Canadian National Railway: The Great Railroad Construction Robbery

Edel Rodriguez

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 to the Southern Investigative Reporting Foundation 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.

img_20161111_110559646

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.

In a December 2004 email, construction unit engineering chief Barnett outlined how $207,000 in costs could be billed to Metrolinx and thus make a $385,000 over-expenditure drop to $78,000. Additionally, Barnett ordered Holmes to get “7000 PW 14-inch tie plates.” In railroad construction parlance, PW means “partly worn.” In other words, a key element used for the construction of new tracks, the tie plates, had already been exposed to heavy use and weather.

Another internal accounting maneuver saved Canadian National millions of dollars in track maintenance and construction costs through the manipulation of the letter code system the railroad’s computers used to assign bills to Metrolinx.

Here’s how it worked: Rail crews completing work on Canadian National’s assets would submit invoices that were assigned a payer code that began with the letter C. Shortly afterward, a construction unit office worker removed the invoice from the system and changed the payer code, using a pen to write an M, which typically meant that Metrolinx would be assigned the bill. (Payer codes that began with an M, as Holmes noted in his affidavit, were used to designate third-party payers, which often — but not exclusively meant Metrolinx.)

Copies of several hundred changed invoices that the Southern Investigative Reporting Foundation obtained during a series of in-person interviews conducted in Canada suggest that the gambit was frequent and brazen, with Metrolinx assigned bills for work performed in Niagara, a locale far beyond the reach of its commuter trains (as shown in 11 documents.)

——————–

Over the past 15 years, Canadian National’s reputation for efficiency has been quite a calling card for the railroad.

Practically speaking, improvements in efficiency metrics are highly attractive variables for investors who want to see that a railroad is using its assets to the fullest extent possible, while railroad operations managers want to meet performance targets and qualify for bonuses. Canadian National tracks these metrics on its website.

“No one on Wall Street has ever gotten fired for owning the most efficient company in a sector and in railroads, that’s [Canadian National],” said rail industry consultant Larry Gross.

“Being the on-time leader, having the least dwell time in rail yards, those are major factors that allowed [Canadian National] to get and keep price hikes that constantly outpace inflation,” Gross said. In turn, he added, Canadian National’s price increases have kept profits — and thus its stock price — healthy, despite slowdowns in other areas of the economy.

Charts available from railroadpm.org, a website that collects voluntarily disclosed efficiency metrics from six North American long-haul railroads, documented Canadian National’s dwell time — the amount of time a railcar spends in a yard or terminal before it’s sent out again — and suggest that this company is literally set apart from the competition.

But there’s more to the story than Canadian National’s hard-won gains in asset utilization and it involves “ghost tracks.” This is a railroad term used to refer to the practice of assigning a delayed train a made-up track number in a train yard. That way the incident can bypass a railroad’s daily inventory management system so that the lag doesn’t drag down efficiency metrics.

A 2013 whistleblower lawsuit filed against Canadian National in U.S. District Court in Memphis, Tennessee, surfaced the practice of making a train disappear in a computer system. Timothy J. Wallender, the suit’s plaintiff, was a trainmaster for Canadian National in Memphis who claimed that he was fired in retaliation for alerting his superiors to widespread misreporting of train metrics, much of them at the behest of his boss, then the yard’s general superintendent.

Canadian National argued that Wallender was fired solely for ignoring a warning about misreporting data, and when the company discovered in late 2011 that this had occurred, its president, Keith Creel, released a letter to employees demanding it stop. In February a U.S. magistrate judge granted Canadian National’s motion for summary judgment, ruling that the company was within its rights to fire him.

What the Wallender case shows is that circumventing the Canadian National computer system to arrive at ever-improving on-time and train dwell statistics was a fairly widespread practice, with a variety of different tactics used — from rail scanner manipulation to changing the internal clock in the railroad’s office computers — at yards throughout U.S. and Canada.

Paul Bourzikas, a former trainmaster colleague of Wallender in Memphis, said in a March 2014 deposition that the Memphis train yard was hardly the only Canadian National one where employees changed departure and arrival data.

“It happens all across that system,” Bourzikas said. “It happens in Geismar. It happens in Baton Rouge. It would happen in and out of Jackson. It would happen in Chicago.”

An October 2013 Canadian Broadcast Corporation investigation based on Wallender’s suit quoted two of his former colleagues in Memphis who corroborated his assertions about the extent of manipulated efficiency data. (A followup CBC report interviewed a British Columbia-based former Canadian National train conductor who alleged that he and his colleagues regularly went to great lengths to misreport trains as having departed when in fact they were tied up in the yard.)

The Southern Investigative Reporting Foundation interviewed six current and former Canadian National employees, all unconnected to Wallender’s litigation and having 15 years or more of train yard operations or transportation unit experience, about whether efficiency data like dwell times or terminal arrival data was often misreported. They declined to speak on the record for fear of losing their jobs or being sued for publicly discussing company-specific issues.

The consensus view of the six was that the practice of misreporting such data was endemic throughout Canada National’s operations in the U.S. and Canada until 2014, when this began to occur less frequently but still occurs.

Additionally, all six argued that investors’ and analysts’ ignorance of just how many things go awry when a train is hauling nearly 10,000 feet of freight to a terminal made them susceptible to believing management assertions about sharp drops in dwell time.

“It is virtually impossible for any long-haul [freight train] to arrive on time,” said a former Canadian National employee, a 25-year veteran of train yard operations. “No one wants to hear it, then or now. So when [Hunter] Harrison came in and on-time delivery became the focus, yard [superintendents] had massive pressure put on them,” he said.

The biggest component of delays, according to the six, were “slow orders,” or directives from, say, Transport Canada’s rail safety inspectors, to decrease speed on a specified stretch of track, usually because it needed repair.

One train engineer with more than 30 years of experience said, “What do you [suppose] happens to your on-time guarantee when you have six slow orders on a 800-mile run with 150 cars behind you?” He went on to describe decreasing speed many miles before the actual slow order and then waiting until the train cleared the area, only to have to do it again and again.

Nor are they the speedy shipment’s sole foe. “Your time and speed [measurements] get [screwed up] when you ‘pop a knuckle'” he said, referring to when a  coupling device connecting railcars to one other snaps. “You have to stop the train and walk hundreds of yards to find where it is, repair it or even call a crew and then get going again. Happens all the time.”

(Slow orders or relatively minor mishaps like “popped knuckles” can and do happen to all railroad companies, not just Canadian National.)

Another yard operations veteran, with 20 years of experience, said that he first learned of ghost tracks about 15 years ago at Canadian National’s MacMillan yard in Toronto when a manager finally got fed up with his supervisors’ castigating him for the yard’s dwell-time figures.

“He came over to my desk and walked me through how to do it,” he said. “So we immediately improved on our arrival/departure and dwell time numbers. No one asked us how we [had] done it,” he added. Nor did the manipulation involve just so-called ghost tracks but, per the accounts described in the Wallender claim and news reports above, it included moving trains a few hundred yards to trigger the scanner, making Canadian National’s computers to mark the train as departed.

In response to a reporter’s question about the possible risk of being deceitful, the yard manager laughed scornfully, “In the railroading [life] the shit runs downhill. No one who lasts long in the job asks many questions [of] a man who’ll fire you.”

A 34-year veteran engineer said he witnessed firsthand while driving trains to Sarnia, where Ontario borders Michigan, how effective ghost tracks could be in keeping a train away from prying eyes.

“After taking a shipment down there, they had [internal yard] printouts we’d see where the train’s destination was shown as track A004, which was a main rail line,” he said, in accordance with the image  below. “And you can’t park there.” He said that trainmasters would then enter the train as being on tracks C16 or C33, which don’t exist and couldn’t be accounted for in the Canadian National system. (On the image below, Track A004 — shortened to A4 — appears two tracks above A-6 in the upper right-hand corner.)

sarnia_yardChart: Transport Canada

Sarnia’s ghost tracks, as well as the ones a few miles across the U.S. border in the Port Huron, Michigan, train yard, were central to Canadian National’s role in an odd 2010 episode that involved shipping biodiesel back and forth across the U.S. and Canadian borders to take advantage of a renewable energy tax incentive in the U.S.

A railroad’s on-time promise can be translated into substantial money.

A logistics consultant to industrial and agricultural clients throughout Ontario told the Southern Investigative Reporting Foundation that on-time promises are easier to fudge for railroads than for a trucking or air freight company. That’s because, he said, “Federal Express has to get it to your home or office door at a certain time; railroads only have to get it from one terminal to another,” where another train takes it to [a distribution facility] where trucks or ships pick it up.

Practically speaking, overpaying for on-time performance, said the logistics consultant (who wouldn’t consent to his name being used because he said he does business with Canadian National), amounts to paying slightly extra for Canadian National’s so-called Series 100 trains, its fastest freight movers, to depart from one terminal at 5 a.m., for example, when it really leaves at 10:30 a.m.

“Few are going to be the wiser because the trains to the [distribution] facilities always leave hours after the scheduled arrival time,” he said.

Commenting on the money to be had in charging for an arrival at a terminal that may not happen as planned, the logistics consultant said, “If Canadian National, or any railroad, can pick up an extra $50 a car load from a customer on certain trains,” then that would translate into “an easy $50 million per year, maybe more.”

The problem, he concluded, is “the volume customers are the smartest about how ‘the system’ works and have the leverage to strike deals after competitive negotiations.”

The Southern Investigative Reporting Foundation repeatedly sought comment from all the people named in this story. Without exception they declined.

Canadian National spokesman Patrick Waldron was provided with the documents referenced above and declined to comment on questions submitted to him, apart from reiterating the railroad’s comment on the auditor general’s report. He did note that in 2013 Canadian National had issued a public rebuttal to certain claims that Holmes had made in his ongoing litigation.

 

 

9 thoughts on “Canadian National Railway: The Great Railroad Construction Robbery

  1. So $725m over past 5 years compares to $30bn of operating profit for CN and CP, and you think some fraction of that is over billed? Does not seem material even if true, seems like a lot of work for immaterial conclusion to the companies.

    • Impressive logic.

      If my wife and I earn $200K in after tax income and I only commit $5000 in tax fraud, I don’t suppose that’s material. No need for authorities to investigate this immaterial fraction.

  2. Great report! Regarding ‘gaming’the performance metric, If the individual customers are aware of both the leave/arrive time what is the relevance of the recorded metrics that are ‘gamed’? Won’t the customers pay based on the actual time it took in transit vs any performance metrics posted by CN? Thanks.

Leave a Reply

Your email address will not be published. Required fields are marked *