It was supposed to be a quiet holiday week in the midst of a Christmas federal election campaign. That all changed on Dec. 28, 2005, when the RCMP confirmed it was launching a criminal investigation into the possible leak of a key tax policy announcement relating to income trusts.
That policy announcement was officially made by then-finance minister Ralph Goodale around dinnertime on Nov. 23. But it wasn't long before there were allegations that some Bay Street players found out the details early and spent the hours before the announcement making money by trading on information that most investors didn't have.
What are income trusts?
Companies that set themselves up as income trusts do not pay corporate taxes, and so are able to pass along their income directly to their shareholders. This allows them to pay steady distributions that are typically much higher than dividends paid by corporations. That ability to provide high yields amid a low-interest rate environment has made them very attractive to investors. Just about any business with a strong and steady cash flow is a trust candidate – oil and gas companies, real estate partnerships, newspapers, even mattress and pizza makers have made the switch. There are now more than 200 income trusts listed on the Toronto Stock Exchange and more are on the way. They trade just like regular stocks.
Why did Ralph Goodale decide to wade into the income trust issue in the first place?
The Department of Finance calculated that the federal treasury lost $300 million in tax revenue in 2004 because so many companies had converted to income trusts, and their growing popularity meant more "tax leakage" was to come. In September 2005, Goodale announced his department would carry out a four-month review of the income trust field. Word of that review quickly cast a cloud over the whole trust sector. Would Goodale start taxing trusts? Would future conversions be blocked? Income trusts lost billions in total market value.
What did Goodale announce on Nov. 23?
Facing an imminent election call and with the investment community and seniors groups demanding a quick resolution to the market uncertainty, Goodale ended the review period early. On Nov. 23, he said he would not impose a tax on income trusts, as some had feared. And to try to "level the playing field" between corporations and trusts, he lowered the tax on dividends paid by corporations.
What suggests that an advance leak of Goodale's announcement may have taken place?
Goodale did not make his announcement public until after 5 p.m. on Nov. 23, well after the stock markets had closed. But earlier in the day, especially during the last two hours of the trading day, there were noticeable spikes in the trading volumes and share prices of many income trusts and dividend-paying stocks – sometimes triple their normal volumes. These would be the kind of securities that would be expected to benefit from the type of announcement Goodale made later that day. Of the 10 most actively traded stocks on Nov. 23, eight were income trusts, trust candidates or dividend-paying stocks. All eight went up between five and seven per cent that day.
Is there general agreement that a leak did, in fact, take place?
Opposition politicians and market watchers looked at the trading patterns and immediately suspected that some people knew something in advance. "The volumes and prices are just screaming at you to say, 'Just a minute, someone knew more than the ordinary little bit of stuff,' " was how forensic accountant Al Rosen put it. How big was the scream? One example: Shares of BCE, which pays a rich dividend, had their biggest advance in four years on Nov. 23.
Christopher Thomas, whose company Measured Markets provides early warnings of unusual stock movements, agreed that the signals were flashing that day. "Statistically, these stocks were behaving as though something unusual was going on which the world at large was probably not aware of."
But even the opposition acknowledges there's no proof of a leak – at least, not yet. Indeed, on the same day it confirmed the launch a criminal investigation, the RCMP said "at this time, there is no evidence of wrongdoing or illegal activity on the part of anyone associated to this investigation, including the Minister of Finance Ralph Goodale."
But if there was no leak, then what could explain the sudden trading surge?
There was a widespread feeling that Goodale would not let the trust review drag on into an election campaign. Goodale himself appeared to float a trial balloon on Nov. 22, the day before he made his announcement. He told reporters he wanted to give the trusts issue "the greatest degree of certainty that's possible" before the imminent defeat of the government. The Bloomberg wire service posted a story that day predicting Goodale would give an interim update "as early as this week" on income trusts. The following morning, on Nov. 23, the Globe and Mail reported that the early end of the review would be "a sudden change of timing that experts believe could pave the way for a politically popular dividend tax cut." Hours later, Goodale did exactly that.
Veteran market watcher Ross Healy of Strategic Analysis Corp. thinks the RCMP won't find anything criminal because "there's nothing to find." He thinks the probe will be little more than a "wild goose chase." Tom Caldwell, chairman of Caldwell Securities, told Canadian Press that he thinks traders just bet that an early end of the review would be good news for certain sectors. "You knew it was going to be positive," he said. But he acknowledged that leaks, "conscious or unconscious," were a possibility.
Don Drummond, the TD Bank Financial Group's chief economist and a former senior Department of Finance official, thinks most of the trading can be explained by educated speculation. "Here's a minister, within 72 hours of his government likely getting defeated, making an announcement. Is he going to outrage pension funds and people saving through their RRSPs? Not likely. So it was a pretty safe bet." But Drummond acknowledges that he's heard the talk on Bay Street that something more sinister may also have been at work on that day in November.
Who is doing the investigation?
The RCMP is using a special Integrated Market Enforcement Team (IMET) to look into the case. IMET teams are made up of specially trained RCMP officers and securities regulators. They can also include representatives of other law enforcement agencies, forensic accountants and Department of Justice lawyers. Six IMET teams are operational across the country, three of them in Toronto.
What happens next?
The IMET team has a huge paper trail to sift through, which they will do using sophisticated software programs that flag unusual trading patterns. The team will likely be looking at thousands of trades in dozens of income trusts and dozens more dividend-paying stocks. They will be looking at the derivatives markets, where stock options are traded. They will be talking to people inside the government and in the investment community. They can get access to e-mails and phone records. In short, it's likely to be months before the RCMP announces whether there's evidence to lay charges of insider trading or tipping.
Sept. 9, 2005:
Ralph Goodale announces that the Finance Department would conduct a review of the income trust sector. Among other things, the review is to address the implications of income trusts on federal tax revenues, the economy, and corporate decision-making. The deadline for public input is set at Dec. 31, 2005.
Sept. 19, 2005:
The federal government alarms investors with the announcement that it will give no advance tax rulings to companies that want to convert to an income trust while the review process is underway. The income trust index loses $9 billion in market value — a 5.9% drop — in the following four trading days.
Goodale promises a quick review of income trusts once the consultation period ends on Dec. 31.
Nov. 18, 2005:
Goodale says he hopes to release the government's new policy on income trusts in January, even if it comes during an election campaign.
Nov. 22, 2005:
Goodale tells reporters he may provide some direction on the income trust issue before the review period ends.
Nov. 23, 2005:
There are big jumps in trading activity in a number of income trusts and dividend-paying stocks, and prices move higher. By the close of trading at 4 p.m., rumours are widely circulating that some kind of trust announcement is imminent. Shortly after 5 p.m., the government releases the details: no new taxes on income trusts and more favourable tax treatment for stock dividends. Goodale tells a subsequent news conference the income trust review has ended.
Nov. 24, 2005:
With the new policy officially out, investors jump into trusts and dividend-paying blue chip stocks. The TSX gains 162 points and closes at a five-year high. The income trust sector gains 4.3 per cent that day; BCE climbs 6.5 per cent.
Nov. 25, 2005:
Some market watchers, citing the trading patterns on Nov. 23, publicly wonder if the details of the income trust announcement leaked out. Goodale denies any information slipped out early. "There was no leak," he says.
Nov. 27, 2005:
The Conservative Party and the NDP call for an investigation into the possibility that information about the income trust announcement may have leaked.
Nov. 28, 2005:
The Liberal government is defeated in a motion of no-confidence. Prime Minister Paul Martin announces the next day that an election will be held on Jan. 23, 2006.
Dec. 9, 2005:
Conservative Leader Stephen Harper calls on Goodale to step aside because of allegations that details of his income trust announcement may have leaked early.
Dec. 28, 2005
The RCMP confirms a release from the NDP that it will launch a criminal investigation into "a possible breach of security or illegal transfer of information" before Goodale's news conference on Nov. 23. The Conservatives, the NDP and the Bloc Québécois all call for Goodale to step aside as finance minister until the probe is finished. Goodale refuses. "I am absolutely confident about my conduct in this matter and I do not see any basis upon which to resign," he says.
Dec. 29, 2005:
Prime Minister Paul Martin says he stands by his finance minister as a man of the "greatest integrity." A spokesman for Goodale also reveals that the Prime Minister's Office was told the details of the income trust policy announcement shortly before it was made public.
Mar. 7, 2006:
Former public works minister Scott Brison responds to an article published in the Globe and Mail about the RCMP investigation. The article reveals that on Nov. 22, 2005, one day before Ralph Goodale revealed the new policy on income trust and dividends, Brison sent an e-mail to an acquaintance at the Canadian Imperial Bank of Commerce. In that e-mail Brison wrote, "I think you will be happier very soon ... this week probably." Brison said the e-mail contained no specifics about what Goodale would announce because Brison didn't know the details. He said the e-mail was a general response to the bank employee's complaints about the state of the stock market.
Brison says he discussed the e-mail with the RCMP on Jan. 18, 2006. He denies that he leaked anything.