Crocus debacle could affect entire LSIF sector, experts warn

(June 9, 2005) While the recent scathing report from Manitoba Auditor General Jon Singleton focused exclusively on the Crocus Investment Fund, industry experts warn the fallout could spread to labour-sponsored funds throughout the country.

The 245-page report — five months in the making — identified numerous causes for the $61.1 million decline in the value of Winnipeg-based Crocus’s portfolio between last September and this past April.

They include weak oversight and governance, flawed investment processes and procedures, poor management of operating losses, significant abuse of the fund’s travel and expense policy and the misrepresentation of a $10-million cash injection from Quebec’s Solidarity Fund as an investment rather than a loan.

Dan Hallett, a Windsor-based analyst who follows the LSIF market closely, says geographic proximity will cause ENSIS Growth Fund, Crocus’s long-time competitor in Manitoba, to feel the most immediate impact.

The backlash began during the 2005 RRSP season, which effectively kicked off with Crocus announced the freezing of its shares and the “retirement” of its founder and CEO, 52-year-old Sherman Kreiner. Despite having the whole LSIF market to itself, ENSIS raised just $10 million from Manitoba investors this year, a 33% decline from the $15 million it raised in 2004.

But the nearly 50 other LSIFs across the country are unlikely to emerge unscathed, he warns, because Crocus’s failures have raised questions about all of their operations.

“People say, “If it’s happened there, where else is it happening?” Hallett says. “It’s long been a concern for the LSIFs that they lack transparency in terms of how portfolio values are adjusted from time to time and what the carrying values of specific investment are.”

Steven Kelman, president of Toronto-based Steven G. Kelman & Associates, says when directors forget their responsibilities, capital markets and investor confidence can be negatively affected.

He questions whether advisors will consider the increased due diligence responsibilities on LSIFs that will undoubtedly result in the wake of Crocus’s situation to be worth the payout.

“You have to do a lot of work for your $200,” he says, noting LSIFs could go a long way towards boosting investor confidence if they provided more transparency with their operations.

Hallett says the Crocus debacle only compounds the situation facing the LSIF sector, which saw negative returns over the last two years cause sales to struggle at the same time as investors were flocking back to stocks, bonds, mutual funds and income trusts.

“The sector was struggling before the whole Crocus thing came along. It just exacerbates the challenges they were having already.”

There may be a silver lining, however, Kelman adds.

“I think if directors of other funds haven’t been doing what they should be doing, they’ll be taking a better look at internal governance and programs. And if anybody hasn’t got their valuations up to date, I’m sure they’ve done it by now,” he says.

Fred Wing, executive vice-president of Winnipeg-based Rice Financial, is also relatively optimistic. He says while the situation is undoubtedly tough on current Crocus unitholders because they’re unlikely to get their principal back, let alone any profit, the fund’s troubles will ultimately prove beneficial to investors in the long run.

“This is a relatively new product and sometimes the due diligence isn’t perfect. I firmly believe the manufacturers and sales people will become better at that,” he says.

Wing even speculates other firms, and ENSIS in particular, could see a rebound in the 2006 RRSP season if they aggressively report their strengths of due diligence, open their books and be more up front with investors.

“They have to pass the consumer and regulatory acid test.”

Geoff Kirbyson is a Winnipeg-based freelance writer

(06/09/05)