How to block an 'End Run'

Anyone who thinks Enron's collapse is an isolated incident that couldn't happen in Canada is, to put it mildly, naive. If anything, the probability that Canadian investors could fall victim to an Enron-like failure is much higher than in the United States.

The Financial Post
January 17, 2002

How to block an 'End Run'
Enron-like stock blowouts more probable in Canada
Al Rosen

Anyone who thinks Enron's collapse is an isolated incident that couldn't happen in Canada is, to put it mildly, naive. If anything, the probability that Canadian investors could fall victim to an Enron-like failure is much higher than in the United States.

Our securities systems do not protect investors' private property and too many of our laws favour directors, officers and auditors over investors. Our class-action laws are feeble.

Even scarier is how passively Canadians reacted to the Bre-X swindle and the Nortel meltdown. Instead of demands for fast and severe tightening of securities regulations, there's indifference. Which is odd, considering virtually every Canadian is affected by stock-price plunges. Most harm comes to those who hold shares of these crumbling companies in their personal portfolios. But you don't need to have a direct stake to get hurt. Your pension plan has probably invested in one of these companies, too.

The Canadian way seems to be to play down corporate failures. Indeed, many investors do not seem aware that we have had several Enron-like meltdowns over the past 15 years: Livent, Confederation Life, Castor Holdings, Canadian Commercial Bank, Northland Bank; National Business Systems, Standard Trust, Principal Group, Bramalea, and many more.

Even professionals are hopelessly out of touch with what's going on. I bet only one in 100 analysts can tell you about the Supreme Court's landmark decision in 1997 that instructed individual investors to stop relying on financial statements for investment decisions. Pretty scary, when you consider millions of people make stock picks based on analysts' advice.

So how can we protect investors? Let's start by making directors, officers and auditors clearly accountable. Shredding of files and auditors' working-paper evidence when a blow-up occurs is a mere symptom of a much larger issue: Penalties for such behaviour are trivial in Canada, with the upside far exceeding the downside for those who choose to bilk the public.

Something must be done to resolve the conflict between the role accountants play as auditors and consultants. How can we expect auditors to be independent while accepting lucrative non-audit consultancy and tax fees from the same companies?

But there's a more fundamental problem that makes Canadians more exposed than U.S. investors.
Canadian accounting rules are exceedingly loose and contain many built-in Ponzi fraud opportunities, whereby investors' capital can be relabelled as income.

All too often, under U.S. accounting rules a Canadian company would have to report a loss. Yet for the same period, the Canadian company issues a press release and financial statements that show a huge profit. An analyst then foolishly places a 20-times valuation multiple on the income, and up goes the stock price. If Enron (or is it End Run?) can easily get around the U.S. accounting rules, try to imagine what it could have produced under Canadian accounting.

Seemingly without effort, huge sums of money can get transferred from the average citizen to con artists. We have laws to help prosecute those who directly steal purses and wallets. But somehow we grant an exception when stock markets are chosen as the vehicle to extract our savings. We have no choice: we have to change motivation systems drastically, enforce serious penalties — and soon.

L.S. (Al) Rosen is president of Rosen & Associates Limited, forensic accountants.


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