Now that we’re getting towards to end of the CCAA process and the Representative Actions are getting under way, I’m re-posting an article I wrote for SolaGratia back on Sept 14, 2015. This article provides a useful summary of how a stodgy, low-risk loan-to-limited-clientele business morphed into a high-risk “bet the farm on a roll of the dice and the dice are loaded” affair that continued to lure in security-seeking investors even as it was swirling around the drain.
To address the question of “who’s responsible for this mess” and “how could this have happened”, one needs to make a brief foray into CEF’s history.
CEF was founded in the early 1900s with the “core principle” of helping church members help other church members construct church buildings in return for a modest return on their deposit. CEFs initial investment style was to make a number of smaller investments against properties that would retain their value and could be easily be sold to recover the fund’s money if things didn’t work out. This kept the fund’s risk at a low level, which means it was a secure, “don’t think about it” place for depositing your money.
When the CEF Board decided to develop the Prince of Peace retirement village, there were a number of challenges they had to overcome in order for the project to be successful. It would need specialized expertise to perform the up-front due diligence, then design, build, and operate at a profit in order to pay the principal and interest back to the fund’s depositors and make a profit. If the project’s building phase needed more money to cover contingencies, or ongoing expenses exceeded its income, then further injections of money would be required along with a potential change in management to bring the project to a profitable state. Finally, if enough depositors wanted their money back at some point in time, management would have to either re-finance the project by getting a loan from a regular bank, or sell the property outright in the hopes of recovering its accumulated investment – both of which would take a long time to complete with no guarantee of success or profit.
Contrast this with CEF’s previous activities and one can see that committing to the Prince of Peace project meant that CEF left it’s historical, low-risk portfolio of relatively small investments and exchanged it for a single real estate development project that would require committing a substantial portion of CEF deposits in a complex, “all-or-nothing” type of investment. Yet CEF continued to issue marketing material that stated “nobody had ever lost money in CEF.” While this statement was “literally true” as far as it went, it falsely implied that the CEF deposits enjoyed the same low level of risk after the start of the Prince of Peace development as the deposits had prior to the development’s start.
This “mislabelling of risk” is exactly the kind of behavior that resulted in the Financial Crisis of 2008 – ratings agencies labeled investments as “safe”, “AAA”, and “investment grade” – which meant that anyone who needed a safe place to put their money could include these investments in their portfolio. The reality was that these investments should’ve been labelled as high-risk junk that only experienced investors with deep pockets should even consider – with the consequences that millions of people and organizations – including pension funds – lost money they wouldn’t have lost if the investments had been properly labelled.
In CEF’s case, a change in risk level has huge implications for their depositors – particularly the elderly for whom security is an absolute priority before returns due to their ongoing need for access to their funds and the limited amount of time and opportunity they have to recover from any losses. If the Board failed to inform the fund depositors of the change in their risk profile, then the depositors were denied the opportunity to make an informed decision about participating in the Prince of Peace development. This, in turn, meant that the Board took advantage of the depositors’ trust and the reputation that prior CEF managers had earned over the decades in order to advance the Prince of Peace project.
Barring evidence to the contrary, the only conclusion one can arrive at is that the Board misled the CEF depositors by omitting the truth about what was being done with their money, that this action was either intentional or reckless, and that any accounting for responsibility must start with them.
Credit: Featured image from Group1 Security
Update 2017-12-07: Since this is a duplicate of my post on SolaGratia I recommend reading the comments on the SolaGratia version as they’re also informative.