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.
Canadian National Railway
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 that will reduce these profits.
- For years, train yard personnel, under intense pressure from management, have intentionally misreported on-time performance, helping it boost revenues 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 the 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 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 the auditor general of Ontario 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 has 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 November 30th concerning 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 has billed Metrolinx over the past two decades is difficult but since 2010, adding up four separate land sales, the Lakeshore West construction discussed below and ongoing maintenance contracts it’s at least $1.1 billion, the majority of which likely went straight 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 by 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