Southern Investigative Reporting Foundation : December 12, 2016
For much of the past two decades Canadian National Railway Co. has been credited with revolutionizing the North American railroad industry.
The company’s former chief executive E. Hunter Harrison’s theory of “precision railroading” — a data-driven focus on charging customers a premium for superior on-time performance — made him an industry icon and his shareholders very happy.
But in railroading, as in life, how you get there matters.
Acting on a tip, the Southern Investigative Reporting Foundation began investigating Canadian National in the fall of 2014. Here’s what our reporting uncovered:
- For over 15 years Canadian National earned hundreds of millions of dollars in profit by marking up rail construction costs up more than 900 percent to a public-sector client.
- Canadian National regularly engaged in questionable business practices like charging internal capital maintenance and expansion projects to the same taxpayer-funded client and billing millions of dollars for work that was never done.
- A just-released auditor general investigation suggested a series of reforms designed to reduce these profits.
- For years, train yard personnel, under intense pressure from management, have intentionally misreported on-time performance, helping the company boost revenue by hundreds of millions of dollars.
On the evening of Dec. 6, 2004, two longtime Canadian National railroad employees, track construction supervisor Scott Holmes and his boss, railroad construction chief engineer Daryl Barnett, were in an elevator at the Deerhurst Resort a few hours by car north of Toronto and on their way to their unit’s Christmas party when Barnett got a call from Manny Loureiro, his supervisor and then head of engineering for the eastern region.
Taking the call on speakerphone, Loureiro told Barnett that he was in a bind because the fiscal year was drawing to a close and his division’s budget was $12 million over what his then boss, Keith Creel, the eastern region director, had set. Missing his budget bogey would be a major blot on his performance review; it would also eliminate his eligibility for a six-figure year-end bonus. (Editor’s note: All dollar values expressed are Canadian dollars.)
To avoid this, Loureiro told Barnett to transfer $12 million to his unit’s account from a $28 million advance payment that a customer had recently made to purchase signal equipment.
Barnett tried to object but was overruled.
After the weekend when they were back at the office, Barnett told Holmes that Loureiro had requested a transfer of $2 million in addition to the $12 million.
A week later during a conference call that included most of Canadian National’s senior management, CEO Hunter Harrison singled out Loureiro for commendation, singing his praises for having obtained such a large payment from a key customer so late in the year.
Barnett and Holmes concluded that Loureiro must have met the requirements for the maximum bonus.
The customer was GO Transit, Metro Toronto’s commuter rail system, which merged five years later with Metrolinx, Ontario’s taxpayer-funded public transportation agency. The required signal equipment was installed but the $14 million was not returned to Metrolinx’s construction project’s account, according to a former unit executive.
(Loureiro has retired from Canadian National and did not return a message left at his residence. Barnett, who left Canadian National in 2008, is now Metrolinx’s director of railway corridor infrastructure. He did not return an email and a phone call requesting comment.)
On Nov. 30 of this year when the office of Ontario’s auditor general publicly released its 2016 annual report, a 38-page chapter detailed Metrolinx’s billing and rail-construction project-management practices over the previous five years. The auditor general’s staff concluded that both of Canada’s major railroads, Canadian National and Canadian Pacific, profited from Metrolinx’s lack of internal financial controls by marking up construction charges well above industry norms.
A reader doesn’t have to parse the report too closely, however, to see that the auditor general took a keen interest in Canadian National’s work for Metrolinx. Put bluntly, the auditor general laid out a case that Canadian National saw Metrolinx coming a mile away and sought to harvest every last taxpayer dollar.
The auditor general’s investigation concluded that Canadian National had billed Metrolinx for new rail products but installed recycled ones from other tracks, that Canadian National’s labor prices were 130 percent above the industry average and that Metrolinx had been charged for projects that had nothing to do with commuter rail lines.
The money involved is real enough: The report stated that Metrolinx paid Canadian National and Canadian Pacific $725 million over the past five years and Canadian National’s projects were singled out as examples of bad news for Ontario’s taxpayers. On one project Metrolinx was charged an astounding $95 million for nine miles of track constructed on the Lakeshore West line.
Christine Pedias, a spokeswoman for the auditor general’s office, declined to specify how much each railroad was paid. It’s fair to assume, though, that the majority of Metrolinx’s construction payments went to Canadian National since most of Toronto’s commuter trains run on railroad tracks it owns or sold to Metrolinx.
Anne Marie Aikins, a Metrolinx spokeswoman, provided via email a statement from the agency’s president, Bruce McCuaig, “The Auditor’s report focuses on a small sample out of the many hundreds of projects Metrolinx is currently working on or has completed between 2011 and 2016.” Additionally, Metrolinx is “proud of its record” and taking steps to address the issues raised.
For its part, Canadian National spokesman Patrick Waldron reiterated the statement it made to news organizations on Nov. 30 about the auditor general’s report, “CN is dedicated to transparency, fairness and accountability in all its contracts and projects with Metrolinx and Go Transit. Projects we have partnered on utilize rigorous construction management processes covering project specifications and budgets to deliver quality work with strict oversight.”
The auditor general also made a series of reform recommendations for Metrolinx that, if implemented, would save Ontario taxpayers money and thus hit Canadian National squarely in the wallet. These included carefully assessing labor and equipment estimates for “reasonableness” using industry standards as a benchmark prior to a contract’s approval, regularly auditing a project underway and assigning an inspector to monitor progress at construction sites.
Long before the Ontario auditor general’s office began its investigation, Canadian National was using Metrolinx as an automated teller machine, albeit one with no deposits required. Over 15 years executive teams have come and gone at Canadian National but the one constant has been the river of profit that its Toronto construction unit has been able to reliably wring from Metrolinx.
Determining how much Canadian National billed Metrolinx over the past two decades is difficult but considering since 2010 four separate land sales, Lakeshore West construction and ongoing maintenance contracts, it’s at least $1.1 billion, the majority of which likely went to operating income. In other words, Metrolinx’s long-running failure to properly scrutinize Canadian National emboldened it to charge prices so high that many of the construction and maintenance contracts amounted to almost pure profit.
The most audacious episode occurred from 2004 to 2008 when Canadian National’s construction managers developed a billing scheme that reaped hundreds of millions of dollars in profits and benefits through wildly inflating the cost of construction, according to documents obtained by the Southern Investigative Reporting Foundation and attached to ongoing litigation.
The project involved a track expansion project that Canadian National performed for Metrolinx’s Lakeshore West line, on a route that stretched about 40 miles from Hamilton, Ontario, to Toronto’s Union Station. The work was completed in 2012.
Windfall profits and bonus payouts weren’t the half of it. In numerous instances Canadian National billed Metrolinx for work that Canadian National did for its own capital maintenance and expansion projects, saving itself many millions of dollars in expenses.
From 2004 to 2008, Canadian National did track construction work for Metrolinx on a 4.5-mile stretch between the Burlington and Hamilton stations, referred to by Canadian National as Lakeshore West/West. On a separate stretch of the same track in late 2009, crews began adding track to the 9.1-mile stretch from the Port Credit station to Kerr Street, or the Lakeshore West/East line. (The Ontario auditor general’s annual report discussed an unnamed 9-mile track extension that cost $95 million to construct “on the Lakeshore West corridor” but did not identify the project’s location or its date of completion.)
The Lakeshore West/West project’s cost is unclear.
According to an email, Metrolinx had originally approved a construction price tag of $45 million, but in short order the project’s chief engineer, Daryl Barnett, in a bid to reduce costs, noted that the price tag had quickly ballooned past $70 million. Metrolinx’s spokeswoman Aikins did not answer repeated questions on the matter but the Southern Investigative Reporting Foundation obtained an April 2015 internal audit Metrolinx conducted at the auditor general’s request that put the final tab for Canadian National’s 2004 to 2008 work on that stretch at “over $200 million.”
What cost “over $200 million?” Three Canadian National railway construction unit staffers (including current and former employees) said the only project underway on Lakeshore West at that time was the Lakeshore West/West and that commuter trains were fully operational on that stretch by the spring of 2006.
(The audit document itself is highly unusual: Metrolinx’s internal auditors asked Canadian National to reauthorize their expired “audit rights” in order to properly document the project’s cost in terms of the labor and material provided. But the railroad refused, forcing the auditors to analyze the billing using only Metrolinx’s documents. The report concluded that the Lakeshore West project had no payment irregularities.)
Interviews with former Canadian National construction employees suggest that much of the Lakeshore West cost run-up can be attributed to Canadian National’s billing Metrolinx for an extensive series of upgrades around Canadian National’s Aldershot train yard. This was work of little apparent benefit to a commuter rail service like Metrolinx. From 2006 to 2007, Canadian National added a mile of mainline quality track enabling newly assembled freight trains to be switched onto another track when exiting the yard so they could rapidly increase speed.
How did they do this? The crew built switches or “turnouts,” which are mechanical installations that guide a train from one track onto another.
Improving access to and from the Aldershot yard solved twin logistical headaches for Canadian National that were its greatest challenges in the Toronto region. Previously trains exiting the Aldershot yard traveled 15 miles per hour and had to switch onto the main tracks at that speed, thus slowing the trains behind them. Now they can reach 25 mph. After improvements at Bayview Junction, Canadian National trains can reach 40 mph when traversing through those switches, sharply lessening the frequency of backlog-inducing stalls during a trip up Dundas Mountain.
Those improvements, according to former construction unit executives, appear to have been charged to Metrolinx.
The picture, below, taken from the Snake Road overpass in Burlington, Ontario, shows a few of the switches that were in the area around Canadian National’s Snake Road facility when a reporter visited the bridge in October. About nine were apparent. This is sharply more than a mere commuter train could ever plausibly need but helpful to long freight trains arriving from Toronto (such as those of Canadian National). Documents suggest that costs mounted rapidly for Metrolinx at least partly because of Canadian National’s order for at least 25 switches: The cost to install them was about $1 million apiece.
Canadian National’s documents indicate that building track is a remarkably profitable business and that doing so for Metrolinx has generated the type of margins usually enjoyed by the developers of a breakthrough medicine.
According to a March 2006 Canadian National internal pricing spreadsheet obtained by the Southern Investigative Reporting Foundation, Canadian National could build a mile of track for a little over $1.12 million: This included a “track labor surcharge” of 138.4 percent and a 69.1 percent “track material surcharge.” (These surcharges, according to the Ontario auditor general’s report, were sharply above industry norms.)
But by charging Metrolinx $10 million to construct a mile of track, Canadian National was able to reap a profit of almost 900 percent.
(Not every customer was charged this way, however. In 2008 Canadian National built track for the federally owned Via Rail for $3 million a mile — without any bridges or switches — in Kingston, 150 miles away from Toronto.)
Nonetheless, Metrolinx had clear oversight provisions to safeguard taxpayers that were built into its Lakeshore West contracts with Canadian National, including a requirement for audit committees, frequent inspections and even aerial photographs, according to copies of the contracts obtained by the Southern Investigative Reporting Foundation. The problem is that all these measures stayed on paper and none appear to have been followed, according to interviews with former employees.
To profit from Metrolinx work, Canadian National used accounting practices that would ordinarily never have publicly surfaced. Unfortunately for Canadian National, though, former construction manager Scott Holmes, who has been fighting his termination from his construction supervisor job since 2009, has claimed that he was let go, in part, because he observed — and complained about — improper billing practices.
In late October of this year Holmes’ legal team submitted a pair of exhibit-heavy filings in response to a sworn affidavit from Gary Poplyansky, a former Canadian National finance official. (Holmes declined to expand on his filings, given the ongoing litigation.)
One of the more profitable accounting gambits that Holmes has claimed to have observed is best described as “over budgeting.” Having agreed in advance to pay annual maintenance and service charges, Metrolinx paid for scheduled work that Canadian National charged it but never performed. A November 2005 email from Canadian National’s Edmonton, Alberta-based capital-projects finance officer, Joe Vanderhelm, to James Lam, then finance chief for the railroad construction group, asked if a total of $3.66 million in capital improvement and labor costs already budgeted for would be incurred by the end of the year. They were not, according to a former construction unit official.
Metrolinx officials apparently did not suspect anything was amiss and the $3.66 million was paid. At Canadian National these funds became a “betterment,” a catchphrase for revenue in excess of the managers’ year-end objectives and often the basis for a performance bonus.
Time after time, with a few keystrokes, Canadian National’s railway construction managers made almost any financial concern vanish by assigning the costs to Metrolinx and its seemingly endless pool of construction cash.
(read the full article at Southern Investigative Reporting Foundation