Spring Has Sprung; Crocus Scandal Blooms
originally posted April 4/05
The Black Rod
Ahh, you know spring has sprung when the Crocus Scandal blooms.
The Manitoba Securities Commission has announced a "statement of allegations" against the Crocus Fund board of directors. It says they "acted in a manner contrary to the public interest" in the way they handled the setting of the real value of shares in the fund last year.
The Crocus board can dispute and challenge these allegations at a public hearing set for May 6. Or they may choose to settle with the commission before then.
In the meantime, the statement confirms the sequence of events outlined in The Black Rod four months ago.
Now, when we take the details in the Securities Commission's release and mix in the names of the players that we identified in January, add in what we've learned since, and we get a much fuller picture of what occurred in the fall and winter of 2004.
And it's not a pretty picture. It's much worse than the newspaper stories would lead you to believe.
For five whole months, from April to September, the fund's valuation sub-committee did not meet. (The sub-committee recommends the share value to the board of directors at regular intervals throughout the year.)
The Securities Commission says this was because valuations were not completed or were not available until mid-September.
We suspect this was due to the still-mysterious resignations of the staff of valuators.
We also believe it was the fresh eyes of a newcomer to the Crocus family, John Pelton, who joined in April 2004 as Senior Vice President, Investments, that zeroed in on problems.
Because, when the committee did meet, the statement of allegations says, "senior officers" realized that the "net realizable value" of the portfolio should be lowered by $15 million. That wording suggests that some of the assets were not worth what they were listed being worth in the prospectus.
(Here we suggest re-reading The Black Rod [Hollywood edition] Crocus goes to the Movies. If you didn't receive it, let us know, and we'll send one out.)
The full board was given the bad news Sept. 23, 2004. And there was more.
There were "significant risks" with some of the rest of the portfolio. The way the Securities Commission puts it, the risks came from "managing the portfolio as well as the actual investee companies."
To us, that translates into a risk of conflicts of interests between the fund and the individual companies.
Or, as in the Crocus venture into moviemaking, were losing ventures being propped up to defend their recorded value on Crocus books?
Furthermore, the valuations committee had also only been able to complete their examination of 23 of 50 companies that Crocus had invested in, less than half. The board should have known that the $15 million drawdown might be just the start.
The Crocus Fund announced a reduction of its share price Sept. 27. That same day they said goodbye to James Umlah, Chief Investment Officer and President of Crocus Capital Inc., who was leaving to take control of another company. Pelton took Umlah's job as CIO while Laurie Goldberg, Chief Operating Officer since January, took over at Crocus Capital. Overnight, there were two new business-savvy men at the helm of important arms of Crocus.
With the sudden cut in share value, the public was left with the impression that Crocus had acted decisively when faced with a problem, and that the future would be smooth sailing. After all, didn't Crocus have a reputation of good, prudent management?
The Securities Commission picks up the story almost two months later.
The Crocus Finance and Audit Committee met to finalize the annual audited financial statement that had to be released soon. They were advised there was "an issue" and another writedown was possible.
Exactly what the "issue" was has not been explained. But it was another red flag that should not have been ignored.
Nevertheless, the same day, two members of the audit committee signed 8 backdated share valuation certificates, thereby committing themselves to authenticating the value of shares as far back as Sept. 24, or almost two months earlier.
Crocus CEO Alfred Black says this isn't a "high-level policy issue" because each certificate basically calculates the funds sales and redemptions over the previous week. In the small picture, he's right.
But in the big picture, there's a danger to dismissing what they did so cavalierly.
The Crocus Fund had exhibited a loosey-goosey attitude to the valuations of its shares almost all year. For five months the committee in charge of evaluating the worth of the portfolio hadn't met; when it did, it recommended reducing the value of the portfolio by $l5 million, with more than half the portfolio still to be evaluated; it had warned the Board of significant risks and potential writedowns, and still board members acted as if nothing was wrong as they sold shares to an unsuspecting public ... It's more than an oversight; it borders on negligence.
Three days later - it only got worse.
The Securities Commission says "senior officers", who we believe were Pelton and Goldberg, warned the board that another "significant" writedown was necessary. Necessary.
In plain language, Crocus had been selling overvalued shares for months.
We believe that after these men settled into their new jobs following Umlah's departure, they learned details of Crocus operations that they had not known, and which made them shudder.
As the evaluation of the entire portfolio wasn't complete, the officers couldn't agree how big the writedown had to be, but they said the board should start their thinking at $23.5 million and go up.
Remember that two months earlier they had written off $15 million in value, so the possibility exists that as early as September the real value of Crocus was at least $38.5 million less than the book value.
But why stop there? Were the shares equally overvalued during the 2004 RSP season?
Despite the bombshell of a massive revaluation on the horizon, the board of directors did nothing. At first they clung to the reed of a disagreement between "senior officers" over how big the writedown should be. While even the optimists agreed a writedown as likely, they disagreed over the amount.
We believe the disagreement pitted Pelton and Goldberg, the new faces at Crocus, against Sherman Kreiner, President and CEO and the man behind the vision of the labour-managed fund.
The board put off any decision until the optimist faction had a chance to make its arguments at a meeting Nov. 30. After hearing his pitch, the board members made a bold decision --- to look into hiring someone from outside the company to evaluate the portfolio.
But from here on in the statement of allegations tells a story of increasing desperation.
Thursday, Dec. 2 The board meets in-camera to discuss issues including "the roles of senior management." Seeing as how they probably knew what jobs they hired people to do, we assume this has a deeper meaning. We suggest they were looking into how much input senior managers like Kreiner and Umlah had into valuations. They also discussed how a writedown in value would affect sales in the coming RSP season.
Friday, Dec. 3 Redemptions exceed sales by $67,000 to $27,000 over the week. The Securities Commission makes no reference to the sudden reversal. There's no indication of a leak from the board of a pending devaluation, so the numbers must be coincidental.
The next week is a series of almost daily meetings and conference calls as the board tries to manage the rising storm.
Saturday, Dec. 4 A committee is asked to talk to two of the senior officers.
Sunday, Dec. 5 Board member Wally Fox-Decent tells the pair that the board is "not comfortable with the size of the proposed devaluation." According to the Manitoba Securities Commission, he then asked the men if they would sign a new prospectus with a smaller writedown. They said no.
Monday, Dec. 6 The board meets in-camera and realizes there's no delaying the inevitable. Director Peter Olfert, president of the Manitoba Government Employees Union, expressed concerns that Crocus would miss the coming RSP sales season if a renewal prospectus could not be quickly approved.
Wednesday, Dec. 8 The officers meet with the board and refuse to sign off off on a new prospectus until all the valuations have been completed.
Thursday, Dec. 9 A delegation is directed to meet with the Securities Commission to advise it that Crocus would stop trading shares. As The Black Rod reported four months ago, that delegation consisted of Laurie Goldberg, John Pelton, board member Albert Beal and Alfred Black.
Friday, Dec.10 The Securities Commission announces Crocus has stopped trading shares. Crocus announces CEO Sherman Kriener has "retired" and director Wally Fox-Decent has resigned.
This past week Crocus approved a cut in its portfolio value of $46 million, dwarfing even the most pessimistic estimates of a writedown last fall.
The Securities Commission allegations has board members accused of acting "contrary to the public interest." That's an interesting term. And it should echo through the halls of the Manitoba Legislature.
Because if anyone acted "contrary to the public interest", it was the government, that had a representative sitting on the Crocus board of directors the entire time and who said nothing.
The watchdog did not bark.
And more than 33,000 shareholders have watched their savings evaporate.
Crocus will have to answer to the Securities Commission.
But what Commission will determine whether the government of Gary Doer is guilty of acting "contrary to the public interest" ?