Income Trusts and Seniors

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Spinrite Income Fund: Seniors Were Duped

Postby urquhart » Thu Aug 24, 2006 5:39 am

The income trust model did nothing to assist this otherwise sound and previously successful North American business situated in Listowel, Ontario_Spinrite.

- Raised IPO cash of $203 million, of which virtually none went into the company
- Raised the company debt from under $5 million to $68 million
- New York hedge fund, Sentinel Capital Partners, invested $31 million in February 2004 and flipped it into the income trust IPO within one year, making an upfront cash profit of $107 million plus the residual value of its 3.6 million units owned ( now trading at a $1 down from $10 at the IPO in February 2005).
- Paid $12 million of investment banking fees to Scotia Capital and CIBC World Markets co-lead and to BMO Nesbitt Burns, RBC Dominion and TD Securities in the syndicate
-Paid $5 million in other restructuring and IPO fees to Torys and Stikeman Elliot legal firms
-Set up a $15 million cash reserve upfront to pay special bonuses over 3 years to 6 managers, Dario Magvre, Ryan Newell, Richard Brown, Frank Janssen, John Verwey and Catherine Blythe.
-Within 18 months of the income trust IPO, the original $1 per unit distribution was eliminated, the unit price dropped to $1 and the seniors and other conservative investors in the Spinrite Income Fund lost $183 million
-8% of the 500 employees were laid off in January 2006 and the pending event of default puts the remaining at risk of losing their jobs in this small town

Was Scotiabank and Scotia Capital acting in the interest of the IPO buyers?
Was Scotiabank and Scotia Capital even acting in the interest of the company, Spinrite Inc.?
Or, was Scotiabank and Scotia Capital acting in their own interests?

- Scotiabank provided $38 million financing for the hedge fund acquisition of Spinrite Income Fund in February 2004
- Scotiabank was a creditor to Spinrite Inc. in the interim $38 million credit facility set up between the original acquisition in February 2004 and the IPO in February 2005
-Scotiabank is a creditor in the new $68 million credit facility set up at the IPO in February 2005, with undisclosed fees for the repayment of the interim credit facility and for arranging the new credit facility
-Scotia Capital was co-lead underwriter for the IPO, for which the total syndicate received $12 million in fees
-Scotiabank is in the creditor syndicate in negotiations with respect to the possible future event of default and the breach of the credit covenants , within 18 months of the IPO

Now what can the Spinrite investors do to get remedy for their losses? Forget derivative and shareowner oppression legal actions, these do not apply to income trusts that are not governed by the investor protection provisions in the federal and provincial company acts. There's the civil liability provisions governing prospectuses and continuous public disclosure in the Ontario Securities Act, which require proof of fraud, misrepresentation or omissions of material information. Then, there's the costly route of individual lawsuits seeking remedy for the damages of unsuitable investments recommended by financial advisors, who work for the investment banks.

Will Spinrite Income Fund file for creditor protection? There is a lot of experience with creditor protection and securities offences amongst the trustees of Spinrite Income Fund. Gary Lukassen, Robert Gillespie and George Taylor are trustees of Spinrite Income Fund. Lukassen was on the Stelco board of directors during its creditor protection proceedings. Robert Gillespie was a trustee of Atlas Cold Storage Income Fund during the period when securities offences are alleged to have occurred there. George Taylor is on the Brookfield Asset Management board, whose affiliate Tricap reaped hundreds of millions of dollars of short term gain by its participation in the restructuring of Stelco. Will plaintiff lawyers have the stomach to fund contingency class actions, if they have to add the cost of the creditor protection legal process that has been demonstrated to be hostile to shareholders? It is well-acknowledged that Stelco shareholders were screwed in the Stelco creditor protection proceeding. Stelco shareowners were forced out, even when there had been no interest payments missed or no liquidity crisis caused by the call for full repayment of its credit.

Now, Spinrite owners may think they can obtain some answers for their plight from an investigation by the Ontario Securities Commission. But, David Wilson, the current Chairman of the OSC, is the former CEO of Scotia Capital, who supervised the Scotia Capital investment banking personnel that conducted the Spinrite Income Fund due diligence and signed off on the prospectus.

Who will be held to account for these losses by seniors and other conservative investors and for the unnecessary distress of this company and its employees? It's time for investigation of this case and for the proposed new laws governing income trusts to deter future calamities like this one.

Diane Urquhart
Independent Consulting Analyst
Mississauga, Ontario
Telephone: (905) 822-7618
E-mail: urquhart@rogers.com
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Urquhart Comments-CSA Staff Notices on Income Trusts 8/4/06

Postby urquhart » Tue Aug 08, 2006 2:04 pm

CSA Provides Further Evidence of the Problem, But Its Solutions are a Breach of Trust

This communication provides my comments on Canadian Securities Administrators Staff Notice 51-319 Second Continuous Disclosure Review of Income Trusts and Notice 52-306 (Revised) Non-GAAP Financial Measures, which were released on Friday, August 4, 2006.

My overall conclusion is that the Canadian Securities Administrators ("CSA") are public officials in a Ubreach of trust to seniors buying business income trustsU, given their direct knowledge that 84% of 45 business income trusts have unacceptable financial reporting, and their failure to take actions as noted below:

(A) Unot disclosing the names of the miscreantsU, so that seniors may have the opportunity to decide whether they are suitable investments relative to their investment objectives of secure income and preservation of capital;

(B) Unot imposing sanctionsU for failing to meet the requirements of National Instrument 51-102 - Continuous Disclosure Obligations - Management's Discussion & Analysis; or, for making statements that are misleading or untrue or for omitting to state a material fact that is required to be stated as set out in the provincial and territorial securities acts;

(C) Unot recommending the introduction of new securities laws and regulations Uto define how much estimated distributable cash and cash distributions are from income and how much are from the return of capital; and to restrict the definition of yield to its internationally known convention of return on investment (not to include the portion of cash distributions that are the return of capital);

(D) Unot requiring that income trust issuers report their GAAP income with equal prominence to the estimated distributable cash and cash distribution. U

CSA Permits CAcSB to Abdicate Its Public Interest Responsibility to Set Accounting Standards

The Canadian Accounting Standards Board ("CAcSB"), a self-regulator, is not willing to set new accounting standards for income trusts, which would be the appropriate course of action here since these are securities targeted to seniors and other conservative income investors, who cannot replace investment losses caused by misleading non-GAAP financial measures and inflated prices. The CSA is not requiring the CAcSB to set new accounting standards for income trusts, nor is the CSA establishing its own accounting rules or definition for estimated distributable cash in the provincial and territorial securites acts.

The prevalence of income trusts in Canada and the frequency of torpedoes amongst them have exposed the mess in Canadian accounting standards for the cash flow from operations. MD & A public disclosures do not fix the mess in the accounting standards for cash flow from operations. For example, cash flow from operations must be stricter in the handling of capital leases versus operating leases and in the reclassification of debt to long term liabilities. Maintenance and replacement of capital assets has to be considered an operating expense that cannot be ignored. Income trusts should not be permitted to inflate their net income by income tax credits that are of a non-recurring nature arising when assets are written up on conversion to an income trust.

The CSA is adopting the premise that Uincome trust management can do whatever it wants in its estimated distributable cash for income trusts, but it must do a better job explaining the estimate and its sustainability in the Management Discussion & AnalysisU. If income trusts are free to operate at management's full discretion as proposed, while only being required to explain their actions in the MD & A, then the majority of Canada's economy will move towards income trusts. This trend makes a mockery of the Canadian Accounting Standards Board function to set accounting standards for all entities in Canada.
CSA Permits Income Trusts to be Ponzi Schemes Without Warnings

Under the new CSA Staff Notices 51-319 and 52-306 , it is acceptable for income trust management to pay distributions in excess of net income, without requiring the plain and obvious disclosure that this excess distribution is the return of investors' capital. The sources of funding for the return of capital can be underspending on the necessary maintenance and replacement of capital assets, new debt, and the use of reserves of cash from prior credit and equity raising activities. UThis ponzi structure can be sold to seniors Uand other buyers of income trusts provided management explains that they got the money from these sources in the the Management Discussion & Analysis.

Unfortunately, seniors and their financial advisors are told to focus on the estimated distributable cash, cash distributions and cash yields at their face value and rarely do these people have the knowledge or time to study the Management Discussion & Analysis in the Annual Information Form. These unsophisticated investors cannot be expected to prepare their own valid calculations on the income yield and prospective return on their investment, removing the impact of underspending on capex, the debt and reserve financing of distributions, and the failure to recognize goodwill impairment.
New CSA Requirement for Reconciliation to GAAP Cash Flow Makes the Problem Worse

The CSA Staff Notices 51-319 and 52-306, in fact, now require that the income trusts do a reconciliation of the estimated distributable cash to the GAAP cash flow from operations, including changes in working capital. The CSA disallows a reconciliation of the estimated distributable cash to the GAAP net income, without providing a sound justification for this new restriction. I am concerned that this new restriction preventing reconciliation with GAAP net income will make the whole income trust financial reporting problem worse and there will be billions more losses for seniors and other conservative investors buying business income trusts. The new restriction preventing reconciliation of estimated distributable cash to GAAP net income will likely encourage the income trusts and investment banks to continue their present abusive practice of publishing cash distributions and cash yields, without equal and prominent reference, and often no reference, to the net income or income yield of the income trust.U Those income trusts who do mention net income in their press releases, unitholder presentations and other marketing materials may cease to do so now. U
Miscreants Get Warning, While Seniors and Other Income Investors Have Already Lost $ 3 Billion

It is just not credible for the CSA to be issuing a staff notice whose purpose is to clarify their expectations about the presentation of distributable cash, while the findings of their review is serious misrepresentations and omissions that any senior executive of an income trust and any reasonable accounting and securities professionals should consider unlawful, deserving penalties and not just warnings for future conduct. USeniors and other conservative investors in business income trusts have already lost $ 3 billion on business income trust IPOs since January 1, 2001.
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

CSA Confirms Income Trust Financial Reporing Problems

Postby urquhart » Tue Aug 08, 2006 2:02 pm

The key findings of the CSA Staff Notice 51-319 Second Continuous Disclosure Review of Income Trusts, released on August 4, 2006, are:

1. "In many trusts we reviewed, the consolidated financial statements revealed that some portion of distributions to unitholders was funded from sources other than cash flows from operations. For example, in some instances, a portion of distributions were funded from operating lines, long-term credit facilities, reserves held-back from prior periods, or a return of unitholder’s capital" (Note that these named sources are over and above any underspending on the maintenance and replacement of capital assets that are not covered in the GAAP cash flow from operations.)

2. 13 out of the 45 business income trusts reviewed did not give more than boilerplate risk information, so these did not provide specific information of risk factors to their own income trust, such as their plans for maintenance and replacement of capital assets. "The risk associated with the maintenance and replacement of the operating entity’s capital assets is a significant and primary risk for most income trusts. The cash commitment required to maintain and replace its capital asset base is information an investor needs to assess a trust’s ability to sustain distributions over the long-term. The operating entity’s capital assets generate the cash flows to pay distributions. Therefore, an adverse change in their composition is likely to have a significant impact on distributions."

3. "SN 52-306 also states that when non-GAAP measures are presented, the most directly comparable GAAP measure should also be presented in equal or greater prominence than the non-GAAP measure. In our review, many trusts did not provide this level of equal prominence, and in some instances, did not even disclose a GAAP measure."

4. "Our review identified some instances where it appears that the goodwill impairment testing required by CICA Handbook Section 3062 Goodwill and Other Intangible Assets (S.3062) was not done in an appropriate timeframe."

5. "Some income trust issuers use an external management company to provide executive management services to the trust and or operating entity. In some instances that we reviewed, due to this external management structure, compensation paid to these executive officers was not fully disclosed in accordance with Form 51-102F6."

6. "in three instances, a trust’s operating entity breached financial covenants under its credit facilities. As a result, in each instance, the trust issuer either suspended or significantly reduced distributions to its unitholders. Although, the filing of the press release announcing the change in distributions had a significant effect on the market price of the trust’s units, the issuers argued that these events do not meet the definition of a material change."

7. "We identified three income trust issuers that obtained waivers for financial covenants and made amendments to their credit facilities, but did not file the amended credit agreements on SEDAR."
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Posts: 125
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Location: Mississauga

Retirement Residences REIT Cuts Distribution 50%

Postby urquhart » Fri Jul 21, 2006 10:18 am

Isn't it interesting that Retirement Residences REIT management has suddenly concluded that it is not a good idea to fund cash distributions above cash generated from operations and so it needs to cut its distributions by half today. This distribution cut is occurring before a planned take-over by Reichman International Property Corporation, and guess what, the Reichman family owns 5.8% of the Retirement REIT and Paul Reichman has just resigned as one of its trustees. The seniors and other conservative investors in this income trust have had a capital loss of 46% on this one since May 30, 2002.

Scotia Capital Research Report dated July 21, 2006 says:

"The magnitude of the distribution cut was much larger than the 25%-30% cut we were expecting. Based on our revised estimates, the new distribution rate results in a 57% AFFO payout ratio for 2007. At this low payout ratio, we think investor focus will turn firmly toward NAV rather than a yield-oriented valuation. We think the large reduction in distribution will also be received positively by prospective buyers, as value is no longer being destroyed"

The Retirement Residences REIT Prospectus March 21, 2003 says:

Five of the Underwriters, CIBC World Markets Inc., Scotia Capital Inc., TD Securities Inc., BMO Nesbitt Burns Inc. and HSBC Securities (Canada) Inc., are, directly or indirectly, wholly-owned subsidiaries of Canadian chartered banks (the ‘‘Banks’’) that are lenders to Retirement REIT. Consequently, Retirement REIT may be considered to be a connected issuer of those Underwriters for the purposes of securities regulations in certain Canadian provinces.

Here are quotes from the CBC coverage of the Retirement Residences REIT distribution cut.

The Mississauga, Ont.-based company also announced Wednesday it is cutting its distributions to unitholders from an annualized rate of 84 cents per unit to 42 cents.

That news caused its units to trade as low as $7.03 on the Toronto Stock Exchange, before rebounding slightly to close at $7.50, down a dime, after heavy trading.

"Critical to Retirement REIT's business strategy is the conservation of cash to allow for investment in existing residences and the accretive acquisition and development of complementary residences," said CEO Derek Watchorn in a release.

"Retirement REIT had been distributing more than the cash generated from operations after sustaining capital expenditures and has been funding this shortfall with existing capital resources. The reduction in distributions will eliminate this shortfall and allow us to carry out our business strategy."

Retirement Residences real estate investment trust (TSX:RRR.UN) says Reichmann International Property Corp., which is led by a prominent real estate family, plans to make a takeover offer for Canada's largest owner of nursing homes.

Reichmann has now resigned as a trustee of the trust amid the planned takeover offer by Reichmann International Property. He declined further comment.

Diane Urquhart

Independent Consulting Analyst

Telephone: (905) 822-7618
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Movies Distribution Income Fund This Week's Broken Trust

Postby urquhart » Fri Jul 21, 2006 10:01 am

Here is this week's broken business income trust: Movie Distribution Income Fund. The capital losses are $66 million or 37% of the IPO offering that closed on October 15, 2003. This income fund has dropped 26% in the last two days on the news that its founder and Motion Picture Distribution's chairman, Victor Loewy, has stepped down, a move that exposes the company to the potential loss of an important contract. Movie Distribution Income Fund is the 24th on the list of business income trust IPOs that are in capital loss since their Initial Public Offerings.


MOVIE DISTRIBUTORS Date IPO 10/15/2003; IPO Price $10.00; IPO Units Sold 17.900 million; IPO Offering Size $179.0 million; Investmetn Banking Fee 5.75% & $10.3 million; Current Price per Unit $6.30; % Capital Loss -37%; Capital -$66.2 million.


Underwriters: CIBC World Markets and RBC Dominion co-lead
BMO Nesbit Burns, TD Securities and Westwind syndicate members

Auditor: Pricewaterhouse Coopers

Legal Counsel: Goodmans for the underwriters
Torys for the fund

I have provided solutions to the developing income trust financial calamity for seniors, which involve urgent remedies by the Canadian Accounting Standards Board, the provincial securities commissions (not waiting for the typically late and massively diluted solution from the Canadian Securities Administrators), and the Federal Government Finance and Industry Ministries. We have social responsibility, if not a moral duty, to protect our Canadian seniors from the irreparable losses in income trusts that are sold on distributions and cash yields that are inflated inaccurately and that are misleading. Most importantly, it is reprehensible that more than half of the income trusts are expected to cut their distributions in the next few years with consequent capital losses for seniors, while the vendors and their investment banking, banking, legal and accounting suppliers have pocketed their substantial cash upfront from the restructurings of corporations into income trusts.

Diane Urquhart
Independent Consulting Analyst
Telephone: (905) 822-7618
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Retirement Residences REIT Cuts Distribution by 50%

Postby urquhart » Wed Jul 19, 2006 6:00 pm

Isn't it interesting that Retirement Residences REIT management has suddenly concluded that it is not a good idea to fund cash distributions above cash generated from operations and so it needs to cut its distributions by half today. This distribution cut is occurring before a planned take-over by Reichman International Property Corporation, and guess what, the Reichman family owns 5.8% of the Retirement REIT and Paul Reichman has just resigned as one of its trustees. The seniors and other conservative investors in this income trust have had a capital loss of 46% on this one since May 30, 2002.

Here are quotes from the July 19, 2006 CBC coverage of the Retirement REIT distribution cut.

The Mississauga, Ont.-based company also announced Wednesday it is cutting its distributions to unitholders from an annualized rate of 84 cents per unit to 42 cents.

That news caused its units to trade as low as $7.03 on the Toronto Stock Exchange, before rebounding slightly to close at $7.50, down a dime, after heavy trading.

"Critical to Retirement REIT's business strategy is the conservation of cash to allow for investment in existing residences and the accretive acquisition and development of complementary residences," said CEO Derek Watchorn in a release.

"Retirement REIT had been distributing more than the cash generated from operations after sustaining capital expenditures and has been funding this shortfall with existing capital resources. The reduction in distributions will eliminate this shortfall and allow us to carry out our business strategy."

Retirement Residences real estate investment trust (TSX:RRR.UN) says Reichmann International Property Corp., which is led by a prominent real estate family, plans to make a takeover offer for Canada's largest owner of nursing homes.

Reichmann has now resigned as a trustee of the trust amid the planned takeover offer by Reichmann International Property. He declined further comment.

Diane Urquhart
Independent Consulting Analyst
Telephone: (905) 822-7618
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Letter to OSC Commissioners Who Signed MRRS Exemptive Relief

Postby urquhart » Thu Jul 13, 2006 5:25 pm

Diane A. Urquhart
486 Marshwood Place,
Mississauga, Ontario, L5J 4J6
Telephone: 905-822-7618
FAX: 905-822-0041
E-mail: urquhart@rogers.com

Delivered by E-mail:

July 13, 2006

Robert W. Davis
Commissioner
Ontario Securities Commission

Carol S. Perry
Commissioner
Ontario Securities Commission

C/O John P. Stevenson,
Secretary to the Ontario Securities Commission,
Ontario Securities Commission,
20 Queen Street West, Suite 1900,
Toronto, Ontario, M5H 3S8
Telephone: 416-593-8145
FAX: 416-593-2318
E-mail: jstevenson@osc.gov.on.ca

Re: The Matter Of The Mutual Reliance Review System (MRRS) Decision on Exemptive Relief for CIBC Asset Management Inc., CIBC Global Asset Management Inc. and RBC Asset Management Inc. to Permit the Purchase of Teranet Income Fund IPO and Over-allotment Units, Posted On June 9, 2006.

Dear Carol Perry and Robert Davis:

On June 9, 2006, the two of you were shown to be the signatories of the MRRS Decision that granted exemptive relief to allow CIBC Asset Management Inc., CIBC Global Asset Management Inc. and RBC Asset Management Inc., who are responsible for the CIBC and Royal Bank proprietary mutual funds, to purchase the IPO distribution units of a connected issuer, the Teranet Income Fund. This MRRS decision explicitly permits the CIBC and Royal Bank proprietary mutual funds to purchase Teranet Income Fund IPO units without requiring any public disclosure of this in the Teranet Income Fund IPO prospectus, nor elsewhere for 97 days after the end of the IPO distribution. The number of shares permitted is any fixed number that is submitted by the CIBC and Royal Bank mutual funds, of which the IPO syndicate allocated number must be purchased within five days of June 9, 2006. The remaining amount of this fixed number of units, not filled in the IPO distribution, may be filled if the underwriting syndicate exercises its Greenshoe over-allotment option for up to 10.5 million units within 30 days. The MRRS Decision has conditions attached, including the need for the Royal Bank mutual fund independent committees to review and approve the purchase of Teranet Income Fund IPO or over-allotment units.

I would like the two of you to answer the following questions that are of interest to the public, such as the members of the list of associations receiving a copy of this letter:

1. What were the public interest criteria that you took into account when making the noted MRRS Exemptive Relief Decision?

2. What consideration did you give in this MRRS decision to the conflict of interest of the Ontario Government being both the primary beneficiary of a successful Teranet Income Fund IPO in terms of the size of the offering and its indicative valuation of the Teranet business, and, the Ontario Government also having the mandate to protect investors under the Ontario Securities Act?

3. What steps did you take or will you take now to satisfy yourselves that the CIBC and Royal Bank have properly managed their conflicts of interest in the Teranet Income Fund, as they are described in the attached letter to Gord Nixon, C.E.O. of the RBC Financial Group dated June 28, 2006?

4. Did you give any public notice that the MRRS Exemptive Relief Application was made by the named parties to the Ontario Securities Commission?

5. Is there a mechanism under which any of the associations listed below may request a public hearing to review the noted MRRS Decision, for the purpose of clarifying when similar exemptive relief will be granted to other mutual funds seeking to purchase shares or trust units in public offerings that are underwritten by related investments banks?

I understand that National Instrument 81-102 restricts mutual funds from purchasing shares or trust units in public offerings that are underwritten by related investments banks, until 60 days after the public offering is completed.


The conflict of interest restrictions in NI 81-102 are in place for sound reasons to protect the investing public, in my opinion:

• The availability of a ready market for an IPO may cause a decision to price the IPO higher than would otherwise be the case, or to fill a demand gap in an otherwise under-subscribed IPO.
• It encourages further erosion of the mythical “ethical walls” between mutual funds and their brokerage affiliates; these are the same walls that supposedly exist between analysts and investment bankers.
• Mutual funds may end up buying unsuitable or non-optimum investments merely to placate superiors and/or receive rewards for such actions.
• The mutual funds can be used to artificially prop up a weak IPO to prevent it from tanking too shortly after distribution.
• The effectiveness of independent “ monitors” is a real question mark. It’s hard to see how in practice a monitor would be able to effectively question or ban a portfolio managers’ potentially conflicted purchase decision.
• Sometimes waiting 60 days allows the market to establish a more rational price of the security; buying early may prove to be expensive.
• If it turns out the IPO was based on material misrepresentations, it's highly unlikely the affiliated fund would participate in litigation or class actions to recover losses from the related dealer on behalf of unitholders.

I am sending you for your consideration electronic files called Research & Communications -Teranet Income Fund and Media - Teranet Income Fund. The bookmarks in these PDF files provide a list of the contents for these files. I thank you in advance for your response to the questions in this letter.


Yours sincerely,




Diane A. Urquhart
Independent Consulting Analyst

CC:

All OSC Commissioners

Stan Buell
President, Small Investor Protection Association

Judy Muzzi
President, United Senior Citizens of Ontario

Art Field,
President, National Pensioners & Senior Citizens Federation

Ian Thomson
Kairos Social Ecumenical Justice Initiative

Joan Huzar
President, Consumer Council of Canada
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Letter to OSC Commissioners Who Signed MRRS Exemptive Relief

Postby urquhart » Thu Jul 13, 2006 5:24 pm

Diane A. Urquhart
486 Marshwood Place,
Mississauga, Ontario, L5J 4J6
Telephone: 905-822-7618
FAX: 905-822-0041
E-mail: urquhart@rogers.com

Delivered by E-mail:

July 13, 2006

Robert W. Davis
Commissioner
Ontario Securities Commission

Carol S. Perry
Commissioner
Ontario Securities Commission

C/O John P. Stevenson,
Secretary to the Ontario Securities Commission,
Ontario Securities Commission,
20 Queen Street West, Suite 1900,
Toronto, Ontario, M5H 3S8
Telephone: 416-593-8145
FAX: 416-593-2318
E-mail: jstevenson@osc.gov.on.ca

Re: The Matter Of The Mutual Reliance Review System (MRRS) Decision on Exemptive Relief for CIBC Asset Management Inc., CIBC Global Asset Management Inc. and RBC Asset Management Inc. to Permit the Purchase of Teranet Income Fund IPO and Over-allotment Units, Posted On June 9, 2006.

Dear Carol Perry and Robert Davis:

On June 9, 2006, the two of you were shown to be the signatories of the MRRS Decision that granted exemptive relief to allow CIBC Asset Management Inc., CIBC Global Asset Management Inc. and RBC Asset Management Inc., who are responsible for the CIBC and Royal Bank proprietary mutual funds, to purchase the IPO distribution units of a connected issuer, the Teranet Income Fund. This MRRS decision explicitly permits the CIBC and Royal Bank proprietary mutual funds to purchase Teranet Income Fund IPO units without requiring any public disclosure of this in the Teranet Income Fund IPO prospectus, nor elsewhere for 97 days after the end of the IPO distribution. The number of shares permitted is any fixed number that is submitted by the CIBC and Royal Bank mutual funds, of which the IPO syndicate allocated number must be purchased within five days of June 9, 2006. The remaining amount of this fixed number of units, not filled in the IPO distribution, may be filled if the underwriting syndicate exercises its Greenshoe over-allotment option for up to 10.5 million units within 30 days. The MRRS Decision has conditions attached, including the need for the Royal Bank mutual fund independent committees to review and approve the purchase of Teranet Income Fund IPO or over-allotment units.

I would like the two of you to answer the following questions that are of interest to the public, such as the members of the list of associations receiving a copy of this letter:

1. What were the public interest criteria that you took into account when making the noted MRRS Exemptive Relief Decision?

2. What consideration did you give in this MRRS decision to the conflict of interest of the Ontario Government being both the primary beneficiary of a successful Teranet Income Fund IPO in terms of the size of the offering and its indicative valuation of the Teranet business, and, the Ontario Government also having the mandate to protect investors under the Ontario Securities Act?

3. What steps did you take or will you take now to satisfy yourselves that the CIBC and Royal Bank have properly managed their conflicts of interest in the Teranet Income Fund, as they are described in the attached letter to Gord Nixon, C.E.O. of the RBC Financial Group dated June 28, 2006?

4. Did you give any public notice that the MRRS Exemptive Relief Application was made by the named parties to the Ontario Securities Commission?

5. Is there a mechanism under which any of the associations listed below may request a public hearing to review the noted MRRS Decision, for the purpose of clarifying when similar exemptive relief will be granted to other mutual funds seeking to purchase shares or trust units in public offerings that are underwritten by related investments banks?

I understand that National Instrument 81-102 restricts mutual funds from purchasing shares or trust units in public offerings that are underwritten by related investments banks, until 60 days after the public offering is completed.


The conflict of interest restrictions in NI 81-102 are in place for sound reasons to protect the investing public, in my opinion:

• The availability of a ready market for an IPO may cause a decision to price the IPO higher than would otherwise be the case, or to fill a demand gap in an otherwise under-subscribed IPO.
• It encourages further erosion of the mythical “ethical walls” between mutual funds and their brokerage affiliates; these are the same walls that supposedly exist between analysts and investment bankers.
• Mutual funds may end up buying unsuitable or non-optimum investments merely to placate superiors and/or receive rewards for such actions.
• The mutual funds can be used to artificially prop up a weak IPO to prevent it from tanking too shortly after distribution.
• The effectiveness of independent “ monitors” is a real question mark. It’s hard to see how in practice a monitor would be able to effectively question or ban a portfolio managers’ potentially conflicted purchase decision.
• Sometimes waiting 60 days allows the market to establish a more rational price of the security; buying early may prove to be expensive.
• If it turns out the IPO was based on material misrepresentations, it's highly unlikely the affiliated fund would participate in litigation or class actions to recover losses from the related dealer on behalf of unitholders.

I am sending you for your consideration electronic files called Research & Communications -Teranet Income Fund and Media - Teranet Income Fund. The bookmarks in these PDF files provide a list of the contents for these files. I thank you in advance for your response to the questions in this letter.


Yours sincerely,




Diane A. Urquhart
Independent Consulting Analyst

CC:

All OSC Commissioners

Stan Buell
President, Small Investor Protection Association

Judy Muzzi
President, United Senior Citizens of Ontario

Art Field,
President, National Pensioners & Senior Citizens Federation

Ian Thomson
Kairos Social Ecumenical Justice Initiative

Joan Huzar
President, Consumer Council of Canada
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

BCE & Ace Aviation U.S. Trust Dist'ns Prohibited?

Postby urquhart » Thu Jul 13, 2006 2:42 pm

The payment of cash to U.S. shareholders rather than income trust units by BCE and Ace Aviation, shows how much Canadian businesses want to avoid distributing income trusts to Americans. I wonder whether the U.S. regulators have said no to these effective American distributions, or whether Canadian businessmen voluntarily choose not to distribute income trusts in America to avoid U.S. regulatory scrutiny and class action rigour. To me, the avoidance of the U.S. market, in such simple reorganizations of Canadian business assets, illustrates how problematic income trusts are, since they are securities for unsophisticated Canadian retail investors only. Canadian retail investors are not protected by Canadian accounting and securities authorities.
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Bell Alliant Trust Units Not Issued to American BCE Owners

Postby urquhart » Thu Jul 13, 2006 2:38 pm

BCE takes care of U.S. shareholders
Sells Bell Aliant block to send them cash, not units

Barry Critchley
Financial Post

Thursday, July 13, 2006

Every so often a situation comes along that demonstrates that the term "an integrated North American capital market" is not as extensive as many of us had presumed.

Yesterday was such a day, when a block of 9.7 million units of Bell Aliant Regional Communications Income Fund was crossed at the market opening on the Toronto Stock Exchange. The units were crossed at $33.50, or 10 cents below the closing price on Tuesday. The units (BAun/TSX) closed yesterday at $33.59.

Units of the fund -- formed this year when BCE Inc. and Aliant Inc. made a number of moves, including combining their wireline operations -- started trading on Monday. Initially, BCE had a 73.5% equity interest in the fund, with 28.8% held directly in units.

As part of the plan of arrangement, BCE will distribute that 28.8% interest -- which represents 64.6 million units of the fund -- to its common shareholders. Distribution is scheduled for July 18. BCE will continue to own about 45% of the fund.

But not all of BCE's shareholders could participate in the distribution of units of the fund. A trio of reasons were at work:

- BCE placed a minimum on the number of BCE shares stockholders had to own to participate. In this case, the limit was 150. Under the exchange ratio of 0.0725 to one, a stake of 150 BCE shares translated into 10 fund units.

- Non-Canadian investors, particularly those from the United States, were not eligible to participate.

The reason: The Bell Aliant income fund has not been registered with the U.S. Securities & Exchange Commission. Accordingly, U.S. investors could not receive the Bell Aliant securities.

- Fractional shares were not distributed.

Put the three factors together and owners of about 134 million BCE shares were ineligible to receive the distribution. That's about 15% of BCE's float.

Thanks to yesterday's events, the holders of those 134 million shares will get paid. But unlike the rest of BCE's shareholders, the affected group will receive cash and not units.

Indeed, the proceeds from yesterday's issue -- which was split 65/35 between institutional and retail investors -- will be used to fund those payments. Yesterday's deal, done by way of a marketed overnight offering, was led by RBC Capital Markets.

Aeroplan's move Yesterday's example is at least the second distribution of Canadian trust units this year where some shareholders were ineligible.

In February, ACE Aviation Holdings Inc. announced it had made a special non-cash distribution to shareholders of units of Aeroplan Income Fund. The distribution was about 0.18 Aeroplan units per share. ACE distributed about 10.1% of the units of Aeroplan Income Fund.

ACE Aviation said the distribution was valued at about $266 million or $2.37 per ACE share.

At the time, ACE Aviation said, "Aeroplan units cannot be distributed to shareholders of ACE resident in the United States. Units that would have otherwise been distributed to such shareholders will be sold in the market through an orderly sale and the net cash proceeds remitted to them." To obtain that cash, a group of underwriters sold the affected Aeroplan units to investors in Canada.

The units that were distributed were also efficient to both ACE shareholders in Canada and the United States. "The cash proceeds received on the special distribution by an ACE shareholder resident in the United States will be exempt from Canadian withholding tax," ACE said at the time.

As with BCE, ACE imposed a minimum shareholding level for unitholders to participate. In that case, an investor had to own 200 ACE Aviation shares.
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FOI Request for the Ontario Government PORA Agreement

Postby urquhart » Wed Jul 12, 2006 9:19 am

June 27, 2006

Lynn Gottshling,
Access & Privacy,
Ontario Ministry of Government Services,
250 Yonge Street, 3rd Floor,
Toronto, Ontario, M5B 2N5
Telephone: (416) 326-8470

Re: Urgent Request for the Participation Ownership Restriction Agreement between Teramira and the Province of Ontario dated about August 7, 2003.

Dear Access & Privacy Co-ordinator of Ontario Government Services:

I am writing to make a Freedom of Information Request for the Ontario Government document, referred to on Page F-30 of the Teranet Income Fund IPO Final Prospectus dated June 9, 2006 as:

The Participation Ownership Restriction Agreement ("PORA")

The PORA is defined in the Teranet Income Fund IPO prospectus to be an agreement between Teramira and the Province of Ontario that provides the Province's equity participation rights and consent rights pertaining to the re-sale of the Teranet business. The PORA is assumed to have been signed at about the time of attached the press release from the Ontario Ministry of Finance dated August 7, 2003 that briefly describes the participation and ownership restrictions in the requested PORA Agreement.

Jack Santos, Freedom of Information Co-ordinator for the Ontario Ministry of Finance has indicated that the requested document is not in the possession of the Ontario Ministry of Finance, but rather in the possession of the Ontario Ministry of Government Services. Jack Sanders has also informed me that there has already been an approved Freedom of Information request for this document to another unnamed party. Consequently, it is my understanding that there can be no impediment to your release of the PORA to myself upon my request.

I will come to your office to pick up a copy of the PORA Agreement.

Yours sincerely,


Diane Urquhart
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Income Trust Financial Reporting Solutions

Postby urquhart » Wed Jul 12, 2006 9:17 am

Backgrounder on Who is Responsible for Deterring Income Trust Abuses?

Prepared by: Diane Urquhart, Consulting Analyst Date: June 23, 2006
Telephone: (905) 822-7618 E-mail: urquhart@rogers.com

What are the objectives of income trust reform? 1
What is the motivation for the changes regardless of who has responsibility or jurisdiction? 1
Where does responsibility and jurisdiction lie for making the changes necessary to stop the income trust financial reporting and yield valuation inaccuracies and misrepresentation? 2
Canadian Accounting Standards Board to Make Changes in Accounting Standards 2
Provincial Governments to Make Changes in Securities Acts 4
Canadian Securities Administrators and Canadian Association of Income Funds on the Wrong Track in Looking for Definition of Distributable Cash 5
Federal Government to Make Changes in the Income Tax Act & Canada Corporations Act 6
Time for the Federal Government to Eliminate Self-Regulation of Accounting and Auditing Standards 9

What are the objectives of income trust reform?

1) Fix the income trust financial reporting and yield valuation methodology, which are inaccurate and misleading.

2) Eliminate self-regulation of the Canadian Accounting Standards Board, which sets the Canadian Generally Accepted Accounting Principles for income trusts and corporations.
What is the motivation for the changes regardless of who has responsibility or jurisdiction?

1) Objective one is to stop seniors from being deceived by distributions and yield in the financial reporting of income trusts. When the distributions and yield are above the net income and income yield of the underlying business, respectively, the distributions are less likely to be sustainable when business conditions deteriorate. So, seniors cannot rely on these distributions for retirement income. Furthermore, when the distributions and yield are above the net income and income yield, respectively, seniors are more likely to pay excessive prices at the time of the purchase of income trusts. Income trusts that are bought at too high a price too often result in capital losses in the retirement accounts of seniors at some point in the future. The timing of capital loss is when the market eventually recognizes the fair price. These capital losses are usually not recoverable in a reasonable time frame, since the original offering was significantly mispriced.

The mispricing of income trusts is caused by the vendor and the leaders of the investment bank syndicates not clearly distinguishing distributions = income distributions + return of capital distributions. The buyer needs to know these components because he needs to value the income distributions differently than the return of capital distributions. Valuation of the return of capital distributions should be just paying one times for your own capital, taking into account the time value of money for the lapse of time between when you give the capital and when you are getting this capital back.

2) Objective two is for the Federal Government to establish an independent Canadian Accounting Standards Board that acts in the public interest and is accountable to the public through its democratic representation in the Federal Legislature. The CAcSB should not be effectively controlled and funded by the Canadian Institute of Chartered Accountants. The motivation for this is that every other country has independent oversight of the setting of accounting and auditing standards, with the authority responsible being a crown regulatory agency or department. The rationale is that only Government and crown agencies can act in the public interest, and have the legislative tools needed for thorough and fair investigation and prosecution. In the case of income trusts, the self-regulating CAcSB has not shown that it acts in the public interest, rather than the commercial interest of its members and of their members’ corporate and institutional clients. The CAcSB has been unwilling to set new accounting standards for income trusts that would have deterred the financial reporting and yield valuation abuses occurring in this type of investment.
Where does responsibility and jurisdiction lie for making the changes necessary to stop the income trust financial reporting and yield valuation inaccuracies and misrepresentation?
Canadian Accounting Standards Board to Make Changes in Accounting Standards

I have written a letter dated May 30, 2006 to Paul Cherry, Chairman of the CAcSB, which provides recommendations for changes in accounting standards governing income trusts. These will be reviewed and actions determined at a CAcSB meeting on June 14, 2006. The main recommendation for accounting change is:

The Handbook of Canadian Institute of Chartered Accountants (CICA) is Canadian Generally Accepted Accounting Principles (Canadian GAAP), which are developed and approved by the CAcSB. The term distributions is found in the financial statements of income trusts, such as those in the Yellow Pages Income Fund shown at the end of this response note. The term distributions does not have a definition in the Handbook of CICA. Specification of the component income distributions and return of capital distributions is defined implicitly by the Canadian GAAP rules in place today and as such cannot be the subject of disagreement on what the terms mean. I am asking for the CAcSB to make the two components of income distributions and return of capital distributions explicit terms, which means there are two lines in the cash flow statement and the statement of changes in unitholders’ equity and not one – income distributions and return of capital distributions and not just distributions. The Handbook would provide definitions for the income distributions and the return of capital distributions.

The CAcSB has so far refused to make any accounting changes governing income trusts. The Accounting Standards Board Decision Summaries, May 3, 2006 says:

“The AcSB does not provide standards for financial information, such as yields, provided outside of financial statements or for any of the numerous non-GAAP measures, such as distributable cash, found in published disclosures. Such disclosures are subject to securities regulation. However, the AcSB is concerned that the failure to distinguish clearly between returns on capital and returns of capital is inaccurate and potentially misleading, particularly when terms such as “yield” are used to describe the amount distributed.”

My recommendation clearly disagrees with the last CAcSB decision not to make accounting changes and the apparent rationale for this decision being that the CAcSB has no jurisdiction for this and that it is the jurisdiction of provincial securities regulation.

The following are the reasons for CAcSB actions that I have provided in my May 30, 2006 letter to Paul Cherry and a subsequent e-mail:

The Canadian Accounting Standards Board should not be accepting an accounting standard, which permits the use of the term distributions in the income statement, statement of unitholders’ equity and statement of cash flows, where it has concerns about this term being inaccurate and potentially misleading.

My recommendation for the CAcSB to add to the Handbook of the Canadian Institute of Chartered Accountants a requirement that income trusts report both income distributions and return of capital distributions, is easy for the CAcSB to implement, and has virtually no cost to income trusts for the preparation and auditing of the new financial statement terminology. I strongly believe that the acknowledged financial reporting abuses are much more difficult to execute if the CAcSB requires both income distributions and return of capital distributions to appear in the income statement, statement of unitholders’ equity and statement of cash flows. This is especially the case, when the Handbook contains a prohibition on the use of the term distributions in the financial statements, where distributions are the sum of income distributions and return of capital distributions.

The announcement of the CAcSB accounting standard changes for distributions would itself cause all the players in the income trust market to be warned that cash distributions need to be specified by income distributions and return of capital distributions. There is no acceptable Canadian GAAP concept for distributions appearing on the financial statements, so there is no such acceptable reference to distributions in any other financial reporting. Furthermore, continued attempts for prospectuses and equity research to focus financial advisors and unsophisticated investors onto cash distributions and cash yields would be less successful since there is a hook or reference point in the financial statements that clearly distinguishes the income distributions from the return of capital distributions.

Neither the Federal Government, nor the Provincial Governments, have become involved in the oversight or regulation of accounting and auditing standards, such as is done by the U.S. S.E.C. These functions have been the jurisdiction of self-regulation under the auspices of the CAcSB that is effectively controlled by the CICA.
Provincial Governments to Make Changes in Securities Acts

Estimated distributable cash and yield are not financial measures that appear in the financial statements, so as the Library of Parliament notes indicate, the CAcSB does not directly control the use of these financial terms. It is here that the provincial securities commissions should also be taking intervention actions, both in public disclosure requirements within the provincial securities acts, and in the denial of receipts for final prospectuses that do not meet the letter and principles of the new public disclosure requirements for financial measures used in relation to the performance and valuation of income trusts. Firstly, the estimated distributable cash should have specification of its two components that parallel the new proposed Canadian GAAP income distributions and return of capital distributions. There would need to be estimated net income and estimated return of capital in the new requirements, and a prohibition on the combination of these components into one estimated distributable cash figure.

The provincial securities commissions need to set a new requirement for income trust prospectuses and other public disclosure documents and for investment bank marketing materials that the income yield be calculated and clearly provided. The income trusts should not be permitted to show a yield calculation that includes a return of capital because the term yield by international convention is known to investors and consumers to mean return on investment. The definition of income yield cannot be the subject of disagreement on what the term means because the income distributions and return of capital distributions, are implicitly defined by the Canadian GAAP rules in place today. If the CAcSB acts on my recommendation, then the income distributions and return of capital distributions are defined explicitly in the Handbook and are explicitly visible on the financial statements.

The Provincial Governments have jurisdiction to set the financial reporting standards that I describe and to enforce these standards in the Provincial Securities Acts. The Federal Government has not historically been involved in securities regulation, although the work of the Federal Wise Persons Committee concludes that the Constitution does permit the Federal Government to enter the field of securities regulation. It is likely that future securities regulation will be a joint Federal and Provincial jurisdiction responsibility. Federal Finance Minister James Flaherty has already indicated that he wishes the Federal Government to be a party to any single national securities commission initiative and the creation of a single national securities act.

The Parliament Library notes says that the provincial securities regulators are trying to remedy the income trust financial reporting problem. Let’s not be complacent to think that this is a sincere initiative. Firstly, the income trust financial reporting problems of income trusts have been acknowledged by David Wilson, Chairman of the Ontario Securities Commission, who said the following at a Toronto securities conference on February 23, 2006, according to Paul Waldie of the Globe and Mail “Regulators decide no specific rules for hedge funds”:
“Regulators are also working on new rules governing how income trusts calculate and report their cash distributions, he said yesterday. By design, income trusts are supposed to spin off cash to unitholders. But there are no rules governing how that cash flow is calculated. Mr. Wilson said the CSA is hoping to come up with a "definition that provides consistency for investors.”…"So when an income trust says 'this is what our distributable cash flow is,' it's calculated in essentially the same way for every income trust," Mr. Wilson said.”
It has been my observation that hot issues requiring resolution by the OSC are often sent to the Canadian Securities Administrators to be diffused by the need for further study and for consensus amongst the thirteen provincial and territorial securities commissions. Policy initiatives sent to the CSA rarely get resolved quickly, and when they do, the solution is at the lowest common denominator that thirteen provinces and territories could agree on.
Canadian Securities Administrators and Canadian Association of Income Funds on the Wrong Track in Looking for Definition of Distributable Cash

The Canadian Securities Administrators and the Canadian Association of Income Funds (CAIF) are moving as quickly as they can to a set of guidelines for a definition of estimated distributable cash. I can imagine that this will be the creation of some form where the income trust’s management reconciles its estimate of distributable cash to net income or cash flow from operations, which are Canadian GAAP defined terms appearing on the financial statements. This reconciliation form would have standardized items for additions and subtractions from the Canadian GAAP items. It is my opinion, that this urgent private sector and CSA effort to create a definition for estimated distributable cash to resolve the problem of income trusts financial reporting is unacceptable, and it will in fact institutionalize the deception that cash distributions and yield are in some way income.

The efforts to create a definition for estimated distributable cash is in essence an effort to replace Canadian GAAP for the income trust business structure. The President & C.E.O of Yellow Pages Income Fund has in fact said this is the objective, when he said he supported the CAIF initiative to develop guidelines for the financial reporting of income trusts that did not need to be Canadian GAAP rules. Should Canadians and the Federal Government accept that the income trust structure has its own financial reporting rules that are not Canadian GAAP and as such are not audited measures? Why should the Federal Government rely upon new rules defining estimated distributable cash that do not have even the degree of oversight that the CAcSB provides, especially when the corporate governance of trusts is acknowledged to be so much less than corporations, and especially if there is going to be less Federal Government revenues collected from the income trusts owned by tax deferred entities, such as RRSPs and pension plans, and foreign investors.
Federal Government to Make Changes in the Income Tax Act & Canada Corporations Act

The Federal Government must always take responsibility for attainment of the benefits expected from making federal tax concessions. Income trusts are receiving federal tax concessions relative to corporations, despite the current steps taken towards tax parity. The pursuit of benefits from no business taxes on income trusts should not have the significant side effects upon seniors and other income seeking investors that are financially harmed by the improper execution of these flow through business structures, i.e., deceptive cash distributions and yield that cause their mispricing in the market. The Federal Government cannot rely upon the CAcSB or the provincial and territorial jurisdictions to resolve the investor protection issues on its behalf. So, far the CAcSB and the provincial securities commissions have failed to protect investors in income trusts.

Income trusts are receiving tax concessions compared to corporations despite the Federal Government pronouncement of steps taken towards tax parity between these two business structures. Firstly, the Federal Government initiative to date aims for tax parity between income trusts and only large public corporations. Secondly, tax parity is not achieved by the Federal Government alone, because the thirteen provinces and territories have to cut their share of taxes on dividends. Thirdly, even the expected Federal plus Provincial tax parity will take four years, since this is the phase in period for the decline in the corporate tax rate from 36% to 32%. Fourthly, the non-taxable RRSP accounts and pension funds continue to have an advantage from the income trust structure, since income trusts do not pay business taxes while corporations do, and entities that are not taxable will not have the beneficiaries of these funds paying the related personal income taxes for many years in the future. Fifthly, we know that foreigners own an estimated 24% of Canadian-based income trusts, so there may be income trust demand from this source, where there is clear tax leakage from Canadian Governments.

It was hoped that tax parity between income trusts and large public corporations would stem the tide of income trust conversions in Canada, since there would be no economic rationale for doing these conversions when investors get the same after tax returns from an income trusts as they do from a corporation. If there were to be less income trust conversions, then there would be fewer deployments of the financial reporting and valuation abuses found in income trusts. But, the Federal Government’s efforts to obtain tax parity has not and may not be capable of being accomplished.

Furthermore, the Federal Government must ensure that individual taxpayers do not misunderstand the nature of any income or return of capital that they receive from an investment, so that these taxpayers are not making erroneous tax filings. The investment bank literature almost always misrepresents the return of capital component of distributions to be tax deferred rather than tax exempt. The return of capital is tax exempt because tax authorities cannot tax income already taxed a second time. The return of capital distribution is a deduction from the cost base of the income trust unit so that the double taxation of original income does not occur. If taxpayers were not receiving this inaccurate information on the taxation of return of capital distributions, they would likely be more attentive to the matter of return of capital distributions having a reducing affect on the value of an income trust rather than a beneficial one.

The Federal Government should make amendments to the following Federal Acts:

a) Federal Income Tax Act – Revenue Canada and Finance Canada
b) Canada Business Corporations Act – Industry Canada

The proposed amendment to the Federal Income Tax Act is intended to have the effect of an income trust being required to report in both its financial statements and other financial reporting documents income distributions and the return of capital distributions, and not the combined distributions. The proposed prescribed condition for income distributions and return of capital distributions in the Federal Income Tax Act would supersede the CAcSB accounting standard of not requiring these specified components of distributions to be made in the financial statements. This requirement would have the authority of federal law, whereas the CAcSB is a self-regulated standard. The income trust needs to make these calculations once a year for the income trust owners to make their income tax filings, so this new prescribed condition says such reporting must be made in every public disclosure.

The estimated distributable cash presented outside of the financial statements would need to be explicitly specified by its components of net income and return of capital, in all financial reporting documents, whether they be fact or estimates. The income yield must be calculated and clearly provided. The income trusts should not be permitted to show a yield calculation, that includes a return of capital.

These requirements are being placed directly in the Federal Income Tax Act because the CAcSB refuses to make the accounting change in the Handbook for income distributions and return of capital distributions and because the provincial and territorial governments have also either refused or been unable to adopt the parallel changes in their securites acts for estimated distributable cash, distributions and yield that are presented in documents outside of the financial statements.

.Would the Federal Government need to implement this proposed change in the Federal Income Tax Act, if the CAcSB made the recommended accounting standard change for specification of income distributions and return of capital distributions and if the provincial and territorial governments made the parallel changes for estimated distributable cash, cash distributions and yield in public disclosures, other than the financial statements. The answer is yes: (1) The Federal Government needs to execute its own responsibility to achieve the benefits of income trust tax concessions; and, (2) the Federal Government needs to help individual taxpayers not making erroneous tax filings.

The Federal Government has constitutional jurisdiction for securities regulation according to the work of the Federal Wise Persons Committee, and so it likely follows that it also has constitutional jurisdiction to enter the regulation of accounting standards as well, since one purpose of accounting standards is to provide information that is useful to investors to assess a business’s financial performance and its valuation. Securities regulation deals primarily with truthful and timely public disclosure and the fair treatment of investors in the capital markets. Neither the Federal Government nor the Provincial Governments have historically deployed any jurisdiction to regulate specific accounting standards, so the Federal Government cannot be perceived to intrude on a matter that has been historically of provincial jurisdiction, especially when the Federal Government has the jurisdiction to define income and return of capital within the Federal Income Tax Act for the purpose of defining how much Federal income taxes must be paid.

The use of the Income Tax Act to impose requirements on public disclosure of estimated distributable cash and yield of income trusts could be construed to be an intrusion on provincial securities regulation jurisdiction, but the Federal Government has the constitutional authority for joint federal and provincial jurisdiction and the provincial governments have failed to address the need to clarify these inaccuracies and misleading financial measures. The Federal Government has already adopted definitions for income distributions and return of capital distributions for the purpose of collecting personal income taxes from owners of income trusts and this proposed change crystallizes the use of these terms by income trusts, so there can be no misunderstandings or implied meanings other than the truthful ones given to Canadian taxpayers.

Time for the Federal Government to Eliminate Self-Regulation of Accounting and Auditing Standards
It is time to address the root cause of CAcSB resistance to adopt accounting standards that provide better transparency for investors and deter abuses by income trusts and corporations, their owners and their corporate advisors. Sections 70 and 71 of the CBCA Regulations today says that “Canadian GAAP” means generally accepted accounting principles as set out in the Handbook of the Canadian Institute of Chartered Accountants. I recommend that Section 70 and 71 of the CBCA Regulations be changed so that “Canadian GAAP” means generally accepted accounting principles established by the Canadian Accounting Standards Board, defined as independent and representative of all stakeholders including public investors; and, authorized within the Canada Business Corporations Act (“CBCA”). Federally registered corporations would need to follow accounting standards set by the newly restructured Canadian Accounting Standards Board.

If there is a requirement for a new Federal Government body setting accounting standards for Federal corporations, it is very likely that the accounting industry and issuers would capitulate to the creation of one new CAcSB for both Federally and Provincially registered corporations and for Provincially registered income trusts. This CBCA legislative change would then be the catalyst for a newly restructured CAcSB that can be required to address the specific income trust changes of income distributions and return of capital distributions, where these income trusts are not federally incorporated. The newly restructured CAcSB would reduce the prospects for corporate calamities caused by lax accounting principles that allow executives of both income trusts and corporations to act in their own interests, rather than creating long term investment returns for investors.

The New CAcSB needs a clear majority of fully independent Board members, the accounting principles of the Board will be authorized in the CBCA and the Board will report to Industry Canada, who administers the Canada Business Corporations Act. The Board can not report in any manner to the Canadian Institute of Chartered Accountants and cannot be a self-regulator of the accounting industry. The CBCA revisions would also define the CAcSB’s purpose to be the setting of accounting principles for financial statements that are intended to be utilized in individual investor decision-making. These CBCA changes would supersede the precedent set to the contrary in the Hercules Management v. Ernst & Young Supreme Court of Canada decision in 1997.

Since the Federal Government very likely has constitutional jurisdiction to enter the regulation of accounting standards and since the Provincial Governments have not historically been involved in the regulation of accounting standards, it is not clear to me why it would be necessary to move forward on a joint Federal and Provincial responsibility basis to restructure the CAcSB, so as to make it accountable to the public through its democratic representation in the Federal Parliament.
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Toronto Sun - Mortgage Fraud Crisis & Teranet

Postby urquhart » Mon Jul 10, 2006 7:06 am

Toronto Sun published an article on the Ontario mortgage fraud crisis on June 27, 2006 that had this to say about the Teranet electronic land registry service. There was nothing about this problem in the Teranet Incoem Fund prospectus.

"Ontario should restrict access to the Teranet electronic document registration system, condemned worldwide for being too open. An Australian alternative makes sense -- limit users to licensed real estate professionals who carry liability insurance."

The Toronto Sun
© Copyright 2006, Sun Media Corporation
MORTGAGE FRAUD CRISIS
COURT OF APPEAL RULING OPENS UNINTENTIONAL LOOPHOLE AND ONTARIO NEEDS TO RESPOND Tuesday, June 27, 2006
Tag: 0606270354
Edition: Final
Section: Business
Length: 85 lines
Page: 46
BY ALAN SILVERSTEIN

What's worse? An indecisive government? Or a government that's out of touch with reality on vital public issues?

Thanks to the McGuinty Liberals at Queen's Park, we've got both.

The Fiberals' flip-flop on election promises is legendary. But their refusal to stand up for property owners and tackle the rapidly escalating problem of title theft and mortgage fraud is appalling.

Title theft means title to a property title literally is stolen. With mortgage fraud, a phony mortgage is registered on title, stealing a homeowner's equity, but not their title.

As Ontario completes its move to online document registrations, registering deeds and mortgages online, most property titles have been switched to the newer land titles system. Since the parcel register is designed to mirror a property's current ownership, there's no need to search further back to establish good title. What you see is what you get.

With one major exception -- fraud.

Null and void

Historically, anyone dealing with a fraudster never became the registered owner of a property, since fraud negated a transaction. So if Bob bought property from Frank (the fraudster), Bob's title was null and void even if Bob was totally unaware of the fraud. But if Charlie subsequently dealt with Bob, and Charlie was an innocent buyer or lender with no knowledge of the earlier fraud, Charlie's deed (or mortgage) would be legal, valid and enforceable. Strange but true. Only the second person dealing with a registered title property after a fraud (Charlie) would get good title, not the first (Bob).

What about Owen, the original property owner whose title literally was stolen from beneath his feet? He can claim against the Land Titles Assurance Fund, but it's a "fund of last resort" in Ontario law.

To qualify for compensation, Owen must first exhaust his legal remedies against Frank the fraudster. Another painful screw that just deepens the pain for stiffed property owners.

Everything changed in November 2005, when the Ontario Court of Appeal erased the need for a second deal before good title could be acquired in the face of fraud. The court ruled that a registered deed or mortgage conveys good title, even if the party delivering that document is the fraudster, when the recipient is an innocent buyer or lender. So if Bob bought a property from Frank the fraudster (or advanced funds to Frank on a mortgage), and Bob knew nothing about the fraud, Bob's deed (or mortgage) would be valid and binding.

Of course, Owen the innocent victim still loses title to his property. By knocking one transaction off the process, the Court of Appeal inadvertently played right into the hands of fraudsters.

Inaction by Ontario

What has the McGuinty government done in response since that shocker hit the streets seven months ago? Absolutely nothing. Inaction has been its reaction. No emergency legislation to undo its impact, no public advisories helping on ways property owners can protect their titles, and no blue-ribbon panel of fraud experts to allay fears and propose solutions. Is the severity of the problem beyond the Liberals' grasp? Or do they simply not care about property owners?

What can be done to address the twin threats of title theft and mortgage fraud? Here are some ideas:

- Buyers and existing homeowners should arrange title insurance coverage. Never before has the need been greater. For a one-time charge of several hundred dollars, title insurance offers protection against both title theft and mortgage fraud.

- Ontario should import a New Brunswick law that reinstates an owner-occupant's title (Owen in that example) following a fraudulent sale. The buyer instead of the defrauded homeowner must seek compensation from the Assurance Fund, not the defrauded owner.

- Ontario should refashion its assurance fund into a "fund of first resort" -- another New Brunswick idea. Fraud victims would get compensated more quickly, curbing their enormous costs (financial and emotional).

- Ontario should restrict access to the Teranet electronic document registration system, condemned worldwide for being too open. An Australian alternative makes sense -- limit users to licensed real estate professionals who carry liability insurance.

- Federally, Stephen Harper's Tories should make mortgage fraud a specific Criminal Code offence, following Georgia's lead last year. That U.S. state's fraud law packs a wallop: One to 10 years in jail plus fines up to $5,000 for first offenders; and three to 200 years, plus fines of $100,000 for repeat offenders.

When it comes to title theft and mortgage fraud, the McGuinty government is a deer standing in the headlights, paralyzed.

Will Ontario consumers suffer the deer's fate?

© Copyright 2006, The Toronto Sun Unauthorized reproduction or Web posting prohibited.
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Letter to Nixon, C.E.O. of Royal Bank, on Teranet Conflicts

Postby urquhart » Wed Jun 28, 2006 1:24 pm

Dear President & C.E.O. Gordon Nixon, RBC Financial Group

I wish to bring to your attention as the President & C.E.O of RBC Financial, my serious concerns about how the bank is handling its conflicts of interest in business income trusts and the Teranet Income Fund Initial Public Offering, in particular. I am an independent consulting analyst, who is consulting to numerous associations representing seniors and other individual investors. These associations include the National Pensioners & Senior Citizens Federation, the United Senior Citizens of Ontario, the Small Investors Protection Association, the Kairos Social Ecumenical Justice Initiative and others. Royal Bank affiliates have conducted considerable business with respect to the Teranet Income Fund, for which it has received very large undisclosed fees, while seniors purchasing Teranet Income Fund IPO units and purchasing mutual funds owning Teranet Income Fund units are being marketed inaccurate and potentially misleading financial information.

The inaccurate and potentially misleading financial information is described fully in the attached independent research report, called "Teranet Income Fund - Ontario Government Compromised & Seniors Deceived By Yield." The Teranet Income Fund Green Sheet published a Teranet Income Fund yield of 7.5%, whereas the estimated income yield is only 4.7%. The attached Canadian Accounting Standards Board Decision of May 3, 3006 says the use of estimated distributable cash and yield is inaccurate and potentially misleading. These financial measures were the focus of the Teranet Income Fund prospectus and Green Sheet. I have also attached independent research reports from Accountability Research Corporation and Standard and Poors that provide similar conclusions on the inaccurate and potentially misleading nature of estimated distributable cash and yield. Canadian income trusts are reporting inaccurate and potentially misleading yields, but I have also reported on the problem of income mutual funds not reporting any yield information for their funds similar to that provided by U.S. high yield funds and the SEC prescribed yield calculation required for U.S. mutual funds.

RBC Dominion Securities Inc. was the co-lead underwriter of the Teranet Income Fund with CIBC World Markets, where total investment banking syndicate fees are $35 million and another $5 million, if the overallotment option is exercised 30 days after the IPO offering on about June 15, 2006.

RBC Financial is a significant new creditor and one of its affiliates may possibly have been an owner of the junior and senior bonds that were paid down, for which there was estimated total creditor breakage penalties and new credit fees of $45 million. The Teranet Income Fund Final Prospectus, Initial Public Offering Dated June 8, 2006, says on page 24 and page 78:


New Credit Facilities to be made available to Teranet will consist of a $70 million Revolving Facility, a $30 million LC Facility, a $315 million Bridge Loan Facility, a $150 million Term Loan Facility and a $100 million Capex Facility, subject to the satisfaction of certain customary conditions, including the completion of the Offering.



The Revolving Facility will be used to finance Teranet’s working capital requirements and for other general corporate purposes, including normalizing distributions to Unitholders of the Fund.



Repayment of the Senior Bonds and the Junior Bonds will be made in part from the proceeds of the New Credit Facilities and in part from the net proceeds of the Offering.



It is very surprising that the Royal Bank has provided a new Revolving Facility that will be used in part for normalizing the distributions to Unitholders of the Fund. In public corporations, dividends may not be legally paid in excess of net income and when shareholders' equity is negative. In the Teranet Income Fund, the distributions will exceed net income out of the gate and for the foreseeable future, so that the owners will be getting net income and the return of capital. The Royal Bank Revolving Facility is already set up to finance the normalizing of distributions that are a return of capital and that would not be permitted legally to occur in a public corporation. One would normally call such a scheme to be a Ponzi scheme, where the promised yield needs to be financed by new investors, where this time the new investor is the Royal Bank itself standing by willing and ready. Of course, the Royal Bank knows that it holds the deck of cards on stopping the distributions any time and recalling its loans, while the seniors owning the income trusts bear the pain of significant losses in their retirement accounts.

Late Friday on June 9, 2006, The Ontario Securities Commission granted exemptive relief to allow CIBC Asset Management Inc., CIBC Global Asset Management Inc. and RBC Asset Management Inc to invest their mutual funds in the distribution units of a connected issuer, the Teranet Income Fund. This MRRS decision explicitly permits the CIBC and Royal Bank mutual funds to purchase Teranet Income Fund IPO units without requiring any public disclosure of this for 97 days after the end of the IPO distribution, which would be 97 days from about June 15th. The number of shares permitted are any fixed number that is submitted by the CIBC and Royal Bank mutual funds, of which the IPO syndicate allocated number must be purchased within five days of June 9, 2006. The remaining amount of this fixed number of units, not filled in the IPO distribution, may be filled if the underwriting syndicate exercises its Greenshoe overallotment option for up to 10.5 million units within 30 days. The MRRS Decision has conditions attached, including the need for the Royal Bank mutual fund independent committees to review and approve the purchase of Tenanet Income Fund IPO or Overallotment units.

Under NI 81- 102 section 4.1 (I), RBC mutual funds would have to wait 60 days before being able to invest in an equity offering underwritten by RBC Dominion; but with the waiver in place seniors might be hurt in several ways:



The availability of a ready market for an IPO may cause a decision to price the IPO higher than would otherwise the case or to fill a demand gap in an under- subscribed IPO
It encourages further erosion of the mythical “ethical walls” between mutual funds and their brokerage affiliates; these are the same walls that supposedly existed between analysts and investment bankers
Mutual funds may end up buying unsuitable or non-optimum investments merely to placate superiors and/or receive rewards for such actions
The mutual funds can be used to artificially prop up a weak IPO to prevent it from tanking too shortly after distribution
The effectiveness of independent “ monitors” is a real question mark. It’s hard to see how in practice a monitor would be able to effectively question or ban a portfolio managers’ potentially conflicted purchase decision
Sometimes waiting 60 days allows the market to establish a more rational price of the security; buying early may prove to be expensive
If it turns out the IPO was based on material misrepresentations, it's highly unlikely the affiliated fund would participate in litigation or class actions to recover losses from the related dealer on behalf of unitholders
I would like to know who it is in the RBC Financial organization, that acts as a gatekeeper for the interest of the seniors who are targeted to purchase business income trust IPO's and income mutual funds invested primarily in income trusts. It seems to me there are many managers who look after the RBC Financial making large fees upfront, while poorly trained and highly incenticized financial advisors are relied upon to ensure that seniors are buying suitable investments. The Teranet Income Fund IPO appears to have paid a 2.5% fee to the RBC financial advisors, indicating a 50-50% sharing relationship with the investment bankers. I received a call late Tuesday evening June 6th from an RBC financial advisor in the West who informed me that he had just been allocated Teranet Income Fund units to place with his clients. I learned from him that he was relying upon his training and the marketing teleconference call on the Teranet Income Fund IPO to look at the expected yield of 7.5% and the payout ratio of 95%, and that these were both attractive. I noticed that the Green Sheet he was working from focused upon the estimated distributable cash and expected yield, which were both 60% more than a reasonable estimate of the net income of the Teranet business. The only mention of the net income of Teranet Income Fund was in a micro-type footnote to a Revenue and EBITDA chart on page 14 of a 20 page Green Sheet.

Research findings on accounting, financial reporting and yield valuation abuses in the income trust asset class is not esoteric intellectual debate. These abuses are contributing to serious investment losses in the business income trust market, as noted in the attached file called "Business Income Trust IPOs in Capital Loss 6232006.pdf". 49% of business income trust IPO's since January 1, 2001 are now in capital loss. The total capital losses on the 60 business income trust IPO's in capital loss is now $2,858 million and the average degree of loss on these business income trust IPO's in capital loss is 28%. Over one third of business income trusts have cut or eliminated their distributions, causing a considerable dent in the incomes of seniors.

Given the execution flaws in income trusts that are now well-documented and the billions of dollar losses being borne by seniors and other conservative long term investors in business income trusts, I strongly urge that the President & C.E.O. of RBC Financial brings himself up to speed on the reputational, civil liability risk and potential retail customer impacts caused by unhappy seniors owning losing income trusts. These seniors are being sold income trusts on the basis of inaccurate and potentially misleading yields and on the concept of mature businesses that are able to sustain distributions (not ones supported by Royal Bank Revolving Credit Lines). I consider this to be an emergency situation for seniors and hope that you treat this in the same manner.

Yours sincerely,


Diane Urquhart
Independent Consulting Analyst
Telephone: (905) 822-7618
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

Teranet Income Fund Investor Protection Issues

Postby urquhart » Wed Jun 28, 2006 1:22 pm

Teranet Income Fund IPO – Ontario Government Compromised and Seniors Deceived By Yield
Prepared by: Diane Urquhart, Consulting Analyst Date: June 8, 2006
Telephone: (905) 822-7618 E-mail: urquhart@rogers.com

Executive Summary

The largest business income trust to date, Teranet Income Fund, produced a windfall gain for the Ontario Government estimated at $554 million and an upfront cash payoff for Teranet management of at least $167 million; while the new buyers, who are primarily seniors, were enticed to pay too much by a yield calculation that is inaccurate and misleading. Existing Teranet owners got only paper units, and apparently relied on the corporate governance of their representative directors, with no concern about the depressing impact of the $167 million cash payments to management and an estimated $100 million plus of income trust conversion, debt restructuring and going public fees. There is no explanation of why the future of the Teranet business was better under the income trust structure than the corporate one, and that the massive outflows of cash to management, the investment banks and banks and the lawyers were justifiable.

The Teranet Income Fund IPO Green Sheet, prepared by the co-lead underwriters, RBC Dominion and CIBC World Markets and used by the investment syndicate’s sales personnel, refers to an Expected Yield of 7.0% - 7.5%, which implies an equity valuation for the Teranet Income Fund of $1,551 to $1,661 million. The final pricing done on June 7, 2006. was at the lower end of the range at $1,551 million.

The Teranet Income Fund had a final price determined on the basis of the so-called expected yield of 7.5% in the Green Sheet. This yield calculated as the cash distributions per unit divided by the unit price is an inaccurate and a misleading financial measure. At the final pricing, the income yield is only 4.7%. The difference of 2.8% is investors' return of capital. Would the buyers have been willing to pay the $1,551 million implied valuation, if they plainly saw that the income yield was just 0.4% more than the 10 year government bond? The final pricing based on a cash yield calculation is especially excessive, taking into account the finite Teranet 11 year contract period and the likely prospects for a cyclical decline in Teranet’s business, which is related to the cyclical real estate market now operating at peak levels.

For the 12 months ending December 31, 2005, the Teranet Income Fund preliminary prospectus has estimated distributable cash of $122 million and estimated cash distribution of $116 million, calculated at 95% of the estimated distributable cash. The net income after tax is a $43 million loss after tax and a $60 million loss pre tax for the 12 months ending December 31, 2005. The cash distribution of $116 million is in my opinion, $74 million of income and $43 million return of capital (the sum difference is due to rounding).

The $43 million of cash distribution above net income can be attributed to the difference between management’s estimate of $5 million for maintenance capital expenses and the $48 million of amortization expenses deducted to obtain net income. The estimated distributable cash omits $26 million for the 2005 amortization of about $500 million in historic software development costs and $15 million for the 2005 amortization of about $200 million in historic pre-paid royalties paid to the Ontario government in August 2003. I conclude that these amortized software expenses and pre-paid royalties should be deductions from the estimated distributable cash.

I am not the only expert who finds serious problems with the omission of important amortized expenses from the calculation of estimated distributable cash and the use of cash yield to value an income trust. This report shows you where the Canadian Accounting Standards Board, the British Columbia Securities Commission, the Accountability Research Corporation and the Standards and Poors have all made written statements about the cash distributions and yield being either inaccurate, potentially misleading for the purpose of valuing income trusts or at the least not capable of being used to compare one income trust to another one.

The consequence of the deceptive expected yield in the Green Sheet, in my opinion, is an overvaluation of the Teranet Income Fund by an estimated $275 million above the reasonable $1,275 million that I defend in this report. This is about a 22% overvaluation. Figure 18 summarizes the value of Ternanet under various scenarios from Figures 9, 12, 14, 15, 16 and 17 using different valuation methodologies and using different assumptions for cash distributions relative to net income and the terminal value of Teranet at the end of the contract period in 2017. The values in Figure 18 are a combination of the equity value of the underlying business and the estimated value of capital invested that will be paid back as a return of capital, (the present value of the return of capital anticipated over the contract period to 2017 arising due to the cash distribution exceeding net income).

Of the Ontario participation of $554 million, about $405 million is cash received upon closing, and the residual amount of the Ontario participation is from the proceeds of the sale of units after 90 days. The Ontario Government benefit from the deceptive yield is estimated to be about $138 million at the final pricing.

The Ontario Government approved a minimum $90 million long term incentive payment for management at about the IPO closing date, bringing the total long term incentive payment granted to management to at least $167 million over the past 21 months. The payments to management are $50 million more than the net income over the same 21 months. The exorbitant cash payments to management is stripping cash from the company that would have been better deployed in productive uses at the company, such as research, software development and new customer marketing expenses. Teranet is highly leveraged with $665 million of debt anticipated upon conversion to an income trust.

It is very disappointing that Canada’s securities regulators, and the OSC in particular, have not required that the estimated distributable cash and cash distributions have their components of income and return of capital clearly specified; and, that they did not require that the income yield be reported directly and simultaneously with the cash yield (=expected yield) in the Green Sheet. This report gives 11 reasons for the OSC to require that these additional public disclosures are made in the prospectus and the Green Sheet.

The Teranet Income Fund IPO was sold at an excessive price since the Canadian investment bank retail marketing machine is very powerful and not held to a high standard of conduct in this country. The Teranet Income Fund may well sustain its $10 offering price until the 90 day holding period for the Ontario Government’s second tranche of participation and for the 180 days before which the institutions are free to sell their units. But, all market players in this transaction must recognize that deceptive cash distributions and cash yield methodologies, like all unsavory practices, ultimately break down and become recognized at some undefined point in the future. Bifurcated capital markets, where sophisticated investment banks and institutions take advantage of unsophisticated seniors and retail investors, are not fair and are very damaging to the economy in the long term.

Buyers of Teranet Income Fund need to be aware that the debate on accounting and financial reporting abuses in the income trust asset class is not esoteric intellectual debate. The financial reporting abuses and cash yield valuation methodology are contributing to serious investment losses in the market. Appendix II provides a list of 54 business income trust IPOs that have been underwritten since January 1, 2001 and that are trading at a capital loss relative to their IPO price. The total capital losses on these business income trust IPO’s in capital loss is $2,611 million and the average degree of loss on these business income trust IPO’s in capital loss is 31%.

Income trusts are not corporations and so many of the investor protections in the Canada Business Corporation Act (“CBCA”) are not available to the unitholders of income trusts. Seniors and income seeking investors need to be especially concerned about buying Teranet at an excessive price because they will have no recourse for remedy of their investment losses in the courts using CBCA oppression or derivative action remedies.
urquhart
 
Posts: 125
Joined: Tue Jun 14, 2005 3:43 pm
Location: Mississauga

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