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					                                          Chapter 8

          The Pathologies of Regulatory Inaction: Institutional Dimensions

               What looks to the analyst like nonrational behavior may be quite sensible
               when situational constraints...are fully appreciated. ...That such behavior is
               rational or instrumental is more readily seen, moreover, if we note that it
               aims not only at economic goals but also at sociability, approval, status, and

                      Granovetter (l985: 506)

               ...institutional theorists remind us that sunk costs can be cognitive rather
               than economic. Their repudiation of rational actor models is not based on
               the observation that behaviour can be irrational so much as unreflective.
               From that perspective, much of the regulator's behavior becomes
               understandable as almost "natural" responses to taken-for-granted
               assumptions and premises. It isn't that power, self-interests, and economic
               considerations are unimportant, but they only tell part of the story...

                      (Oliver, l993: personal communication; communicator's emphasis)

               The concept of choice as a focus for interpreting and guiding human
               behavior has rarely had an easy time in the realm of ideas.

                      March (l976: 69)


         In Chapter 2, the basic theoretical background of this research was discussed,
particularly with respect to institutional dimensions of such research. Thereafter, the
method used in this research was described in Chapter 3, while the case studies of the
financial institutions under consideration were presented in Chapters 4 to 6. Chapter 7
serves as a broad introduction to the themes to be discussed in this chapter and
Chapters 9 and 10. In this chapter, the themes believed to primarily lend themselves to
institutional explanations will be discussed.

       From the review of institutional theory, the overview of regulation theories and
existing research with respect to financial institution failures in Chapter 2, several points of
convergence emerge which are relevant to the current chapter. From Chapter 2, we may
see that institutional theories and evidence provide persuasive support for explanations
as to inertial behaviours and sense-making activities which appear to be largely resistant
to changed circumstances. In addition, institutional theories complement regulation
theories and evidence by providing a caution as to expectations from regulation theories

as to the reasonableness of the detection of deviant behaviours by regulators.
Regulation theories and evidence are further discussed in Chapters 9 and 10. The
institutional dimensions of the regulatory environment are most frequently not referenced
explicitly in regulation literature. It is submitted that a major contribution of institutional
theories and evidence is to temper expectations of regulatory behaviours, which appear
to be comparatively elevated in the regulation literature.

         In Chapter 2, it was also noted that the existing literature with respect to financial
institution failures provides theory and evidence with respect to image-maintenance
behaviours, distorted communication processes and attributions of fault among financial
institution regulatory participants--the regulators, financial institution management and the
external auditors. The three case studies herein would appear to serve as further
evidence in support of the behaviours noted in the extant "financial institution failure"
literature. As complemented by institutional theories, the behaviours identified in the
"financial institution failure" literature may be viewed as being more predictable and less
blameworthy than otherwise perceived. The cases under consideration will now be
examined with reference to emerging themes which are believed to be most
complemented by institutional explanations.

Institutional Themes

              It is not hard to imagine a society in which requests for information, and
              insistence on reports and analyses, would be signs of indecisiveness or
              lack of faith. Even within the rational traditions of enlightenment, decision-
              theory perspectives on intelligence have competitors.

                     Feldman and March (l981: 182)

              Any successful institutionalization, in essence, can create its own internal
              contradictions as unintended consequences.

                     Leblibici, Salancik, Copay and King (l991: 337)

       As discussed in Chapter 3, the research approach adopted is that of emerging
thematic identification. With this objective, the principal commonalities and contrasts in
the cases, from the perspective of regulatory delay, have been examined. From these
commonalities and contrasts, various themes have been identified and categorized in
Chapter 7. Those themes viewed as lending themselves predominantly to institutional
explanations are as follows:

       The Public and Private Face of Regulation and Domino Effects

       Reputation Effects: Perpetual Licenses, Closure Versus Merger (The Meaning of
       Failure) and Escalating Commitment to Closure

       Institutional Dimension of Accounting Representations: Strategies to Minimize the
       Reporting of Losses

        These themes are considered to most benefit from institutional explanations in that
such themes are primarily associated with (i) image-maintenance, (ii) inertial behaviours
and (iii) sense-making independent of evidential quality.

(a)    The Public and Private Face of Regulation and Domino Effects

              Mackenzie's priority is to develop a larger network of contacts in the
              (financial institution) industry: "While one can glean some knowledge of
              financial institutions from the forms they file, you need meetings and street
              gossip to identify flashpoints."

                     Interview with Michael Mackenzie, Federal Superintendent of
                     Financial Institutions, shortly before he assumed office. As reported
                     by Horvitch (l987a).

              ...moral suasion has some value in this whole system. That is the way the
              system has been for a long, long time. ...I never stopped to think about the
              precision of the language in that phrase, moral suasion. But if you would
              prefer the wink and the nod approach, then I think we still hope that works...

                     Testimony of Assistant Inspector General Macpherson at the Estey
                     Inquiry, as quoted by Estey (l986: 155).

        The "public and private face of regulation" refers to the fact that most of the
regulation of financial institutions takes place outside of the public eye. Bureaucracies
are recognized as being necessarily secretive (Merton, l968: 251). Unlike environmental
impact hearings or public hearings with respect to land use and development, the federal
and provincial regulators of financial institutions are not inclined to make the public privy
to the facts upon which various determinations are made. In addition, in the three cases
under consideration, it would appear that in most cases, regulators followed a regulatory
policies which relied on the integrity of financial institution management. These
behaviours may be examined from institutional perspectives--specifically, from the
perspective of regulatory reluctance to believe that decisive actions were necessary to
control aberrant behaviours of financial institution managements. The behaviours may
also be examined from the perspective of discretionary enforcement strategies, discussed
in Chapter 10.

        The exercise of regulatory discretion is generally outside of the public view (Davis,
l969 [l979: 167]). As a recent example of the "private face" of regulation, the confidential
nature of the relationship between a financial institution regulator and regulated financial

institution was cited in support of the refusal of the federal Superintendent of Financial
Institutions to obey a court order to appear at an inquiry into the collapse of Standard
Trust. This refusal was supported by the president of the Canadian Bankers' Association,
who argued that

              ...(t)he whole regulatory system depends on institutions feeling they can
              freely hand over confidential, often personal, information to the

                     As reported by Yakabuski (l991f)

              I can get the goods, but only because I've been on the street for 20 years. I
              have access to people, other than PR at the company.

                     Comments of an investment analyst as to why financial difficulties of
                     Central Capital Corporation were anticipated and profited from by
                     certain investors, as reported by D. Best (l991).

         To the extent that discretionary regulatory actions are outside of the public view,
the reasons for and the circumstances of regulatory inaction are generally not disclosed
to or otherwise observed by the public. To illustrate the passive role of financial institution
regulators, which passivity may be considered to be associated with a reluctance to
suspect anything other than bona fide actions on the part of financial institution
management, we may observe the processes by which negative information about the
financial institutions came to the attention of regulators. With respect to the financial
institutions under consideration, increased regulatory interest in the financial institutions
appeared not to be motivated by the regulators themselves, but rather from rumours
which came to the attention of regulators--the "word on The Street". For example, in late
l982, representatives of the Office of the Inspector General began to demonstrate
increased interest in the affairs of the Canadian Commercial Bank. Rumours had begun
to circulate in the financial community which questioned the financial health of the bank,
including reports of significant withdrawals from the bank. A widely circulated "secret"
memorandum within the Bank of Canada, dated October 6, contained hearsay comments
from a Bank of Canada "contacts" questioning the health of the Canadian Commercial
Bank and alleging that $500,000 had been withdrawn by one of the institutional
depositors of the Canadian Commercial Bank. This memorandum was circulated to the
Governor of the Bank of Canada, with a copy apparently made available to the Office of
the Inspector General (Estey, l986: 422).

        While important information may be obtained by the regulator having an ear
"close to the ground", the regulator will often not act on such information in the absence
of public complaint or a request from the regulated. For example, in l984, Principal Group
regulators noted a schedule of interest rates in an Edmonton newspaper which included

"Principal Group" among a list of trust companies. Upon telephoning Principal Trust,
purporting to be interested investors, a regulator was directed over the telephone by a
Principal Group salesperson to investments in the investment contract companies,
accompanied by various misrepresentations. Regulators decided to expand their
investigation of Principal Group representations, only to have a directive to do so
immediately countermanded by the Deputy Minister, partly on the basis that the complaint
concerning the representations had not come from the public (Code, l989: 398-399).

              Q: investigating improper sales practices, you might bring down the
                     whole company? ...So what consideration was given to the future
                     purchasers in that decision?

              A:     Well, I don't think I gave any consideration in making decisions to
                     future purchasers. I was more concerned about the ongoing
                     existence of the company.

                     Testimony of Martin, Deputy Minister of Alberta Consumer and
                     Corporate Affairs, with respect to cancelling an investigation into the
                     sales practices of the Principal Group, as reported by Code (l989:

       Regulatory actions demonstrating institution specific concerns generally relate to
the degree of disclosure of regulatory involvement. It is apparent that much of the
regulatory activity leading to a decision to close or merge a financial institution takes place
out of the public eye. At the same time, it is apparent that, when called upon to make a
public declaration, the declarations made by regulators with respect to the financial health
of an institution have been generally positive or neutral. A public attitude of neutrality on
the part of a regulator appears to generally be viewed as necessary to avoid regulatory
precipitation of a financial institution collapse.

              Bureaucracy is administration which almost completely avoids public
              discussion of its techniques, though there may occur public discussion of its

                     Merton (l968: 251)

        Public assurances by a regulator of the financial health of an institution,
contradicting information which a regulator possesses, raises the question of the extent to
which public attitudes towards regulation becomes affected once the institution fails.
Public assurances were provided by regulators as to the financial health of the Canadian
Commercial Bank and of the Northland Bank. Both to the public and to his political
superiors, the Inspector General of Banks expressed optimistic sentiments,
notwithstanding knowledge of the financial difficulties of these institutions (Estey, l986:
502). The Governor General of the Bank of Canada, Gerald Bouey, expressed similar
sentiments to the public, as did the Minister of State for Finance (Estey, l986: 499).

Governor Bouey later argued that all depositors of the failed institutions should be
compensated, in part due to the public assurances that had been provided (Estey, l986:
529-530). When the public receives assurances by regulators that are not in accordance
with subsequent regulatory action, a question arises as to the extent to which there is an
erosion of public confidence in subsequent regulatory actions. The view of the regulator
would appear to be that public knowledge of the involvement of a regulator with a
financial institution is prejudicial to the financial future of the institution.

              Had we told the world there would have been a run (on deposits). That's
              fine for the guy who gets there first. But the guy who gets there late in the
              day loses. I for one don't think that's very fair.

                     Michael Mackenzie, Federal Superintendent of Financial Institutions,
                     with respect to regulatory actions associated with financial institution
                     closures, as reported by Yakabuski (l991e).

              The belief is that you cannot speak ill of a financial institution until the day
              you are ready to close it. But if you're never going to say anything but the
              good things, how is the public going to be protected?

                     Garth MacGirr, trustee in bankruptcy of Standard Trustco Ltd., as
                     quoted by Yakabuski (l991c).

         This attitude, which borders on one of "all must suffer the same opportunity for
loss" is underscored by regulatory actions immediately prior to the closure of the Principal
Group. While the Principal Group investment contract companies were prohibited by
regulators from soliciting new funds from the public, management was permitted to
encourage investors of investment contracts coming due to reinvest their funds in what
regulators were aware were institutions in perilous financial difficulties. Regulatory
justification involved concerns as to whether it was proper to "prefer" investors whose
contracts were maturing over those who were not (Code, l989: 388). Similarly, the
Inspector General of Banks permitted the Canadian Commercial Bank to accept deposits
over $60,000 until the time of its closure, on the basis that the bank should be open or
closed. At the same time, Minister of State (Finance) McDougall would not release to
anyone a particularly negative report on the Canadian Commercial Bank, based on its
damaging contents. Frequent regulatory monitoring and supplementary audits were part
of the regulatory processes to which the Canadian Commercial Bank and the Northland
Bank were subject, though the extent of such monitoring was not public knowledge until
six months prior to the failures. With respect to the Principal Group, the involvement of
regulators since the early l970s was largely not public knowledge.

              Though costly to taxpayers, procrastination is attractive to Federal
              officials.... ...the worsening problems that officials inherit as deferrals from
              the past seem to saddle them unfairly with popular blame for the unpleasant

              consequences of decisions taken in predecessor regimes. ...officials can
              reap short-term benefits from not settling things.

                     Kane (l989: 20)

              Should circumstances excuse a regulator from responsibility for the
              development of the causes of bank failure, there still remains the question
              of responsibility for failing to intervene and terminate the bank's operation
              as soon as such condition could or should have been detected. The
              courage to fight off oncoming insolvency is commendable but surely not in
              those instances where to do so is simply to prolong the existence of the
              bank to the serious detriment of those such as investors and creditors who
              deal with it.

                     Estey (l986: 162)

         There would appear to be a domino effect to regulatory action. Such a domino
effect is illustrated by the cascading regulatory processes associated with the closures of
all three financial institutions, based on the initial decisiveness of one agency. There
would appear to be a chain of events leading to the closures, a chain which commenced
with the unprecedented seizures of Ontario-based financial institutions in the early l980s.
In early l983, at its annual meeting, it was announced that the president of the Canadian
Commercial Bank, Howard Eaton, had resigned. The public was advised that the bank
president's resignation had been prompted by his business dealings with one Leonard
Rosenberg, who had recently become notorious by virtue of his association with three
trust companies which had been seized in early January by the government of Ontario. In
addition, Rosenberg, through related corporations, had accumulated but not been
transferred 30% of the outstanding shares of the Canadian Commercial Bank, in
contravention of bank ownership restrictions. Management of the Northland Bank took
the position that many of the Northland Bank's problems were due to the association in
the public's mind of the Northland Bank and the Canadian Commercial Bank. This
position has recently been shown to have empirical support, in that after the
announcement of the support program for the Canadian Commercial Bank, there was a
"flight to quality" (or at least to the perceived quality) of the "big six" Canadian banks on
the part of the investing public (B.F. Smith and White, l990). From l983, and particularly
from l985 onwards, both banks encountered difficulties raising funds from the public,
leading to the announcement in March, l985 of a support program for the Canadian
Commercial Bank. At the time of the September, l985 collapse of the Canadian
Commercial Bank and the attempted reorganization of the Northland Bank, other
Canadian banks were also in financial difficulty. The Mercantile Bank of Canada, the
Continental Bank and the Bank of British Columbia become publicly identified as
recipients of Bank of Canada liquidity support. As has been discussed, all of these
banks were shortly thereafter the subject of mergers.

              Appointed and elected officials fear being forced from office for having been
              prematurely judged to have adopted poor policies. This fear predisposes
              them to go slow and to put undue weight on the initial effects of changes in
              public policies.

                     Kane (l989: 20)

       From the foregoing, a question that arises is whether, without the unprecedented
seizure of the three Rosenberg-controlled trust companies by the Ontario government,
federal and provincial regulatory authorities would have been as willing to close three
major financial institutions in l985 and l987. Given a precedent of outright government
seizure of a financial institution, regulatory closure would appear to become more
acceptable. A parallel question is why regulatory authorities did not adopt a consistent
pattern with respect to financial institution difficulties--choosing in the three cases under
consideration to close the institutions, while in the vast majority of other cases choosing to
provide support to effect financial institution mergers.

              Willingness to impose control declines as visible responsibility for the
              results increases.

                     The twenty-third "Law of Organizational Stupidity", as codified by
                     Dixon (l992)

              There was not a lack of awareness or information, but an apparent lack of a
              will to act.

                     Estey, (l986: 164), with reference to the conduct of the Office of the
                     Inspector General of Banks.

              The Estey Report clearly shows most of the shortcomings in a tripartite
              system (of banking regulation) stem from a basic lack of resolve to act,
              especially when taking action would inevitably cause upheavals and maybe
              even temporary, but necessary, crises.

                     Patterson (l987: 954)

       The public profile of most regulatory agencies is comparatively low, other than in
times of regulatory crisis. It is at the time of regulatory crisis that the actions of the
regulator leading up to the crisis come under increasing public scrutiny. At the same
time, the regulated is more affected by the routine operations of a regulatory agency,
rather than by conduct occurring during times of crisis; the latter are by definition
occasional occurrences (Wilson, l980a: xi). To the extent that regulators appreciate the
consequences of public scrutiny, a "disaster plan" attitude, relative to anticipated public
impressions, would appear to permeate ongoing regulatory action. From an institutional
perspective, this may be viewed as being associated with regulatory efforts to maintain an

appearance of procedural rationality when perceived to be subject to substantive
challenges. In addition, the integrity of the regulatory process may be impaired by the
secondment phenomenon or the regulator viewing the position as a waystation to a much
higher-paying position in private practice or industry. In such circumstances, the regulator
is viewed as having an incentive to hide adverse information concerning regulatory
performance (Kane, l989: 102), which will in turn be a function of the relative dominance
of careerist, political or professional orientations of the regulator (Wilson, l980b: 374). For
example, all of the regulatory parties associated with the failure of the Canadian
Commercial Bank disclosed that they had no knowledge of the immediate financial crisis
of the bank, prior to its disclosure by management at a meeting with regulators in March
of l985. This appeared to contradict earlier documentation and actions by regulators
(Estey, l986: 473).

              Risk aversion is specialization by anticipation.

                     Wildavsky (l985: 214)

              (The attempted rescue of the Canadian Commercial Bank) was a test of the
              regulatory system's ability to cope with crisis. In retrospect, it can be said
              that nobody asked the hard questions whose (sic) answers would have
              shown the CCB's true state of affairs. Given the crisis atmosphere, this
              may have been too difficult. As well, the lack of a precedent meant that no
              one had any real insights on how to proceed.

                     Patterson (l987: 943)

              The paralyzing structures and virtually irresistible mechanisms of
              routine...seem closely associated with the fears, hesitations, and conduct of
              all the participants in the matters of power and of relations of dependence.

                     Crozier (l964: 145), discussing "power as the new central problem of
                     the theory of organization".

       Improved regulatory behaviour will be the function of past crises and the extent to
which a regulatory agency has been permitted to learn from and improve on past
conduct, including past mistakes (Wildavsky, l985; Levitt and March, l988). Regulatory
agencies frequently do not adopt a "longer view" with respect to regulatory actions, but
instead respond primarily to immediate problems. In so responding, the basis for action is
viewed as necessarily being a function of public complaint rather than self-motivated
regulatory investigation. For example, a planned investigation of the representations
made at Principal Group offices was vetoed by the Alberta Deputy Minister, partly on the
basis that the motivation for such investigation was information obtained when regulators
telephoned Principal Group offices, pretending to be customers. Since the proposed
investigation was not founded on a public complaint, it was considered to be inappropriate

(Code, l989: 398-399).

              ...regulatory agencies characteristically sit back and wait for questions to
              arise in particular cases, and the members of the agencies typically do little
              policy thinking except in the process of adjudicating single cases. Because
              the regulation case law is often spotty and even self-contradictory, the
              regulatory law remains uncertain over long periods. Indeed, regulatory
              agencies are notoriously deficient not only in doing the needed overall
              planning but also in announcing the results of such little planning as is
              done. ...The seeming inability of regulatory agencies to take care of
              perspective problems, instead of merely treating the symptoms of those
              problems in the form of hundreds of cases annually, is one of the major
              weaknesses of the administrative process in its present stage of

                      Davis (l969 [l979: 99])

        In Canada, the profiles of regulatory agencies have been heightened by quasi-
judicial inquiries into the regulatory conduct associated with the collapses of the Canadian
Commercial Bank, the Northland Bank and the Principal Group. The 1985 collapses of
the Canadian Commercial Bank and the Northland Bank led to the establishment in l987
of the Office of the Superintendent of Financial Institutions, with broader regulatory
powers than those of the predecessor Office of Inspector General of Banks. The
Superintendent of Financial Institutions remains adamant that the public should not be
warned when a financial institution is in difficulty:

              In Canada, we can't afford to have public street speculation (as to) whether
              my money is safe in that bank or trust company. ...We do not accompany
              our regulatory action with press conferences and banner headlines.

                      Michael Mackenzie, Federal Superintendent of Financial Institutions,
                      as reported by Milner (l991a).

              ...(Superintendent of Financial Institutions) Mackenzie says one common
              thread emerges: the public's interest is best served when a financial
              institution--not the regulator--discloses problems.

                      As reported by Critchley (l991), with reference to regulatory actions
                      associated with the closures of Standard Trust and the Bank of
                      Credit and Commerce Canada.

         The domino effect of financial institution failure is both institution and industry
specific. With respect to a particular institution, the domino effect refers to a "run on
deposits" once the public becomes aware of regulatory concerns with respect to the
institution, and thus changing a possibility of financial failure to a certitude. At an industry

level, the effect refers to the public losing confidence in financial institutions generally,
preferring to keep money in a sock:

              The failure of (the Canadian Commercial Bank) "would have severe
              negative repercussions on smaller financial institutions, particularly those
              based in Western Canada." Trust companies and credit unions would
              sustain material losses. There were international implications for Canada
              and its banking system. The failure of a Schedule A bank could result in
              disruption of the inter-bank market and "undermine confidence of
              international depositors and investors." ...government officials were faced
              with colliding considerations: a desire to avoid the investment of funds by
              the Government of Canada in a business enterprise, and yet a serious
              concern about the disruption of (the Canadian Commercial Bank's)
              borrowers in the event of a failure and the wave effect this would produce in
              the Western economy.

                      Estey (l986: 478-479)

              William Kenny, a lawyer representing Cormie, argued ...(that) the (Alberta)
              government subscribed to the domino theory, believing that if one credit
              union or bank failed, the others would fail. ...(Kenny) said the government
              only allowed "the last domino" to fail after it had patched up all the other

                      Code inquiry testimony, as reported by J. Powell (l988e).

         The domino effect of regulatory action is the obverse of a domino effect of
financial institution failure. In tipping the "last domino", there is an indifference on the part
of regulators to its falling, based on assurances that others in that chain will not fall. To
achieve this effect, the financial institution domino may be tipped away from the other
chain of financial institutions, and instead towards the chain of regulatory agencies. In
short, once one regulatory agency acts, other agencies quickly follow, virtually by
compulsion. This behaviour is not inconsistent with regulatory behaviour during the
nearly 35 years of the existence of the Principal Group, where no one regulatory agency
appeared prepared to act in the absence of a "fallback" position, enabling attribution of
fault to another agency in the event that regulatory actions are challenged. For example,
certain senior regulators of the Principal Group had been expressing concerns about the
organization since the l960s (Owen, l989: 163) and the early l970s (Fisher, l988b), yet the
companies concerned were not closed by the Alberta government until l987.

       With respect to the Principal Group, the relevant licenses to conduct business in
Alberta were revoked by the provincial regulators on June 30, l987. The inquiry findings
of Mr. Code later concluded that the licenses should have been revoked by l984, at the
latest. British Columbia regulators, with comparable jurisdiction over the companies in
that province, did not act until Alberta regulators had acted; licenses to conduct business

in British Columbia were revoked on July 2, l987 (Owen, l989: l89). Similar "follow the
leader" behaviour was evidenced by regulators in Saskatchewan and Nova Scotia. On
June 29, l987, the Saskatchewan government received notice from the Province of
Alberta that the operating licenses of the investment contract companies would be
cancelled in Alberta, effective June 30, l987; licenses issued to the companies in
Saskatchewan were thereafter suspended (McLellan, l989: 3). In Nova Scotia, for
reasons not apparent, the sale of investment contracts did not formally cease until nearly
one month later, when on July 29, l987, the Attorney General of Nova Scotia ordered
trading in the securities to cease (MacLean, l990: 32).

         After the Principal Group closure, various regulators appeared to place regulatory
actions "on hold", awaiting the findings of the Code inquiry, rather than acting on their own
initiative. Charges of misleading advertising against members of Principal Group
management were laid by the Federal Department of Justice one day after the release of
the Code report (Carlisle, l989). Over three years after the Principal Group collapsed and
over one year after the release of the Code report, charges of stock manipulation were
laid by the Alberta Securities Commission against Principal Group management
(Canadian Press, l990j). These latter charges were resolved within five months by those
charged, including then 68 year-old Principal Group founder Donald Cormie, agreeing not
to trade stock in Alberta for a period of 10 years, without any admission of wrongdoing
(Canadian Press, l991c; Cernetig, l991). Within six months after the "dust had settled"
with respect to these events and nearly four years after the collapse of the Principal
Group, the Institute of Chartered Accountants of Alberta announced that it would conduct
separate investigations into the professional conduct two Chartered Accountants, one a
Principal Group executive vice-president and the other a partner of the firm of Chartered
Accountants which conducted the audits of the investment contract companies (Canadian
Press, l991c; Koch, l991).

        Domino effects of regulatory action also incorporate redundancy of actions, since
increasing regulatory action leading to sanction would appear to occur in situations of
decreasing risk to the regulator. As noted by Hawkins (l989: 388-389:), "...prosecution is
more readily used where there is already a body on the floor--where the risk has been
realised". A study of U.S. Securities and Exchange Commission prosecutions of broker-
dealers found that operational viability was the principal determinant of the severity of
sanctions; the most severe sanctions were reserved for corporate offenders who were
bankrupt or nearly so. The redundancy becomes evident: "(r)evoking the license of a
bankrupt firm is a regulatory gesture; it implies action but commits none" (Ewick, l985,
441; author's emphasis). With respect to the Canadian Commercial Bank, in l989 the
Canada Deposit Insurance Corporation amended its lawsuit against former directors of
the bank to include William Scott, Leonard Rosenberg and Howard Eaton. William Scott,
a former Inspector General of Banks, had at the time been dead for five years. Howard
Eaton had been bankrupt since l987. Leonard Rosenberg's major trust company assets
had been seized by the Ontario government in l982; the balance of his assets appeared
to be dedicated to fighting fraud charges (Johnson, l989).

        Redundant regulation is also evident with regulatory sanctions which, by design,
do not affect behaviours of the regulated. For example, with respect to the Northland
Bank, by l984, the opinion of the Office of the Inspector General had rated the bank as
"marginally satisfactory". Previously, the bank had received a "satisfactory" rating. The
effect of this change in rating was negligible, in terms of the bank's operations; there were
no direct sanctions and the rating change was not known publicly.

              Q:     ...given the state of affairs that we have just now discussed, what
                     regulatory system could have saved this bank starting in l982, if any:

              A:     As you have put the question, none, in my view. The die was cast.

                     Testimony of William Kennett at the Estey Inquiry, with reference to
                     the Northland Bank, as quoted by Estey (l986: 261). Proceedings to
                     close the bank were not initiated until September, l985.

         With respect to the Principal Group, a further redundancy, relating to the negligible
effect of the regulatory change, related to the regulation of sales representations. In
addition to making financial representations in audited financial statements, management
of Principal Group companies could induce persons to invest through making
representations in advertising material or through their salespersons.                  Such
representations were also subject to government regulation. Regulator concerns with
respect to representations as to government supervision of First Investors Corporation
and Associated Investors of Canada first arose in l963, with little effect (Trawick, l989:
41). The Investment Contracts Act prohibited the use of any document in connection with
the sale of an investment contract, unless such document had been approved by the
Superintendent of Insurance (Code, l989: 51). Much of the advertising material used by
First Investors and Associated Investors was not submitted for government approval, and
frequently involved wording which implied that the investments were subject to a similar
degree of security as that associated with a bank deposit. This was accomplished by
analogising the activities of First Investors and Associated Investors to those of a life
insurance company. Salespersons were instructed to make representations to that effect,
emphasizing the concepts of "guarantee" and "safety" in relation to the single pay
certificates (Code, 1989: 55).

              Q:     ...I just want to know if you had in mind that there was any third party
                     guaranteeing First Investors--

              A:     No, there was no third party. The government was doing it.

                     Salesperson's testimony, cited by Code (l989: 59).

              (In response to a question as to the nature of representations made to

             A:     I would say that your First Investors Corporation that is governed by
                    the Provincial Government under the Investment Contracts Act, that
                    for every dollar you deposit we must maintain an equal dollar in
                    deposit through a government-approved custodian. There was a
                    constant audit and a full (sic) every three months.

                    Salesperson's testimony, cited by Code (l989: 66).

      Investors were similarly confused:

             Q: was invariably (the salesperson's) practice to refer you to the
                    back of (the investment) contract and what it said?

             A:     For the provincial government guarantee, yes, assets on deposit.

                    Investor's testimony, cited by Code (l989: 59).

      When the government regulators became aware of material which was considered
to be objectionable, the changes proposed by the government did not cease to make
such material misleading. A major misrepresentation made by First Investors Corporation
and Associated Investors of Canada was that at all times assets equal to liabilities were
on deposit at a Canadian chartered bank. The office of the Alberta Superintendent of
Insurance demanded that this representation be changed. An assertion that assets were
on deposit with a chartered bank was required to be changed to an assertion that either
company "is required to maintain" assets on deposit; a change more cosmetic than

(b)   Reputation Effects: Perpetual Licenses, Closure Versus Merger (The
      Meaning of Failure) and Escalating Commitment to Closure

             ...the basic regulatory conundrum: owners of new trust companies must
             obtain a license to do business, a basic barrier to entry; yet ownership is so
             easily transferable that existing trust companies can change their stripes
             with chameleon ease. ...companies completely change character--location,
             company name, even the type of business they do--without regard for
             regulatory predilections. The politicians have decided a barrier is needed
             and then have refused to patrol it.

                    Best and Shortell (1985: 15)

             I think they put more emphasis on a moose license than they put on a
             financial institution license.

                    Charles Mason, Principal Group investor, with respect to actions of

                     Nova Scotia regulators, as quoted by Perrin (l989: 112).

       As discussed in Chapter 2, organizational environments have been categorized by
Scott and J.W. Meyer (l983) and Scott (l987b) along an institutional-technical continuum.
At the extremes, organizations in technical environments are rewarded for the quantity
and quality of their output, while organizations in institutional environments are rewarded
for correct structure and processes. Banking is characterized as an environment which
contains both strong technical and strong institutional requirements (Scott, l987b, 126). In
a regulatory sense, the "reward" by a regulator would appear to relate to general
perceptions of integrity of financial institution management. Correct structure and
processes lead a regulator to assume solvency of output, resulting in regulatory
processes that are more supervisory than investigative.

         The general regulatory reluctance to close a financial institution, as well as a
similar reluctance to sanction the financial institutions under consideration for various
violations have been noted. In addition, incidents of breaches of undertakings remaining
unpunished have been mentioned. These incidents may be viewed as "corruptions of the
relationship with the guardians of trust" which, when taken to an extreme, involve a desire
on the part of the malfeasor for the institutional shelter of a license or other certification
associated with behavioural propriety (Shapiro, l987: 646). With respect to the Canadian
Commercial Bank and the Northland Bank, such breaches of undertaking go to the
essence of the justifications for the founding of the two banks. At the relevant time, no
one could found a bank as a matter of right. Rather, one was required to obtain a bank
charter, which was granted by the federal Parliament. In applying for such a charter, one
was required to demonstrate that the bank would be in the best interests of Canada,
given that banks were associated with concentrations of capital. As noted, those
promoting both the Canadian Commercial Bank and the Northland Bank appealed to the
need to serve western Canadian banking interests. The service of such interests,
perceived as it was to be in the greater national interest, formed the basis of the granting
of the two bank charters. The Northland Bank granted its first loan in November, l976.
From the outset, the intention to serve Western interests appears to have been forgotten,
in that the then president of the bank decided that the bank would participate in sovereign
loans--loans to foreign governments. By l979, less than three years since the granting of
its charter, 50% of the bank's approximately $100 million in loans were loans to foreign
governments, rather than western agribusiness, and bank management had decided to
commence real estate development and offshore syndication loans. Curiously, this
change in direction appears to have met with the approval of the bank's credit union
founders. In l979, with the Northland Bank as the lead syndicator, the central credit union
agencies of British Columbia, Alberta, Saskatchewan and Manitoba, as well as the
Canadian umbrella credit union organization, made a $10 million offshore loan (Johnson,
l986: 103). No action for breach of bank charter undertakings was ever commenced.

              Clearly, an organization's assets at founding need not be fully captured by
              financial assets but could include legitimacy (Singh, Tucker and House,

              l986; Fichman and Levinthal, l991) and established relations with important
              exchange partners.

                     Levinthal (l991: 408, in the context of an ecological analysis of age
                     and mortality rates in newspaper industries)

         From Chapter 2, it is evident that institutional explanations cross domains,
including that of the ecological. From the foregoing, it would appear that there is an
institutional dimension associated with the continuance of an operating license of a
financial institution from the time of its original grant. From the public's perspective, the
values accorded to a continuing license would appear to be associated with some view as
to ongoing propriety of operation. From a regulator's perspective, the continuation of a
license would appear to have a somewhat different association: at some time in the past
management of a financial institution has complied with the procedures for the granting of
a license. Ongoing propriety of operation and the continuation of a license to operate
appear to be viewed separately. When one obtains a license to drive a car, the license is
renewed virtually automatically, provided that the number and severity of known driving
infractions are not such that the license is required to be revoked. The revocation of a
license does not coincide with its term of renewal or the conditions of renewal. In
addition, the number and severity of offences is generally specified by legislation, such
that the revocation of a driving license is not a discretionary act on the part of regulators.
The distinction between license renewal and revocation would appear to be supported in
law. Citing English authority with respect to a deposit insurance dispute, Mr. Code
determined during the course of his inquiry that it was unclear whether the law would
recognize the continued licensing of the Principal Group investment contract companies
as a representation by those charged with the administration of the Investment Contracts
Act that the companies met the statutory requirements (Code, l989: 419). The investor's
perception may be that the license implies propriety of operation; the law does not
necessarily coincide with this perception.

              Information concerning organizational behavior is difficult to obtain, putting
              social control agencies at a disadvantage. ...Because the cost of thorough
              information gathering is beyond most agencies, monitoring corporate
              behavior becomes a matter of examining reports containing data
              accumulated and filed periodically by the organizations being regulated.

                     Vaughan (l983: 98, citing Pfeffer and Salancik [l978: 210])

         From the conduct of certain regulators associated with the Principal Group,
institutional or trust-based explanations would appear to support actions which involved
an indifference to financial information, audited or otherwise. Such behaviours have also
been referred to as reflecting an "occupational psychosis" or a "trained incapacity" on the
part of occupants of a bureaucratic office, which inhibits or prevents the recognition of

changed circumstances requiring changed behaviours. Regulatory conduct becomes that
of satisfying the details of behaviours required by internal rules, irrespective of whether
the aims of the organization are satisfied through such compliance (Merton, 1968: 251-
253). We may compare the behaviours of various Principal Group regulators with respect
to licence renewals as exemplifying the foregoing observations. As has been discussed
in Chapter 6, the review process of Principal Group regulators was primarily based on
"desk audits" or simple recomputations of financial information provided by the Principal
Group. However deficient the review process of the Alberta regulators may have been, it
was superior to that adopted by regulators in Saskatchewan, who acknowledged
receiving financial information from the companies and simply filing it without further
examination. Saskatchewan licenses were then issued through clerks typing the required
information on licenses signed in blank by the Superintendent of Insurance, a process
that "encouraged the view, if indeed there was any consideration of the matter, that the
annual re-licensing was a routine process of minimal consequence" (McLellan, l989: 23,
24). The Saskatchewan process would appear to be still superior to the review processes
adopted by regulators in Nova Scotia, who received no financial information whatsoever,
contrary to legislation, and instead were satisfied with receiving a copy of the investment
contract form and a statement, apparently from Principal Group management, that
Alberta registration was maintained (MacLean, l990: 33). There would appear to be
evidence supporting a contention that the existence, content or integrity of financial
information associated with the Principal Group was substantially irrelevant to its
continued licensing.

        The failures of the Canadian Commercial Bank, the Northland Bank and the
Principal Group are the most well-known in recent Canadian financial institution history, in
part due to being the subject of public inquiries and extensive coverage in the popular
press. In addition, the failures are comparatively unique in that the institutions were
liquidated rather than merged with or sold to another party. At issue is the question as to
why these institutions were liquidated rather than being merged or sold. For example,
the l985 failures of the Canadian Commercial and the Northland Bank intensified the
desire of Alberta regulators to save Alberta-based financial institutions. This was one
explanation for the regulatory delay until l987 with respect to closing the Principal Group
(Code, l989: 377).

              There are several methods for disposing of failing banks. The preferred
              approach is to find a merger partner before it closes. This so-called open
              bank merger is the least disruptive approach, and is nearly transparent to
              the public because the bank continues to operate almost as if nothing had

                     Zweig (l985: 357), describing regulatory practices with respect to
                     U.S. banks.

        While an "open" merger, generally with government assistance, may be the least
disruptive of available regulatory procedures, there exist two other procedures by which
regulators may address the financial difficulties of a financial institution (Zweig, l985: 357).
 One is a "purchase and assumption" transaction, whereby a financial institution is
declared insolvent and sold under regulatory supervision. This approach was used with
respect to the l991 sale of Standard Trust to the Laurentian Bank, whereby the Federal
Superintendent of Financial Institutions effectively acted as the supervising vendor of the
trust company. In such circumstances, the purchaser is able to select the stronger of the
financial institution's assets, leaving the weaker assets to be disposed of by regulators.
Alternatively, the purchaser may make the asset purchase conditional on being able to
return assets which deteriorate within a specified period after the purchase. "Open
merger" and "purchase and assumption" transactions do not appear to differ in
substance, in that both are initiated by direct regulatory action (seizure of the institution)
or under compulsion of such regulatory action if the merger is not effected otherwise.
The third approach available to a regulator is a direct liquidation, as occurred with respect
to the three financial institutions under consideration. A recent review of closures of
savings and loan associations in the United States has found that liquidations of these
financial institutions were generally less costly than assisted purchase transactions
(Kormendi, Bernard, Pirrong and Snyder, l989: 67-69).

       Historically, and particularly after l900, Canadian financial institutions in difficulty
have generally been the subject of mergers or sales, rather than closure and liquidation.
The merger or sale of a financial institution would appear to involve a lesser degree of
erosion of public confidence than does the closure and liquidation of such an institution.
This is so notwithstanding that the amount of public financial support contributed to the
merger may be quite significant if not, as previously noted, more costly. A merger or sale
may also be a harbinger of future financial health. It is to be noted that three of the six
largest banks in Canada (the Toronto-Dominion Bank, the Canadian Imperial Bank of
Commerce and the National Bank of Canada) are themselves products of mergers or
amalgamations--in l955, l961 and l979, respectively (Mittelstaedt, l989).

       At the time of the l986 Estey inquiry into the failures of the Canadian Commercial
Bank and the Northland Bank, the majority of banks founded in Canada or its
predecessor regions had failed or were merged, with such failures or mergers occurring
subsequent to the l867 establishment of Canada. As of l867, there were 35 active banks
in Canada, growing in 11 years to 51 by l878. The number of active banks then began to
decline, until l980 regulatory reform which permitted foreign-controlled banks to operate in
Canada (Estey, l986: 364). Of 79 banks founded between l831 and l984, only 10 were
active subsequent to the failures of the Canadian Commercial Bank and the Northland
Bank (Estey, l986: 359-364). The smaller four of these ten (the Bank of British Columbia,
the Continental Bank of Canada, the Western & Pacific Bank of Canada and the Bank of
Alberta) were shortly thereafter the subject of mergers, leaving but 6 banks of 79 originally
founded, with 73 "disappearances". In October, l986, he Continental Bank commenced
merger proceedings with the newly-formed Lloyds Bank Canada, after the former had

received nearly $3 billion in Bank of Canada support (Waddell, l986). One month later, in
November, l986, after management disclosed that it had been seeking a merger
candidate since the early fall of l985, the Bank of British Columbia merged with the
Hongkong Bank of Canada. The merger was forced by the federal government, which
passed special legislation to permit the merger without shareholder approval, and
provided $200 million in public support through the Canada Deposit Insurance
Corporation to effect the sale. At the time of the merger, the Bank of British Columbia
owed in excess of $400 million in advances from the Bank of Canada (Chisholm, l986).
In l988, the Western & Pacific Bank of Canada and the Bank of Alberta were merged to
form the Canadian Western Bank (Galt, l988; Bloomfield, l990). In early 1990, the
merged Lloyds Bank of Canada itself merged with Hongkong Bank of Canada (McNish,

             Indulging in what he called a Celtic propensity to doom, Mr. Mackenzie said
             his major concern right now is "system risk"--elements beyond the control of
             individual financial institutions.

                    Federal Superintendent of Financial Institutions Michael Mackenzie,
                    shortly after assuming office, as reported by Galt (l987).

       The merger and liquidation trends in Canadian banking are illustrated in Table 1.
With respect to Table 1, certain adjustments are now described. The original data is
reformatted from Estey (l986: 359-364), Table A-1, "Growth and Change in the Canadian
Banking Community", which covers the period l831-l986 (part, given that the report was
issued in August of l986). In addition to the 73 "disappearances" of 79 banks founded, as
previously mentioned, one must add mergers and disappearances associated with Lloyds
Bank of Canada and Hongkong Bank of Canada transactions. The Continental Bank is
already included in the 73 "disappearances", having merged with Lloyds Bank Canada.
As noted, Lloyds Bank Canada was itself subject to a l990 merger with another foreign-
controlled bank, the Hongkong Bank of Canada. Given the interrelationship of these two
banks with the history of closures of Canadian controlled banks, the two are considered to
be "Canadian controlled" for the purpose of this analysis, bringing the total bank
foundings to 81, with 1 additional "disappearance" through merger. A final adjustment
relates to the l988 merger of the Bank of Alberta and the Western and Pacific Bank of
Canada, to form the Canadian Western Bank in l988. The merger is already included in
the total; the Canadian Western Bank is added as an additional founding, bringing the
total number of institutions founded to 82. Thus, of the 82 institutions founded, 74 have
"disappeared" through merger or liquidation. Not included in the total are two acquisitions
where neither "side" of the transaction relates to a "first tier" or widely-held Canadian
bank: (i) the June, l980 acquisition of City and District Savings Bank by the Laurentian
Group to form Laurentian Bank (Stewart, l982: 158, 292) and (ii) the November, l985
acquisition of Morguard Bank by Security Pacific Corporation of Los Angeles, to form
Security Pacific Bank Canada (Johnson, l986: 243-244). Relative to the closures
reviewed, the eight remaining banks are as follows:

Bank of Montreal
Bank of Nova Scotia
Toronto-Dominion Bank
Canadian Imperial Bank of Commerce
Royal Bank of Canada
Banque Nationale
Hongkong Bank of Canada
Canadian Western Bank

         The Canadian banking system is generally identified as being associated with a
history of solvency, subsequent to the Home Bank failure and liquidation of l923.
However, in the years prior to this failure there were 53 bank closures in Canada, 24 by
way of liquidation and 29 by way of merger (Estey, l986: 359-362). In Table 1, it is
demonstrated that the majority of Canadian bank closures (47 of 74 or 64%) have been
by way of merger rather than liquidation. The failures of the Canadian Commercial Bank
and the Northland Bank are considered to be significant because there had been no bank
failures subsequent to the failure of the Home Bank in l923. Such a view must be
qualified by the meaning ascribed to the term "failure": may both liquidations and mergers
be considered to be actions in response to financial institution failure? Patterson (l987:
937) contends that, historically, most bank mergers were for reasons of expansion, rather
than to avoid failure. Between the Home Bank liquidation and those of the Canadian
Commercial Bank and the Northland Bank, there had been 12 bank mergers, or nearly
25% of the 49 bank mergers in the history of Canada. Furthermore, prior to l900, the vast
majority of bank closures were by way of liquidation (17 of 23 or 74%) rather than by way
of merger. Subsequent to l900, the major period of bank liquidations is the l905-l9l0
period, when 6 of 13 bank closures were by way of liquidation. Also of interest is the fact
that there were no bank closures whatsoever, either by liquidation or merger, in the l932-
l954 period, which period includes both the Great Depression and the Second World
War. While resolute government support of financial institutions is to be expected during
times of war, the willingness and the capacity of a government to support financial
institutions generally in an economic depression is of interest.

        A similar bias in favour of merger over liquidation is evidenced in the United
States, in connection with closures of Savings and Loan Associations. For example,
between l970 and l988, 264 California-based Savings and Loan Associations were
closed--with but 17 closed by way of liquidation and the balance by way of merger
(Haveman, l992: 59). Economic considerations do not appear to be the determining
factor since, as noted, there is evidence that the liquidation of a savings and loan
association is less costly than an assisted purchase or merger (Kormendi, Bernard,
Pirrong and Snyder, l989: 67-69). Regulator-induced merger activities have been
expanded in the United States, involving compulsory mergers of several savings and loan
associations into one institution, and known as "the phoenix plan" (Kane, l989: 153;
Eichler, l989: 78). The extent of government guarantees in such "phoenix plan" mergers

means that the deposits of both insured and uninsured depositors are effectively insured
by the government, the latter bearing most of the risks of loss (Eichler, l989: 82).

                                          Table 1
                     Summary of Bank Closures in Canada 1868-1990 (n = 74)
        Liquidations     Mergers
 1868       1                     1
 1870                             1
 1873       1
 1875                             1
 1876                             2
 1877       1
 1879       4
 1881       1
 1883       1                     1
 1887       5
 1893       1
 1895       1
 1899       1
 1900                             1
 1901                             1
 1902                             1
 1903                             2
 1905       1                     1
 1906                             2
 1907                             1
 1908       3                     1
 1909                             1
 1910       2                     1
 1911                             1
 1912                             2
 1913                             2
 1914       1                     1
 1917                             1
 1918                             2
 1919                             1
 1922                             1
 1923       1                     1
 1924                             2
 1925                             2
 1928                             1
 1931                             1
 1955                             1
 1956                             1
 1961                             1
 1977                             1
 1979                             1
 1985       2                     1
 1986                             2
 1988                             2
 1990                                 1
                   -----              -----
                   27                 47

 Sources: l868-l986 (part)--Estey (l986: 359-364; Table A-1, "Growth and Change in the Canadian Banking
                    Community"), as reformatted. In the summary in the Estey Commission Report,
                    liquidations are classified as "failures"; mergers are classified as mergers.

                   l986-l990--Popular press reports and commentary

        From the foregoing, a question arises as to why, given past practice in Canada
and contemporary practices in the United States, a regulator would ever liquidate a
financial institution, when faced with merger or sale alternatives. From the perspectives
of both the regulators and the public, a merger or sale of a financial institution appears to
be viewed as something other than the failure of that institution. In short, the liquidation of
a financial institution is "framed" as a failure, with consequent attributions of fault, but not

        In circumstances where regulators are discouraging liquidations to preserve public
confidence and in an effort to reduce deposit insurance costs, Rao and Neilsen (l992:
461) note that the distinction between a liquidation and a forced merger is "somewhat
thin". This becomes evident if one compares similar amounts of support funds at risk in
the context of different financial institution "bailout" arrangements. For example, the initial
support program for the Canadian Commercial Bank amounted to a proposed $255
million "buy down" of bad loans by other participating banks and government agencies.
Such a "buy down" was accomplished after many meetings and the expressions of grave
concerns by the participants and the public. By contrast, shortly after the Canadian
Commercial Bank and the Northland Bank failed, in excess of $200 million was
contributed by the Canada Deposit Insurance Corporation to the "buy down" of loans prior
to the 1986 Bank of British Columbia-Hongkong Bank of Canada merger, with few
concerns expressed by the public or to the public by regulators. The predominant view
appeared to be that the payment of $200 million by the Canada Deposit Insurance
Corporation to the Hongkong Bank of Canada was cheaper than to pay out all depositors
in the event that the Bank of British Columbia failed. Paradoxically, the bank's difficulties
were attributed in part to public reports in the spring of l986 that the bank had been
refused an $800 million federal assistance package (Chisholm, l986).

       In l985, shortly after the failure of the Canadian Commercial Bank, the Mercantile
Bank was merged with the National Bank of Canada. Prior to this merger, the Unity Bank
had merged with the Provincial Bank of Canada, with the merged organization later
merging with the National Bank of Canada. Also in l985, shortly after the failure of the
Canadian Commercial Bank, the Morguard Bank, with assets of $336 million, associated
with and funded by some of the same persons and pension funds originally capitalizing

the Canadian Commercial Bank, was purchased by the Security Pacific Corporation of
Los Angeles, to thus become a "Schedule B" (foreign-owned) Canadian bank (Johnson,
l986: 243-244). In October, l986, the Continental Bank commenced merger proceedings
with the newly-formed Lloyds Bank Canada, after the former had received nearly $3
billion in Bank of Canada support (Waddell, l986). One month later, in November, l986,
after management disclosed that it had been seeking a merger candidate since the fall of
l985, the Bank of British Columbia merged with the Hongkong Bank of Canada. The
merger was forced by the federal government, which passed special legislation to permit
the merger without shareholder approval and, as previously noted, provided $200 million
through the Canada Deposit Insurance Corporation to effect the sale. At the time of the
merger, the Bank of British Columbia owed in excess of $400 million in advances from
the Bank of Canada (Chisholm, l986). In early 1990, the merged Lloyds Bank of Canada
itself merged with Hongkong Bank of Canada (McNish, l990).

        Similar merger trends are noted in other financial institution domains, such as that
of credit unions (Alberta Report, l987), where "phoenix plan" regulatory actions
comparable to those in the United States, earlier discussed, are evident. For example,
between l984 and l989, the number of credit unions in British Columbia decreased from
136 institutions with 314 branches to 118 institutions with 280 branches, with the
decrease attributable to various "consolidations" (Schreiner, l989). As of l989, there was
but one credit union in the city of Calgary, First Calgary Financial Savings and Credit
Union Ltd., formed in l987 from the merger of seven money-losing credit unions in that
city. The merged institution continued to record losses (Financial Post, l989a).

         Based on the foregoing, the liquidations of the Canadian Commercial Bank, the
Northland Bank and the Principal Group become all the more surprising. The decision to
liquidate appears to be related to the escalation of commitment to so act, whereby other
options are more readily discounted. Merger options were considered and then rejected
by the regulators of the Canadian Commercial Bank and the Northland Bank, who opted
instead to close the institutions, rather than to effect a merger which no merger candidate
would accept without government support (Estey, l986: 174, 529, 598-599). In March of
l985, some five months prior to their actual closures, the governor of the Bank of Canada
and other government officials made public declarations as to the solvency of the
institutions and the willingness of the federal government to provide support, as required
(Estey, l986: 498-499).        Instead of providing continued unqualified support, the
government became unreservedly committed to the closure of the two institutions,
rejecting merger options presented which would have seen the banks "folded" into other
banks on a liquidation basis (Estey, l986: 477, 529, 597). With respect to the Canadian
Commercial Bank, government regulators assisted in the search for merger candidates,
while with respect to the Northland Bank, management was provided with a "grace
period" subsequent to the appointment of a curator to find a merger candidate through
management's own efforts.           The dispute by Northland management as to the
appointment, objectivity and cost of the curator was met by government resolve to
liquidate the bank. For example, court challenges by Northland Bank management were

met by government actions which involved assumptions as to liquidation irrespective of
the result of court proceedings (Cox and Barnes, l985; Canadian Press, l985). Similarly,
management of the Principal Group offered to give the Government of Alberta the
investment contract companies to satisfy regulatory concerns:

              (Rather) than having us work it out the way we were working it out, I simply
              said, "If you think you can do it better, then here are the keys".

                      Testimony of Kenneth Marlin, Vice-President of the Principal Group,
                      at the Code inquiry, as reported by Necheff (l988).

         This offer was rejected, with the Alberta government opting to close the
institutions, without waiting for the receipt of the final version of a consultant's report as to
the extent of loss exposure.

(c)    Institutional Dimensions of Accounting Representations: Strategies to
       Minimize the Reporting of Losses

              Because confidence is so important to the banking system, pretense
              occasionally plays a role in getting over rough spots.

                      Editorial, Globe and Mail (l988a)

              ...the requirements to maintain public confidence in financial institutions has
              historically been considered to justify various expedients to smooth reported
              losses and income over a cycle.

                      Skinner (l987: 474)

              It is understandable that a management under seige may prefer to gaze
              with undue optimism into the future since the alternative may entail a write-
              down of assets of a magnitude too painful to contemplate.

                      Senate Committee on Banking, Trade and Commerce (l985
                      [December 19]: 28-29), in report concerning compensation to
                      depositors of the Canadian Commercial Bank and the Northland

       The failures of the Canadian Commercial Bank, the Northland Bank and the
Principal Group were characterized by disputes between management and the regulatory
authorities, including the corporate auditors as a regulatory component, as to loan
valuation and income recognition. Some of the accounting policies adopted are now
discussed, not for the purpose of establishing causal connections to the failures of the
financial institutions, but rather to investigate regulator reactions, or non-reactions, to


              Q:     ...was the regulator influenced by the fact that if the Alberta economy
                     had come back in '83, '84, that the bank probably would have
                     staggered back? Was that an influence which you took into account
                     in permitting or not prohibiting some of these measures?

              A:     It was certainly an attitude, and I will speak for myself, sir, I think
                     personally if I may. That was an attitude that influenced us in these

                            Testimony of William Kennett, Inspector General of Banks, in
                            relation to the Northland Bank, at Estey Inquiry, as quoted by
                            Estey (l986: 261)

              Commissions tend to organize not for action but for adjudication. The staff
              is geared to cautious consideration of pending formal proceedings and not
              to taking speedy action. Flexibility in handling complex regulatory situations
              tends to give way to inflexible reliance on prescribed formal procedures.

                     Bernstein (l955: 174)

         The resolution of disputes as to accounting policies was generally in favour of
financial institution management (e.g. Estey, l986: 89, 143), with regulators frequently
relying on the external auditors as the final arbiter (e.g. Estey, l986: 156-158; Code, l989:
345-346). Of concern here is the fact that subsequent inquiries into the financial
institution failures involve conclusions that the accounting principles adopted by the
financial institutions were not in accordance with generally accepted accounting
principles, if not fraudulent. For significant periods prior to the failures, regulators and
auditors, many of whom were professional accountants, thought otherwise. For example,
with respect to the Canadian Commercial Bank and the Northland Bank, one of the
defences to the criticisms of the findings of the Estey Commission was that an economic
recovery was under way, an that all parties concerned, particularly the auditors and bank
management, were optimistic that the workout programs would be successful. In
addition, the future-oriented approach to valuation was asserted to be common in the
banking industry. Larger banks with sovereign loans to nations in financial difficulty also
had wide gaps between the recorded value of the loans and their current recoverable
amounts; these loans had not been written down, but were instead assessed based on
"probable recovery" (Jeffrey, l987: 1).

              Testifying before the Senate Banking Committee, the (General Accounting
              Office) officials claimed that GAAP is (sic) allowing banks to delay
              recognition of estimated losses. It gives too much leeway in bank financial
              statements, permitting banks to ignore losses until they are "probable". The

              GAO says the trouble is that too many banks interpret "probable" as
              meaning "virtually certain", which delays the write-down of problem assets
              to fair market value.

                     LaVine (l990), reporting comparable U.S. accounting practices in the
                     Savings and Loan industry.

     its present state of development Accounting is at one and the same
              time an unhappy mixture of abstracted and pragmatic scientism.

                     Lowe and Tinker (l989: 47)

              Accounting is closer to the occult sciences than to exact mathematics.

                     Leo-Paul Lauzon, described as "the guerrilla accounting professor",
                     as interviewed by Dougherty (l991).

        It has previously been noted that one distinction made with respect to depositor or
investor reliance was the general accessibility to depositors and investors of the audited
financial statements of the banks, whereas no comparable general accessibility existed
with respect to Principal Group financial information. If the statements are accessible, but
misleading or fraudulent, the investor is in no better position than he or she would be if
the misrepresentations had been made orally. In the cases of the Canadian Commercial
Bank and the Northland Bank, the banks' external auditors generally agreed with
managements' future-oriented attitudes. Until the year prior to its failure, the external
auditors of the Principal Group had also been in agreement with this management
position (Code, l989: 379-380). Another way disagreements were resolved in favour of
management was by management simply ignoring regulatory directives with impunity, a
practice which is also evident in the more recent Standard Trust failure (Howlett, 1991b).

              A property is worth what you can get paid for it.

                     Comment by Richard Wertheim, spokesperson for Campeau
                     Corporation, in disputing that Campeau Corporation had sold, to
                     satisfy creditor demands, a real estate complex with an alleged value
                     of $250 million for $150 million. As reported by Shalom (l991).

              The banks had already realized on the securities of many of the loans--
              mainly real estate--which, at the time, couldn't be sold at any price. But that
              doesn't mean that it was worthless. But how long down the road can you
              project? Ten years? Five? The (Canadian Institute of Chartered
              Accountants) has set no standards or guidelines, and that's what I think the
              fundamental problem was.

                     Unattributed commentary (at the commentator's request) on the
                     findings of the Estey Commission, as reported by Jeffrey (l987: 1).

              The banks wanted us to throw taxpayers' money into a black hole, but they
              couldn't even tell us how deep the hole was.

                     Senior Department of Finance official, commenting on the reversal of
                     a government decision in May, l992 to provide support to Olympia
                     and York Developments Ltd.. As reported by McNish (l992: A8).

         One area of major concern with respect to the financial institutions under review is
that of accounting and valuation policies adopted with respect to doubtful loans. Loans
which later became doubtful were generally granted based on anticipated increases in the
values of property securing the loans, rather than on the basis of the cash position of a
borrower. In Alberta, where the majority of the doubtful loans of the financial institutions
were secured, values of properties rose and fell in direct response to announcements and
postponements of projects in the energy sector of the province. The growth in the Alberta
economy in the l970s was exemplified by rapid increases in property values in central
business areas and in areas where oil or natural gas was thought to be located. As
examples, between l977 and l980, certain properties in Cold Lake, Alberta, an oil-
producing region, increased by 240 per cent, while the prices of certain commercial
properties in downtown Calgary escalated at the rate of 6% per month (Estey, 1986: 410).
 Between l971 and l985, the value of Alberta's goods and services increased from $8
billion to $62 billion; accordingly, loan policies based on assumptions of sustained growth
made good business sense (Patterson, l987: 942-943). To the prudent businessperson,
the severity of the economic collapse in Western Canada might well not have been

              The Inquiry heard expert testimony to the effect that, as late as l981, a
              prudent member of the Alberta business community would not have
              foreseen the magnitude of the economic downturn which occurred in l982.
              All this must be borne in mind when assessing both the actions taken in the
              Alberta community, including the banking community, and the economic
              devastation which befell the region commencing in l982.

                     Estey (l986: 410)

              ...we were hoping and expecting, as the bank was and as other observers
              were, that this economy would turn around and...(that) the most severe
              problems, would be short-lived. It turned out that the economy did not turn

                     Testimony of Inspector General Kennett at the Estey Inquiry, as
                     quoted by Estey (l986: 160).

              (By l983, the) fundamentals of the income statement ceased to make any
              sense. ...I guess the proof in the pudding is where you end up at the end of
              the day, assuming that you get to the end of the day.

                     William Neapole, former chief executive officer of the Northland
                     Bank, in testimony at the Estey inquiry (as quoted by Estey, l986:
                     187, 188).

       The values of raw land in Edmonton and Calgary dropped 80% to 90% in the early
l980s, while house prices declined 40% and commercial land declined by 50% (inquiry
testimony of Edward Shaske, real estate appraiser, as reported by Powell, l988b). When
property values declined, borrowers generally did not have the cash flow to repay the
loans, leaving the financial institutions with two basic options: (i) seize the property as
security for payment or (ii) view price declines as temporary and to "carry" the loan until
economic circumstances and property values improved. In taking either action,
management of the three financial institutions adopted a long-range perspective,
asserting that, in the long run, property values must improve and therefore the risk of non-
recovery of loan advances and interest was minimized.

              We didn't anticipate that we were lending money on property that we would
              own within two years.

                     Kenneth Marlin, President of First Investors Limited and Associated
                     Investors of Canada, in testimony at the Code Inquiry (as reported by
                     Code, l989: 69)

              The company's real estate portfolio has increased 41% since the year end
              and there is currently $39.2 million worth of mortgages being foreclosed on.
              In light of the above, (First Investors Corporation) could become a real
              estate company if foreclosure continues at the same rate.

                     Report extract, based on a regulatory examination of First Investors
                     Corporation for l982 and the first seven months of l983, as quoted by
                     Code (l989: 359)

              It was an unbelievably uncertain environment because we were getting
              appraisals that would vary up to 100 percent different (sic) between two
              appraisals in the same period. ...It was almost like a guessing game at the

                     Inquiry testimony of Pennock, one of the auditors of the Principal
                     Group, as reported by Code (l989: 147).

          Within the banking industry, doubtful loans are generally classified as one of two
types: "unsatisfactory" and "doubtful". The term "nonproductive" loan in the banking
industry refers to a loan upon which no interest has been paid for a period of time,
generally 90 days. Interest on such a loan is normally not accrued, and a provision is
made to address the potential for loss on such a loan. An "unsatisfactory" loan is a loan
requiring the attention of management as to whether it should be written off, in whole or in
part, due to doubts as to the ultimate recovery of principal or interest. The Chief
Executive Officers of all three financial institutions argued with regulators and auditors,
initially successfully, that a "wait it out" approach was reasonable with respect to avoiding
the reporting of loan losses. Such an attitude finds historical support in the reaction of
regulators and Government to stock market losses of financial institutions during the
Depression. For example, in l931, by Order-in-Council, the Government of Canada
permitted banks to maintain stock prices at market prices that had prevailed several
months earlier, in recognition of what was perceived to be the transitory nature of the
near-collapse of the stock market (Estey, l986: 163). With respect to the cases under
review, Principal Group management initially used a time frame of three to four years
prior to it being considered reasonable to recognize losses. This time frame was later
extended to seven years as of l985 (Code, l989: 139).

              ...the strategy was simply to buy time in the hope, and sometimes in the
              belief, that economic levels of business in Alberta and British Columbia
              would improve and return to something like the glory days of the late l970s.

                     Estey (1986: 242)

              Preferences for high variance alternatives are not constant but are
              responsive to changing fortune.

                     Cyert and March (l992: 227)

              ...the surveillance technologies of social control agencies--monitoring and
              investigating the behavior of business firms--may also be related to unlawful
              conduct. Surveillance subjects an organization to accountability. To hold
              an organization accountable is to set up norms or criteria by which its
              success in goal attainment is judged. Not only may this intensify pressures
              to attain goals, creating tensions to attain them unlawfully, but organizations
              may respond to the surveillance by falsifying the performance indicators
              being monitored.

                     Vaughan (l983: 108)

              Recalculated figures that improved the status of a troubled Principal Group
              Ltd. subsidiary by $60 million have been defended by an Alberta
              Government auditor at a court-ordered inquiry. "I don't have a crystal ball; I

             can't tell you what the real estate is worth at any given time," Burt Eldridge
             told the Alberta Court of Queen's Bench probe...

                    Canadian Press (l988c)

       The position of Principal Group management that property values would recover
was generally accepted by senior Alberta regulators. For example, in l984, a proposed
investigation of First Investigators Corporation and Associated Investors of Canada was
not pursued, based on a meeting among the Superintendent of Insurance and the
Minister and Deputy Minister of the Alberta Department of Consumer Affairs.
Government auditors had proposed to perform their own appraisals of loan securities; this
was considered to be ineffective since "in the context of Alberta's troubled real estate
market, the values would be `nothing but opinions'" (Canadian Press, l988d).

             For troubled loans, the (bank) examiners should be looking at the realistic
             current values at today's markets, not some vague idea of a future market
             value that may or may not occur some day. ...The fact that real estate
             values are lower now doesn't mean that they will ever come back to the
             levels that they reached a few years ago.

                    Donald H. Chapin, an assistant U.S. comptroller general, as reported
                    by Labaton (l991b)

             Bank examiners earn less than bankers but they are compensated by being
             allowed to define reality for bankers, to dictate what has worth and how

                    M. Singer (l985: 135), with respect to U.S. regulatory practices.

             A regulator undertaking the revaluation of... loan assets must be familiar
             with the credit practices of the bank and the creditworthiness of the
             borrower in order to make an informed regulatory revaluation decision. The
             regulator's impact on the valuation process should be focused on
             supervision of lending and loan valuation practices, as communicated to it,
             and to the audit committee, by the bank's auditors. Management decisions,
             properly supervised, are preferable to regulatory fiat in the accepted
             Canadian tripartite system of bank regulation.             ...the proposed
             administrative power to revalue a bank's assets is an extraordinary power in
             our legal and political system, and cannot without much more than has
             been seen in the evidence here be recommended.

                    Estey (l986: 624), commenting with respect to proposed changes in
                    bank regulation.

       The positions of financial institution management have been shown to have some
empirical support, in that the values of some of the properties seized subsequent to the
demise of the institutions have improved in value, though neither as quickly nor to the
extent originally predicted by management. Nonetheless, there have been reductions in
the deficits projected subsequent to the closures of the institutions (e.g. Canadian Press,
l990h, with respect to the Northland Bank). By l988, commercial land in Calgary and
Edmonton had recovered 10%-15% in value, while house prices had recovered 10%-20%
in value (inquiry testimony of Edward Shaske, real estate appraiser, as reported by
Powell, l988b).

              Continental (Illinois Bank) widely credited with inventing the so-called
              evergreen revolver, the financing method making its reserve-
              based oil and gas loans. ...a customer borrows $100,000 at 20%, so by the
              end of a year he owes $120,000. Then he borrows another $150,000 to
              pay back the $120,000, leaving him with $30,000 to play with.

                     Zweig (l985: 73-74), with respect to U.S. bank lending practices in
                     the late l970s.

              By lending not only all the development costs but also enough extra funds
              to cover interest for several years as well as the fees, thrifts could create a
              self-fulfilling prophecy by booking the interest and fees as current profit.
              Since nothing in GAAP (generally accepted accounting principles)
              specifically prohibited such a practice--although auditors are always
              supposed to look beneath the surface for substance--auditors would go
              along with it until the completely uneconomical character of the projects was

                     Eichler (l989: 97-98), with respect to comparable practices of U.S.
                     savings and loan associations.

              When you don't have a buyer who can borrow, you don't have a price.

                     Testimony of John Lytle, former vice-president, Continental Illinois
                     Bank, in l982 U.S. House of Representatives inquiry into the collapse
                     of Penn Square Bank (Committee on Banking, Finance and Urban
                     Affairs, House of Representatives, l982: 36).

       Intercorporate transactions were used by the three financial institutions to preserve
the value of a loan or to recognize a gain. For example, if Principal Group management
were concerned about the erosion in value of assets, these assets would be transferred
to an affiliate at book value or at a higher value. The affiliate, often nominally a public
company, would issue shares or debt in payment for the assets. If shares were received,
they would frequently be more difficult to value than the assets transferred, such as real

estate. This was because the shares would be thinly traded or consist of preferred
shares. The idea was that it would be more difficult to challenge the valuation of the
shares received in exchange, as opposed to the real estate transferred, particularly in
circumstances where Principal Group management was in a position to influence the
share price of the affiliate. If the assets were transferred at an amount higher than book
value, a gain would be realized. Often the gain was fictitious, since a non-affiliate would
not have paid as much for the assets (Code, l989: 131).

              ...a major part of the strategy of the bank...was to apply accounting
              procedures to management's policies and actions that would maintain the
              appearance of health through the bank's financial statements in order to
              survive until the salvage workouts could succeed. It was in this era that the
              "loan warehouse" concept...was shifted into high gear.

                     Estey (l986: 188), with respect to the accounting policies adopted by
                     management of the Northland Bank.

     I have said before in the commission, we have no magic. We were
              discussion regularly with the bank, its condition, the procedures it was
              following; we were improving our accounting processing in the handling of
              nonperforming loans, but regardless (of) how you handle them, they are still
              there. They are on the books of the bank and they are either earning or
              nonearning in some real cash-flow sense.

                     Testimony of William Kennett, Inspector General of Banks, at the
                     Estey Inquiry, with respect to the actions of the Office of the
                     Inspector General concerning the Canadian Commercial Bank (as
                     reported by Estey, l986: 459).

        It was not always necessary to utilize a Principal Group affiliate to effect the
strategy, if Principal Group management could find a third party sympathetic to its
interests. Such a third party would be willing to accommodate the objectives of Principal
Group management if there were no risk to the third party and benefits to be obtained
from agreeing to the accommodation. These "no risk third party" transactions were
similar in nature to transactions associated with the collapses of the Canadian
Commercial Bank and the Northland Bank, most noticeably the latter. Prior to the
Northland Bank collapse, management had established Epicon Corp., into which much of
the Northland Bank doubtful loan portfolio was transferred on the basis of 100% financing
from Northland, and by which losses were deferred or income recognized on such poor
quality loans (Estey, l986: 554-556). Similarly, Principal Group management would
guarantee a third party a gain or fee and assure it of no risk if it would take over a loan or
loan assets. One simple way to effect such a transaction would be to provide excess
financing to the third party, such that the loan transaction was 100% financed by Principal
Group, yet the third party had excess funds to invest for other purposes. Understandably,

these transactions were more costly to Principal Group than those involving the use
of affiliates (Code, l989: 131).

             By conventional standards, the (Northland) bank could have closed its
             doors sometime in l983. l984 the financial statements of the bank had
             seriously departed from reality. ...Courageous bank management is one
             thing but complete and accurate disclosure regarding the rules of the road
             in banking must be at all times present. Here, that line was crossed,
             probably as early as l982, but certainly by l984.

                    Estey (l986: 191, 198, 206)

             I think our 1984 report was the first time that we made a concerted effort to
             tell the outside world what we thought we were and what we were trying to
             be and evolved into.

                    Testimony of William Neapole, former chief executive officer of the
                    Northland Bank, at the Estey inquiry, as quoted by Estey (l986: 224).

             A phrase common in all this testimony was "managing the bank's income

                    Estey (l986: 187)

        By way of comparison, the Northland Bank made similar use of a subsidiary to
create wealth where no wealth had been before, through the creation of Epicon
Properties Inc.. The creation of the company was announced publicly in July of l983.
The corporation had a share capital of $100. It was owned 55% by Northland Bank and
45% by Ellesmere Developments, the latter being a company in which two real estate
developers and borrowers from the Northland Bank had an interest. The idea was that
poorly-performing loans would be transferred to Epicon and thereafter "disposed" through
Epicon to other corporate vehicles in which Northland had no direct interest. In
transferring the loans to Epicon, it was considered that Northland would at least recover
the value of its security--thus, there was no need to write the loan down to currently
depressed real estate values. When the loan was then assumed by another corporate
vehicle, it was assumed that the loan was essentially a new loan, and that any interest
previously unrecognized could now be recognized, based on the "new" loan also being
treated as a "performing" loan. Previously, and in accordance with normal banking
practice, Northland had not accrued interest on loans which had been classified as
nonperforming. The fact of foreclosing on the property securing a nonperforming loan
was not considered to improve Northland's situation such that interest could be

             They (Northland) wanted to repaint the loans so that they did not shine out

              as a bad debt; they wanted to repaint them as a good debt, I take it? ...I am
              no accountant but it looks like they took a used car and repainted it.

                     Comments of Mr. Justice Estey during the course of his inquiry, as
                     reported by Schreiner (l986b)

              Can I saying the molten core of this bank, the loan portfolio,
              had not been itself organically changed but the view taken of it changed...?

                     Question by Estey Commission counsel to one of the Northland
                     Bank auditors, as quoted by Estey (l986: 239).

        With the establishment of Epicon, management took the position that foreclosing
on the property actually put Northland in an improved situation, since the loan would be
transferred to Epicon and ultimately refinanced to a new borrower. Thus, with the
consent of its auditors, management of Northland changed its accounting policy and
began to recognize revenue when properties were foreclosed. While the creation of
Epicon was disclosed in the bank's l983 annual report, the change in accounting policy
relating to interest recognition was not. Northland would also obtain fees for restructuring
loan transactions. If these transactions all had involved injections of new money into
Northland, the loan valuation and revenue recognition policies adopted would appear to
have been supportable. However, in most cases, virtually all of the funding for the
restructuring of a loan was being provided by Northland itself. In the United States, such
arrangements and consequent accounting practices have been referred to as "daisy
chains" (O'Shea, 1991, 126-135), being a borrowed metaphor "for a group of people
having sex simultaneously" (O'Shea, l991: 130). This term would appear to be a Texas
variation of the "evergreen revolver" associated with the lending and accounting practices
of the Continental Illinois Bank and its correspondent institutions (Zweig, l985: 73-74).
The accounting practices have been generally described as "guacamole accounting",
whereby money went through a "bookkeeping blender" (Saunders, l990).

              If bank accounting standards were more specific with respect to permissible
              practices, many of the questions regarding fair presentation (of the
              Canadian Commercial Bank) would not have arisen. ...We believe that the
              accounting and reporting practices of Canadian financial institutions should
              be reviewed with the objective of constraining the reporting alternatives
              available to management.

                     Waterhouse and Tims (l987: 157, 158)

              Market prices cannot be used to arbitrate disagreements over assessment
              values, since the essence of the "going concern" approach is that current
              market values are an inappropriate measure. What matters is the value of
              the asset that the bank will be able to realize over an indefinite time horizon,

             an uncertain outcome that leaves considerable scope for honest
             disagreement as well as for convenient fudging. ...In the case of (the
             Canadian Commercial Bank) and Northland, however, the divergence of the
             financial statements from reality was too wide to be explained away by a
             reasonable divergence of professional opinion.

                    Report of the Standing Senate Committee on Banking, Trade and
                    Commerce, concerning compensation legislation for depositors of
                    the Canadian Commercial Bank and the Northland Bank (l985
                    [December 19]: 28, 45).

             ...should (Canadian Commercial Bank) tactics, practices and performance,
             from l983 to l985 inclusive, be measured, not against the standards and
             principles followed by the major banks in their conventional operations, but
             against the conduct of management in an enterprise whose energies must
             be largely devoted to simply keeping the doors open?

                    Estey (l986: 80)

       With respect to the Canadian Commercial Bank and the Northland Bank, it was
found that the foregoing accounting practices were not generally subject to challenge by
the external auditors, notwithstanding that some of the accounting policies adopted
involved a direct rejection by bank management of recommendations of the auditors (e.g.
Estey, l986, 89, 143). For example, loan loss provisions recommended by the auditors of
the Canadian Commercial Bank in l983 and l984 were rejected by bank management.
Instead of reflecting the loan loss provisions as a reduction in income, management
chose to reflect the loss through an appropriation of the bank's retained earnings. Such
an appropriation did not involve the establishment of a cash reserve, but rather a
repositioning of an residual accounting number with no cash effect--a repositioning which
nonetheless was not reflected as a reduction in the income reported by the bank. Such a
compromise was accepted by the auditors in their report to the directors of the bank
(Estey, l986: 146).

             The (Office of The Inspector General of Banks) relied almost entirely on the
             auditors' inferred approval of the loan portfolio as assessed by
             management when (the auditors) certified the financial statements without
             qualification. So long as this condition continued, the (Office of The
             Inspector General of Banks) submitted it was inappropriate for the regulator
             to move in and close the bank.

                    Estey (l986: 158), summarizing a justification advocated by the
                    Office of The Inspector General of Banks.

       Principal Group management adopted similar policies to defer direct recognition of
losses, by way of the appropriation of retained earnings, rather than recognizing such loss

directly as an expense through writing down the loan. This policy was adopted by
Principal Group management for reporting the results of the l984 fiscal year and following,
concurrently with changing the classification of foreclosed real estate from inventory to
that of a long term investment.

    "Retained earnings" is a residual balance sheet account, primarily comprised of the
accumulated year-to-year income or losses of a business entity. It does not represent

               The retained earnings account does not, of course, represent the amount
               available to the shareholders to take out of the company any time they like.
                There are two reasons for this. First, whether the company has sufficient
               and suitable assets to pay dividends is something that can only be
               determined by analyzing the asset side of the balance sheet. Second, the
               net incomes and/or losses that have been included in the retained earnings
               account each year are the end result of an accounting measurement
               process... The usual historic-cost-based accounting system does not
               attempt to portray the current market values of the assets, and hence (since
               retained earnings is the ultimate balancing figure on the balance sheet) the
               balance in retained earnings does not represent the net market value of the
               assets available to shareholders.

                      R.H. Crandall (l990: 637)

        In short, any appropriation from retained earnings does not amount to the
establishment of a cash reserve, which must be constituted separately. Principal Group
management made appropriations from retained earnings with respect to losses, and in
so doing appeared to adopt a variation of an accounting practice at the time generally
accepted by banks, including the Canadian Commercial Bank and the Northland Bank.
These practices did not improve the financial health of the financial institutions.

               The evidence tends to show that accounting policies and the manner of
               financial presentation were brought in aid of presenting the best picture
               possible. But behind the scene, the evidence tends to show, many
               accounting gains were not real, full disclosure of intercorporate transactions
               and accounting manipulations was not made...

                      Code (l989: 132)

       Regulators of the Canadian Commercial Bank and the Northland Bank did not
challenge various accounting practices adopted by the banks, on the basis that they
relied on the expertise of the external auditors (Estey, l986, 156-158). In addition, the
insurer of bank deposits (The Canada Deposit Insurance Corporation), a federal agency,
while greatly familiar with the financial difficulties of financial institutions, was not directly
involved in the assessment of bank accounting practices or the determination as to

whether the banks should be "rescued" (Estey, l986, 119). By contrast, regulators of the
Principal Group, even though not going beyond the audited numbers in their own reviews,
commenced warning the Alberta government about difficulties with the investment
contract companies as early as l973 (Code, l989: 346).

             When explaining the theory of relativity in layman's terms, J.L. Synge (l970),
             the noted physicist, commented on the tendency of many people to confuse
             conceptual models of real-world things and events with the things and
             events themselves. He dubbed this the Pygmalion Syndrome, after the
             symptoms of the legendary sculptor of Cyprus who a carved a statue of
             such surpassing realism that it came to life and he fell in love with her (it?).
             ...I have found the disease to be as "rife" among accountants as Synge
             found it to be among physicists.

                    Heath (l987, 1,2)

             At issue is whether reliance on technical accounting rules is acceptable
             when the resulting financial statements are misleading.

                    C. Robinson (l987), commenting with respect to the commencement
                    of litigation against the auditors of the Canadian Commercial Bank.

        By l986, the distinction between economic reality of the Principal Group and the
accounting representation of that reality appeared to be increasingly blurred. After one of
the investment contract companies recorded a $2 million loss in September of l986, the
Superintendent of Insurance told Principal management that "he would be willing to
overlook the questionable valuation of the assets if the companies stopped posting
losses" (Canadian Press, l988f). Thus, provided that accounting representations
demonstrated profitability, the economic substance of such representations need not be
further addressed. Most recently, this "form over substance" approach to the assessment
of loan quality has found legislative support in U.S. banking reform legislation, whereby
short-term construction loans maturing within two years may be "rolled over" (that is,
refinanced and not considered for writedown) provided that "prudent banking standards"
are met (Bacon and Bleakley, l991). It would appear that the "evergreen revolver"
previously described has now received legislative sanction, at least in the short term.

             This culture of (Generally Accepted Accounting Principles) has one
             overriding maxim: calculate what you can verify.

                    Abdel-Khalik (l991: 83; author's emphasis)

             According to what we allude to as our "generally accepted accounting
             principles", we appear to prefer to be precise, though wrong, rather than
             vague, though right.

                     Ross (l971 [l972: 165])

              GAAP calls (sic) for recording and maintaining most corporate assets and
              liabilities based on their original cost--a practice akin to measuring a
              person's size by his birth weight...

                     Worthy (l982: 117)

              If individuals have become accustomed to using probabilistic weather
              forecasts in making decisions on how to dress...isn't it time they learned
              how to use probabilistic financial statements?

                     Comments from public lecture of accounting professor J. Ronen, as
                     reported by C. Robinson (l986).

        With respect to the financial institution failures, a major difficulty noted has been
the valuation of long-term monetary investments (such as mortgage loans) in a
recessionary environment. With respect to regulator conduct, it has also been noted that
the auditor's report appeared to take on a "rational myth" quality. With respect to the
financial institution failures, a similar mythical quality appears to have been associated
with the accounting information generally. The precepts of external reporting, such as
historical cost, have not been significantly altered by accountants, despite criticisms. In
addition, the limited role of accounting information in decision-making is not generally

              Our Bank Act stipulates that every bank must have a chief accountant,
              (but)...the accounting function has typically been treated as a dumping
              ground for worn-out branch managers for whom the bank could find no
              other useful purpose.

                     Comments of Richard Taylor, a Vice-President of the Canadian
                     Imperial Bank of Commerce, as reported by Galt (l986).

       In the regulation of the financial institutions, accountant regulators reviewed
accounting information prepared by and audited by other accountants. The form of
accounting information was also as determined by accountants. In making accounting
representations, management of the Principal Group was required to follow the
pronouncements of the Canadian Institute of Chartered Accountants and other
accounting principles generally accepted. Managements of the Canadian Commercial
Bank and the Northland Bank were required to follow the directives of the Inspector
General of Banks and other accounting principles generally accepted. The regulation of
accounting information is effectively by accountants. The information is produced by
accountants. The information is audited by accountants. This is an historical trend which
has generally gone unchallenged. Public perceptions that the interests of accountants

may be in furthering the interests of their employers or clients through the use of
accounting information is relatively recent (Boland, l982). Reference has been made to
the use of experts by financial institution management to justify the positions taken,
primarily with respect to the avoidance of recording losses. Thus, accounting may be
viewed as means of sustaining existing social, political and economic arrangements by
persons legitimized by virtue of their professional status. The legitimacy accorded to
accounting regulators by the public may in fact be a legitimization of a fallible professional
status quo:

              ...a process or institution is legitimate if it continues to be acceptable to its
              constituency in spite of the challenges posed to its credibility by the
              inevitable crises that surround the exercise of such authority. In short,
              legitimacy implies acceptability in the face of uncertainty, and that, in turn,
              implies institutional durability.

                     Johnson and Solomons (l984: 167)

              ...accounting is becoming more an esoteric language of the elite, and less a
              means of communication to the ordinary investor.

                     Mathias (l990b)

        The foregoing has led to such questions as whether accounting regulation is
predominantly an ideological exercise (Merino and Neimark, l982; Neimark, l990) and
whether external financial disclosure in purported compliance with such regulation may be
dichotomized as a ritualistic ("going through the motions") or as an opportunistic
(disclosing that which is to one's advantage) exercise (Gibbins, Richardson and
Waterhouse, l989, l990). One view emanating from this perspective is that most
accounting disclosure will generally not exceed that which one is compelled to disclose,
either as a consequence of current regulation or, as a consequence of a "crisis of
credibility" in the wider social system (Merino and Neimark, l982: 47) in anticipation of
further regulation if one does not disclose. These perspectives relate to earlier
perspectives developed in organizational behaviour that information is often more
important for its symbolic value than for its relevance to decision-making. Based on a
review of several case studies in this literature, Feldman and March (l981: 174) made
several conjectures, including the assertion that much of the information used to justify a
decision is collected after the decision has been made.

        With respect to the financial institution failures under consideration, the concerns
emanating from the foregoing relate to the degree to which regulators and others
regarded accounting as reflecting some form of objective or rhetorical (Carruthers and
Espeland, l991) "truth", requiring more of such information prior to deciding to act. As
previously noted, much of the regulation of the financial institutions was based on
financial information submitted by the institutions; information which was largely

unquestioned as a primary basis for decision-making, to the extent that the information
was used at all. For example, in l983, a note to the financial statements of First Investors
Corporation raised concerns as to the company's continued existence as a going
concern. Senior Alberta regulators did not appreciate the significance of the note,
testifying at the Code inquiry that they did not recognize it as a going concern note. No
regulatory action was taken as a result of this disclosure (Code, l989: 367).

              Tell me any other business where you can book future profits, currently,
              especially when the same future profits are in substantial jeopardy for a
              number of reasons... . I don't care what the auditors recognize, the bank
              simply did not make the money, and we can't spend it.

                     Speech of Northland Bank director K.M. Stephenson to the Board of
                     Directors in l982, as quoted by Estey (l986: 184)

              If we `stand back', in the words of (expert accounting witness) Broadhurst, it
              is evident that something must be wrong with a system which can produce
              financial statements for a bank, approved as being fair by external auditors
              and showing an improvement in the condition of that bank, when the true
              situation revealed by a close examination by neutral examiners of the loan
              portfolio is quite the opposite.

                     Estey (l986: 248)

       Quite simply, accounting income bears but a coincidental relationship to the
existing and prospective cash flows of an enterprise, though this basic fact is frequently
overlooked or misunderstood. For example, in reporting to the Minister of Finance as to
the financial condition of the Canadian Commercial Bank prior to the l985 support
program, the Inspector General of Banks referred to the bank "earning money" at certain
times previously (Estey, l986: 472). On the other hand, in the three cases under
consideration, management's motivation for seeking government assistance was that the
financial institution had run out of cash, irrespective of the reporting of positive
acccounting income. Management may choose to be frank about the limitations of the
representations of accounting income, though in the cases under consideration,
management of the three financial institutions appeared to believe that accounting
policies enhancing accounting income would stay depositor concerns.

              Left to itself, bank management may be sorely tempted to cross over the
              boundary of appropriate accounting treatment in order to maintain, through
              synthetically enhanced income statements and protected balance sheets,
              the confidence that, in banking, is essential for survival.

                     Estey (l986: 162)

              ...the investors maintain the collapse of Western real estate "hosed the
              sand away from the rock", exposing what was taking place in the

                     Argument of lawyer for Principal Group investors, in context of court
                     motion, as reported by Powell (l988d).

              Apart altogether from the technicalities of accounting rules, it offends
              common sense that a bank with the level of unsatisfactory loans which (the
              Canadian Commercial Bank) had in the years l983 and l984 could by the
              simple workout device obviate all need for cessation of income recognition
              or the taking of provisions against losses. Thus on principle and in detail
              the practices followed by the auditors of (the Canadian Commercial Bank)
              in reviewing the financial statements proposed by management were clearly
              in error...

                     Estey (l986: 144)

       That which was "clearly in error" was frequently a negotiated error between the
auditors and bank management, with the extent of negotiation or ranges of possible
negotiated values largely unknown to either the general public or to the regulators. For
example, with respect to the Northland Bank, an original proposal by the auditors to
reverse approximately $5 million in interest and fee income was reduced to $550,000 as
a result of negotiations with management.

              Somehow I had to try to measure what level of tolerance there was out
              there for a turnaround. Tolerance in the minds of auditors, regulators,
              depositors, other banks, the system if you like.

                     William Neapole, former chief executive officer of the Northland
                     Bank in testimony at the Estey inquiry (as quoted by Estey, l986:

        With respect to the Canadian Commercial Bank and the Northland Bank,
scepticism with respect to the public face of auditing was translated into lawsuits by the
liquidators of the banks against both the auditors and management of the banks. The
confusion between the public and private face of auditing was recently maintained when
these lawsuits were settled by management, directors and the auditors of the Canadian
Commercial Bank and by the auditors of the Northland Bank. The amounts to be paid in
settlement are substantial: $82.4 million with respect to the Canadian Commercial Bank
and $43.2 million with respect to the Northland Bank (S. Smith, l990). While it is
estimated that the Canadian Commercial Bank auditors are responsible for 80-85% of the
settlement payable in that action (Jeffrey, l990), it is dictated in the terms of settlement
that the specific amounts to be paid by the auditors and the specific amounts to be paid
by management and directors not be separately disclosed (Milner, l990a; Jeffrey, l990).

In addition, the terms of settlement in both actions incorporate a specific denial in the
court record by the auditors of "all liability or fault" (Milner, l990a; Yakabuski, l990b;
Jorgensen, l990).


       From the foregoing, we may observe that there are several institutional effects
associated with regulatory actions, to the extent that one examines institutional effects
from perceptual bases and the "environment" from the perspective of the regulator. From
this chapter, the primary events considered
to be reflective of institutional effects may be summarized as follows:

(1)   The specifics of the regulation of the three financial institutions took place largely
      outside of the public eye. The private regulatory "cloak" extended to the
      expression of public assurances by regulators to the public in circumstances where
      there existed internal regulatory reservations. The private regulatory "cloak" would
      appear to have been facilitated by the fact that prior to the closures of the three
      financial institutions, the public profiles of the regulatory agencies were low.

(2)   Justifications for the regulatory "cloak" were referenced to (i) the perceived
      regulatory need for frankness and confidentiality in the regulator-regulated
      relationship and (ii) concerns as to public loss of confidence, leading to a "run on
      deposits", if regulatory actions with respect to the serious financial distress of a
      financial institution became public knowledge. With respect to (ii), regulatory
      concerns appear to be referenced more to regulatory concern that knowledge of
      regulatory involvement precipitated the "run", rather than being based on more
      general concerns as to the integrity of the financial system.

(3)   Regulators exhibited a general passivity with respect to their regulatory tasks,
      including (i) a passivity with respect to the evaluation of financial information upon
      which regulators were expected to exercise judgment and (ii) reacting
      unreflectively to the immediate stimuli of circumstances.

(4)   Regulatory passivity extended to regulatory behaviours with respect to addressing
      infractions by financial institution management, including breaches of agreements
      with regulators; such infractions or breaches of accords were largely ignored,
      unsanctioned, or sanctioned with ineffective or cosmetic consequences.

(5)   With respect to (3) and (4), regulatory passivity changed to accelerated action,
      once a decision to take action had been made internally, with political approval, or
      in circumstances where another regulatory agency had initiated action. "Follow the
      leader, whoever the leader may be" behaviour is evident, much like following the
      direction of a crowd to an exit in a fire--or to what is believed to be the fire exit,
      given the direction of crowd movement. Such accelerated actions are most

      frequently out of time and ineffective or redundant. This has been described as a
      "domino effect".

(6)   Regulators were generally satisfied with an appearance of solvency on the part of
      the financial institutions, as supported by accounting representations. Accounting
      representations assisted in creating appearance of solvency by enabling financial
      institution management to support representations as to financial institution
      solvency in circumstances where the substance of deteriorating loan portfolios had
      not changed. The "stimuli of circumstances" of the regulator, referred to in (3),
      often took the form of disagreements and negotiations between the regulator and
      financial institution management as to the propriety of financial statement
      representations, which negotiations were generally resolved in favour of financial
      institution management. To the extent that the financial information presented in
      support of the maintenance of an image of solvency by financial institution
      management is considered to be erroneous, such errors were negotiated errors
      between the regulator and the regulated. Such representations met with the
      concurrence of external auditors during the major periods of the lives of the
      financial institutions during which such representations were made; direct
      involvement between regulators and external auditors only occurred during the
      latter periods of the lives of the respective financial institutions.

(7)   Contrary to the history of Canadian financial institution regulation, the three
      institutions under consideration were closed and liquidated, rather than being
      merged with other financial institutions. It is noted that the closures and
      liquidations are not unique to the history of Canadian financial institutions, but that
      related precedents are not common.

       From Chapter 2, four aspects of the "blended" relationships among institutional
theory and evidence, an overview of related regulatory theory and evidence, and an
overview of theory and evidence from the "financial institution failure" were identified.
These "blended" aspects will be reproduced herein and thereafter discussed with
reference to the findings from this chapter.

(1)   Existing literature with respect to contemporary financial institution failures
      emphasizes perceptual effects: of the regulator, of the external auditor and of
      financial institution management. All appear to have an interest in a sense-making
      process associated with objective financial distress that defers the recognition and
      acceptance of such distress. As briefly summarized (in Chapter 2), the regulation
      literature would appear to be less concerned with general sense-making, but more
      concerned with procedures whereby it is reasonable to expect the regulator to
      identify wrongdoers.

        From the review of symbolic legitimation practices in Chapter 2 (e.g. Richardson,
l985), it is submitted that a related dimension to sense-making is that of image-

maintenance, relative to the perceived expectations of another and based on an
assumption by the image-maintainer that the other's expectations are largely based on
ignorance of the "true" state of affairs. In other words, the image-maintainer is aware of
the need for sense-making on the part of the other, and "plays" to those expectations.
The doctor-patient relationship as compared to a doctor-doctor relationship was used in
Chapter 2 to illustrate the distinction between symbolic legitimation practices (which are
submitted to be present in the three cases under consideration) and legitimation in
substance. It has been noted that an institutional dimension to such behaviours may be
summarized as "correct structure and process lead a regulator to assume solvency of
output". Image-maintenance practices of financial institution management have been
discussed with reference to the uses of accounting information and favourable
negotiations with the regulator concerning matters of judgment with respect to such
representations. The regulator is also concerned with image-maintenance, predominantly
with respect to managing the perceptions of the public, thus justifying the existence of the
regulatory function as to the maintenance of the solvency and integrity of the Canadian
financial system. This has been viewed in the "financial institution failure" literature as a
"distorted communication process" (Wright, l989) in that justifications with reference to
larger public interests are in fact supportive of private interests benefiting from such
justification, such as the maintenance of the regulatory regime. There is no evidence of
image-maintenance behaviours on the part of a regulator to manage the perceptions of
the regulatory function by management of the regulated financial institutions. In short,
while the regulated manages the perceptions of the regulator, the converse does not
occur. Ex post image management on the part of the external auditors of the financial
institutions is evident by the fact that none have yet to admit error and, in the context of
litigation settlements associated with the Canadian Commercial Bank and the Northland
Bank, all specifically denied fault.

(2)    In the institutional literature, conforming behaviours consequent upon institutional
       forces are identified, leading to repetitive, inertial behaviours as a general sense-
       making exercise in circumstances of uncertainty. Repetitive, inertial behaviours
       lead to a general resistance to change and an inability to appreciate changed
       circumstances requiring altered behaviours.

        As discussed in this chapter, regulatory sanctioning processes were largely
ineffective. There appeared to be a general reluctance on the part of regulators to accept
that altered courses of regulatory conduct were required in order that financial institution
management remain "on side". This reluctance is particularly evident with respect to the
regulator-regulated relationship associated with the Principal Group.

(3)    Blending the perspectives in (1) and (2), it is to be expected that regulatory sense-
       making will be evidenced by patterns of routinized behaviours which are primarily
       referenced to the satisfaction of regulatory expectations as to form rather than
       substance. To the extent that such behaviours and behavioural patterns are
       discovered through the three case studies, they may be viewed as evidencing the

       consequences of institutional forces.

      In the review of this chapter, as well as from the case studies, the specified
behaviours are evident, particularly with respect to the use of accounting representations
and the "desk audits" associated with such representations. Provided that solvency in
form was represented through the assets of the financial institutions being shown as
unimpaired notwithstanding depressed market conditions, regulars were generally
prepared to accept that the financial institutions were solvent in fact.

(4)    With reference to (1) and (2), while it may be that the regulation literature
       evidences a concern for the discovery of the wrongdoer, institutional theory and
       evidence, coupled with existing literature referenced specifically to financial
       institution failures, involve companion predictions that the wrongdoer, the deviant
       or the incompetent will not be the subject to ready discovery by regulators.

         Crisis-based intervention in the affairs of a financial institution is not a routinized
regulatory behaviour; in fact, with respect to the regulators in the three cases under
consideration, it is a behaviour without precedent. Passivity of regulatory action, based in
part on considerations of trust, are to be expected, as are image-maintenance behaviours
by the regulated--through, among other means, accounting representations. In the three
case studies under consideration, the impending financial doom faced by these financial
institutions appeared to come as a surprise to the regulators.

         It has been noted that conforming behaviours are associated with institutional
effects, but that behavioural differences in substance rather than form are generally not
subject to discriminant rewards. In short, the hypocrite remains undetected in an
environment rewarding conformity. These institutional effects may be generalized as
involving a positive ascription of values and a reluctance to accept or act on evidence
which challenges such ascriptions or, in the case of the private face of regulation, which
might cause others to challenge the ascriptions. Roughly, if you believe that something is
good, it is difficult to accept evidence that it is bad. Regulators are reluctant to disclose
their concerns with respect to a particular financial institution, due to fear as to how that
disclosure might affect public perceptions of the financial institution and financial
institutions generally. Failures are "framed" as mergers, again based on regulatory
concern with respect to the consequences of a challenge to public perceptions of financial
institutions.    Accounting representations are regarded as objective and reliable,
notwithstanding evidence of wide variations between the representations and the
economic reality.

A Potential Contribution to Theory: Obliterating Institutional Challenges

      To the four generalized institutional-regulation-"financial institution failure"
dimensions of a literature "blend" identified in Chapter 2 and discussed herein, a fifth may
be added based on the discussion in this chapter:

(5)    Actions subsequent to inertial behaviours do not mean that institutional forces
       have been overcome, or that altered behaviours may be expected in the future.
       Rather, one observes repetitive actions aimed at obliterating the challenge to the
       propriety of the institutional belief.

         As was noted in this chapter, regulatory passivity changed to accelerated action,
once a decision to take action had been made. This has been described as "follow the
leader, whoever the leader may be" behaviours, as well as reflecting "domino effects". As
has been noted, such accelerated actions are most frequently out of time and ineffective
or redundant. Incidents have been detailed of multiple actions taken by regulatory
agencies, notwithstanding that such actions may be of questionable utility in deterring
future behaviours--such as regulators suing former Canadian Commercial Bank chief
executive officer Howard Eaton, subsequent to his bankruptcy. Delay is a predictable
consequence of a reluctance to accept or an inability to recognize that an imposter is in
one's midst. When such imposter is discovered and one regulatory agency determines to
act, it has been observed that others will quickly follow, irrespective of the redundancy of
actions. It is as if all must "blot out" the imposter in order that institutional perceptions be
restored and not further contradicted. Such behaviours are evident in the fact that, in all
three cases, once a decision was made to close a financial institution, evidence
potentially disconfirmatory of the closure decision, as made in representations by financial
institution management or potentially available through refinement of loss estimates, were
ignored. Inertial tendencies, habituated to significant degrees, give way to unrestrained
haste to obliterate the discomfort to inertia.

              Many institutionalized practices are self-sustaining, persistent patterns of
              activities and beliefs that do not need either social intervention or supporting
              incentives to be perpetuated, nor are they necessarily attributable to self-
              interested motives. Once social consensus around the stability and integrity
              of financial institutions is entrenched in history, habit and convention, once
              the legitimacy and apparent rationality of the whole financial infrastructure is
              institutionalized (including external auditor reports and accounting
              representations), then in many ways it is not at all surprising that regulatory
              examination was cursory and protracted. It is not surprising that accounting
              information was largely unquestioned, that there was "excessive" reliance of
              the regulators on the external auditors' reports, that there was an inability
              (as much as there was a reluctance) to perceive fatal weaknesses in these

                      Oliver (l993: personal communication; communicator's emphasis)

              Saying that procrastination benefits officials...does not imply that officials
              are fully aware of these benefits or that they calculate them consciously or

               routinely. ...These incentives effectively put a high price on doing the "right"
               things. The problem is ignorance, not venality.

                      Kane (l989: 21-22), with respect to legislative delays associated with
                      the U.S. Savings and Loan "crisis".

         There is one dimension to the behaviours of regulators that contradicts
institutional predictions and, as has been noted, is generally contrary to the history of
regulation of Canadian financial institutions. This dimension relates to the fact that the
three financial institutions have been liquidated and sold, rather than merged with other
financial institutions. The prediction from institutional theory and evidence may be
formulated as follows:

       An Institutional Prediction as to Financial Institution Merger


       Failed financial institutions will be merged, rather than liquidated and sold, based
       on considerations of image maintenance and conformity.                   Irrespective of
       discriminant financial considerations, a merger of a financial institution is not
       perceived to be a failure of that institution and thus does not present a challenge to
       institutionalized beliefs with respect to financial institution regulatory processes or
       government supervision of such processes.                 The challenges to image
       maintenance of government and related regulatory regimes of a perceived failure
       of a financial institution outweigh cost considerations in determining the means by
       which a failed financial institution will be removed from the market.

          In explaining the anomalous liquidations of the three financial institutions, relative
to institutional predictions, certain aspects of the financial institutions or their respective
circumstances appear to be unique. Firstly, it is to be noted that in all three cases the
respective governments were at liberty to do nothing, thus compelling creditors to act to
protect their interests. The actions of creditors could have taken the form of seizure and
liquidation of financial institution assets or operating and later selling a financial institution
as a going concern. In the three cases under consideration, there is no evidence that the
"do nothing" alternative was addressed by the respective governments. This absence of
consideration of the "do nothing" alternative may be viewed as a "taken for granted"
assumption of participants at the political level that financial institution distress involved an
obligation on the part of government to act, or to appear to act, in the interest of the
protection of the financial interests of its citizens.

        With respect to the Principal Group, it was one of only a few remaining investment
contract companies in Canada, the deposits of which were uninsured. Thus, short of the
Alberta government agreeing to insure all deposits on an ad hoc basis, and thus drawing
attention to its own previous inaction, any merger with another investment contract

company or financial institution was effectively impossible. It is to be noted that the
related trust company, Principal Trust, was acquired by the Metropolitan Life Insurance
Company, and changed in name to Metropolitan Trust, without apparent public concern.
The extent of deposit insurance protection required to effect this sale, if any, is unknown.

          With respect to the Canadian Commercial Bank and the Northland Bank, the
difficulties of these banks came to the attention of the Government within a year of the
Conservative Party coming to power. The support program for the Canadian Commercial
Bank, initiated in April, l985, was formulated within months of the government coming to
power in the fall of l984. With the exception of a nine-month Conservative government in
l979, the Conservative Party had not been the governing party in Canada since the
Diefenbaker government of the early l960s. When the responsible Ministers were faced
with the immediate financial distress of two financial institutions, one may conjecture that
the institutional forces favouring merger were not sensed by comparatively inexperienced
regulatory participants at the political level. With respect to the establishment of norms,
there is general recognition in the institutional literature that the appreciation of such
norms are a function of experience. Perceptions of regulatory failure become a function
of misperceptions at the political level as to the nature of institutional forces. In short,
relative to the general direction of such forces, the closures and liquidations of the
Canadian Commercial Bank and the Northland Bank may be viewed as a mistake; the
nature and direction of such forces were misperceived.

         From the discussion in this chapter which references merger and liquidation
developments both prior and subsequent to the closures of the two banks, it is to be
noted that, at the Federal level, all subsequent closures of Schedule 1 banks have been
by way of merger. The only bank liquidation subsequent to the closures under
consideration has been that of the Bank of Credit and Commerce Canada which, as has
been noted, was closed at the behest of regulators in England and under a "cloud" as to
allegedly fraudulent or unethical business practices (Canadian Press, l991h; Lascelles et
al., l991a). In addition, at the level of Federal regulation of trust companies, subsequent
to the liquidations of the Canadian Commercial Bank and the Northland Bank, there has
been no closure of a trust company other than by way of merger. At the level of provincial
regulation of trust companies, there has been one liquidation which has been noted--that
of Shoppers Trust, a one-office Toronto-based trust company that was closed and
liquidated within two months (Howlett, l992; Yakabuski, l992c). It is submitted that the
minimal public presence of this trust company and the speed of its liquidation rendered as
inconsequential any challenge to institutional effects otherwise posed the act of
liquidation. Thus, it is submitted that the institutional forces favouring the merger of
financial institutions continue to be present.

        Regulators do not regulate in an unconstrained or self-contained fashion.
Financial institution regulators are accountable to the politicians who have established the
regulatory mandate. Often, the regulator appears to be alone, in the front of the "firing
line" of public opinion. The political dimensions of financial institution regulation, while

frequently not prominent in the public's mind, are pervasive. In this Chapter, some of
predictions from institutional theory have been associated with political conduct. The
general political dimensions of regulation will be discussed in the Chapter 9. In addition,
some of the "blended" political-institutional dimensions of regulation will be discussed in
Chapter 10.

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