Income-trust crackdown: The inside story
When the telephone rang, Flaherty knew he had to act
SINCLAIR STEWART AND ANDREW WILLIS
Globe and Mail
November 2, 2006 at 1:00 AM EDT
Three weeks ago, almost to the day, Michael Sabia dropped an early-morning bombshell on Canadian investors: His company, BCE Inc., was planning to follow the lead of archrival Telus Corp. and transform its storied telephone operations into a $27-billion income trust.
It was a surprise to almost everybody. Everybody, that is, except Jim Flaherty. The night before, Mr. Sabia had tracked down the federal Finance Minister in Vancouver, where he was giving a speech on money laundering, and politely informed him of his intentions.
In most circumstances, this would have been regarded as a courtesy call. But for the burgeoning income-trust sector, it was the coup de grâce.
For several months, Mr. Flaherty and his team had been fretting about the rampaging advance of trusts. They had caught wind of rumours that Suncor Energy Inc. and EnCana Corp. were each modelling trust conversions that could be valued at close to $40-billion, opening the door to mass conversions in the oil patch.
High-profile directors and CEOs, meanwhile, had approached Mr. Flaherty personally to express their concerns: Many felt they were being pressed into trusts because of their duty to maximize shareholder value, despite their misgivings about the structure. Paul Desmarais Jr., the well-connected chairman of Power Corp. of Canada, even railed against trusts in a conversation with Prime Minister Stephen Harper during a trip to Mexico, and told him he should act quickly to stop the raft of conversions, according to sources.
Amid this escalating tension, Mr. Sabia's phone call became a flashpoint, prompting the federal government to accelerate its crackdown on the sector. Mr. Flaherty was convinced the twin conversions of icons such as Telus and BCE would incite other corporate titans to follow in their wake.
Faced with this prospect, a select group of a dozen people in the Department of Finance and the Prime Minister's Office, sworn to secrecy, redoubled their efforts to stem the rising tide. By Tuesday, they had come up with plans for a new tax on trust distributions, among other measures, and Mr. Flaherty unveiled them in a surprise Halloween announcement.
While his officials worked frantically behind the scenes, Mr. Flaherty remained characteristically reserved in public.
“We do remain concerned about the issue and continue to monitor the situation,” he told reporters after the BCE announcement, the same answer he had provided a month earlier, when Telus informed the markets it would convert.
Privately, however, his mind was all but made up. He knew that virtually every major company in Canada, from the banks to the insurers to the big oil and gas plays, had begun modelling the trust structure. Some had even informally approached Ottawa about the possibilities for their business, further spooking the Conservative government.
“It was clear from the BCE people that they felt compelled to follow Telus, and that taught us a lesson — quite clearly and dramatically — that if other sectors imitate that sector, we'll see a domino effect,” Mr. Flaherty told The Globe and Mail's editorial board Wednesday.
He declined to identify which companies he expected to embark on a trust conversion, although he acknowledged he had heard of “one or two” in the league of BCE and Telus, and that he had concerns in other sectors such as financial services and energy.
Only last winter, in their campaign platform, the Tories promised to preserve the trust market and not impose any new taxes. Yet as the spate of conversions hurtled toward the $70-billion mark, that resolve began to fade.
The problem, however, was more than merely reversing a campaign pledge: It was avoiding the pitfalls of the former Liberal government, whose handling of the file was besieged by accusations of leaks that are now the subject of an RCMP investigation.
Mr. Flaherty kept the circle of insiders very small in an effort to maintain absolute secrecy, yet there were some hints of what was coming.
A week after BCE announced its planned conversion, the Prime Minister was feted in the oak-panelled dining room of the Toronto Club by deal-maker Tony Fell of RBC Dominion Securities Inc.
As three dozen CEOs sipped their after-dinner coffee, Mr. Harper gave a brief speech on foreign policy. Then Ira Gluskin, a money manager who holds $802-million of trusts, stood up and pointedly asked what the government planned to do with the sector, considering BCE's decision.
“Harper hummed and hawed and basically avoided answering,” said one CEO in the room. “I took it as a sign that this was something the government was worried about.”
The market never caught on. Indeed, Mr. Flaherty's decision was made several weeks ago, with the intervening time spent hammering out last-minute details.
Ottawa felt it could not risk another major conversion and decided to announce its new rules Tuesday — an easy night, as it turns out, to have a caucus meeting and prepare MPs for a possible voter backlash.
In the final hour before markets closed, a group of bureaucrats were glued to their computer screens, scanning stocks for any telltale signs that word had leaked out. They were prepared to take extraordinary steps and pull their announcement if trust units staged suspicious dives, but nothing happened; the markets never suspected a thing, something that was clearly evident when Mr. Flaherty announced the trust crackdown on live television about 5:30 p.m.
For at least an hour, as the information trickled out, confusion reigned. In Toronto, most bankers and CEOs had already left the office and were on their way home to take their children trick-or-treating.
At Telus headquarters in Vancouver, where it was still midafternoon, the reaction was disbelief.
In Montreal, the mood was decidedly more upbeat. Sources said BCE's Mr. Sabia was a reluctant convert to the trust model, and “there was dancing in hallways at Bell” after Ottawa's announcement.
Reaction among foreign investors, who have enjoyed feasting on the uniquely Canadian income-trust offerings, was decidedly negative. Wednesday morning, some U.S. clients of one Canadian trader were describing Mr. Flaherty as the “Chavez of Canada” in reference to the Venezuelan President with a penchant for nationalizing oil plays.
Mr. Flaherty knew it wouldn't be a popular decision in some quarters, but he was hardly exercised. After his announcement, he went straight into a meeting with the Tory caucus and, along with Mr. Harper, informed the group of the new rules.
There was some concern about irate investors, but the reaction was mostly positive, according to people at the meeting.
Afterward, Mr. Flaherty phoned provincial finance ministers in Quebec, Alberta and Ontario to discuss his rationale. The first two were clearly on board, while Ontario was more lukewarm.
“You have to either leave it alone or fix it,” Mr. Flaherty shrugged Wednesday. “We were going to see the two largest telecommunications companies in the country not pay corporate taxes. That's a clear and present danger to fairness in the Canadian tax system. I thought we had to act.”
With a report from Eric Reguly
