Coming soon to an endless appeal courthouse near you: Castor Holdings Ltd. – Canadian Investor Horror Epic of the Century.
Expect prequels, sequels, reality spinoffs and legal jaw music unto eternity.
Do not expect, however, substantive change in laws governing the reliability of audited financial statements in Canada, even after the 12-year court saga, one of the longest trials in Canadian history.
However, there are some investor reasons to be cheerful in the wake of the April 14 Castor decision in Quebec Superior Court. For one: there’s hope under the law that auditors bear some responsibility to parties beyond their clients.
The courts have not always ruled thus.
For example, in a 1997 ruling involving Hercules Management, the Supreme Court of Canada, in effect, ruled that auditors bear no duty of care toward individual investors and that audited financial statements in annual reports are not produced to help shareholders make personal investment decisions.
Details of the Castor case would likely fill entire sections of law libraries. But here’s the back-of-napkin summary: Montreal-based Castor was a private real estate investment bank that raised, borrowed and loaned money for real estate properties across North America until it went bankrupt in 1992. The collapse left roughly $1.6 billion in debts and a financial mess that might never be untangled.
A group of investors and creditors subsequently launched legal action seeking roughly $1 billion from Coopers & Lybrand (C&L), Castor’s auditor.
The court dealt with professional responsibilities and whether, indeed, the accounting firm was negligent in issuing opinions for Castor.
To keep the case manageable, the case focused on audited financial statements from 1988, 1989 and 1990. For a host of reasons those statements were found to be “materially misstated and misleading.”
For example, conclusions in the judge’s 752-page decision pointed out that “readers of the audited financial statements of Castor … could not have known that Castor was tolerating the systematic failure of its borrowers to pay interest and fees in cash or about the degree to which capitalized interest and fees contributed to the falsely impressive growth in the loan portfolio, as represented in the audited financial statements.”
So much for the value of those statements in the marketplace and the integrity of audits in the minds of shareholders and prospective investors.
The defendant argued that all was in order according to generally accepted accounting principles and that if the court ruled otherwise “Castor was one great ‘theatre of misconception’ and the fraud was so pervasive that it prevented C&L from uncovering the true nature of the misstatements on the financial statements.”
Theatre aside, in the real world, as forensic accountant Al Rosen points out, “case after case in Canada shows that investor protection essentially does not exist here.”
He added that corporate governance in Canada as illustrated by the Castor case “was dreadful … because the problems extended for over 10 years.”
The good news is that the judge in Castor found that when it’s clear that the purpose of the financial statements is to solicit investment, auditors have responsibilities not to “sign off” on false financial statements.
The bad news is that even though Castor shows clear evidence of the need in Canada for changes to investor protection laws and, as Rosen recommends, the need to establish, among other things, a national prosecutor separate from a national securities regulator to pursue crooks in the investment sector, there’s no sign of that happening any time soon.