REPORT OF INVESTIGATION BY THE SPECIAL COMMITTEE OF THE BOARD OF DIRECTORS OF HOLLINGER INTERNATIONAL INC. Gordon A. Paris, Chairman Graham W. Savage Raymond G.H. Seitz Counsel and Advisors Richard C. Breeden & Co. The Law Offices of Richard C. Breeden Counsel O’Melveny & Myers LLP August 30, 2004 TABLE OF CONTENTS Page I. INTRODUCTION AND EXECUTIVE SUMMARY 1 A. A CORPORATE KLEPTOCRACY 4 B. EVALUATING THE BOARD’S CONDUCT 31 II. GLOSSARY 48 III. PRINCIPAL FINDINGS 60 IV. ACTIONS BY THE SPECIAL COMMITTEE 72 A. SUMMARY 72 B. SCOPE OF INVESTIGATION 75 1. TORYS AND KPMG 79 C. EVENTS RELATING TO THE UNAUTHORIZED PAYMENTS 82 1. THE SEC CONSENT DECREE 87 2. THE DELAWARE LITIGATION 88 3. THE ONGOING SPECIAL COMMITTEE PROCESS 93 V. THE BLACK GROUP’S CONTROL OF HOLLINGER 94 VI. THE FIDUCIARY DUTY OF LOYALTY OWED BY COMPANY OFFICERS, DIRECTORS AND CONTROLLING SHAREHOLDERS 100 VII. EXCESSIVE MANAGEMENT FEES PAID BY HOLLINGER TO RAVELSTON 104 A. OVERVIEW 104 B. THE EXCESSIVE FEE PAYMENTS 111 C. THE MANAGEMENT SERVICES AGREEMENT AND NEGOTIATION OF THE ANNUAL MANAGEMENT FEE 123 D. UNWARRANTED AND EXCESSIVE COMPENSATION TO AMIEL BLACK 143 VIII. U.S. COMMUNITY NEWSPAPER TRANSACTIONS AND RELATED “NON-COMPETE” STYLED PAYMENTS 146 A. BACKGROUND 146 B. “NON-COMPETE” STYLED PAYMENTS TO HLG 155 1. AMERICAN TRUCKER 155 2. CNHI I 158 3. HORIZON PUBLICATIONS INC 163 4. FORUM COMMUNICATIONS CO 165 5. PAXTON MEDIA GROUP 167 6. CNHI II 168 IX. FRAUDULENT TRANSFERS OF HOLLINGER CASH TO BLACK, RADLER, BOULTBEE AND ATKINSON 171 A. $5.5 MILLION PAYMENTS IN FEBRUARY 2001 181 B. $600,000 TAKEN FROM HOLLINGER IN APRIL 2001 185 X. THE CANWEST TRANSACTION AND THE RELATED-PARTY PAYMENTS 190 A. HOLLINGER PROCEEDS REDUCED IN RETURN FOR MANAGEMENT FEES TO BLACK AND RADLER 193 B. NON-COMPETE PAYMENTS TO BLACK AND THE RAVELSTON GROUP 198 C. HOLLINGER PROCEEDS DIVERTED TO RAVELSTON 208 XI. PUSHING THE CANWEST RELATED-PARTY PAYMENT PAST THE BOARD 214 A. THE MISLEADING KIPNIS MEMO TO THE AUDIT COMMITTEE 214 B. THE SEPTEMBER 11, 2000 AUDIT COMMITTEE AND BOARD APPROVALS 221 C. INTEREST PAYMENTS ON NON-COMPETES 228 XII. MAY 2001 AUDIT COMMITTEE AND BOARD RATIFICATION OF CANWEST NON-COMPETE PAYMENTS; DELAYED AND MISLEADING PUBLIC DISCLOSURES 230 A. THE MAY 2001 “RATIFICATION” OF THE NON-COMPETE PAYMENTS 230 B. DELAYED AND MISLEADING SEC DISCLOSURES 239 -i- C. BLACK’S MISSTATEMENTS TO SHAREHOLDERS REGARDING THE CANWEST NON-COMPETES 240 XIII. 2001 OSPREY TRANSACTIONS AND “NON-COMPETE” STYLED PAYMENTS 242 A. JULY 2001 TRANSACTION 242 1. THE $4.5 MILLION ALLOCATION TO NON-COMPETITION AGREEMENTS 242 2. DECISION NOT TO CHARGE HCNLP FOR ANY OF THE $4.5 MILLION NON-COMPETE ALLOCATION 244 3. FAILURE TO OBTAIN PRIOR AUDIT COMMITTEE APPROVAL 246 4. PRESENTATION TO AUDIT COMMITTEE AND AUDIT COMMITTEE’S SEPTEMBER 2001 RATIFICATION 247 B. NOVEMBER 2001 OSPREY II TRANSACTION 250 XIV. UNAUTHORIZED AND EXCESSIVE PAYMENT TO COLSON 252 XV. RELATED-PARTY ASSET SALES TO HORIZON AND BRADFORD 256 A. HORIZON AND BRADFORD OVERVIEW 262 B. HORIZON I TRANSACTION 265 1. BLACK AND RADLER MISREPRESENT THE HORIZON CONCEPT’S INITIATION 268 2. FINANCING OF THE HORIZON I TRANSACTION 268 3. MISREPRESENTATIONS REGARDING THE HORIZON I PRICE 271 4. THE “FAIRNESS OPINION” 280 5. OTHER FAIRNESS CONSIDERATIONS IN THE HORIZON I TRANSACTION THAT THE HOLLINGER BOARD NEVER CONSIDERED 281 6. SEC DISCLOSURE OF HORIZON I TRANSACTION 282 C. THE LERNER EXCHANGE 283 D. ARGUS & JOURNAL SALE 291 E. THE BRADFORD TRANSACTION 296 1. HISTORY OF THE BRADFORD PAPERS 296 2. AUDIT COMMITTEE AND BOARD APPROVAL 298 3. MISLEADING STATEMENTS AND OMISSIONS REGARDING THE BRADFORD TRANSACTIONS 301 4. HOLLINGER FINANCING, SUBORDINATION AND GUARANTEE 307 5. SEC DISCLOSURES REGARDING BRADFORD 311 F. THE BISHOP & BLACKFOOT SALE TO HORIZON 312 G. MAMMOTH TIMES SALE 317 1. TARGET MEDIA OFFER 317 2. AUDIT COMMITTEE AND BOARD RATIFICATION OF THE MAMMOTH TIMES $1 SALE 325 H. THE KELOWNA TRANSACTIONS 327 1. EFFORTS TO CONSOLIDATE THE KELOWNA PAPERS 328 2. HORIZON BUYS THE KELOWNA DAILY FROM THOMSON IN 1999 329 3. CANADIAN COMPETITION BUREAU SCRUTINY OF KELOWNA NEWSPAPERS’ OWNERSHIP FOLLOWING HORIZON’S 1999 PURCHASE OF THE KELOWNA DAILY 330 4. DAVID BLACK’S OFFERS IN 2000 TO ACQUIRE THE KELOWNA CAPITAL AND SAN JUAN JOURNAL FROM HOLLINGER 332 5. HOLLINGER’S 2001 SALE OF THE KELOWNA CAPITAL TO WEST PARTNERS 333 6. WEST PARTNERS’ 2003 SALE OF THE KELOWNA CAPITAL TO DAVID BLACK FOR $13.7 MILLION 336 XVI. HOLLINGER DIGITAL, TRIREME AND THE FDR COLLECTION 339 A. HOLLINGER DIGITAL 339 1. FORMATION AND PURPOSE OF DIGITAL 342 -ii- 2. THE 1997 PROPOSED INCENTIVE PLAN 343 3. PROPOSED INCENTIVE PLAN REVISIONS 345 4. FINAL DIGITAL INCENTIVE PLAN 348 5. BOARD AND AUDIT COMMITTEE APPROVAL OF THE DIGITAL INCENTIVE PLAN 354 6. OUTSIDE ADVICE THAT THE INCENTIVE PLAN’S TERMS WERE ATYPICAL AND EXCESSIVELY GENEROUS 356 7. DIGITAL’S INVESTMENTS AND PAYMENTS UNDER THE PLAN 359 8. DISCLOSURE OF DIGITAL INCENTIVE PAYMENTS 361 B. HOLLINGER’S INVESTMENT IN TRIREME PARTNERS 362 C. HOLLINGER’S NEGOTIATIONS WITH TRIREME 366 D. BLACK’S PURCHASES OF FDR MEMORABILIA WITH HOLLINGER FUNDS 373 XVII. EXCESSIVE PERQUISITES PAID TO BLACK, RADLER, COLSON AND AMIEL BLACK 386 A. OVERVIEW OF NON-AIRCRAFT PERQUISITES 388 B. BLACK’S AND RADLER’S PERSONAL USE OF CORPORATE JETS 393 C. SEC DISCLOSURES RELATING TO PERQUISITES 400 XVIII. ABUSE BY BLACK AND RADLER OF HOLLINGER’S CHARITABLE GIVING 409 A. CHARITABLE GIVING BY THE DAILY TELEGRAPH 410 B. CHARITABLE GIVING BY HOLLINGER’S U.S. AND CANADIAN OFFICES 414 C. CHARITABLE GIVING BY THE JERUSALEM POST 421 D. IMPLICATIONS FOR DIRECTOR INDEPENDENCE 422 XIX. SALE OF NP HOLDINGS TAX LOSSES TO RAVELSTON 426 A. BACKGROUND 428 B. SALE OF HOLLINGER’S INTEREST IN NP HOLDINGS TO CANWEST 429 C. CANWEST’S OFFER TO PURCHASE THE LOSS CARRYFORWARDS FOR $4.1 MILLION 434 D. SALE TO RAVELSTON FOR $3.6 MILLION 436 E. THE TRANSACTION STRUCTURE DICTATED BY RAVELSTON HAS EXPOSED HOLLINGER TO POTENTIAL DOUBLE LIABILITY ON THE $14.6 MILLION OBLIGATION TO CANWEST 439 F. RAVELSTON DEMANDS REPAYMENT OF INTERCOMPANY NOTE 442 G. KPMG’S REVISED ESTIMATE OF TAX LOSS CARRYFORWARDS 446 H. FALSE AND MISLEADING PUBLIC DISCLOSURES 448 XX. MANIPULATION OF LOAN TRANSACTIONS WITH HLG TO HOLLINGER’S DETRIMENT 449 A. INTRODUCTION AND SUMMARY 449 B. THE SEPTEMBER 1997 LOAN TO HLG 452 C. HLG’S FAILURE TO HONOR 339’S OBLIGATION TO HOLLINGER 462 D. HOLLINGER’S JULY 2000 LOAN TO 504, SUBSEQUENT REPRICING, AND ATTEMPTED REPAYMENT BY OFFSET AGAINST ANOTHER INTERCOMPANY LOAN 468 E. SUMMARY OF DAMAGES SUFFERED BY HOLLINGER 479 XXI. RICHARD PERLE 482 A. PERFORMANCE AS AN EXECUTIVE COMMITTEE MEMBER 482 B. PERLE’S HOLLINGER DIGITAL COMPENSATION 489 XXII. CONDUCT OF HOLLINGER’S AUDIT COMMITTEE AND BOARD OF DIRECTORS 493 -iii- I. INTRODUCTION AND EXECUTIVE SUMMARY The Hollinger Chronicles The Special Committee of the Board of Directors of Hollinger International Inc. submits this Report to the U.S. Securities and Exchange Commission and the Honorable Blanche M. Manning of the United States District Court for the Northern District of Illinois pursuant to Section III.4 of the Order of Permanent Injunction dated January 16, 2004 in the matter of United States Securities and Exchange Commission vs. Hollinger International Inc. The Report covers the results of the Special Committee’s investigation since it was formed in June 2003 in response to allegations of fiduciary duty violations and other misconduct at Hollinger. The Report chronicles events at Hollinger over the decade since it first became a U.S. public company in 1994. Hollinger is a publishing company, but the story of the last decade at Hollinger, which is the subject of this Report, is not about Hollinger’s valuable publishing assets or the quality of the staff at its many publications. Rather, this story is about how Hollinger was systematically manipulated and used by its controlling shareholders for their sole benefit, and in a manner that violated every concept of fiduciary duty. Not once or twice, but on dozens of occasions Hollinger was victimized by its controlling shareholders as they transferred to themselves and their affiliates more than $400 million in the last seven years.1 The aggregate cash taken by Hollinger’s former CEO Conrad M. Black2 and its former COO F. David Radler and their associates represented 95.2% of Hollinger’s entire adjusted net income during 1997- 2003. 1 For ease of reference, this Report presents all monetary amounts in U.S. dollars. To the extent that a conversion from a foreign currency was required and amounts related to a specific transaction, the amounts were converted to U.S. dollars at the closing exchange rate on the date preceding the transaction. For all other conversions, an average annual exchange rate was applied. 2 The Report contains a glossary of the names of individuals and entities that are referred to in the Report, and a brief identification of the major transactions. Individuals, entities or transactions defined in the Glossary will be used in the Report text solely using the defined terms, without repeating definitions. At the outset, the energies of many people went into building Hollinger into a major publishing enterprise. Over time, however, Hollinger went from being an expanding business to becoming a company whose sole preoccupation was generating current cash for the controlling shareholders, with no concern for building future enterprise value or wealth for all shareholders. Behind a constant stream of bombast regarding their accomplishments as self-described “proprietors,” Black and Radler made it their business to line their pockets at the expense of Hollinger almost every day, in almost every way they could devise. The Special Committee knows of few parallels to Black and Radler’s brand of self-righteous, and aggressive looting of Hollinger to the exclusion of all other concerns or interests, and irrespective of whether their actions were remotely fair to shareholders.