Intellectual Dishonesty at the Ivey Business Journal

Under the headline “Canada Isn’t Rotten to the Core”, the new editor of the Ivey Business Journal, Thomas Watson, attacked my book “Thieves of Bay Street” in his inaugural editorial. Although the book hit bookstores almost two years ago, and has faded from view, I found this assault so distorted to what “Thieves” explores I felt it warranted a response. Unfortunately, Watson declined to publish my reply, suggesting intellectual discourse is not highly prized at his publication.

The Ivey Business Journal is produced by the Ivey Business School at Western University in London, Ontario. Watson is a former Canadian Business magazine writer and currently a columnist for the Financial Post Magazine. Fundamentally, I found Watson’s review intellectually dishonest. And in the larger scheme of things, his analysis reflects a specific moral perspective commonly found in the Canadian business world and therefore worth exploring: A perspective disturbing in light of the scandals that chronically plague this community.

Let me first address the distorted manner in which Watson criticized my book. In his review he maintains “Thieves” states there exists “a nation-wide conspiracy by Canadian elites to rob the poor and middle classes”. I claimed no such thing. What I did argue, using example after example, is that the Canadian financial industry, specifically, seeks to take as much money from the pocketbooks of Canadians as they can, using all legal and illegal methods at its disposal. This is not, by the way, an opinion I alone share. For example, Stephen Jarislowsky, the Montreal billionaire investor often referred to as Canada’s Warren Buffett, told me when we spoke that “All the financial business tries to do is separate the investor from his money… In the meantime the poor investor is like a sheep being shorn in all directions.” Another former top executive at CIBC World Markets, who currently runs one of Canada’s largest investment companies, told me much the same thing when he said: “Canada is dominated by business oligopolies and the consumer is fucked” when we were discussing the banking industry.

Canada’s business community is large and varied. While Watson gives the impression I went after it in toto, in fact my book focused on just one aspect of it – where investors and their cash meet the capital markets. It’s in this milieu I argued the vaunted reputation of our financial sector was overblown. Yet by headlining his review “Canada is Not Rotten to the Core”, Watson suggests I tarred the entire business class. Anyone who reads the book can see I was not investigating the behavior of the oil, mining, manufacturing, service, technology or drug industries, etc.

Furthermore, the very thing that gave rise to the book in the first place – the 2007-’09 credit crisis – is only mentioned by Watson in passing. Yet that crisis, which almost toppled the global economy into another Great Depression, was engineered by the reckless and criminal behavior of those who run the financial system, of which the Canadian division played its part. Watson complains that I am too harsh on a sector that is now generally viewed with utter contempt by the general public. The most recent poll done in the US shows that only 14% of Americans have a favourable view of Wall Street, while 42% view it unfavourably.

What is the proof that Watson puts forward that the financial industry does not have a problem with fraud and fiasco? He writes: “I’ve never been robbed by a broker. Last time I checked, my bank card still worked.”

This is one of the most asinine statements I have ever seen in print. It’s akin to suggesting that because, after having lots of unsafe sex during the AIDS crisis and failing to catch the disease, the AIDS crisis simply did not occur. If this is what passes for systemic analysis of the most important sector of the economy, then we are in deep trouble.

Moreover, as Watson should well know, we wouldn’t even have much of a financial industry today – let alone his broker and his bank card – if it were not due to the massive intervention by governments around the world to bail out the entire banking system. In the US, that came in the form of TARP. In Canada, the Harper government, through the auspices of the CMHC, allowed $90-billion (or $114-billion depending on the numbers) of mortgage risk to be transferred to taxpayers from the five chartered banks during the credit crisis. In a study of this program, the Canadian Centre for Policy Alternatives says that at one juncture three of our five chartered banks were completely under water.

Watson then points to a report that says Canada is the 10^th favoured place in the world to invest globally, with $45.4-billion coming into the country in 2012, suggesting we are not a problem country for fraud. This is a misleading figure to bandy about in the context of the point of my book – which is there’s too much unscrupulous behavior in our capital markets. After all, investment in countries often has little or almost nothing to do with levels of policing of capital markets or corruption in a particular country. It’s a factor, of course. But countries rich in scarce natural resources, such as Canada, will attract massive investment, despite problems with corruption or corporate governance. Oil companies were lining up to invest in Iraq after the US invaded in 2003, as were companies that wanted access to Russia after the fall of communism, and China has attracted enormous foreign investment despite being riddled with corruption. Canada’s mining industry works in all parts of the developing world where corruption is a problem, as does SNC Lavalin (such as in Libya).

Moreover, I never claimed in my book that Canada is a corrupt country on par with a Mexico or Italy or Russia.  My point is that too much fraud happens here that goes unpunished. Which is a legitimate point to make, and not disputed by many members of the business establishment. For example, a few years ago, Barbara Stymiest, the current chair of Blackberry, a former chief operating officer of the Royal Bank of Canada and former CEO of the Toronto Stock Exchange, called Canada’s securities enforcement an “international embarrassment.”

Instead, Watson should examine this report: In 2011, Douglas Cumming of the Schulich School of Business at York University and Sofia Johan at the University of Tilburg, produced a study comparing reported cases of fraud in the capital markets of Canada, the US and UK. In all, they looked at 4,190 cases of improper conduct at publicly traded firms over a six-year period ending in 2011. What they found is that while financial fraud was committed at 7 per cent of Canadian publicly traded companies, a grand total of 0.3 per cent of TSX listings were subject to fraud litigation each year between 2005 and 2011. That compares with 1.9 per cent of NYSE listed companies and 4.5 per cent of Nasdaq firms. Canadian securities regulators, they found, are 8.9 per cent less likely to detect financial fraud in the markets than the SEC. “When you compare Canada and the U.K. to the United States, the results are quite shocking,” Cumming was quoted as saying, “with about 10 times less reporting or litigating of corporate fraud or fraud involving corporate shares in Canada.Yet it is unlikely that the incidence of corporate fraud in Canada is that much different than in the United States.”

In fact, despite diminishing the seriousness of crime in the financial industry, Watson fails to discuss the massive ones that have roiled that sector – since the credit crisis. Such as:

• The Libor scandal, whereby it was discovered that some of the world’s biggest banks were falsely inflating or deflating their rates so as to profit from trades, or to give the impression they were more creditworthy than they were.The London Inter-Bank Offered Rate (Libor) underpins the financial system and is embedded in more than $350 trillion of financial contracts, derivatives and loans. Illegally fixing this rate cost borrowers around the world untold sums.

• A massive price-fixing scam by some of the world’s biggest banks was exposed last year, whereby they manipulated benchmark foreign-exchange rates used to set the value of trillions of dollars of investments. Employees have been front-running client orders and rigging WM/Reuters rates by pushing through trades before and during the 60-second windows when the benchmarks are set. Dealers colluded with counterparts to boost chances of moving the rates.

• JP Morgan Chase’s London Whale trade loss of $6.2-billion, to which the bank paid out nearly a $1-billion in fines and settlements to US and British regulators. In fact, Chase has paid a stunning $8 billion in settlements in the years 2009-2012, and spent $16 billion in legal defense fees during that same period, which means that fully one third of Chase’s net income has been spent on the cost of doing bad business, i.e. cleaning up after its high risk and/or illegal behavior.

• Revelations that Europe’s biggest bank, HSBC, allowed the most notorious international drug cartels to launder billions of dollars across borders. US prosecutors announced a record $1.92 billion settlement with the bank last year. Lax money laundering controls at HSBC allowed two cartels – one each in Mexico and Colombia – to move drug proceeds through the bank over the second half of the last decade. To speed things along, the criminals even designed “specially shaped boxes” that fit the size of teller windows at HSBC branches. Prosecutors revealed how HSBC had degenerated into the “preferred financial institution” for drug traffickers and money launderers. In addition, the government said HSBC violated U.S. sanctions for years by illegally conducting transactions on behalf of customers in Iran, Libya, Cuba, Sudan and Burma. Some of HSBC’s Saudi and Bangladeshi clients had terrorist ties, according to a Senate investigation.

And what about here in Canada? Even before the credit crisis, the Canadian Securities Administrators had published a report in 2007 saying one million Canadians had been the victim of some kind of fraud.

In 2011, we had the collapse of Sino-Forest – the largest timber company trading on our markets at the time, which had a market capitalization of $6-billion that was reduced to nothing overnight. Sino-Forest snuck onto the TSX by way of a reverse takeover in 1994 and was only exposed 17 years later by the short-selling firm Muddy Waters as nothing more than a shell – that it did not actually own the forests in China in claimed to. And yet for its entire existence, the company’s accountants and underwriters were blind to this, as were regulators.

Moreover, Sino-Forest was clearly not the only case of such fraud emanating from China. As I detailed in an investigation for the Globe and Mail’s Report On Business Magazine last year, Chinese companies have no need to raise money on our capital markets: therefore, companies like Sino-Forest and others using reverse takeovers due so mostly to commit fraud, specifically pump and dumps. Yet, from 2004 to 2011, at least 370 Chinese companies were able to obtain US and Canadian listings through reverse mergers with shell companies, producing some (US) $50-billion worth of stock that was alluring to investors keen on China. For example, in 2012, two senior executives at the Chinese company Puda Coal, Inc. which traded on the NYSE Amex exchange, were charged by the SEC after being accused of selling off assets of the company prior to raising more than (US) $100-million from investors – money partially rustled up by Macquarie Capital, a Canadian investment firm and one of Puda’s underwriters. Puda had entered the markets by way of a reverse merger in 2005.

Meanwhile, in 2012, the US Commodity Futures Trading Commission charged the Royal Bank of Canada (RBC) “with conducting a multi-hundred million dollar wash sale scheme in connection with exchange-traded stock futures contracts,” according to the CFTC’s press release on the case. “The CFTC’s complaint also alleges that RBC willfully concealed, and made false statements concerning, material aspects of its wash sale scheme from OneChicago, LLC (OneChicago), an electronic futures exchange, and CME Group, Inc. (CME Group), the entity that exercised the regulatory compliance function for OneChicago.”

Finally, there is the on-going revelations about how Canada’s richest citizens and companies use our financial system and laws to move income offshore to avoid paying taxes, a list that includes prominent business families such as the Bronfmans, Stronachs, Irvings, and Paul Martin Jr., as well as companies such as Cameco, Cirque du Soleil, Gildan Activewear and the banks themselves. Recent revelations made earlier this year by the International Consortium of Investigative Journalists (ICIJ), showed that 2.5 million files and 120,000 companies and trusts use offshore tax havens around the world, including prominent Canadians. Moreover, Jim Love, chairman of the Royal Canadian Mint, and a good friend of Jim Flaherty’s, helped a wealthy Canadian family move millions through offshore havens to avoid paying taxes, revealing how big a business this has become. Indeed, the third and fourth largest countries which are recipients of Canadians’ direct foreign investment are Barbados and Cayman Islands – which reflects all the money flowing offshore so it can’t be taxed. Estimates of the tax gap the federal and provincial governments are facing due to all of this offshore chicanery range from $8-billion to $30-billion a year.

Watson does not deny that there are problems with crime and fraud in our financial system. But then he coughs up one of the most insidious and hoary retorts to this problem: “Simply put, markets are not always consumer-friendly, which is why the principle of caveat emptor exists. But Livesey glosses over the need for consumers to better understand business cycles and investment risks. Instead, he expresses outrage over the fact that people have lost money that they can’t afford to lose investing in mutual funds. With all due respect to anyone who has lost money in equities, you don’t need to be an investigative reporter to know mutual funds are not recommended for folks interested in 100 per cent capital protection.”

This too is hogwash. As I pointed out to Watson in an email – to which he did not reply – in most cases of financial fraud or other disasters bedeviling our capital markets, the schemes are so well hidden and camoflauged that even seasoned industry insiders, let alone your average retail investor, can’t spot them. For example, in 2007, Barrick Gold, the world’s largest gold company, bought $66-million worth of third-party ABCP from CIBC World Markets. At one point Barrick’s people specifically asked CIBC whether this ABCP had any subprime debt exposure contained in it. CIBC lied to Barrick and said the paper had no such exposure, when in fact there was plenty of it. When the ABCP market froze that summer due to concerns about subprime mortgage exposure, Barrick’s money was frozen too, and the company was forced to sue CIBC to get its money back. In fact, third-party ABCP was sold in Ontario without a prospectus, making it impossible for average consumers to know what sort of debt lay behind it. And when the Bay Street banking community received a report from Coventree Inc., an independent third-party ABCP seller, just prior to the market freeze, which detailed how much subprime mortgage exposure existed in its product, the bankers decided to keep this information from investors.

Then there is the case of hedge fund manager John Paulson and Goldman Sachs conspiring to create a CDO filled with subprime mortgage debt that they specifically designed to explode in order for the bank and Paulson to cash in on investors’ $1-billion in losses. Goldman paid a massive fine after this scam was exposed. Yet this was engineered by be the most “reputable” investment bank in the world. Clearly, Paulson and Goldman’s did not advertise they were cooking up this scheme.

In fact, caveat emptor, or “buyer beware”, is always the fallback of the financial sector – “you should have never have trusted us in the first place.” While there is no question that investors should be more skeptical of how they invest – hence why I wrote the book (although Watson counsels people to not read it) – the financial industry is not your neighborhood casino or poker game. Nor does it bill itself as such. In fact, as the credit crisis demonstrates, the financial industry is the most important sector of our global economy, and has the power to wipe out the wealth of entire nation states. Moreover, every dollar borrowed or lent, every savings or retirement fund, pension plan or investment, is wrapped up in our markets, either directly or indirectly. Every company and entrepreneur around the world is dependent on banks and investment houses to access credit. This is not a situation of “buyer beware” – it should be a situation where the financial industry is sound and well-regulated and well-managed. But as events keep showing, this is simply not the case. And Watson is an apologist for the current state of indifference to this perilous condition.

Perhaps I should not be surprised he is willing to turn a blind eye to the persistent problems of fraud in our financial community. Look at the Ivey School of Business itself. On its own advisory board sits Kevin O’Leary, the prominent TV personality and Dragon’s Den cast member. By any yardstick, O’Leary is not only a terrible businessman, but an unethical one and should likely have been charged with securities fraud or violations on more than one occasion. In 1999, the company O’Leary was president of, The Learning Company (TLC), was sold to Mattel for $4-billion and O’Leary appointed president of Mattel’s new TLC division. Yet O’Leary had sold Mattel a turkey, and quickly the wheels fell off, with Mattel immediately racking up huge losses as a result of the TLC purchase. Shareholder lawsuits accused O’Leary of being part of a scheme to obscure the poor shape TLC was in, and of insider trading. He was fired six months into his three-year contract, while Mattel’s CEO also lost her job (blaming the TLC purchase). Mattel dumped TLC in 2000 for a mere $27-million. At one point, Mattel shareholders lost $2-billion in the value of their shares due to this debacle.

In 2008, O’Leary started his own investment firm, O’Leary Funds. But again, in my opinion, O’Leary has given investors misleading information about his funds. For example, in 2008 he said on BNN that  “This fund doesn’t grind its capital which means it has enough generation of yield to pay five percent”. The reference to “grinding capital” means the fund would be paying investors back their very own money to meet annual distributions (which is what a Ponzi scheme does, by the way). Yet, by 2009, O’Leary Funds indeed was paying out distributions to investors with their very own money (O’Leary doesn’t deny this). It’s legal, but highly questionable.

You can read about O’Leary’s dismal track record as a businessman in reports written by Joe Castalado in Canadian Business, and by myself and Tim Kiladze at the Globe’s ROB Magazine, and by Mark McQueen of Wellington Financial.

In the end, despite Watson’s false assertion that I claimed Canada is rotten to the core, what he has done is evade the very real problems facing our capital markets. I can produce, as I did in the book, reams of evidence to show there are needed reforms for the governance of our financial sector. Sticking your head in the sand and claiming there really isn’t such a big problem is doing Canadians a terrible disservice.