Crocus failure should prompt greater disclosure
Aside from keeping the media busy, labour sponsored investment fund (LSIF)
Crocus Fund has caused a lot of grief for Manitoba investors. Its trading freeze
last December was followed by a flurry of terminations, big cost cuts,
allegations of wrong doing, and most recently the announcement that they were
throwing in the towel.
Does this mean investors should give up on LSIFs or venture capital as an
investment class? No. Rather, it should remind investors and advisors of the
need for real due diligence in alternative asset classes.
At the root of Crocus’ problems is the thorny issue of fairly valuing
investments not priced by or traded on any public exchange. (See my previous
column on valuation from 2002.) Between the Manitoba
Securities Commission and the Auditor
General of Manitoba, they allege that the Valuation Committee (a subset of
Crocus Fund’s board of directors) did not meet for months while there were
concerns voiced of deteriorating values.
There were also allegations of extravagant spending by the fund for its
former CEO on trips seemingly unrelated to Crocus business. Just prior to the
of a RCMP probe, Crocus made the only obvious decision – i.e. to either
wind up the fund or dispose of its investments and other assets to interested
This has taken a toll on the often beaten up class of LSIF investments. But
should all of this turn everyone off of LSIFs?
I have always stressed, even for traditional investments, how important it is
for investors and advisors to do their homework. But once investments actually
have had time to attempt to fulfill the big promises made during sales
presentations, and after a few good scandals – i.e. Portus,
Crocus – investors are likely to overreact. I’m not going to condone
investing in things that are not well understood. But instead of swearing off
such investments forever, perhaps those burned by these or other investments
gone bad should simply learn what went wrong in the decision-making process and
if there are actions that can be done in the future to help detect investment
The fact is that there is no way to objectively confirm that LSIFs, hedge
funds, or other alternative asset investments actually do what they say they do
with respect to their investment processes and other internal procedures. This
has long been a point of frustration for me as an analyst trying to evaluate
some of these products.
With any investment, one must look past the hype, past the sales pitch and
all of the promised benefits. We all want to believe that a great investment
offering great risk-reward potential exists. And some do. But investors and
advisors would do themselves lots of favours if they approached all such
products with more scepticism and ask tough questions.
Plus, if you don’t really know how something is structured, refuse to
invest in it or recommend it to your clients. That will motivate the person or
company selling the product to help educate you on the aspects of an investment
not found in the sales pitch – i.e. the finer details within which the devil
In the mid-1990s, prior to the growth in LSIF assets, the funds used to
provide cost and market values for each individual investment. Today, and for
the past several years, funds provide individual cost figures but only provide
aggregate market value figures (i.e. for the venture portfolio as a whole). As a
result, we’re demanding better transparency for my firm’s annual LSIF
research report. One fund allowed us a peak at its internal documents including
investee company financials and due diligence documents.
In my firm’s future LSIF
research efforts, we will continue to make additional disclosures mandatory
– or face being removed from our annual survey. Realistically, investors aren’t
in a big bargaining position to demand such disclosure. But advisors influencing
significant client money have some pull – particularly with some of the small
and mid-sized LSIFs.
Look for LSIFs to voluntarily provide additional portfolio disclosures – as
another fund did early this year. But if they don’t, advisors should push for
more information. No longer should they accept a negative response to requests
for greater disclosure. It is within advisors’ power to influence greater LSIF
disclosure. And while I believe that Crocus’ problems are not indicative of
the LSIF industry as a whole, the very existence of its demise provides us all
with greater bargaining power regarding improved disclosure.
Regulators will help a bit in this regard as CSA’s National
Instrument 81-106 (Continuous Disclosure) contains some tidbits for LSIFs.
While 81-106 requires all funds, including LSIFs, to disclose market values for
individual investments, it offers LSIFs exemption. They can get out of that
requirement by breaking down its venture investments by stage of development and
industry class (and then by number of investments, cost, and market value). This
will help in narrowing down carrying or market values that LSIFs use for their
Recall that LSIFs must get an external valuator to review each investment.
LSIFs will now have to file the valuator’s report along with its audited
financials. It won’t contain valuations of individual investments in the
respective funds. But expect them to resemble the auditors’ reports that
accompany most funds’ audited financials. Most are pretty standard but where
the valuator has real concerns, it should be disclosed along with other filings.
NI 81-106 doesn’t provide a quantum leap in LSIF disclosure, but it’s
certainly a step in the right direction.
Dan Hallett, CFA, CFP is the President of
Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as
Investment Counsel in Ontario and provides independent investment research to
financial advisors. He can be reached at