The madness of Crocus

It would be hard to imagine a more complete fiasco than the Crocus Investment Fund, the labour-sponsored venture-capital fund that burned through millions of dollars of private and public money before being placed in receivership last month.

As documented by the province’s auditor general, the fund failed to value its assets correctly and marketed its shares to investors without proper checks on their readiness to assume such risks. Management pursued a reckless and rudderless investment policy even as it was racking up personal expenses worthy of a Bourbon king, unchecked by a board that seemed incapable of exercising the most elementary oversight responsibilities.

For their part, government officials appear to have known that much was amiss but did little. Some point to an institutional conflict of interest -- the Industry ministry was both monitor and promoter of the fund -- others to a political one, given the NDP government’s obvious ties to the fund’s sponsors, the Manitoba Federation of Labour. Either way it bespeaks a spectacular breakdown in accountability.

The results: the fund, after losing, with the help of $61-million in writedowns, nearly half of its value, stopped trading last December. Two boards of directors have since resigned, an RCMP investigation is in the works, and a $100-million class-action suit is being readied on behalf of the fund’s 34,000 investors.

But the failure of the Crocus fund is not merely a matter of management extravagance or political complacency, nor can it be explained solely with reference to the mistakes or misdeeds of a few individuals. It was a fiasco in the making from the day it was born, and would have been even had it overcome the various incentives to misallocation of funds that were implicit in its very conception. While it was scarcely surprising that it should have squandered so many millions, it would have been a policy failure even if it had never lost a dime.

The real question that people should be asking in its messy aftermath is not, who took our money, but what could possibly have moved the government of Manitoba to make such a gift to organized labour in the first place: a fund in which half the board were appointed by the MFL, but as much as 40% the money was put up by government, via the matching 20% federal and provincial tax credits (later reduced to 15% apiece) for investors in labour-sponsored venture capital funds. The real question, in other words, is not why this particular labour-sponsored fund was so mismanaged, but why any of these funds exist.

But who’s going to ask too many questions, when the tax-assisted allure of these funds is so great? Consider: an investor who put $1,000 into the Crocus fund, would, on the original terms, have got back $400 in tax credits, for a net investment of $600. Granted, he was required to hold onto the investment for seven years. Big deal: even if the fund earns nothing at all on its investments, he clears a 66% return on his.

Mind you, that’s before management fees. But investors have proved remarkably willing to share some of their bounty with the managers of these funds. Notwithstanding performance numbers that are as often as not mediocre at best, labour-sponsored funds typically charge fees in the 4-to-5% range, more than twice the industry’s already-inflated average. And why not? It’s not the investor’s money, after all. It’s the taxpayers’. So long as the fund managers don’t completely blow their brains out, the investor still comes out ahead.

Ah, but there’s the rub. The first line of defence in any financial market is not the regulators, but vigilant investors, cracking the whip over managers to keep expenses down and returns up. But when it is not their own money but the public’s that is at stake, investor vigilance is the less, making it all too likely that managers will run amok. Those aggrieved Crocus investors who are now suing the fund are entitled to a degree of sympathy, but only that: It seemed too good to be true, and it was.

What on earth is the public policy rationale for handing investors and fund managers millions of dollars in tax credits to divvy up between them, just because organized labour lends its imprimatur to the enterprise? The Crocus fund was variously justified in the name of encouraging employee ownership, or keeping investment dollars in Manitoba, or helping small startup firms, among other objectives. The fund used to boast of its “multiple bottom lines,” a red flag if ever there was one.

Every investment, whatever its objective, has costs and benefits. If the benefits do not exceed the costs, it is usually a good sign that the investment should not be made. So it is almost always a good idea to ensure that the people who reap the benefit of any investment also bear the costs, that the two should stand in constant comparison to one another. Separate the two, allowing one group of people to invest funds that another group must provide, and you are asking for trouble.

There are benefits to investing in small Manitoba startups, but there are also risks -- costs, in other words -- and investors are entirely capable of assessing these for themselves, without the aid of tax credits, federal or provincial. Correction: They will only assess them correctly when they do so for themselves.