Crocus board deserves no protection: receiver

Directors and officers of the Crocus Investment Fund “abdicated their responsibilities” to more than 33,000 shareholders, according to a new report released by the court-appointed receiver, and that has convinced Russ Holmes to push for an end to their indemnification from a class-action lawsuit.

Holmes, a partner at the Winnipeg office of Deloitte, spent more than $700,000 and reviewed more than two million pages of documents in compiling the much-anticipated report on the failed labour-sponsored fund. The report is broken down into three volumes and covers more than 500 pages.

In the report, he said the board, which was dominated by appointees from the fund’s sponsor, the Manitoba Federation of Labour, “succumbed to strong-willed management.” He said all the directors had an obligation to familiarize themselves with the Corporations Act and bylaws and to make their best efforts to ensure Crocus complied with the obligations imposed upon it for the protection of the investing public.

“The receiver has a concern that the board collectively failed to meet this standard and, when viewed objectively, did not act in a manner that entitles them to the benefit of the indemnity of Crocus,” Holmes wrote.

“It is the receiver’s view that the Directors fundamentally abdicated their overall responsibility to manage the business and affairs of Crocus. That abdication manifested itself most significantly by allowing for the gradual, unsustainable inflation of the value of the investment assets, and, correspondingly, to the net asset value per common share.”

The indemnity protects the fund’s former directors and officers from being responsible for their own legal fees and a judgment if the $200-million class-action suit, which is awaiting certification, is successful.

The fate of the report had been in the hands of Manitoba Court of Queen’s Bench Judge Deborah McCawley for several weeks prior to its release.

Holmes had asked the court to issue an order to make the report public, a move that would have granted Deloitte protection against potential legal action by any of the people named in it.

She declined and instead issued a decision unsealing the report. In her decision, she said it was “worthwhile” noting the receiver’s report wasn’t the result of a comprehensive investigation but instead was a “limited and selective” review of some of Crocus’s records. She also noted Holmes didn’t conduct any interviews in making his report.

“To the extent that any conclusions are drawn or opinions offered, they must be seen in this context,” she wrote.

Unlike with its previous reports, Deloitte did not post this one on its website. Holmes has declined all media requests.

The fund’s managers were also in Holmes’s crosshairs. He accused them of purposely delaying downward valuations of the fund’s investee companies — and by extension, the fund’s unit price — until after the RRSP season to avoid any negative impact on sales. He alleged in the report that fund managers gradually replaced external valuators with an increasing reliance on internal valuations.

“The conclusion of the receiver, based on the records review, is that senior management of Crocus, with the passive acquiescence of the Board, determined that it was in the best interests of Crocus, as an entity separate and apart from its Class ‘A’ Common Shareholders, to take over as much control [of] the valuation process as possible,” Holmes wrote.

Notwithstanding some spirited debate and criticisms, the board was compliant with the wishes of senior management, particularly when founding CEO, Sherman Kreiner, made it clear that management should be permitted to dictate the timing of valuations of the investee companies, the report said.

Crocus, once the focal point of venture capital activity in the province with a portfolio of investments worth $170 million in September 2004, halted trading three years ago amid serious concerns about the carrying values of many of its holdings. From the fall of 2004 until the spring of 2005, the board twice wrote down the value of its portfolio, first by $15 million and then by $45.8 million. It was placed into receivership in the summer of 2005. Deloitte has been systematically selling off its assets ever since.

Hugh McFadden, leader of the provincial Tories, reiterated his call for a public inquiry to get to the bottom of what happened during the last days and months of Crocus.

“The fundamental conclusion of the receiver’s report is the directors failed to live up to their duties. They let Manitobans down. Shareholders have been at the back of the bus for too long. It’s time we gave them a front row seat,” he says.

But the province isn’t biting. A spokesman for Premier Gary Doer’s government says it has no plans to reconsider holding an inquiry.

“We think it has been investigated thoroughly through the Auditor General’s report, the court case, the review from Deloitte, and it will be reviewed by the Manitoba Securities Commission. The RCMP is also looking at it,” he says.

The spokesman says the government estimates holding such an inquiry would cost approximately $12 million.

“We’d rather spend that money on health care and other things rather than duplicate investigations that have already been done,” he says.

Bernie Bellan, the outspoken Crocus shareholder who spearheaded the class-action lawsuit, says the Deloitte report is a shot in the arm to all shareholders.

“There was such a lack of supervision of the valuation process from the directors. They abandoned any sense of their duty to properly supervise the management. They turned over complete responsibility of the management of the fund to the officers. Why were they so reluctant to voice any objections to what was going on? What were they thinking?” he says.

Holmes’s report is itself somewhat controversial. Many of the former directors and officers named in it have questioned whether he should have been named the receiver in the first place because Deloitte provided consulting services to Crocus prior to it being placed in receivership. Those services included researching a major revaluation of the Crocus portfolio, a process that led to the $45.8-million write-down in the spring of 2005.

Those critics also say Holmes didn’t have the authority to spend the money on his investigation, which they say largely duplicates the work of the province’s auditor general, who released a scathing report on Crocus’s operations in the spring of 2005. While Holmes reviewed financial statements, valuation reports, correspondence between Crocus and its investee companies, board minutes and e-mails between the fund’s staff members, he didn’t conduct a single interview with any of the parties named in the report.

It was recently revealed that the Manitoba Securities Commission was warned not to hire Deloitte in the first place because of the perceived conflict. Alfred Black, who took over as Crocus CEO after Kreiner stepped down in December 2004, said in an affidavit that he passed on his concerns regarding Deloitte in the spring of 2005.

“I told the lawyers that, in my view, they should not retain Deloitte because Deloitte was either potentially or already in conflict as a result of its involvement in Crocus leading up to the then-imminent receivership,” he said.

Kreiner, arguably the most vilified of all of Crocus’s officers and directors over the past three years, went on the offensive in an affidavit filed just after the report was released. He said Holmes was in a conflict of interest, which caused him to “mischaracterize the problems at Crocus, and, therefore, misallocate the blame.”

Kreiner said he did nothing to improperly inflate share values and to his knowledge, nobody at Crocus contrived to delay valuation changes to maximize sales in the RRSP season.

“Mr. Holmes’ report is an exercise in self-justification. Based on my own recollection of what occurred, I believe he has presented a one-sided and distorted report to the court,” Kreiner wrote.

Ken Filkow, a partner at the Winnipeg law firm of D’Arcy & Deacon, who is representing a dozen former directors of Crocus, says judging from the wording of Justice McCawley’s decision to unseal the report, she didn’t embrace its contents.

“She was careful to make the observation it was based on select documents on select investments and that there was no opportunity given to the directors to make representation. She used very specific language, and the report has to be read in that context,” he says.

Filkow adds the report falls short in its efforts to disqualify the directors from their indemnification.

“I don’t think there’s any evidence in the report of dishonesty or bad faith. To reach those conclusions is a leap of faith in terms of the documents they cite. There would have to be some kind of smoking gun [but] there isn’t and there wasn’t,” he says.

Filkow says the next step is to assess whether the matter has to be returned to Justice McCawley by the directors’ side for a declaration that the indemnification continues to apply or by the receiver to get an order to ratify his ceasing payment of the indemnification going forward.

“Our present view is that the onus is on the receiver, but we haven’t conclusively determined that,” he says.