There were several suitable candidates for the Outrage this week. A Harvard educated MBA trained as an accountant, who founded a center to deal with governance issues in global financial institutions, claimed to be befuddled by both accounting rules and good governance practices. RIM co-CEO Jim Balsillie spun quite a story to escape any suggestion of wrongdoing over stock options he and others backdated at that company.
Then there is the role of the Ontario Securities Commission in all of this, which is becoming quite a loser in enforcement cases. A conviction in a major stock tipping case was thrown out on appeal. The Bre-X trial has taken years without result. They dropped a case altogether last week in the middle of the trial. And there is the regulator’s perpetual tardiness in adopting rules to protect investors and give them more clout long after they have been approved in the United States.
Since last September, the OSC has given RIM extension after extension for the filing of financial statements. They even allowed company founders to exercise more than 750,000 stock options during this period. This week, they extended their extensions until June. There is not the slightest evidence to suggest that the OSC sees anything terribly wrong with a company that repeatedly fails to provide investors with the audited information they are entitled to by law, which along with its embarrassingly inept enforcement record, leaves many to conclude that the OSC must be the most dysfunctional securities regulator in the G7. Does the OSC even have files marked Livent or Nortel any longer or is justice to be a casualty there as well?
Worthy as these incidents are for this weekly slot, they pale in comparison to revelations that certain U.S. companies exploited the terrorist attacks on America by backdating stock options to that horrific time in order to further line their pockets. When the full extent of this disgraceful conduct emerges, it will shock and outrage Americans in a way that previous abuses in CEO pay have not.
Much has been said and written about the generation that fought a world war against oppression, saved democracy and built the foundation for today’s prosperity. They have been called the Greatest Generation. This was the generation of my father and mother. The grandchildren of this generation carry on that tradition on battlefields far away in Afghanistan and Iraq, where they courageously fight to bring peace to lands too long in the grip of tyrants and the intolerant. I have opposed the war in Iraq and, more particularly, the manner of its commencement and execution by the Bush administration. But I have never for a second doubted the heroism of those answering their country’s call.
At home, however, we see time and again leadership of a different kind: a world where no CEO can be left behind. For many, there is never enough. They believe the world owes them tens, and sometimes hundreds, of millions just for showing up. They need to be motivated, so the conventional boardroom wisdom goes. And the money just pours into their laps. Thus we see, both in the United States and in Canada, reflections of the Greatest Generation and what I call the Greediest Generation: young men and women struggling and dying for a cause that is greater than themselves; CEOs amassing unparalleled fortunes for a cause that is so often singularly about themselves.
And now we have some that have used the tragedy of 9-11 as an opportunity to gain even more. It doesn’t get much worse than that in the boardroom. Which takes this growing scandal of stock options backdating into an entirely different ethical sphere that should appall responsible investors and thoughtful individuals. It is a story we will be hearing much more about in the weeks and months ahead and is, without doubt, the Outrage of the Week.
Like a ghost ship that vanishes and reappears in the mist with long gaps in between, the strange case of Bre-X has taken another turn. The judge who was supposed to deliver his verdict this week announced that he was postponing it until next July, thus taking a full year since closing arguments were made. It is just another one of the strange twists in a case that is like peering through Alice’s Looking Glass.
Here’s part of what I wrote about Bre-X in the Financial Post in 1997, before any charges were laid.
At its height, Bre-X had a market capitalization in excess of 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, not to mention regulators, to take a closer look at the company. It never happened.
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.
Questions began to surface about the company in 1996. A strange little man hired by Bre-X as its local geologist, and who should have had the answers, mysteriously fell to his death from a helicopter in Indonesia in March of that year. The stock soon plunged to a similar fate. Accusations and investigations followed. Eventually, only one person, Bre-X’s chief geologist, John Felderhof, was charged. And it wasn’t even under Canada’s Criminal Code. The alleged offense was one of insider trading under Ontario’s Securities Act.
The case was heard in Ontario provincial court, Canada’s most junior bench, where drunk drivers and break and enter crooks are taken. Mr. Felderhof was charged in 1999. His case came to trial in 2000. During the course of the trial, the Ontario Securities Commission, which is prosecuting the case, decided it didn’t like the judge’s rulings. It sought his removal. Incredibly, that side show lasted nearly fours years. The OSC lost in its attempts to get a new judge and the trial resumed. Closing arguments took place last July. The verdict was to have been delivered this month but the judge announced he needed more time, so the decision is another six months off. There is no jury in cases like this –that’s the way it’s done in Canada. Its antiquated justice system may not require wigs in the courtroom any longer but it resembles its English parent nevertheless, clinging to the notion that Her Majesty’s realm would be imperiled if juries took an active role in dispensing justice like they do in the United States.
Everything about Bre-X shouts of dysfunctionality, if not incompetency. It was a company whose way was paved to a premier listing on the top TSE (as it was at the time) 100 index by unworried securities gatekeepers eager to have the business generated by a hot stock. That mistake gave Bre-X an important imprimatur to investors and its stock soared even further. Due diligence was, shall we say, perfunctory for a junior mining company whose stock capitalization reached into the billions and had never made a penny in profit.
There were more red flags about Bre-X prior to its collapse than fly on an admiral’s ship. Some of those I highlighted in the excerpt above. (I actually raised a number of governance questions during interviews with reporters about Bre-X while it was at the top). No gold, other than samples that were “salted”, was ever found. Billions were eventually wiped out, except for the hundreds of millions the founders conveniently made by cashing in their shares in a feet of remarkable luck, when the stock was at the top and no gold had been produced. Yet the RCMP, Canada’s federal police force, claims that it couldn’t find anyone to charge with criminal wrongdoing. Since Canada is the only member of the G8 and one of the few OECD nations not to have a single, federally legislated securities commission, and prefers that securities matters instead fall to some 13 separate provincial and territorial jurisdictions, the OSC was left to pursue the matter on its own. Like many cases the OSC prosecutes, this one was headed for trouble. It set in motion a chain of events that led to the longest originating trial in Canadian history. In fact, between the period when Mr. Felderhof was charged in 1999 and closing arguments were heard in 2006, the prime suspects in one of Canada’s biggest trials, the Air India case, where 329 passengers were killed by a terrorist bomb, were charged, their case heard and the verdict given in a British Columbia court. The judge in the Bre-X case will spend longer pondering and writing his verdict than was taken by the judge in the Air India trial or in most of Canada’s top appellate cases.
All the actors in this spectacle have much to answer for, yet few seem prepared to begin that process. The farce continues. In Bre-X, Canada’s systems of corporate governance, securities regulation, law enforcement and judicial functioning have all been revealed at their worst and in dire need of major reform, which makes the mishandling of the biggest mining scandal in history the Outrage of the Week.
Listening to today’s late afternoon webcast of RIM’s preliminary third quarter results was like being taken back to the dot.com era when analysts acted more like cheerleaders than objective examiners of the corporation’s health and financial results. Not a single question focused on RIM’s stock option problems. No one asked why the board’s internal investigation was taking so long, why the OSC was recently told that the resulting adjustment would be “significantly higher” than originally expected or what that was likely to mean. Amazingly, the topic of whether RIM would continue to issue stock options to non-management directors in the face of IBM’s much praised move to eliminate them wasn’t even raised. Judging from this show, we have moved back to a time when corporate governance doesn’t figure into the analysts’ equations. Almost every question started off with effusive congratulations to management for their stellar accomplishments. By the soft nature of the questions and unchallenging acceptance of the answers, it seemed more like RIM’s public relations department on the call.
RIM’s short-term results were impressive. But as we have learned from painful experience in recent years, that is only part of a company’s picture. And as was so often the case in the past, it was the questions not asked about matters not considered important that caused the greatest pain to investors.
RIM’s latest news sends up a large red flag about the management of both organizations.
What a surprise. After claiming in numerous news releases that RIM did not expect any material charge as a result of its stock options probe –they estimated between $25 million and $45 million at the time– the company’s lawyers now say it will be “significantly larger”. The revelations arise from RIM’s third appearance before the OSC to give an update as to why the company has failed to satisfy its disclosure obligations. However, this recent clarification does not appear on RIM’s web site, unlike the lower estimates. So investors are left again to wonder in the dark about this, just as they are about the company’s current financial picture. RIM remains in default of its statutory filing requirements.
RIM also claims that delays in getting to the bottom of its options probe arise from the discovery of 250,000 additional documents. Wow. Everyone misplaces a document or two now and then. But it takes a special skill to lose a quarter-million and then discover them by surprise.
RIM lawyers, acting for the board’s audit committee, advise that the voluminous new documents were uncovered through “forensic imaging” of company hard drives. Translation: They recovered files and records that had previously been deleted. That’s a troubling admission which again raises questions as to when they were deleted, why and by whom.
A legitimate further question, and one the OSC does not appear to have asked: When did the company become aware of these additional documents? Did RIM know about their existence when it asked the OSC on November 30th to lift the insider trading ban to permit management to exercise hundreds of thousands of stock options? The OSC granted the request.
There is often a tendency in these matters to underplay the expectation of bad news at the outset and then let it drift out during the course of an investigation in the hope that the market will not react with shock when the details finally surface. Like certain of its corporate governance practices, which were the subject of an extensive posting on Finlay On Governance, RIM’s handling of the probe from the outset raises significant issues.
First, there was the initial formal announcement on September 28th:
Research In Motion Limited (RIM) (Nasdaq: RIMM; TSX: RIM) announced today that the Audit Committee of RIM’s Board of Directors, comprised solely of independent directors, is completing a management-initiated, voluntary review of RIM’s historical option granting practices.
Notice that, on September 28th, the first time the company made mention of its internal investigation, it said the audit committee was “completing” its review.
Later in the release, the company claims:
Although the review is ongoing, it is currently expected that the potential effect of such restatement will be to increase the amount of non-cash charges associated with past option grants and thereby reduce the amount of the Company’s previously reported GAAP earnings by an aggregate amount of approximately $25-45 million over the period since the Company’s IPO in 1997.
And then it states:
The Company does not at present anticipate a material adjustment to current or future fiscal years’ operating results, including the preliminary Q2 operating results reported today in its separate earnings press release, and RIM has defined enhanced procedures and controls to address issues of this nature.
It is curious that RIM seemed to have enough information in September to estimate the $25 to $45 million charge and to assure investors that it was not material. But you have to ask, How did it arrive at that figure? How long had it been investigating the issue before it made the disclosure to investors? And why, if the audit committee was “completing” its probe in late September, did it take three more months to announce that the investigation is more complicated, that it will take longer and that its outcome will be more costly, than originally thought? Does the company’s newest position of a “significantly higher” charge than previously announced, veer into the material lane?
The investing public is entitled to more information than the company has provided or which the OSC seems to think relevant. That’s got to be a red flag regarding the management of both organizations. It is especially troubling that the OSC, after temporarily lifting its insider-only trading ban so that RIM executives could exercise their hefty number of stock options, a subject commented about here, felt it to be in the interests of the investing public to allow the company until March of next year to set its books right or report back on the status of its continuous disclosure obligations. The operative word is status. There is no ultimatum requiring RIM to get its act together or else. Indeed the OSC’s ‘drop back in a few months if the problem is not resolved’ approach seems more typical of a family doctor than a securities regulator.
I have a feeling we have not seen the last of surprises at RIM over its stock options probe. It may well highlight the need for changes in the corporate governance landscape of the company given some of the shortcomings which were raised previously on these pages.
The Centre for Corporate & Public Governance has received so many inquiries about the RIM affair, and the OSC’s role in it, that it felt it necessary to issue a statement. It will continue to monitor the progress of RIM’s investigation and the OSC’s handling of the file.
The OSC’s decision to reverse its previous order and allow RIM insiders to exercise 750,000 options while recent financial statements remain long overdue is a disservice to the investors it is mandated to protect.
There is a second chapter to yesterday’s posting about Research In Motion. You will recall that back in October RIM put out a media release to announce that it had voluntarily requested the Ontario Securities Commission issue a cease trade order against management and insiders because the company had failed to file its quarterly statements. The OSC should have done that without RIM’s requesting it, but you never know, as you will see when you read on. On November 7th the OSC issued the order stating:
…all trading in and acquisitions of securities of RIM, whether direct or indirect, by any of the Respondents cease until two business days following the receipt by the Commission of all filings RIM is required to make pursuant to Ontario securities laws.
The OSC had asserted in its statement of allegations:
It would be prejudicial to the public interest to allow the respondents to trade in the securities of RIM until such time as all disclosure required by Ontario securities law has been made by RIM.
But wait –they both got a do-over. (more…)
