Endgame for Norshield investors, but mystery remains

Investors in what was once reputed to be a billion-dollar Canadian hedge fund manager may get five to seven cents on the dollar for their investments. The “guiding minds” behind Norshield face regulatory sanctions as well as civil litigation. But a veil of mystery remains around where $472 million in investor assets actually ended up.

Norshield Financial Group is the umbrella name for a complicated array of interrelated companies offering investments to retail, institutional and high net worth private investors. Those companies were put into receivership in June 2005 after they could no longer meet investor requests for redemptions.

In its most recent report, posted in January, receiver RSM Richter set in motion a process for 1,900 retail investors to file claims on $34.4 million in recovered assets, out of $159 million invested. Institutional investors are owed $194 million and other, direct investors, another $130 million, both on recoveries of $15 million. It’s RSM Richter’s first public report since July 2007. Four reports made in the interim remain sealed thanks to pending litigation.

In addition, the Ontario Securities Commission last week ruled that Norshield officers John Xanthoudakis, Dales Smith and Peter Kefalas breached a number of sections of securities law.

After the OSC issued the Norshield receivership order in 2005, the regulators quickly moved to lock a number of NFG entities including: Olympus United Group, a mutual fund dealer; Olympus United Funds; and Norshield Asset Management. In other jurisdictions, Olympus United Bank in Barbados, Olympus Univest and Mosaic Composite, both in the Bahamas, were caught up in the liquidation proceedings — requiring the Canadian receiver to operate with local receivers and courts.

Despite an expensive five-year inquiry (the costs of which will halve investor recoveries), RSM Richter is no more apprised of where investor money went — once in the Caribbean — than it was five years ago. There are no audited statements after 2003.

While some money — 10% to 15% — was managed by Norshield Asset Management to provide a tactical overlay at the Olympus Bank level, most flowed to Olympus Univest, where it was managed by Mosaic Composite. There retail, institutional and direct investor money was commingled, contrary to what was set out as the Olympus Univest structure.

The money Mosaic managed was divided between two types of assets: a hedged portfolio and a non-hedged portfolio. The hedged portfolio &#151: $385 million — actually consisted of two parts: an option with the Royal Bank on a portfolio of hedge funds, funded by a 15% to 25% premium; and a margin loan of $300 million. RSM Richter says this leverage was not disclosed to investors.

The non-hedged assets, which were invested in a variety of private companies, were to provide collateral for the loan. Roughly 87% of the assets were related to Norshield or Olympus entities. Although they had a book value of $307 million, RSM Richter ways the assets were overvalued by 88%. Mosaic had only $82 million in assets.

By the time of Norshield’s receivership, only US$6.5 million of the option value on the hedged portfolio remained to investors, down from US$52 million eight months earlier when the option was transferred to another party in the Cayman Islands in order to raise funds needed to meet redemption requests.

RSM Richter has put forward a civil case against Xanthoudakis and Smith for $159 million. It alleges that Xanthoudakis and Smith used the companies of which they were directors as “pawns in a complex, intertwined investment structure” and thus breached their fiduciary obligations and duty of care, by investing “recklessly, negligently and improperly,” for “unexplained reasons.” RSM Richter has also offered to cooperate, should there be criminal proceedings.

The statement of claim alleges that Norshield entities diverted corporate assets, invested them in speculative, non-hedge fund investments contrary to the offering documents, often in non-arm’s length and sham transactions designed to inflate net asset values, while using money from new investors to fund redemptions. Improvident deals were entered into on “commercially unreasonable terms,” and investor money was used to fund private companies that, for the most part failed. The receiver alleges that Xanthoudakis and Smith “turned to elaborate schemes to overstate the financial condition and performance” of the Norshield companies.” In the end, the Norshield companies “ceased to have a legitimate purpose and existed only to attract new investors to meeting growing redemption requests.”

Both Smith and Xanthoudakis are contesting the statement of claim, with Xanthoudakis dismissing its “extravagant and broad allegations.” They claim they had little involvement in how Mosaic Composite invested money. They say fund asset values were set by a competent administrator and that Mosaic’s books were audited by competent accountants. They also argue that the claim should be thrown out due to the length of time that has passed.

The OSC, for its part, has conducted hearings over the past two years into Olympus Group and Norshield Asset Management, as well as Xanthoudakis, Smith and Peter Kefalas, using information from RSM Richter and OSC staff on whether they fulfilled their duties as officers and directors according to securities laws.

Among the breaches of duty, OSC staff alleged that investors “were never told that the fund that they had invested in was in fact a combination of legacy funds and assets for which records and valuations did not exist.”

As well, some investors made “in-kind” contributions of between $40 million and $100 million. OSC staff alleged that this as well as the partial sale of the Mosaic hedge fund option, constituted preferential treatment for some investors. These also allege investor money was paid to third parties with connections to Xanthoudakis and Smith.

The OSC did not rule on the in-kind contributions, though it found them “deeply concerning.” Nor did it rule on third-party payments. But it did find that net asset values for Norshield’s retail investors were “artificially inflated,” and that Norshield should not have been accepting new investor money in 2004 and 2005, since its books were not in order. In addition, Xanthoudakis and Smith were in breach of their fiduciary duty in not being able to account for the whereabouts of investor funds at the Mosaic level. At minimum, the OSC ruled, Smith and Xanthoudakis acquiesced in breaches of securities law.

It also found that Xanthoudakis and Smith misled OSC investigators.

Finally, it ruled that Xanthoudakis and Smih, along with Kefalas, engaged in abusive conduct that undermined the integrity of capital markets and was contrary to the public interest.

Sanctions are pending.

(03/16/10)