Evidence of meeting #59 for Finance in the 39th Parliament, 1st Session. (The original version is on Parliament’s site, as are the minutes.) The winning word was trust.
A recording is available from Parliament.
12:55 p.m.
Conservative
The Chair Conservative Brian Pallister
Mr. Kesteven, I appreciate that.
We'll move on now to Mr. Del Mastro.
12:55 p.m.
Conservative
Dean Del Mastro Conservative Peterborough, ON
Thank you, Mr. Chair.
Ms. Urquhart, I'm just reviewing your résumé a little bit. You have quite a bit of experience in relation to investment, and you are certainly a professional witness before this committee. I appreciate your being here.
I spent a lot of time reading your report of October 12, entitled “Income Trusts: Heads I Win, Tails You Lose”. When I read that report, it actually struck me that the first line in about a fifty-page report reads, “Business income trusts will likely suffer a 25% to 35% correction as an asset class.” That's not my question, but it was striking that you chose to begin a fifty-page report with that particular comment.
The income trust lobby has spent a lot of money on advertising. In my mind, they've put a lot of fallacies out there. Furthermore, today we hear that the finance minister is wrong. Obviously, the provincial finance ministers, by relation, must therefore be wrong. You must be wrong. Mr. Teasdale must be wrong. Anyone who doesn't believe there is tax leakage is obviously wrong, because we have counter information that says there is no tax leakage.
Would you like to comment a little bit about the types of assumptions that are being made on the other side? How can that be?
12:55 p.m.
Independent Consulting Analyst, As an Individual
The point I would make is that the income trust product was to the substantial benefit of the vendors and promoters of income trusts. Basically, they converted into income trusts businesses for which they were selling out of the market, taking the cash up front. In addition, the investment banking industry and the securities legal community that supports the income trust industry have taken out exorbitant fees, at the rate of 7% for every cash financing pass.
In addition, I would note that while those vendors were taking cash out of the businesses and the investment banks were taking $2.5 billion in fees on $35 billion of business income trust offerings, the performance has been pathetic. The facts speak for themselves.
In the $35 billion business offering market comprised of 286 offerings from the year 2001, one in three is down more than 20%, and the average decline is 45%. There are $10 billion of losses in one of three business income trusts. Two out of three of them are below water.
We have a situation in which products are sold to seniors on the basis of a deceptive cash yield. That is unsuitable because those seniors don't have a proper legal format for seeking restitution for damages in the courts. Meanwhile, the vendors are taking hundreds of millions of dollars off the table while the investment banks are taking out $2.5 billion in fees. They're fighting because this was 40% to 50% to 60% of the business that was done on Bay Street.
I used to work on Bay Street. I'm pro business, but I'm pro honest business. In transparent markets, you don't have vendors taking billions of dollars off the table to sell products to seniors.
1 p.m.
President and Chief Executive Officer, Canadian Association of Income Trust Investors
Transparent markets—
1 p.m.
Independent Consulting Analyst, As an Individual
We do not have a transparent market.
1 p.m.
Conservative
The Chair Conservative Brian Pallister
Mr. Fullard, I'd appreciate it if you would conduct yourself as a gentleman, starting now. Thank you, sir.
1 p.m.
President and Chief Executive Officer, Canadian Association of Income Trust Investors
Are you suggesting I haven't?
1 p.m.
Conservative
Dean Del Mastro Conservative Peterborough, ON
Secondly, Ms. Urquhart, Mr. Fullard referred to the know-your-client rule. I found that remarkable, since the income trusts were marketing themselves as having 15% returns in many cases—a reliable 15% return—but they weren't telling people that part of that return was their own money coming back to them, their own capital, in these distributions. It wasn't earnings; it wasn't earnings at all. They were paying people back with their own money or, even worse, borrowing money to pay them back money.
Would you like to expand on that a little bit?
1 p.m.
Independent Consulting Analyst, As an Individual
Yes. When you borrow money to pay an investment return above earnings, that's commonly referred to a Ponzi scheme. That's why Prudential took a $2 billion settlement for communicating in their marketing materials to seniors that these were extremely attractive cash distributions, without referral to the return on capital.
I disagree with Mr. Kesteven based on 25 years' of experience analyzing financial companies and supervising up to 60 analysts and associates responsible for determining the fair value of securities in all sectors and all types of securities in the Canadian economy. Return on capital is defined by accounting standards; it's not up to the management of an income trust to decide they can tell investors that capital is something they define. Accountants, accounting standards, define return on capital. That definition is a convention in the world.
The excess cash paid above the earnings is not a tax deferral; the tax deferral was the depreciation charged. That's not simply a tax matter. Depreciation is the amount of cash that needs to be set aside for the purpose, in the case of energy, of depleting reserves. In the case of other business investments, depreciation is for the purpose of replacing machinery, equipment, plant, or software. If you do not maintain those necessary sustaining capital assets in your business, your business is dying.
What has happened in—
1 p.m.
Conservative
The Chair Conservative Brian Pallister
Madam, I'm sorry, but I have to cut you off, as Mr. Del Mastro's time is done.
We'll continue with Madame Wasylycia-Leis now.
1 p.m.
NDP
Judy Wasylycia-Leis NDP Winnipeg North, MB
Thank you, Mr. Chairperson.
I just wanted to say that I didn't hear Dianne Urquhart condoning Enron. What I heard Dianne Urquhart saying was that we need to be vigilant at all times, and whenever there is the possibility of unethical practice or even criminal undertakings, we should be ready to crack down on it.
I want to ask Dianne, since I'm just getting up to date on this Prudential Securities issue, are you saying that what is common practice in Canada would be considered criminal in the more tightly regulated U.S. environment?
1 p.m.
Independent Consulting Analyst, As an Individual
I would say that the RCMP and provincial and municipal police forces have the tools within section 380 of the Criminal Code today to call the deceptive cash yields...as has been said by the chairman of the Canadian Accounting Standards Board and by Paul Hayward, OSC senior legal counsel, who said in a tax journal in 2002 that an investigation could be conducted and fraud could be found. I'm not making that allegation specifically, but the wording concerns the Canadian Accounting Standards Board and Paul Hayward, OSC senior legal counsel. The actual criminal charges in the United States suggest that the misconduct of the limited partnerships of the eighties and early nineties was similar to that which has occurred in the Canadian income trust market, and it could be considered criminal in Canada upon investigation.
1 p.m.
NDP
Judy Wasylycia-Leis NDP Winnipeg North, MB
Thank you.
I have one more question for Dianne Urquhart and then one for Mr. Teasdale.
Dianne, as you and others know, I have publicly stated that I support measures to shut down income trusts used as a way to avoid paying taxes, and I accept the statistics we've now had from a number of jurisdictions and a number of years, which are consistent with what you and others are saying.
My question to you, Dianne, is given the fact that the ways and means motion is likely to go through, based on the previous vote in Parliament.... And I've been working on this issue you've raised about the undervaluing—or overvaluing, sorry.
1:05 p.m.
President and Chief Executive Officer, Canadian Association of Income Trust Investors
It's one or the other.
1:05 p.m.
NDP
Judy Wasylycia-Leis NDP Winnipeg North, MB
No, it's clearly overvaluing.
It's a serious issue to change the Income Tax Act to deal with this. Is it still worth my while to do this, given the fact that, hopefully, we'll see over the grandparenting period the end of income trusts? Is it still important for consumers that we do it?
1:05 p.m.
Independent Consulting Analyst, As an Individual
Yes, there is still $200 billion of current income trusts in the market, and 288 of the trusts are, I believe, in non-bifurcated markets--full transparency. I don't want those who know that their income trusts are overvalued having the opportunity to sell them to unsophisticated players. I believe we should have immediate requirements; the sooner we can get this into the Income Tax Act the better. The sooner we get transparency on the return on capital and the distributions, then we can have a market that's honest and not one in which sophisticated players dump trusts onto those who do believe the return on capital is there for their household expenses. It's just not there, because there is a limit on access to the amount of cash that's on the balance sheets and on the financial markets paying it.
1:05 p.m.
NDP
Judy Wasylycia-Leis NDP Winnipeg North, MB
Thank you very much.
My question is to Mr. Teasdale. I'm a bit concerned about the lobbying that's being done to try to extend the grandparenting period. My sense is that it would just perpetuate unfairness. I'm wondering if you can tell us, in your opinion, what the advantage or disadvantage is of extending the grandparenting period beyond the four years now planned.
1:05 p.m.
Total Asset Management Research & Investment Rights Consultancy
I can't really see any advantage at all. I think income trusts need to convert back to corporate status as soon as possible. Essentially, a large number of income trusts rely on the ability to raise capital. If they can't raise capital or debt, then they have to reduce their distributions, since income trusts are primarily valued on their cash distributions, even if they're holding their share price.
Income trusts are going to have to start operating like companies and stop distributing all their cashflow, and retain their cashflow to fund capital expenditures and support a low level of distributions. They're effectively going to have to start acting like corporations. Some of the better-run income trusts have actually been operating pretty much like corporations since they converted. They need to convert back as soon as possible. I see the four-year period primarily as the time period to allow them to do that, not really to continue to operate as income trusts.
1:05 p.m.
Conservative
The Chair Conservative Brian Pallister
Thank you very much, Madam Wasylycia-Leis.
I'll just inject a couple of questions here, if I might. I've heard the number $35 billion thrown around quite a bit. I know, as do the people who use it, that they're trying to make the point that there's tremendous hardship out there among investors. So I'm interested in the facts in respect of this so-called $35 billion.
This $35 billion is predicated on the assumption that people bought income trusts on October 30 and sold them on October 31. Is that correct, Cameron?
1:05 p.m.
Royalty and Income Trust Analyst, BMO Capital Markets
It would be very close to that, yes, within a week after the announcement.
1:05 p.m.
Conservative
The Chair Conservative Brian Pallister
Okay.
I know that with 160-plus trusts we're not going to get into the details on each individual one. I'm interested in whether there is such a thing as a trust index we could refer to, to get a ballpark idea of how trusts have performed over the past period of time.
1:05 p.m.
Royalty and Income Trust Analyst, BMO Capital Markets
Absolutely. We were actually just out presenting to clients a couple of weeks ago, and we looked to the beginning of November. So that would be one month after the announcement. There have been many other factors that have played in since then. At that point, the market had settled down around 12.5%. It was down 12.5%, which is approximately $28 billion.
1:05 p.m.
Conservative
The Chair Conservative Brian Pallister
Thank you.
So it was $28 billion. They bought it the day before, and then by the middle of November....
1:05 p.m.
Royalty and Income Trust Analyst, BMO Capital Markets
By the beginning of November, yes.
1:05 p.m.
Conservative
The Chair Conservative Brian Pallister
Okay.
Today's National Post cites numbers since the middle of November, saying that since then, 134 of 162 trusts have gained an average of 9%. Are those your numbers, too?