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It’s a money trail that leads from Nassau to Montreal and Minnesota – a trail of tears said to have evaporated $1.5 billion or more in investor money and shareholder assets. And it all started with a secret $4 million offshore investment. Whether there’s any money left for investors to claim – beyond a paltry nickel on the dollar for Norshield unitholders – is impossible to tell amid complex dealings of three Montreal companies that remain, to put it generously, mystifying.

The greed, fear and ego that brought down children’s filmmaker Cinar, a “financial services management firm” named Mount Real and Norshield Financial Group, once Canada’s largest domestic hedge fund advisor, are amply documented by former Norshield trouble-shooter William Urseth.

Cinar investors lost much of their stake as the former billiondollar company went private, now operating as Cookie Jar. Its successor pursued claims related to Mount Real, Cinar’s founders and Norshield, among others, for the return of roughly US$22 million. In the aftermath, some 1,600 Mount Real retail debtholders lost $130 million in promissory notes promoted primarily by a Mount Real affiliate, iForum, 24 of whose brokers face securities charges in Quebec. Mount Real shareholders saw $100 million in market value reduced to zilch. Another 1,900 retail clients of Olympus Univest are out $131 million through the collapse of Norshield Financial Group, one of whose offshoots was iForum – and that’s not taking into account the claims of institutional investors.

Urseth, a Minnesota entrepreneur who, among other things, runs a hunting lodge, and who, as a result of a non-compete agreement, now spends a lot of time in Canada, has added weight to many of the suspicions first aired in the Montreal press about the Bahamas triangle of Cinar-Mount-Real- Norshield in his just published Death Spiral: The Collapse of Cinar, Norshield and Mount Real (ECW Press). He holds out some faint hope that Norshield investors, at least, may recover some money through a class-action lawsuit against Royal Bank of Canada (RBC).

In any case, his emphasis is far more on how lawyers and accountants, billing at substantial hourly rates, burned through the assets of potentially valuable properties, rather than trying to restore the income-earning potential of those assets. One of Urseth’s favourite refrains, whenever a lawyer is engaged to help mop up the newest toxic mess, is to ask how much the retainer will be: “One hundred thousand dollars.”

More startling is his conclusion that RBC actually managed Norshield’s portfolio, and thus knew the company inside and out. And, unlike the image many hedge fund managers like to portray today – sophisticated quants who read market directions or turn-around artists who delve into balance sheets with an eye to profit from anomalies – there is little evidence here of either perspicuous analysis or financial acumen on the part of the main players, just small-time wheeling and dealing.

In the end, despite colourful and revealing details about the main players, Urseth’s book grows progressively less illuminating as the personal dramas of the various characters take precedence over the money trail. While the machinations of Cinar are allowed full play along with the involvement of both Mount Real and Norshield, how profitable Mount Real’s actual business was, and whether Norshield really made 12% to 15% annual returns remain under a cloud of uncertainty. Urseth himself seems convinced that Mount Real and Norshield did nothing particularly wrong, other than “minor” securities infractions, and were instead relentlessy hounded out of business by Cinar’s new owners, the reputations of their principals left in tatters.

THE CINAR STORY
Urseth begins with a familiar theme of the 1990s: earnings management. Cinar, with its popular franchises such as Arthur the Aardvark and Paddington Bear, was on track not only to meet, but to beat analysts’ expectations. Its top management decided to move those earnings into another quarter, and invest the proceeds in the meantime, without bothering to consult the board of directors. That, according to Urseth, was pretty much par for the course at Cinar, where co-founders Ron Weinberg and Micheline Charest routinely charged household expenses to the company – a piggy bank where they held only 12% of the equity, but two-thirds of the voting shares.

By 1999, Cinar faced a dual problem. First, the tax authorities suspected that credits intended for employing Canadian writers were being deployed to hire Americans instead. Cinar’s board of directors also discovered that Weinberg, along with CFO Hasanain Panju had undertaken off-book transactions with company earnings, originally begun as currency-hedging trades.

The currency trades were abetted by Mario Ricci, a former Mount Real controller, later to become vice-president at Norshield Financial. Mount Real, the brainchild of Lino Matteo, himself a former Norshield controller, was an obscure business, albeit publicly traded. Urseth notes that Mount Real “had clients in secondhand car sales, telemarketing, telephone equipment, vitamins and nutraceuticals; he was their business adviser, administrator, bookkeeper and lender.”

More ominously: “it included some loan-sharking, oppression (squeezing owners out) and factoring (high-interest, inventorytype financing).” (It’s not clear from Mount Real’s annual statements that it actually made money. When its operations were pushed into liquidation in 2005, the assets were deemed largely illusory.)

It was Ricci, in Urseth’s account, who pointed Cinar to Norshield International, a Bahamas outfit that promoted a hedge fund called Globe-X Canadiana, ultimately managed by Montreal’s Norshield Financial Group. The principals, Tom Muir and former Norshield Financial CFO Robert Daviault were possessed of, in Urseth’s description, “the ability to be trustworthy and dishonest at the same time, a difficult thing to accomplish under any circumstances. But that’s exactly what someone wants when they are trying to hide money offshore: trustworthy and dishonest.”

What they offered was a “backto- back transaction.” Money would flow from Montreal and then be loaned back to Cinar, or perhaps, Weinberg, Charest and Panju’s private companies for other investments. The funding for these transactions stemmed from $4 million in earnings that were above analysts’ expectations of $21 million. By taking a currency hedging loss, Cinar would save those earnings for another day. As those “hedges” worked their accounting magic, Cinar would eventually send US$108 million to Nassau, only to be managed from Montreal once again by Norshield.

Curiously, for a company on its way to becoming a billion-dollar hedge fund, Norshield Financial’s (and Norshield International’s) largest client was originally Cinar, starting with $20 million anted up to $108 million. Norshield Financial, or rather John Xanthoudakis, a university pal of Matteo and Daviault, was now managing something called an “Enhanced Bond Yield Formula” offered by Globe- X. But Norshield International’s books were a mess. Xanthoudakis sent his sister-in-law, Maria Castrechini, down to clean them up – with apparently almost $200 million in investor money to keep track of.

MOUNT REAL CONNECTION
Mount Real had done a little bit of business with Cinar; Urseth says Matteo would become jealous as he learned of how much business it had done with Norshield Financial. With Cinar’s audit committee closing in to regain possession of Cinar money, Norshield International had to produce some balance sheets for the monies invested.

Over time, most of the Cinar funds had been exhausted in other things, Urseth says. “Some had gone to fund redemptions, some for fees, some of the money was paid out in interest to other Globe-X investors, and about half of the $80 million had found its way into leverage deals and private placements that John had found in Montreal and throughout the world.”

At this point, Matteo enters the main story. Norshield International had to stave off Cinar’s demand for an immediate return of the funds. The problem for Castrechini was not only were there no books to audit, basic bookkeeping amounted to reconciling the chequebooks. “To make matters worse,” Urseth says, “the chequebook made things look like the money that came from Cinar had been used to pay redemptions and fees, and wasn’t even invested on Cinar’s behalf. The credits that should have been issued to prove the indebtedness had never been issued.” To give Matteo time to paper the transactions, Castrechini compiled binders of data about the investments Norshield International had made for Cinar.

“Each binder held all the information on the 19 private equity investments that had been made by Norshield on Globe-X’s behalf. Nineteen separate equity investments each were minority positions in various businesses throughout the world, including software, timber, developmental businesses and second-stage equities.” This seems far removed from an enhanced bond-yield formula, but Urseth doesn’t seem to detect the incongruity.

Nor does he supply much detail on the investee companies. But evidence from Norshield’s receiver, RSM Richter, suggests the scope: a niobium miner, a videoconference company, an animation company, an ATM servicer, a property and casualty insurer, an airplane component company, a Spanish lumber interest, copper mining claim, a logistics company and a computer manufacturer, among others. The receiver has not established how these companies were related to the whole Norshield Group (or the parts of it in receivership – there are a multitude of companies bearing the Norshield name).

Once the accounting was done, it was up to Xanthoudakis to find the money to pay Cinar. He managed to liquidate positions to the tune of $86 million before the great bear market of the earlier part of this decade set in.

THE NORSHIELD OPTION
According to Urseth, Xanthoudakis had been returning 12% to 15% annually. And he was in the midst of “introducing a leverage concept into the portfolio by borrowing money from RBC so the principal withdrawals for Cinar wouldn’t reduce the net return to the fund, due to principal reduction.” The agreement with RBC “gave him access to a credit line supported by a hedge fund basket. The leverage ratio was 6:1; so for every $15 million Norshield held, RBC would advance $85 million. And the bank would hire Norshield Financial to manage the funds.”

But thanks to adverse markets, Xanthoudakis had to curtail Cinar repayments, unleashing a storm of litigation. As attempts to recover money directly from Weinberg and Charest failed, and as Globe-X Canadiana yielded little in assets, attention would be focused on Norshield Financial.

And yet, Norshield Financial seemed to become neither fish nor fowl, until massive redemptions fouled up the model. According to the receiver, RSM Richter, Norshield, through Univest, had an option agreement with RBC, such that $30 million would buy exposure to the economic returns of a $330 million hedge fund portfolio. A swaption is what it is called, with Norshield investors receiving the returns on a leveraged portfolio, minus interest costs. Still, says Urseth: “With the way the funds were structured, the investors never knew about the leverage against the hedge fund basket because neither RBC nor Norshield ever divulged it. It was simply a proprietary trading model. John rationalized the non-disclosure as being necessary thanks to various confidentiality clauses and because the documents clearly allowed leverage against the investments. What no investor would ever know is that before any of the leverage they would expect took place, the entire underlying hedge fund basket was already leveraged with RBC, who held all the securities in total.”

In other words, RBC ran the hedge fund portfolios Norshield bought an option on. Urseth also asserts that RBC understood the collateral that backed the option – private equity investments that Univest investors were not to profit from. Among these private equity investments were stakes in the various fund management companies that were supposed to be running money for Univest investors. Urseth doesn’t address this circularity, except to argue that RBC knew what was going on.

The underlying collateral of Univest was something called Mosaic, some of whose assets were private equities such as the nowbankrupt Microslate and the stillgoing Oceanwide logistics company. Some were also related asset managers, whose value seemed to have been based on some calculation on forward earnings – earnings that came to naught, since the business (or businesses) was busted. Certainly the receiver noted that those stakes were of no value

And, then there was the freighted relationship with the distributors in the Norshield-Mount-Real fold, not least the iForum brokers. Notes Urseth: “Most important for John and Lino was that the brokers had served as a key distribution network for the financial products they had developed, including Commax, Balance Return Fund, Olympus Univest, MRACS, RealVest and Sterling Leaf. The agents knew and sold these products and had done so for years.”

iForum had grown out of Norshield; after going public it shared its president with Mount Real.

THE MOUNT REAL DENOUEMENT
MRACS, RealVest and Sterling Leaf were the vehicles to fund Mount Real’s continual cash flow problem, whether through highyield promissory notes for the first two, or setting up a highyield income trust for the latter. As for Mount Real, Urseth notes that it was really in the magazine business despite the veneer of being a partner with thriving small businesses – none of which, Urseth says, managed to survive intact. “His [sales]force sold magazine subscriptions, multiple magazines for multiple years. Before the consumer knew it, he or she had bought six to eight magazines for up to four years and owed $800 to $1,500, which was charged to a credit card. With a good infrastructure, good publishers, good financing and a clever sales force, this business would be the fuel that was putting the Mount Real/ Honeybee rocket into orbit. None of the annual reports ever seemed to say this, none of the press releases ever touted the fact.”

scamsters, like any boiler room. But it attracts the wildly optimistic. As Urseth quotes Matteo: “The economics of telemarketing are basically these: product cost, sales cost, processing cost and overhead. It’s really pretty simple . . . the magazines are cheap because the publishers need to build paid circulation to attract advertisers so they subsidize the business. Sales costs need to be less than 20%, including salaries, commissions and managers; processing needs to be 10% or less and consistent; overhead should be 15% or less. When you add it up it’s 60%. So, that’s 40% for profit, less five for bad debt. That’s how we’ll make money.”

Holdbacks are what credit-card processors charge to cover consumer charges declined, whether because the card doesn’t work or because the consumer changes their mind. And, Urseth explains, “everyone at the table knew their sales costs were closer to 30% than 20%. The overhead was 25%, the phone bill alone was 15% and processing was unreliable and running at 80% with a 20% holdback.”

This was the basis for Mount Real’s commercial paper. And, shortly after the Norshield receivership, Mount Real had to suspend its 10.5% interest payments to investors, as well as the redemption of short-term “commercial paper.” The cash cow had been milked out, all for want of a trusting credit-card processor.

Lots of investors lost, big time. So did their brokers. There is much more to this story, and much more to be learned.

Urseth’s underlying point is that successful businesspeople were tripped up over little things by rapacious lawyers and accountants, eager for money and, in its absence, willing to destroy reputations and run formerly successful companies into the ground, companies that, granted a little time (up to five years) might return to robust health.

And yet, though he seems not to recognize it, there was a way to prevent this death spiral. Had Weinberg and Charest not treated Cinar as their piggy bank, but presented their currency hedging strategies to the board for approval; had Xanthoudakis come clean on his involvement with Cinar, and what’s more, disclosed in his offering documents his arrangement with RBC that only a portion of the investor money went into the hedge fund portfolio; had Mount Real not talked its book through iForum and its sales team, instead of issuing a prospectus on its “commercial paper” (that laid out all the risks and non-arm’s length transactions Mount Real was involved in) they might all have approached the securities law standard of disclosure: “full, plain and true.”

Then again, disclosure full, plain and true might have aborted the business – and saved a lot of investors and brokers money, time, and turmoil in the first place.

Originally published in Advisor's Edge Report