Nothing Ventured, Nothing Gained: The Rise of Canada’s Unique Capital Market for Start-Ups
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Many people know of the historic dinner where bitter foes Alexander Hamilton and Thomas Jefferson, moderated by James Madison, hashed out a compromise that put the United States on a sound economic footing over many bottles of claret: federal assumption of the states’ Revolutionary War debts in exchange for a new capital to be built in the South. Although it was not quite so momentous, a similar evening of earnest discussion and good wine enabled the various regional stock exchanges in Canada to combine to form what is today the Venture Exchange. While that institution is formally only 12 years old, its predecessor exchanges trace their heritage back more than a century.
Global access to capital was also the topic on October 25, 1861 when 24 men gathered at The Masonic Hall in Toronto. It was just three months after the first Battle of Bull Run opened the American Civil War in deadly earnest, and the rapidly-spreading war south of the 48th parallel severely restricted Canadian access to markets in the US, especially New York and Philadelphia. The war at sea even made communication with London and Paris more difficult. Insurance and interest rates were rising.
A resolution was passed that day and Toronto Stock Exchange (TSX) was born. The cost of membership was $5. In its early years trading volume was very modest, amounting to two or three transactions daily. Trading hours were limited to daily half-hour sessions, and the trading list consisted of 18 securities.
Just as in the United States, Canada was once dotted with regional stock exchanges. The oldest of these, in Vancouver, opened in 1907 to serve the capital needs of mining and timber operations in British Columbia. Just as in the United States, where California became a state long before the interior territories were organized, BC joined the Canadian confederation in 1871 but the provinces of Alberta and Saskatchewan were not formed until 1905.
But they got right down to business, literally, incorporating a stock exchange in Calgary in 1910 to fund the oil, grain and cattle businesses east of the Rockies. The same year the Winnipeg Stock Exchange came on the scene to support the grain and other agribusiness of the Canadian prairies.
To this day those industries continue to provide the core of the provincial economies, and are still served by the Venture Exchange. Mining companies constitute 54% of the Venture Exchange by number of listings, and 58% by market cap. Oil and gas companies are 13% by number of listings and twice that by market cap.
On November 30, 1999, Vancouver and Alberta Stock Exchanges joined to form the Canadian Venture Exchange (CDNX). The Canadian Dealing Network, Winnipeg Stock Exchange and junior equities portion of the Montreal Bourse subsequently merged with CDNX. By the end of 2001 the TSX completed overhaul of its trading platform as well as the acquisition of the Venture Exchange. CDNX was renamed TSX Venture Exchange in 2002. The S&P/CDNX Index was launched on December 10, 2001. The Index was renamed S&P/TSX Venture Composite Index in May 2002.
By its 10th birthday the Venture Exchange was hitting records. On November 9, 2010, volume traded was 527,777,070 shares, which surpassed the previous record of 437,715,396 set only the day before. A new historical peak for number of Venture Exchange trades executed was also established, with 85,350 surpassing the previous day’s record of 70,624.
Companies listed on Venture Exchange can graduate to the TSX once they meet the listing standards of the senior market. Over the last nine years, 441 Venture-listed companies have graduated, which affirms Venture Exchange’s position as a growth platform. Venture graduates listed on the TSX currently account for $87.6 billion in market capitalization.
From its start in 1907 the Vancouver Exchange grew through the boom years of the Jazz Age. In the momentous year of 1929 the exchange moved to a beautiful Art Deco building in Downtown. For most Vancouverites the structure is still known as the Stock Exchange Building, but it is now formally the Crown Trust Building.
At its peak in the early 1990s there were more than 2,000 issues listed on the Vancouver Exchange, with annual trading volume of approximately $4 billion. The sizes of the exchanges in Canada mirrored the league table of city populations with Toronto first, Montreal second, Vancouver third and Calgary fourth.
The Alberta Exchange ceased operations in 1917, primarily because of declining business volume during World War I, and did not resume until 1926 when it took the name Calgary Stock Exchange. The moniker Alberta Stock Exchange returned in 1975 and remained until the Venture combination.
In Winnipeg the commodity markets ruled, and the stock exchange usually played second fiddle to the grain exchange. An October 16, 1930 story in the Financial Post noted that the stock exchange was moving into a C$25,000 building on Main St. “next to the Wheat Pool.” With the new digs, the exchange also offered longer trading hours, and “transactions in any stock or bond on any other exchange in Canada or the US.” In another reform, all trades were handled through the exchange, rather than between individual brokers.
In the post-war boom and through the next decades Canadian exchanges saw strong growth, but were challenged by governance and regulation as were exchanges in the US. “Manipulation was still common in mining securities through the 1940s and 1950s, and boiler rooms were active,” wrote Lewis D. Johnson and Bohumir Pazderka in their book It’s No Gamble: The Economic and Social Benefits of Stock Markets (The Fraser Institute, Vancouver, 1995). “There were no filing requirements for insider trading, and wash trades were common if not exactly legal. The Windfall Oils & Mines scandal of 1964, in which Viola MacMillan was accused of stock manipulation and wash sales, and convicted of the latter offence, led to the formation of a royal commission and a subsequent tightening of regulation of common stocks on the Toronto Stock Exchange in 1966.”
Little did Johnson and Pazderka know that as they wrote their book, but the biggest market scandal in Canadian history was brewing. It broke just two years after their book was published.
To be sure, the Bre-X gold scandal hit markets across North America. The wrongdoing was confined to the company itself and hurt the exchanges as much as the investors. But it led many to wonder about the relationship between venture capital and public markets.
“The laws of stock market gravity returned with a vengeance in the shape of a Bre-X Minerals calamity,” wrote Canada Stockwatch on March 27, 1997. “The VSE tumbled 56 points to 1130 on 45.6 million shares; the ASE tumbled 88 points to 2711 on 22.4 million. The combined volume of 68 million shares, 6.3 million more than last Friday, saw the ASE’s share of western trading recover to 33 percent, from 27 percent a week ago. In the past five days, the VSE, at 1130, is down 155 points, compared with down 60 points last week; the ASE, at 2711, is down 205 points, compared with down 64 last week.”
The market watchers continued, “Yesterday’s terse comment from Bre-X’s mineral consultants, ‘that there appears to be a strong possibility that the potential gold resources on the Busang project in East Kalimantan, Indonesia, have been overstated because of invalid samples and assaying of those samples,’ was confirmed today by Freeport-McMoRan. ‘Insignificant amounts of gold’ was Freeport’s description, and the blood bath was on. When trading resumed at 12:00 pm Bre-X plummeted to $2.50, forcing the TSE to close early as a result of computer overload.”
Just a week earlier the company’s chief geologist, Michael de Guzman, committed suicide by jumping out of a helicopter more than 700 feet over the Indonesian jungle.
According to a retrospective business case written by Paul J. Irvine, assistant professor of finance at Emory University’s Goizueta Business School in Atlanta, “At its peak, the market capitalization of Bre-X reached over C$6 billion, all from a company that had been a penny stock with a market capitalization measured in the thousands just four years earlier.” Dan Campbell and Daisy Gao assisted Irvine in the analysis.
At one time, Bre-X claimed to have found the largest known gold deposit in the world, according to Irving. The company had been followed and recommended by some of the best-known gold analysts in both Canada and the United States and had been added to the Toronto Stock Exchange’s TSE 300 index and traded on NASDAQ.
Mutual funds, pension plans and private investors all over North America took heavy losses when the stock plummeted in value and was eventually delisted, Irving noted. Numerous class-action lawsuits were filed in Canada and the United States, some naming the Canadian and American investment firms as defendants because they had recommended the stock for so long.
Rowland W. Fleming, CEO and president of the TSX, said of the Bre-X affair, “The lessons here are the old ones. No matter how tough the securities regulations or laws, perpetrators of deceit, and there now seems no doubt that deceit…massive and unprecedented fraud were at play, those people will find a way to break the rules.”
McCoach recalled that “the Vancouver Exchange had developed a reputation not as favorable for access to capital. A lot had changed by the 1990s. The VSX made a lot of progress, but it could not get past the reputation of the ‘80s.” He worked as a broker on the VSX from 1981 to 2002, and was on the Board of Governors.
“There were always many good, early-stage companies on the Vancouver, Alberta and Winnipeg exchanges,” said McCoach. Without capital coming from Toronto or Montreal, there was a need for these exchanges. From their inception to through the 1980s they served their members. But as global capital markets changed, and electronic trading capabilities developed, the reasons for regional exchanges were no longer valid.”
“By 1998 we decided to pursue something different,” said McCoach. “Talks had been held in the past about merging with the Alberta exchange, but they never went anywhere. The new idea was not simply to merge but to create a whole new exchange.”
The Venture genesis started with an exploratory meeting over dinner at the Westin Hotel in Calgary. “The Board of Governors of the VSX invited the chairman and several of the Board of Governors from the Alberta Exchange to dinner,” said McCoach. “I wrote the letter. I don’t remember what wine was served, but the Alberta governors suggested we have BC salmon and Alberta beef. That was a very nice gesture.”
At the time the two exchanges were aggressive but not hostile rivals, and were both proud of their regional focus and flavor. “The question very quickly turned from whether or not the two exchanges were better off separate or together, to what we could do that would really serve Canadian capital markets.”
The answer soon became apparent: a national exchange for early-stage public companies. “That was the vision, not just a merger, but something completely new,” said McCoach. Within a few weeks a plan came together, and the Winnipeg Exchange was invited to the party, as was the Canadian Dealing Network. “The reception was positive each time,” said McCoach.
The reception was also positive when the plan reached regulators. There was no major opposition. Quite to the contrary, within two years of the Venture Exchange opening in 2000, the TSX came back with an offer to acquire the whole show. “That was really a surprise,” said McCoach. “I remember wondering how quickly that offer came after we just got started. Sometimes sitting over a meal and a glass of wine can have some very positive results.”