Financial Reporting Fiascos: Don’t Forget About Canada!

We Canadians are generally modest folks, but we do like to remind the world of our accomplishments now and then. This is true even regarding business scandals. We’ve got ’em, just like everyone else does.

Here’s an article by Al Rosen, Canada’s dean of forensic accounting: On trusts and Greedy Media from yesterday’s Financial Post.

The article is about how the business media in Canada are complicit in hurting the investing public by unreflectively promoting “Income Trusts.” [Wiki-Warning] The technical details aren’t important here, so suffice it to say that investment trusts are essentially a kind of investment vehicle, more common in Canada than in the U.S., designed to produce a constant trickle of income for investors and (until recently) offering certain tax advantages over other investments.

Rosen’s main point about Income Trusts is that, as investments, they’re a mixed bag. Because of this they ought to be invested in only very carefully, something perhaps best left to professional fund managers and avoided by “retail” investors.

But Rosen has a more general point to make about the naivete of Canadian investors regarding the security of their investments — which depends, of course, in part on credible financial reporting:

Whereas the evidence is overwhelming that financial reporting chicanery abounds in our prosecution-free country, we choose to our detriment to pretend otherwise. Instead of being able to name 25 recent Canadian fiascos, most Canadian investors can refer only to U.S. examples. The home-grown disasters are simply not registering in our collective consciousness, and our national media are a significant reason for that.

Instead of referencing Canadian misfortunes such as Bre-X, Livent, YBM Magnex, Castor Holdings, Nortel, Royal Group, Biovail, Hollinger, Atlas Cold Storage, Heating Oil Partners, FMF Capital, Specialty Foods and others, our media use U.S. examples like Enron and Worldcom.

The media leave the impression that Canada is largely free of any major financial reporting dustups, leaving an investing public that is naive, overly trusting, and all too ripe for the next scam.

Mea culpa! It’s not just the media that is to blame. I teach business ethics — at a Canadian university — yet I too am much more apt to mention Enron and Worldcom during lectures and in conference presentations than I am to mention any of the Canadian examples Rosen mentions. My lazy excuse is that students and others recognize the name “Enron” — heads nod knowingly when I mention it — but would surely stare blankly if I mentioned “Bre-X”, even though the latter is a Canadian scandal that also happens to be the biggest mining scandal in history.

But the risk here isn’t just that Canadian students (or investors!) will forget that we, too, have had our share of corporate scandals. The point is that the overuse of now-standard American examples like Enron and Worldcom is liable to allow people to assume that there is something special about those companies, or perhaps about the American financial market, that allowed those scandals to happen. The truth of course is that no one has cornered the market on dodgy financial reporting. Financial reporting is always going to be fraught with challenges, first because it involves a complex 3-party relationship between a company, its investors, and auditors who are paid by the former yet serve the latter. The second reason why financial reporting is always (and everywhere) a challenge is that it involves a considerable degree of human judgment, judgment that is inevitably affected by varying degrees of greed, incompetence, and excesses of optimism. And those frailties, unfortunately, are universal.

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