From the stock market watchdogs who permitted the premature listing of the company to the cops and regulators who were unsuccessful in bringing even a single fraudster to justice, Bre-X was a colossal failure at every level.
It’s not surprising that the Ontario Securities Commission has decided not to appeal the acquittal of John Felderhof, the only person ever to be charged in the infamous Bre-X fraud. Frankly, there have been so many strange twists and remarkable disappointments with this case that there is really little left to be astonished about. As we noted here with chagrin even before this recent setback, the OSC is clearly losing its appetite for criminal prosecution, partly because it has been doing so badly in that regard and partly because it has a leadership culture that prefers to retreat to its less aggressive era. This was pretty much reflected in a statement by OSC chair David Wilson, who told Macleans recently that the agency’s priority was “not to beat the drumbeat of more criminal cases.” As we observed previously, there were many problems with the case, and where it was heard at Canada’s lowest court level, that were beyond the OSC’s control. But if you look at the length of time it took to have the case tried (seven years), the three- year-long motion and appeal interval where it was trying to have the judge removed, and the full year it took for the judge to write his decision (there was no jury in this case) the outcome was probably as predictable as the bewildering process that gave birth to it.
So it is that the largest mining fraud ever has now become the biggest bungled case of its kind in history. From the stock market watchdogs who permitted the premature listing of the company on the prestigious TSE 100 without due diligence to the shut-eyed independent directors, credit rating agencies and analysts who saw only the glitter of fools gold and eventually to the cops and regulators who were unsuccessful in bringing even a single fraudster to justice —and now have given up entirely— Bre-X was a colossal failure at every level. It might also serve as a cautionary lesson to today’s old line boardroom stalwarts who argue that too much emphasis has been placed in recent years on structure and that there is no connection between the architecture of corporate governance and corporate performance. I will have more to say about the confused logic and selective memory of those who would move the boardroom back to the future in another posting. But it would be hard to find a worse example of corporate governance than Bre-X — unless of course you were looking at Hollinger Inc. during Conrad Black’s era or Research In Motion more recently or the nearly 25 percent of companies listed on the TSX Venture Exchange that do not comply with even the minimum disclosure regarding their own boardroom practices which is required as a condition of listing by that exchange.
In the entire decade since the scandal unfolded, not a single agency, regulator or individual has admitted even the slightest responsibility, however indirect, for this calamity. No apology has ever been made to the investors who lost billions or to the larger investing public which has an irrefutable stake in the integrity of the capital markets and the institutions that guard them. No criminal has ever been convicted. You would almost think Bre-X were an inexplicable act of nature for which no mortal can be held accountable. At least not in Canada.
If the Bre-X fiasco occurred elsewhere, and certainly if it happened in the United States, outraged legislators and congressional committees would be in full flight holding hearings to find out why the company went so far beyond the arm of justice. They’d call aggrieved shareholders as witnesses and demand that stock market officials, regulators and justice department chiefs appear before them. They’d want to know if this case was symptomatic of any larger problem and whether such a travesty could happen again in the form of another memorable name. But in Canada, where it is hard to imagine a more dysfunctional system of securities regulation and boardroom crime policing, the biggest disaster in mining history ends with barely a whimper. And the politicians go back to sleep.
Exactly ten years ago, in an Op-Ed column in the Financial Post, I first brought to public light a number of the corporate governance failures that allowed Bre-X to happen. As we close the book on this sad saga, I thought it would be interesting to reprise the article that in many ways foreshadowed all the other failures that came to be associated with that scandal.
Bre-X Was A Failure of governance
J. Richard Finlay
Originally published in the Financial Post, August 1997
Continuing denials of culpability by former directors of Bre-X Minerals Inc. and securities regulators show once again that there is a predictable rhythm to corporate governance issues in the wake of disaster. In what has become the corporate version of line-dancing, academics and the media stamp their feet in demands for reform, regulators scurry for cover from the descending wrath of shareholders, and directors pirouette in elegant assertions that things will change. But when the revivalistic music stops, exhausted directors too often slump back into their boardroom seats, returning to their customary somnolent ways. The ritual is recurring in the Bre-X debacle.
Bre-X was a massive fraud to be sure. But it was also a massive failure of corporate governance. And the failure occurred on a number of fronts. With its insider board, dubious disclosure record, curious insider trading patterns, ever-expanding boasts about ore deposits and confusion about who owns them, Bre-X was a time bomb waiting to go off. But those who could have defused it heard only the siren song of fast money and not the tick, tick, tick, of impending ruin.
Of Bre-X’s board of six, only two members qualified as independent directors. The TSE’s guidelines for publicly traded companies call for a majority of outside, independent directors. This did not appear to bother many institutions or funds. When directors began to engage in heavy insider trading, regulators and advisors should have seen the signs and looked deeper into the details of the operation. Previous problems about licensing and ownership should have provided clues. Few followed that trail. When directors made ever-exaggerated claims about the size of the Busang find, regulators and investment advisors could have demanded more details. None did.
At its height, Bre-X had a market capitalization greater than Imperial Oil, Bombardier, Inco and Molson combined. And that was without any sales or profits. That alone should have prompted major financial institutions and pension funds, to say nothing of regulators, to take a closer look at the company. It never happened.
Another board that should also be doing some soul-searching is the TSE’s. The TSE’s guidelines on corporate governance raise an interesting question: Why does the TSE itself not comply with them?
Of the TSE’s board of 14, only four directors qualify as being independent. That’s far from a majority and far short of its own guidelines on corporate governance. Would a board composed of a majority of independent directors who are unaffiliated from member institutions have been more cautious about Bre-X? Would it have been more wary about putting Bre-X on the blue chip composite index when the company had no track record and when there were so many unanswered questions? Like many things about this scandal, we may never know. But we do know from the past, and from the TSE’s own study, that independent directors make for better boards. And better boards are motivated by the longer view, not necessarily the fastest buck.
Modern corporate governance practices, as every regulator and investment advisor has been taught, have grown out of disasters like Bre-X. The collapse of Great Britain’s Royal Mail Steam Packer Company in the 1930s (which, like Bre-X, also had a board of six directors) and Robert Maxwell’s empire, the S & L scandal in the United States and the demise of Confederation Life and dozens of other financial concerns in Canada all have involved failures of corporate governance. Had those lessons been applied in the Bre-X case, the fraud likely never would have achieved the level it did because institutional investors and regulators simply would not have endorsed a company that failed to practice even the most elementary standards of good corporate governance.
Directors, regulators and investment advisors are paid to read the signs of disaster as well as the portents of profit. The investing public is still waiting for an explanation as to why they failed in their duty over Bre-X.
The Centre for Corporate & Public Governance has issued a statement on the stunning acquittal of former Bre-X executive John Felderhof. As the statement notes:
In the time it took to charge and try John Felderhof, the lone defendant in the Bre-X case, the scandals of Enron, WorldCom, Tyco, Computer Associates and dozens more came and went; their top executives were indicted, tried, convicted and sent to prison. But in the world’s largest ever mining fraud where billions of dollars were lost, not a single person has been found guilty of even a petty crime.
I have had a number of comments on Bre-X and related issues over the years. I view the outcome today as confirmation of what I have been saying for more than a decade: Canada has a hopelessly inept system of securities regulation and enforcement that is an embarrassment around the world. Perhaps this will prompt Canadian politicians to finally do something about it.
A fraud without a fraudster? Some think it could happen only in Canada. I hope to revisit this topic after my return from vacation.
After raising the alarm some months ago over what he termed a crisis of competitiveness facing Wall Street, and endorsing the recommendations of a blue ribbon committee on capital market reform, U.S. Treasury Secretary Henry Paulson recently formed —you guessed it— yet another committee to look into the problem. Crisis? The only crisis is the chronic inability of Bush administration policy makers, eager to do Wall Street’s bidding, to acknowledge that higher standards of ethics, transparency and accountability serve the interests of North American investors and long-term confidence in capitalism. Wall Street has never liked reforms, whether they arrived in the form of the Pujo committee of the early 1900s, the Pecora commission of the 1930s or Sarbanes- Oxley in the 21st century. As Ferdinand Pecora wrote nearly 70 years ago, “Bitterly hostile was Wall Street to the enactment of the regulatory legislation.” It has not changed — thus the efforts to roll back and ease recent reforms in the guise of answering a competitive crisis. Secretary Paulson, it will be recalled, came to office last June fresh from his post as CEO of Goldman Sachs.
The problem is that even Wall Street and its high-placed friends realize it is difficult, during a period of unprecedented earnings and bonuses, as well as record Dow Jones levels, to make such a case. Rather than just admitting their folly, another committee seems the best way for them to beat a fast retreat.
The Wall Street Journal’s Alan Murray suggested a rather novel idea this week. He argued:
Hedge funds — at least the five percent of them who pursue activist investing strategies — look to me like the saviors of capitalism. They are in the best position to hold CEOs accountable – and someone other than regulators, trial lawyers and left-leaning public pension funds needs to play that role.
I like Alan, but I’m glad he isn’t slugging for the Yankees this week. Because, this time, he really struck out.
An important part of the evolution of modern capitalism has been its wide and dynamic base of stakeholder participation —of share owners as well as consumers. That model has given people a stake in supporting key drivers of the economy along with a sense that they are benefiting from them. It is a system that requires public consent as well as efficiency.
The fact is that too little is known about most hedge funds and how they will affect all the stakeholders who have come to depend upon the modern, transparent corporation. Its often secretive practitioners seem to want to keep it that way. We know a great deal about their economic prowess. Much less is understood about their concepts of responsibility, their vision for the future of capitalism and how they plan to govern. And there is that little thing called derivatives that can see huge fortunes wiped out overnight.
Some hedge funds efforts, like those involving Carl Icahn, have proven mixed in terms of results and rather destabilizing to large groups affected. An occasional shake-up can be good for organizations, especially those run by the smug and self-satisfied. A regular series of earthquakes probably is not.
One can debate whether or not capitalism needs a savior. I am fairly certain, however, that hedge funds are an unlikely candidate for that task. Some might argue that the best way to ensure an efficient and accountable market is to have more and better informed shareholders —and a system of governance that allows investors a meaningful role in exercising the privileges and responsibilities that go with ownership. I distinguish here from the Wal-Mart approach, which seems to regard shareholder involvement and proxy initiatives as some kind of subversive activity requiring extensive background checks, and goodness knows what else, of the proponents.
A century or so ago society was promised a new approach to capitalism which was also supposed to make companies and managers more efficient. It was dominated by a handful of actors on a stage where J.P. Morgan had the leading role. It didn’t end so well, as I recall. Concentrations of power, in the long run and very often sooner, generally produce more suspicion, political outrage and public discontent than widespread improvements in progress and prosperity.
I will be the first to admit that there are serious weaknesses with the way most boards work. Management self interest often saps performance and makes companies far less productive, accountable and responsible than they need to be. Think of recent experiences with Home Depot and Hollinger, for instance. But before we throw out the concept of the widely held, shareholder owned, stakeholder dependent corporation, let’s understand better what we are getting with the inheritors of this tough-minded approach that seems to be the defining hallmark of hedge funds.
It would be unwise to adopt a cure —or a savior— that could prove more costly than the illness.
The Centre for Corporate & Public Governance was the first to raise concerns regarding BCE’s press statements in connection with its private equity talks. It has since received several dozen emails and calls from individual investors expressing fears that they were provided, at best, an incomplete picture by BCE when it denied on March 29th that any private equity talks were taking place or that any were intended to take place. The Centre has called for an explanation by BCE and, failing that, an investigation by market regulators. The Montreal Gazette carries the story in a piece today. It also carries a rather troubling response from a manager in Market Regulation Services, the body that is supposed to ensure market integrity. Here is an excerpt from the Gazette story:
A corporate accountability watchdog wants regulators to investigate whether BCE misled shareholders when it denied it was in talks with private equity firms on March 29.
Richard Finlay of the Centre for Corporate and Public Governance said many shareholders relied on BCE’s affirmation that it had no plans to take the company private. “It just doesn’t happen that fast. … It takes a lot of time to pull things together, to gather advisors and law firms.”
He is also suspicious of a spike in trading of BCE shares last Monday, the day before BCE did confirm talks with the pension funds.
“You have to ask if some people were acting on privileged information,” he said.
But an official at Market Regulation Services saw no need for an investigation. “Who knows how quickly things move along,” said Chris Lewer, manager of market surveillance. “The more high profile the case, the more things have tendency to evolve. All we can go by is the press release BCE issued.”
I was not aware that regulators were in the business of blindly accepting without question what publicly traded companies say. If that’s true, they can all shut the doors and we might save a lot of money —except for all the investors that will be fleeced. Certainly the misbehavers in the marketplace —and it is rumored there are more than a few— will be pleased to hear about the new policy of securities regulators, who appear to have been struck with a sudden case of acute panglossianism.
Anyone looking at the two releases, and the huge spike in the trading of BCE stock just the day before the announcement, would have serious questions to ask BCE management. If the right answers are not forthcoming, an investigation should be conducted. That’s the way the system is supposed to work. Dozens of investors have already expressed that opinion and I expect there are hundreds out there who feel the same way.
Fortunately, BCE stock is also traded on the NYSE board. There are a number of U.S. investors who also relied upon BCE’s statements and have some concerns about the contradiction that later followed. So once again, Canadian investors will have to look to U.S. regulators to dig a little deeper than their northern counterparts
The market’s Canadian watchdog prefers to sleep.
With 90 OSC employees making more than the chairman of the SEC, it’s time to look at the Ontario securities regulator’s performance and accountability
Its chair and just one of its vice-chairs together make more than all five members of the U.S. Securities and Exchange Commission combined, including SEC chairman Christopher Cox. Yet the Ontario Securities Commission has become the object of ridicule among investors for acting like something of a dummy to the SEC’s ventriloquist when it comes to prosecuting high profile cases such as Hollinger and Nortel. And the OSC still lags in adopting corporate governance and disclosure standards similar to those in the U.S. and continues to bungle and drag its feet on one major case after another. Just look at how it handled the RIM stock options backdating scandal, for instance.
But, in a move that can only be seen as an attempt to compete with Nigeria in a race to the bottom in investor protection, the OSC is apparently considering ending criminal prosecutions in Ontario courts altogether. It claims the standard of proof may be too high to obtain a conviction. The boo hoo prize is hereby awarded. If the OSC is allowed to carry through with this policy, there would be no jail time for insider trading or other violations of Ontario Securities laws. Talk about a move backwards. If the idea is to attract capital markets miscreants from the U.S. and other jurisdictions and encourage them to set up shop under a more lax regulatory regime, it’s headed in the right direction. But if the OSC’s mandate is still to protect investors, it seems akin to going the wrong way on a very busy superhighway.
One of the big problems with the OSC is that it was made “self-funding” in the 1990s. The change allowed the OSC to become accountable essentially to itself. It even gets to nominate its own members, which it has in plenitude. The OSC has 13 commissioners as compared with the SEC’s total of five (who are nominated by the President and confirmed by the Senate). The SEC regulates a capital market of 300 million citizens. The OSC regulates just for Ontario. Its board sets policy, makes rules, adjudicates hearings and oversees the commission’s finances. That’s already a lot of power for one body. The OSC —not the government— even sets the salary for its own chair, commission members and staff. And it shows. As revealed for the first time by The Centre for Corporate & Public Governance, in 2006 the OSC had a staggering 90 employees who made more than the SEC chairman himself. Even a senior manager at the OSC pulls down $194,000. The previous OSC chair, by the way, roamed the world as part of his official duties and spent thousands on a foray to Kenya alone. How did that protect Ontario investors? Has any elected official ever questioned the OSC’s salary and expense levels? Unlike the sharp Congressional supervision that occurs with the SEC, there is no meaningful oversight of the OSC, which explains why it can indulge in a lavish style of self-governance more resembling Conrad Black than a securities regulator.
I think most investors will agree that this is not the time for the OSC to engage in introspective musings. A more volatile capital market that is capable of turning south overnight needs rigorous and competent enforcement of the rules. And I am on record as far back as 1994 in advocating a single national securities commission for Canada —long before it became the current popular topic that it is. But, since the OSC has opened the door to this discussion by thinking out loud about abandoning criminal prosecutions and seems to be a delayed echo of the U.S. regulator anyway, you might wonder why the OSC doesn’t just find another line of work entirely and leave regulation of the North American capital markets to the SEC, which, when it comes to cases like Hollinger and Nortel, seems to be doing the heavy lifting in protecting Ontario investors.
You can post your comments here or send them to finlayongovernance at gmail dot com.
