – boosting profits by the same amount.

It was the single largest item among a total of $80-million of non-operating head office reserves that were used in the quarter to transform Nortel from a loss to a profit in the period.

In court Tuesday, Mr. Underwood showed Mr. Hathway an internal Deloitte memo in which a junior partner on the audit file analyzed Nortel's decision to release $35-million from the OOB provision in the first quarter of 2003, and concluded the release "appears plausible" and was "appropriately disclosed" in the notes to Nortel's financial statements.

Mr. Hathway, however, noted that someone else from Deloitte had inserted a comment into the memo questioning "are we sure" about that conclusion.

"I'm not sure what the wording 'appears plausible' means," Mr. Hathway said. "It's not a typical conclusion I've seen."

Mr. Underwood, however, replied that Deloitte had accepted the provision release.

"Based on the information we were given at the time, yes we did," Mr. Hathway replied.

Mr. Underwood added that Deloitte "took comfort" in the fact the provision was being reduced in line with the findings of an internal analysis in 2003 showing it was too large.

The company's entire OOB reserve was later reversed and eliminated in a second restatement of Nortel's books completed in January, 2005, after staff reconciled the out-of-balance accounts back to the periods the reserves were created between 1999 and 2001.

Mr. Hathway testified he wanted the entire OOB reserve eliminated in the first restatement in October, 2003, but was told Mr. Dunn wanted to keep $25-million of it on the books, which meant it would still be available for use in the future.

"Mr. Gollogly and I had agreed as part of the first restatement that all of the OOB would be reversed in its entirety, so there wouldn't be any OOB provision for any period on the books," he testified.

"Mr. Gollogly later reported to me that that agreement had been undone by Mr. Dunn who objected to that treatment."

Mr. Hathway said he argued against keeping $25-million of the provision on the books for the future, but was pressured to accept a compromise and finally agreed because he said he decided that a reserve of $25-million would not be a material amount for a company of Nortel's size.

"Mr. Gollogly advised me to let it go, it wasn't a big deal and Mr. Dunn would make a big deal out of it at the next audit committee meeting," he testified.

Mr. Underwood showed Mr. Hathway an internal analysis listing reasons for keeping the reserve at $25-million. Mr. Hathway replied that he accepted the reserve on the basis that it was not material, and not because he felt it was correct.

"But there was a reasoned basis," Mr. Underwood insisted.

"There were reasons. I didn't think they were particularly good ones," Mr. Hathway said.

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