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2012 ABASC 131 (*)
Karen A. Prentice, QC
for Commission Staff
Chris Archer and John James
for Dennis Morice
Glenn Solomon, QC and Darren Reed
for Merendon Mining Corporation Ltd.
and Gary Sorenson
2010; 1-4, 16-17 and 19 February 2010; 13-16, 19-
23 and 26-29 April 2010; 10, 12, 17-20, 25-26 and
28 May 2010; 19-22 July 2010; and 13 December
2010
INTRODUCTION
HISTORY OF THIS PROCEEDING
Interim Orders
Notice of Hearing
2012 ABASC 131 (*)
Amendments
The Allegations
Pre-Hearing and Hearing Applications
The Merits Hearing
Adjournments
Receipt of Evidence and Submissions in the Merits Hearing
Overview
Staff's Case
The Respondents' Cases
Arbour and Morice
Brost and IFFL
Merendon and Sorenson
Conclusions
Evidentiary Matters
General Approach
Evidentiary Standard
Audio Recordings of Conversations
Video Recordings
Hearsay Evidence
Conflicting Evidence and Credibility
Adverse Inference
Fairness of the Proceedings
FACTUAL BACKGROUND
The Respondents and Other Parties
The Respondents
Arbour
Morice
Brost
IFFL
Sorenson
Merendon
Other Parties
(a) 385765 Alberta Ltd. ("385765")
(b) 1061463 Alberta Ltd. ("1061463")
Adair
Arbour Energy Caribbean Ltd. ("Arbour Caribbean")
Arbour Energy US, Inc. ("Arbour US")
Bierwirth
Casey Brost
Elizabeth Brost
Charles D. Burgess ("Burgess")
COREL
Capital Alternatives
Ward Capstick ("Capstick")
Eiger
Expedia
2012 ABASC 131 (*)
Forrest
Fortris
Grovenor Trust ("Grovenor")
Hobbs
Houston
Kendall
La Conxion
Magna North
Merendon Investment Group LLC ("Merendon Investment Group")
Merendon Colorado
Merendon Nevada
Monkman
(aa) Monkman Consultants
(bb) Parklane International Corporation ("Parklane") (cc) SGD
(dd) Thelma Duron/Thelma Sorenson (ee) Steller
(ff) Strashok
(gg) Stone Mountain (hh) Strategic
(ii) TRL
(jj) True North (kk) Verbeem (ll) Weeks (mm) Werner (nn) Jack Wolfe (oo) Jared Wolfe
Miscellaneous Entities
Summary of Arbour's Activities
Context
Fundraising
Loans to Merendon
Purchases of COREL and TRL
The Brost-Sorenson Alliance
Brost's and Sorenson's Initial Contact
SGD
Formation
SGD/Merendon Relationship
Hoffman as SGD's President
Adair as SGD's President
Blaikie as SGD's President
Blaikie's Role
SGD/Merendon Interaction
Due Diligence Reports
Werner as SGD's President
Conclusions on SGD
2012 ABASC 131 (*)
Stone Mountain
Magna North
International Business Group ("IBG")
General
February IBG Meeting
March IBG Meeting
Descriptions of the Brost and Sorenson Relationship
Conclusions on the Brost-Sorenson Alliance
Merendon
Operations
Financial
IFFL Facts
General
IFFL Structurists
IFFL's Interactions with Investors and Prospective Investors
The "International Side" and "Managed Accounts"
Brost and IFFL Promote Arbour
Arbour
The Resurrection of Arbour – from Bankrupt Shell to Going Concern
Arbour Post-Resurrection Transactions
Existing Board of Directors
2004 Common Share Sales
Crazy Hill Purchase and Sale
Negotiation of $10 Million Loan to Merendon
Arbour's New Board of Directors Appointed
The Roles of Brost and Sorenson
Arbour's Operations and Activities
Arbour's Operations and Expedia
De-listing Arbour Common Shares
COREL and TRL
$10 Million Loan to Merendon Finalized
$45 Million Loan to Merendon
Purchase of COREL
Purchase of TRL
Arbour Caribbean
Sedalia Transaction
Arbour US
Myanmar Transaction
Arbour Preferred Shares Sold
Offerings
Offering Memorandum Exemption Relied Upon
Marketing Activities
The Arbour Offering Memoranda
General
OM 1 (14 July 2004)
OM 2 (19 January 2005)
2012 ABASC 131 (*)
OM 3 (26 September 2005)]
Distributions Reported
Arbour's Use of Proceeds
Merendon
Other Uses of Proceeds
Disbursement of Money to Merendon and Beyond
Conclusions Regarding Arbour
Investor Testimony
General
Investor Witness LB
Investor Witness KA
Investor Witness DR
Investor Witness ST
Investor Witness DRA
Investor Witness SC
ISSUES FOR DETERMINATION
ANALYSIS AND FINDINGS
Knowledge
The Arbour OMs
Trades and Distributions of the Arbour Preferred Shares
Availability of the OM Exemption
Registration and Prospectus Exemptions
The Law
The OM Exemption Requirements
Untrue and Misleading Statements Prohibited
Parties' Positions
Staff
Morice
Arbour, Brost and IFFL
Review of the Arbour OMs
Investor and Expert Evidence Not Necessary
(b) OM 1 (14 July 2004)
Disclosure
Other Deficiencies
Conclusions on OM 1
OM 2 (19 January 2005)
Disclosure
Other Deficiencies
Conclusions on OM 2
OM 3 (26 September 2005)
Disclosure
Other Deficiencies
Conclusions on OM 3
OM Exemption Not Available
Sections 92(3)(c) and 92(4.1) of the Act Contravened?
Statements of Arbour and Morice
2012 ABASC 131 (*)
Intention to Effect Trades in Securities
Knowledge Concerning the Misstatements Found
Business Judgment Rule
Reliance on Legal Advice Does Not Diminish Responsibility
Unregistered Advising
The Allegation
The Law
Parties' Positions
Staff
Brost and IFFL
Analysis
Opinions or Recommendations
Business Purpose
Conclusion on Advising
Exemptions
Conclusion on Unregistered Advising Allegation
Breach of Undertakings and Order
The Law
The Undertakings and Order
Analysis and Finding
Fraud
The Allegation
Parties' Positions
Staff
Arbour, Brost and IFFL
Morice
Merendon and Sorenson
The Law
Statutory Regime
The Elements
The Actus Reus
The Mens Rea
Analysis
Prohibited Acts
Deprivation
Knowledge
Conclusions on Fraud
Conduct Contrary to the Public Interest
General
Illegal Trades and Distributions
Misrepresentations in Offering Memoranda
Unregistered Advising
Breaching an Undertaking or Commission Order (or Both)
Fraud
2012 ABASC 131 (*)
CONCLUSION AND NEXT STEPS
2012 ABASC 131 (*)
This is a proceeding before the Alberta Securities Commission (the "Commission") initiated by Commission staff ("Staff") against six respondents (the "Respondents") – Arbour Energy Inc. ("Arbour"), Dennis Morice ("Morice"), Milowe Brost ("Brost"), The Institute For Financial Learning, Group of Companies Inc. ("IFFL"), Merendon Mining Corporation Ltd. ("Merendon") and Gary Sorenson ("Sorenson") – to consider whether they contravened Alberta securities laws and engaged in conduct contrary to the public interest and, if so, whether it is in the public interest or appropriate to make orders for sanctions and costs against them pursuant to sections 198, 199 and 202 of the Securities Act, R.S.A. 2000, c. S-4 (the "Act").
Notwithstanding suggestions to the contrary, this proceeding is not about any participation of, or conduct by, the Respondents in an alleged overarching fraudulent Ponzi scheme involving sales of securities by Syndicated Gold Depository S.A. ("SGD"), extending to sales of securities of various other entities, including Arbour. Rather, this proceeding, as circumscribed by the allegations made by Staff in a thrice-amended notice of hearing dated 27 May 2009 (the "Notice of Hearing"), is about the alleged involvement of, and conduct by, the Respondents in matters focused on distributions of securities of Arbour, a public company, with it allegedly used by Brost and Sorenson as a vehicle to divert investor money to entities owned or controlled by, or associated with, Brost, Sorenson or both (the "Brost/Sorenson Entities") while at the same time avoiding proper public disclosure. Staff's allegations (two against all of the Respondents, the others against certain of them), as set out in the Notice of Hearing, concern: illegal trading in, distributing of and advising in securities; untrue or misleading statements in offering memoranda; breaches of undertakings and a Commission order; fraud; and conduct contrary to the public interest.
The hearing of this proceeding is bifurcated: first, a hearing on the merits of the allegations made by Staff in the Notice of Hearing (the "Merits Hearing"); and, second, if required, a hearing to address what, if any, orders for sanctions and costs ought to be made (the "Sanction Hearing").
This decision and our reasons for it conclude the Merits Hearing. In sum, we find (as discussed below) that all of the extant allegations set out in the Notice of Hearing have been proved to the requisite evidentiary standard, namely that:
Arbour, Morice, Brost and IFFL breached section 75(1)(a) of the Act by trading in Arbour securities without registration or exemptions;
Arbour, Morice, Brost and IFFL breached section 110(1) by distributing Arbour securities without a prospectus or exemptions;
Brost and IFFL breached section 75(1)(b)(i) by acting as advisors without registration or exemptions;
Arbour and Morice breached section 92(4.1) (and its predecessor) by making statements in three Arbour offering memoranda that they knew or reasonably ought to have known were untrue or misleading;
Brost and IFFL breached sections 93.2 and 93.1 by failing to comply with their written undertakings to the Commission and a Commission order accepting their undertakings, respectively;
the Respondents breached section 93(b) (and its predecessor) by perpetrating a fraud on Alberta investors; and
in so doing, the Respondents engaged in conduct contrary to the public interest.
Accordingly, this proceeding will now move into the Sanction Hearing phase.
2012 ABASC 131 (*)
This proceeding was initiated when Staff issued a notice of hearing on 18 November 2005, subsequently amended on 1 December 2005 (the "Initiating Notice of Hearing"), against Arbour, Morice, Heinz Weis ("Weis") and Arthur Wigmore ("Wigmore") in connection with an application by Staff to extend an interim order that had been issued by a Commission panel on 16 November 2005 (the "Interim Order", cited as Re Arbour Energy Inc., 2005 ABASC 911). The Interim Order prohibited Arbour, Morice, Weis and Wigmore from using all exemptions contained in Alberta securities laws for 15 days.
On 1 December 2005 a Commission panel extended the Interim Order "until the hearing in this matter is concluded and a decision is rendered, or until otherwise ordered" (the "Extension Order", cited as Re Arbour Energy Inc., 2005 ABASC 952). The Extension Order remains in effect.
On 9 May 2005 the Commission's Deputy Director of Capital Markets issued an order barring trading in Arbour securities for 15 days based on Arbour's failure to file with the Commission its annual audited financial statements for the year ended 31 December 2004 (the "2004 Arbour Annual Audited Financial Statements"). According to Staff investigative accountant Nicole Chute ("Chute"), the 2004 Arbour Annual Audited Financial Statements were filed on 18 May 2005 with the Commission and on the System for Electronic Data Analysis and Retrieval ("SEDAR"; SEDAR is the system for the transmission, receipt, acceptance, review and dissemination of documents filed in electronic format with Canadian securities regulatory authorities, including the Commission). On 5 December 2005 the Commission's Associate Director of Corporate Finance issued another order barring trading in Arbour securities for 15 days, this time based on Arbour's failure to file with the Commission its interim unaudited financial statements for the period ended 30 September 2005. On 5 May 2006 the Commission's Associate Director of Corporate Finance again issued an order barring trading in Arbour securities for 15 days, this because Arbour had failed to file with the Commission its annual audited financial statements for the year ended 31 December 2005 (the "2006 Arbour Cease Trade Order"). On 19 May 2006 a Commission panel extended the 2006 Arbour Cease Trade
Order "until further order of the Commission". The 2006 Arbour Cease Trade Order remains in effect and, in the result, Arbour securities have been cease-traded since 5 May 2006.
2012 ABASC 131 (*)
On 10 September 2007 Staff issued a twice-amended notice of hearing, which named four respondents not named in the Initiating Notice of Hearing and the Interim Order – namely Brost, IFFL, Merendon and Sorenson – and added other allegations and particulars. The thrice-amended Notice of Hearing, issued by Staff on 27 May 2009, provided further particulars of Staff's allegations against the then-named respondents.
On 9 December 2009 Staff withdrew the allegations in the Notice of Hearing against Weis, who had been diagnosed with a terminal illness. On 31 December 2009 Staff entered into a Settlement Agreement and Undertaking with Wigmore concerning the allegations in the Notice of Hearing against him. Accordingly, the Merits Hearing relates only to Staff's allegations in the Notice of Hearing against the Respondents – namely Arbour, Morice, Brost, IFFL, Merendon and Sorenson.
In their written and oral submissions, Staff withdrew their allegations that Sorenson had contravened sections 75(1)(a) and 110(1) of the Act and that Arbour and Morice had failed to file or provide certain continuous disclosure required to be filed or provided under Alberta securities laws. The remaining allegations against the Respondents, to which the Merits Hearing relates, are:
Arbour, Morice, Brost and IFFL breached section 75(1)(a) of the Act by trading in Arbour securities without registration or exemptions;
Arbour, Morice, Brost and IFFL breached section 110(1) by distributing Arbour securities without a prospectus or exemptions;
Brost and IFFL breached section 75(1)(b) by acting as advisors without registration or exemptions;
Arbour and Morice breached section 92(4.1) (and its predecessor) by making statements in three Arbour offering memoranda that they knew or reasonably ought to have known were untrue or misleading;
Brost and IFFL breached section 93.2 or 93.1 (or both) by failing to comply with their written undertakings to the Commission and a Commission order accepting their undertakings;
the Respondents breached section 93(b) (and its predecessor) by perpetrating a fraud on Alberta investors; and
in so doing, the Respondents engaged in conduct contrary to the public interest.
Our tasks are to determine whether Staff have proved these allegations and, if so, to determine what, if any, orders ought to be made in consequence. Our findings are thus limited in scope – to the facts and issues relevant to the extant allegations set out in the Notice of Hearing.
2012 ABASC 131 (*)
Prior to 8 July 2009, when the Merits Hearing commenced, we and other Commission panels addressed several preliminary pre-hearing matters, issuing several interlocutory orders and rulings in response to applications. During the Merits Hearing, we also issued several rulings on applications. We discuss some of these orders and rulings in this decision.
The Merits Hearing was originally set to commence on 12 May 2008. On 1 May 2008 Arbour and Morice applied for an adjournment of the Merits Hearing on the ground that they intended to challenge the constitutional validity of certain sections of the Act. Arbour and Morice also requested that a Commission panel refer the constitutional questions to the Court of Queen's Bench of Alberta (the "QB Court"), similar constitutional questions having already been directed to the QB Court by a Commission panel in a different proceeding. Staff, Weis, Wigmore, Brost and IFFL did not oppose this application. Over the objection of Merendon and Sorenson, a Commission panel directed, in Re Arbour Energy Inc., 2008 ABASC 399, that the constitutional questions raised by Arbour and Morice be referred to the QB Court for determination by that court. In the result, this proceeding was suspended by operation of section 13(3) of the Administrative Procedures and Jurisdiction Act (Alberta) until the QB Court had given its decision. The panel, with the agreement of the parties, adjourned the Merits Hearing to 1 December 2008 (a tentative date), pending receipt of the QB Court decision.
The QB Court heard argument on the constitutional questions in September 2008. By the end of October 2008, when the QB Court had not yet given its decision, a hearing management meeting was scheduled for 12 November 2008 to discuss rescheduling the start of the Merits Hearing. At that meeting a Commission panel adjourned the Merits Hearing and set a series of tentative hearing and "cut-off" dates, with a view to commencing the Merits Hearing as soon as practicable after issuance of the QB Court decision while still providing the parties with sufficient time to prepare for the Merits Hearing and to consider other steps they might wish to pursue.
On 9 January 2009 the QB Court issued its decision and reasons (the "QB Decision", cited as Lavallee v. Alberta (Securities Commission), 2009 ABQB 17). In accordance with the previously scheduled hearing and cut-off dates, the Merits Hearing was to start on 16 March 2009 (the cut-off date for such commencement was 13 February 2009). On 6 February 2009 Arbour and Morice applied for an adjournment of the Merits Hearing to September 2009, which application was opposed by Staff and by Merendon and Sorenson. Arbour and Morice argued that, as the judgment roll associated with the QB Decision had yet to be finalized, there was no decision with the result that the 16 March 2009 commencement date might yet fall away and, in any event, they needed time to deal with any appeal and stay of proceeding application. On 6 February 2009 we denied the adjournment request and provided oral reasons for our ruling.
2012 ABASC 131 (*)
On 24 February 2009 Arbour and Morice brought another application to adjourn the Merits Hearing, still set to begin 16 March 2009, on the grounds that certain disclosure had not been provided to them by Staff and that Arbour and Morice needed time to obtain "commission evidence" from Sorenson (then residing in Honduras). Weis and apparently Wigmore supported this application; Brost and IFFL took no position; and Staff and Merendon and Sorenson opposed this application. A Commission panel denied the adjournment request for reasons delivered orally on 24 February 2009 (Re Arbour Energy Inc., 2009 ABASC 89).
On 5 March 2009 Arbour and Morice again applied for an adjournment of the Merits Hearing, this time on the ground that new, potentially relevant material had recently come to the attention of Staff that would not be disclosed in sufficient time to allow all parties to prepare for the Merits Hearing still set to begin 16 March 2009. Staff acknowledged same, and Weis and Wigmore supported this application. Brost and IFFL took no position. Merendon and Sorenson opposed this application and requested that, if the adjournment were granted, they be severed from this proceeding such that the hearing of the allegations against them could begin on 16 March 2009. For reasons delivered orally on 5 March 2009 (Re Arbour Energy Inc., 2009 ABASC 116), we adjourned the Merits Hearing to 1 September 2009 and denied the severance request.
The Merits Hearing commenced on 8 July 2009 and proceeded on 14 and 15 July 2009 in order to deal with a discrete issue regarding a Notice to Attend served by Arbour and Morice on a sergeant of the Integrated Market Enforcement Team of the Royal Canadian Mounted Police (the "RCMP"). The Merits Hearing was then to recommence on 1 September 2009, with Staff being the first party to present evidence.
On 26 August 2009 Weis applied for an adjournment of the recommencing Merits Hearing on the ground that he was unable to attend for medical reasons. Staff, while sympathetic to Weis's situation, suggested alternatives to an adjournment. Arbour, Morice, Wigmore, Merendon and Sorenson did not object to the adjournment; Brost and IFFL were not in attendance or represented. We granted Weis's application on 27 August 2009 and adjourned the recommencing Merits Hearing to 18 January 2010.
The hearing and receipt of evidence in the Merits Hearing took place over 43 days from January through July 2010. The testimony and exhibits were extensive – 19 witnesses testified and 292 exhibits were entered in evidence. We received written submissions from Staff, Morice and Merendon and Sorenson in September and November 2010 and on 13 December 2010 heard oral submissions from Staff, Morice and Merendon and Sorenson.
During the Merits Hearing, we heard testimony from the following witnesses called by Staff:
Chute – She is a Staff investigative accountant who participated in Staff's investigation of this matter.
2012 ABASC 131 (*)
Bradley Dean Regier ("Regier") – He was hired by Brost, a long-time acquaintance, in 1999 to provide part-time bookkeeping for Capital Alternatives Inc. ("Capital Alternatives"). This evolved in mid-2003 into Regier working full-time for Brost at IFFL, where Regier provided office management and accounting services. In early 2004 Regier became the office manager at Expedia Logistics Inc. ("Expedia"), which involved his provision of accounting services for several companies, including Strategic Metals Corp. ("Strategic"). Regier was also a member of the advisory committee (the "IBG Advisory Committee") of the International Business Group ("IBG"), and an officer of Merendon Mining (Nevada), Inc. ("Merendon Nevada"), Merendon Mining (Arizona) Inc., Merendon Mining (California) Inc., Strategic and True North Productions LLC ("True North").
Five IFFL members and the son of two others (to protect their privacy, we refer to these witnesses by their initials in this decision) – Five of these seven IFFL members purchased preferred shares of Arbour.
Owen David Hoffman ("Hoffman") – He was SGD's president from 2000 (or from "its actual inception" in late 1999) until 31 December 2001, and while such also a Merendon director. After Hoffman left Honduras in March or April 2002, he did "some work for Merendon" in Canada, until approximately mid-2003.
Staff also relied on excerpts from transcripts of investigative interviews of individuals, including some of the Respondents, as well as other documentary evidence, audio recordings of conversations and video recordings.
Arbour and Morice, an Arbour principal, were jointly represented by counsel at the first three days of the Merits Hearing. However, immediately prior to the start of Staff's case, we were informed that Arbour was no longer able to retain their counsel. Thereafter, Morice was represented by counsel at the Merits Hearing and Arbour did not participate in the Merits Hearing.
Morice did not testify at the Merits Hearing, nor did any other Arbour director or officer, or any Arbour employee. Morice called two witnesses to testify on his behalf (we do not include the above-mentioned RCMP sergeant in this enumeration):
Ross Sam Chow ("Chow") – He was the manager of the Mineable Oil Sands business unit of the Alberta Research Council ("ARC") when he was hired in 2003 by Tarsands Recovery Limited ("TRL") to evaluate its oil sands technology. He and other ARC personnel prepared an evaluation report dated November 2005 (the "November 2005 ARC Report"). Chow was qualified as an expert, and thus
to give opinion evidence, "in the area of laboratory-based recovery testing and as an evaluator of the technology for the recovery of bitumen from the Athabasca Oilsands from a scientific perspective".
2012 ABASC 131 (*)
Donald Richard Skeith ("Skeith") – He is an experienced Calgary securities lawyer. Skeith first met Brost in the early 1990s when Skeith was providing legal services to Bellringer Resources Ltd. ("Bellringer"). Skeith or his firm has provided legal services to Capital Alternatives, Strategic and Merendon, and Skeith provided legal services to Arbour before and during the period relevant to the allegations.
Morice also relied on transcripts, in whole or in part, of investigative interviews of individuals, including some of the Respondents, as well as other documentary evidence and video recordings.
Brost, an IFFL principal, and IFFL were jointly represented by counsel at some of the pre-hearing applications and management meetings. Despite having been given notice of the Merits Hearing and the allegations against them and having participated in some of the pre-hearing applications and management meetings, neither Brost nor IFFL participated in the Merits Hearing. Brost did not testify at the Merits Hearing, nor did any other IFFL director or officer.
Merendon and Sorenson, a Merendon principal, were jointly represented by counsel at the Merits Hearing. Sorenson testified, on his and Merendon's behalf, at the Merits Hearing. Merendon and Sorenson also called the following witnesses to testify on their behalf:
Harry Charles Blakey ("Blakey") – He is a former RCMP officer and lawyer and was employed by the Commission as its Director of Market Standards until September 2000. Blakey was retained by Brost in 2004 to provide legal services to IFFL. In March 2005 Brost hired Blakey to complete a due diligence report on Merendon and its subsidiaries for SGD. In September 2005 Sorenson retained Blakey to provide legal services to Merendon. This evolved into a general counsel position with Merendon, a position Blakey held until December 2007, after which he continued to provide legal services to Merendon until April 2008.
Graham Ronald Blaikie ("Blaikie") – In October or November 2002 Sorenson hired Blaikie as the general manager of Merendon Hospitality Group de Venezuela C.A. ("Merendon Hospitality Venezuela"). Blaikie held this position until October 2004, when Sorenson hired him as Merendon's budget director, a position he held at the time of the Merits Hearing. Blaikie was also a Merendon director from sometime in 2004 until sometime in 2007. He was SGD's president from 1 January 2004 until 31 March 2007, and a member of the IBG Advisory Committee.
Donald John Gleason ("Gleason") – He is a certified general accountant and was Merendon's chief financial officer ("CFO") from June or July 2006 until November 2007.
2012 ABASC 131 (*)
Kenneth Leroy Sorensen ("Ken Sorensen") – He is Sorenson's brother (despite their differently spelled surnames) and was Merendon's president and chief administrative officer and a Merendon director from approximately April 2005 until November 2007.
Vinicio Pazmay Ruiz – He is a geologist who was employed by Merendon de Ecuador S.A. ("Merendon Ecuador") from 2008 to 2009, working in the Tena concessions in Ecuador.
Shad Prashad – He worked at Merendon de Honduras S.A. ("Merendon Honduras") from October 2002 until January 2004, when he was asked by Sorenson to help manage operations at Merendon de Peru S.A. ("Merendon Peru"). In or about June 2005 Prashad became Merendon Peru's general manager, a position he held at the time of the Merits Hearing.
Catalina Feijoo Marin ("Feijoo") – She was hired by Sorenson in 2005 as Merendon Ecuador's general manager, a position she held at the time of the Merits Hearing.
Merendon and Sorenson also relied on excerpts from transcripts of investigative interviews of individuals, including some of the Respondents, as well as other documentary evidence, tape recordings of conversations and video recordings.
While a respondent is not required to participate in an enforcement proceeding commenced under Alberta securities laws, we will not consider allegations against a non-participating respondent unless we are satisfied that Staff provided adequate notice to the respondent of the hearing and the allegations Staff are making against the respondent. Here, we are satisfied that Arbour, Brost and IFFL received adequate notice of the Merits Hearing and Staff's allegations against them. We therefore consider it appropriate to consider the allegations against Arbour, Brost and IFFL despite their apparent choice not to participate, or participate fully, in the Merits Hearing.
We make some general comments on this proceeding and our approach.
There were, in the evidence before us, minor variations – of no substantive effect – in the names of certain entities. When referring to any such entity in this decision, we have done so using one variation of its name.
The facts of this case are complex, involving a tangled web of corporate and personal relationships and a complicated flow of investor and corporate money. Indeed, we are of the view that some of this complexity was aimed at obscuring or concealing certain conduct by the Respondents.
2012 ABASC 131 (*)
Although this decision and our reasons for it do not address each and every argument made by the parties, we have fully considered all arguments presented to us.
We have carefully reviewed the evidence introduced to find the facts relevant to the issues to be decided by us. During the Merits Hearing, we permitted the introduction of evidence in some areas (allowing direct and cross-examination on such evidence) on the basis that it would be helpful to our understanding of the misconduct alleged in the Notice of Hearing and thus was relevant, or that its relevance was initially unclear. Indeed, evidence of facts and conduct prior to the period relevant to the allegations has assisted us to understand and reach conclusions about the relationships among the Respondents and among the Respondents and various other parties during the period relevant to the allegations. Similarly, evidence of conduct by the Respondents prior to the period relevant to the allegations has assisted us by providing context for certain of their conduct during the period relevant to the allegations. Apart from these caveats, however, we have largely ignored as irrelevant (and thus of no assistance to us in our determination of the allegations in the Notice of Hearing) evidence and submissions relating to purported fraudulent activity involving other issuers and other parties, or relating to any other purportedly improper conduct by some of the Respondents that was not alleged in the Notice of Hearing.
As noted, our task in the Merits Hearing is to determine whether Staff have proved, to the requisite evidentiary standard, the allegations in the Notice of Hearing. The evidentiary standard applied in Commission enforcement hearings is the balance of probabilities civil standard (Re Kustom Design Financial Services Inc., 2010 ABASC 179 at para. 5).
The civil standard of proof was discussed by the Supreme Court of Canada in F.H. v. McDougall, 2008 SCC 53, in which the court confirmed (at para. 49) that the balance of probabilities requires that the trier of fact must decide "whether it is more likely than not that an alleged event occurred". The court also stated (at paras. 40, 45-46):
. . . I think it is time to say, once and for all in Canada, that there is only one civil standard of proof at common law and that is proof on a balance of probabilities. Of course, context is all important and a judge should not be unmindful, where appropriate, of inherent probabilities or improbabilities or the seriousness of the allegations or consequences. . . .
. . .
To suggest that depending upon the seriousness, the evidence in the civil case must be scrutinized with greater care implies that in less serious cases the evidence need not be scrutinized with such care. I think it is inappropriate to say that there are legally recognized different levels of scrutiny of the evidence depending upon the seriousness of the case. There is only one legal rule and that is that in all cases, evidence must be scrutinized with care by the trial judge.
. . . evidence must always be sufficiently clear, convincing and cogent to satisfy the balance of probabilities test. . . .
2012 ABASC 131 (*)
Thus, we decide this case on the balance of probabilities. In doing so, we must be satisfied that there is sufficiently clear, convincing and cogent evidence that the existence or occurrence of any alleged fact required to be proved is more likely than its non-existence or non-occurrence.
We are also entitled to draw inferences from the evidence as a whole, and have done so in reaching some of our conclusions, an approach consistent with that recently enunciated by the Ontario Securities Commission (the "OSC") in Re Biovail Corporation (2010), 33 OSCB 8914 at para. 85: a panel is "entitled to make reasonable inferences from the evidence and to reach conclusions based on the balance of probabilities".
Accordingly, in finding that all of the extant allegations set out in the Notice of Hearing have been proved, we have found that the evidence before us is sufficiently clear, convincing and cogent to prove the allegations on the balance of probabilities.
Hoffman made audio recordings (the "Hoffman Tapes") of conversations he had –typically with one or more of Brost, Sorenson, Steve Kendall ("Kendall") and Christopher Houston ("Houston") – certain of which (in whole or in part) Staff and Merendon and Sorenson entered in evidence through Hoffman. Hoffman said that he made the Hoffman Tapes because he had concerns about what was being done and as a means of having a record of events. Hoffman used a micro-recorder and did not disclose to Brost, Sorenson or apparently any other party to conversations that he was recording the conversations. Hoffman explained that he began recording conversations from about February 2000 to the end of 2008, and he attempted to record as many conversations as he could with each of Brost and Sorenson. However, Hoffman testified that all of the audio recordings made prior to the time he left Honduras (in March or April 2002) were destroyed when the tapes – about 40 of them – were inadvertently laundered; Hoffman said that he kept the tapes hidden in his closet, so "[i]t was quite a mystery" to him how the tapes ended up in the washer and destroyed.
Merendon and Sorenson contended that the Hoffman Tapes entered in evidence should be given limited weight, claiming that they "lack[ed] the entirety of their context" due to the destruction of the earlier audio recordings and that they often dealt with issues of doubtful relevance. Merendon and Sorenson also questioned Hoffman's credibility and motives in making the Hoffman Tapes, suggesting he did so because he wanted money from Sorenson, Brost, SGD or all of them. Nevertheless, the Hoffman Tapes in evidence were entered, in part, by Merendon and Sorenson, and they conceded the relevance of certain of the conversations (in whole or part) recorded on the Hoffman Tapes in evidence (for example, those indicating that Sorenson was not aware of all of Brost's activities).
In determining the weight to attach to the Hoffman Tapes in evidence, we accept them as authentic – there was no dispute as to the identity of the speakers recorded (Sorenson admitted that the voice identified as his was his), and there was no suggestion or evidence that the recordings were anything other than genuine. The Hoffman Tapes in evidence are thus evidence
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that conversations took place and of the words used, although not necessarily of the truth of the statements made. While certain of the conversations recorded on the Hoffman Tapes in evidence are irrelevant to the issues before us and thus deserving of no weight, many of the recorded conversations are relevant to the issues we must decide. In giving weight to the relevant conversations recorded on the Hoffman Tapes in evidence, we have considered them in the context of the totality of the evidence, mindful of any shortcomings in the quality of the recordings and that the destroyed recordings of earlier conversations may have assisted in our understanding or, as Merendon and Sorenson put it, "provided much more context".
Video recordings were entered in evidence by Staff, Morice and Merendon and Sorenson. In determining the weight to attach to the video recordings in evidence, we accept them as authentic – there was no suggestion or evidence that the recordings were anything other than genuine. The video recordings in evidence are thus evidence that events occurred and statements were made, although not necessarily of the truth of any statements made. While certain of the content of the video recordings in evidence is irrelevant to the issues before us and thus deserving of no weight, other of the content is relevant to the issues we must decide. In giving weight to the relevant content of the video recordings, we have considered it in the context of the totality of the evidence, cognizant of any shortcomings in the quality of the recordings.
It is not unusual for hearsay evidence to be adduced, whether by Staff or respondents, in Commission enforcement hearings. Section 29(f) of the Act provides that "the laws of evidence applicable to judicial proceedings do not apply" in Commission enforcement hearings. A Commission panel's primary consideration in determining the admissibility of evidence is its relevance – under section 29(e) a panel is to "receive that evidence that is relevant to the matter being heard". Therefore, a panel is legally entitled to admit relevant hearsay evidence, provided the rules of natural justice and procedural fairness are observed. In The Law of Evidence in Canada, 3rd ed. (Markham, Ont.: LexisNexis Canada, 2009), Alan W. Bryant, Sidney N. Lederman and Michelle K. Fuerst commented (at para. 6.483):
In proceedings before most administrative tribunals and labour arbitration boards, hearsay evidence is freely admissible and its weight is a matter for the tribunal or board to decide, unless its receipt would amount to a clear denial of natural justice. So long as such hearsay evidence is relevant, and can be fairly regarded as reliable, it can serve as the basis for the decision, whether or not it is supported by other evidence which would be admissible in a court of law. [Footnotes omitted.]
Thus, a Commission panel is mindful of the frailties of hearsay evidence when deciding whether to admit it in a Commission enforcement hearing and, if admitted, what weight (if any) to accord to it. For example, a panel would not make a factual finding based solely on uncorroborated hearsay evidence with insufficient indicators of reliability. As this Commission noted in Re Ironside, 2006 ABASC 1930 (at paras. 97-98):
Corroboration is another important factor used to assess the weight to be given to hearsay evidence. While the circumstances surrounding hearsay evidence may provide some comfort as to the reliability of the hearsay evidence, we gave greater weight when the hearsay evidence was
corroborated by or consistent with other evidence. As stated in Re E.A. Manning Limited (1995), 18 O.S.C.B. 5317 at 5322:
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. . . However, when such [hearsay] evidence was the only evidence on a particular issue, we have given it very little weight. To the extent that the evidence was corroborative of other evidence, on the other hand, we were prepared to give it greater weight.
In Starson v. Swayze, [2003] 1 S.C.R. 722 at para. 115, the majority of the court commented that it is generally within a tribunal's discretion to determine the weight to be given to hearsay evidence. However, the court cautioned that the tribunal "must be careful to avoid placing undue emphasis on uncorroborated evidence that lacks sufficient indicia of reliability".
During the Merits Hearing, Staff, Morice and Merendon and Sorenson adduced various forms of hearsay evidence, including:
transcripts of a compelled investigative interview of Morice conducted by Staff on 11 December 2006 and 25 April and 17 October 2007 (the "Morice Interview"), during which Morice was under oath and, except for 17 October 2007, represented by counsel;
excerpts from transcripts of a compelled investigative interview of Brost conducted by Staff on 4 and 9 April 2008 (the "Brost Interview"), during which Brost was under oath and represented by counsel;
excerpts from a transcript of an investigative interview of Brost conducted by the Department of Financial Institutions, Securities Division in Washington state on 16 August 2004 (the "Brost US Interview"), during which Brost was under oath and represented by counsel;
excerpts from a transcript of a compelled investigative interview of Weis conducted by Staff on 8 January 2007 (the "Weis Interview"), during which Weis was under oath and represented by counsel;
excerpts from a transcript of an investigative interview of Wigmore conducted by staff of the British Columbia Securities Commission (the "BCSC") in Vancouver, British Columbia on 15 April 2005 and from a transcript of a compelled investigative interview of Wigmore conducted by Staff and BCSC staff in Vancouver on 5 April 2007 (together, the "Wigmore Interview"), during which Wigmore was under oath and represented by counsel;
transcripts, in whole or in part, of investigative interviews of Regier conducted by Staff on 12 September and 4 October 2005 and 12 March 2009 and of an interview conducted by the RCMP on 15 January 2009 (together, the "Regier Interview"), during which Regier was under oath and at times represented by counsel;
excerpts from a transcript of an investigative interview of Hoffman conducted by Staff on 2 October 2008, during which Hoffman was under oath but not represented by counsel;
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excerpts from a transcript of a compelled investigative interview of Ken Sorensen conducted by Staff on 8 March 2007, during which Ken Sorensen was under oath and represented by counsel;
excerpts from a transcript of a compelled investigative interview of Justin Christopher Bierwirth ("Bierwirth") conducted by Staff on 1 October 2009, during which Bierwirth was under oath but not represented by counsel;
excerpts from a transcript of a compelled investigative interview of Carol Rose Sieberer Hobbs ("Hobbs") conducted by Staff on 19 December 2006 (the "Hobbs Interview"), during which Hobbs was under oath and represented by counsel;
excerpts from a transcript of a compelled investigative interview of Philip Dean Strashok ("Strashok") conducted by Staff on 19 September 2007 (the "Strashok Interview"), during which Strashok was under oath and represented by counsel;
excerpts from transcripts (some transcribed by Staff) of investigative interviews (some compelled) of Arbour investors, IFFL members and IFFL salespersons (facilitators or structurists) conducted by Staff, BCSC staff or staff of the United States Securities and Exchange Commission (the "SEC"), during which some of the interviewees were under oath and some were represented by counsel; and
Chute's testimony as to conversations she had with individuals, and copies of emails, faxes and other documents that she told us were forwarded to her by those individuals, in the course of Staff's investigation of this matter.
Merendon and Sorenson submitted that very little of the Regier Interview is relevant. They also submitted that we ought to give little or no weight to uncorroborated hearsay evidence, and to evidence in respect of which there was no opportunity to cross-examine. Merendon and Sorenson argued that they were effectively denied their right to cross-examine on much of the evidence received in the Merits Hearing. They also argued that natural justice and procedural fairness require that they have the right to test, to the extent possible, all evidence through cross-examination and that they should not be found to have perpetrated a fraud based on compelled statements such as the Morice Interview, the Brost Interview, the Weis Interview and the Wigmore Interview.
Staff are entitled to adduce in a Commission enforcement hearing evidence obtained by them pursuant to sections 40 to 42 of the Act, including transcripts of compelled investigative interviews. Natural justice and procedural fairness require that a respondent be given a reasonable opportunity to comment on and challenge such evidence. However, hearsay evidence can be challenged by means other than cross-examination, means that are in accord with natural justice and procedural fairness.
In the recent QB Decision, Wittmann A.C.J. (as he then was) stated (at para. 205):
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. . . Contrary to what the Applicants [Arbour and Morice], Merendon, Sorenson and Brost [and IFFL] argue, the case law is clear that, in a regulatory context, the admission of hearsay or compelled testimony or the lack of opportunity to cross-examine will not necessarily breach procedural fairness . . . .
In determining that a Commission panel did not err in admitting and relying on transcripts of investigative interviews, the Alberta Court of Appeal in Alberta (Securities Commission) v. Brost, 2008 ABCA 326 observed that the panel did not deny the respondents "an opportunity to test the impugned hearsay evidence". Noting that the respondents did not testify or apply to the Commission for subpoenas to have the interviewees testify, the court said (at paras. 32, 36):
. . . It was up to the Commission staff to decide what case they would present. As L'Heureux-Dubé said in R. v. Cook, [1997] 1 S.C.R. 1113 at para. 39, we "fail to see why the defence
should not have to call witnesses which are beneficial to its own case." Brost had the opportunity to testify at the hearing to explain the circumstantial case against him. He chose not to do so. The other appellants could have sought to call Brost if they believed his evidence would help them. They chose not to do so.
. . .
. . . The proceedings before the Commission were regulatory not prosecutorial or penal in nature and the Commission did not deny the appellants an opportunity to test the impugned hearsay evidence. Any of the appellants could have applied to the Commission for a subpoena to have any of the other appellants testify: ss. 29(c) and 215 of the Act. No such applications were made and all of the appellants elected not to testify. In other words, the appellants chose not to challenge the reliability and content of the impugned hearsay evidence. To exclude that evidence in these circumstances would effectively exempt the appellants from the authority under the Act to acquire the evidence and from the evidential provisions of the Act. A party cannot claim he or she is exempt from the effect of the conscriptive authority of the Act on the basis of tactical decisions taken at hearing that are fully within their control.
The court in Brost recognized that a Commission panel can appropriately admit and rely on transcripts of investigative interviews provided that a respondent is afforded an opportunity to challenge the reliability and content of such hearsay evidence, through (for example) testifying himself or herself or compelling other respondents to testify. Here, the only Respondent to testify at the Merits Hearing was Sorenson, and, of the nine interviewees who testified at the Merits Hearing, only one was called by a Respondent.
In accordance with sections 29(e) and (f) of the Act, we admitted hearsay evidence, including the transcripts of investigative interviews, subject to our determination of the ultimate weight to give such evidence. We appreciate that our findings, which could have serious consequences for the Respondents, must be based on reliable evidence. In the result, we have carefully considered the hearsay evidence admitted, as we have all other evidence admitted, and ascribed what we consider to be the proper weight to the hearsay and other evidence.
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We have not treated all hearsay evidence equally. We are cognizant that such evidence may be proffered to prove the truth of statements made, to prove some objective fact or to demonstrate something about credibility. For some of our findings, we have relied, in whole or in part, on hearsay evidence adduced by Staff, Morice or Merendon and Sorenson that was corroborated by or consistent with other evidence, which may have included hearsay evidence. In assessing the weight to attach to statements made in any of the transcribed investigative interviews, we have considered: whether the interviewee was examined under oath, indicating sufficient appreciation of the solemnity of the process; whether the interviewee was represented by counsel during the interview; whether the interviewee testified, or could have been summoned to testify, at the Merits Hearing, thereby allowing testing or clarification by way of cross-examination or panel questioning; and whether there was other evidence of the interviewee's trustworthiness. That said, mindful that the Respondents are entitled to natural justice and procedural fairness, we generally have given statements made in the investigative interviews less weight than direct evidence and we generally have not relied exclusively on any particular interview content in making any of our findings, with this caveat: because Morice and Brost chose not to testify at the Merits Hearing and were not summoned to testify by any other Respondent, we generally have treated statements made by Morice in the Morice Interview and statements made by Brost in the Brost Interview and the Brost US Interview as we would direct evidence and have sometimes relied on them exclusively in making findings, even though such statements were untested during the Merits Hearing.
It is not unusual in a Commission enforcement hearing for a panel to receive, and thus to assess, conflicting evidence. It is also not unusual for a panel to assess the credibility of the witnesses appearing before it, particularly when parties claim that their witnesses are more credible than witnesses called by other parties.
In deciding the weight to give certain evidence before us, we have needed to assess the credibility of various witnesses from whom we heard, to grapple with conflicting evidence, or both. When faced with conflicting testimony or documentary evidence in this case, we have generally attached greater weight to evidence corroborated by other testimony, documentary evidence or both. In our assessments and determinations, we have been mindful of the following statement from R. v. Boyle, 2001 ABPC 152 at para. 107, citing Faryna v. Chorney, [1952] 2
D.L.R. 354 (B.C.C.A.) at 357, as referred to in Ironside at para. 103:
The credibility of interested witnesses, particularly in cases of conflict of evidence, cannot be gauged solely by the test of whether the personal demeanour of the particular witness carried conviction of truth. The test must reasonably subject his story to an examination of its consistency with the probabilities that surround the currently existing conditions. In short, the real test of the truth of the story of a witness in such a case must be its harmony with the preponderance of the probabilities which a practical and informed person would readily recognize as reasonable in that place and in those conditions.
While specific conclusions on credibility and conflicting evidence are noted elsewhere in our reasons, we here provide some general conclusions on credibility.
Before addressing in somewhat greater detail the credibility of Regier, Hoffman, Skeith, Sorenson, Blakey, Blaikie, Gleason and Ken Sorensen, we note that we have accepted as
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generally credible all other witnesses from whom we heard, relying on their testimony to a greater or lesser extent having regard to its relevance and in certain respects its reliability in light of the evidence in totality. In so saying, we have attached no importance to Chute's presence during Regier's testimony when under cross-examination herself (as noted by Merendon and Sorenson) given that Chute's testimony was, for the most part, non-controversial – that is, directed at explaining Staff's investigation and entering exhibits for Staff's case.
Regier
Merendon and Sorenson submitted that Regier's credibility "is very seriously in issue in this case", noting (among other things) that he was charged criminally, and pleaded guilty to a lesser charge, in respect of some misrepresentations made to Staff in another Commission enforcement proceeding and that he acknowledged being untruthful in making certain statements to Staff during the Regier Interview. Staff conceded that Regier's testimony should be viewed with caution but submitted that, whatever Regier's reasons for previously lying, there was no evidence to indicate he was untruthful when testifying at the Merits Hearing. Staff argued that Regier has "candidly admitted his actions were wrong" and "has since cooperated with Staff, the RCMP" and others.
Regier's credibility, given his past actions, was indeed in issue. A different Commission panel found Regier liable for breaches of the Act and conduct contrary to the public interest in Re Capital Alternatives Inc., 2007 ABASC 79 and subsequently ordered him to pay an administrative penalty and costs totalling more than $200 000. Regier testified that he paid the amount ordered, but with money originating from Merendon Mining (Colorado) Inc. ("Merendon Colorado"), a company of Brost. Relating specifically to his credibility, Regier admitted that the Commission found him to have made misrepresentations to Staff during the Capital Alternatives investigation and that he was charged criminally in respect of certain of those misrepresentations. In 2007 Regier pleaded guilty to, and was convicted of and fined for, misleading a peace officer. Despite this, Regier stated that he would tell the truth at the Merits Hearing and that we should believe that because:
I made a number of mistakes along the way. This was one of them.
. . .
. . . Misleading the [Commission] was one of them, and I did pay a price. I carry with me a criminal record, and I hurt a lot of people that I love. Since that time I have been very cooperative. I've been assisting the RCMP as -- and giving them testimony. I've worked with the Alberta Securities and Exchange Commission [sic], the FBI [Federal Bureau of Investigation] and the IRS [Internal Revenue Service] in the U.S., and I've also recently given evidence to the CRA [Canada Revenue Agency].
As noted, Regier acknowledged (under cross-examination by Merendon and Sorenson) that he was untruthful in making certain statements to Staff during the Regier Interview, including the following statements on 12 September and 4 October 2005: that he owned Expedia, had no business relationship with Brost, and was not involved with other businesses at the time. Regier agreed that, after the Regier Interview in September 2005, he realized that the Strategic transactions were not supported by documentation. Regier further agreed that he, Brost and Edna Forrest ("Forrest") then met, talked about what testimony to give to Staff and created
falsified documents to provide to Staff. Regier did not believe that Merendon or Sorenson had anything to do with the creation of these documents.
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While under cross-examination, Regier also agreed that among the documents he and others fabricated for the Commission's Capital Alternatives enforcement proceeding were distribution instructions from True North: "I was aware that they were fabricated, yes. I just can't recall whether I created them or whether that was done by somebody else." Regier further agreed with the following statements by Merendon and Sorenson: "it was Brost's idea to set out where funds were being directed to and by whom"; no documentation had existed at the time of fund transfers "to substantiate those transactions"; "Brost was directing things"; and Regier "received [his] instructions solely from [Brost]".
Under further cross-examination, Regier acknowledged that he was not involved in conducting business or fundraising for Arbour, in Arbour's day-to-day operations, or with Arbour's accounting. Regier also testified that he had no specific knowledge of when agreements between Arbour and Merendon were prepared – that is, before or after the fact.
Despite his past actions, we have concluded that, generally, the testimony of Regier on key points was credible. To that end, we note that Regier was forthright with us about his previous untruthfulness and that he has since been cooperating with Staff and the RCMP. Most important, his testimony on key points was corroborated by or consistent with other evidence before us, or otherwise believable given the evidence as a whole.
Hoffman
As mentioned, Merendon and Sorenson questioned Hoffman's credibility and motives in making the Hoffman Tapes, and in, it seems, his testimony generally.
While we have some difficulty with Hoffman's explanation for the destruction of certain of the Hoffman Tapes, we have nonetheless concluded that, generally, Hoffman's testimony on key points was credible. To that end, we note that there was nothing in Hoffman's demeanour that caused us to question the general truthfulness of his testimony before us. Most important, his testimony on key points was corroborated by or consistent with other evidence before us, or otherwise believable given the evidence as a whole.
Skeith
Although we have found Skeith and his testimony to be generally credible, it seemed to us that he was reticent to testify on certain matters in issue (perhaps out of a sense of loyalty to his former clients) and that the content of some of his testimony was more a reflection of his former clients' viewpoint than of his experience as a lawyer.
Sorenson
Staff submitted that Sorenson "lacked credibility entirely". Staff contended – a contention with which we agree – that Sorenson's decision to testify after listening to all other testimony during the Merits Hearing affects the weight that can be given to his testimony. Staff ultimately contended that we ought to disregard Sorenson's testimony in its entirety, except where Sorenson testified as to uncontested matters or made admissions against his own interest.
Sorenson's testimony concerning non-controversial matters was generally credible, and evidence to which Merendon and Sorenson referred us concerning such matters was not inconsistent with other evidence.
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However, Sorenson's testimony in important aspects – generally regarding matters that might implicate, or be damaging to, him in relation to issues in the Merits Hearing – was not credible. Concerning such matters, Sorenson was at times evasive or conveniently forgetful, and his testimony in relation thereto was inconsistent with other evidence before us, simply defied belief as nonsensical, simply defied belief given the evidence as a whole, or seemed tailored to address the earlier testimony of others. For instance (and as discussed below), we have found not credible Sorenson's testimony that, or to the effect that, he: was not a hands-on chief executive officer ("CEO") directly involved in Merendon's management decisions related to issues in the Merits Hearing; was not involved in the management or operation of, and made decisions about, SGD; was not involved in the IBG discussions about Arbour; and was not involved in negotiating the Canadian Oilsands Recovery Enterprises Ltd. ("COREL") and TRL sales transactions. As discussed below, we also reject Sorenson's testimony claiming or suggesting he was unaware that Arbour was reactivated for the purpose of collecting investor money being raised by Brost and others from IFFL members, which money would then be funnelled to Merendon ultimately for use by Brost, Sorenson or both.
Blakey, Blaikie, Gleason and Ken Sorensen
The testimony of Blakey, Blaikie, Gleason and Ken Sorensen, whose interests were at least in some respects aligned with those of Sorenson, has also presented challenges. Each was sometimes evasive or conveniently forgetful when testifying about certain matters – those that might implicate, or be damaging to, him or Merendon or Sorenson in relation to issues in the Merits Hearing. Blakey's, Blaikie's, Gleason's and Ken Sorensen's testimony generally regarding such matters lacked credibility – being inconsistent with other evidence before us, simply defying belief as nonsensical, or simply defying belief given the evidence as a whole.
Merendon and Sorenson submitted that an adverse inference should be drawn against Arbour and Morice, who had, in a pre-hearing application, declared an intention to call Forrest as a witness at the Merits Hearing (if Staff did not do so), suggesting that her testimony would support Arbour's and Morice's theory of the case and be damaging to Brost and Sorenson. Merendon and Sorenson argued that, given that neither Arbour nor Morice called Forrest as a witness at the Merits Hearing, it must be concluded that her testimony would not have supported Arbour's and Morice's theory of the case.
We are entitled to draw an adverse inference against a party when, in the absence of an explanation, that party fails to call a witness who would have knowledge of the facts and presumably would be willing to assist that party. However, given our findings below that all extant allegations against Arbour and Morice have been proved to the requisite evidentiary standard based on sufficiently clear, convincing and cogent evidence, we need not address this point.
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At various stages of this proceeding, various of the Respondents expressed concerns that they suggested brought into question the fairness of this proceeding. Some of these concerns we addressed above. Another concern raised by Morice and Merendon and Sorenson involved Staff's handling of their disclosure obligation to the Respondents.
Morice contended that Staff should have requested and obtained all material that the RCMP had gathered in the course of its investigation of alleged criminal activity involving certain of the Respondents.
Merendon and Sorenson submitted that Staff's approach to disclosure has resulted in an unfair hearing for Merendon and Sorenson. They suggested that Staff had been "playing games" with disclosure, arguing that it became obvious during the Merits Hearing that Staff effectively had more disclosure within their "grasp" than they ever indicated in the many applications for disclosure. Merendon and Sorenson contended that Staff used other cooperating agencies, such as the RCMP and the SEC, as "a library of convenience" from which "Staff could check out what [they] needed to prove [their] case, where [they] needed it, while safely keeping everything else from the scrutiny of the [p]anel and the Respondents". Merendon and Sorenson argued that Staff did not properly fulfil their investigatory function because, "if [they have] a source for information, they should at least ask the source for everything relating to a given subject of interest".
Merendon and Sorenson theorized about Staff's motive for so acting. They pointed to the results of a pre-hearing application made by them for disclosure of some 34 000 pages of documents Staff had obtained from the SEC. Staff had apparently voluntarily disclosed approximately 1000 pages, but refused to disclose the remaining documents as being irrelevant. A Commission panel, after reviewing these documents, directed that Staff disclose the majority of them to the Respondents. Merendon and Sorenson appeared to suggest that, following this direction, Staff then sought to avoid disclosure of exculpatory documents or panel scrutiny of documents in their possession by embarking on a course of "selective disclosure" resulting in "disclosure of convenience".
Staff submitted that there is no merit to these contentions of Merendon and Sorenson, which they characterized as "offensive". Staff's position was that there was no evidence to support the suggestion that Staff had not complied with their duty to provide full and timely disclosure to the Respondents or that the Respondents were not given a fair hearing. Staff argued that documents obtained by them late in the Merits Hearing for the purpose of impeaching Sorenson's credibility neither formed part of Staff's disclosure nor constituted late disclosure.
The extent of Staff's disclosure obligation in a securities regulatory proceeding has been evolving since the issuance of the Supreme Court of Canada's seminal decision R. v. Stinchcombe, [1991] 3 S.C.R. 326, which confirmed that Crown counsel, in the criminal proceeding context, has a duty to disclose all relevant information in its possession relating to the investigation of an accused. The purpose of obliging pre-trial disclosure of the prosecution's case is an adjunct to an accused's right to make full answer and defence and, ultimately, to
provide for a fair trial. The fundamental principle of fairness that an affected party has the right to know the case it has to meet has been long established in administrative proceedings, but the Stinchcombe disclosure duty has met with varying applications in administrative proceedings.
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The principles governing the duty of disclosure set out in Stinchcombe were formulated in the context of criminal prosecutions of indictable offences. Mr. Justice Sopinka specifically noted (at 342) that the court's endorsement of a broad duty of disclosure cannot be applied without a consideration of the nature of the proceeding, and that the courts would need to decide "where to draw the line" as to what constitutes proper disclosure in cases involving less serious criminal offences. That is, the disclosure obligation is to be considered in the context of the particular proceeding.
There is no question that securities regulatory proceedings, such as here, involve serious allegations and potentially grave consequences. In the result, this Commission and other securities regulatory authorities have accepted that the Stinchcombe criminal process rules of full pre-trial disclosure apply in enforcement proceedings, obliging Staff to disclose to a respondent all relevant fruits of their investigation of a respondent's alleged misconduct that are in their possession or control. The objective of such full disclosure, as is the case in criminal proceedings, is to enable a person alleged to have contravened Alberta securities laws to make full answer and defence to the allegations faced, and to provide for a fair hearing.
However, a respondent's rights to disclosure and a fair hearing must be balanced against other systemic demands, practicalities and the interests of others involved in the securities regulatory proceeding. In R. v. O'Connor, [1995] 4 S.C.R. 411, in dissenting on the issue of production in criminal proceedings of records in the possession of third parties, McLachlin J. (as she then was) said (at paras. 193-94):
The task before us on this appeal is to devise a test for the production of records held by third parties which preserves the right of an accused to a fair trial while respecting individual and public interest in privacy and the efficient administration of justice. The key to achieving this lies in recognition that the Canadian Charter of Rights and Freedoms guarantees not the fairest of all possible trials, but rather a trial which is fundamentally fair: R. v. Harrer, [1995] 3 S.C.R. 562. What constitutes a fair trial takes into account not only the perspective of the accused, but the practical limits of the system of justice and the lawful interests of others involved in the process, like complainants and the agencies which assist them in dealing with the trauma they may have suffered. Perfection in justice is as chimeric as perfection in any other social agency. What the law demands is not perfect justice, but fundamentally fair justice.
Perfect justice in the eyes of the accused might suggest that an accused person should be shown every scintilla of information which might possibly be useful to his defence. From the accused's perspective, the catalogue would include not only information touching on the events at issue, but anything that might conceivably be used in cross-examination to discredit or shake a Crown witness. When other perspectives are considered, however, the picture changes. The need for a system of justice which is workable, affordable and expeditious; the danger of diverting the jury from the true issues; and the privacy interests of those who find themselves caught up in the justice system -- all these point to a more realistic standard of disclosure consistent with fundamental fairness. That, and nothing more, is what the law requires.
Administrative tribunals such as the Commission must be increasingly judicious in their use of formal court-like processes in enforcement proceedings to ensure not only that
respondents are accorded natural justice and procedural fairness but also that allegations of contraventions of regulatory requirements are handled with due efficiency and effectiveness. Courts, too, recognize the need be judicious in their use of process as the court in R. v. McNeil, [2009] 1 S.C.R. 66 commented (at para. 28):
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. . . it is important for the effective administration of justice that criminal trials remain focussed on the issues to be tried and that scarce judicial resources not be squandered in "fishing expeditions" for irrelevant evidence. . . .
The objective of disclosure in a Commission enforcement proceeding is to assist a respondent in making full answer and defence without allowing the proceeding to be diverted by irrelevancies, or become "a conglomeration of satellite hearings on collateral matters" (McNeil at para. 45). A process that provides for adequate disclosure yet dissuades fishing forays is one that appropriately balances a respondent's right to procedural fairness with efficient process.
Staff are obliged to disclose the fruits of their investigation that are in their possession or control. However, when information lies in the hands of a third party, it falls outside the Stinchcombe disclosure regime. Thus, a respondent seeking to obtain "information in the possession of a third party must look to some other procedural mechanism" (Re Workum, 2005 ABASC 986 at para. 49), such as an O'Connor proceeding by which third-party information may be accessed on application to the court. In an O'Connor proceeding, the judge, acting as a gatekeeper, must be satisfied that the applicant is not engaging in a "speculative, fanciful, disruptive, unmeritorious, obstructive and time-consuming" (O'Connor at para. 24, quoting R. v. Chaplin, [1995] 1 S.C.R. 727 at para. 32) fishing expedition, and that it is appropriate for the court to compel the production of material held by a third party. Once a Commission enforcement hearing has commenced, section 29 of the Act permits a respondent to access third-party information by obtaining a notice to attend and produce documents, which compels third parties to produce relevant materials in their possession. A witness so compelled may resist attendance and production of their documents if the respondent cannot establish that the evidence sought is potentially relevant to the allegations to be decided in the enforcement proceeding.
Staff did not have ready access to information in the hands of the RCMP (we understand that, in fact, a court order was required to obtain certain information from the RCMP) or the SEC and so could not disclose what they did not have.
Consistent with our rulings on earlier applications (Re Arbour Energy Inc., 2009 ABASC 366; and Re Arbour Energy Inc., 2010 ABASC 11), we are of the view that the principles set out in McNeil do not require Staff to search out information from government or policing authorities or agencies who are strangers to this proceeding. Neither the RCMP, a separate policing agency, nor the SEC, a separate government agency in another country, can be said to be a policing or government agency on the same first-party footing as Staff with respect to disclosure. In the case of Arbour and Morice, they sought information in the possession of a separate policing agency, the RCMP. In respect of such information Arbour and Morice apparently commenced, but did not follow through with, an O'Connor application in the QB Court. At the outset of the Merits Hearing, Arbour and Morice did summon an RCMP sergeant, who was directed to bring with him several documents; however, excerpts from only a few of those documents were found
to be relevant to the allegations in this proceeding (Re Arbour Energy Inc., 2009 ABASC 366; and Re Arbour Energy Inc., 2009 ABASC 428).
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Even if we assume that Staff had a duty during their investigation to make further inquiries of these agencies, we conclude that such duty would extend only to making reasonable inquiries after a disclosure request had been received by Staff and the information in their possession reasonably required such inquiries.
In any event, it appears that Staff in this proceeding did make inquiries or in some other fashion obtained material from the RCMP and the SEC, from which relevant material was ultimately disclosed to the Respondents. There was no evidence before us as to the nature or extent of inquiries made of these agencies by Staff. There was also no evidence before us that Staff failed to make appropriate inquiries of these or other agencies, that their inquiries would have failed to uncover any documents with a clear nexus to the issues in this proceeding, or that Staff had in their possession information that reasonably compelled them to make further inquiries. None of the Respondents sufficiently particularized or identified any documents that were not disclosed to them. There was no evidence that either the RCMP or the SEC had additional material that was directly related to the circumstances of the allegations made against the Respondents and not disclosed. Contrary to the suggestions of Merendon and Sorenson, there was no evidence that, in discharging their disclosure obligation, Staff acted deliberately or in bad faith with a view to frustrating the Respondents' defences.
We understand that over many years Brost, IFFL, Merendon and Sorenson engaged in activities that garnered the attention of criminal investigators and securities regulatory investigators in this country and the United States, resulting in numerous civil lawsuits, criminal proceedings and securities regulatory actions. Apparently these related to their involvement in a myriad of ventures, most of which were not connected to Arbour. Such lawsuits, proceedings and actions could, we do not doubt, be the source of irrelevancies, clouding matters and impeding proper resolution of the allegations before us.
Staff made extensive disclosure to the Respondents – such disclosure continued throughout the Merits Hearing. In our view, even if there were a failure by Staff to disclose all potentially relevant information, we find that any such failure would not have prevented the Respondents from knowing the case they had to meet or in making full answer and defence. We reiterate that perfect disclosure is neither possible nor required.
Finally, because the relevance of certain evidence led by Staff and the Respondents was unclear, we gave all parties considerable latitude in the conduct of their cases, sometimes hearing what we ultimately determined to be evidence irrelevant to the issues before us. A defence was aggressively advanced by each of the Respondents who participated in the Merits Hearing, and we are satisfied that none of the Respondents has been prejudiced in any way in this respect. The Respondents were able to summon witnesses and their documents. The Respondents were also able to, and those participating in the Merits Hearing did, call witnesses of their choosing to provide evidence as part of their defences. The Respondents who participated in the Merits Hearing also conducted cross-examinations, sometimes extensive, of witnesses called by other parties.
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In short, we are satisfied that neither the Merits Hearing nor the actions of Staff were such as to violate the rules of natural justice or procedural fairness.
The following descriptions of the Respondents and other parties are the panel's findings of facts based on the evidence. We discuss some non-parties quite extensively as background necessary to an understanding of the labyrinth of corporate and personal relationships involving and surrounding the Respondents. The extensive connections among some of the entities and individuals lead to some necessary repetition in this section.
Arbour was incorporated in Alberta on 9 April 2001 and had its head office in Calgary. Calgary lawyer Strashok was one of the original founders of Arbour, as well as a director and officer and its legal counsel. Other directors and officers at the time included Gary Strashok, Gary Holden ("Holden"), Michael Gardner ("Gardner") and Cliff Monar ("Monar"). Gary Strashok, Gardner and Monar remained in those positions until new management took over in June 2004; Strashok stayed slightly longer, as did Holden (in his position as chair of the Arbour board of directors).
Morice and Weis were appointed as directors of Arbour on 11 June 2004, with Wigmore appointed a director on 9 September 2004. Morice was also Arbour's president and secretary from 11 June 2004, becoming its CEO and CFO on 9 September 2004. As of 2 August 2007, the directors of Arbour were still Morice, Weis and Wigmore.
Arbour became a reporting issuer in Alberta when it filed a preliminary prospectus and a prospectus – the latter was receipted by the Commission's Executive Director (the "Executive Director") on 18 December 2001. No preliminary or final prospectus has ever been filed or receipted by the Executive Director for the distribution of the Arbour preferred shares (the "Arbour Preferred Shares") at issue in this proceeding. Arbour has never been registered with the Executive Director to trade in securities.
Arbour common shares had been listed and posted for trading on the TSX Venture Exchange (the "Exchange") until their de-listing on 21 July 2004. Arbour's securities never resumed trading on the Exchange, although they continued trading on the Canadian Trading and Quotation System Inc. (the "CNQ"). In June 2007, Morice advised Arbour shareholders that the CNQ had de-listed Arbour. A November 2006 letter in evidence referred to Arbour being "inactive".
It seems that Arbour is currently inactive and unlikely to resume operations. The investors from and about whom we heard appear to have lost some – if not all – of their investments in the Arbour Preferred Shares.
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Morice, a Calgary resident, is a certified general accountant. His employment over the 27 years prior to his employment at Arbour was primarily in the accounting field with some sporadic involvement in some "entrepreneurial type ventures [and] a couple of public companies". Morice has never been registered with the Executive Director to trade in securities.
Morice became president, secretary and a director of Arbour on 11 June 2004 and became CEO and CFO on 9 September 2004. Morice's IFFL connection predated his involvement with Arbour – his accounting firm had apparently been retained by another organization to assist IFFL members with the preparation of their 2003 annual tax returns.
Brost is a Calgary resident. A high school graduate, he worked in the construction and sales industries for several years. He then worked in the financial services industry, including as an insurance and mutual fund agent for a few years. Brost was registered with the Executive Director as a mutual fund salesperson from approximately 1992 until September 1996, but has not subsequently been registered with the Executive Director to trade in securities or to act as an advisor.
In 1999 Brost founded Capital Alternatives; we are satisfied that he was its controlling mind. According to Brost, Capital Alternatives created in 1999 "morphed" into IFFL, although IFFL was a separate corporate entity incorporated in Alberta on 23 April 2003. Brost estimated that several hundred Capital Alternatives members later became IFFL members. Brost formed and ran IFFL and was, at the time relevant to the allegations, a director, its sole shareholder and CEO. Brost described himself as an "owner" and "[f]igurehead" of IFFL; we find he was IFFL's controlling mind.
Brost also held numerous other corporate and directorship positions including: a shareholder of SGD; an officer of Bellringer; and the controlling mind of True North. Brost was a member of the IBG Advisory Committee.
Brost's first name is sometimes spelled "Milo" or "Mylo" in the evidence. He is also known by various aliases, including M.B. Gonne and Phillip K. Collins.
On 22 September 2004 Brost gave a written undertaking for himself (the "Brost Undertaking") and another as president and CEO of IFFL (the "IFFL Undertaking") to the Commission. These were accepted by the Commission as reflected in an order dated 30 September 2004 (the "Undertaking Order"). In the Brost Undertaking, Brost, in his capacity as president and CEO of IFFL, undertook that he would "not, directly or indirectly, cause, encourage, instruct, allow, condone or participate in any trading in securities or acting as an advisor" personally or on behalf of IFFL or any of IFFL's facilitators, structurists or agents. He also undertook not to "incorporate or organize" another entity to "trade in securities or act as an advisor". In the IFFL Undertaking, Brost, also in his capacity as president and CEO of IFFL, undertook that IFFL would not trade in securities or act as an advisor.
IFFL was incorporated in Alberta on 23 April 2003 and had its head office in Calgary. IFFL is not a reporting issuer in Alberta and has never been registered with the Executive Director to trade in securities or act as an advisor.
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As discussed more fully above, IFFL entered into the IFFL Undertaking and was subject to the Undertaking Order.
Sorenson is a resident of Calgary. Since 1999, Sorenson had resided predominantly in Tegucigalpa, Honduras until his return to Calgary in 2009. After attending high school, Sorenson spent many years involved in gold mining and personal business ventures in both North America and Europe. In 1996 he learned about gold mining opportunities in Central America and began Merendon. At the times relevant to the allegations, he was CEO, chairman, a director and – both directly and indirectly – the controlling shareholder of Merendon.
We find that Sorenson was Merendon's directing mind and that he was, for all intents and purposes, Merendon. Sorenson ultimately owned or controlled 90% of Merendon's shares and had a select group of directors, with friends and family members representing close to half of the composition of the board of directors during the period in question. He was an officer (usually the most senior) of most if not all of the Merendon subsidiaries. He had the final approval on all Merendon expenditures and all material contracts.
Sorenson had numerous other corporate and directorship interests at the times relevant to the allegations – he was a shareholder of SGD and a shareholder and the controlling mind of Eiger Capital Corporation ("Eiger", sometimes referred to as "Eigar" in the documentary evidence). Sorenson was listed for a time as a director of Strategic (in error, he contended) and was the president of and owned for a time (through Merendon, his company) Stone Mountain Resources Ltd. ("Stone Mountain"), until selling it to Strategic in January 2005. Sorenson was also a member of the IBG Advisory Committee.
Sorenson is also known by the aliases "Don Grey Wolf" (or "Don Greywolf") and "Greywolf".
Merendon was incorporated as 685106 Alberta Inc. in Alberta in 1996, subsequently changing its name to Merendon on 9 May 1996. Merendon is a private company.
Merendon was a junior exploration mining company focused on the exploration and development of mining concessions.
Merendon maintained its head office in Calgary until leaving the jurisdiction in late 2007 to relocate in Belize with its headquarters in Honduras. Merendon's headquarters in Honduras during the period relevant to the allegations was located outside of the city of Tegucigalpa, Honduras and consisted of a number of buildings within a walled compound of some 12.5 acres.
This included a gold refinery, office buildings and a medical clinic. Sorenson's residence was also in Honduras.
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Alberta Corporate Registration System ("CORES") records for Merendon as at 16 March 1998 showed that William Dallas ("Dallas", with a Carstairs address), Jack Monkman ("Monkman") (with a Medicine Hat address), Rodney Morris (with a Calgary address) and Wigmore (with a Delta, British Columbia address) were appointed directors of Merendon on 16 September 1997, and that the other directors were Rolando Luque (with a Honduras address), Sorenson (with a Calgary address) and Donna Sorenson (Sorenson's wife at the time, with the same Calgary address as the one then showing for Sorenson).
CORES records for Merendon as at 22 March 2004 showed that: Larry Adair ("Adair"), Darrell Hewitt and Wigmore ceased to be directors on 2 March 2004; 685141 Alberta Inc. and Carmen Pinto were inactive shareholders; Blaikie (with his name misspelled) and Thelma Sorenson (both with a Tegucigalpa address) and Monkman and Strashok (both with the same address as Merendon's registered office address) were appointed directors on 2 March 2004; and its main shareholder was Eiger (with a Tegucigalpa address) with 65% of the voting shares. There was no indication on CORES as to who held the balance of Merendon's shares.
CORES records for Merendon as at 14 July 2004 identified Merendon's directors as: Blaikie and Thelma Sorenson (both with a Tegucigalpa address); Dallas (with a Carstairs address); and Monkman, Sorenson, Strashok and Jack Wolfe (all four with the same address as Merendon's registered office address). Two shareholders were identified – Eiger (with a Tegucigalpa address) with 65% of the voting shares and Glenda Savard of Calgary with 7% of the voting shares. In 2007 Eiger became the holder of 93% of Merendon's voting shares, reduced by the time of the Merits Hearing to approximately 86 or 87%.
Sorenson was the chairman and CEO of Merendon at all times relevant to the allegations. Wigmore was the president of Merendon from approximately October 2001 until November 2003. Merendon apparently then had no president until Monkman became its president on 11 February 2004, a position he held until 1 April 2005 when Ken Sorensen was appointed president. Ken Sorensen remained president until November 2007.
Brost claimed to believe that the president of Merendon at any given time was the person who made the decisions for Merendon. We reject that contention. It is clear from the evidence before us that Sorenson exercised complete control at Merendon, including making the important decisions, and we so find. We also note the approximately 3-month gap between Wigmore's and Monkman's presidencies when Merendon had no president – obviously the position of president was not critical. It is also clear from all the evidence – and we find – that Brost was fully aware of Sorenson's power and influence over Merendon's affairs.
Jack Wolfe was Merendon's controller until his death in 2005, when his son, Jared Wolfe, assumed the position for a short time. Bierwirth, who worked in accounting at Merendon, was then appointed controller, leaving shortly before Gleason was appointed Merendon's CFO in June or July 2006.
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Merendon's non-consolidated comparative financial statements for the years ending 31 December 2003, 2004 and 2005, along with the pro forma statements to 31 December 2006 (the "Merendon Financial Statements") list a number of entities in a section titled "Investment in and advances to subsidiaries". Using that list and other information in evidence, we compiled at least a partial list of Merendon's subsidiaries (some of which had Sorenson as president, at least at one point):
Merendon Honduras, a wholly-owned subsidiary of Merendon, was incorporated in 1996. It operated a gold refinery and was Merendon's "administration entity for Central and South America".
Merendon Jewellery S.A. (Honduras) ("Merendon Jewellery") was a Honduran corporation primarily owned by Merendon. It produced and sold jewellery.
Merendon Hospitality Group (Honduras) – about which we had little pertinent information.
Oro y Metales Preciosos S.A. (Honduras) ("Oro Metales") was a Honduran corporation owned by Merendon Honduras. It was the mining division or "geological department" of Merendon's operations in Honduras.
Seguridad Honduras Canada S.A. (known as "SEHOCAN") was a security company owned by Merendon Honduras. It provided security for Merendon's operations and personnel in Honduras.
Merendon Ecuador, a wholly-owned subsidiary of Merendon, was established in 2004. Its activities involved "the acquisition of mining concessions, exploration of those concessions, development and production of mines, and production of precious metals" in Ecuador, including the operation of mining concessions in the Tena region of Ecuador (the "Tena Concessions"). The evidence indicated that Merendon Ecuador's monthly operating expenses were approximately $100 000 at the time of the Merits Hearing, but had been approximately $240 000 in earlier years.
Merendon Peru, a Peruvian corporation, had been 60% owned by Merendon; Merendon later owned 79% and Eiger owned the remaining 21%. The evidence indicated that Merendon Peru's mining operations had been suspended in 2003 to concentrate on exploration.
Merendon de Venezuela C.A. ("Merendon Venezuela"), a corporation incorporated in 2001, was owned by Merendon Honduras. It operated a custom gold milling operation.
Merendon Hospitality Venezuela operated a resort called Saranda.
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Empresa Minera Portovelo Ecuador S.A. ("EMPEC") apparently was 55% owned by Merendon Honduras and operated a gold mine and processing plant. The operating costs of EMPEC had been in the range of $250 000 to $500 000 per month until Merendon lost control of EMPEC in 2007 when it was taken over in an armed invasion.
Alegre Events & Marketing was a Calgary "events and marketing company" about which we had little pertinent information.
COREL – discussed later in more detail.
Guanja Reef Club – about which we had little pertinent information.
Magna North Gold Ltd. ("Magna North") – discussed later in more detail.
Sorenco Oil & Gas ("Sorenco") was an entity owned by Ken Sorensen (51%) and Merendon (49%).
Tari Tari Tours – about which we had little pertinent information.
Universal Lighting – about which we had little pertinent information.
Stone Mountain was a British Columbia corporation owned by Merendon until sold to Strategic. Sorenson was president of Stone Mountain until replaced by Wigmore.
TRL – discussed later in more detail.
Merendon, Sorenson, Monkman and Jack Wolfe were sanctioned by this Commission in October 2004, following the approval of a Settlement Agreement in which they admitted to illegal trading in Merendon securities and other conduct contrary to the Act. The market-access bans ordered ranged from two years (for Merendon and Sorenson) to six months (for Monkman and Jack Wolfe).
Many other parties who are not Respondents or did not appear as witnesses during the Merits Hearing were or are referred to during the course of the Merits Hearing and in these reasons. To provide some helpful context, we identify and briefly discuss these parties here.
385765 was one of four vendors which sold COREL shares to Arbour. Its president at that time was Pat Page ("Page"). 385765 also owned 25% of the shares of TRL.
1061463 was one of four vendors which sold COREL shares to Arbour. Its president at that time was Ian McIntyre ("McIntyre"). 1061463 also owned 25% of the shares of TRL.
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Adair was a Florida lawyer. He was a business associate of Brost and had known Brost since 1993. In approximately 1995 when Brost was president of Bellringer, he asked Adair to become the vice-president of Bellringer, and Adair assumed that position. Adair was also president of SGD from January 2002 until the end of 2003, and a director of Merendon for a time until 2 March 2004. Adair was counsel for SGD and Merendon and appeared to have a strong relationship with both Brost and Sorenson.
Arbour Caribbean was incorporated on 15 November 2004 under the laws of Barbados as a wholly-owned subsidiary of Arbour. Morice was its president and a director.
Arbour US was a wholly-owned Nevada subsidiary of Arbour incorporated in 2005. Arbour's apparent intention was to transfer Arbour's future-acquired technology and oil and gas activity in the US to Arbour US.
Bierwirth was the controller at Merendon from sometime in 2005 until early or mid 2006.
Casey Brost is Brost's son. He was involved with a number of companies mentioned during the course of the Merits Hearing such as SGD when its records were moved to Belize, 3Sixty Earth Foundation Ltd. ("3Sixty"; several versions of this name were in evidence), Expedia and Fortris Business Systems ("Fortris"). Casey Brost was also a member of the IBG Advisory Committee.
Elizabeth Brost is Brost's former wife. She provided administrative services to SGD in Honduras at the Merendon Honduras compound from some time in 2004 until the SGD records were moved to Fortris in Belize in late 2005 or early 2006.
Burgess is a Calgary lawyer who was one of three lawyers hired by Brost in 2005 to conduct due diligence on Merendon and report his findings (the "Burgess DD Report", dated 5 December 2005) to SGD.
COREL was an Alberta corporation. Until its sale to Arbour in 2006, its four shareholders were Merendon, 385765, 1061463 and Monkman Consulting (Medicine Hat) Ltd. (the proper name for the latter was apparently Monkman Consultants Medicine Hat Ltd.; we refer to it as "Monkman Consultants") and its directors were Sorenson, Page, McIntyre and Monkman.
Merendon paid $52 for its 52% of COREL's shares in 2003 – we infer that the other three shareholders paid $1 for each 1% of ownership as well. Arbour purchased 100% of COREL effective 1 January 2005 for $10.3 million and Arbour common shares.
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Capital Alternatives was an Alberta corporation between 1999 and 2003, when it, according to Brost, "morphed" into IFFL and continued the "strategy and business development-type education platforms". We find that Brost was the controlling mind of Capital Alternatives. Some of the investor witnesses had been members of Capital Alternatives before becoming IFFL members.
Capstick was an associate of Brost and an IFFL structurist. Capstick was a director of Merendon Nevada and also part of the IBG Advisory Committee.
Eiger was incorporated in Belize. Its president and sole shareholder during the period relevant to the allegations was Sorenson. (We note that the Burgess DD Report stated that Eiger was a Bahamian company, which appears to be a mistake.) The evidence indicated that Eiger was Merendon's majority shareholder, owning approximately 86 or 87% at the time of the Merits Hearing. Sorenson stated that, at the time of the Merits Hearing, his son now owned and controlled that majority shareholding of Eiger.
Expedia was an Alberta corporation, registered on 6 November 2003 under the name Expedient Serving Inc. until it changed its name to Expedia on 12 March 2004. The sole director and shareholder, as of a 2 August 2007 CORES search, was James Verbeem ("Verbeem"), Brost's stepson. According to Regier, who worked for Expedia, it was "indirectly" controlled by Brost. Based on all the evidence, we find that Brost was the controlling mind of Expedia.
Forrest was an associate of Brost. She was the president and a director of Strategic. Blaikie thought that Forrest worked for Fortris in Belize on SGD administration. She may have had a role with Expedia as well.
Fortris was a company operated out of Belize by Casey Brost. Fortris took over SGD account administration from Elizabeth Brost in late 2005 or early 2006.
Grovenor was apparently an entity owned, controlled or operated by Kendall and Houston out of Belize.
Hobbs, an Alberta resident, was a chartered accountant who provided accounting services to Arbour on a consulting basis until her appointment as Arbour's CFO in August 2005.
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Houston was an associate of Brost and apparently had a business degree. Houston was a former SGD shareholder and was involved with Grovenor and Steller Trust Services Ltd. ("Steller", sometimes referred to as "Stellar" in the documentary evidence). He was Strashok's initial contact – representing Brost – regarding what became the resurrection of Arbour.
Kendall was an associate of Brost and was apparently an accountant. Kendall was a former SGD shareholder and was involved with Grovenor and Steller. He was a former vice-president of Bellringer.
La Conxion (sometimes referred to as "La Conexion" in the documentary evidence) was described by Brost as a Belize corporation owned by an international trust – IPC Corporation –of which he was the declared manager, giving him the authority to manage La Conxion's affairs, including its money. Brost alternatively described La Conxion as "my bank account which does international joint ventures with other companies". Brost also referred to La Conxion as one of his "many joint ventures", with the particular role of participating in the "bond deposit" of about
$10 million required by the "First National Bank of East Timor" – "a significant bond [that a bank has to have in place] before it can ever do any business". Regier understood that Brost owned or operated La Conxion. It is clear from the totality of the evidence – and we find – that Brost owned or operated La Conxion.
Magna North was a project in the Yukon of which Merendon was the 60% controlling shareholder. Merendon's board of directors decided in 2007 to liquidate Merendon's holdings in Magna North.
Merendon Investment Group was incorporated in Nevis, with Eiger as its only shareholder. The evidence indicated that Merendon Investment Group was the shareholder of Merendon Nevada, at least as of February 2007, although Sorenson denied it. Regier thought that Brost had transferred Merendon Nevada to Sorenson, but Regier did not know whether Sorenson was aware of the purported transfer. Sorenson claimed not to be aware of Merendon Colorado's and Merendon Nevada's existence until 2002 and not to be aware of at least some of Brost's connections to those companies until 2009.
Merendon Colorado was a company incorporated under the laws of Colorado in 2003. Its three directors were Brost, Elizabeth Brost and Capstick.
Merendon Nevada was a company incorporated under the laws of Nevada in 2002. Brost was president and CEO, Capstick was a director and Regier was secretary and treasurer. Regier stated that Merendon Nevada was a parent company, owning all the shares of Merendon
Colorado. Although Sorenson denied it, other evidence indicated that, by February 2007, Merendon Nevada was owned by Merendon Investment Group, which was owned by Eiger.
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Monkman was the director of Monkman Consultants, at least during the period 25 October 2001 to 2 August 2007. He was a former director and president of Merendon. According to Sorenson, Monkman introduced both the COREL and TRL projects to Merendon.
Monkman Consultants was an Alberta corporation registered on 2 June 1977. Monkman was the only director listed as of 2 August 2007, with Red Ridge Resources Inc. as the only shareholder, although there had been a "Change Director / Shareholder" filing on 25 October 2001. CORES records stated that Monkman Consultants held shares in TRL and Magna North.
Monkman Consultants was one of four vendors which sold COREL shares to Arbour. Monkman Consultants also owned 25% of the shares of TRL.
Parklane was a corporation managed by Christopher Thompson, a Vancouver resident. Parklane was apparently an organization that, although soliciting investors to invest in SGD in a manner similar to Capital Alternatives and IFFL, was a separate organization. Sorenson was aware of Parklane, as shown by a report made to him by Adair in 2005 regarding an investigation into its operations by the BCSC.
SGD was a Bahamian corporation dating from 1999. As of January 2000, SGD's shareholders were Brost, Sorenson and Hoffman (Houston and Kendall had originally been shareholders as well). SGD is now called Bahama Resource Alliance Ltd. ("Bahama Resource Alliance").
Hoffman was president from SGD's 1999 incorporation until 31 December 2001. Adair was SGD's president from January 2002 until the end of 2003. Blaikie was SGD's president from 1 January 2004 until 31 March 2007, at which time Martin Werner ("Werner") became SGD's president.
There was another company with a similar name but incorporated in Belize on 15 January 2002 ("SGD Belize"). The evidence indicates that Sorenson was aware of SGD Belize by 12 July 2005 at the latest, when he received its minute book from Adair. "IPC Corporate Services, Inc." (similar in name to the "IPC Corporation" through which Brost stated he managed La Conxion) became director and secretary for a short time until Adair was appointed to both positions on 24 January 2002.
Thelma Duron (Figueroa) or Thelma Sorenson (we refer to her as "Thelma Sorenson") is Sorenson's wife who resided in Honduras. She was president of Merendon Ecuador for a time
and held other positions with other Merendon entities. Her sister was controller of Merendon Honduras at some point.
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Steller, an incorporated Belizean trust, was apparently managed by Kendall and Houston out of Belize. Steller described itself as an "international management account provider".
Strashok was a Calgary lawyer who helped found Arbour. He was one of Arbour's counsel, doing some legal work for it until approximately May 2004. He was president, secretary and a director of Arbour at various times from incorporation until approximately September 2004. Strashok was a director of Merendon between approximately February and May 2004 (he disagreed with a CORES report identifying him as still a Merendon director in July 2004). He was also counsel for Merendon from approximately December 2001 to May or June 2004. Strashok was a director of and counsel for Stone Mountain, both for periods unclear in the evidence.
Stone Mountain was a company incorporated in British Columbia in 1993. It was owned by Merendon for a time, then sold to Strategic effective 1 January 2005 for $9.6 million. When owned by Merendon, Sorenson had been president of Stone Mountain, until he appointed Wigmore to that position.
Strategic was incorporated under the laws of Alberta on 27 April 2004. Sorenson was originally identified as one of the directors of Strategic in CORES records. This was characterized as an error that was later corrected by Skeith – Strategic's legal counsel (and Arbour's and Merendon's). He caused a notice of change of directors to be filed on 25 October 2004 identifying Forrest, Carol Weeks ("Weeks") and Regier as the directors. Forrest was Strategic's president. Regier stated that Brost controlled Strategic. Strategic bought Stone Mountain from Merendon, and was involved in negotiations to purchase Magna North from Merendon.
TRL, formerly 1061470 Alberta Ltd., was a private Alberta corporation, initially with four shareholders (as with COREL) each owning 25% of TRL's issued and outstanding common shares – Merendon, 385765, 1061463 and Monkman Consultants, whose principals were Sorenson, Page, McIntyre and Monkman, respectively. Sorenson was a TRL director. TRL had a license agreement with COREL "relating to the licensing of certain patent pending processes and a patent pending vessel for the cleaning of processed sands in Alberta". Merendon acquired its 25% interest in TRL on 14 August 2003 for $100 and sold it to Arbour effective 1 January 2006 for $28 672 617 (subject to upward adjustment).
True North was a company controlled and managed by Brost. Brost was a signing authority on True North's bank account. We conclude that he controlled the money deposited into and disbursed from that account.
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Regier was a manager and an officer of True North, with signing authority on True North's bank account.
Regier identified two "True North" companies – "True North Arizona" and "True North Nevada". He stated that True North Arizona was set up in the name of Tim Thomas, but that the signing authority for the bank account was "M.B. Gonne", an alias of Brost. Regier said that True North Nevada was owned by True North Arizona, with "the people of responsibility" being Brost, Regier and Dale Joseph. True North's only source of revenue was investor funds; it had no other business.
Verbeem is Elizabeth Brost's son and Brost's stepson. Verbeem worked at IFFL. He was the sole director and shareholder of Expedia, although we found that Brost was Expedia's controlling mind.
Weeks was a director of Strategic. She provided some office assistance to Arbour.
Werner, an attorney from Florida, was appointed the president of SGD in 2007. Werner was still SGD's president up to at least November 2009. He was one of three lawyers hired by Brost in 2005 to conduct due diligence on Merendon and report his findings (the "Werner DD Report", dated 14 December 2005) to SGD.
Jack Wolfe was a director of Merendon and its controller from at least 2001 until his death in 2005. According to Sorenson, Jack Wolfe was secretary and treasurer of Merendon at its inception.
Jared Wolfe is Jack Wolfe's son. Jared Wolfe worked in Merendon's accounting department and had responsibility for handling all intercorporate money wires and other banking functions. He acted as Merendon's controller for a short time after his father's death.
We heard little evidence as to the ownership, control or purpose – or, in some cases, even the legal names – of a number of entities that were connected in some way with Brost, Sorenson or both. These entities included: 3Sixty; Alluvial United Inc. ("Alluvial"); Base Metals Corporation LLC ("Base Metals"); Bearstone Capital Management Inc.; Bridgewater & Co. Inc.; Canadian Audit Defense Network; Cascadia Management Services S.A.; Consumer Debt Recovery Trust; Dorlan Trust Services ("Dorlan"); Evergreen Management Services LLC;
Frontera Resources; Evergreen Trust Services Ltd.; Heritage Financial; IPC Corporate Services, LLC; Nordic Merchant Credit Union; Onyx Trading Group LLC; Quattro (or Quatro); Rapid Express; Red House; Tena Capital Corporation; Tena Capital Trust; Transiciones Universial S.A.; Vicap Corporation; Voyageur (or Voyegeur); and Watchers International Transit Ltd.
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The activities of Arbour (and those allegedly responsible for those activities) are a crucial part of the Merits Hearing. Later in these reasons, we provide extensive detail about the evidence before us on Arbour's activities and the various participants. Here, however, we provide a brief summary of those activities as context for the other background information.
In 2004 Arbour issued approximately 2 million common shares at $1 per share to various investors and a further 6 million common shares to Weis at $0.05 per share (Weis apparently passed some of those on to Morice and Wigmore). All of these common shares were purportedly issued pursuant to the accredited investor exemption.
Arbour sold the Arbour Preferred Shares under three separate offering memoranda between July 2004 and 16 November 2005. The total amount raised was approximately
$45.5 million, with over half coming from Alberta investors; the majority of all investors were IFFL members.
Arbour loaned money to Merendon as reflected in two loan agreements dated 10 July 2004 and 1 January 2005 (although the loans pre-dated the signing of the loan agreements). Merendon and Sorenson agreed with the dates and amounts of advances under these loans as set out in the evidence.
The sale of COREL to Arbour – apparently announced by Arbour in January 2005 – was documented in an agreement dated 1 January 2005, under which the four vendors (one of whom was Merendon) were to receive a total of $5.3 million and 5 million common shares of Arbour (valued at $1 per share). Merendon had acquired its 52% stake in COREL for $52; the other three shareholders, we have inferred, paid proportionally the same. COREL's value was linked to TRL's as COREL's principal asset was its license to sell the TRL technology in a specific territory. There was no valuation – one done by an independent professional – of COREL or of TRL at the time COREL was sold to Arbour.
The TRL transaction, with its purchase price of some $28.6 million, was completed in March 2007; it was documented in an agreement made effective 1 January 2006. Merendon had acquired its 25% stake in TRL for $100. There was no valuation of TRL at the time Merendon sold its 25% interest to Arbour.
The TRL transaction extinguished the amounts loaned by Arbour to Merendon under the second loan plus any interest owing thereon, totalling some $28.6 million. Moreover, in
December 2008 Merendon claimed that, because Arbour had yet to complete a valuation of TRL
which could result in an upward adjustment of the TRL transaction's purchase price to
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$50 million – Arbour might owe Merendon in excess of the amounts loaned by Arbour to Merendon under the first loan plus any interest owing thereon. Merendon so claimed despite indications in the evidence and our finding (discussed below) that Brost and Sorenson pressured Morice to finalize the TRL transaction before a valuation could be completed. If that claim were to succeed, the TRL transaction could result in the extinguishment of all amounts (principal and interest) owing from Merendon to Arbour under the two loans and Arbour being indebted to Merendon for over $11 million.
In the result, Merendon received in excess of $28 million – and could receive as much as
$50 million – for its sale of the unproven and unvalued TRL technology to Arbour.
Brost and Sorenson first met in 1999 when the then-president of Bellringer, Rodney Alain, introduced Brost to Sorenson, apparently with a view to completing some sort of transaction between Bellringer and Merendon that would revive the then-defunct Bellringer as a going-concern. Brost suggested a proposal that apparently was of no interest to Sorenson.
We review SGD's activities as part of our examination of the relationship between Brost and Sorenson and to address what certain of the parties knew or ought to have known about the evolution of the Brost-Sorenson alliance over the years, from their dealings with Brost and Sorenson in earlier periods.
A short time after meeting, Brost and Sorenson began discussing a proposed transaction between an apparently as yet unincorporated entity – eventually SGD – and Merendon. In an affidavit sworn by Sorenson on 27 November 2009 opposing the appointment of a receiver over the assets and undertakings of Merendon (the "Sorenson Affidavit"), Sorenson stated that he had never heard of SGD prior to Brost's approach and had no prior business dealings with SGD. The evidence before us did not indicate an acknowledgement by Brost of any discussions with Sorenson regarding SGD; Brost stated that he was not involved in any companies with Sorenson. In the Brost Interview, Brost said that he knew only that there was a general security agreement between Merendon and SGD and had no knowledge of whether Sorenson was the controlling mind, controlling shareholder or even a shareholder of SGD. Brost's statements were false, as will become evident.
While there are some minor discrepancies in the details given in the evidence, it is clear that Brost and three associates – Hoffman, Kendall and Houston – had or were developing a business (soon to be SGD) that would provide long-term financing to developing companies. They proposed to lend money to Merendon to assist it in developing its assets. Hoffman testified that:
[When SGD] was first set up, the structure of it was – was very specific. It was to provide capital to Merendon. Now, where it got that capital, it was supposed to receive capital from individual
offshore corporations that were being set up by Steve Kendall, Milowe Brost, Chris Houston, but predominantly Steve and Chris. Now, they were to set these corporations up for Canadians that wanted to invest funds offshore. So the whole idea this was, they would set up a corporation for these individuals, get a bank account, transfer their money to the bank account. [A] portion of that money was supposed to be invested with SGD, and in turn with Merendon. . . .
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Sorenson and Merendon were interested in the SGD proposal. Sorenson acknowledged that Merendon, at the time, was having difficulty raising the capital it required to continue its business operations as a junior exploration mining company and that the SGD loan money would provide Merendon with the capital it needed to develop its asset base. Hoffman described the negotiations in his testimony:
What followed was a number of conversations with Gary Sorenson, myself, Chris Houston, Steve Kendall, Milowe Brost in negotiating a contract which then would give the ability for a company that Milowe named, Syndicated Gold Depository, to give Merendon financing to allow them to buy feedstock for their refinery.
At this point in time, Gary was telling us that Merendon's goal was to go public. So this was to act as a -- as bridge financing for a period of time until Merendon in fact went public. Then whatever investment was given him would be paid out, and everybody would go their separate ways.
Sorenson described SGD's business as "a lending organization or fund manager". He understood that SGD would receive money from its lenders and SGD would then lend this money to Merendon. SGD would profit by charging Merendon a higher rate of interest than the interest rate SGD was to pay to its lenders. These lenders were the offshore international business corporations ("IBCs") described by Hoffman.
According to Sorenson, the others – at some point during the SGD and Merendon negotiations – provided Sorenson and Merendon with a proposed form of contract to document the lending arrangement between SGD and Merendon. Sorenson said he had concerns with some of the terms of the contract – the rate of interest and SGD's ability to call the loan without notification to the borrower Merendon. Sorenson's lawyer recommended a unanimous shareholders' agreement under which Sorenson's holding company would become a shareholder of SGD. This was to address Sorenson's concern by giving him the right to veto any attempt by SGD to call the loan to Merendon.
A Shareholders' Agreement dated 23 August 1999 was entered into between 685141 Alberta Ltd. (Sorenson's company), McBee Marketing Corp. (Brost's company), Hoffman, Kendall and Houston. It appointed Hoffman as president, Kendall as vice-president and treasurer, and Houston as secretary. The Shareholders' Agreement was signed by Sorenson, Brost, Hoffman, Kendall and Houston.
There is discrepancy in the evidence as to whether SGD was incorporated at the time Sorenson was negotiating to become a shareholder of SGD. Hoffman explained that:
On paper [SGD] was created as Steve Kendall, Chris Houston, Milowe Brost and myself. Now, the company had not been formally incorporated anywhere yet, and as the negotiations toward the
contract between this unnamed entity at the time and Merendon were going on, Gary asked to be a full partner in the investment company [SGD].
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In any event, the evidence is clear that SGD was a company incorporated under the laws of the Bahamas sometime in 1999. Hoffman was introduced to the Bahamian law firm that incorporated SGD by a contact referred to him by Sorenson.
Sorenson said he had been told that SGD was a company domiciled in Nassau, Bahamas with Hoffman as president, Kendall as vice-president and treasurer, and Houston as secretary; he was not told what position Brost held, if any. Hoffman acknowledged that he, Brost, Kendall and Houston had decided that Hoffman would be president of SGD before they approached Sorenson with the lending proposal for Merendon but that SGD had not yet been incorporated. At a meeting in Calgary in 1999, Brost, Sorenson, Kendall and Houston confirmed that Hoffman would be appointed president of SGD, a position Hoffman held from SGD's inception in 1999 through to 31 December 2001. Hoffman also became a director of Merendon.
On incorporation, according to Hoffman, no SGD shares were issued to the five shareholders; instead, shares were held in trust for them by a Bahamian lawyer and his son who acted as nominee shareholders, with Hoffman as the sole director. Consistent with Hoffman's evidence are SGD share certificates issued to the Bahamian lawyer and his son on 3 November 1999 by Hoffman as director and resolutions passed by Hoffman as the sole director of SGD. Also in evidence is a Corporate Services Agreement between Hoffman and the Bahamian law firm dated 3 November 1999 containing a provision that Hoffman was beneficially entitled to all the shares issued by SGD. These documents were found by Blaikie in SGD's records in Honduras. Consistent with Sorenson's evidence about a unanimous shareholders' agreement, Hoffman said that there was originally a shareholders' agreement identifying Brost, Kendall, Houston, Hoffman and Sorenson as SGD's shareholders. In January or February 2000, Kendall's and Houston's association with SGD ended, leaving Brost, Hoffman and Sorenson as three equal shareholders of SGD. A document entitled "Shareholders Agreement" – dated 25 January 2000 (found by Blaikie in SGD's records in Honduras) among Brost, Sorenson and Hoffman as the shareholders of SGD – provided that each of them would utilize a nominee shareholder and a nominee director to be named by the Bahamian law firm. That document also appointed Hoffman as president of SGD.
An agreement in evidence (obtained by Staff from the SEC) entitled "Joint Venture Agreement" and between Merendon and SGD (the "JV Agreement") bore what it described as a revised date – 3 January 2002. The JV Agreement stated that it replaced earlier versions signed by the parties on 17 September 1999, subsequently revised on 29 November 1999, 30 November 1999 and 25 January 2000. Hoffman confirmed that the JV Agreement in evidence was a revised agreement and that he, Brost, Kendall and Houston negotiated the JV Agreement on behalf of SGD, while Sorenson negotiated it on behalf of Merendon.
In the JV Agreement, "Merendon" was defined to include all affiliates and subsidiaries of Merendon. The JV Agreement provided that SGD would provide capital (US dollars) to Merendon, to be used exclusively for the purchase of unrefined gold, or as deposits towards metals supply contracts of gold, silver platinum, or supply contracts of complex ore and
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concentrates. These would be processed at the facilities owned by Merendon in Tegucigalpa and used for the construction and expansion of the Tegucigalpa gold refining facility. In accordance with the terms of the JV Agreement, Merendon executed a general security agreement in favour of SGD over the assets of Merendon as security for the money advanced by SGD. Under the JV Agreement, Merendon agreed to pay SGD interest on the monies advanced to Merendon at the rate of 4% per month. The JV Agreement also provided that SGD would appoint an individual as its agent in Honduras and that Merendon was to provide office facilities for SGD's agent at the Tegucigalpa facility at no cost to SGD.
Hoffman – at the time SGD's president – was appointed SGD's agent under the JV Agreement and moved to Honduras in 1999 or 2000. For a time, he lived on Sorenson's property in Honduras; he also worked out of the SGD offices located at the Merendon Honduras compound. As SGD's agent, Hoffman was responsible for monitoring Merendon's use of the SGD money provided to it; Hoffman described his responsibility as "keep[ing] track of all monies that were attributed to" SGD – "funds that Milowe was raising that SGD was responsible for".
Hoffman described SGD's operations and funding while he was president during the years 2000 and 2001. Hoffman was in regular contact with both Brost and Sorenson during this time and was also, as noted, a director of Merendon. In addition to Sorenson, Hoffman dealt with Wigmore (then Merendon's president) and Jack Wolfe (then Merendon's controller). Hoffman testified that both Wigmore and Jack Wolfe had a close working relationship with Sorenson at the time. Brost was the individual responsible for raising money for SGD. He also provided Hoffman with SGD investor names and assisted in preparing and mailing SGD investor statements of accounts.
We conclude from the evidence that prospective investors were solicited by Brost and his sales people to join Capital Alternatives (as of 2003 this morphed into IFFL) as members, the primary attraction apparently being access to IBCs. The IBCs were corporate vehicles incorporated offshore by Brost and his associates – they were acquired by investors, then used to move investor money offshore by lending it to SGD. Hoffman thought that Kendall and Houston first formed the IBCs in Costa Rica, later using other offshore locales. Investor money (after deduction of costs paid to Brost and his Capital Alternatives or IFFL sales team) invested in SGD was in turn invested in Merendon, with the representation to SGD investors that their investment money was guaranteed by refined or raw gold being kept at Merendon's Honduran refinery (or by cash). The investor, as the principal of the IBC, entered into a written loan agreement with SGD, which documented the IBC's investment in SGD. Sorenson described these as "lender contracts".
In short, Brost was responsible for raising money from investors and that investor money, after Brost deducted his fees, was ultimately destined for Merendon, which was to pay interest to SGD on the money loaned to it. Hoffman testified that he believed this activity went on from the fall of 1999 until 2008. (After 2003, Brost's entity involved was, of course, IFFL rather than Capital Alternatives.)
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A 29 August 2000 e-mail from Sorenson to Hoffman attached a document entitled "[SGD] Program", which was a summary of the SGD program. This had been prepared for prospective SGD investors who had set up IBCs and were being solicited to invest in SGD's "exciting new US dollar investment opportunity for the offshore investor" (the "SGD 2000 Investor Summary"). This document, which Sorenson had checked and revised, included the following information:
offered the investor a rate of return of 3% per month;
advised that SGD had entered into a joint venture agreement with a private Canadian corporation to fund the purchase of raw gold feedstock;
advised that the private Canadian corporation owned a gold processing refinery in Tegucigalpa that was operated by the Canadian corporation's wholly-owned subsidiary, Merendon Honduras;
the raw gold purchased with SGD money was refined at the Honduran refinery under the supervision of SGD's onsite agent, whose sole purpose was to look after SGD's interests;
at the end of each day SGD's onsite agent and the refinery's representative audited the plant's production and balanced the day's output of finished gold, raw gold and cash;
the finished gold was then inventoried for safekeeping until sold, with the cash used to buy more gold;
excess amounts of raw gold were stored offsite at the bank for safekeeping until needed;
SGD employed an extensive daily, weekly and monthly auditing procedure to track the use of funds and gold;
the refinery issued to SGD its appropriate interest from the gross proceeds of the sale of the gold (verified by SGD's onsite agent). Once SGD received the funds it was to disburse the net proceeds (net of fees) to the individual investor's account at the end of each month or, at the investor's discretion, the funds would remain in the program and compound; and
a summary of the operations of Merendon Honduras and Oro Metales.
Despite similar information and representations appearing in a form of investor and SGD loan agreement, the evidence is that SGD did not operate in the manner described in the SGD 2000 Investor Summary.
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Hoffman's testimony was that the flow of SGD investor money was structured by Sorenson and Brost. Hoffman was unaware of any investor money being sent directly to an SGD bank account, but was aware of investor money being sent indirectly to Merendon. Sorenson testified that Merendon never received any SGD investor money directly from Capital Alternatives or, later, IFFL. Rather, SGD investor money was paid to Merendon through a lawyer's trust account – first Jack Alsten (a Calgary lawyer), then Adair or Werner – or to a trust account set up in the name of Grovenor or Steller (managed by Kendall and Houston), with the ultimate destination being Merendon. Hoffman, on behalf of SGD, was then notified by Merendon personnel that money had been accepted by Merendon on behalf of SGD. That notification included the amount and sometimes the investor's name. Because the SGD money was flowing ultimately to Merendon and being accounted for by Merendon Honduras personnel, Hoffman said it was obvious that Sorenson was also aware of the money coming in.
Hoffman stated that the original intent was for only 10% of SGD investor money to go to Merendon; however, he understood that almost all of the SGD investor money went to Merendon after Brost, Kendall and Houston had deducted the money that was to go to them.
Investors received statements of account from SGD showing the principal amount of their investment and accrued interest – examples of some statements were in evidence. Hoffman, assisted by Brost and Elizabeth Brost, created many of the SGD statements of accounts for investors from January 2000 until September or October 2001, when Elizabeth Brost took over the task.
Hoffman described the SGD statements of account as paper accounts or as an "accounting function", because no money was held in an individual investor's SGD account, the money having been sent to Merendon. Hoffman prepared the SGD statements of account from information he received from Merendon personnel, Kendall, Houston and Brost. Hoffman would receive a list of investors' names from Kendall, Houston or Brost "that they said belonged to funds that they had forwarded to Merendon, and I was to attach a dollar amount to each name and a -- a company name they said that these individuals owned that was -- was required to be on the statements". Hoffman saw no supporting documentation, such as banking information or wire transfer information, to support the SGD investors' statements of account.
The money received by Merendon from SGD investors was supposed to be governed by the terms of the JV Agreement. However, while the JV Agreement required Merendon to pay SGD interest on the money it received from SGD investors at the rate of 4% per month, Merendon did not make regular monthly interest or principal payments to SGD. Rather, SGD would ask Merendon to pay SGD the amount of money that it needed to repay those SGD investors who wanted to redeem their investment (principal or interest) (investors who were keeping their funds invested would obviously not generate such requirements) and to cover SGD's sundry costs in Honduras. SGD had to provide Merendon with 30 days' written notice of the money it required to meet investor redemption requests. The written request was then provided to Sorenson who would approve the request and take steps to provide the requested money to SGD. SGD would then forward the money. Hoffman described the flow of money between Merendon and SGD as follows:
. . . whenever there [were] requests made by individuals made via e-mail or coming from Steve, Chris and/or Milowe on people that wanted some money, then a letter had to be drawn up and . . . given to [Sorenson] so that he could put aside monies in a Merendon account that then could be sent to these individuals.
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According to Hoffman, during his tenure as SGD's president, SGD had no business operation of any kind and had not had any operating business since its inception in 1999. SGD's sole business was to lend SGD investor money to Merendon. Hoffman said that SGD had no money of its own because Merendon had not been paying SGD the interest money it was required to pay under the JV Agreement (or as represented in the SGD 2000 Investor Summary). Because SGD investor money was being paid to Merendon, Hoffman said that SGD was "100 percent reliant . . . on Merendon paying [SGD]" the money it needed to pay investor redemptions. The money that Merendon paid to SGD was sourced from Brost's fundraising efforts; if Brost ceased his fundraising activities then SGD investor money would stop flowing to Merendon and SGD would be unable to retrieve money from Merendon to pay the SGD investor redemptions.
During Hoffman's tenure as president of SGD, Brost arranged for certain SGD investors to visit Merendon's facilities in Honduras, visits to which Sorenson agreed. Hoffman said that Sorenson would meet with SGD investors and confirm to them that SGD was the entity that had secured their money "with himself, with Merendon Mining Canada and Honduras and Peru and Ecuador and Venezuela."
Hoffman testified to concerns he had about the activities of Brost and Sorenson that involved SGD.
Hoffman testified that during his term as SGD president, contrary to Merendon's reporting obligation under the JV Agreement (as was also expressed in the SGD 2000 Investor Summary), Hoffman never was given any daily, weekly or monthly reconciliations of SGD investor money received by Merendon, and "that was one of my problems". He said that there was no way for SGD to determine what Merendon was doing with the SGD investor money received (it did not go to or through an SGD bank account) because Sorenson would not allow anyone from SGD to access Merendon's accounting records. Hoffman did not know whether SGD's subsequent presidents, Adair or Blaikie, received any reconciliations from Merendon.
Hoffman's concerns with Brost related to Brost's handling of SGD investor money generally. Hoffman agreed that Brost "was constantly changing the numbers on" Hoffman. In a 9 May 2001 email to Kendall, Hoffman stated "It has become very evident that Milo has been playing with the money, a lot. I am going to bail him out this time. He is trying to maintain control of a situation that can't be controlled by him. He has been using this control to play with the money." Hoffman described the confusion he encountered in trying to account for SGD investor money when dealing with Brost:
[Brost] would provide notice of funds that were made on deposit to SGD, and then he would say those funds actually belonged to this client. And then sometimes a month or two later he'd say, Well, no, actually they belong to that client and -- and give them the start -- he -- he was moving money around from the account to account. We could never really -- sometimes he would tell us it would belong to somebody else much later after it had been delivered.
. . .
. . . There seemed to be a disconnect between the amount of money they were investing and the amount of money that ended up in SGD, and I didn't understand any of it.
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Hoffman had concerns with how Sorenson "was managing the money that Milowe was providing". In Hoffman's opinion Merendon was not complying with the terms of the JV Agreement. First, Hoffman stated that he was not given the access he needed to verify that Merendon had sufficient liquid assets to cover its indebtedness to SGD. Hoffman did not believe that Merendon (or Sorenson) was using the SGD money as had been intended or had sufficient assets to repay its indebtedness to SGD (the SGD investor money paid to Merendon Honduras). Second, the JV Agreement required Merendon to hold the SGD money in cash, gold or raw gold (gold that had been mined but not refined) that it would then sell. However, that was not happening because, according to Hoffman, the money was being used to fund Merendon's mining exploration activities and Sorenson's personal expenses. Hoffman's concern was that SGD investors should have been told that their money was being invested in a mining exploration venture – the various Merendon Central and South American mining exploration ventures – not told that their investments were in liquid assets such as cash or gold. As Hoffman explained:
The SGD agreement with Merendon was that the money being provided through this arrangement was to be held in cash, gold, or raw gold; and starting in 1999, Gary Sorenson started spending the money on infrastructure projects around Merendon Honduras and spending the money personally, and I started becoming vocal about it. . . .
. . . I had concerns. I voiced those concerns, nobody listened. I continued to voice my concerns. Milowe all of a sudden started producing huge amounts of money, and nobody was paying any attention to how it was being used. . . .
. . .
[That money] was coming from people in Canada [and the US]. . . .
Hoffman added:
[The money coming in to Merendon] was supposed to go to Merendon to be -- to provide capital for feedstock purchase for the refinery, and the requirements of the agreement were it be held as cash and raw gold and/or finished gold, and that's where -- where I had the problem. I said, if this is a mining exploration company, then it has to be sold as a mining exploration company, but when you're saying everybody's investment is guaranteed by a good as -- basically a cash component, and [Sorenson] said that he has the cash in his personal accounts to cover this indebtedness . . . .
When asked why he did not, as president of SGD, terminate the contract with Merendon or resign, Hoffman stated that he was afraid to:
I was the sole officer and director of a corporation that had no assets, no bank accounts, no ability to do anything. If I had have got on my apple box and started screaming to the general public (a) I had a fear for my life; and (b) it wouldn't have made a damn bit of difference because Milowe and Gary were running everything right around me. I was a figurehead.
Hoffman's tenure as SGD's president ended on 31 December 2001 when he resigned from that position for alleged health reasons.
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Hoffman left Honduras in the spring of 2002 and went to work for Merendon, reviewing mining and technological projects Sorenson assigned to him. Hoffman left Merendon's employ in mid-2003. Hoffman had periodic contact with Brost, Sorenson, Kendall and Houston after 2003 as evidenced in the Hoffman Tapes. Hoffman acknowledged that he had no knowledge of how SGD operated after his departure in 2001, and specifically its operations during the time relevant to the allegations, other than what was told to him during various conversations – some of which form the Hoffman Tapes.
After Hoffman's resignation as president of SGD, Adair, a Florida lawyer, (described by Hoffman as counsel for Merendon or Sorenson or both at the time) was appointed the president and sole director of SGD in early 2002. Adair remained president and sole director until January 2004. Adair had been previously associated with Brost, having assisted Brost with some Florida real estate transactions and having been recruited by Brost in 1995 to serve as the vice-president of Bellringer during its financial and regulatory crisis, a position he held until 1998. Adair acted as both SGD's and Merendon's US legal counsel.
Hoffman testified that when Adair was appointed president of SGD by Brost and Sorenson, Adair was given 10% of the SGD shares. Hoffman and Adair then travelled to the Bahamas to change the SGD corporate documents to name Adair as its sole director and president. En route, Hoffman convinced Adair to register the shares in the names of the SGD shareholders – Adair (10%), Brost (30%), Sorenson (30%) and Hoffman (30%) – because Hoffman thought that would protect their respective ownership interests. Hoffman said that "much to my surprise, he put everybody's names as shareholders and filed it. And somehow he got Gary Sorenson and Milowe Brost to sign their documents registering them as shareholders of [SGD]".
Hoffman also testified that Sorenson told Hoffman that Sorenson did not want his name identified on any SGD shareholder document because "he didn't want any legal tie between himself and [SGD] as a shareholder". Hoffman's testimony was confirmed by an exchange that took place between Sorenson and Hoffman that was recorded in the Hoffman Tapes on 20 May 2005:
Sorenson Well it would have been even better if you would have put them [in context, the SGD shares] in the name of your company. Except they are not in the name of your company they're in your direct Owen Hoffman name. So if anybody was going to investigate SGD it would take them about a half an hour to determine that you're a shareholder, I'm a shareholder and Milowe is the shareholder and Graham [in context, Blaikie] merely holds shares in trust for us. . . .
. . .
Sorenson [Adair] went over to Nassau provided the instructions as sole director and changed it from the corporation to personally the three people.
Hoffman I thought you knew that?
Sorenson I don't want my f**king name on that document, nor should you.
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Hoffman I didn't agree with it at the time but I thought everybody else was in agreement with it so I never said anything.
Sorenson Owen, I never knew until Thursday. . . .
. . .
Sorenson Today, right today. Graham holds your certificate, my certificate and Milowe's certificate specifically in trust for each party. Graham doesn't hold all the shares in his name as a trustee for the other entities; do you understand what I'm talking about?
Hoffman M-hmm.
. . .
Hoffman I thought when Larry was the trustee that they were all being held in Larry Adair LLP as a lawyer as holding all those shares and our names weren't there.
. . .
Sorenson And I thought that what [Adair] had done is transfer that situation to Graham so that if you did a corporate search you would find Graham as the President, sole director and officer of the company and the sole shareholder, that's what you would find. Then moving beyond that there would be a private trust agreement between Graham, you, me and Milowe where we knew whatever interest Graham was holding was held for us respectively, do you know what I mean? Graham doesn't hold anything [inaudible] you know he's basically got the shares [inaudible] . . . .
Subsequently it appears that the identification of SGD shareholders was resolved to Sorenson's satisfaction. In a 28 June 2005 exchange with Hoffman (after Blaikie became president of SGD), Sorenson stated that once the last step was completed "the only shareholder of [SGD] will be Graham Blaikie [holding] a percentage in trust for Milowe and I". When Hoffman asked what could change that might affect Hoffman being paid (for his share of SGD), Sorenson replied: "Only, in my opinion, only if I'm not the owner of 50% of SGD and I've been assured that I am." Hoffman confirmed that Sorenson still had ownership and control –"Sorenson had his name on title a very little but controlled -- controlled a lot".
Adair appears to have performed bookkeeping functions for SGD at least from the time he became its president. In one example, a 21 January 2002 document in evidence showed a funds request for SGD from Adair to Sorenson and copied to Brost. Further evidence solidifies our conclusion that Sorenson was aware of and involved in funds being paid from SGD during Adair's term as president – on 1 August 2003 Adair, as SGD president, asked Sorenson, as chair and CEO of Merendon, to acknowledge and affirm for disbursement from SGD funds totalling over $400 000, to be paid out as "monthly interest" and "fund removal" to Capital Alternatives, Parklane and Voyageur.
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Accordingly, we conclude that Adair was keeping the books for SGD during this time and that Sorenson was aware of SGD disbursements. We find on the balance of probabilities that Sorenson was kept informed of – and made decisions regarding – disbursements by SGD on a regular, perhaps monthly, basis.
Because Adair was not called as a witness by any party, there is very little other information about SGD during his tenure as president.
Blaikie was appointed SGD president and sole director in January 2004 and remained in those positions until 31 March 2007 when he resigned as president. This covers the period relevant to the allegations. Given this timing, Blaikie's testimony regarding Brost, IFFL, SGD, Merendon and Sorenson is particularly relevant. As mentioned, however, we approached Blaikie's evidence with some caution due to his still-close association with Sorenson and his claimed lapses of memory. Blaikie also continued on as SGD's sole director and was its director during the Merits Hearing.
Blaikie had been asked by Adair, Brost and Sorenson to become the president and director of SGD because Adair was about to resign from those positions. Blaikie was told that Adair had to resign as president because SGD, as an offshore company, could not have its president or any director located in North America, and Brost and Sorenson were looking for someone they could trust. Blaikie acknowledged that he was not appointed SGD president because of any special skill set he possessed – his role was to be "simply essentially a name and a signature" and he just signed what he was told to sign. When Blaikie was first appointed SGD's president in 2004, he was not physically located at the SGD offices in Honduras but rather was located in Venezuela as general manager of Merendon Hospitality Venezuela and was finishing up a project in Venezuela for Sorenson and Merendon.
Blaikie was told that his responsibilities as SGD president would only require him to hold the SGD shares of Brost, Sorenson and Hoffman in trust, and sign loan agreements on behalf of SGD. He would not act as a decision-maker or a strategist. Elizabeth Brost would become the custodial manager of the records, responsible for administrative activities, including managing and administering all SGD investor redemption requests and preparing SGD investor account statements. Elizabeth Brost moved to Honduras and carried out her custodial duties from the SGD offices at the Merendon Honduras compound. While Blaikie was president, Adair referred to himself as "agent counsel" and was responsible for dealing with the individual SGD lenders in person. SGD investor money went to Adair's trust account, where it became Merendon's money. Blaikie said that either Sorenson or Adair told him that this happened because SGD had "paid . . . off a loan". Adair carried out his SGD responsibilities from Florida. According to Blaikie, Adair had "knowledge of virtually everybody and who they were".
Blaikie did not report to anyone formally, although he had discussions and received information from Brost, Sorenson, Adair and Elizabeth Brost. Blaikie acknowledged that Sorenson and Brost, as the owners of SGD, were the persons with the "higher authority",
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although Sorenson was easier for Blaikie to contact. In keeping with the past practice in which the SGD president was appointed to the board of directors of Merendon because of the significant financial obligations created under the JV Agreement, Blaikie was also appointed a director of Merendon. In October 2004 Blaikie was also appointed budget director of Merendon, reporting to Sorenson. At the time of the Merits Hearing, Blaikie was still budget director of Merendon.
Shortly after Blaikie agreed to become SGD's president, Blaikie met with Adair in the Bahamas at a lawyer's office where a series of documents was executed that resulted in Blaikie assuming trusteeship of the SGD shares from Adair for the beneficial owners – Brost (30%), Sorenson (30%), Hoffman (30%) and Adair (10%). Documents in evidence executed by Blaikie on 4 January 2004 stated that Blaikie was the registered owner of two sets of 15 000 SGD Shares that he held in trust for the beneficial owners – Sorenson and Hoffman, respectively. Blaikie said that he executed a similar agreement at approximately the same time for Brost. Blaikie did not know the reason for the trust arrangement but recalled that he had been told that, if ever asked, he was to say that he was SGD's sole shareholder. Blaikie said that Adair's SGD shares were purchased by SGD in 2005 and returned to treasury. At the time of the Merits Hearing, Blaikie was holding in trust the SGD shares beneficially owned by Brost, Sorenson and Hoffman.
Blaikie said that, while SGD's president, he did not understand exactly how SGD worked, including the flow and management of SGD investor money. He did understand that SGD's sole business was to loan money to Merendon, until Merendon was replaced by Eiger as the recipient of the SGD money (as set out elsewhere in these reasons). Blaikie understood that SGD's revenue was to come from the interest spread between the interest rate it gave to lenders and the interest rate it charged to Merendon and Eiger.
Blaikie also knew that Brost was responsible for soliciting at least some of the individual investors who lent money to SGD. Blaikie appeared to understand that those individual investors were advised and assisted by Brost (and, as we know, his Capital Alternatives and IFFL salespeople) in setting up IBCs into which the investors paid their money. The individual investors were then advised that their IBCs invested in SGD – the individual's IBC would enter into the lender contract that Blaikie received from Elizabeth Brost and then executed on behalf of SGD. The IBC's money to be invested in SGD then made its way to Merendon because of the lending arrangement between SGD and Merendon under the JV Agreement. SGD, in addition to money received through this route, also received money lent to it from Merendon Nevada, Quattro, Rapid Express, Parklane, and the Red House Group. Blaikie, on instructions from Sorenson, signed promissory notes evidencing money lent to SGD by Merendon Nevada, Quattro and Rapid Express. The promissory note in favour of Merendon Nevada evidenced a debt of some $110 million owing by SGD. As was the case with the funds from the IBCs, Blaikie understood that SGD then lent this money to Eiger for its own use, including providing money to Merendon. Blaikie did not recall any other documentation evidencing loans by SGD to Eiger of those Merendon Nevada funds.
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Blaikie understood that the money borrowed by Merendon was to be used for Merendon's future development of its gold refinery operation, as well as acquisitions of mining concessions and gold from various sources. Blaikie confirmed that Merendon's compound in Honduras had a vault that he understood to contain gold, although he had never seen or been inside the vault (access was restricted to Sorenson, Thelma Sorenson and possibly a past production manager).
Blaikie said that SGD was responsible for administering the SGD investors' loans to Merendon; Elizabeth Brost initially had primary responsibility for SGD operations. She and her two staff members in Honduras prepared all SGD investor account statements with information that came from Brost, Adair and Regier. Blaikie did not know what that information entailed. Blaikie said he had little to do with SGD operating activities other than to sign lender contracts provided to him by Elizabeth Brost. Elizabeth Brost's administration of SGD operations from Honduras continued until approximately March 2005 when SGD investor account statements were transferred to a new accounting system set up by Casey Brost and administered by his company Fortris out of Belize. In late 2005 or early 2006 SGD records were shipped to the Fortris offices in Belize. Blaikie said that Brost's former assistant, Forrest, was working for Casey Brost and Fortris in Belize.
While SGD's president, Blaikie never received any reconciliations or other accounting of SGD money received and disbursed to Merendon. Blaikie knew that SGD investor money somehow arrived in Adair's trust account and that Adair "managed trust accounts, and that these funds were designated in some way, SGD or Merendon; or whether it was -- they were funds that came from SGD or whether they were SGD funds, I -- I really don't understand or understand that. I could never understand how that happened". Blaikie understood that SGD money got paid to Adair because SGD never had a bank account in its own name. Blaikie thought that SGD investors received their money back by making a redemption request that made its way to Elizabeth Brost, Adair or Regier, who then requested the money from Merendon or, later, from Eiger. Blaikie understood that Sorenson provided Adair with "orders" for the disbursement of money to SGD and that Merendon would pay the redemption money to SGD, which would then forward the money on to the individual SGD investor.
One of the Hoffman Tape excerpts indicated that, at least as of 24 March 2005, Sorenson had considerable influence – if not control – over the operation of SGD. It further indicated that Blaikie was more involved than he had acknowledged during his testimony (giving us another reason to treat his testimony with caution). In this excerpt Sorenson described to Hoffman the SGD operations under Blaikie with the assistance of Elizabeth Brost at the SGD offices in Merendon's Honduras compound:
. . . Graham [Blaikie]'s the President of SGD you know. The -- the accounts and their -- their communication with the clients has improved probably 60% since Elizabeth took over the actual day to day management of them and Graham became the President because everyday, every morning he goes over there, sits down with her, they go through the problems of the morning, the problems of the day and whatever and if he's unsure of what to do he just picks up the phone[,] talks to me, I tell him what I think he should do, [he] passes the information onto Elizabeth and it's done. She doesn't even talk to Milowe.
According to Blaikie, Adair had kept records detailing the SGD investors, the amounts of money they had lent to SGD and redemption requests. Adair provided daily account
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reconciliation reports to Sorenson showing receipt and disbursement of SGD money in Adair's trust account. In evidence was a daily report for 3 July 2006 (the "Adair 3 July 2006 Account") that Adair had sent to Sorenson's personal secretary in Honduras. Blaikie and Sorenson confirmed that this was one of the daily SGD reports sent directly to Sorenson. Blaikie stated that Sorenson would have instructed all of the disbursements. The Adair 3 July 2006 Account shows money being deposited in Adair's trust account from a number of entities, named there as including Merendon Colorado, True North, SGD, Tena Capital (Sorenson claimed that should have been Heritage Financial), Red House Developments and Frontera. Blaikie did not know of any lending arrangement between True North and SGD and saw no documentation in SGD's records to that effect. He believed that SGD loan money was first received by True North and then advanced on to Merendon and Eiger. The Adair 3 July 2006 Account shows money being paid to, among others, Sorenson, Thelma Sorenson, Sorenson's daughter, Merendon, Arbour (apparently interest on the loan of $10 million from Arbour to Merendon), Stone Mountain, Adair and Ken Sorensen. The closing balance of the Adair 3 July 2006 Account on that date was
$1.36 million.
Adair also prepared an annual statement or account reconciliation that set out the opening balance owing to SGD, the amount of money lent by SGD to Merendon throughout the year, accrued interest and the closing balance of the money owed to SGD by Merendon.
As during Hoffman's tenure as SGD president, SGD investors traveled to Honduras to tour the Merendon compound.
Blaikie said that the last SGD lender contract he signed that came to him through any of Brost's organization was in the fall of 2004. Brost told Blaikie that he had stopped promoting SGD to investors in October 2004, so no more SGD contracts would be coming to Blaikie. Around this time Elizabeth Brost told Blaikie that she had little to do for SGD because "everything was being done out of Calgary". In late 2006 Elizabeth Brost ceased working for SGD and her remaining job responsibilities were assumed by Casey Brost who was then operating out of Belize.
A 13 October 2005 excerpt from the Hoffman Tapes was a conversation between Sorenson and Hoffman that began with what appeared to be a discussion of Brost's health problems. Sorenson commented on Brost's problems with the Commission at that time, stating: "[H]ow do I say this, because I want to be supportive, until this last go around with the [Commission] I had no f**king idea". Merendon and Sorenson emphasized that Hoffman could have disagreed with Sorenson about whether Sorenson had any previous knowledge of the Commission-related issues. In that Hoffman Tape excerpt, Sorenson then seemed to suggest that Hoffman offer to help Brost out until he recuperated. During the conversation, Sorenson stated:
. . . In the last year and a half [that would be approximately April 2004 to October 2005] the organization has grown exponentially we [have] raised a s**tload of money. We probably have seen here at Merendon 48% of it. The marketing division itself has probably consumed about 10% of it just for advertising, operational, administration, whatever. Probably somewhere in the order of 40% has just gone into Milowe's projects . . . .
. . .
. . . You know, the marketing organization, SGD or its affiliates or whatever, provided capital which allowed me to accelerate the growth of this corporation and build a very good company. . . .
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We find that SGD was sending money to Merendon throughout this period and that Sorenson was clearly well aware of the source of those funds flowing to Merendon. Sorenson's discussion of Brost's health and business plans during Brost's recuperation also supports, in our view, a close relationship between Brost and Sorenson.
In late 2005 an "Amended and Restated Loan Agreement and Assignment" with an effective date of 2 February 2002 was entered into by Merendon, SGD and Eiger (the "2005 SGD/Merendon/Eiger Loan Agreement"). Under the 2005 SGD/Merendon/Eiger Loan Agreement, Merendon assigned to Eiger, Eiger accepted the assignment and SGD consented to the assignment of the JV Agreement and all of Merendon's rights and obligations under it. Other pertinent information included:
the establishment by SGD of a demand credit facility ("Facility") for Eiger;
the Facility was to be used by Eiger "for investment purposes with respect to the exploration and mining sector or any other use approved by" SGD;
Eiger was to pay interest at "a nominal rate per annum equal to the [agreed interest rate] in effect from time to time"; and
Eiger provided as security for the money advanced all of its shares in Merendon.
As at 31 December 2006, $76 604 095.32 was the unpaid principal balance owing to SGD by Eiger. In 2005 Eiger repaid SGD principal of $2 811 514.55 by paying $172 314.09 to Flintex Business and $2 639 200.46 to True North.
Although Blaikie was SGD's president at the time, the 2005 SGD/Merendon/Eiger Loan Agreement was negotiated by Adair on behalf of SGD and by Sorenson on behalf of Merendon and Eiger. Blaikie explained that although he was aware of the 2005 SGD/Merendon/Eiger Loan Agreement, he was not involved in its negotiation, and did not know why the agreement was being negotiated or entered into. Moreover, no one reported to him on the negotiations. The 2005 SGD/Merendon/Eiger Loan Agreement was executed by Adair as president of SGD, by Wigmore as the president of Merendon and by Sorenson as president of Eiger. Blaikie –president of SGD when the 2005 SGD/Merendon/Eiger Loan Agreement was signed – said that he had no difficulty with Adair and Sorenson negotiating and executing the agreement because "[i]t was their company. So I assumed they were fine". Sorenson testified that Blakey –Merendon's counsel at the time – suggested Adair and Wigmore sign for SGD and Merendon, respectively, because they were the presidents of those entities, respectively, at the agreement's effective date of 2 February 2002.
While Blaikie was SGD's president, neither Merendon nor Eiger paid SGD interest on the loan as it was simply "calculated" but not paid. Blaikie left that up to the two owners, Brost and Sorenson. Blaikie was unaware of any formal financial statements prepared for SGD, only the informal financial reporting prepared by Adair during his tenure as SGD president. During
Blaikie's term, no financial reporting was done other than the account reconciliation reports provided to Sorenson by Adair, such as the Adair 3 July 2006 Account.
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At some point, Brost proposed to Blaikie that due diligence reports be prepared on Merendon for SGD; Blaikie agreed. Brost advised Blaikie that on behalf of SGD he had hired three lawyers – Blakey, Burgess and Werner – to conduct due diligence on Merendon and its various subsidiaries and joint venture projects and to prepare a report on their findings for SGD. Blaikie had previously met Blakey at a Brost-hosted conference but had never met the other two individuals prior to the SGD engagement. The three individuals, described by Burgess as the "Due Diligence Team", together toured Merendon's various properties and facilities in Honduras, Venezuela, Ecuador, Peru, Calgary and Medicine Hat, Alberta between 28 February and 17 March 2005 and met with various Merendon staff members. Brost, Sorenson (identified by Burgess as "President of each of Merendon's Latin American mining subsidiaries and Eiger") and Blaikie (identified by Burgess as "President of SGD") accompanied the three lawyers on the tour. The purpose of each of their engagements was the same – to review Merendon's operations to confirm that Merendon was a legitimate business and that the value of Eiger's interest in Merendon was sufficient to secure repayment of the SGD loan. Each lawyer prepared a report setting out his conclusions: Blakey in a report dated August 2005 (the "Blakey DD Report"); Burgess in the Burgess DD Report (a letter dated 5 December 2005); and Werner in the Werner DD Report (dated 14 December 2005) (together, the Blakey DD Report, Burgess DD Report and Werner DD Report are the "DD Reports").
In the Burgess DD Report, Burgess stated, as background information, that he understood "that [SGD], a Bahamian company, has loaned funds [to Eiger], a Bahamian company, . . . secured by a general security agreement, a series of promissory notes and a pledge of Eiger's interest in Merendon". The Burgess DD Report stated the amount of the SGD loan then outstanding as $160 million and the value of Merendon's assets as $1.135 billion (over $1 billion was categorized as "Recoverable reserves"). The Werner DD Report stated the amount of the SGD loan outstanding as of March 2005 was approximately $200 million, and the value of gold in Merendon's concessions as of December 2005 exceeded $1 billion. The DD Reports stated variously that the information in the reports was provided by Merendon employees, no audit was conducted, and no third party verification of the facts had been undertaken.
The risk factors set out in the Burgess DD Report tell something of the nature of Merendon's (and its subsidiaries') operations. These included:
Commodity Prices – The vast majority of Merendon's value relates to the exploration, development and production of gold. . . .
Engineering Risk – A significant proporation [sic] of the value of Merendon's assets relate to unmined gold bearing ore. [If] the reserves prove to be less prolific, or the cost of extraction is significantly higher, the economic viability of such assets would be negatively impacted.
Ongoing Capital Requirements – Again, as the vast majority of Merendon's value is represented by unmined gold bearing ore. [sic] There are significant amounts of capital required by Merendon in order to convert such ore to refined gold. . . .
. . .
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Cash Flow Requirements – In addition to Merendon's monthly operating requirements, there are significant additional requirements to satisfy monthly interest payments to SGD, as well as periodic redemptions of SGD's [loans]. The result is a significant monthly cash commitment at a time when the majority of Merendon's assets are in the development rather than production phase. The opinion expressed above assumes that Merendon will be able to continue to meet its monthly cash commitments while at the same time funding its development, expansion and production plans at its various sites in Latin America.
Liquidity of Collateral – The vast majority of Merendon's value is represented by unmined gold reserves. While the [loan] documents specifically provide for an orderly payout of the [loans] over 42 months, there is a significant risk that if the [loans] were called, Merendon may be constrained from fully exploiting the value of its assets due to a lack of capital or insufficient time. . . .
We did not attach any weight to the DD Reports as providing any verification of the value of Merendon's assets in 2005. In so deciding, we considered that Blakey, Burgess and Werner did not have any relevant experience in business evaluation, mining or offshore mining valuations. We also had some concerns as to the independence of Blakey and Werner. Most significant, the DD Reports themselves were all qualified; the most significant qualification was that their conclusions, in essence, were only as good as the information provided by Merendon staff.
In March 2007 Werner was appointed to president of SGD, a position we understand he held during the Merits Hearing. According to Blaikie, the decision to appoint Werner SGD president was made jointly by Brost and Sorenson, although Werner apparently had some history of providing legal services to Brost. Blaikie continued on as a director of SGD after Werner's appointment as its president and to the time of the Merits Hearing.
According to Blaikie, Werner suggested changing SGD's name because of the bad publicity that had begun to cloud SGD. SGD's name was subsequently changed to Bahama Resource Alliance.
Werner did not appear as a witness and testify at the Merits Hearing. Therefore, there is little evidence regarding SGD during his tenure as president.
In a Hoffman Tape, Brost referred to the formation of SGD, stating "I spear-headed it but we all pulled SGD together it wasn't just me it happened because of all of us myself, [Hoffman], Gary and Steve and Chris alike".
Hoffman testified that he believed Brost and Sorenson were, in 2004 to 2006, the "insiders" who were the only ones who knew what was really going on with SGD and "everything that was going on". Hoffman believed that Sorenson controlled SGD, but also stated that, if asked, Brost would say Brost did and Sorenson would say Sorenson did.
Regier testified that Brost operated or controlled SGD. Regier also recalled Brost "indicat[ing] on a couple of occasions that he would have discussions about SGD with [Sorenson], but at the end of the day it -- the real appearance was [Brost] operated SGD".
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Blaikie – SGD's president during the period at issue here – acknowledged that he was president in name only. He had been appointed as someone Brost and Sorenson could trust not to call the SGD loan to Merendon and, later, to Eiger. Blaikie was not responsible for running SGD's operations, nor did he even fully understand those operations – such as where it got its money from, how much money SGD received, and the disbursement of SGD money. His only responsibility was to sign SGD investor contracts as president of SGD. SGD's day-to-day administration was carried out primarily by Elizabeth Brost with assistance from staff in Honduras – although we do conclude that Blaikie was somewhat more involved in the day-to-day operations than he admitted to us; he knew enough to go to Sorenson for directions. Elizabeth Brost received SGD investor information from Brost, Adair and Regier. We are satisfied that she took her instructions from Brost. Sorenson was not involved with SGD's day-to-day administrative activities (except answering Blaikie's queries), but he and Merendon received the SGD investor money and Sorenson approved any repayment of that money by Merendon to SGD. Blaikie reported to Sorenson and received from Sorenson instructions as to how Blaikie was to carry out his role as SGD's president.
We find that Blaikie (although he knew more about SGD's activities than he acknowledged) was a mere administrator and figurehead. We reach the same conclusion for SGD's other presidents – Hoffman, Adair and Werner. We find, from the totality of the evidence, that SGD's real decision-making rested jointly with Brost and Sorenson.
Stone Mountain owned mineral concessions along the Tulameen River in British Columbia. Merendon acquired the property in approximately 2003 for $1 million after Sorenson was introduced to it by Monkman. After the Stone Mountain acquisition, Sorenson was president for a short time before Wigmore was appointed president. Strashok was a director of Stone Mountain.
In January 2005 Merendon sold all of its interest in Stone Mountain to Strategic for a purchase price of $9.6 million. Strategic's directors at the time were known Brost associates –Forrest, Regier and Weeks.
Monkman introduced Sorenson to Magna North, which owned gold concessions in the Yukon and was purportedly in the business of producing gold from placer mining operations. Merendon acquired a 60% interest in Magna North. The Burgess DD Report valued that interest at $16.5 million, although there was no evidence as to the purchase price paid by Merendon.
At one point, Strategic (as noted, a Brost-connected entity) proposed to acquire Magna North from Merendon and its partners for approximately $29 million. It appears that the acquisition was never completed.
The evidence indicated that, in 2007, the board of directors of Merendon decided to liquidate Merendon's holdings in Magna North because "it appears in the best interest of [Merendon] to . . . focus on maximum recovery of [Merendon's] investment in Magna North".
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The existence and purpose of IBG were in dispute, as were the minutes in evidence of two of its meetings. Based on the facts in evidence and for the reasons set out below, we conclude that IBG did exist – perhaps not as a formal corporate entity but certainly as an organized group led by Brost and Sorenson. Its purpose, we find, was to control and keep track of the multitude of entities in which Brost and Sorenson were involved – the Brost/Sorenson Entities.
Regier described IBG as "a group of individuals that, to a certain degree, were handpicked either by [Sorenson] or by [Brost]. And they were chosen, if you will, to bring forward and try and resolve some of the issues that were there from a big-picture perspective."
Blaikie said that he had never heard of IBG until he was asked by Brost and Casey Brost to attend, as SGD's president, an IBG meeting in February 2007. Blaikie was told that the IBG meeting was convened in an attempt to get a group together to gain some control over Brost and the flow of money. Specifically, the hope was that Sorenson, given his history and relationship with Brost, would be able to get Brost to stop spending his own money. Blaikie testified that IBG was "just a name" for that group, as coined by Casey Brost, Regier and possibly others.
Sorenson said that there was no such organization as IBG; it was a "figment of [Brost's] imagination".
What was not disputed was that a meeting was held in Tegucigalpa at the Merendon compound from 8 to 11 February 2007 (the "February IBG Meeting") at which Brost, Sorenson, Blaikie, Regier, Casey Brost, Werner and Capstick – the "IBG Advisory Committee" – were in attendance. A second IBG Advisory Committee meeting held in Calgary on 7 to 8 and 12 to 13 March 2007 (the "March IBG Meeting") was attended by Brost, Sorenson, Casey Brost, Regier, Blaikie and Capstick, although Sorenson was absent for 7 and 8 March and Blaikie was absent for 7 March.
Blaikie described the February IBG Meeting as being "almost like a confession" and "very eye opening", where a great deal was revealed about different companies, funds being disbursed here and there, and Brost's activities. Blaikie said that even though there were a number of companies being discussed that he had no involvement with, he and Sorenson stayed because they felt they needed to find out more information about what had being going on. Blaikie explained that he and Sorenson came to realize that the purpose of the February IBG Meeting was that the Brost group wanted SGD to absorb all of the companies they were discussing and, ultimately, for SGD – therefore, Eiger and Merendon – to assume those liabilities.
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In evidence were minutes from the February IBG Meeting (the "February IBG Minutes") which identified the meeting as IBG's "Advisory Committee Initial Regular Meeting". Werner was the chairperson and secretary of the February IBG Meeting; as secretary, he prepared the February IBG Minutes. Blaikie said that Werner had been so chosen because he was a "neutral body".
Regier confirmed his attendance at the February IBG Meeting and that the February IBG Minutes as a whole fairly represented the discussions at that meeting. Blaikie confirmed his attendance at the meeting but could not confirm whether the February IBG Minutes accurately depicted what had occurred because he claimed to have "pretty much tuned out . . . during the majority of this meeting because it was so far beyond me, in my knowledge and understanding". The February IBG Minutes indicate that of the many motions made and seconded, all of those which identified individuals were made by either Brost or Sorenson (with the exception of one made by Casey Brost) and were seconded by one of them or Werner.
Sorenson disputed the accuracy of the February IBG Minutes, stating that they did not reflect how the meeting progressed. He also disputed making most of the motions and seconds attributed to him and stated that he "wasn't prepared to participate in something that doesn't exist". Blaikie, although he said he had "tuned out" for most of the discussions, did recall some motions being made but not who made or seconded the motions. Specifically concerning Sorenson's making of motions, Blaikie testified: "I could hear motions were being made; but whether or not it was Gary, I don't know." Blaikie later told us that, while he could not recall, Sorenson "may have" made the motion that Brost was to receive a commission "in the amount of 2.5% per each dollar of gross receipts raised by the Company", of which Brost was to receive a monthly draw of $150 000 subject to adjustment once the actual funds were raised. The February IBG Minutes stated that Sorenson "abstained" from voting on his own commission structure; many other motions were noted as having been "unanimously adopted".
We considered the above factors, coupled with the testimony that the February IBG Minutes were prepared by a "neutral" party, Werner. We also considered the lack of evidence (apart from Sorenson's) suggesting the minutes were false or inaccurate. On those bases, we reject Sorenson's evidence on this point and conclude that the February IBG Minutes are at least mostly accurate, including their representations that Sorenson participated in most of the IBG discussions and votes.
The February IBG Minutes were noted in a covering e-mail from [email protected] (Blaikie identified this as coming from Werner) to be draft minutes "for review and comment". They were sent to [email protected] (Blaikie identified this as Brost's email address), with copies to [email protected] (Regier identified this as an email address he was using at the time), [email protected] (Blaikie identified this as an email address he was using at the time), and [email protected] (Sorenson acknowledged using this email address on rare occasions in the past). Blaikie recalled receiving the February IBG Minutes by email and reviewing them. Sorenson claimed not to have received the February IBG Minutes by email; he received them from Blaikie.
The February IBG Minutes discussed many matters; we highlight the relevant ones.
The February IBG Minutes set out the mission statement of the IBG Advisory Committee as follows:
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Be it resolved that the Mission Statement of the [IBG] Advisory Committee is that the nature, extent and scope of the [IBG] Advisory Committee is to advise IBG on all of its business affairs including but not limited to: general and special business issues and concerns, auditing and budgetary issues and concerns and legal issues and concerns. That such advice shall be based on a complete disclosure by IBG to the [IBG] Advisory Committee of all relevant issues pertaining thereto.
The February IBG Minutes described IBG as "a consortium of companies having common goals and diverse jurisdictions" and spoke of an accord being prepared to allow the separate companies of IBG to act together. Subsequently, Blaikie saw two different drafts of an accord agreement but did not know if one was ever finalized.
Under the heading "Consignments" there was a statement that "the company has 150 Structurists" and that "monthly redemptions are growing in dollar amounts". While there was no direct evidence on this point, we find it reasonable to infer that "structurists" were IFFL structurists (given the unusual nomenclature) and that "monthly redemptions" referred to a return of funds on investments made by investors that invested through IFFL and its structurists.
The February IBG Minutes also discussed various legal issues then facing Merendon Nevada, Brost, IFFL, True North, Strategic, Stone Mountain, Arbour and others. Although the particular legal issues of the non-Arbour entities are not relevant here, we find it significant that Merendon Nevada, IFFL, True North, Strategic, Stone Mountain and Arbour were referred to under the discussion of legal issues facing IBG companies. Of particular significance was the discussion of the "legal issues affecting Arbour Energy Inc[.]", which was as follows:
DISCUSSION: The trading in the public stock of Arbour Energy Inc[.], a public company on a Canadian Stock Exchange, has been halted supposedly due to Arbour not filing a timely Offering Memorandum and having an "Associated Company" Loan Receivable Asset on its financial statements that needed to be evaluated. Arbour has lent funds to Merendon Mining and carried a Loan Receivable Asset on Arbour's financial statements in the amount of $42,000,000. There was an issue of valuation of the Asset due to there being an alleged "Associated Company" issue which issue has been subsequently resolved by the [Commissions] with respect to Arbour Energy and as such no evaluation of the Loan Receivable is required as per agreement with the Canadian Governmental Auditor.
There is an outstanding unexecuted contract between Arbour and the TRL Technology (a tar sands oil recovery technology). Arbour has not signed the contract for the TRL Technology. Merendon Mining is receiving purchase offers for the TRL Technology. The president of Arbour, Dennis Morice, is not moving forward, at the present time, with the purchase contract for the TRL Technology.
Arbour needs to begin trading its stock and needs to finalize the purchase contract for the TRL Technology. A new President of Arbour needs to be appointed to fight the [Commission] to resume the trading of Arbour stock and needs to either finalize the TRL contract or have Merendon Mining establish a joint venture with another energy company . . . to utilize the TRL Technology.
Should Arbour finalize [the] contract for TRL Technology then 3Sixty Company will have to fund the Arbour. [sic] Should 3Sixty Company fund Arbour then 3Sixty Company will increase its royalty percentage from 8-12% to upwards to 22% net royalty for funding in the amount of two million dollars. Arbour would then be paying royalties in the amount of 30% to Correl [sic] and 22% to 3Sixty.
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MOTION AND RESOLUTION: The following motion was offered by Milo Brost, seconded by Martin Werner, which upon motion duly made and seconded, was unanimously adopted: Be it resolved that either the President of Arbour finalizes the TRL contract and begins to make efforts to cause Arbour's stock to freely trade on the Canadian Stock Exchange or a new president will be chosen for Arbour who will then proceed accordingly. Martin Werner will investigate, interface with all legal personnel and other required personnel and report back to the [IBG] Advisory Committee with recommendations. [Emphasis added.]
Blaikie said that the Arbour issues were raised and discussed by Brost, Capstick and Regier, none of whom, we note, was an employee, officer or director of Arbour. No directors or officers of Arbour or TRL were at the February IBG Meeting. Although Merendon was also being discussed as the recipient of money loaned by Arbour, the "Associated Company" and one of the owners of the TRL technology, Blaikie claimed that he and Sorenson – the only Merendon representatives present – did not participate in the discussions. According to Blaikie, Sorenson chose to leave the discussion and go sit at his desk, several feet away – ". . . as soon as that issue or point was brought up to discuss, you know, Gary just looks across the table and said, Why the F are we talking about Arbour? And then got up and walked away."
Blaikie did not believe that Sorenson returned to the table for any part of the Arbour discussion, which Blaikie had "tuned out". Sorenson also claimed to have left the table and walked to his desk during part of the meeting. He testified that he was upset when the topic of Arbour was raised, and he had had no proof that Brost had maintained involvement with Arbour. We rejected both Blaikie's and Sorenson's evidence on this point.
We note the February IBG Minutes' resolution (quoted above) by the IBG Advisory Group in early February 2007 for "a new president [to] be chosen for Arbour" unless Arbour's president, Morice, "finalizes the TRL contract". As set out later in these reasons, Arbour completed its acquisition of Merendon's 25% shareholding in TRL on 20 March 2007. We conclude that finalization very soon after the February IBG Meeting was not coincidental – we find that Morice was told to finalize the TRL transaction – likely by Brost, who was also based in Calgary and had the greater connection to Morice. Morice then did as instructed and finalized the TRL transaction without, we find, taking the commercially reasonable step of completing the TRL valuation.
The February IBG Minutes also discussed Arbour under the issue "Whether to develop Bengal Oil project" as follows:
DISCUSSION: Bengal Oil is owned by Perma Securities, partnering with Ken Nazar, owner Quad Energy. Milo Brost set Dwayne [Martyn] as director to set up Bengal [O]il. This was for either Arbour energy [sic] to buy, or use Bengal to buy Arbour. Arbour has funded primarily, also Milo Brost and others personally.
. . .
MOTION AND RESOLUTION: The following motion was offered by Gary Sorenson. seconded by Milo Brost . . . Be it resolved that . . . Ken Nazar is to prepare an executive summary of the projects for Gary Sorenson and Milo Brost to review . . . Milo Brost will manage this project.
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It appears that Brost was recruiting Martyn (an IFFL structurist) to act as a director of Bengal Oil and Gas ("Bengal"), which was then to get involved in a transaction with Arbour –apparently the Malaysian transaction referred to in the third of Arbour's offering memoranda.
The February IBG Minutes discussed whether to arrange a 2008 marketing conference for IFFL members and recorded that Sorenson made the motion to have Casey Brost look after the matter. Blaikie confirmed that a marketing conference was held in the Bahamas in 2008. The minutes also discussed SGD redemptions and that Blaikie was to investigate and clarify the current legal and shareholder status of SGD. Blaikie said he did investigate but could not get any answer and, therefore, provided no such clarification.
The February IBG Minutes discussed Elizabeth Brost – Sorenson was to manage all future contacts with her, and Blaikie was to prepare a letter to her. Blaikie confirmed that Sorenson subsequently dealt with Elizabeth Brost and that Blaikie prepared the required letter.
In evidence are minutes from the March IBG Meeting (the "March IBG Minutes"). The March IBG Minutes were circulated by email on 21 March 2007 from [email protected] (Werner) to [email protected] (Brost), [email protected] (Sorenson) and [email protected] (Blaikie identified this as Capstick's email address), and copied to [email protected] (presumably Casey Brost), [email protected] (Regier) and [email protected] (Blaikie). Werner is noted as the Chairman, presiding member, and secretary for the March IBG Meeting, which was "for the purpose of advising IBG concerning the businesses of IBG". Regier confirmed that the March IBG Minutes also fairly represented the discussions during the March IBG Meeting. Regier agreed that Sorenson was not at all of the March IBG meeting, so may not have had an opportunity to approve the February IBG Minutes. Blaikie believed that he had read the February IBG Minutes by the time of the March IBG Meeting. Sorenson said that he did not receive the email with the attached March IBG Minutes, so had not seen these until they were shown to him by his counsel in preparation for the Merits Hearing.
As for the February IBG Minutes, we considered the evidence surrounding the March IBG Meeting and the March IBG Minutes. We also considered the fact that the March IBG Minutes were again prepared by a "neutral" party, Werner and the lack of evidence (apart from Sorenson's) suggesting the March IBG Minutes were false or inaccurate. On those bases, we reject Sorenson's evidence on this point and conclude that the March IBG Minutes are at least mostly accurate, including their representations that Sorenson participated in most of the IBG discussions and votes on the days he attended.
The March IBG Minutes noted the ratification and acceptance of the February IBG Minutes, except in two areas. First, there were comments that SGD should receive 85% of funds raised, with 15% used by "marketing" for "admin expenses" and Eiger "collateraliz[ing] the 85%". Second, the compensation of 1.5% to Sorenson and .4% to Blaikie approved in the
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February IBG Minutes was discussed, with the comment that "Sorenson and Blaikie do not require or want said payments and do not require or want to be considered junior partners. That of the 15% reserved or paid to admin expenses, all other projects outside of SGD proper would be funded by this 15% amount and that SGD would not have any involvement in other projects." The March IBG Minutes recorded only a blank line instead of a motion and resolution for both the above issues. Blaikie confirmed that discussion. The March IBG Minutes reflected the appointment of Casey Brost as Managing Director of IBG (and his consequent removal as an IBG Advisory Committee member). The list of IBG companies in the March IBG Minutes did not include Arbour; the list was not verified through a motion and resolution. Blaikie indicated that he had nothing to do with a number of those entities purportedly managed by him, such as Alluvial, Base Metals, Onyx Trading, Tena Capital Corporation and 3Sixty.
Sorenson described himself and Brost as "business acquaintances" with "an arm's length business relationship"; Sorenson claimed they were "not close friends". According to Sorenson, he and Brost only saw each other a few times a year at meetings or when Brost brought SGD lenders to Honduras for tours, and they only talked on the telephone occasionally.
Hoffman testified that Brost and Sorenson were "the only two that knew everything that was going on" in the 2004 to 2006 period. Hoffman acknowledged Brost was raising money that, in part, was to go to Merendon, but that eventually nobody knew how much Brost was raising and there appeared to be bottlenecks of money at Brost's end. Hoffman observed them during that period to be "[v]ery much partners and friends", defending each other until the end of that period when Sorenson begin making "disparaging comments about" Brost. Hoffman acknowledged that there was a type of falling-out between Brost and Sorenson, but was unsure precisely when it happened.
Morice summarized his interactions with an observations of Brost and Sorenson during the Morice Interview:
A Well, my dealings were with Milowe, not Gary, and normally my discussions would be with Milowe, Milowe would go talk to Gary, and then when things didn't happen, who decided what, I'm not sure but . . .
Q Was it your understanding that Milowe was making the decisions, or Gary was making the decisions, or it was a combination of both of them?
A I thought it was a combination of both of them. Certainly Milowe had tremendous confidence in Gary, and otherwise, you know, I've always liked Milowe, and, you know, I've always had problems with Gary, so I was trusting Milowe's judgment there, the outcome still to be seen.
Regier met Sorenson through Brost at an IFFL structurists' conference. At the time, Regier understood Sorenson to be president, CEO (or both) of Merendon. Regier considered Brost and Sorenson to be "50/50 partners" and referred to times in which Brost and Sorenson would be seated at each end of Merendon's boardroom table in Calgary "and [Sorenson] would look at [Brost] and say, 'That is my partner. We are equal partners in this.'" Regier understood "this" to be "from a very large big-picture perspective, so it would have been things like SGD,
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Merendon Canada, just the -- the big picture." Brost told Regier that he sat in on some Merendon board meetings as a visitor. Regier agreed with the statements that Morice "was basically the minion doing the bidding of Brost and Sorenson" and that "basically Brost and Sorenson ran Arbour". During cross-examination, Regier changed his statement, agreeing with counsel that it "would be fair" to say that Brost and Morice ran Arbour and that Sorenson did not. Further, Regier agreed with counsel that Morice was the "minion" of Brost, not of Brost and Sorenson. During further questioning on this topic, Regier stated that his understanding "from [Brost was] that [Sorenson] and [Brost] on occasion did talk about Arbour together".
It is clear from the evidence as a whole that Brost and Sorenson had a long-standing business relationship commencing in 1999 with SGD and lasting until at least 2007. They were involved in SGD together. They were involved in Stone Mountain together. They were involved in Strategic together. They were involved in Magna North together. Finally, they were involved in Arbour together.
When the totality of the evidence is considered we find it more likely than not that Brost and Sorenson had developed a very profitable investment model. Brost's role was to collect money from IFFL members; that money would then flow to Brost/Sorenson Entities. Both Brost and Sorenson profited handsomely from this relationship. Investors, for the most part, did not. We conclude that there was a strong alliance between Brost and Sorenson, for the purpose of transferring wealth from investors to Brost/Sorenson Entities.
There was evidence, both witness testimony and documentary, that Merendon had gold-mining and other operations during the time at issue here.
It appears that Merendon was primarily engaged in the exploration and development of mining concessions it owned, mostly located in Central and South America. Merendon's gold mining operations had not, however, developed to the point that Merendon could be characterized as a producer of gold. Sorenson stated in the Sorenson Affidavit that while Merendon and its subsidiaries were involved in the production of gold, the production of gold was not "exclusively [their] business".
Merendon Honduras owned and operated a gold refinery in Honduras, but it is uncertain as to the actual quantity of gold processed through the refinery that was owned by Merendon and its subsidiaries; we are not satisfied by the evidence from Merendon and Sorenson that Merendon and its subsidiaries owned a significant quantity of gold.
Merendon Peru apparently owned seven concessions in Peru. Because the mine it had operated was not economical, mining operations were suspended and subsequent operations concentrated on exploration. In 2007 SGD apparently acquired Merendon's interests in the concessions held by Merendon Peru, the purchase price extinguishing Merendon's indebtedness to SGD. Consistent with that, the Sorenson Affidavit stated that Merendon no longer owed any money to SGD. In support of that statement was an affidavit of Werner, as the current president
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of Bahama Resource Alliance (formerly SGD), confirming that Merendon owed no money to Bahama Resource Alliance. Sorenson further deposed that Bahama Resource Alliance, was, as of November 2009, indebted to Merendon for $37 million. Because we have found that Brost and Sorenson controlled SGD, such that the SGD presidents were essentially figureheads, we do not consider confirmation from Werner to be independent confirmation of Sorenson's contention. We also question the value apparently attributed by SGD to Merendon's interests in the concessions held by Merendon Peru.
Merendon Ecuador owned an interest in the Tena Concessions acquired from Hampton Court Resources Ecuador S.A. ("Hampton Court") in 2004 for approximately $800 000. Hampton Court was in financial difficulty, having accumulated debt of approximately $850 000. Merendon Ecuador had also owned a mine, referred to as EMPEC, but its operations were taken over in an armed mercenary invasion in 2007. As of the date of the Merits Hearing, Merendon had not regained control of the EMPEC mine. The only year Merendon Ecuador produced gold was in 2007 when it produced approximately 750 ounces from the Tena Concessions. Feijoo said that the EMPEC project had produced 24 000 ounces of gold before the mercenaries seized control of the mine.
Merendon Venezuela owned a custom gold milling operation that crushed and processed raw rock, some with visible gold, that was sold to it by local miners. This did not appear to be a significant gold-producing operation.
To provide himself with "a good snapshot of [the] financial history" of Merendon, Gleason prepared the Merendon Financial Statements (non-consolidated comparative financial statements for the years ending 31 December 2003, 2004 and 2005, along with the pro forma statements to 31 December 2006). The unaudited Merendon Financial Statements reflected historical values based on purchase and expenditure amounts. They did not include any value for gold in the ground beyond amounts invested to identify the gold.
The Non-Consolidated Statements of Income and Deficit (the "Merendon Statements of Income and Deficit") showed revenue from gold sales of $37 000 in 2003 (along with "Other income" of $6278), but no gold sales in either 2004 or 2005 (although 2004 had a small amount of "Other income" – $9286). There were no amounts indicated for "cost of goods sold" in those three years. The pro forma (or "a budget, a guess, an estimate" as Chute described it) statement for 2006 set out revenue from gold sales of $6 740 656 and "Other income" of $6122. With a cost of goods sold estimated at $5 750 081 in the 2006 pro forma statement, the gross margin was estimated at $996 696. Operating expenses increased from 2003 through 2005 and were projected to increase further in 2006: $1 356 895; $1 666 413; $3 293 211; and $3 757 146, respectively. Only 2003 and 2005 showed an income before taxes (2004 and 2006 showed a loss and projected loss of $1 379 031 and $2 758 481, respectively). The $1 710 295 income before taxes in 2003 was primarily due to an unrealized foreign exchange gain of $3 023 912. The
$1 557 297 income before taxes in 2005 was primarily due to a gain on sale of shares of
$6 393 526 – Chute believed that this gain was from Merendon's sale of the COREL shares. As Chute noted, both were "extraordinary items, not things that will continue year to year".
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The Merendon Statements of Income and Deficit show that Merendon had a deficit each year:
$24 925 369 in 2003;
$24 629 400 in 2004;
$23 072 103 in 2005; and
$25 830 584 projected for 2006.
In summary, Merendon had lost a cumulative $23 million by the end of 2005 and projected that it would lose almost $3 million more by the end of 2006.
Merendon's Non-consolidated Comparative Balance Sheets (the "Merendon Balance Sheets") showed that Merendon had liabilities greater than assets from 2003 to 2005 (the pro forma amounts for 2006 followed the same pattern). The asset-liability gap was large – over $18 million in each of 2003, 2004 and 2005, with a projected increase to over $21 million in 2006. With those high liabilities and the correspondingly high asset-liability gap, the Merendon Balance Sheets balanced because of the accumulated deficit in the shareholders' equity category. The Balance Sheets also indicated as an asset "Inventory", which Gleason said was the gold Merendon had purchased from its subsidiaries (primarily EMPEC and a little from Magna North) at market value but had yet to resell. The 2003 Inventory was $154 466, 2004 was $1 799 193, 2005 was $1 905 684 and the estimated amount for 2006 was $1 036 331. Gleason said that Merendon would then reduce the corresponding intercompany loan account by the amount of the gold sold to it. However, Gleason did not explain why there was only $37 000 of gold sales for 2003 and then no gold sales until the over $6.7 million expected amount for 2006.
The Merendon Balance Sheets showed long-term debt of $10 800 000 in 2004,
$38 663 457 in 2005 and the same amount projected for 2006. These amounts were the loan amounts owed to Arbour. The other long-term liability category – just under $68 million projected as at 31 December 2006 – indicated for all years is described as "Due to Shareholders", which referred to Eiger. Liabilities of note were an "Interest payable to Arbour" category in 2005 ($749 496) and 2006 ($2 118 526), along with an "Interest payable" category in all four years – the latter ranged from approximately $10 million to approximately $12 million.
The financial position of Merendon in 2003 through to 2005 (and the projections for 2006) appeared to support Hoffman's concern that Merendon was not generating sufficient returns in 2000 and 2001 to pay the promised return of 3% to SGD investors. Hoffman testified:
Funds, when requested, were provided to the -- back from Merendon to the investors by Merendon.
[Sorenson] said he had a certain amount of capital that he was back-stopping the SGD investment with and had said numerous times he was going to his personal money to cover redemptions. And I had requested to see proof of that, and he said it was in lawyers' trust, and he said -- and Milowe
-- came back that Milowe was satisfied that that was there.
. . .
My concern was always that it was -- Merendon never had the assets to cover the indebtedness of the investors, and if they all decided they wanted their money back, they -- I wanted -- I was very concerned that Merendon didn't have the assets to make repayments.
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Regier acknowledged that money paid by Arbour investors was being used to pay other Arbour investors in what he agreed was a Ponzi scheme. Regier stated that Brost and Sorenson and "the people that were on that IBG list of people" were those involved in this Ponzi scheme. That included Regier himself and Werner.
IFFL was Brost's company. Brost was IFFL's sole shareholder, a director and CEO. IFFL's head office was in Calgary and in the same building as Arbour, Expedia and Strategic Metals. Brost described himself as an "owner" and "[f]igurehead" of IFFL. In the Brost Interview, Brost stated that he had always been CEO of IFFL until he "resigned as a result of [Commission] hearings". We find that Brost was clearly the guiding and controlling mind of IFFL.
In the Brost US Interview, Brost described IFFL as having a somewhat similar structure and purpose as Capital Alternatives, operating as "an information club" that taught people "financial strategies through restructuring of assets to accomplish financial freedom", although he said that IFFL members were encouraged to become clients of a major Calgary law firm so they were in a solicitor and client relationship when they completed their membership contracts. Brost also described Capital Alternatives and IFFL as being "strategy and business development-type education platforms.
As CEO, Brost said he was responsible for IFFL's "[g]eneral direction", as well as "information meetings with both structurists and membership". He elaborated on the meetings: "We are in the business of teaching people different ideas about how to view their financial position, how to develop their finances, and so I was -- was in a constant state of presenting concepts." He acknowledged being the primary presenter at those information meetings.
Sorenson knew that Brost controlled and ran IFFL operations and was its guiding mind. He understood that IFFL's "activities included informing and educating members on investment opportunities." Sorenson said that he understood IFFL instructed those of its members who were interested in moving money offshore on how to create IBCs, which were apparently the corporate vehicles used for these investments. Sorenson also knew that Brost had IFFL raise money from its members for SGD and Arbour.
Regier began working at IFFL in July 2003, providing office management and accounting services. His prior employment had been with Capital Alternatives, providing similar office managerial services. Regier described IFFL as an "information club" and "an educational institute where they had people doing educational seminars". He also confirmed that Brost controlled and operated both Capital Alternatives and IFFL.
Regier said that IFFL was one of three companies "raising funds for SGD" (the others were Parklane and Red House). He also acknowledged that IFFL was marketing Arbour (and other companies, including Strategic) as possible investments for IFFL members.
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Brost was personally involved in IFFL's promotional activities. He participated in IFFL structurists' meetings and gave presentations on specific investments. Regier recalled Brost and Morice speaking about Arbour at structurists' conferences. Regier described Brost's presentation
he "would just echo [Morice's] comments and exaggerate them, make them bigger". Regier said that he saw both Brost and Sorenson interact with the structurists – "Sorenson made presentations to the structurists with regards to Merendon Mining Corporation and its South American properties and the state of those properties".
Morice said that he dealt with Brost and Regier from IFFL and also with Forrest, Weeks and Verbeem, although he did not know which, if any, of those last three were IFFL members.
There was no clear evidence as to how much money IFFL raised from its members, but the amount was in the millions of dollars. In October 2005 Hoffman wrote Blaikie seeking confirmation that as at the end of December 2001, SGD had provided Merendon with approximately $24 million. In a 24 March 2005 conversation, Sorenson told Hoffman that he estimated that IFFL was raising at least $6 million per month, of which Merendon was to receive 70% or just over $4 million per month (but was receiving $2 million). Sorenson in the Sorenson Affidavit deposed that IFFL had reportedly raised over $97 million in 2006. Sorenson claimed that the Merendon entities received slightly over $26 million through SGD that same year pursuant to the loan agreement between Merendon and SGD.
As noted, IFFL representatives were referred to as "structurists". They were retained by IFFL to provide prospective members with financial information and advice. As Regier acknowledged, IFFL structurists "were the people who were in charge of . . . disseminating . . . 'the gospel according to Milowe'". Structurists would solicit people to join IFFL's membership, which then entitled those members to receive more specific investment information, including information and access to an investment that would offer both a domestic and international side. Investors paid an initial membership fee, with annual fees subsequently payable – the typical membership fee appeared to be $1600 (plus GST) and the renewal fee was $400 (plus GST) per year.
IFFL structurists earned commissions based on the amount of money invested by members in certain specific companies recommended by them. Regier explained that structurists were compensated in two different ways. First, they received a commission for every member they brought into IFFL. Second, they received additional compensation when a posting (investment or allocation) was made to the international account of an investor that the particular structurist had introduced to IFFL. Regier clarified that meant a structurist only received such compensation if an investor invested in one of the Brost-connected entities, such as Arbour or Rapid Express. Regier thought that the latter form of compensation was approximately 7% and generally not a cash payment. Rather, the appropriate amount would go into the structurist's
account, from which the structurist could draw a "redemption". Regier believed that the maximum redemption allowed was about $50 000 per month.
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As stated, no commissions would have been paid to the structurists for purchases of any publicly listed securities as IFFL members would have been required to purchase those securities outside IFFL, presumably through registered dealers with access to the applicable exchange. Thus, we find it reasonable to conclude that the international component of IFFL's compensation structure provided a strong financial incentive for structurists to steer or recommend IFFL members to invest in the Brost-connected entities, which were the only companies offering the "international" side.
Sorenson was also aware that IFFL structurists received financial benefits from IFFL members who invested in the Brost-connected entities. He told Hoffman on 19 February 2005, "Because [Brost] told these f**king structurists that they could have more money up and above their commissions . . . they're all living like f**king kings and queens . . . and they're taking more money out of the f**king program than the f**king clients are."
Apparently structurists were provided with training documentation, such as the "Structurist School" binder that was in evidence. Because that binder was dated January 2007, several months after the last of the sales of the Arbour Preferred Shares, we placed no weight on it.
Thayer Jackson ("Jackson"), a former IFFL structurist, attended a meeting in April 2002 at which Brost gave a presentations on a number of specific companies as investment opportunities. Jackson was subsequently asked to join IFFL "as an employee to present their educational program". He described his understanding of IFFL's business:
Q . . . What's your understanding of the business of the IFFL? A To educate individuals on what they can do with money.
Q So you attended a two-day seminar in Calgary put on by Milowe Brost in May of 2002? A Yes.
Q And what was that seminar regarding?
A About the business aspect of IFFL on the educational side. Q What type of education was provided to the members?
A The education is basically to educate people [on] the difference between conventional investing -- mutual fund, stock market and those types of things -- and other things that are around. That's basically the whole concept of what the educational side is about.
. . .
Q . . . What do you mean by "other things around"?
A Well, there's other things internationally that you can invest in, which people have the right to do it.
. . .
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A Well, conventional investing, in my opinion, is when you go to a stockbroker here or mutual fund broker or banks or whoever.
The evidence is clear that IFFL and its structurists discussed with IFFL members –potential investors – investment strategies and investment opportunities in specific companies.
Brost and IFFL presentations to attendees focused on teaching them how to maximize their investment returns by moving assets (such as RRSPs) into what IFFL claimed were higher-performing assets with more favourable tax treatment. The presentations were designed and executed to convince attendees to become IFFL members, which would entitle them to learn of and invest in international opportunities offered only through IFFL. At presentations, Brost and structurists generally represented that the international investments through IFFL were backed by Merendon gold.
Regier described how IFFL structurists would initially provide generic financial advice to people interested in joining IFFL's membership:
They would give, I think they were one or two-hour seminars at either hotel rooms or whatever where people could come and listen to a speech, if you will, on -- I think at that time it was very generic, but it dealt with national erosion of -- the erosion of interest -- the erosion of money growth with tax as a result of tax, interest rates, those types of things, and talked about in the international or offshore-type investing where tax and the rate of growth was better.
Different speakers would make presentations at group meetings or seminars – these included Brost and guest speakers, such as Ken Sorensen and Morice. Members and non-members could then attend one-on-one meetings with structurists to learn more about becoming a member, making an investment or further understanding an existing investment. During the presentations, prospective members were told that IFFL had an investment opportunity involving international companies – referred to by Regier as the "International Business Group" – that offered the advantages of an offshore investment. Only IFFL members were given this international opportunity and permitted to invest, exclusively through IFFL, in entities offering this international side, including Arbour. Regier described the international prospect as the "sweetener".
After becoming an IFFL member, the individual would receive a list of five or six specific company names to consider as potential investment opportunities; contact information was also provided. This information apparently was typically provided in a letter on IFFL letterhead and signed by Brost as CEO (the "IFFL List of Companies"). Only one (or two) of the entities on the IFFL List of Companies would offer the international side; the rest of the entities were well-known publicly traded issuers. IFFL members had, by that time, been primed to gravitate to the sole entity on the IFFL List of Companies offering the purportedly desirable international side. It was, therefore, simple for Brost and his structurists to complete the task of
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steering the members to those entities that would provide the international component and theoretically generate the high returns. IFFL members were also assisted by Brost and structurists in setting up their IBCs, from which they were told they could manage their international investment. In reality, however, Brost and his organization managed the investment of the money.
Regier identified two IFFL Lists of Companies in evidence as typical of the documents Brost and IFFL structurists used to promote the international investments to IFFL members. We reproduce one IFFL List of Companies:
Dear Member,
On behalf of the presenting Structurist and myself I would like to thank-you [sic] for attending the workshop(s) and trust that these concepts and strategies have created an interest for you to explore many types of financial opportunities.
As a financial educator, IFFL researches many investment opportunities. Opportunities range from well[-]promoted mutual fund Companies to little[-]known National and International opportunities; whereby word of mouth coupled with exceptional growth, create interest in the target opportunity. Each Member must assess their personal objectives and risk factors based on the strategies they are comfortable with.
The following is not an exhaustive list, but some of the Companies listed below may help meet your personal financial freedom goals:
Canadian Tire offers a corporate security (stock) as well as a debenture. [phone number and website given]
Walton International Group offers real-estate investments. [phone number and website given]
Axcess Capital Partner offers mortgage investments. [phone number and website given]
Warren Buffet[']s Company; Berkshire Hathaway offers many different investment opportunities.
[no phone number but website given]
Arbour Energy Inc[.]; an up and coming junior Oil and Gas Company. [phone number, email address and website given]
Dundee Wealth management offers many types of investments including mutual funds, stocks, bonds.
[phone number and website given]
If you require additional strategy assistance, please contact your presenting Structurist. Warmest regards,
Milo A Brost, C.E.O[.]
In the Brost Interview, Brost acknowledged that IFFL would provide its members with an IFFL List of Companies at workshops – "companies that we thought, given the nature of our discussions with them, would be pragmatic for them to go and have a look at". In answering what IFFL did to identify such companies, Brost replied:
There were people that I -- we took a look at, liked what they stood for, in completely different sectors, and were presenting them to the membership for them to give whatever consideration they deemed appropriate. We told [IFFL members] that we looked at [these companies], we found
them interesting, thought they were a good idea, go take a look at 'em.
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When discussing what Brost and IFFL structurists told members about the companies on the IFFL List of Companies, Brost said in the Brost Interview that:
A . . . IFFL has an organization that raises up structurists, and structurists are taught different business-type strategies. In the course of them working with someone, putting on a workshop, they would've produced a single piece of paper that would've had some concept, some companies, go take a look at them, said if you wanna look at some companies that are relative to what they're discussing in our -- our workshop here, here's five in five different sectors that you go take a look at.
Q Did you personally ever provide those documents to anybody or that document to
anyone?
A If I was putting on a workshop, then I would've provided the same document that any structurist would've provided.
Q Okay. And when you provided that document, what did you say about it?
A Here's five different sectors, business sectors, that have the ability to produce what we consider to be better than average returns, Take what you're doing with your affairs,
take a look at these different opportunities and decide for yourself if -- if they're a good idea for -- for you to look at, get involved in, et cetera.
Q So there are different sectors. What -- what sector did you say that Arbour Energy was from?
A Oil and gas.
Q What information on Arbour was provided on that sheet of paper?
A Its name and probably a contact website or telephone number, depending on which would've been more appropriate. And the same would've been for all five of them.
. . .
Q When did you -- did you ever remove Arbour Energy from this list of companies?
A When it became evident that there was room for misinterpretation, that we had provided a list for people to go look at companies, that the [Commission] would and -- could and would interpret that as a potential advice advising you are being sent, commissioned, go send -- go spend your money there, we removed the communication from the structurists.
Q When was that?
A Year ago or so [approximately April 2007].
Regier attended the twice-yearly IFFL structurists "group meetings" that Brost organized to provide his structurists with "updates, issues, those types of things". Regier also stated that the companies promoted by Brost "were either set up by [Brost] or had directorship and/or
management by IFFL, either structurists and/or members". The evidence is clear – and we find –that IFFL members made investments as directed by Brost and IFFL.
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Brost acknowledged that he and structurists discussed risk or risk tolerance and diversification (he stated the latter was always raised and was "a good idea") with IFFL members. He described what IFFL members were told about risk tolerance and, in particular, discussions about the risks associated with an investment in Arbour:
Q . . . What, if anything, was taught to your members with regard to risk tolerance?
A Well, when dealing with people, try to find out what their risk tolerance is. Any particular member will have a different panic point when it comes to what they're comfortable with, what type of instrument that they're gonna be comfortable with, so if they're a very conservative individual, then they don't wanna be looking at some type of instrument that's gonna take them outside of their sweat zone, and -- you might as well go [to] the next [topic in the document being referred to], which is "Diversify, Diversi[f]y, Diversify." It's why I made the comment that we're focused here -- or, you're focused here on the 30 or 40 million dollars that has been said that Arbour Energy was able to encourage members to place at Arbour Energy. "Diversify, Diversify, Diversify," that will be some small fraction of what the membership, as investors, would be involved in, and I don't have a number for that, but I would certainly assume that 30 or 40 million dollars is probably 30, 40 million of certainly 500 million, could be 30, 40 million of a billion dollars, but they just happened to be able to attract that -- that interested segment.
. . .
Q With relation to risk tolerance, you said that there were different levels of risk tolerance of your members. [D]id you talk about risk with relation to any of these companies
listed here [in a document being referred to]?
A Risk tolerance would not come up when -- in this type of a workshop. In this type of workshop, it would be trying to expand people's horizons to take a look at different things. If they found something that they're interested in, if they ordered up another session or a private workshop where they were actually talking about something that they were specifically interested in, risk tolerance would then -- would've come into play.
Q Do you have any knowledge or did you ever speak to any of your members or potential members with relation to risk tolerance on Arbour Energy Inc.?
A Did I ever have conversations? Yes. In workshops that I conducted where people had expressed interest in Arbour Energy or had gone on to go get an offering memorandum, et cetera, and came back to a workshop and said, you know, Is this a good idea or a bad idea? that's when risk tolerance comes into play.
Q So your members would come back to you and ask that question[?] A Often.
Q And what would you tell them when they asked that question? A Depends on their risk tolerance.
Q What would you tell them about the riskiness of the Arbour investment?
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A My perception of the risk with Arbour investment would be medium to high. So if somebody had a low risk tolerance, then they're in conflict with themselves. If they're a medium risk tolerance person, then Arbour is something that, looking at it, you'd have to weigh the -- the risk over the reward of the experience and if you -- if they were high entrepreneur-type people and Arbour Energy was clearly within their -- their scope, then the question would be what due diligence or how were they able to satisfy themselves that that's something they'd be interested in. That's if they came back and asked for a workshop to actually talk about Arbour Energy, some -- some would. Or talk about anything else, for that matter.
With some members, we would wind up having many workshops after the initial workshop, and other members, we'd wind up having one or two workshops and never see 'em again. It's all over the board.
. . .
Q How did you determine what risk tolerance the member would have?
A By conversations with the member: What are the things that they're presently involved in, why are they happy or unhappy with -- with what they already have, what's been their previous experience. Many of the members that we work -- and I would say a high percentage of the members that we work with have had some type of bad experience when it comes to investing, lost significant money. That usually factors in greatly to their low, medium or high risk sensitivities. You discuss these things, [they're part] of a private meeting, and discuss why do they feel the way about (sic) what they've done and
-- and what they're thinking about doing.
. . .
Q With regard to Arbour, if someone had said, I'd like to -- I've got an offering memorandum from Arbour, I'd like to discuss it, would that result in a breakout session?
A Probably not. [If] they made that exact statement, they would probably be sent to Arbour to discuss it. Fundamentals of an offering memorandum are the company's business, not our business.
Q So when would you discuss Arbour with them?
A If somebody wanted to get together and -- and understand how Arbour would impact their -- their financial future, how would it factor in, is this something that they can get comfortable with, we would talk about that. We would talk about their -- from the impact perspective, not from the actuals [sic]-- not from the actual investment.
Q So you would talk about how an investment in Arbour would impact their portfolio of investments?
A More what their comfort is with that type of investment, where do they see it taking them. May get into what percentage of their finances will be tied up with Arbour, et cetera, because that factors back to risk again. It's hard to say. . . .
Q You said that when you discussed Arbour, you'd talk about, you know, how Arbour would impact their future, where do they see the Arbour investment taking them. What input did you have into those discussions?
A If I was in the session, I'm listening and I'm providing a sounding board for people, talking about their risk tolerance, percentage of their portfolio, what it would or would not do for them if they got involved in Arbour. I'd become a sounding board.
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Those who became IFFL Members apparently received a members' handbook. In evidence was an IFFL "Members' Handbook" (the "First Members' Handbook) provided by Jackson. Another version (the "Second Members' Handbook") was received by the Commission from the SEC.
The First Members' Handbook contained several articles and considerable commentary on investing, including commentary on financial education, international aspects, markets in general, terminology and suggested reading material. In an introductory "Message from the CEO" in the First Members' Handbook, Brost described IFFL:
The Institute for Financial Learning, Group of Companies Inc. is an organization dedicated to providing a supportive environment where members can explore the many channels of domestic and international jurisdictions. Through The IFFL, members can raise their financial knowledge in areas of market analysis, regulatory tax issues, protection of assets and banking practices; and they can learn new strategies to accelerate their ability to achieve financial security and develop personal planning skills. Complementary Workshops are widely available, and provide an introduction to these new strategies. Workshops are presented by a Structurist (an Institute authorized representative) to educate, guide and facilitate the learning process.
The Second Members' Handbook contained a "Membership Agreement" for a US couple, dated 15 June 2004. The Membership Agreement set out the following services to be provided by the IFFL:
[IFFL] will provide to the Member general education and guidance on concepts, strategies and opportunities in various financial fields.
[IFFL] will not provide, and the Member will not receive from [IFFL], the following:
Investment advice on specific securities or any specific financial instrument or business proposal;
An invitation to a Member or any individual of the public to subscribe for securities;
A distribution of securities to the Member or any member of the public; or
A solicitation of a Member or any individual of the public to make any investment or provide any funds to participate in a placement.
This Agreement shall not in anyway [sic] be interpreted to be an agreement in relation to the provision or receipt of any of the functions referred to in section 11 [sic].
All financial concepts and strategies developed and presented through [IFFL] are generic in nature, and are not to be considered as specific advice for the Member or any other particular person.
Although reasonable efforts are made to accommodate each Member's vision of the alternative financial future that he or she desires, [IFFL] gives no assurance or guarantee as to the success of any concept or strategy implemented by the Member.
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The Membership Agreement also contained "Non-Disclosure", "Confidential Information" and "Non-Circumvention" provisions. The Second Members' Handbook also contained various articles, charts and other materials about finances and investing, some of which was the same as the material in the First Members' Handbook.
It became clear during the Merits Hearing that investors who invested in Arbour (and other companies) through IFFL were told that they would receive not only securities in the domestic company in which they were directly investing, but also a somewhat nebulous "managed account" on the "international side". This supposed international investment would enable investors to earn an extremely high rate of return, purportedly tax-free. Some of the details became apparent through the documents and testimony before us.
Regier explained that members investing through IFFL would receive an international investment of some sort with SGD. For example, an IFFL member who invested in Arbour would receive Arbour Preferred Shares and "would have a managed account available". That managed account was "the international investment piece", for which "you had a choice of quote/unquote investments . . . you could manage that money in a number of different investments", with an average rate of return of approximately 2% to 3% per month.
Regier agreed that "the real inducement for becoming involved with this IFFL group was getting the offshore accounts backed by Merendon and Gary Sorenson's gold", with the additional advantage of potentially tax-free money. As noted, non-IFFL members who invested in Arbour would not receive the international account. Regier acknowledged that the "managed accounts essentially became currency within this framework within this big picture".
Hoffman confirmed that "managed accounts" were what investors received after they invested:
[F]rom what I could ascertain from the information that was told to me, from the conversations, was there was one company, and I think it was Grovenor, and all the investor money was put into Grovenor from all the investors, and they had an account that they called the "managed account" within that corporation, I think, if I've got it right.
Chute confirmed that she was told by some investors that they were to receive, in addition to their domestic investment, an offshore-managed account and that the money would grow tax-free (with tax payable when they took the money out). Investors told her that the international interest rate varied, but was approximately 3% per month, with the Arbour domestic account paying interest at the rate at 5.75% per year.
Regier explained that the managed accounts "didn't have real dollars" – none of the funds invested in Arbour Preferred Shares, for example, went into the managed account. Regier had this to say:
Q [W]hen you say it wasn't a real account, what was happening, as I understand your evidence -- and please correct me if I don't understand it correctly -- is that really what these managed accounts were was they drove off the investment -- the Arbour investment
so, say, they -- somebody invested $10,000 in Arbour preferred shares, is it then the case that the managed account would take that $10,000, not the dollars, but would say you're now going to earn interest of 2 percent per month off that $10,000?
A Off a portion of it, yes.
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. . .
Q Okay. So there were fees?
A There [were] some fees. I think it was -- for the first while it was 78 cents on the dollar.
Q [S]o that managed account really had nothing to do with the investment in the Arbour preferred shares?
A Other than a direct correlation in amounts.
Q Right. But there were no funds going from -- the monies that were paid to Arbour weren't going into any kind of account, it was really just --
A No.
Q -- an accounting that was done, whether it was the 2 percent per month or the 3 percent per month?
A That's correct.
Q And so no actual money was invested in any legitimate financial institution that would have been capable of earning this?
A No[.]
Regier said that investors would receive a monthly statement from SGD for their offshore-managed accounts, and he agreed that the statements would show a "strong return" on the original investment. A sample statement in evidence showed interest earned of $64 854.48 over approximately 26 months (from September 2005 to November 2007) on a total investment of $78 305 ($76 855 of which was the initial investment). Regier conceded that monthly statements were "essentially false. That wasn't really how the money was moving" and that the monthly statements were "just a fiction that was created to give people the impression that their money was growing".
Regier acknowledged that Expedia was Brost's company and that Brost had given him responsibility for its day-to-day operations. He explained that Expedia provided administrative and accounting services. More important, he agreed that "Expedia was the link between the national side and the international side", with the national side being "where the money went" and the international side being "a fiction". He described Expedia as the "administrative conduit, that connects both sides" – the domestic and the international parts of the investment offered through Brost and IFFL.
Those who had loaned money to SGD – here, IFFL members who made an investment in one of the international business companies were sometimes invited to view Merendon
Honduras's operations. Sorenson said that he agreed to such tours on the condition that Brost not use the tours to solicit potential lenders for SGD.
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Brost and Sorenson were both involved in the Merendon Honduras tours and portrayed themselves as business partners to participants on some of those tours. Sorenson and Brost would make presentations to the group about Merendon and its operations.
Regier testified that his discussions with IFFL structurists led him to form the view that the structurists wanted an RRSP-eligible investment vehicle to sell because they thought "that Canadians were more ready to part with RRSPs than they were cash money, and so [the structurists] viewed [RRSP money] as low-hanging -- quote/unquote low-hanging fruit". Regier noted, in that context, that Arbour would be an RRSP-eligible investment.
Brost promoted Arbour to the IFFL structurists at the structurists' conferences and Regier "would assume" that structurists then promoted Arbour to IFFL members at member seminars. Regier also noted that Morice provided a presentation on Arbour's projects at a structurists' conference. Regier knew that IFFL members were being referred to Arbour by the IFFL structurists. Regier agreed that "the IFFL, through its structurists, senior associates or [Brost], recommended specific stocks to members", and stated that Arbour securities were among those recommended.
Arbour itself did not advertise or otherwise promote the sale of the Arbour Preferred Shares to investors. Hobbs confirmed that the majority of Arbour investors came through IFFL, with the others being "business associates or people that [Morice] would have known".
In January 2003 Arbour, then a capital pool company, completed its qualifying transaction when it participated in an exploratory well. Arbour's lawyer was Skeith, a friend of Strashok, one of Arbour's directors.
Strashok in the Strashok Interview described how he came to become involved with Sorenson and Merendon. While looking for office space, apparently in 2001, Strashok learned of vacant office space next door to Merendon's Calgary offices. He contacted Sorenson, whom he had previously met socially, and Sorenson agreed to allow him to share the adjoining office space. At that time Strashok was both a director and officer of Arbour as well as its legal counsel. Over time a relationship developed between the two men, resulting in Sorenson asking Strashok to act as Merendon's legal counsel. As noted, Strashok provided legal services to Merendon from about December 2001 until May or June 2004 and was a director of Merendon for a few months in 2004. Strashok's contacts at Merendon were Sorenson and Jack Wolfe, from whom he received his instructions. One of Sorenson's instructions to Strashok was to incorporate TRL.
Strashok also provided legal services to Stone Mountain and was a director of Stone Mountain until he severed all relationships with the Merendon group of companies in the late
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spring or summer of 2004. Strashok said that Sorenson had asked him to become a director of Stone Mountain after Merendon had acquired Stone Mountain but that once appointed a director, Strashok had very little involvement in Stone Mountain's activities. It was during his involvement in Stone Mountain that Strashok had some contact with Wigmore, the president of Stone Mountain.
Sorenson deposed that Jack Wolfe first learned of Arbour from Strashok, then advised Sorenson that Merendon should purchase Arbour common shares because of its potential for a successful oil and gas well. Merendon purchased 1 million Arbour common shares as part of Arbour's qualifying transaction in 2002.
Sorenson was married on 16 September 2003 in Honduras. Brost, Strashok, Weis, Wigmore and Monkman attended Sorenson's wedding.
During 2003 Arbour experienced financial difficulty and sought protection under the Bankruptcy and Insolvency Act (Canada) on 4 July 2003. Efforts were undertaken by the Arbour board of directors to search for parties interested in purchasing a shell public company or providing another solution that would allow Arbour to emerge from bankruptcy and continue in business. From both Strashok's and Sorenson's versions of how Sorenson learned of Arbour, we conclude that Sorenson was familiar with Arbour by the time it sought bankruptcy protection.
Also in 2003 Brost and IFFL were looking for a way to access its members' RRSP money
referred to as "low hanging fruit" by IFFL structurists, according to Regier. An investment in shares of a public company would qualify as RRSP-eligible, thereby providing such access. (As later confirmed by a 10 August 2004 letter from Skeith, an investment in shares of Arbour, which was a public company, was a qualified investment for an RRSP.)
Brost became interested in Arbour – one of many available public companies in dire straits listed on the Exchange – as an investment vehicle for IFFL members.
In or around July 2003 Sorenson and Merendon (which, as noted, had a substantial shareholding in Arbour), expressed interest in acquiring a public company like Arbour. Skeith advised Strashok on 30 July 2003 that the Exchange wanted Sorenson to complete a personal information form and consent form and provided Strashok with the necessary forms. In a September 2003 letter, Strashok outlined a proposal for consideration by Sorenson. The letter indicated that it was sent by fax to "Sorenson – Merendon" for a "Proposed Acquisition of [S]hares" and to Adair as a "Proposed Director of Arbour". A proposal was ultimately put forward, but the Exchange did not approve the proposed transaction and it never proceeded. Strashok generally confirmed this in the Strashok Interview.
Despite some inconsistencies and Sorenson's attempts to distance himself from Arbour's resurrection attempts, the evidence is clear and we find that Sorenson was aware in 2003 that Arbour was a shell public company desperate for third party capital if it were to be saved from bankruptcy and continue as a going concern.
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Ultimately, a group of people associated with Brost – some from at least as far back as Bellringer – become actively engaged in resurrecting Arbour. Regier confirmed it was Brost's idea to resurrect Arbour. Morice, Weis, Wigmore, Hobbs and Martyn were those directly involved in running the revamped company. Strashok confirmed that it was Brost "who was interested in helping out Arbour".
In late 2003 Strashok was contacted, he agreed, "out of the blue" by Houston who, acting as an intermediary, advised Strashok that Houston had individuals interested in taking over Arbour. Apparently one of these individuals was Brost. Although Strashok had met Brost at Sorenson's wedding in 2003, Strashok did not know how Houston and Brost learned about the Arbour opportunity. Houston and Brost presented a number of proposals to Strashok and the Arbour board of directors as they searched for a viable solution.
According to Strashok, he and Houston "didn't see eye to eye", and Strashok began to deal directly with Brost, because it "became apparent" that Brost was the party interested in assuming control of Arbour and working out a proposal for Arbour's continuation.
At some point Houston withdrew and was no longer involved in the negotiations. Weis –a long-time friend of Brost and Brost's former accountant – entered the picture.
Many of these events were confirmed in a conversation between Brost and Hoffman on 8 June 2005. Brost spoke about how "Chris" (presumably Houston) was supposed to organize in the summer of 2003 a public company to use for RRSP money for the end of 2003, but there were delays that enraged Brost. Brost said that he then took over because he was "going to resurrect this public company, I'm going to finish putting the deal together exactly the way it was orchestrated", then Chris could also organize a public company, and they would "launch them both and we'll see who gets to the trough first". Brost then confirmed that "in the middle of June we launched the public company that I was involved with" but that it then was cease-traded for a failure to file financial statements. However, Brost then told Hoffman that was resolved "yesterday", and the shares of the public company were "up and trading this morning". Although Arbour was not named, it is clear from the evidence – and we find – that Brost was discussing the resurrection of Arbour by him: new management was installed at Arbour in June 2004; Arbour was cease-traded for failure-to-file financial statements on 9 May 2005; and that cease-trade order was to expire in late May.
In the Brost Interview, Brost stated that he talked about Arbour with Weis, but did not recall asking Weis to become a director of Arbour. Weis said that he learned of the Arbour opportunity from Sorenson; Sorenson denied such a conversation. Strashok did not know exactly how Weis became involved in Arbour, but recalled the loan from Weis to Strashok that Strashok then lent to Arbour to help satisfy its creditors (discussed below). Strashok also did not recall who proposed Weis as a director of Arbour. Weis said in the Weis Interview that he became involved in the Arbour negotiations in January 2004 when he negotiated with Strashok, then "put up the $300,000 necessary to save [Arbour]". According to Sorenson, Kendall claimed to have provided that $300 000.
Given the prior close relationship between Brost and Weis and their continuing close interaction on Arbour matters, we find that Brost was responsible for introducing Weis to Arbour. We also find that Sorenson was, at the very least, aware of Weis's involvement.
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On 21 January 2004, a draft letter (erroneously dated 2003) from Weis to Strashok was prepared. In that letter, Weis proposed a change of control transaction involving Weis purchasing 6 million Arbour shares for an investment of $300 000 and reconstituting Arbour with five directors – three nominated by Weis and 2 nominees of Arbour. In evidence were comments from Skeith to Strashok about that draft proposal.
Skeith was Arbour's lawyer through its revival; he produced material from his Arbour file and referred to some of it during his testimony. Skeith dealt primarily with Brost and Weis, working on a plan that would "fund [Arbour] and with a focus on oil and gas", allowing it to emerge from bankruptcy and continue operating. Skeith understood that Brost would not become a director or officer or be involved in running Arbour; however, he would raise money for Arbour.
Skeith's statements of account confirmed Brost's active involvement in resurrecting Arbour. Skeith's statements of account in evidence first mentioned Brost's involvement in Skeith's Arbour file on 12 February 2004, with frequent involvement by Brost for some time thereafter, particularly from March through June 2004. Of note, the 27 July 2005 record referred to telephone calls with Brost.
In February 2004 negotiations were continuing between Brost and Strashok as evidenced in email communications between Strashok and Skeith. Strashok advised Skeith of Brost's four-stage restructuring plan. Stage one involved $200 000 being loaned to Strashok so that the money could be immediately released to the trustee (presumably to be paid to the Arbour creditors), and Strashok was to repay the loaned money. Stage two made clear that there would be three new Arbour directors and these would be directors of Brost's choice. Stage three involved issuing up to 10 million Arbour shares at $1 per share (Brost expressed concern that if the Exchange approval process took too long, it would be a "bust"). Stage four called for Strashok to transfer all his Arbour shares to Weis in late 2004 or early 2005, at which point the former Arbour directors would have all resigned, leaving the three Brost-nominee directors running Arbour.
As part of the bankruptcy proceedings, Arbour filed a proposal to creditors that provided for partial payment to them. Arbour stated that it completed a private placement of 6 million common shares for gross proceeds of $300 000. The proceeds were to be used for partial payment to the Arbour creditors who had accepted the proposal. As contemplated, Weis provided the money to satisfy Arbour's creditors by way of a loan to Strashok (despite some uncertainty in the evidence as to the final figure, we conclude that $300 000 was the correct amount of that loan although we do not know where that money originated – we do not believe it was Weis's).
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In March 2004 Arbour, emerging from bankruptcy protection, had resumed operations, ostensibly under then-existing directors Strashok, Gary Strashok, Gardner and Monar. Communications were had with the Exchange to effect the resumption of trading in Arbour shares, communications (at least certain of them) shared with Brost.
The evidence is clear that, despite the continuation of then-existing Arbour directors, they played little role in the resurrected Arbour's decisions, negotiations or other actions; the involvement of Brost in the resurrection of Arbour, however, was profound. We now turn to these events.
By the time Morice was brought into Arbour, IFFL had already loaned Arbour $25 000 until the "[$]2.1 million placement . . . was through" because Arbour had no money to fund its operations, the $300 000 injection of capital provided by Weis having been used to settle with Arbour creditors. Morice agreed that the $25 000 was "basically . . . seed money", and he said that Regier wrote the $25 000 cheque, probably at Brost's direction. Arbour repaid IFFL the
$25 000.
A 12 March 2004 news release announced that Arbour proposed to raise at least
$2 million in a private placement of common shares priced at $1 per share. A draft letter to prospective investors dated 16 March 2004 and referenced "Common Share Subscription Agreement" thanked recipients for their "consideration in participation in Arbour's common share placement", enclosed among other documents the subscription agreement, and requested return of the completed subscription agreement as soon as possible. A 16 March 2004 note on this draft letter from Strashok to Skeith queried whether Arbour or "Milo's group" was conducting this common share placement.
By March 2004 Brost's fundraising efforts for Arbour from IFFL members were under way. A 19 March 2004 email from Strashok to Skeith noted that some of Brost's investors –"some investors of [M]ilos [sic]" – were wondering why there was no offering memorandum.
A 22 March 2004 email from Strashok to Gary Strashok, Gardner, Monar, Skeith and Weis advised that he had "asked Brost to explain the financing and eventual plan more fully to you all", suggesting a meeting at Brost's Calgary "offices" on 7, 8 or 9 April 2004. In the same email, Strashok indicated that Brost "says he has about $3.8 m[illion] in subscriptions returned" for Arbour.
A 30 April 2004 statement of account from Skeith to Arbour (the "April 2004 Skeith Account") referenced Skeith's involvement, primarily with Brost and Strashok, in providing legal services in respect of this common share placement.
Skeith attended meetings on 8 and 9 April 2004 – the April 2004 Skeith Account included a time entry for a meeting on 8 April with "Milo and directors" and for a meeting on 9 April with Strashok, Brost and Sorenson "re: directors, exchange, etc". Skeith testified to
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Sorenson being "involved at the early stage and then not so much later on" in what Staff termed Arbour's "reorganization and recapitalization group"; Skeith elaborated that by 14 July 2004 Sorenson "was no longer an active participant". Skeith also testified to Sorenson's attendance at a meeting of that group in spring 2004, and, when referred to the April 2004 Skeith Account, surmised that meeting was the noted 9 April meeting. When further questioned, Skeith admitted to having no specific recollection of Sorenson's attendance at a meeting on 8 or 9 April 2004. Sorenson denied his participation in the 9 April 2004 meeting – he produced his wife's passport and a travel itinerary to demonstrate that he was in Hawaii with his family on 9 April 2004, and he also denied any telephoned participation.
We do not find this denial by Sorenson credible. Rather, we think it more likely than not
and therefore find – that Sorenson did attend the 9 April 2004 meeting, whether in person or by telephone. In so finding, we note that the April 2004 Skeith Account was prepared by someone with no motive to be untruthful about any of its entries. We also note that the April 2004 Skeith Account – indicating Sorenson's participation in the 9 April meeting – was prepared and sent to Arbour very close in time (30 April) to that meeting. We further note that, while the April 2004 Skeith Account, which covers services rendered from 6 August 2003 to and including 28 April 2004, contains numerous references to other individuals (including Brost) the 9 April 2004 reference is the only one mentioning Sorenson; we think it no mistake that Sorenson is referenced on that date. Finally, we note that travel itineraries are often and easily changed, and that the itinerary and passport entered in evidence prove only that Sorenson's wife was in Hawaii during the period indicated.
In March and April 2004 Skeith was sending material to Brost (who had no official position with Arbour) and Strashok for their review, including letters from the Exchange. On 22 April 2004 Skeith drafted a letter to the Exchange, which was faxed to Brost for his review. (Skeith believed that he also emailed this draft letter to Strashok.) In this draft letter Skeith set out details in relation to a proposed private placement of Arbour shares at $1 per share. Skeith advised the Exchange that 80% of the money raised would be placed on deposit with (a misspelled) Grovenor Trust (according to Skeith, "a company that Milowe had suggested would be holding money or investments or whatever", with which company Skeith was unfamiliar) for no less than one year and no more than 10 years, with the balance of the money being available for Arbour's use "in pursuing its oil and gas business". Details about Grovenor Trust, including identification of its trustee, beneficiaries and business, were left blank. However, as noted above, it was apparently an entity owned, controlled or operated by Kendall and Houston out of Belize. Skeith also advised: "The financial planners who are placing the funds on behalf of Arbour Energy in return for a 2% commission were introduced to Arbour through [Strashok]'s connection [details to come]. The financial planners are all at arm's length with Arbour." Skeith clarified in his testimony that the referenced "financial planners" were Brost's "fundraising people".
Skeith had no independent recollection concerning his handwritten notes from his Arbour file referring to "Dorlan Trust Services Ltd." in Belize City. A 13 May 2004 letter from Hoffman to Sorenson (the "13 May 2004 Letter") referred to a potential interaction between Arbour and a Belize corporation called "Dorlan Trust Services". Hoffman testified that Sorenson wanted to buy Dorlan "and put everything Milowe was doing and [SGD] and everything that was
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surrounding the companies inside the trust company [Dorlan]". Further, according to Hoffman, the conversations he had with Sorenson and Brost at the time indicated Arbour was to be included "in this as a way of legitimizing the sales process that they had ongoing and the investment . . . that [SGD] had in Merendon, as well as . . . the people that had given money to Milowe, Steve and Chris for -- that ultimately flowed to SGD, that ultimately flowed to Merendon". Hoffman continued:
. . . Milowe owned or Milowe was the lead force behind Arbour Energy. Gary was involved in Arbour from a standpoint of, there was an asset that Gary had that he was selling to Arbour, and then the money was going to flow to Merendon Canada or Merendon Honduras or combinations thereof.
Hoffman stated in the 13 May 2004 Letter that "Arbor [sic] Energy will solicit investors to purchase a security (preferred share or something similar) with registered funds" –information, Hoffman told us, that was given to him by Sorenson. Hoffman also stated in the 13 May 2004 Letter that all Brost's salespeople "could possibly now be selling legally when working for Arbor [sic] (this point I need to review in detail with legal counsel)".
The 13 May 2004 Letter also contained Hoffman's suggestion for improving accountability between Merendon and SGD. Hoffman explained during his testimony:
. . . SGD never had a bank account anywhere. It was incorporated in Nassau. It had no assets, it had no bank accounts. The funds coming into Merendon were either delivered to Merendon Canada, wired to [Adair], sent to Merendon Honduras directly or combinations thereof. None of it went through a bank account that SGD owned, which was one of -- one of the things that I disagreed with.
There was no way to complete an audit trail because [Sorenson] would never give anybody in [SGD] access to Merendon's books to see exactly where the money was going after it came in.
When funds were required to be sent to an investor of [SGD], a request was made to [Sorenson]. He would approve it, the funds were transferred over to an account that one of the individuals . . . assigned to [SGD] then could transfer or send a lump sum out.
So the reference [in the 13 May 2004 Letter] of maintaining the flow for everyone from client to Merendon and back would be funds coming to Merendon from the client to Merendon and then going back to the investor when they requested funds back.
Hoffman testified that Sorenson ultimately purchased Dorlan, but that payment for the purchase came to Hoffman from Adair's trust account so Hoffman was not certain whether Sorenson bought Dorlan personally or through Merendon or another corporation.
In a 22 October 2004 excerpt from the Hoffman Tapes, Sorenson confirmed to Hoffman that "we're buying" Dorlan and changing its name to "Evergreen Trust [which] is really going to own 100% of SGD". Sorenson also confirmed that "Evergreen is going to operate SGD with all of the old contracts". Hoffman testified that he believed the referenced "old contracts" were "contracts that were signed between individuals and SGD".
In a 5 March 2005 excerpt from the Hoffman Tapes, Sorenson reiterated to Hoffman that "Dorlan . . . is going to be renamed Evergreen". Sorenson also stated that "Evergreen Trust
Services Limited will own 100% of a company called Base Metals" and that "Base Metals will own 100% of SGD". Hoffman acknowledged that he had no information indicating that these apparently future plans ever materialized.
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A 9 September 2004 Arbour news release declared that Arbour was "in the final stages of completing the previously announced private placement" of 2 142 023 common shares at a price of $1 per share. A Report of Exempt Distribution ("Distribution Report") filed by Morice reported the distribution on 31 October 2004 of 2 142 023 Arbour common shares at a price of
$1 per share, with all sales made in reliance on the accredited investor exemption. In the Morice Interview, Morice said that: he did not know how it was ensured that the purchasers were accredited investors; he did not do any work to ensure that they were accredited; the information came through IFFL, which told him that the purchasers were accredited; and Morice made no further inquiries.
Another Distribution Report reported the distribution on 31 October 2004 of 6 million Arbour common shares at a price of $0.05 per share – 1.2 million and 4.8 million Arbour common shares acquired by Morice and Weis, respectively, in reliance on the accredited investor exemption. In the Morice Interview, Morice explained that the $300 000 provided by Weis to Arbour "went in under an option to convert to 6 million shares" and part of Morice's "agreement going into Arbour" was that he would acquire 1.2 million of those 6 million shares.
On 31 May 2004 Arbour entered into a preliminary agreement with Crazy Hill Resources Ltd. ("Crazy Hill") to acquire a producing oil and gas property near Drayton Valley, Alberta. The agreed purchase price was $1 million, consisting of $350 000 and 650 000 Arbour common shares at $1 per share. In a 9 September 2004 news release, Arbour announced that the closing on the Crazy Hill asset purchase was scheduled for 30 September 2004. The Management's Discussion & Analysis ("MD&A") for Arbour's year ended 31 December 2004 ("Arbour's 2004 MD&A"), which was dated 18 May 2005 and filed on SEDAR, indicated that the Crazy Hill acquisition closed on 1 November 2004.
Strashok said that he believed Brost had negotiated the Crazy Hill acquisition, and then Strashok and Morice were told "this is going to be the deal". Morice said that he negotiated the acquisition with Allen Vogel ("Vogel"), the principal of Crazy Hill. Interestingly, Vogel was, or had been, a director of Merendon. Negotiations were lengthy, carrying on throughout the summer of 2004. We suspect that the Crazy Hill acquisition was negotiated by both Brost and Morice, with Morice entering the negotiations at a later stage, although such a finding is not necessary given the allegations we are deciding.
In 2006 Arbour sold the Crazy Hill property back to Crazy Hill (Vogel). We were given two alternate explanations for the sale. Morice explained that Arbour had received the revenue for the period it had the property, but there had been some decline and it did not get the deep hole rights it had wanted. In the result, Arbour's management decided to sell the property back to Vogel for the same price and effectively end the relationship. Gleason's version was that Crazy Hill (Vogel) was interested in buying the "Drayton Valley well properties" back from Arbour, and Vogel contacted Merendon "for some possible funding" to make the acquisition.
Merendon agreed to "finance the transaction and use this as an opportunity" to reduce – by
$850 000 – Arbour's indebtedness to Merendon on the COREL transaction.
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A Purchase and Sale Agreement made effective 1 May 2006 documented Arbour's sale of the Crazy Hill property back to Crazy Hill for $1 million. The sale actually closed on 11 October 2006. That day Merendon provided Skeith with a cheque in the amount of
$850 159.40 ($1 million less adjustments) representing Crazy Hill's purchase money, after which (Arbour having assigned the sale proceeds to Merendon) Skeith provided Merendon with a cheque in the same amount. In a 13 October 2006 letter Gleason confirmed to Morice that the
$850 159.40 had been received and would be applied to reduce Arbour's approximate
$1.1 million indebtedness to Merendon on the COREL transaction, leaving a balance of
$345 860 owing by Arbour.
Gleason had no explanation as to why Arbour had sold a producing asset – the Crazy Hill property – to retire a portion of $1.1 million owing from it on the COREL transaction instead of retiring the entire $1.1 million by offsetting it against the $38 million it had already advanced to Merendon (detailed below).
Gleason advised that, after Arbour's sale of the Crazy Hill property back to Crazy Hill, a joint operating agreement to operate the wells was entered into between Sorenco and Crazy Hill, with Crazy Hill having a 5% interest and Sorenco having a 95% interest.
A 31 May 2004 statement of account from Skeith to Arbour included this 29 April 2004 entry: "Telephone calls from Milo, Gary Sorenson; review of TSX-V policies re: new proposal". We find, consistent with Sorenson's testimony about talking with Skeith, that the noted call from Sorenson pertained to Arbour's pursuit of an interest in TRL involving the loaning of money to Merendon.
Skeith received a 3 May 2004 fax from Sorenson attaching a draft letter of intent (the "Draft Letter of Intent") directed to the attention of Strashok, detailing a proposal whereby Arbour would lend $10 million to Merendon on or before 15 June 2004 for a maximum of 10 years at an interest rate of 3.5% per annum. (A $10 million loan (the "10 Million Loan") was eventually made, with the funds advanced by Arbour to Merendon between 27 July and 8 December 2004.) The proposed terms also provided that Arbour could convert the loan proceeds plus interest (in addition to 5 million Arbour common shares) into "5% of the Oil Sands Recovery Patent in common shares of the Corporation holding the patent" – in other words, a 5% stake in TRL, partly owned by Merendon. The Draft Letter of Intent referenced and appended a "Tarsands Project Overview" mentioning ARC's "very detailed testing and evaluation" of the TRL technology – which, we note, was not informative but rather nonsensical – and "a general historical overview" of Merendon detailing its North, Central and South American properties. Arbour was to accept the Draft Letter of Intent no later than 15 May 2004. On 4 May 2004 Skeith emailed to Sorenson a revised form of the Draft Letter of Intent. In this email to Sorenson, Skeith wrote that he thought the Exchange would "want some idea of the financial strength of Merendon". Skeith also wrote: "I have traded calls with Milo, but don't know what e-mail to send this to for him. Please forward it on to him." Skeith did not know whether
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Sorenson had forwarded this email to Brost. Skeith testified that he was intending to send the revised form of the Draft Letter of Intent to Brost because Brost "was involved in these discussions", and Skeith agreed that Brost would be generating the money. Sorenson testified that he did not forward Skeith's email to Brost and that he did not know why Skeith was mentioning Brost – "It had nothing to do with the transaction."
In a 6 May 2004 letter, Skeith advised the Exchange that Arbour had "reviewed its proposed arrangement with the trust company that was going to hold their [offshore] assets", had "refined their plan" and wished to enter into the attached letter of intent (a revised form of the Draft Letter of Intent) with Merendon. Skeith also advised: "Merendon is currently a shareholder of Arbour, and [Strashok] does sit on the board of Merendon." Skeith further advised that "$6 million is currently available to [Arbour] at this time" – a reference, we find, to money raised by Brost (and his organization IFFL), as Brost was the only one raising money for Arbour at the time. Skeith included with this letter Merendon's 30 September 2003 and 31 December 2002 consolidated, and apparently unaudited, financial statements (the "2003 Merendon Financial Statements").
Sorenson had sent the 2003 Merendon Financial Statements to Skeith in response to Skeith's comment about the Exchange likely wanting information about Merendon's financial strength. The cover letter to the 2003 Merendon Financial Statements, entitled "Notice to Management", indicated that they were prepared by "Sig-Ney Consultants Ltd.". While this could, perhaps, suggest an independent accounting, the cover letter was signed by "Jack R. Wolfe, Registered Public Accountant", who, as noted, was Merendon's controller at the time.
The 2003 Merendon Financial Statements stated that as at 30 September 2003: the assets of Merendon were some US$1.1 billion, of which slightly more than $1 billion was attributed to "Delineated Reserves"; and its liabilities were some US$1.1 billion, of which slightly more than
$1 billion was attributed to "Revaluation Surplus". As at 30 September 2003, its income was stated to be US$474 332 – sourced from "Gold Sales" (US$288 322) and "Jewelry Sales" (US$186 000) – and its deficit was stated to be US$9 765 319. Notes to the 2003 Merendon Financial Statements stated under "Summary of Significant Accounting Polices":
The carrying values of the mineral properties and deferred exploration costs represent accumulated costs and are not intended to reflect present or future values. The recoverability of the amounts is dependent upon the confirmation of economically recoverable reserves, the ability of the Company to obtain the necessary financing to successfully complete their development and upon future profitable production.
According to Morice, it was Brost who suggested that Arbour lend to Merendon the IFFL money already raised for Arbour. Morice explained that, at the time, Arbour was aware of the oil sands technology interests Merendon had, which were of interest to Arbour, but Merendon said Arbour could not afford to buy those interests, which were "too valuable" – apparently, given the proposed terms in the Draft Letter of Intent, Merendon's interests in TRL were worth approximately $75 million (with the TRL enterprise apparently being valued at approximately
$300 million).
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Weis said in the Weis Interview that one of the reasons for investing in Arbour was to possibly use it as a vehicle to take over Merendon's 25% interest in TRL. According to Weis, Sorenson said that "he might divest himself of" his 25% interest in TRL. Weis said that he believed the oil sands investment was a great opportunity, and that Arbour was the vehicle to take over that interest "[a]nd make something out of it". It appears that the sale of Merendon's interest in TRL to Arbour was being contemplated at the time of Arbour's resurrection. We so find.
In the Brost Interview, Brost disclaimed any involvement in setting up the $10 Million Loan between Arbour and Merendon, but admitted he had suggested to Morice that Merendon might be interested in a loan:
Q Were you involved in any discussions in which the loan agreement or the terms of the loan agreement were discussed?
A Yes and no. Yes, that a loan agreement could be accomplished. Yes, what might that look like for Arbour. No, I don't remember discussions with Gary or Merendon as to what that loan would look like from their side, and no, I was not involved in helping prepare or close on that loan agreement.
Q So on the side of Arbour Energy, you had some discussions about the terms of the loan agreement; is that correct?
A More -- not so much the terms of the loan agreement, but that a loan relationship could be
-- I think that Merendon would be interested in entertaining it, not -- not so much the terms; I don't remember the terms.
Q Can you just elaborate on what the discussions were regarding the loan relationship?
A I had reason to believe that Merendon would be interested in having a lender/debtor relationship with Arbour. From that point, [Morice] pursued that and had his own meetings with Merendon and established how much and what the terms would be and what the rates would be, what the payment terms would be, et cetera. I wasn't involved in that process at all.
Q So you had reason to believe they'd be interested in a lender/debtor relationship. Why did you have reason to believe they'd be interested?
A I know that Merendon is involved in developing many of its projects. I'm also aware that in the mining industry, it takes an awful lot of money to develop mining projects and that if money could be made available in a reasonable fashion, that additional money being available to have Merendon develop its interests would be a good thing.
. . .
Q So you are confirming that you gave a positive impression to [Morice] on --
A. The concept, yes, I would've.
Q The concept of loaning money to --A Yes, I would.
Q -- Merendon. Did you mention any risks of loaning money to Merendon to[Morice]? A Not my place.
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Brost characterized the $10 Million Loan as "a means to an end"; he acknowledged discussing this "as a point of strategy how could [Morice] best posture himself to take up the opportunity with COREL" given that at the time COREL's owners were not interested in selling "their project". Brost elaborated that Merendon was a minority shareholder in the COREL project and described COREL as:
The COREL project, which is proprietary technology for the separation of heavy oil sands and removing the residual oil, which provides both production and an environmental clean-up, is something that Merendon had an interest in and was rapidly becoming a very viable and potentially profitable marketplace. [Morice] and my discussions centred around if one was going to try to acquire COREL, what would be the best way to go about it. Discussion that I had had about the project with the project owners is that they were not interested in selling their project, given what -- what they believed the potential would be.
Sorenson had a slightly different version. First, he testified that the only person with whom he negotiated the Draft Letter of Intent was Morice. Second, Sorenson claimed that Morice, who was in Honduras visiting Brost at the time, came to Sorenson's office to discuss Arbour's interest in purchasing an interest in TRL. Sorenson, who did not think that Arbour had the money to do so, told Morice to come back and see him when Arbour could raise the money. According to Sorenson, Morice then said that he thought Arbour had the money and that they should "look at the ramifications of entering into a letter of intent". Third, Sorenson said Morice suggested to him that they structure the purchase as a loan because Morice would then not have to disclose it to regulatory authorities. Sorenson further said that he discussed this structuring with Skeith, who indicated that Morice's suggestion was correct. Fourth, Sorenson testified that he sent the Draft Letter of Intent to Skeith. Sorenson said that, although he had negotiated with Morice, he addressed it to Strashok because Morice, who had said he was becoming the president of Arbour, had yet to assume that position.
Weis confirmed a meeting in Honduras, although the timing and circumstances he referred to were different, including Weis's contention that it was part of the negotiation process (rather than the start of it) and that Weis was also at the meeting (not only Sorenson and Morice). At some point during the negotiation of the Draft Letter of Intent, Morice and Weis travelled to Honduras to meet with Sorenson – according to Weis, he and Morice "wanted ourselves to satisfy that Merendon has the ability and to do a $10 million loan; and TRL might be worth, 5 percent might be worth $10 million", so they inspected Merendon's plants in Honduras and "looked at some mining reports and engineering reports" and "some financial statements, basically a review of the [sic] Merendon, and first time we met the other people in TRL, the other shareholders".
Morice confirmed that he had seen Merendon's internal financial statements at the time Arbour entered into the verbal deal with Merendon, which showed assets of over $1 billion, based on the value of its mining ventures. (These would appear to have been the 2003 Merendon Financial Statements, which also showed liabilities of over $1 billion.) Morice recalled that the financial statements he reviewed showed that Merendon did not have any significant income
being produced from those assets. Morice said that he was not concerned because the income statement did not show gold sales not yet made, and he had seen what he believed was about
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$1 million worth of gold in Merendon's vault in Tegucigalpa. Morice's evidence does not accord with the 2003 Merendon Financial Statements, which showed income from gold and jewellery sales of US$474 332 before expenses.
There was conflicting evidence as to how the negotiation of the Draft Letter of Intent unfolded. There was clear evidence of Sorenson being involved, on behalf of Merendon, throughout the negotiation process. There was evidence from Skeith and Morice indicating involvement by Brost early in the process – indeed, Brost's evidence suggested he was the impetus. There was also evidence indicating involvement in the process by Strashok and then Morice (and perhaps Weis) on behalf of Arbour. Notwithstanding any evidence to the contrary, we find that Brost for all intents and purposes instructed Morice that Arbour was to lend money to Merendon, while indicating to Morice that Merendon would be amenable to having Arbour do so. The Draft Letter of Intent was negotiated, we find, between Brost and Sorenson – it could not have been otherwise because in early May 2004 the then-existing Arbour directors were not actively involved in making decisions for Arbour and the involvement of Morice (and Weis, to the extent he was involved) was as individuals being recruited by Brost to be Arbour directors. And, as we detail below, the negotiated terms of the Draft Letter of Intent continued into the agreement as finalized.
In early 2004 Morice was being recruited by Brost and Weis to become a director and the president of Arbour. A certified general accountant, Morice had previously acted as a consultant preparing tax returns for IFFL members, knew Weis through accounting circles, and knew Brost through their mutual association with Bellringer in the 1990s.
Brost stated that he contacted Morice to see whether Morice was interested in becoming an officer or director "of a public corporation, of which Arbour Energy was one candidate". According to Morice, he and Brost met to discuss the possibility of Morice becoming president of Arbour, at which meeting Brost "was fully confident that we could raise an amount of money" using an offering memorandum; Brost indicated that Arbour would get investors "through the network", which Morice understood to be IFFL. Morice also understood that IFFL was a "membership-type organization" and that its members had originally invested in gold-related ventures, with Merendon as the investment vehicle for that activity, but had decided to branch out and invest in oil and gas ventures and Arbour had been chosen as the investment vehicle for that venture. Morice found this an attractive proposition because:
. . . the money was discussed to be raised before we had the deals, and that's what everybody dreams about. Normally, in my past dealings, we have good deals, and then we have to figure out how to get the money to get them off the ground. This was the other way around, so I liked that opportunity.
According to Morice, Brost told Morice that "the group was looking for a suitable candidate"; then he introduced Morice to Weis and Strashok, "and discussions progressed from there". Morice said that Weis ultimately hired him. Skeith also understood that Brost "and/or"
Weis – neither of whom was an Arbour director at the time – brought Morice in to be the president and a director of Arbour.
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By the time Morice was brought into Arbour, fundraising for Arbour from IFFL members was already under way, as were plans for Arbour to loan the investor money to an offshore entity. According to Morice, Brost and to some extent Weis "laid out what was in progress", and Brost explained "the initial strategy": first, IFFL members were interested in making qualified –generally RRSP eligible – investments; second, the qualified investments would be in Arbour; and, third, the investor money would be "parked" offshore short-term but would be available to Arbour "to make . . . deals that would allow Arbour to be a solid vibrant oil and gas company". Morice understood that a $2 billion offshore organization was "backstopping Arbour to go get some valuable oil and gas properties" – that was the "commitment" made to him when he "joined" Arbour. Morice said that he, Brost and Weis were involved in the decision to raise money through the sale of Arbour Preferred Shares to IFFL members, and Morice worked with Skeith to prepare any offering memoranda.
Originally Brost told Morice that the IFFL money invested in Arbour would be deposited short-term with an offshore entity called Evergreen Trust that was to be formed out of Belize. For reasons unknown to Morice, Evergreen Trust could not be used and Brost decided to lend the Arbour money to Merendon, which according to Morice, "had a structure of moving money internationally".
Skeith thought that Morice became involved in Arbour in May 2004 "on a consultive [sic] basis or potential director basis". A 20 May 2004 letter from Skeith to the Exchange advised the Exchange that Arbour was proposing to appoint Morice and Weis as directors. A 31 May 2004 letter on "Arbour Resources Inc." letterhead to Skeith from Morice as "Consultant" indicated that Morice was familiar with a number of oil and gas transactions Arbour was undertaking at that time (despite the slight differences in name and address on that document, we find this referred to Arbour).
On 11 June 2004 Morice and Weis were appointed as directors to the Arbour board of directors, as announced in a news release of that date. Morice was also appointed Arbour's President and Secretary on 11 June 2004, and he became its CEO and CFO on 9 September 2004. Contemporaneously with the appointments of Morice and Weis as Arbour directors, Arbour directors Monar, Gardner and Gary Strashok resigned their Arbour directorships. These appointments and resignations were part of Arbour's reorganization and change of control. The remaining original director, Strashok, agreed to remain on the Arbour board of directors for a short time. Strashok apparently had no interest in staying on with Arbour after its reorganization and change of control and had no significant role with Arbour during that period, other than allowing his name to continue as a director.
The evidence is clear that Brost was actively involved in recruiting and appointing both Weis and Morice as directors of Arbour and Morice as its president. We also find that Weis and Morice were Brost's nominees, placed on the Arbour board of directors to follow his instructions. We so find.
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An Arbour news release dated 9 September 2004 stated that Strashok "has resigned, having fulfilled his commitment to stay on through [Arbour's] reorganization", although Strashok told Skeith that Strashok resigned effective 12 August 2004. In his place, Wigmore – a long-time friend and business associate of Sorenson, former president of Stone Mountain, and a former director (until his resignation in March 2004 at the behest of Sorenson) and the president of Merendon until November 2003 – was appointed to the Arbour board of directors. Wigmore said that either Morice or Weis had contacted him to see if he was interested in becoming a director of Arbour. Weis stated that he recruited Wigmore, having met Wigmore through Sorenson. In the Wigmore Interview, Wigmore stated he had known Brost for 5 to 7 years "mostly from a distance", meeting him at Merendon functions, such as board meetings and dinners after board meetings, but had "never spent a lot of time with him". Skeith believed Brost "had a say in" the appointment of the three new Arbour directors – Morice, Wigmore and Weis. Blaikie believed that Wigmore was within "Sorenson's sphere of influence" and not affiliated with Brost or his associates Elizabeth Brost, Casey Brost or Regier.
We think it no coincidence that Wigmore, a long-time Sorenson associate, was appointed as a director of Arbour. We also think it reasonable to infer from all the facts and circumstances that – given Wigmore's close connection to Sorenson and relative lack of connection to Brost –Sorenson was significantly involved in the decision to appoint Wigmore as a director of Arbour. We find that Wigmore was Sorenson's nominee on the Arbour board of directors.
Notwithstanding that neither Brost nor Sorenson held any official position with Arbour, both exercised influence over actions taken by Arbour. We now consider the roles of Brost and Sorenson in Arbour.
In a 19 October 2004 Hoffman Tape, Sorenson discussed Arbour and Brost with Hoffman and referred to a conversation he had with "Larry" (identified by Hoffman as Adair):
. . . I was under the impression, this is Larry still talking[,] that the reason that Milowe was forming Arbour Energy was that this was going to legitimize his solicitation of funds because he can sell preferred shares in a public company and his representatives or strategists or whatever can sell preferred shares in--in a public company convertible to common shares, not being a registered securities dealer as long as they file an offering memorandum . . . .
Skeith stated that he would describe Brost as Arbour's controlling mind at the beginning of 2004; however, in the middle and towards the end of 2004, Skeith was told to talk to Morice and that Brost "would be looking to [Morice] for business decisions".
In the Strashok Interview, Strashok described Brost's role after summer 2004 as "the money raiser".
Hoffman testified that Brost spoke of Arbour as being Brost's company. Hoffman agreed that Brost "seemed to have ongoing involvement with Arbour and . . . purported to have an understanding of its affairs". However, Hoffman acknowledged that he did not know who set up Arbour, nor what Brost's or Sorenson's involvement in that would have been. Hoffman also
stated that he did not know why Arbour was set up or if Sorenson had any involvement with Arbour.
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Morice in the Morice Interview described Brost and Sorenson as the "key players" and that although not certain, he believed that the idea for Arbour came from them.
Wigmore stated in the Wigmore Interview that he was not aware of Sorenson having any role in setting up Arbour. Wigmore characterized Brost as "involved in raising money for [SGD, which was] one of the companies that financed Merendon". In contrast to much of the evidence before us, Wigmore stated that Brost was "not part of any decisions [for Arbour]. He's never attended a board meeting. As far as I know, he does not own any shares in Arbour", although the Arbour board of directors "has met with him, at one time, to look at investment opportunity". Given the entirety of the evidence before us, we do not accept Wigmore's evidence on this latter point.
Regier became involved with IFFL in 2003 and with Expedia in 2004. These positions led him to some interaction and involvement with Arbour and its affairs. He agreed with the characterization of Brost as Arbour's head and Weis as the adviser. Regier testified that Morice made Arbour's decisions "[o]perationally" in the 2004 to 2006 period and that "Brost also provided [Morice] with some guidance . . . with regards to the purchase of certain assets". As for Sorenson, Regier stated that he understood Brost and Sorenson to be "like the kingpins . . . at the top of the ladder", with Morice falling "more under [Brost's] . . . line of authority". Regier also confirmed his opinion that Sorenson was aware of what Brost was doing with Arbour's funds, but that Morice did not know "what Merendon may have been doing with the funds".
Despite some inconsistencies in the evidence, we are satisfied from the evidence as a whole that Brost was principally responsible for resurrecting Arbour and exerted significant control over Arbour affairs certainly in its early stages and in all major decisions involving Arbour, its fundraising and its use of money raised by Brost and IFFL. We so find.
The evidence as a whole is less clear about Sorenson's involvement, but we believe – and find – that he played a role, albeit minimal, in Arbour's resurrection and restructuring, and that he was always in the background, prepared to exert his influence with respect to any decisions that could affect the movement of money to Merendon. We think it no coincidence that, immediately after Sorenson failed in his bid for Arbour, Brost, "out of the blue" pursued Arbour as the RRSP-eligible investment vehicle for IFFL members. We think it no coincidence that Wigmore, a known Sorenson associate with relatively little connection to Brost, was appointed a director of Arbour. We think it no coincidence that Sorenson knew Arbour (out of all potential lenders) would be receptive to lending Merendon $10 million, although Arbour had not yet raised any funds. We think it no coincidence that substantial Arbour money was lent to Merendon on the strength of the apparently unaudited 2003 Merendon Financial Statements (which showed large unproven reserves). We think it no coincidence that technology with no proven commercial viability was purchased from Merendon with neither security nor a formal, binding agreement.
By the summer of 2004 Brost's people had infiltrated Arbour.
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Immediately following the appointment of Morice and Weis as Arbour directors, Arbour relocated from premises provided by Strashok (through Sorenson) to premises leased from Expedia. This was the same office space as Strategic and IFFL. In approximately November or December 2005, Arbour moved another time, again leasing from Expedia.
Morice – Brost's hand-picked candidate – was Arbour's president. Carol Weeks – a known Brost associate – was, according to Skeith's Arbour file dealing with Skeith's office on behalf of Arbour, including some involvement in "filings, AIF, etc." and share certificates. Dwayne Martyn, a known Brost associate and IFFL structurist, also did some work for Arbour.
It appears that Morice was operating Arbour essentially on his own, with Hobbs, a Brost associate from at least the mid-1990s, at some point joining Arbour as a consultant assisting with Arbour's financial matters. In August 2005 Hobbs was appointed Arbour's CFO. Various other people appear in time records from Skeith's Arbour file, indicating their involvement, but apparently to a minimal degree.
This is consistent with evidence from Regier, who testified that, in addition to Morice and Hobbs, he only observed one or two other Arbour employees. Regier confirmed that he did not notice operations or technical people at Arbour, such as would typically be associated with a company engaged in oil and gas activities.
Expedia also provided Arbour's office administrative and reception services, as well as investor relations services. Morice confirmed that Expedia's investor relations activities did not involve assistance with any of Arbour's fundraising activities or soliciting investors; rather its assistance was limited to answering telephone inquiries from investors and processing investor subscription agreements as they came into Arbour.
Arbour had an oral agreement to pay Expedia 1% of the money raised under the offering memoranda for the administrative and investor relations services it provided to Arbour. Morice explained why that arrangement was verbal:
And, you know, that was -- like, we didn't know how much money would come in at that time, so it was always -- the reason [the contract between Arbour and Expedia] was oral is that we understood we would have to revisit that depending on the amount of service and the amount of money raised, and at the end of the day we felt it was reasonable service. And if you want support for any of the people that worked there and how much they should have been paid and that, it would be good value for what we actually paid.
In 2005 Arbour paid Expedia approximately $257 000 for these services.
As discussed earlier, the sole shareholder and director of Expedia was Verbeem, Brost's stepson. Morice explained that Brost had made the arrangements with Expedia before Morice was hired, so that the Arbour and Expedia relationship "was basically set up" by the time Morice
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got to Arbour. Regier performed accounting services for Expedia for approximately two years –from approximately early 2004. During Regier's time at Expedia, Brost conducted all of Regier's performance reviews. Regier said that Expedia was "indirectly" controlled by Brost and confirmed that Brost had arranged for Arbour to retain Expedia to provide administrative services to it. One of the investor witnesses, who also had been hired by Brost to work at Expedia, said that Expedia "was the work company for the IFFL".
We conclude that is reasonable to infer from these facts that Brost was responsible for retaining Expedia (controlled by Brost) to provide administrative services to Arbour, for which services Expedia (and, indirectly, Brost and his associates) received handsome compensation. Brost exerted this control despite not being an employee, officer or director of Arbour. We also conclude that Brost wanted the arrangement between Arbour and Expedia to be verbal. We so find.
Effective 17 June 2004 the Exchange suspended Arbour common shares from trading on the Exchange pending the Exchange's review of certain of Arbour's financial transactions and agreements for compliance with Exchange requirements.
Effective 21 July 2004 Arbour common shares were, as requested by Arbour, de-listed from the Exchange. The evidence suggests that Arbour requested that de-listing to avoid having to answer questions being asked of it by the Exchange. Arbour common shares then continued to trade on the CNQ.
In the summer of 2003 and approximately one year before Arbour's first advance of money to Merendon, Monkman introduced Sorenson to the TRL technology, which was apparently an additive that removed bitumen from oil sands. Monkman gave Sorenson a demonstration of the TRL product in his Calgary office. Sorenson, with his basic knowledge of oil sands activity in Athabasca, said he was very impressed. At the time, TRL had yet to be incorporated. Sorenson testified that Monkman, Page and McIntyre planned to incorporate TRL (and COREL) with Merendon and the three companies controlled by Monkman, Page and McIntyre each becoming a 25% shareholder of TRL. We find that Sorenson was also involved in that decision and in instructing Strashok to incorporate those entities. On 14 August 2003, Merendon subscribed for and agreed to purchase one million TRL Class A common shares ("TRL Shares") for an aggregate price of $100, which was 25% of the issued and outstanding TRL Shares.
Monkman advised Sorenson that he and Page had contracted with ARC to perform a study on the TRL product. Sorenson said that a confidentiality agreement prevented him from talking to ARC about the ARC study until it was completed.
COREL – which, as noted, was planned by the four TRL parties at approximately the same time – was to be the licensed entity for TRL. COREL's principal asset was its license to sell the TRL technology in a specific territory. Merendon paid $52 for its shares in COREL.
Sorenson, on behalf of Merendon, agreed to fund the costs – estimated to be between
$500 000 and $1 million – of a prototype plant in Medicine Hat. According to Sorenson, that is how Merendon was to "earn our 52 percent".
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Regier agreed that Sorenson and Brost – who were both "very, very keen on this technology" – had "touted" it to him "as being very valuable". Regier believed in the TRL technology.
Following the Draft Letter of Intent, a letter of intent ( the "Letter of Intent") was signed by Sorenson – dated 5 July 2004 – and Morice – dated 9 July 2004. Putting this in context with other events at Arbour, the first offering memorandum (detailed later in these reasons) was dated 14 July 2004, mere days after the Letter of Intent was signed by both parties.
Sorenson said that Morice returned to Honduras around this time, which was when Sorenson gave Morice the Letter of Intent signed by Sorenson. According to Sorenson, Morice would not sign the Letter of Intent until he returned to Calgary and discussed it with Skeith. While Morice did not dispute signing the Letter of Intent, he said that he first met Sorenson "formally" regarding the plan for Arbour to loan money to Merendon at the Calgary Stampede in 2004, which would have been around the time the Letter of Intent is dated. Morice did not mention that he had received the Letter of Intent from Sorenson in Honduras. Morice did note that "it was obvious [at the time he met Sorenson about the loan] that Milowe and Gary had a very integrated business relationship and kind of worked as a team it seemed to me".
The Letter of Intent, which was to form the basis for a formal agreement between the parties, provided for Arbour to lend Merendon $10 million – described as a "funding loan". The
$10 Million Loan was to bear interest at a rate of 3.5% the first year, escalating by 0.05% per year after the first year and was to have a term of 10 years. Pursuant to the terms of the Letter of Intent, Arbour had until 15 October 2004 to provide Merendon with at least $1 million, and the remaining $9 million was to be paid to Merendon by no later than 31 December 2004. The Letter of Intent provided a brief description of Merendon, some its subsidiaries and their activities.
The Letter of Intent also provided Arbour with the option to purchase 5% of the "Oil Sands Recovery Patent in common shares of the Corporation holding the patent" (presumably referring to TRL) in exchange for the principal balance of the loan plus accrued interest, if any, and the issuance of 5 million Arbour common shares. Therefore, this option valued 5% of TRL at $10 million (plus accrued interest), plus the value of 5 million Arbour common shares –although Merendon had paid $100 for 25% of TRL approximately one year earlier. In the Morice Interview, Morice stated that Arbour wanted to see a report from ARC before putting a value of $10 million on 5% of the TRL technology (we note he did not do so). If the option were exercised, all voting rights attaching to the TRL Shares would remain with Merendon "for the life of the license and the patent".
The Letter of Intent also provided "a general overview of the Alberta Tarsands Project in which Merendon has a significant interest and in which Arbour has indicated it would like to
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. . . It was estimated in reporting that 1% (percentage) point increase in the industry by the process translated too [sic] $1.000,000,000 [sic] to the project bottom line profits.
. . . The Government of Alberta currently states revenues from royalties at $8,000,000,000 . . . .
Therefore it would not be unreasonable to enter into specific agreements, now, under negotiation to estimate a sale of only the Canadian patent to a specific license authority at a cost of not less than 10% of current revenues per year over a (5) year acquisition.
. . .
With respect to Merendon's and its associates' "Canadian Tarsands Oil Recovery Ltd", the general overview in the Letter of Intent stated one industry estimate of recovery of oil from cleaning as " not less then [sic] 1,000 barrels per day at start-up".
In accordance with the Letter of Intent, Arbour advanced $10 million to Merendon. Arbour's first payment to Merendon of $210 000 was paid on 27 July 2004 and its last payment of $690 000 was made on 8 December 2004, even though no written agreement formalizing the Letter of Intent had been executed by the parties.
A formal loan agreement evidencing Arbour's $10 Million Loan to Merendon, "to be used for working capital", was not executed until approximately May 2005 (the "$10 Million Loan Agreement"), well after the entire $10 million had been advanced to Merendon – the last advance, as noted, occurred on 8 December 2004. The $10 Million Loan Agreement was prepared in response to a request by Arbour's auditors and was backdated to 10 July 2004 –before the date of Arbour's first offering memorandum. When asked about the delay in signing the $10 Million Loan Agreement, Sorenson testified that it was Arbour's responsibility to prepare a formal agreement and that Arbour "just didn't do it", although Sorenson said he reminded Morice periodically that he should formalize the arrangement.
Morice offered the following explanation as to why Arbour advanced the entire
$10 Million Loan to Merendon before it had executed a formal agreement:
Q Under what terms were those funds advanced?
A Well, what I indicated was those funds were advanced so that Merendon would help us close international -- well, oil and gas deals, either TRL or international oil and gas deals. That was the agreement.
Q They were advanced under the same verbal-agreement conditions as the $45 million loan; is that correct?
A. Right.
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Morice elaborated. Merendon, a mining exploration and development company, was being relied on by Arbour to use its influence to assist Arbour in acquiring international oil and gas assets. Morice understood Merendon to be a $2 billion company that could access funds whenever it needed. Therefore, he was comfortable that Merendon, even though it for some reason needed to borrow $10 million from Arbour, would honour its verbal commitment to provide Arbour with the money when it needed the money to "close the deals we chose".
Weis acknowledged that Arbour advanced the loan money based on a "handshake agreement" with Sorenson. Sorenson disagreed with the suggestion that that the $10 Million Loan to Merendon was completed on a "handshake", pointing to the Letter of Intent that had been executed by Merendon and Arbour at approximately the same time as the first advance of money to Merendon. Sorenson assumed that Arbour had the appropriate approvals in place to enter into the Letter of Intent and to act as it did.
Until execution of the $10 Million Loan Agreement, no security was contemplated for Arbour's $10 Million Loan to Merendon. Section 6.1 of the $10 Million Loan Agreement provided:
As continuing collateral security for all Indebtedness of [Merendon] to [Arbour] from time to time pursuant to this Agreement, including due performance, payment and satisfaction of all its obligations and Indebtedness hereunder, [Merendon] shall execute and deliver to [Arbour] such security on the shares of [TRL] as [Arbour] may, from time to time, request.
In fact, the $10 Million Loan remained unsecured. Although section 6.1 of the
$10 Million Loan Agreement placed the onus on Arbour to request the security from Merendon, no request was made until after Arbour's auditors apparently requested it do so. In a 10 May 2005 letter from Hobbs to Ken Sorensen, the then-president of Merendon, Merendon was requested to deliver the security provided for in section 6.1 of the $10 Million Loan Agreement by placing all of Merendon's TRL Shares – 25% of the issued and outstanding TRL Shares – in trust with Skeith. The letter also requested that confirmation of the delivery be sent to Arbour's auditors.
No valuation of TRL had been obtained or requested by Arbour when it agreed to accept TRL shares as security for its $10 Million Loan. (Ultimately Arbour lost the right to this security when it purchased Merendon's interest in TRL.)
Hobbs in the Hobbs Interview confirmed that no valuation of the TRL Shares had been done at that time. She said that she determined the value to be assigned to them based on "[d]iscussions with -- with Dennis Morice and the discussions that he had with shareholders of Tar Sands".
Morice, acknowledged that he had no specific education or experience in evaluating oil sands technology or technology for recovering bitumen from oil sands. He had attended pilot projects being run by the other three partners in TRL – Monkman, Page and McIntyre – which he said gave him "comfort with regard to the value of the technology". Other than those attendances and receiving from the TRL principals some notes and papers (targets for revenue
projections and other estimates as to expected volumes when deployed commercially), Arbour management apparently did little – or nothing – else to verify whether the 5% interest in TRL provided by Merendon was security enough to support the $10 Million Loan.
At the time Arbour arranged to accept 5% of Merendon's TRL Shares as security for the
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$10 Million Loan, all of Merendon's assets had already been pledged as security for a loan for "variable amounts of capital" to Merendon by SGD. Arbour's director Wigmore, a former director and president of Merendon, was aware of the SGD loan to Merendon and the general security agreement that Merendon had executed in favour of SGD.
The evidence is inconsistent as to why the decision was made to cause Arbour to loan money to Merendon.
Morice in the Morice Interview said that the intent was for Arbour to make short-term investments and park the money raised until such time as management had identified appropriate oil and gas ventures to acquire. Arbour decided that its "short-term" investment would be to loan
$10 million to Merendon for a time on the understanding that Sorenson would use his contacts to locate international oil and gas opportunities for Arbour.
Sorenson denied that was the basis for the $10 Million Loan. He testified that he had no "influence or clout in the international oil business world", so could not have helped Arbour in that way. He also stated that he did not make such an offer, nor was the subject ever discussed between him and Morice. Sorenson testified that Arbour took the position that the $10 Million Loan was not actually a loan but "a deposit on the acquisition [by Arbour] of TRL".
Weis explained that Arbour loaned the money to Merendon partly to acquire TRL. He also explained that he and Morice negotiated a loan with an option because:
A . . . we didn't know enough at the time for sure if, if it was anywhere close to the [$]10 million, it looked like it; but, again, it was a very short window.
Q Why was it a short window?
A Well, [Sorenson] said if you want to get yourself in.
Q So, and he wanted a loan, he didn't want to actually sell you those shares?
A We didn't want a loan right away because we weren't sure what the value of the shares, that was more our option than his option.
Q Okay. So you suggested loaning the money to Merendon? A A loan convertible to an option.
Q Okay.
A That's just for our own protection rather than his obviously.
Regier testified as to his understanding of the $10 Million Loan and Arbour's purchase of the TRL technology:
. . . some of the first monies that went from Arbour to Merendon were classified as a loan, and that there may have been some issues with an auditor on disclosure and books and so they were looking for -- or they needed some other justification, if you will, to -- for that money that was sent to Merendon.
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[This understanding was from] discussions that [Brost] and I had, and I believe I may have, in passing, had some discussions with Carol Hobbs about where Arbour was at.
In our view, Morice described the scenario best when he noted that "it was expected there would be deals involving the contacts or assets of Merendon, so that [the $10 Million Loan] was one of the options". We find it is more likely than not that, whatever the stated reasons, the real reason for making the $10 Million Loan was to get money to Merendon and into the hands of Sorenson, some of which would then be passed on to other Brost/Sorenson Entities. We so find.
Merendon did make some interest payments on the $10 Million Loan. On 3 May 2005, further linking Brost with Arbour as well as with Merendon and Sorenson, Arbour's Hobbs sent Merendon's Bierwirth an email showing that Brost and Sorenson had been discussing the interest payments from Merendon to Arbour for the $10 Million Loan: "Milo has just spoken with Gary regarding the payment of the accrued interest on the loan to the end of Dec 31, 2004". Brost was not a director or officer of Arbour at the time of that email (or at any other time). Sorenson claimed not to recall Brost speaking with Sorenson about this matter. We do not believe Sorenson on this point.
Between February and the end of November 2005, Arbour advanced $28 663 456.95 to Merendon. The first advance of $900 000 was paid to Merendon on 1 February 2005. As was the case with the $10 Million Loan, Arbour's payment of slightly more than $28.6 million to Merendon remained unsecured and without formal documentation until well after that sum had been advanced. The second and third offering memoranda, dated 19 January 2005 and 26 September 2005, respectively, were used to raise this money.
Morice explained that these advances were initially based on a "verbal agreement" with Sorenson and were once again made on the condition that Sorenson would use his influence to assist Arbour in acquiring international oil and gas assets, and "the amount outstanding would be offset against those purchases, or cash would be generated from Merendon to make those purchases".
Weis referred to these advances as another "handshake" agreement with Sorenson. Hobbs also confirmed this was a verbal agreement.
Wigmore said that Arbour made what was later papered as a $45 million loan (the "$45 Million Loan") to Merendon because the intention was to earn a higher rate of interest than Arbour could obtain locally, invest that money in international oil and gas ventures, and hope to buy TRL. Wigmore said that because he had experience with Merendon and knew the people Arbour was dealing with, he was satisfied that the money was safely invested. He viewed Merendon as a "very able company" with "large assets" that had done well with no debt and the
"size of our loan would be an insignificant liability to them. And they had a history, when I was involved with them, of paying and meeting their commitments."
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According to Sorenson, Morice approached him, indicating that Arbour was still interested in buying TRL. Sorenson advised Morice that the purchase price for Merendon's 25% interest in TRL was $50 million – Arbour was to continue advancing money towards that purchase price and when $50 million had been received, Merendon would sell its interest in TRL to Arbour. Arbour continued to advance money in 2005, although no agreement was in place to document the arrangement. Sorenson said that Morice was asked repeatedly to provide the documentation, but he never responded. Sorenson eventually instructed Blakey to see to drafting and having the appropriate documentation executed, by which time Merendon had already received at least 50% of the asking purchase price. According to Sorenson, Morice wanted the arrangement classified as a loan even though the purpose of the advances was to purchase TRL from Merendon. Sorenson said that Morice told him that Arbour had received a legal opinion that if the arrangement were documented as a loan then Arbour would not have to provide normal public company disclosure.
In early 2006 a Loan Agreement with an effective date of 1 January 2005 was executed by Merendon and Arbour (the "$45 Million Loan Agreement").
The $45 Million Loan Agreement provided for Arbour to lend $45 million to Merendon to be used for working capital with a maturity date of 31 December 2015. The security for the money advanced under the $45 Million Loan Agreement was a guarantee and general security agreement from Merendon Ecuador, an offshore subsidiary of Merendon.
According to Sorenson, it was Morice who requested security specifically over Merendon Ecuador because he wanted eventually to move into the gold business. Sorenson confirmed that, although the general security agreement was executed by Sorenson (as president of Merendon Ecuador), Arbour never followed through and registered the general security agreement in Ecuador. Sorenson stated that he had advised Morice on a number of occasions that Arbour should register the security in Ecuador.
According to Sorenson, Merendon had obtained a release from SGD relating to the security that Merendon had given SGD (which was in place at the time of the $10 Million Loan Agreement and would have included Merendon's interest in Merendon Ecuador). The 2005 SGD/Merendon/Eiger Loan Agreement was also in place by the time the $45 Million Loan Agreement was executed.
In evidence were the financial statements, including an auditor's report, for Merendon Ecuador's 2005 financial year ("Merendon Ecuador's 2005 Financial Statements"). The total assets shown in Merendon Ecuador's 2005 Financial Statements (as at 31 December 2005) were US$3 295 470.92 (current assets of US$286 839.83), with total liabilities of US$3 294 470.92 (current liabilities of US$218 372.19 and shareholders' equity of US$1000). There was no income statement. The Cash Flows Statement showed no cash flow from operating activities and a negative "Net Effect Provided by Operating Activities" of US$1 171 026.88, with US$1 611 994.48 provided by "Loans from Shareholders". Note 3 to Merendon Ecuador's 2005
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Financial Statements stated that the 31 December 2005 accounts receivable (US$46 257.76) "refer[s] to 100% of gold and silver sales made to related company Merendon de Honduras S.A.". Note 12 stated that the long-term liability on the balance sheet of US$3 076 098.73 in Loans from Shareholders "refers to financing made by Merendon Mining Corporation, to execute of operations; the agreement of this loans are in procedure. Due to this fact, we do not know about guarantees, interest rates and time limit." (reproduced verbatim).
Merendon Ecuador's major asset was the Tena Concessions, purchased quite recently for approximately $800 000. Note 15 to Merendon Ecuador's 2005 Financial Statements disclosed that: (reproduced verbatim):
On June 10, 2004 Hampton Courtresources Ecuador S.A. and Merendon del Ecuador S.A., signed the "Agreement to transfer Mining Rights, Other Assets and Revenues"; and made transfer of assets and 10 mining concessions from Hampton Courtresources Ecuador S.A., to Merendon Ecuador S.A., assets value was US$ 428.478,65, distributed as follows: Accounts receivable US$ 2.832,90; Suppliers Advances US$ 40.000; Inventory US$ 67.429,91, and, net fixed assets US$ 318.215,84. Additionally, Merendon of Ecuador S.A. assumes to pay to suppliers of Hampton an approximated amount of US$ 787.299,15, financing though Merendon Mining Corporation, because of this, value of concessions is US$ 358.820,25, and the parts have to give compliment to all agreement dispositions.
Sorenson testified that, based on information he had, he believed that Merendon Ecuador was worth more than the $45 million maximum it was to secure under the $45 Million Loan Agreement.
Sorenson said that the $28.6 million forwarded to Merendon under that agreement was used for development and operations. Wigmore's understanding was that Merendon was going to use the money advanced under the $45 Million Loan Agreement for its operations and that the money would not be held in cash. However, Wigmore believed that Merendon held that much or more in cash or in gold reserves, and had the ability to use that in the event Arbour needed the money for a different offshore investment.
As with TRL, other than accepting Sorenson's assertions of value and some geological reports requested by Morice, Arbour's management seemingly did little, if any, due diligence to assess the value of Merendon Ecuador and, in particular, the value of the Tena Concessions.
In fact, Arbour's management was aware the security provided by Merendon did not support the $45 Million Loan.
Hobbs stated that there was partial security for the $45 Million Loan, as suggested by the "Hampton Court report". However, she agreed that it did not substantiate the full value of the
$45 Million Loan, and there was no other security for that loan. Hobbs expressed that she had not been comfortable with the insufficient security and had discussed the matter with Morice. She said that Morice told her that was all the security they were able to get from Merendon and confirmed to her that the loan was only partially secured.
Wigmore indicated that he knew very little about Merendon Ecuador and the Tena Concessions (he had no prior knowledge from his time as president of Merendon). However, he
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stated that initial verbal representations made by Merendon assured Arbour management that the Tena Concessions were very valuable. Contrary to that position, subsequent information obtained from an appraisal conducted on the Tena Concessions indicated that their value "would not equal the forty-five million in anybody's -- in my mind", but that did not matter because the loan was based "on the old princip[le], know the people you're dealing with" and he "trusted Merendon". Wigmore also acknowledged that he did not know what was done to confirm that Merendon owned the Tena Concessions.
Regarding the lack of security requested from Merendon for the $45 Million Loan, Morice engaged in this discussion in the Morice Interview:
Q Did you ask for additional security on the loan?
A There was continued ongoing discussion about security, but the reality is all of the deposits were in countries likes [sic] Honduras and Venezuela and Peru and Ecuador, so having copious paper wouldn't necessarily mean much anyway. It was an issue of trust and our final judgment as to whether or not we trusted the international network, and we did.
. . .
Q Why didn't you paper or document these transactions at the time the money was advanced to Merendon?
A You know, essentially it, it was a trust situation, the, the assets of Merendon are located in places like Honduras and Ecuador and Peru and Venezuela, so in terms of collecting, we could have had the greatest security in the world and not been able to do anything with it, so that's probably a feeble excuse, but the bottom line is we were busy and everything started, and, and, you know, it was a challenge for us just to keep up with the day-to-day stuff.
Weis had reviewed financial statements, apparently the 2003 Merendon Financial Statements. When asked whether Merendon was a profitable company, he stated that, if profitable, it was only by a "very insignificant" amount. In 2004 Merendon had $0 revenue and in 2005 it had revenue of $9286, with an accumulated deficit of $23 072 103 at the 31 December 2005 year end.
We find that Brost introduced the COREL opportunity to Morice and advised him how Arbour could acquire COREL. Brost in the Brost Interview described it as follows:
Q What was your response when [Morice] asked you if COREL could be acquired?
A I suggested to him that, based on my knowledge of the principals and the conversations -and my conversations were restricted to Jack Monkman and Gary Sorenson, Gary Sorenson representing the interests of Merendon Mining Canada - that they were not interested in selling and that, if he approached them directly, the costs would be astronomical.
Q Did you provide him with any advice as to how he may approach them in another way?
A I suggested that if he struck a relationship with Merendon and was financially involved with Merendon, that he could probably back door this technology far more successfully than the front door.
Q What do you mean by "financially involved with Merendon"?
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A If there was financial transaction -- it -- it ultimately became the initial loan that Arbour wound up doing to Merendon Mining Canada. That financial commitment created a relationship. That relationship, [Morice] was eventually, when the timing was right, to utilize -- utilize later to get COREL at an extremely good price.
Q So you suggested to [Morice] that he should become financially involved in Merendon in order to acquire this technology.
A I thought it was a good idea.
Q And you were the one that brought the technology to his attention? A In this case, I believe so.
When asked why Merendon and Monkman (who Brost said initially had no interest in selling COREL) had decided to sell COREL to Arbour, Brost responded:
I think that is simply an issue of cash flow. Before there was a lender/borrower relationship between Arbour and Merendon, Merendon has this terrific project. Of course it's gonna need capital to develop. It's got its own business life cycle that it's going down we called COREL. After a year, two years, whatever the time period was, Merendon of course is developing other interests which have come up to be particularly positive. I think at that time they outshone perhaps the potential of COREL and were more receptive to settling some or all of their bill with Arbour with the COREL sale and acquisition by Arbour. So I think -- I simply think that the circumstances of Merendon shifted, based on project potential, other than COREL. I think that opened the door for [Morice] to get -- to get a deal.
As envisioned by Brost, Arbour and Morice made the $10 Million Loan and the
$45 Million Loan to Merendon. Shortly thereafter, as predicted by Brost, Arbour successfully acquired COREL (which included all of Merendon's interest) and Merendon's 25% shareholding in TRL.
Sorenson testified that Monkman advised him that he had an interested buyer for COREL; Sorenson was surprised to learn it was Morice and Arbour. According to Sorenson, Monkman negotiated the COREL sale with Morice and Brost – Sorenson was not involved.
Despite Sorenson's assertion of non-involvement, on 18 October 2004 Sorenson received a written offer from Arbour to purchase Merendon's interest in COREL for $2.3 million and 2 million Arbour common shares valued at $1 per common share. Sorenson, on behalf of Merendon, agreed to Arbour's offer and dated his acceptance 25 November 2004. Further, in a letter dated 1 April 2005, Sorenson, on behalf of Merendon, wrote to Morice at Arbour requesting that the closing of the COREL sale be effective 2 January 2005 because, according to Sorenson, the other three shareholders – Monkman, Page and McIntyre – preferred to have the sale recognized in 2005 rather than 2004 for taxation purposes. In that correspondence Sorenson also referenced a 24 March 2005 meeting at Merendon's Calgary boardroom at which "all parties
agreed that Merendon would acquire the rights [the royalties] to the licensing agreement" and confirmed that Merendon had reached an agreement with the other three TRL shareholders for its entitlement to the royalty of "30% net profits". The 1 April 2005 letter concluded with the following offer to Arbour:
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Accordingly, and pursuant to our meeting of March 24th 2005 referred to herein Merendon is further by this notice offering to Arbour the opportunity to purchase this right of 30% net profits of COREL so as to give Arbour 100% of net profits.
This as both Arbour/Merendon agreed would enhance Arbour's position dramatically for future earnings.
Therefore Merendon will await Arbour's proposal to acquire these rights.
. . .
On 11 June 2005 Morice wrote Sorenson at Merendon following up on Sorenson's "willingness to consolidate the interest with respect to the forward flowing royalty of our acquisition of [COREL]". Morice advised that Arbour's management had been focused on completing its "required audit" and having its shares resume trading on the CNQ, which occurred on 9 June 2005. Morice continued by stating that this had now "cleared the scrutiny of outside parties" and requesting Sorenson to consider the possibility of Arbour purchasing Merendon's "forward flowing royalty" in COREL.
Considering the whole of the evidence, we conclude that Sorenson was not being truthful when he claimed to have had little, or no, involvement with the negotiation of the sale of COREL to Arbour.
Arbour ultimately purchased COREL from four parties: Merendon; Monkman Consulting; 385765; and 1061463 (the same parties and principals who owned TRL). A Share Purchase Agreement documenting the sale of COREL to Arbour was dated 1 January 2005 (the "COREL Share Purchase Agreement"); it was not executed until late May 2005 at the earliest and perhaps not until May 2006.
The COREL Share Purchase Agreement provided for the sale of all the issued and outstanding shares (10 000) of COREL to Arbour for $10.3 million, for which the four COREL vendors received $5.3 million and five million Arbour common shares valued at $1 per common share. According to Sorenson, Merendon should have received 52% of the purchase price, but he agreed to Monkman's proposal that Monkman, McIntyre and Page would each receive
$1 million and 1 million Arbour shares, with the balance of the money and shares – $2.3 million and 2 million Arbour shares – to Merendon. In return Merendon would be entitled to receive the first $1 million on any royalties earned.
Arbour paid $2.76 million towards the purchase price of COREL in 2005 and a further
$1.344 million in the first three months of 2006.
The assets of COREL sold to Arbour in 2005 were its license agreement with TRL and physical assets consisting of vessels, a building, tanks, small tools and office equipment (with a value of slightly more than $94 000). TRL's balance sheets showed:
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total assets of $49 238.91; total liabilities of $342 957.42 (including a shareholder's loan to Merendon of $347 771.93); and total equity of -$293 718.51 as of 31 August 2004;
total assets of $47 996.24; total liabilities of $424 706.94 (including a shareholder's loan to Merendon of $432 771.93); and total equity of -$376 710.70 as of 31 August 2005; and
total assets of $19 397.56; total liabilities of $535 155.88 (including a shareholder's loan to Merendon of $482 771.93); and total equity of -$515 758.30 as of 30 June 2006.
All TRL profit and loss statements showed negative net income:
-$293 718.51 for August 2003 through August 2004 (with royalty income of
$42 800);
-$82 992.19 for September 2004 through August 2005 (with no income); and
-$139 047.60 for September 2005 through June 2006 (with interest income of
$42.57).
The "TRL/COREL License Agreement", dated 14 August 2003 between TRL as licensor and COREL as licensee, had a five-year term with renewal provisions. The technology was described in the COREL Share Purchase Agreement as "relating to the licensing of certain patent pending processes and a patent pending vessel for the cleaning of processed sands in Alberta, including therein the supply of all materials to utilize the processes and vessel from the licensor". The original royalty was $10 per cubic metre of processed material; that was changed to 30% of net profits in a 1 January 2005 amendment.
In the COREL Share Purchase Agreement, the vendors represented and warranted that COREL held the TRL/COREL License Agreement free of all claims. The vendors also represented the following:
The products, processes and systems subject of the [L]icense Agreement have been under review by the Alberta Research Council for several years and have satisfied all expectations causing the Vendors to believe that the Province of Alberta may soon mandate the process in order to deal with a growing environmental problem in extracting products from the produced oil sands.
The project has reached the point where a commercial plant must be built in order to demonstrate that large volumes of material can be processed at an acceptable cost to the Government and oil industry. The Vendors represent that a plant capable of processing 100 cubic meters per day can be built for less than $500,000 and that the initial full scale commercial unit is substantially complete.
When asked to explain the dramatic increase in value between the price Merendon paid for its interest in COREL – $52 – and the price paid by Arbour a little more than a year later –
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$10.3 million – Sorenson said that they knew more about the technology and its application and had other people review the technology. Sorenson said that Monkman had set the COREL sale price.
Ken Sorensen stated that he inquired of others at Merendon "as to why the sale value for shares of [COREL] is different than the balance sheet value on its balance sheet before the sale of the shares". Sorensen told Staff investigators in a 23 March 2007 letter from Blakey:
Information from the developers of the patented process currently held by [TRL] indicated that there was huge potential for using this process to clean processed sands. Processed sands are produced by the current process to extract oil from the bitumen deposits in Northern Alberta. The sands are not fully cleansed and are stored. This accumulation slowly becomes a major concern to the issue of environmental pollution. Processes then available made the cleaning of processed sands an expensive undertaking.
COREL held a license to clean processed sands using the process developed by [TRL]. The process represented an efficient and less costly means to clean polluted sands which were and continue to be an ecological problem. Should it be marketed properly, then COREL had a much greater potential to create profits than was represented by the investment it had made in obtaining the license.
The Alberta [R]esearch Council issued a report believed to be favo[u]rable to the commercial use of the patented process.
[TRL] had built an experimental processing plant which demonstrated the efficiency of the process.
These factors were considered to enhance the future value of the process, which could be used to clean discarded but polluted sands in the Alberta oil sands. As the holder of a license to use this process in Alberta it was believed that COREL could develop into a highly successful corporation.
The above factors led Merendon to believe the value of COREL was far greater than the amount it had invested and stated on its balance sheet. The final sale price was derived through negotiation by another principal of COREL.
As was the case with TRL, Arbour had obtained no valuation of COREL before purchasing it. Minutes of a 21 July 2006 Arbour board of directors' meeting revealed that the issue of obtaining a valuation was still under discussion at that time – past the date of the purchase.
Weis confirmed that Arbour had not hired an outside business evaluator to value COREL at the time, but determined COREL's $10.3 million sale price from looking at the technology itself and a cash flow analysis prepared by Hobbs, which he reviewed. Weis advised Staff during his interview that Arbour was in the process of obtaining a valuation of COREL from an independent evaluator. He suggested that the Staff investigator wait for that valuation to confirm the value of COREL. As of the date of the Merits Hearing, no valuation of COREL had been obtained.
Arbour eventually reached an agreement with Merendon to purchase Merendon's 25% interest in TRL, which appeared to have been an amendment or revision to the $45 Million Loan Agreement.
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In correspondence dated 15 March 2006, Blakey, as legal counsel to Merendon, wrote Hobbs of Arbour confirming her advice that the parties had agreed to an amendment to the
$45 Million Loan Agreement and correcting a number of accounting entries, arriving at a revised total of advances made to Merendon of $28 663 457.45 as at 29 November 2005.
In correspondence dated 11 July 2006 Morice, on behalf of Arbour, apologized to Sorenson for the delay caused by Arbour's "regulatory and audit issues". Morice advised Sorenson that although the Arbour board of directors had not yet approved the agreement they had negotiated at a meeting on 17 January 2006, Arbour was still interested in completing the transaction. Morice also advised Sorenson that:
[T]he final deal must produce assets to Arbour with value and/or collect[a]bility that is satisfactory to our auditor and regulators. At the present time, they appear to believe that the purpose of Arbour is to flow cash and assets to Merendon. A further deal, like the one we are contemplating, would only compound our problem.
In an undated email from Morice to Blakey (apparently sent sometime between 5 September 2006 and 11 September 2006), Morice advised Blakey that the Arbour board of directors was ready to execute a share purchase agreement and not the non-binding letter of intent provided by Blakey. Further, Morice advised Blakey that Arbour was prepared to put a minimum price – $20 to 25 million – in a price adjustment clause: "if the valuation comes in below [that minimum] we will take our chances justifying our decision". In response, Sorenson emailed Blakey on 11 September 2006 to instruct him that: Morice's suggestion was not what had been negotiated between Morice and Merendon; the value of the transaction was "Not Negotiable and not depend[e]nt on any evaluation done by Arbour"; and US$38 million (of the
$50 million Sorenson said TRL would be sold for) was "to be applied against all outstanding loans", with the remaining "$12,000,000 as a receivable note". Sorenson also noted that "Arbour has made the business decision to acquire this interest based on it (Arbour's) [sic] evaluation of acquiring 'Corel' a corporation who is only licensed by 'TRL' to 'clean produced sands' not tar sands".
A letter of intent dated 19 September 2006 (the "2006 Letter of Intent") was entered into between Arbour and Merendon in which it was stated that Merendon and its principal shareholder and creditor, Eiger, "agreed to continue the process to bring Arbour to a position where it can acquire no less that 25% of the outstanding and issued shares of TRL". The 2006 Letter of Intent stated that: Arbour would complete an independent evaluation of TRL; Merendon agreed to assist in the evaluation; Merendon had a shareholder loan to TRL of approximately $500 000; and Merendon had the right to collect the first $1 million from any royalty income payable to TRL.
On 20 March 2007 Arbour completed its acquisition of Merendon's 25% shareholdings in TRL. We note that this was approximately 6 weeks after the IBG Advisory Committee decided
at the February IBG Meeting that Arbour's president was to finalize the TRL transaction or be replaced. Arbour's president, Morice, clearly received the message and did as he was told. We so find.
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A Share Purchase Agreement between Merendon as vendor and Arbour as purchaser was then made effective 1 January 2006 (the" TRL Share Purchase Agreement").
As a result of the sale to Arbour of Merendon's 25% stake in TRL, Merendon did not have to repay Arbour the funds advanced to Merendon under the $45 Million Loan Agreement –instead, that amount (set out in the TRL Share Purchase Agreement as $28 317 617) was converted into the purchase price of Merendon's TRL Shares. Further, Merendon Ecuador was released from its guarantee and general security agreement.
After completing the TRL Share Purchase Agreement, Arbour also lost its right to the security set out in the $10 Million Loan Agreement for the $10 Million Loan. The TRL Share Purchase Agreement specifically contemplated that loss, but it was also a natural outcome because Arbour was acquiring Merendon's TRL Shares. The result was that, after that date, Arbour no longer had the right to any security for the $10 Million Loan.
Arbour's management was aware that this placed Arbour in a potentially tenuous position. Morice – although he previously agreed to accept Merendon's offshore assets as security – expressed the view that Arbour's ability to enforce security against Merendon's offshore assets was questionable. Morice stated:
Well, again, it was a question of collectability should any default occur. This was an insistence of Merendon, and we, you know, we did wrestle with that quite a bit and knew that it would cause some concerns, but the reality was we didn't see an ability to enforce security anyway, so all of their assets are outside of Canada.
We were acquiring everything they had in Canada, so, so we didn't see, you know, the added -- the security we were holding as enforceable, and essentially we wanted to close off our relationship with them as quickly, as neatly as we could, and we do still have the [$]10 million to deal with, but, you know, we'll work towards that.
The TRL Share Purchase Agreement provided for a purchase price adjustment. Arbour was to hire an independent third party to provide a valuation of TRL Shares at closing – there would be an upward adjustment of the purchase price of up to $50 million should the valuation of TRL exceed the specified purchase price of $28 672 617 (less approximately $1.2 million for a shareholder loan and royalty rights). However, the $28 672 617 (less the same amounts) would not decrease if the valuation fell short of that price.
Although the TRL Share Purchase Agreement called for a valuation of TRL, the transaction concluded before Arbour obtained a valuation of TRL. (Even after the transaction closed, Arbour did not complete a valuation – Morice stated that Arbour stopped answering the valuator's questions.) Morice said that "as time went on, we had to close, . . . the [$28 million] was the minimum Merendon would accept, and we decided to close to make sure that the deal didn't fall apart". According to Morice Arbour management was prepared to "take [its] chances" and proceed with the TRL purchase despite the absence of a completed valuation. It is important
to reassert that this pressure to close – and the ultimate closing – occurred mere weeks after the February IBG Meeting at which those present agreed to replace Morice as Arbour's president if he did not finalize the TRL transaction.
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Because Arbour did not pursue a valuation, there was no rational or realistic basis for choosing that particular purchase price, other than the amount outstanding under the $45 Million Loan Agreement. Regier testified that the TRL purchase price of approximately $28 million was determined as a means to justify, possibly for an auditor, the amount of money Arbour had given Merendon.
There is no evidence that Merendon ever pushed Arbour to complete the valuation of TRL, even though, if the technology were as valuable as Sorenson touted and claimed to believe, a positive valuation could have meant up to an approximately 80% increase in the purchase price
from approximately $28 million to $50 million) – payable by Arbour to Merendon.
There is evidence as to the uncertainty of the TRL technology and its value. For example, as noted above, the Burgess DD Report provided to Brost and Sorenson in late 2005 as SGD shareholders valued Merendon's 25% interest in TRL at cost ($500,000), but did not explain the rationale for arriving at that value.
One piece of information that both Merendon and Arbour had had regarding the value of TRL was the November 2005 ARC Report. Minutes of a 21 July 2006 Arbour board of directors' meeting stated that management had received the November 2005 ARC Report and that management was to proceed with ACS Engineering to establish the value of both TRL and COREL.
The November 2005 ARC Report cautioned that the TRL technology for oil sands development was very much in the experimental stage, apparently with limited application. The November 2005 ARC Report also listed a number of outstanding issues still to be addressed, most importantly, the technology's viability on a commercial or industrial scale. Chow testified that even as of February 2010, the technology was still being evaluated and remained at the experimental stage because he needed "to understand how it works before you can get to a commercial basis". Chow also acknowledged that ARC had not examined factors that might affect commercial viability, including the cost of supply and transportation. Chow agreed that his view in 2005 was that the TRL technology "should be tested on a larger scale to demonstrate its feasibility", which would require a cost analysis of implementing and maintaining the technology. Chow noted that experimental processes continued to the date of his testimony in February 2010. Chow confirmed that he had never spoken to Morice or anyone else from Arbour.
Merendon also recognized uncertainties surrounding the value of the TRL technology. In a 19 June 2006 letter (less than a year before the sale of Merendon's interest in TRL to Arbour) signed by Gleason on behalf of Merendon (drafted by Blakey) to Monkman as president of TRL, Gleason raised a number of concerns regarding TRL. First Gleason noted a representation, relating to the COREL sale to Arbour, that TRL had a patented process and patented vessel; however, no patent applications had been granted. A second concern expressed was that:
. . . With the tar sands being developed using other processes, TRL has a limited window of opportunity. The opportunity is time constrained. Developers will be reluctant to spend monies on a TRL process once committed to another process. We consider it vital to have this process commercially proven in a tar sands application or its value is negligible.
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Morice also admitted that Arbour was aware of significant uncertainties surrounding the commercial viability of the TRL technology, but "a lot of this was based on trust".
As noted, Arbour Caribbean was incorporated on 15 November 2004 under the laws of Barbados as a wholly-owned subsidiary of Arbour. For an unexplained reason, on 23 October 2006 Morice sent Blakey – Merendon's in-house counsel at the time – a copy of the incorporation documents for Arbour Caribbean, indicating on the cover sheet that Morice was its "President and Director".
Arbour Caribbean was apparently established for tax planning purposes; it seems to have conducted no business.
Arbour entered into a 25 January 2005 Participation Agreement with Arbour as participant and Avalon Energy Ltd. ("Avalon") as grantor. Under that agreement, Arbour agreed to pay 90% of the drilling costs in Avalon's development drilling program in the Sedalia area of Alberta.
In a news release announcing the transaction, Arbour stated that its planned budget for the first of up to 8 shallow gas wells was approximately $175 000, future drilling dependent on the success of this first well. It was also disclosed that Arbour would receive 63% of net revenue before payout and 45% after payout. Drilling was to commence in the spring of 2005.
In 2005 Arbour established Arbour US. According to Arbour documents, Arbour US merged with Biltmore Enterprises, Inc., a Nevada corporation. The merged entity took the name of Arbour US.
Arbour apparently intended to transfer to Arbour US all of its future-acquired technology and oil and gas activity operated in the United States. Some of the documentation for this transaction was in evidence, but was inconsistent and unclear.
The February IBG Minutes discuss Arbour's investment in the "Bengal Oil project". We received some evidence on this project.
Martyn introduced Arbour to a tentative deal involving a joint venture with a company called Quad Energy Inc. ("Quad"). Martyn, a friend of Ken Nazar ("Nazar"), Quad's president, proposed that Brost, Morice, Weis and he travel to Southeast Asia and meet with Nazar to discuss a possible deal. Brost made the travel arrangements, and they met with Nazar.
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Shortly after the trip, Bengal was incorporated with Martyn as president and Perma Securities ("Perma") as a shareholder. Nazar, Quad's "owner", apparently partnered with Perma on Bengal. Morice believed that Brost was a shareholder of Perma. The proposed transaction seemingly involved Arbour acquiring all of the shares of Bengal. Blakey's handwritten notes of a meeting between Blakey, Morice and Hobbs on 30 November 2006 recorded "Bengall [sic] O & Gas", "Perma Securities in Belize", "Loan to Perma for its interest in Bengall [sic] – by assignment" and "Dwayne Mart[y]n is Pres. of Bengall [sic]".
A 16 September 2005 news release described "a preliminary arm[']s-length agreement" entered into by Arbour regarding its acquisition of a Malaysian company. This information was repeated, expanded on and clarified in a 27 September 2005 news release:
. . . The potential acquisition is at such an early stage that it is not possible for the Board [of Arbour] to make a decision or recommendation to shareholders. The information required will not be available until the due diligence process is substantially complete, which is expected to take up to 8 weeks.
Arbour has entered into a preliminary arms-length agreement to acquire the Malaysian subsidiary of an international company. The vendor represents that the oil and gas assets being acquired have significant proven reserves and that it will arrange additional financing to carry out the initial development program. The subject properties are located in Myanmar. Subject to various conditions Arbour has agreed to pay $25,000,000 plus 60,000,000 common shares in [Arbour].
[Arbour] cautions that there is significant work to be done before its board can determine whether it is in the best interests of the shareholders to proceed with this acquisition. Management is planning to make a site visit to examine the assets, while technical experts are reviewing existing engineering reports. Title to the property will have to [be] confirmed, as will the financial status and records of the target company. In addition, Arbour will have to confirm the existence and terms of the proposed financing the vendor is arranging to complete the first development phase. [Arbour] will also have to examine and then determine whether the foreign country risks are acceptable.
Since the share issuance would result in a change of control of [Arbour], the agreement is also subject to regulatory and shareholders' approval which would take place at a meeting to be held later this year. However, before such a meeting is called, [Arbour] would have to first come to the decision to proceed with the project, at which time a [news] release will be issued and an information circular prepared. [Arbour] continues to develop its current properties and projects.
This transaction was never completed, although the 2007 February IBG Minutes refer to Arbour having "funded primarily" the "Bengal Oil project". According to that record, the project was set up through Brost "for either Arbour [E]nergy to buy, or use Bengal to buy Arbour". Martyn, an IFFL structurist, was set up by Brost as a director of Bengal.
From approximately July 2004 until 16 November 2005 (the date Arbour was denied access to the statutory exemptions available under Alberta securities laws), Arbour offered the Arbour Preferred Shares for sale. Arbour raised a total of approximately $45.5 million from these offerings of Arbour Preferred Shares; more than half of the sales – approximately
$25 million – occurred in Alberta to Alberta investors.
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The Arbour Preferred Shares entitled holders to receive a cumulative 5.75% annual dividend and were redeemable at the option of the holder 10 years from the issue date at the issue price of $1.35. The Arbour Preferred Shares were also convertible to common shares, generally on a one-for-one basis at the holder's option.
Arbour Preferred Shares were offered for sale in several provinces. In Alberta, most of these sales were purportedly made in reliance on an exemption from the registration and prospectus requirements of the Act on the basis that the securities were sold under an offering memorandum (the "OM Exemption") purportedly prepared in accordance with requirements in force at the relevant times – Multilateral Instrument 45-103 Capital Raising Exemptions ("MI 45-103") and National Instrument 45-106 Prospectus and Registration Exemptions ("NI 45-106").
As noted, Arbour did not advertise or otherwise promote the sale of the Arbour Preferred Shares to investors. Rather, Arbour Preferred Shares were sold through the combined efforts of Brost, IFFL, Arbour and Morice. Morice stated that Arbour did not contact potential investors; rather, "virtually all" potential investors came to Arbour through IFFL.
As we discuss in more detail elsewhere in these reasons, IFFL members, as directed by IFFL structurists or other personnel and without any solicitation by Arbour, contacted Arbour directly, requested an offering memorandum and subscribed for Arbour Preferred Shares. The majority of the Arbour Preferred Share purchasers were IFFL members, with more than half of the sales – totalling approximately $25 million – occurring in Alberta to Alberta investors. Those who purchased Arbour Preferred Shares through IFFL received "international accounts" (at least some of which were purportedly in SGD); however, information about those "international accounts" is not found in the offering memoranda prepared for the Arbour Preferred Shares.
Three offering memoranda for the sale of Arbour Preferred Shares were prepared by Skeith with input from Morice (and limited input from Hobbs). They were dated 14 July 2004 ("OM 1), 19 January 2005 ("OM 2") and 26 September 2005 ("OM 3") (collectively, OM 1, OM 2 and OM 3 are the "Arbour OMs"). Of the Arbour OMs, only OM 3 was filed with the Commission, as required (it was filed on 4 November 2005); OM 1 and OM 2 were not.
Morice (as president and CEO of Arbour) and Weis and Wigmore (on behalf of the Arbour board of directors) signed the Arbour OMs, certifying that they did "not contain a misrepresentation" (OM 1 was signed and certified by Strashok in place of Wigmore, and OM 3 was also signed and certified by Hobbs as Arbour's CFO). Consistent with the pattern of drafting errors throughout many of the documents in evidence, Weis's name was misspelled "Weiss" on OM 1 and OM 2.
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Morice was the person at Arbour responsible for filing the Arbour OMs and Distribution Reports with the Commission. Morice agreed that he was primarily responsible for the content of the OMs, for raising funds for Arbour and, ultimately, for determining if investors qualified for the OM Exemption. Morice also worked with counsel – Skeith – on these matters. Hobbs denied any involvement in OM 1 or OM 2 but acknowledged working with Skeith on OM 3, providing him with "technical numbers".
During the Morice Interview, Morice stated that he did not believe Brost reviewed any of the Arbour OMs or provided any of the information that was included in the Arbour OMs. Morice claimed that was his function, as president. However, Morice did say that Brost was involved in some general discussions about the structure of the offering – offering preferred shares and the conversion price to use. Skeith confirmed that Brost had a role in preparing the OM 1 and that Martyn was also involved in fundraising for Arbour.
With respect to use of the money raised from the offering of Arbour securities, Morice had this to say:
Q What about on use of funds, did [Brost] provide you with any information on the use of funds and how the funds would be used?
A Well, the key for them was that money get parked offshore right away, and that was understood, and again, as I've said before, the commitment back to me was that significant funds would be available to make Arbour a big company, so that was the understanding going in.
Q Did [Brost] tell you where you were going to park those funds offshore?
A Well, again, it goes back to initially it was going to be Evergreen Trust, and ultimately it became Merendon.
Q So he did tell you that they were going to go to Evergreen Trust and then ultimately Merendon?
A It, it was understood that if they didn't, the money would stop.
Q So you put the money in one of those two locations or the IFFL members would no longer be investing in Arbour?
A That seemed to be -- we never tested it, but that was my understanding of what would happen.
Q Were they to be involved in any further decisions as to where that money would go after that? You said you were looking at oil and gas opportunities, did you have to --
A As I say, [Brost] was the one or the driving force regarding East Timor. . . .
Q So in general, [Brost] told you where you're going to park the money, he then brought opportunities to you --
A Right.
Q -- for where you could then invest from that point, and you did some work on those opportunities --
A Right.
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Q -- to determine if they were something that you felt was in the best interest of your shareholders?
A Right.
Q But those opportunities were brought to you, your attention by [Brost]?
A Not all of them but most of them, the ones I mentioned, you know, the East Timor one specifically was, was, you know, high on the international group's list because there [were] so many opportunities, some banking opportunities, they were looking at a whole lot of things that didn't involve me in East Timor.
Q Was it your understanding that you would have to discuss with or essentially get approval from [Brost] to make the investments and transfer the money out of these trusts or Merendon loans prior to making the investment?
A It, it was quite obvious that would be the case because the money was offshore and would be, have to be brought back or moved to whichever country the deal was in essentially.
Q And [Brost] was the one who would have brought that money back?
A He would have facilitated it for sure. I mean, my understanding again, I'm not totally aware of what they had for decision-making process, but [Sorenson] was the, was the supposed billionaire who would be there to backstop deals as they came up.
Q What was your understanding of [Brost's] and [Sorenson's] relationship in this movement of money?
A Well, I mean, they, they seemed very close and very tight in terms of their own master plan for how, how things should develop, but I was impressed with what was going on, and all the signs were positive in 2004 that we would have support to do major deals.
. . .
Q So he -- your understanding is that [Sorenson] would have had knowledge of what [Brost's] plans were with regard to the funds raised by Arbour?
A He would have been aware that we were looking to, to kick-start Arbour into a significant oil and gas company, he was supportive of that in discussions early on in a general way.
You know, we never got to test it early on, it was really after the cease trade order where funds had stopped where other opportunities would have been explored if, if money was as readily available as it seemed to be before.
Morice said that he did not recall Sorenson reviewing any of the Arbour OMs or providing any of the information that was included in the Arbour OMs. Sorenson testified that neither he nor Merendon was involved in the preparation of the Arbour OMs or had involvement in whether Merendon was named in the Arbour OMs.
OM 1 described an offering of up to 25 million Arbour Preferred Shares at a price of
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$1.35 per Arbour Preferred Share, for a possible maximum offering of $33 750 000. The offering was to close no later than 31 December 2004 or such other date as Arbour might determine, and there was no minimum subscription level.
OM 1 disclosed that the maximum available funds from the offering – after deducting offering costs ($100 000), sales commissions and fees ($675 000) and working capital deficiency ($195 929) – would be $32 779 071. OM 1 declared its intention to expend the net proceeds (except for $400 000 assigned to "working capital") on "Acquisitions of technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions". OM 1 stated under the heading "Reallocation": "[Arbour] intends to spend the available funds as stated and reallocate funds only for sound business reasons."
OM 1 described Arbour's business as carrying on "oil and gas exploration and development". OM 1 disclosed under the heading "Business Summary" that Arbour:
had acquired a working interest in an oil and gas well in the Pembina area that produced approximately $4000 in revenue per month for Arbour;
had, on 31 May 2004, entered into a preliminary agreement with Crazy Hill to acquire an oil and gas property near Drayton Valley, Alberta at a purchase price of $1 million, comprised of $350 000 and 650 000 common shares valued at
$1 per share, with closing scheduled for 31 July 2004;
"participated in drilling a shallow gas development well in the Kirkpatrick Lake area of Alberta" at a capital cost of $50 000;
was, at the time, evaluating other opportunities and expecting to enter into further agreements in the near future; and
planned that proceeds would allow Arbour "to operate at an appropriate level of efficiency and hire competent staff on a full time basis to properly evaluate and exploit larger opportunities. Having the proceeds in place prior to identifying larger opportunities will allow [Arbour] to negotiate from a position of strength."
OM 1 referred to existing documents incorporated by reference, including an Annual Information Form ("AIF") dated 14 July 2004 (the "2004 AIF"). However, the 2004 AIF had not been filed on SEDAR by Arbour as required.
OM 1 disclosed that Arbour's directors, senior officers, promoters and principal securityholders were comprised of only three persons: Morice (president, director and beneficial owner of 600 000 Arbour common shares); and Strashok and Weis (directors and the beneficial owners of 2 619 917 and 3 000 000 Arbour common shares, respectively). Morice's "Principal
Occupation for the Previous Five Years" was declared to have been a "Financial Consultant and oil & gas company executive".
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OM 1 cited a number of "Risk Factors", introduced with the caution that an investment in the Arbour Preferred Shares "should be considered speculative" due to the nature and stage of development of Arbour's business. Included among the specific risk factors identified and related commentary were:
Exploration and development activities depend in large measure upon oil and gas prices. . . .
If oil and gas prices decrease or fail to meet expectations, exploration and production activities may be reduced significantly, which can have a material adverse effect on [Arbour's] operations and financial condition.
[Arbour's] operations are subject to the seasonal nature of exploration and development activity in western Canada. . . .
Competition among oil and gas exploration and development companies is significant. . . .
Oil and natural gas operations are subject to extensive legislative and regulatory controls imposed by various levels of government, which may be amended from time to time. . . .
Title to oil and natural gas interests is often not susceptible of determination without incurring substantial expense. . . .
Hazards, such as unusual or unexpected geological formations, high pressures or other conditions are involved . . . .
OM 1, under the heading "Industry Conditions", declared additional risks associated with "extensive controls and regulations imposed by various levels of government" over the oil and gas industry that might affect Arbour and described these controls and regulations under the following italicized headings:
Canadian Government Regulation Pricing and Marketing - Oil
Pricing and Marketing - Natural Gas
The North American Free Trade Agreement Production Regulation or Limitation Royalties and Incentives
Land Tenure
Canadian Environmental Regulation
A 22 October 2004 exchange in the Hoffman Tapes indicated Sorenson's awareness that Brost was using Arbour and an offering memorandum to raise money:
Sorenson [Brost is] now doing OM's and registering them with whatever regulatory bodies they need to be regulated with.
Hoffman Right.
Sorenson So that he's upfront on the table because quite frankly he can't afford to be anywhere but there from now on.
Hoffman No, understood and that was the whole purpose behind Arbour, yes?
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Sorenson No. Arbour was for an entirely different purpose. You're right in assuming that because I assumed that too.
Hoffman Okay.
Sorenson But what they were going to do with Arbour was a completely different product and that product is going well because it's on the -- on the table, you know above board. . . .
OM 2 described an offering very similar to OM 1: up to 25 million Arbour Preferred Shares, described in the same terms as OM 1, at a price of $1.35 per share for a maximum offering of $33 750 000. There was again no "minimum subscription level" and the statement "You may be the only purchaser" appeared on the cover. The closing date was to be 31 December 2005 or such date as Arbour might determine. OM 2 disclosed that, assuming the maximum offering were sold, after deducting selling commissions ($675 000) and offering costs ($100 000), the net proceeds would be $32 975 000.
OM 2 declared that the $32 975 000 maximum net proceeds of the offering now were intended to be used as follows:
$14 685 000 would go to "Acquisitions of further technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions";
$10 million would go to "Loan/Option Re: Tarsands Technology" (although the funds had already been advanced by the date of OM 2) and $7 million towards "Share Purchase: [COREL]";
$350 000 would go to purchase the "Drayton Valley oil & gas property" (the transaction with Crazy Hill), $300 000 towards the "Kirkpatrick Lake gas property" and $240 000 towards the "Meekwap gas property"; and
$400 000 would be applied to working capital.
OM 2, under the heading "Business Summary", contained disclosure similar to that in OM 1 of: the Pembina area working interest; the acquisition from Crazy Hill (now indicating that it had closed on 1 November 2004); and the participation in the Kirkpatrick drilling venture (now with a more extensive investment). It also disclosed that management was evaluating other opportunities and that proceeds would enable Arbour to hire competent staff to assist it in identifying "larger opportunities". OM 2 stated that with "proceeds in place prior to identifying larger opportunities", Arbour would be able "to negotiate from a position of strength". That
strong position did not materialize because Arbour sent the majority of those proceeds to Merendon.
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The Business Summary section also contained disclosure about the $10 Million Loan Agreement and the COREL transaction:
In August, Arbour entered into a loan/option agreement with an arm's length private Alberta company whereby Arbour agreed to loan $10,000,000 to the company with the option to convert the loan into an interest in proprietary oilsands recovery technology plus 5,000,000 Arbour common shares.
In January 2005, Arbour announced that it has acquired all of the issued shares of [COREL] for
$5,300,000 plus 5,000,000 common shares. COREL holds the master operating license relating to oilsands recovery technology and intends to build a commercial plant in the summer of 2005. Further plants will be built as opportunities arise.
OM 2 again referred to Arbour's 2004 AIF being incorporated by reference, although the 2004 AIF had still not been filed on SEDAR.
The disclosure concerning Arbour's principals continued to name Morice as president and a director, now holding 1.2 million Arbour common shares (8.6%); no description of his principal occupation or experience was included. Wigmore and Weis were identified as the other two directors and their Arbour shareholdings were disclosed.
The risk disclosure in OM 2 was essentially unchanged from that in OM 1.
OM 3's offering was similar to those in OM 1 and OM 2, but was for only up to 15 million Arbour Preferred Shares at a price of $1.35 per share for a maximum offering of
$20 250 000. OM 3 declared that 28 165 638 Arbour Preferred Shares had been issued under a previous private placement. There was again no minimum subscription level, and the closing date was to be 31 December 2005 or such other date as Arbour might determine.
OM 3 disclosed that, assuming the maximum offering were sold, selling commissions and fees would be $1 012 500 (up from $675 000 in OM 1 and OM 2) and offering costs would remain at $100 000. Assuming the minimum nil offering, both selling costs and, surprisingly, offering costs were disclosed as nil for both OM 2 and OM 3. The maximum net proceeds of the offering under OM 3 (assuming the sale of all offered Arbour Preferred Shares) were specified to be $19 137 500.
OM 3 now declared Arbour's intention to spend: $3.5 million of the net proceeds of the offering on "Acquisitions of further technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions";
$15 million on a "[w]ork program for Myanmar, if that acquisition proceeds"; and $637 500 applied to working capital. OM 3 (as with OM 1 and OM 2) stated that Arbour "intends to spend the available funds as stated and will reallocate funds only for sound business reasons". All three Arbour OMs also warned that there is "no assurance that alternative financing will be available", if proceeds from the offering were insufficient to complete all of Arbour's objectives.
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OM 3, under the heading "Business Summary", contained similar disclosure to that in OM 2 of: the Pembina area working interest; the acquisition from Crazy Hill (now stated to be in production); the participation in the Kirkpatrick drilling venture (now stated to be in production); the $10 Million Loan to the "arm's length private Alberta company" with an option to convert the loan into an interest in an oil sands recovery technology company; and the acquisition of COREL. It also stated that management was evaluating other oil and gas opportunities and that proceeds would be used to pay for such acquisitions. In addition, OM 3 included the following two new prospective acquisitions:
. . . On September 1, 2005, [Arbour] announced that it had concluded negotiations to enter into two substantial oil and gas transactions including offshore shallow gas concessions and a block of existing onshore oil wells. Both acquisitions are located in what is generally referred to as Southeast Asia. Arbour has first right of refusal to participate in other international bids being made in India, Africa, and the Middle East. Technical advisers are currently substantiating reserve estimates and, once completed, formal contracting will be carried out. This process is expected to be completed by the end of 2005.
Further to the negotiations concluded on September 1, 2005, Arbour has entered into a preliminary arm[']s-length agreement to acquire the Malaysian subsidiary of an international company. The vendor represents that the oil and gas assets being acquired have significant proven reserves and that it will arrange additional financing to carry out the initial development program. The subject properties are in Myanmar. Technical advisors are currently evaluating the data. Subject to various conditions, including due diligence review, Arbour has agreed to pay $25,000,000 plus 60,000,000 common shares [Arbour]. [20 394 538 Arbour common shares were disclosed as then outstanding.] [Arbour] cautions that there is significant work to be done before its board can determine whether it is in the best interests of the shareholders to proceed with this acquisition. Management is planning to make a site visit to examine the assets, while technical experts are reviewing existing engineering reports. Title to the property will have to [be] confirmed, as will the financial status and records of the target company. In addition, Arbour will have to confirm the existence and terms of the proposed financing the vendor is arranging to complete the first development phase. [Arbour] will also have to examine and then determine whether the foreign country risks are acceptable. Since the share issuance would result in a change of control of [Arbour], the agreement is also subject to regulatory and shareholders' approval which would take place at a meeting to be held later this year.
The disclosure concerning Arbour's principals and risk factors appeared essentially unchanged, except for updating the shareholdings of Morice, Wigmore and Weis and adding an additional risk factor:
(q) The oil and gas industry has experienced a high degree of invention and innovation. It is possible that new technology will be developed which will compete with [Arbour's] products and services.
Arbour filed Distribution Reports with the Commission for distributions stated to have occurred in every month commencing in September 2004 and ending in November 2005; the filing were made between 17 November 2004 and 23 November 2005. All but one of the Distribution Reports were filed outside the 10-day filing period mandated under MI 45-103 (and NI 45-106).
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Hobbs stated that "Morice was ultimately responsible for" filing the Distribution Reports, although she assisted with and prepared the filings by putting the information together and ensuring its accuracy. Hobbs explained that the Distribution Reports were filed late because "we were a very small company, and frankly, I -- there was a very large volume, and it was difficult to get caught up. And eventually, we did get caught up."
According to the filed Distribution Reports, and as noted above, Arbour raised approximately $45.5 million, including approximately $25 million from Alberta investors. The filed Distribution Reports stated that most of the sales in Alberta were made in reliance on the OM Exemption. The form item regarding commissions and fees was either unmarked or marked "Not Applicable", notwithstanding that the Arbour OMs disclosed selling commissions would be paid.
Once Arbour received money from selling the Arbour Preferred Shares, it almost immediately advanced the funds to Merendon, retaining only those amounts necessary for Arbour's operational activities, limited as they were. Morice described Arbour's use of the Arbour Preferred Shares proceeds as follows:
Q So [Arbour] didn't hold money in [Arbour's] accounts for long. You either used them for operational expenses, or you advanced them to Merendon?
A Right, yeah. I mean, normally we had a couple million dollars at that time at all times, you know, that was more than sufficient for what we were doing, and the balance was moved out.
As discussed above, even before the 14 July 2004 date of OM 1, plans were under way for Arbour to make the $10 Million Loan to Merendon – the Draft Letter of Intent had been circulated since at least 3 May 2004 and the Letter of Intent was signed in early July 2004. The first advance of OM 1 proceeds was made on 27 July 2004 to Merendon, well before 20 September 2004, the date Arbour reported as the date on which its first distribution closed. By the end of 2004 Arbour had raised over $11 million under OM 1, of which $10 million had been paid to Merendon.
A 3 July 2004 conversation between Sorenson and Hoffman on the Hoffman Tapes indicated that Sorenson was aware Brost had "a tremendous amount of money backstopped in the pipeline" of his public company, Arbour. Sorenson also stated to Hoffman that "all this looks like it's going to be a very lucrative month from where you and I sit today". We find that Sorenson was referring to receiving that "tremendous amount" of Arbour investor money soon after 3 July. In fact, as noted, the first advance was approximately 3 weeks after that conversation.
Between February and the end of November 2005, Arbour advanced further money to Merendon from the approximately $45.5 million proceeds of the Arbour Preferred Share offerings. As discussed above, $28.6 million of this money was eventually recorded as money advanced under the $45 Million Loan Agreement.
As noted, Arbour paid $2.76 million in 2005 and a further $1.344 million in the first three months of 2006 to the four COREL shareholders for Arbour's purchase of COREL.
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In summary, Arbour advanced approximately $42.7 million to Merendon and COREL – a company in which Merendon had a significant interest. This represented almost 94% of the money raised from sales of the Arbour Preferred Shares under the OMs.
Apart from paying significant money to Merendon, Arbour used the proceeds from the sales of the Arbour Preferred Shares to make other payments.
In 2005 Arbour paid approximately $257 000 of the proceeds realized from the sale of the Arbour Preferred Shares to Expedia for "Administration Services" (as noted, Morice referred to an oral agreement for Arbour to pay Expedia 1% of the money raised by Arbour).
Through 2005 and 2006, Arbour paid a net amount of approximately $1.9 million of the proceeds from the sale of Arbour Preferred Shares to its wholly-owned subsidiary, Arbour US.
Through 2005 and 2006, Arbour paid a net amount of almost $70 000 of the proceeds from the sale of Arbour Preferred Shares to its wholly-owned subsidiary, Arbour Caribbean.
Regier testified that advances of Arbour money to Merendon were made at the direction of Brost. Brost would instruct Regier, who worked for Expedia in offices next door to Arbour, to walk down the hall to Arbour's offices and ask Morice if Arbour had any money available to forward on to Merendon or to tell Morice how much money Brost was requesting be sent to Merendon or Sorenson. Morice would let Regier know how much money was available to send to Merendon. Morice never questioned Regier's authority to make these requests, and complied with them by preparing cheques and giving them to Regier. Regier would then send the funds to Merendon, along with distribution instructions (discussed below). Regier stated these requests from Brost would happen at least one per month, "as we got close to the typical redemption payout period".
Regier testified that initially when Arbour was beginning its fundraising, the amount sent to Merendon was based on what Arbour had available to send. Later, Brost informed Regier "on numerous occasions" that the goal was to get $2 million per month to Merendon. Regier did not know whether Brost had discussed this $2 million goal with Sorenson or whether Sorenson had provided Brost with a budget of how much money Sorenson needed.
Regier believed that the cash flow from Arbour to Merendon was being used for "SGD redemptions [to] SGD account managers" – those "IFFL members who made an investment in an IFFL-promoted company" and some of whom would have been Arbour preferred shareholders. However, Regier acknowledged that, although he understood Merendon had borrowed money from SGD pursuant to an agreement or series of documents, he had never seen those documents. He agreed that he had "no idea whether or not there were any contractual or other legal
obligations that required Merendon to be provided a total of [$]2 million a month by SGD" or by Arbour. Regier further agreed that it was Brost who dealt directly with Sorenson regarding how much money was to be sent and that Regier knew only what Brost told him. Regier did not receive any such information from Sorenson or anyone else at Merendon.
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A 24 March 2005 conversation between Hoffman and Sorenson on the Hoffman Tapes, seemed to substantiate Regier's belief that Merendon was receiving about $2 million per month from IFFL's fundraising activities. Given the date of the conversation, we conclude that included money raised from sales of Arbour Preferred Shares through IFFL. The conversation also revealed some of Sorenson's knowledge of IFFL:
Hoffman You know when we were--we were a small company and Milowe was small, he only had enough strategists that between you and myself we could keep--can keep their stories from getting too loud and we--now you can't meet everybody. Graham has no idea how many people he's got out there, he never hears from them and there's no way of--of couching what they're saying.
Sorenson Well do you want to know how many people there are? 59 structurists, 225 agents, 176 prospects. According to his business development [inaudible] they're writing an average of between 8 and 10 contracts per day for an average between 50 thousand and 100 thousand [presumably dollars].
. . .
Sorenson [inaudible] Let[']s take the lowest number 8 times 50 thousand, that's 400 thousand a day we'll just give them a 15 day month, 6 million dollars a month. Now 70% is what we get, that's 4 million 200 thousand dollars.
. . .
Sorenson Owen, we get half of that.
Hoffman The rest is going into those other projects.
Sorenson The cash flow right now for the last 3 months has been roughly about 2 million dollars, so where's the rest?
Hoffman Going into whatever wherever.
Sorenson Yeah. It's not coming, even those--those clients aren't even opening accounts in SGD. . . .
As noted, Regier – at Brost's direction – sent Arbour's cheques signed by Morice to Merendon along with a covering memorandum and distribution instructions that Regier created –again at Brost's direction – for Merendon to follow with respect to that money from Arbour to Merendon (the "Brost/Regier Distribution Instructions"). Regier stated that he received instructions about distribution and wiring funds from Brost only.
The Brost/Regier Distribution Instructions were sent from Regier to "Jack Wolfe" (Merendon's controller at the time) or to "Jack Wolfe/Karen" (apparently referring to another Merendon employee) or "Jack Wolfe/Jared Wolfe". Regier said that no one from Merendon,
Jack Wolfe included, ever questioned Regier's authority to send such instructions. Regier was unaware of anyone from Arbour being shown the Brost/Regier Distribution Instructions.
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The Brost/Regier Distribution Instructions included advice to Merendon as to amounts from the funds that should be sent to or retained for Brost-connected entities, including True North, La Conxion and Grovenor.
Regier had no documentation to confirm whether Merendon followed the Brost/Regier Distribution Instructions, although he said that the True North Arizona and True North Nevada bank statements would show money coming in from Merendon. Such bank statements were not produced. Brost never told Regier that Merendon was not following the Brost/Regier Distribution Instructions.
Gleason and Blakey both testified that they learned of the Brost/Regier Distribution Instructions some time later, then reviewed them to see if they had been followed. They concluded that two payments (totalling US$23 484) had been made to La Conxion in August 2004, booked as an advance to Eiger by SGD. These appeared to match the Brost/Regier Distribution Instructions relating to advances made by Arbour to Merendon dated 30 July 2004 and 5 August 2004. Gleason and Blakey both testified that their review satisfied them that other transfers listed in the Brost/Regier Distribution Instructions were not paid. Other payments were, however, made by Merendon to True North – purportedly credited against Eiger's indebtedness to SGD (discussed below).
Further evidence as to the disbursement of Arbour investment funds by Merendon was found in an undated handwritten memo from Jack Wolfe to Sorenson with the notation "Re: Disbursements. 1. Arbour [E]nergy Agreement" (the "Wolfe Distribution Summary"). The Wolfe Distribution Summary listed the dates money was received from Arbour between 27 July 2004 and 16 September 2004, the amounts received (totalling $3 610 000), and the amounts due to Grovenor (totalling $917 002) and to True North (totalling $412 879). These correspond with the dates and amounts set out in 18 January 2005 and 3 May 2005 summary documents (the "Brost/Regier Distribution Instructions Summary"), except for three differences: an apparent error in the Wolfe Distribution Summary in which a payment to Grovenor is listed as $108 966 instead of $198 966 (making the Wolfe Distribution Summary total $90 000 lower than it should be); a date of 27 July in the Wolfe Distribution Summary compared to 30 July in the Brost/Regier Distribution Instructions Summary; and the reference to True North in the Wolfe Distribution Summary in place of La Conxion from the Brost/Regier Distribution Instructions Summary.
The Wolfe Distribution Summary states that "[w]e have paid" $17 666 and $13 236 for a total of $30 902 (to be converted to US$23 484, as required by the Distribution Instructions). These are the first two amounts under the heading "Due to True North" in the Wolfe Distribution Summary and under the heading "La Conexion" in the Brost/Regier Distribution Instructions Summary. The Wolfe Distribution Summary then restates the "Balance due in Canadian funds" as $917 002 owing to Grovenor (as noted, that should have been $1 007 002) and $381 977 owing to True North. The Wolfe Distribution Summary is evidence that Sorenson knew Jack Wolfe, as Merendon's controller, was receiving Arbour money and some of that money was then
being paid to Brost (through La Conxion or True North) and that other money was to be paid to Grovenor.
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After the first two Brost/Regier Distribution Instructions, the instructions changed. The Brost/Regier Distribution Instructions associated with the second 5 August 2004 payment contained Regier's advice to Jack Wolfe that money payable to La Conxion was "to go to [True North] for the next while". Regier testified that Brost made that change and told Regier; Regier thought it was because "the banking for La Conexion was terminated for some reason". That wiring of La Conxion's share to True North continued through the rest of the Brost/Regier Distribution Instructions in evidence. The Brost/Regier Distribution Instructions associated with the 1 September 2004 payment contained Regier's direction that Merendon was now to "continue to hold the funds for Grovenor as instructed". Those instructions also continued.
Consistent with Regier's revised instruction that money for La Conxion was to be wired to True North instead, Merendon's banking records showed that from the first $10 million advanced to Merendon by Arbour, payments were made to True North in 2004 in the amount of US$473 554.75.
There are no Brost/Regier Distribution Instructions after December 2004. Regier said that this was because Strategic began raising money, and that money was then sent to True North to pay SGD redemptions.
The Brost/Regier Distribution Instructions Summary summarized the distribution of the
$10 Million Loan: 59.42% ($5 942 259.14) to Merendon; 7.59% ($759 061.98) to La Conxion; and 26.09% ($2 608 680.88) to Grovenor. Although Regier testified that the Brost/Regier Distribution Instructions Summary looked like a document he prepared, he stated that the handwriting on the 3 May 2005 version was not his, nor were the percentage calculations on the right side of the document.
Throughout 2005, Arbour investor money continued to be advanced to Merendon. Merendon's US bank account records for that year show transfers of almost US$3.2 million from Merendon to True North.
Regier testified that Arbour investor money that ended up at True North went to a US bank account "to be distributed by M.B. Gonne" (Brost). The "funds were used for SGD redemptions" to anyone with an SGD account. Although the "potential existed" and Regier was "90 percent confident" that some SGD redemptions went to Arbour investors, he gave no proof of that.
Sorenson did not deny the payments to La Conxion, but attempted to justify them. According to Sorenson, Jared Wolfe had mistakenly followed Regier's instructions to make the payments to La Conxion. Sorenson, after learning of these payments to La Conxion, said he contacted Brost and told him there was no reason for La Conxion to have that money. Brost agreed to credit the two payments against the SGD loan and the payments by Merendon to La Conxion were "reversed", with the effect that neither of the La Conxion payments directed by Regier ended up being made.
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Sorenson said that all funds coming from, or going to Grovenor, Steller or True North were either capital loan receipts or payments. Sorenson explained that since Merendon (through Sorenson) owed money to SGD and True North (through Brost) was "administering capital loan repayments" for the SGD program, Merendon could retire a portion of its SGD debt by paying True North directly – what Sorenson termed "capital loan repayments". Sorenson did not point to any agreement between True North and SGD allowing for this or any written confirmation from either SGD or True North to Merendon of payments or corresponding reductions in Merendon's debt to SGD.
We reject Sorenson's testimony on these matters. We find that he well knew portions of the Arbour investor money sent to Merendon were being paid to La Conxion and True North. We accept that Sorenson may not have been aware of the exact amounts or mechanics of the Brost/Regier Distribution Instructions, but we are convinced – and we find – that he was aware of the existence and implementation of the Brost/Regier Distribution Instructions.
The Brost/Regier Distribution Instructions and Merendon banking records available do not reconcile completely. Perhaps the conversion between Canadian and US dollars was a factor. Perhaps not all of Brost/Regier Distribution Instructions were paid as directed. However, we are satisfied from the evidence as a whole that the Brost/Regier Distribution Instructions were generally followed and were a critical part of moving the Arbour investor money to Merendon and, through Merendon, to other Brost/Sorenson Entities.
Merendon banking records reflected transactions that further evidence connections between Brost and Sorenson. For example, one statement showed a $100 000 payment to IFFL. Another statement showed incoming wire transfers on 3 and 4 August 2004 – depositing
$330 310 and $300 000, respectively, into the account.
We are satisfied on the balance of probabilities, having carefully reviewed the whole of the evidence, that Morice became involved in Arbour and its transactions as the nominee for Brost and Sorenson. We so find. We also find that Arbour's corporate transactions – namely the offering of Arbour Preferred Shares under OM 1, OM 2 and OM 3 and the purchases of COREL and Merendon's TRL Shares – were planned, initiated, controlled and directed by Brost, Sorenson or both. Morice was guided and instructed at various times by or through Brost or Sorenson (primarily Brost). We reject Sorenson's contention that he never spoke to Brost about business transactions with Arbour.
Some effort was made in cross-examination and in argument to establish the extent of Morice's role – acting independently or purely as a nominee of Brost or Sorenson. We do not believe that Morice was as naïve as his counsel would like us to believe, and we did not have the benefit of his direct testimony. However, it is clear – and we find – that Morice initially acted as a puppet with the strings being pulled by Brost, Sorenson or both. Later, however, Morice realized (or should have realized) what Brost and Sorenson had planned and executed for Arbour and Merendon, but did nothing to stop the flow of investor money to Merendon, money which eventually flowed to other Brost/Sorenson Entities.
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Five investor witnesses testified at the Merits Hearing, all called by Staff. All gave evidence regarding their interaction with IFFL; only some had purchased Arbour Preferred Shares. Staff also called a sixth witness – LB – who was not an IFFL member or investor himself but testified regarding investments made through IFFL by his parents. Also in evidence were transcripts of Staff's interviews of other investors. These individuals did not testify so were not cross-examined and some of the interviews were not taken under oath. We placed no weight on this transcript evidence, given the circumstances.
LB was not a member of IFFL and did not invest in Arbour Preferred Shares. However, LB's father, AB, (a retired Manitoba farmer, who was approximately 75 years old at the time of his Arbour investment) and mother were members of IFFL and did invest in Arbour – with the investments in AB's name. Because the documents and testimony before us refer to AB, we use only his name rather than his and his wife's names.
In the course of assisting AB – according to LB, he had an authorization to assist AB –LB learned some information about both IFFL and Arbour. LB attended three IFFL "information sessions", which were for non-members and existing members. LB understood that Brost established and operated IFFL, which was purporting "to be an educational process". LB agreed with characterizing Brost as the "kingpin of the IFFL".
LB said that people called structurists would explain "investment opportunities", then "facilitate the purchase of . . . investments . . . through the IFFL". After the information sessions such as the ones LB attended, both members and non-members would have the opportunity to attend "one-on-one meetings" with a structurist to discuss "about becoming either a member or making a new investment or coming to understand better about the investment they had made through the IFFL". LB attended a one-on-one meeting with a structurist because LB was considering becoming a structurist. LB said the structurist explained to him:
. . . how [IFFL] worked and how a person, if you became a structurist, could make hundreds of thousands of dollars from the fees that were -- that were coming off the investment. And that fee structure was based upon the amount of money that a person was able to bring in. So if you were a structurist and raised one or $2,000, there would be a certain fee; and then if you raised a million dollars, there would be more of a fee that you would get, that within a year, you could be making a lot of money [as] a structurist.
LB further described what occurred at the sessions he attended:
Well, at the sessions they would explain to you -- the structurists would explain . . . for example, would explain how the process worked and would talk about, for example, a gold mine in Honduras and how there were high rates of return for this and how you would make an investment on the Canadian side, and the money would somehow then flow over through this management process to the international side; and . . . there were different opportunities. For example, there was the gold mine opportunity, there was a bad debt collection opportunity, all of which had varying degrees of high rates of return. And that if you wanted -- so he would describe those --those specific opportunities, and then if you wanted to invest in those, you had to be a member.
So if you weren't a member, you'd have to become one. And if you were a member, then you would talk to [a structurist], and [the structurist] would sort of facilitate the process.
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So you would then learn about specifically what you were going to be purchasing. In this case, it would be Arbour that [AB] made his investment in -- the first one was Quattro. But [AB] would have learned about the specifics, like the name. And the documentation would have been processed following the meeting. But the opportunity was described in the course of the meeting, so talking about the gold mine, how you could go down and visit the gold mine, how he actually had a little bag of gold that you could see that, you know, it had all seemed very open and very transparent and very attractive.
LB understood that structurists earned money in two ways: from signing up individuals as members, and from member purchases of securities promoted by the structurists. LB's clear understanding was that structurists were paid a small amount of money for recruiting members but that they earned their "real money" from selling investments promoted by IFFL.
According to LB, AB first invested through IFFL after learning of IFFL in, most likely, early 2003 through an individual who later became a structurist. AB invested $50 000 in Quattro in August 2003; he was an IFFL member by then, as membership "was required" before investing.
AB made his second investment through IFFL when he purchased Arbour Preferred Shares in August 2005 after learning about Arbour from an IFFL structurist. AB told LB that he was given all the information about the Arbour investment, including the identity of Arbour, during his one-on-one meeting with the IFFL structurist and told his son "that's the only place I would know about it".
LB said his father was attracted to the Arbour investment not only by the prospect of high returns on the international side, but also "a representation of what was a pretty solid rate of return on the Canadian side. So there [were] both sides, because he was going to be getting 7 or 8 percent a year on Arbour, and that was going to accumulate". LB stated that the international side was to have a return "closer to about 30 or 40 percent", which he agreed was "a significant inducement for an investor". LB was never satisfied with the explanation of how one investment could have both a domestic and an international side, particularly since a significant amount was deducted for commission fees – leaving a lesser amount to be divided between those two sides. LB did not know why his father thought the rate of return would be 7 or 8% on the Canadian side when section 5.1 of OM 2 referred to a dividend rate of 5.75%.
LB understood "that the offshore side had a gold mine in Honduras" that could be visited
"they were doing very well, and they had these very high rates of returns; and these high rates are not uncommon in the international investment arena . . . this was not unreasonable internationally". LB said that Merendon was not discussed at the information sessions, as the specifics discussed at those meetings mentioned no names (for example, references were made to a mining property in Honduras):
. . . They would have described the mining operation [at the information sessions], and then you would have learned about that, I guess, as a one-on-one member afterward. I learned about it through -- partly through my father and his documentation, and through my work tracking down official legal documents.
. . .
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. . . at the meetings, [IFFL structurists] would talk about a specific company, not gold mining in general in Honduras -- a specific company in Honduras. Not naming it, but they would talk about a specific investment opportunity. So the meetings weren't generally about gold mining in Central America, they were about a specific company in Honduras without naming that company. That's the distinction I'm making between general and specific.
LB thought that Merendon was "on the international side of where this money was going". LB did not know which Merendon entity Arbour had investments with or what type of investments were involved.
AB received OM 2 (dated 19 January 2005) and a subscription agreement for his August 2005 investment in a 5 August 2005 letter to him on Arbour letterhead from "The Arbour Team". AB was asked to return the completed subscription agreement by courier to Arbour at Arbour's expense. AB's subscription agreement showed his initials next to the "eligible investor" category of net assets over $400 000 or net income before taxes over $75 000 (or, with a spouse, over
$125 000) in the most recent two years. AB completed a "Risk Acknowledgment" form acknowledging the Arbour investment was "a risky investment". That document and the bank draft from AB to Arbour for US$50 000 (converted to $60 345) are dated 15 August 2005. LB did not know why the subscription money was paid in US funds when the OM 2 amounts were in Canadian funds. LB acknowledged that OM 2, received by AB, said nothing about an international account, nor about any transactions between Arbour and Merendon. AB received an Arbour share certificate for 45 000 "Preferred Series 1" Arbour shares dated 16 August 2005. AB never received a share certificate for the international side of his investment. Apart from receiving such documents or correspondence, AB did not deal directly with anyone at Arbour.
AB had been given an online account for his international investment. The account "would show [AB] how his money was growing at these very high rates of return" – at one point AB believed he had $177 000 in his international investment.
LB understood that of the approximately $60 000 AB invested to buy Arbour Preferred Shares, 40% would be taken for "fees" and commissions, with the remaining 60% (or $36 000) going to the international side and the same amount somehow staying with Arbour. He said that "it seemed to be represented to go through some kind of a process to result in parallel investments, but I didn't understand how that could happen".
LB and his brothers were concerned when they learned, several weeks later, about AB's Arbour investment. LB described his concerns:
The concern was that this whole scheme, or what seemed to me to be a scheme, seemed not legitimate. It didn't make sense that you could make an investment on the Canadian side, and so if you purchased $50,000 Canadian, that you would have a 10-year investment there, that somehow money would go over to the international side, and you would be a manager under that construct; that you would be making money as a legitimate investment on the Canadian side -- like, in this case, with Arbour -- and then at the same time, your money would be working on the international side, while concurrently 40 percent or some significant portion of the initial investment had been taken off in the form of fees. So the math didn't work.
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And -- and there was a . . . sort of a sense of secrecy around the whole -- the whole process, because at meetings there would be representations that, you know, the government didn't want to support the little guy, that the Securities Commission was out to get the company, the company wasn't doing anything wrong, that the IFFL was sort of being targeted as a victim in all of this as well.
So all of that to me didn't sit well, and it wasn't someplace that I wanted my father and my mother to be investing their limited life savings.
In July 2007 (well after AB's investment in Arbour), Brost spoke at an IFFL session attended by LB's parents in Winnipeg. LB, who was not present at the session, spoke to them immediately after the session. LB's parents told him that the issues surrounding Arbour and IFFL were being addressed, that the Arbour investment was still very promising, and that Brost told investors they could take their money out if they wished, but that he did not encourage redemptions because investors would forfeit the very attractive returns. According to LB, AB "felt reassured" and believed "that everything was being dealt with".
AB received some money back through a withdrawal process that had apparently been set up by IFFL. AB was required to purchase a debit or credit card for $3000. AB could then use that card to withdraw funds from his investment, but only in specified "standard increments". LB was unsure to whom his father paid the $3000, but understood that a structurist had facilitated the withdrawal process. AB withdrew $1500 using the debit card, but that was the only money that AB was able to withdraw. Apparently the process for withdrawing funds changed, requiring an application to withdraw funds that had to be approved.
AB submitted an application to withdraw $60 000 but delays started to occur and no money was paid to him. When AB made his withdrawal application, his online account statement showed that $60 000 had been withdrawn from his account, although AB never received that money.
In the course of trying to recoup his parents' money, LB spoke with Hobbs in early August 2007. LB spoke with Hobbs "to understand the Canadian side" of the investment; she confirmed that Arbour received most of its initial funding from IFFL members. Later on, LB decided to pursue both IFFL and Arbour for return of his parents' money because, as he explained:
Well, by the time I wrote the second letter or the letter to Carol[e] Hobbs, I was putting them all [IFFL and Arbour] together and saying . . . my father wants his money back. I recognized by
that point that, I believe, that there was a -- there was a strong connection between the two, that they were inseparable and untangleable, in my -- as I understood, and so I was asking for money back from Arbour, and referencing IFFL. I was asking for money back from people who were Syndicated Gold that were connected with IFFL, and I just was asking anybody, who had some form of representation on this investment, for the money back, and I was connecting the dots. So I was referring to other people who I understood to be connected to these relationships, because I wanted them to understand that I knew there was -- that there was a relationship between them, and it didn't matter to me where the money came from; we just wanted it back.
. . .
And I was wanting my [father's] money back from Arbour because I felt that my father had made an investment in Arbour, and that in itself should be a self-contained investment that I could deal with on the terms of a legitimate investment as it was intended to be and was represented to be. . . .
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A structurist gave LB the telephone number for Forrest who worked in "the Belize office" and apparently could "help me facilitate a withdrawal". When Forrest told him she would need the approval of Werner, the president of SGD, LB concluded that the Belize office and Forrest were part of SGD.
LB and his parents had many communications with various people while attempting to obtain a refund of AB's investments: a 10 August 2007 fax to Forrest, copied to Brost and three structurists; a 16 August 2007 fax to Werner as President of SGD; a 22 August 2007 fax to Hobbs, copied to Brost, Forrest, a structurist and an auditor for Arbour; and a 24 August 2007 fax to two structurists, copied to Brost and Forrest, advising that "Martin Werner, who represented himself to me as the President of SGD, has agreed to immediate release of [AB's] funds. He was to communicate this direction to Edna (Forrest)"; and a 5 September 2007 fax to IFFL to the attention of Brost and two structurists. LB himself had at least two conversations with Werner in approximately August 2007 requesting a refund of his parents' investment.
In apparent response to the 24 August 2007 fax, LB received, in approximately September 2007, an undated letter on IFFL letterhead from "Phil Lievers Office Manager". The letter informed LB that he would not be dealt with because he was not an IFFL member, would be barred from ever being an IFFL member, and would potentially be the subject of a defamation action if he contacted the IFFL office in the future.
LB acknowledged that he never contacted Merendon or Sorenson in trying to recover his parent's investment, nor was LB aware of anything that would lead him to conclude that AB had a contract with, invested in or sent money to Merendon.
KA is a Calgary resident with "average" investment knowledge – his Arbour and IFFL experiences were his "main venture into investments". He became an IFFL member and a "facilitator" – KA described as the moniker given to those whose encourage others to join IFFL. KA was introduced to IFFL by his daughter who knew Brost and some of his family members and had invested $10 000 through IFFL and "on paper [was] doing very well".
KA, who attended a small IFFL workshop in Calgary, explained what an IFFL structurist told the group:
They went through just what typical investments are and what they will earn you for interest. And then they talked about what they had available as an international and that the interest rate was a whole lot higher, and that it was open to -- where -- we were told sort of that this is where banks made their money, and so forth, is going into these higher interest rate investments. And this way, through them, they could show us how to take advantage of these companies with our investments, and that we could actually be -- we could invest domestically, and then that we would be given international accounts that we could manage.
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KA became an IFFL member after the workshop, was given a book of information and signed "their nondisclosure agreement". KA said that, although not encouraged to do so, investors could bring an accountant or someone else to the meeting – "if you wanted to have . . . somebody else look over this stuff, you had to bring them to a meeting so that they could sign a nondisclosure form first".
KA subsequently attended a further small meeting, then a larger one with approximately 40 attendees and several speakers, including Brost. KA understood that Brost was the CEO of IFFL. At the latter meeting, there were more details, including IFFL's role of "trying to teach people how to become financially independent -- financially free" and that "if you became a member, that their knowledge would be available to you". KA said that at the large meeting IFFL members were given a list of, he estimated, 10 specifically identified companies, some of which offered the "international" side – the IFFL List of Companies. KA explained as follows:
. . . at that time, we were given a sheet of paper, and it had the names of different companies that you could invest in, and then there [were] some brochures that corresponded to the names, that you could read some of the information on. Some of them had information, some of them didn't; but they all had websites, I believe, that we could go to.
. . .
The only one I do remember was the Arbour one [KA later remembered that Arbour was mentioned not at that time but at another large meeting approximately a year later], and that was the one that I was interested in because they -- they talked about their oilsands recovery technology, and that one sounded -- well, oilsands [were] new at that time, and it looked like a good plan that they had. It was a way of -- basically they said that the technology was going to enable them to extract more oil from the sand than the current technology and that they would be able to use it for actually refining oil and also doing cleanup . . . .
. . .
[The companies referred to] were ones that we could invest with domestically, and then from
there, there would be an account set up internationally that would be earning a higher interest rate that I would become a manager of.
KA explained his understanding of the investment that offered both the domestic and the international or managed account side:
The way it was explained to us was that when you do an investing normally -- and this was done at a workshop. So when you normally invest into, say, a bank and you put in $10,000 and you get an interest rate back from them of whether it is a GIC or something, but you get a -- you get an interest rate back that's comparable to the market. But the bank takes that money, and they reinvest it into other -- other places that -- that earns them a considerably higher interest rate, which is why they pay us a lower one, so they're making profit on it.
And that when we were investing with these other companies, like Arbour and the Rapid Express, that's what they would be doing is they had access to other foreign markets and other places to invest the money where they would be getting the higher interest rate. So even though -- so I give them [he meant Arbour] -- I invested this money. They're probably going to reinvest it the same way a bank would. They would realize the profit from that, plus we would get the other profit that
-- we'd split -- sort of split the profit with them. And that's the way it was explained to us.
[One thing discussed on] the international end was the SGD, the gold fund, and that was --Merendon was mentioned with that. And at the -- at the beginning, that was about the only thing internationally that was available. And then other things came available after that, as well as the SGD.
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KA recalled that the money invested on the international side was used to buy what IFFL told members was "discounted gold that was stockpiled". He agreed that "gold was something that was pushed pretty hard at the IFFL meetings as being a very secure form of investment" and which, he said, added credibility to the investment:
. . . There was a lot of talk about how the how the gold markets worked and stuff. They even had these little packages of -- with a gold bar in it and different forms of gold that were -- I believe they were -- they were supplied by Merendon because they had a stamp on the gold bar. I believe it was a Merendon seal on it.
. . .
Structurists . . . usually had them in their briefcase, when they were giving presentations they could bring them out so that you could handle them.
. . .
Certainly also made the whole idea of gold being a solid investment when you'd be able to handle gold. I mean, they had this stuff around, enough so that you could actually be carrying this stuff with you and showing it to people. It -- it sort of helped to lend credibility to the whole idea.
KA said that Merendon was brought up at some workshops as "one of the places that –when money went internationally, that it was a place that would be able to give the higher interest rates back", and there were "brochures about Merendon and some of the companies or some of the things that they had". He assumed that Merendon and SGD "were the same thing".
KA conceded that another attraction to the RRSP-eligible international investments identified by IFFL was that they provided a vehicle for seemingly having tax-free RRSP money remain in Canada (for example, invested in Arbour Preferred Shares) when the money had actually been moved offshore and invested in an entity (SGD or Merendon) that provided significant rates of return from the international market. KA agreed that the IFFL culture promoted a distrust of government and the banks, as he discussed in the following exchange:
Q . . . I'm going to suggest is the culture of the IFFL, kind of drew you into that whole belief system.
A Yeah.
Q And by which I mean, look, if the banks can do it, I can do it; if the rich can do it, I can do it, that kind of thing?
A Well, that's what we were told, yes. And it wasn't breaking the law, it was bending it. It was making the law work for us. That's what we were told.
KA agreed that IFFL was "actively involved in orchestrating your investment", and brought the opportunity "to your attention, they advised you to make it, they assisted you in
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executing the making of that investment". However, KA resisted the suggestion that IFFL told him he "should take a mortgage on [his] house and that [he] should convert [his] RRSPs and [his] pension to the investment in Arbour". KA said that "I made the decision that I was going to make the investment and I was going to put everything I had into it. I think they were very careful about doing that."
KA's first investment was in Rapid Express for $125 000, funded with a home equity loan, which was "[o]ne of the strategies that the IFFL told us about". KA's recollection was that Rapid Express was the only available investment at the time that "you could invest domestically with, . . . and access the international side of the investment". As he was only interested in the international side, he would not have chosen any company on the list that did not offer that side. A structurist assisted KA in filling out the investment paperwork.
Approximately one year later, KA received another list of companies, with some of the companies offering the "international" aspect, but only one company – Arbour – was an RRSP-eligible investment that also offered the international side. KA was interested in Arbour not only because of its oil sands technology but also because he could use his RRSP and pension money to purchase the Arbour Preferred Shares; he stated "it was the only thing that they had for registered funds to be able to take advantage of the international market again". KA also acknowledged that the 3% per month from the international side was "a significant inducement or encouragement for [him] to invest through the IFFL". KA understood that Arbour had its own legitimate business from which he would realize a return, but did not understand exactly how money would be moved into another company – "whether it would be a loan or an investment or whatever". He understood that "a bit got left in Arbour, but the bulk went into that international account".
KA received an Arbour OM (given the date of his investment, it would have been OM 1) and Arbour subscription agreement before purchasing Arbour Preferred Shares. Those documents were given to him at the IFFL office. He recalled reading "the page about the risk, the high risk" of the investment and questioning his structurist about those statements of risk. KA's structurist assured him "that any investing you had to do with -- with a company, they had to disclose that it was a high risk, and you had to understand that" and also "claimed that there was very little risk involved". KA did not read the whole offering memorandum because he "didn't understand a lot of it" but "it didn't really matter" because he had already decided to invest in Arbour and buy the Arbour Preferred Shares. KA did not speak to anyone at Arbour before investing.
KA purchased 128 821 Arbour Preferred Shares for $173 908.35 and received an Arbour share certificate dated 10 September 2004. KA made a second purchase of 49 435 Arbour Preferred Shares for $66 737.25 and received a second Arbour share certificate dated 10 September 2004. KA made a third purchase of 1777 Arbour Preferred Shares for $2398.95 and received a third Arbour share certificate dated 8 March 2005. KA's total investment in Arbour was approximately $243 000.
KA said that after his investment in Rapid Express and Arbour, he was given a choice of where he wanted the money to go in the offshore-managed account. His "choice" came to him
through "a paper package that came from the office in Belize" (or what he was told was an office in Belize) to the Calgary IFFL office. KA attended at the IFFL office to complete the paperwork that would set up the offshore-managed account and left the completed paperwork for further handling by IFFL. He explained how the managed account process worked:
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. . . is this is what you're asking, did I know that it was going to go into Syndicated Gold when I first made the investment with Arbour or with Rapid Express, no, I did not. I knew that there was going to be some type of an account that we would be -- that I would be managing, and I didn't know what form it was going to take until it arrived.
. . .
Well, we received the statement on it, and then you had the options of taking that, because it all came out as SGD, first of all, and then reassigning it to other things that were -- like the Tena Gold. There was about four or five of them, so you could take them and redistribute the money into other accounts if you found the one that was going to be -- that would be more profitable.
KA explained that Arbour would somehow – he did not know how – deposit the principal and interest into his SGD offshore-managed account. He said he was told:
. . . that it was like putting money into the bank, but instead of a bank, it was within Arbour. Arbour reinvested the money into a higher interest, and that's where the account came through --became an international account, because that's where they were investing it, and we [KA] were managing that.
KA said that IFFL members were advised by IFFL that because they were managing offshore money they need not disclose the gains on the money in the offshore account to Canada Revenue Agency. He was also advised that, because of a "rule change", IFFL was looking at a restructuring – IFFL would "reassign the money" and investors would become "limited partners", but even then with having to pay tax on the investments "you were making so much -- there was so much money there that it didn't matter to have to give the government [its] due".
KA received monthly statements under SGD letterhead by mail, then later through the internet. Although the statements eventually stopped, they did show his investment growing significantly, with substantial accrued interest.
KA said he did not receive any "returns" on his investments, although he made redemptions from his offshore-managed account when there were "rumblings . . . that things weren't working out". KA redeemed $1000 a month for about 12 months for a total return of approximately $12 000. KA withdrew the money from an ATM machine using a debit card or credit card issued under a "business expense program", which was the mechanism IFFL set up for investors to access money from their offshore-managed accounts. He recalled having two different cards (an original and a replacement), one of which was under "Nordic" (apparently "Nordic Merchant Credit Union"). He did not recall paying for the card. KA also received a payment of $1000 after a cousin he introduced to IFFL invested (perhaps $25 000) in Arbour.
KA recalled Sorenson participating in some of the IFFL conferences. KA met Sorenson at an IFFL conference in Calgary some time after investing in Arbour. KA knew that Sorenson was the president and CEO of Merendon and owned "Merendon Mining". At the time, Sorenson
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gave what KA described as "sort of a pep talk and thank-you" to the IFFL membership –"congratulating the members for the wonderful work that they were doing, the IFFL members, and the money that they had brought in for investing". KA did not recall other specifics of Sorenson's talk, although KA did say that during Sorenson's talk and at the IFFL meetings or conferences he attended, there was never any talk of making an investment in Merendon. KA said that Sorenson never mentioned Arbour. KA was less confident regarding SGD, but thought Sorenson may have mentioned SGD in the course of praising IFFL members. KA did confirm that no one from Merendon spoke to him about the return on his Arbour investment – he only received this information from IFFL personnel.
KA was under the impression that Brost did not want anything to do with Arbour; Brost told KA that Brost "was never going to be part of Arbour, that it was an arm's length company, and that that's the way it was supposed to be".
KA worked for Capital Alternatives (from about spring to December 2005) – his boss there, whom he never saw, was Martyn. He was later employed by Expedia from approximately early 2006 to the winter of 2007. At Expedia, KA reported to Casey Brost and Regier.
KA received a letter from IFFL (the "Anti-Regulator Letter"), similar to a letter in evidence signed by Brost as CEO of IFFL and titled "Confidential Communication, from the des:k [sic] of the C.E.O." and copied to, among others, "Merendon Group of Companies". According to KA, the Anti-Regulator Letter was sent to IFFL members during the time when people were unable to access their offshore-managed account money and IFFL was going through some changes. KA identified a passage that read:
Information shared by a member will be utilized by the ASC investigator to build a case against myself and the IFFL. There is however an unseen opportunity and that remains the power of your rights! For example, you do not have [to] respond to their calls or communications. You can choose to see any inquiries as a threat to your personal and financial well being, you may choose to either disregard their efforts or choose to conduct yourself in an uncooperative fashion. [Emphasis in original.]
The letter continued:
I/we cannot and will not tell you what to do, however, having fought these battles over the years let me share one unmistakable fact, anything that you say in response to a Securities Investigation' [sic] can and will be used against the IFFL and then you the member' [sic]. . . .
At the time of the Merits Hearing, KA – in his fifties – had returned to work: "I can't ever see myself ever being able to retire again. I owe 124 grand on my house, I have no pension, I have no RRSPs, I have no savings; and I will be working until I die."
DR, a Calgary resident with "middle of the road" investment knowledge, had an enduring power of attorney (along with his wife) over the affairs of his step-daughter, KO.
DR was introduced to IFFL in 2003 by an investment counsellor he had known, who asked DR if he wanted to look at something for which DR could achieve better returns – "in the
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neighbourhood of 30 percent a year". That "something" was IFFL. After learning that IFFL "was basically an association of people who were being taught to invest in . . . different ways", DR attended a presentation in approximately July or August 2004 run by an IFFL structurist –"no specifics were talked about at that time". DR and his wife then decided to join IFFL for an initial fee of approximately $1600, with subsequent annual fees of about $400. His stepdaughter KO also became an IFFL member. DR acknowledged that he was attracted to IFFL initially because of the stated potential for a 30% return.
After DR and KO joined, DR and his wife attended a second IFFL presentation that "talked about more specific investments, investments that would have a Canadian component to it as well as an offshore component":
[T]hey talked about some investment strategies where you could put money into Canadian organizations, and a portion of that money would be forwarded to some offshore investments. There was a gold company, an environmental company, one for buying bad debts. There [were] a number of different offshore investments that were there, as well as a number of different Canadian opportunities.
DR received a version of the IFFL List of Companies containing various company names, all of which he (erroneously) believed offered the offshore investment. From the list, he only remembered the names of the two companies in which he invested – Arbour and Rapid Express (approximately $140 000 in Rapid Express). DR said that he was told to conduct his own research on companies in which he was interested in investing. DR could not recall if he was "steered away from the recognizable companies [on the list] and steered towards the unrecognized ones".
DR did not consider that IFFL "advised" him to do certain things or take certain steps, rather he "was told the process to follow" and had to take the steps himself – IFFL "made sure I did everything myself".
DR decided to purchase Arbour Preferred Shares for himself and KO after satisfying himself from reviewing directories that Arbour was "real", the information on the website "fit in with what I knew about the oil patch operations" and that the Arbour investment was RRSP-eligible, which was a "key aspect for myself and also [KO]". DR "felt comfortable" at the time with investing in Arbour. He did not recall doing due diligence on any other company from the IFFL List of Companies other than Arbour.
IFFL advised DR to contact Arbour if he was interested in it as an investment and Arbour would send him a package. DR contacted Arbour and Arbour mailed him the subscription agreements and OM 1. DR read OM 1 and that confirmed his decision to purchase Arbour Preferred Shares. He considered the Arbour investment a little high risk, but thought "it was a legitimate investment" with a chance to provide a return.
DR purchased 12 210 Arbour Preferred Shares for himself personally for which he paid
$16 484 with RRSP money, with $9933 being directed to his offshore-managed account and only
$330 remaining with Arbour. DR's expectation was that the interest on his Arbour investment would accrue on the approximately $16 000 not the $330. DR also invested approximately
$140 000 in Rapid Express through IFFL. DR understood that IFFL took "a cut" of DR's original investment money for various purposes – as commissions and to "defend you, if necessary, against regulators".
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On or around 7 September 2004 DR purchased for KO, under the power of attorney, 905 Arbour Preferred Shares for a purchase price of $1221.75 and on 2 October 2004 a further 58 143 Arbour Preferred Shares for a purchase price of $78 493.05. DR said there were two separate investments because the money came from KO's two separate RRSPs. KO received two Arbour share certificates for both investments on 17 November 2004.
DR understood that "IFFL has an arrangement with Arbour and other companies that basically allowed them to take a percentage of what I had invested and put it into SGD or other offshore investments". DR explained that he understood the Arbour investment provided "a vehicle for investing funds in Canada", with some of the money remaining with Arbour and some of the money being forwarded to an international investment, which in his case was SGD. DR understood that "the largest portion of the monies that were put in wound up in an offshore investment" – here SGD – and that the offshore investment was reflected in the SGD statement that he received. DR also understood that Arbour or Rapid Express "would also invest in similar investments like I was investing in, to wind up getting the returns to pay me back the amounts that they said they would -- in the case of Arbour, it was 5.75[%] in 10 years". DR acknowledged that OM 1 did not disclose that money raised was being forwarded by Arbour to SGD; he had learned of that through IFFL structurists. DR recalled filling out some forms for SGD shortly after his Arbour and Rapid Express investments.
DR believed that his offshore-managed account, with "whatever dollars were in it" was backed by gold because: SGD was the relevant entity; IFFL meetings " talked about a gold mine that was going to make us all rich"; and he had actually "talked to people who had gone down and seen the mine". He understood:
[T]here was enough gold in the ground [somewhere in South America] that had to come out and obviously be processed and mined, but the value of the raw materials in the ground far exceeded what investment monies that we had there. . . . [T]here was a mining company someplace. I thought the management organization was SGD.
DR did not recognize the names Merendon, La Conxion, Grovenor or True North, nor was he aware of the possibility his Arbour money would be directed to any of those entities. DR had no dealings with Merendon or Sorenson with respect to DR's Arbour investment or SGD account. DR was never told that "Merendon Mining" was backing the SGD account. DR also did not know if the reference he remembered at an IFFL meeting to "Merendon Mining" referred to "Merendon Mining Corporation Limited or Merendon Mining, a U.S. entity".
DR received a "token" of SGD shares for referring KO to IFFL, although he did not learn of that compensation program until after KO invested. DR's 31 January 2005 SGD statement reflected a credit of US$421 to DR for his referral of KO.
DR received regular monthly SGD statements by mail, then later through email. The statements eventually stopped, and DR was told his funds were "being transferred into a vehicle
that would allow you to wind up getting your money back out on a regular basis, and it was a Canadian-held vehicle", but he could not remember the name.
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Over approximately 12 to 18 months, DR withdrew $30 000 from his offshore-managed account in various ways, including a debit card for which there likely was a fee and bank drafts. None of KO's money was taken out. DR acknowledged that there was nothing in OM 1 indicating that he would get money back that way. DR had that expectation because of the international side – "my understanding was that the Canadian sources would be paid out over a 10-year period of time, like the Arbour Energy shares, the Rapid Express; and the international investments could be cashed at any point in time".
After making his investments, DR attended other IFFL meetings at hotels in Calgary that were for the general membership and conveyed "an update, state-of-the-union message delivered by Milowe Brost, and Arbour was discussed at that point in time". Brost, whom DR understood to be "the head of IFFL", reiterated that Arbour was under investigation by the Commission, was "fighting it vigorously" and "believed that they were going to win". DR did not recall Sorenson speaking at those meetings.
DR responded to a 16 September 2005 letter from the Commission by giving responses in the negative to all questions relating to whether he had received any advice from or invested through IFFL. However, he testified that he responded that way to "an unsolicited letter from [a] regulator who at that time I believed was not working [in] my best interests, and this was just a kiss-off, 'get lost' kind of thing, none of your business". DR confirmed that legal representation and certain legal fees (in unsuccessfully challenging the Commission's ability to interview him and relating to a subsequent interview) were arranged and paid for by IFFL.
Both DR and KO experienced and will continue to experience significant financial distress from their investments. DR has had to return to work and may need to sell his company or home. He described the effect on KO and her future as "catastrophic", given that she is an AISH recipient with now no other source of funds.
ST, an Alberta resident, described herself as not a knowledgeable investor, with her previous investments restricted to bank RRSPs.
ST never invested in Arbour but made other investments through IFFL.
In October 2006 ST and her partner JW were invited to an Edmonton IFFL meeting by a structurist friend, who had invested in the IFFL "Base Metals" investment. Another structurist spoke at the meeting – he also was apparently a private investment advisor. In the general meeting, ST described that presentation:
What he did is promote -- what he did was talk to how regular investors weren't making any money in the normal scheme of RRSP investment or bank interest, and how, if people invested in a combination of onshore and offshore investments, that they could do much better. And he drafted sort of a schedule of this is what happens with $100 000 if you go the regular silly-people
route, and this is what you get if you are smart and go the Merendon Mining [later determined to be Merendon Mining Nevada] route.
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In a separate one-on-one meeting, the structurist had ST and JW sign a form of membership agreement similar to the Membership Agreement referred to earlier ("ST's Membership Agreement") and pay a $1696 fee (with provision for a $424 annual renewal fee).
In ST's Membership Agreement, IFFL described itself as "operat[ing] as an Educational Service Corporation in the form of an Exclusive Members Club and possess[ing] confidential proprietary information regarding the reorganization of capital, capital appreciation opportunities and other asset management strategies". Members were to "be provided with Strategic Finance information, which will posture [sic] the Member to increase their financial knowledge base", and that information would be provided through oral presentations by "approved personnel called Structurists". The document stated that some of the fees may be paid by IFFL to another member as "referral fees for new members". Under services, ST's Membership Agreement contained the same provisions as the Membership Agreement regarding IFFL's role in education, its non-provision of advice, and its denial of being involved in solicitations or distributions of securities.
There were also confidentiality provisions, under which members agreed to keep "Confidential Information" confidential for two years. This included a restriction from disclosing such information to a member's professional advisers unless they required it and observed the same restrictions as the member (and with the member responsible for any breach by the member's adviser).
After ST and JW became IFFL members, the structurist became more specific about investment opportunities – "he talked about this onshore opportunity that just got you a regular rate of interest at 8.75[%], and then this offshore entity through a company called IBG that invested in a number of companies, and he mentioned Base Metals where you got significantly better returns". ST testified that the structurist explained this, using notations on a piece of paper now in evidence:
. . . IBG . . . he explained that to be an International Business Group that managed the offshore investments, and then, oh, just down underneath that, you can see "BM," which is Base Metals, and 3Sixty. And he described that as two investment vehicles that would net a better -- a good return.
[The structurist also] mentioned that the -- the national company was Merendon Mining [ST clarified that the Merendon entity referred to was Merendon Nevada], and that was a national investment; and then these were the international investments that you could somehow get through the primary investment.
After returning home, ST and JW received a binder in the mail with Stellar Trust on the cover. The binder contained information about three primary investments – Base Metals, Alluvial and 3Sixty – along with a welcome letter and IFFL handbook. The welcome letter, from Brost, included an IFFL List of Companies, with Merendon Nevada as one of the six named companies.
Encouraged by their structurist friend and by "what gold was doing in the marketplace", ST and JW chose to invest in Merendon Nevada. ST characterized their investment as:
. . . at the time we didn't really invest in a company as much as we sent our money to Merendon [Nevada], and then we were asked to decide which offshore vehicles we were to invest in . . . .
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. . . it got really confusing, because we were a member of IFFL, we were looking at giving
money to Merendon Mining (Nevada), we were getting a binder from Stellar Trust, and then inside, the investment opportunities that were offshore were connected to Merendon de Venezuela and Merendon -- a variety of Merendon companies in South America that were associated with a Merendon in Alberta. . . .
ST thought she would be receiving, in addition to the 8.75% "domestic" return, a return on the "international side" by the money flowing through Base Metals, Alluvial and 3Sixty, with the money "managed by the International Business Group". ST thought "there were business agreements to lend money to mine gold -- process" – "I think it went from Merendon Mining --there was money that went to an IBG group who then entered into loan agreements with a variety of organizations, including Base Metals, who would then process for gold".
ST and JW decided to invest US$75 000 in Merendon Nevada because they were "directed to" do so by the structurist – "that was the primary way to do the onshore and offshore investment. That was the only way out of any of these companies".
The structurist helped JW at the bank in arranging a wire transfer to send to Merendon Nevada on 13 December 2006 for a "Promissory Note". When the investment was confirmed by a 13 December 2006 receipt from Merendon Colorado, ST and JW started to ask their structurist friend some questions. They were reassured when he told them Merendon Nevada and Merendon Colorado were "one in the same company, and they probably were just doing some business out of that office". A 22 December 2006 letter from Brost as president and CEO of Merendon Nevada to ST and JW enclosed "a fully executed Promissory Note". ST said they had been expecting a "shiny piece of paper with a gold mine investment", not a promissory note, despite earlier mentions in documentation. The promissory note had an eight-month term, with interest payable at 8.75% per year. The promissory note stated: "This loan will be secured by a pledge of certain proven gold reserves from the 'Glory Hole' or Patch mineral properties which are located in Gilpin County, Colorado."
ST became concerned in spring 2007, when she noticed for the first time that Brost was the head of both IFFL and Merendon Nevada. ST and JW left the investment where it was because they thought there was no choice. In August 2007, "our promissory note was renewed without our signature, and that was a huge concern". However, they were assured that Brost would be at an October 2007 IFFL meeting in Red Deer and could answer their questions. Brost was "dismissive" and "arrogant" about their concerns. ST then did some independent research, discovered troubling information about IFFL, and sent a registered letter and email to try to get their money back. There was no response from October 2007 to February 2008. The emails were sent to [email protected]. Eventually ST spoke to Capstick, who put her in touch with Glen Selig; "Carol" was later involved (ST did not know the last name). Carol eventually said the money would be sent in April or May 2008, but no money was ever received.
ST and JW never received any returns or repayment of principal; they did pay income tax on interest they did not receive. ST informed Brost, through the above-noted email address, and her structurist that she was going to talk to the Commission and the RCMP:
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. . . I was told at the time that I should not do that because I was prejudicing the opportunity for other investors to get their money back, that the company was restructuring, that there were a lot of things happening, and I was going to create a problem. And then I was also told that they didn't like troublemakers, and I would not get my money back if I made inquiries.
. . .
[ST was told that because she had] signed a confidentiality agreement, . . . we could take you to court if you talk about your concerns, if you show any of the documentation.
ST said her structurist had spoken of both Brost and Sorenson, and that she understood Sorenson "had the gold mines in South America". She never quite understood how Sorenson may have been related to one or more of the Merendon entities – "Merendon Mining (Nevada) Merendon Mining (Venezuela), the documentation -- I mean, Merendon Mining (Alberta), it all just seemed to run together for me".
ST had no communication with Merendon, Sorenson, Merendon Venezuela or Merendon Honduras.
DRA was a Calgary resident with self-described average investment knowledge. In approximately 2000 an acquaintance referred DRA to an individual – a Capital Alternatives structurist – to talk about "a gold investment [with] all these great returns" in which the acquaintance had invested. DRA eventually had several initial meetings with that structurist. DRA became a member of Capital Alternatives and invested in a company while a member of Capital Alternatives.
Approximately one year later, DRA was told that, because of "some problems", his membership was "switched over" to IFFL. DRA's view was that, in contrast to Capital Alternatives, the information provided by IFFL was "more vague, and people weren't given as much information, but were given information as they became members" of IFFL.
After joining IFFL, DRA continued to deal with his previous structurist as well as two others, one of whom was Martyn. DRA explained that the role of a structurist was to run workshops for members and explain the process to "access . . . certain investments, certain international opportunities", without getting into the specifics of the investment until the one-on-one meetings. DRA liked the message from IFFL – that he could invest nationally, get international advantages, and earn a high (possibly tax-free) rate of return. Prospective members and members were told that the international side offered through IFFL would give individuals a right to access money like the banks did. Individuals were also told they could invest their RRSP money domestically, then acquire the international side as well, through IFFL. DRA acknowledged that the specifics of the international investment opportunities offering significant rates of return – 30% per year – were available only to IFFL members. DRA said that once an individual joined IFFL as a member they received the IFFL List of Companies. The member
was then told to contact the company on the list that offered the international side (for example, Arbour) in order to access that international side.
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In approximately 2003 or 2004, after learning of the opportunity through an IFFL structurist, DRA invested about $40 000 in Rapid Express. He understood that investment to be in a promissory note, with some money "left behind for that so that it could grow", "a portion of the money would go internationally into [managed accounts under] a bunch of different types of structures" and "some of that money you could sort of delegate to where you wanted it to go, in terms of whether it was, you know, gold, Merendon/SGD or, you know". He thought there was a connection between Merendon and SGD or that they were possibly the same. DRA was under the impression that the investment was separated into the domestic and international components to achieve greater returns and shelter it from taxes or defer taxes. DRA understood that Rapid Express had its own business separate from the international side.
DRA learned of the Arbour opportunity when IFFL was no longer able, for some reason (he surmised it was "technical" or "regulatory"), to offer investments in Rapid Express or another opportunity he referred to as Quattro. In early 2004, DRA attended an IFFL meeting at which Brost (whom DRA described as IFFL's CEO) told members that IFFL was close to creating another vehicle – a public company offering common shares and preferred shares – for people to access the international side. DRA soon learned that the public company was Arbour and that it was involved in the oil and gas business. He also recalled Brost discussing Arbour's oil sands technology.
DRA became interested in investing in Arbour, which he understood offered both the domestic and international investment. He expected a return on the international side of the investment of about 30 to 40%. Those returns, he understood, were generated from Merendon's gold, which was located in Honduras and Venezuela, where locals had "hobby farms" and Merendon supplied the locals with tools and equipment in exchange for gold. Merendon would then process the ore getting "silver, platinum and any other ores out of the gold that would all --basically kind of what I heard was it helped finance the operation, that in itself, and also Venezuela, and then operations like Ecuador and Peru". He also understood the high returns were being generated from selling gold jewellery that Merendon manufactured. DRA was not aware of any loan transaction or agreement directly between Arbour and Merendon.
DRA decided to purchase Arbour Preferred Shares, not common shares, and was clear that nobody from IFFL suggested to him which shares he should purchase. DRA believed he contacted Arbour to send him the paperwork to complete his purchase of Arbour Preferred Shares. He received and completed the subscription agreement, risk acknowledgement form and other paperwork and sent those documents back to Arbour. DRA thought he received an Arbour OM, although he would not have read it closely or relied on the information contained in it. At the time he invested in Arbour, the only other information DRA thought he would have had about Arbour would have come from IFFL or from conversations about Arbour with other IFFL members or with friends investing in Arbour. DRA understood the Arbour investment was risky.
As for the international and domestic sides, DRA thought perhaps 10% of his investment money was designated to remain with Arbour – enough to allow Arbour to continue operating. DRA explained his understanding of Arbour's domestic and international sides:
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. . . the preferred shares could be sort of like the gravy on top of the potatoes, because I was thinking the international side was more the potatoes where, you know, the bulk of maybe your money or earnings could occur. And if the preferred shares [did well, then] great. But if it didn't, well, you're sort of hedged by this other side.
. . .
[M]y understanding was a portion [of the money invested] would stay, you know, a small --probably a smaller portion would stay with Arbour to do some operations. And then, you know, a larger amount would go internationally to -- I mean, at that time, I can't remember if it was a managed account or a portfolio managed account . . . .
. . . part of that money would go is it SGD, or is it some other company who has a loan with
Merendon? But at the end of the day, the money was being somehow directed or being loaned to Merendon as part of the -- that international side.
. . . I'd ask other people [apart from the structurist] how is this whole thing structured? And it seemed like every time I asked, like a lot of different times, it was always different. There was always some different names.
DRA purchased 11 182 preferred shares for $15 095.70 on 19 August 2004. He received a share certificate dated 15 October 2004. DRA confirmed that of the $15 095.70 he invested in Arbour Preferred Shares, he understood that only $301.91 "was going to stay in Arbour". The balance of the money was paid to the international side and to administration fees and commissions. DRA chose to invest the net funds ($10 868.90 after deductions) with SGD, which was to pay a return of 3% per month.
DRA said he never informed IFFL that he had purchased Arbour Preferred Shares, but he still received the international side. He simply purchased the Arbour Preferred Shares and sometime later began receiving the SGD account statements that reflected a portion of the money he paid for the Arbour Preferred Shares now invested in SGD.
DRA received monthly statements from SGD that showed his investments increasing in value substantially – at the expected 3% per month. Initially the statements were mailed to him from, he believed, Honduras. Later the SGD account statements were available through the internet. DRA understood that Elizabeth Brost was working in Honduras "putting statements out for Merendon -- well, okay, SGD, I guess, maybe".
DRA estimated that he invested approximately $120 000 through IFFL and received back approximately $80 000 over time, with the last amount in about 2007. His mother invested approximately $45 000 through IFFL (not in Arbour) and received back approximately $15 000. The early redemptions came via a cheque in the mail. Later, DRA made redemptions using a "debit card", after filling out the required paperwork and paying a fee of some amount. The debit card system gave way to "I think it was called Nordic they created. It was like some bank, international bank". DRA was unsure who established "Nordic", but stated its full name was Nordic Credit Union. He had to set up an account at Nordic and pay a fee (he thought $1200)
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from the international SGD account. Then, as DRA understood it, "you put a redemption in, and the money from the international side would go to Nordic, and then it would come . . . right into your -- your bank account". When Nordic stopped working for some reason, DRA was able to have funds directly wired from the international account to his own bank. DRA assumed that Nordic was a bank created "somewhere through IFFL . . . I think [Brost's] whole family was involved . . . were kind of into everything".
DRA never spoke to Morice about the international side, nor did he hear Morice talk to anyone about the international side. DRA once questioned Brost about the security for DRA's investments, particularly the international side, but could not recall if Brost stated that the investments were secured by Merendon, SGD or Base Metals.
DRA recognized the names of Houston and Kendall – DRA knew they were associated with Brost but did not know they were associated with Sorenson. He was unsure if Houston and Kendall were the people behind Steller. DRA had also heard the names La Conxion, Grovenor and True North, likely through IFFL, but did not know what their roles were.
DRA became a facilitator (who told people about opportunities) and a structurist (who kept track of investments), the latter for only a short time. He referred about 15 people to IFFL, some of whom "went through that Arbour investment". Although not sure that he was supposed to mention the name Arbour, he did occasionally mention it to some people. DRA received compensation – a small amount of cash when DRA recruited someone to become an IFFL member, and, when someone DRA solicited invested in one of the IFFL investments offering the international side, DRA's international account was credited a percentage of the amount invested.
DRA met Sorenson in both Honduras and Calgary. DRA travelled to Honduras in approximately 2003 (before his Arbour investment) after being "kind of invited" through IFFL around the time he was interested in becoming a facilitator. IFFL paid for the trip. About 12 others took the trip, including Brost, who was "showcasing . . . leading people and showing them what was going on there". During the trip Sorenson was also "kind of leading us through some of the facilities. I remember, you know, they brought a bunch of trays of gold and silver out, and, you know, they poured that ingot gold, . . . passing it around. Actually, we were taking pictures together." While in Honduras, DRA visited Sorenson's home. There was no discussion of Arbour during the trip to Honduras. DRA's Calgary contact with Sorenson occurred at IFFL meetings. At one such meeting, Sorenson "thanked everybody for making him a very wealthy man". DRA understood that Brost and Sorenson had "a business relationship" and said that Brost at IFFL meetings would sometimes "kind of talk about how he had to be negotiating with [Sorenson] about certain rates of return".
In about 2009, DRA sent a letter to Sorenson, Werner, Blaikie and Blakey (and to two women, apparently Sorenson's wife and daughter) asking for DRA's and his mother's money –either the principal and interest or at least the principal. DRA said he did not address it to IFFL or his structurists because he assumed that the money had been "loaned to either SGD and then probably to Merendon". DRA apparently learned of this list of names through a "recovery group", from which he also received the information that "Greywolf" was associated with
Sorenson, as was the email address [email protected]. DRA did not receive any response to his letter.
DRA received a letter from Brost similar to the Anti-Regulator Letter received by KA.
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When contacted by the Commission regarding an interview, DRA challenged his interview summons in court. For both the unsuccessful challenge and the subsequent interview, DRA had legal representation arranged for him through IFFL.
SC, a Calgary resident, was introduced to IFFL through friends. She and her husband became IFFL members on 5 September 2004 for $1712, with an annual renewal fee of $428. The IFFL membership agreement signed by SC is very similar to ST's Membership Agreement dated approximately two years later.
Before joining IFFL, SC attended a small meeting at the IFFL office in Calgary at which a structurist spoke. She did not receive any written information at the time, nor did she recall specific companies being named, but IFFL structurists:
. . . told people about different strategies for rearranging their finances and putting them on the path to financial freedom asked several people what their impression of financial freedom
was, and then they talked about different investment opportunities. One was the gold mining, the second was to do with environmental cleanup, and there was a third that had to do with consumer debt.
They talked about how the banks had a lot of money offshore and how they, you know, had preferred interest tax rates for doing so, they talked a lot about Paul Martin, they discussed the various interest rates that were being offered on the three investment that they talked about.
SC was told that, to go any further than the first workshop, she and her husband had to become IFFL members. SC understood that she had to join IFFL to invest in the opportunities being discussed. SC and her husband decided to join IFFL. SC received from IFFL an IFFL List of Companies – one of the six companies set out was "Capital Alternatives" which "offers a variety of Preferred Share opportunities". SC stated her theory as to why she received this letter:
. . . my understanding of why we all got this letter was because if they -- if they told you that they were offering or that they were recommending companies like Canadian Tire, Warren Buffet, that they wouldn't be seen as just promoting their own investments. They wouldn't be seen, then, as sort of acting like financial advisors or brokers.
At a second meeting, SC became interested in SGD, the gold mining venture, after seeing a video of the Merendon Mining operations. The structurist asked SC and her husband for their financial information, such as their net worth and assets. The structurist then explained to SC different things investors could do to fund an investment, such as using a home equity line of credit or cashing in RRSPs. SC and her husband were advised they could offset the interest earned on the Canadian investment with the interest paid on the loan. SC was advised that there were two levels of these managed offshore accounts; one offered a higher interest rate if RRSP funds were used to invest, to compensate for the "tax hit up front"; the other garnered a lower interest rate if "ordinary funds" were used.
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SC understood that "Merendon" was the gold mining operation they would be investing in and that "there was a loan agreement between Grovenor Trust and Syndicated Gold Depository, and from what we understood, Grovenor Trust took the funds, lent them to Syndicated Gold Depository; Syndicated Gold Depository funded Merendon Mining's activities". SC understood Merendon's activities to include refining and purchasing gold, as well as conducting a jewellery business. SC did not understand whether "this money that we invested in the Canadian operations then was sent to Grovenor Trust".
SC and her husband used a home equity line of credit (suggested at both meetings by IFFL as a possible funding strategy) to invest $100 000 in Rapid Express – apparently a transportation company, although they were provided with few details. When asked why they invested in Rapid Express when she was interested in the gold company, SC explained that Rapid Express was "the Canadian company that we had to invest in in order to have the offshore Syndicated Gold Depository". SC described her understanding of the international side of the investment:
You signed an account manager agreement, and for that you -- you didn't have any ownership of the funds, but you just managed the accounts, and you would get a statement every month showing what interest you would get on your money. The money that was transferred offshore, there was quite substantial administration fees taken off of it, and there was also a $2,000 fee for opening the managed account, and then it was converted to U.S. dollars. So $100,000, I think, became like $54,000 U.S. by the time it was in U.S. funds. And then the interest rate -- they did give us the higher interest rate, even though it was not RRSP funds that we used for the investment.
. . . you didn't have ownership of [the managed account], because if you had ownership of it, it meant that you would have to pay tax up front on any interest that you got, so your -- your real investment was with the Canadian entity.
. . . we understood that -- that our investment was highly backed up with gold reserves in Merendon Mining, and that Gary Sorenson, you know, wanted this money to purchase more gold ore, more gold and do more refining. So that's how it was generated.
SC confirmed that with her Rapid Express investment she became an account manager with an offshore company called Transiciones Universal, which "managed some money that had somehow magically gotten into Grovenor", which "then somehow loaned money to SGD", which "apparently had some obligation to Merendon to provide funds to it". SC agreed with the suggestion that "you knew that you weren't an investor in Merendon, but you knew your money may somehow end up there".
As for which Merendon entity was referred to, SC confirmed that the Merendon Mining they were told the most about was Merendon in Honduras. She understood partly from what IFFL was telling her that "Sorenson was Merendon Mining" in Honduras. She also knew that some members and structurists had travelled to Honduras – "you were able to arrange through your structurist to go and take a tour of the refinery, and it was Gary Sorenson's residence that everyone stayed at". SC did not travel to Honduras. SC never spoke to anyone from Merendon and had never met Sorenson or seen him at an IFFL meeting.
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SC did not remember a subscription agreement or offering memorandum, nor did she ever speak with anyone at Rapid Express. She and her husband thought the investment had "some risk", but with the backing of "big gold reserves", they had the understanding from their first meeting with the IFFL structurist that the Rapid Express investment was less risky and more secure than the consumer debt and environmental opportunities.
SC received monthly SGD statements of account by email. Three SGD statements of account – for 30 November 2007, 9 November 2007 and 13 October 2007 – showed that SC's international investment grew from a balance of $76 855 as of 1 September 2005 to $134 109.48 as of 1 November 2007, with the "Asset Reassigned" on 2 November 2007. The increase was attributed to $64 854.46 in interest earned, less $9050 paid in redemptions and fees. SC understood her redemptions were coming from the interest shown as being earned on the SGD account. SC acknowledged that receiving some cash gave her some confidence in the investment:
[W]e had paid out thousands of dollars in interest on our home equity line of credit, we paid numerous fees. And -- but we hadn't received any return on our Canadian investments, and so we wanted to know whether there was actually some money there anywhere. So, yes, I suppose that's correct, it did give us a bit of confidence that at least there was some money.
SC did not receive the principal back from the Rapid Express investment, nor any returns from it.
SC also invested approximately $130 000 in Strategic Metals, once through Capital Alternatives (which they were told was strictly a simple investment paying 14.95 percent per year for five years with no related offshore managed accounts), and later approximately
$129 800 through IFFL (which was a vehicle for placing more money into SGD or Merendon). Although SC did not receive "returns" on that investment, she accessed some "redemptions". However, because she was never satisfied as to how to report wire transfer redemptions for tax purposes, she did not redeem any. She did, however, redeem approximately $6800 through the debit card or business expense program, which was a mechanism for accessing the offshore money on a tax-free basis (although the expenses were apparently not required to be actual business expenses). She completed the debit card application for a fee of approximately $1400 and received the debit card in the mail with a letter from True North. After the business expense program closed down because of some accusation of money laundering, she heard of another method of accessing money through a Nordic Credit Union or Nordic Merchant Credit Union account, but did not pursue that.
In trying to recover her principal, SC unsuccessfully contacted various parties, including IFFL and Brost (whom she understood was the CEO of IFFL). She did not think that Brost was involved in any of the companies in which IFFL members were investing.
At the last IFFL meeting she attended, SC and the others were told that all account managers would become owners in a limited partnership and would be allowed to tell other people about that, unlike "the past investments where you weren't really supposed to speak to other people about your investment".
SC received an email setting out the "two correct and legal responses" for IFFL members who might be contacted by the Commission. At one point Brost referred SC to Blakey, whom Brost identified as IFFL's lawyer. SC met with Blakey at the Merendon office in Calgary.
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SC, who never invested in Arbour, was not familiar with the company or its business.
The extant allegations set out in the Notice of Hearing raise the following issues:
Did any or all of Arbour, Morice, Brost and IFFL illegally trade in or distribute Arbour securities (or both)?
Did any or all of OM 1, OM 2 and OM 3 contain misrepresentations or untrue or misleading statements?
Did either or both of Brost and IFFL illegally act as advisors within the meaning of the Act?
If either or both of Brost and IFFL engaged in illegal trades, illegal distributions and unregistered advising (or some of that misconduct), did they breach the Brost Undertaking or the IFFL Undertaking, respectively, or fail to comply with the Undertaking Order accepting the Brost Undertaking and the IFFL Undertaking?
Did any or all of Arbour, Morice, Brost, IFFL, Merendon and Sorenson engage in a course of conduct relating to the Arbour Preferred Shares that they knew or reasonably ought to have known would perpetrate a fraud on Alberta investors?
If any or all of the Respondents engaged in any such misconduct, did they also act contrary to the public interest?
In considering the allegations against the three individual Respondents – Morice, Brost and Sorenson – we have, based on the totality of the evidence, reached conclusions about what they knew or reasonably ought have known at particular times. We have not assumed simply because someone at Arbour, IFFL or Merendon was aware of particular information that Morice, Brost or Sorenson, respectively, automatically and necessarily had the same information. However, as discussed herein, we have concerns regarding Sorenson's credibility, and about the accuracy of some of the evidence of Morice and Brost. We have, therefore, treated with scepticism – and in some instances found untruthful – certain of their evidence indicating what they knew or did not know at various times. Further, we have drawn reasonable inferences from the evidence as a whole in reaching our conclusions in this area.
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Alberta securities laws and our regulatory system are ultimately directed at the protection of investors and the fostering of a fair and efficient Alberta capital market. Our regulatory system was not designed to ensure successful investments but rather to "ensure that investors are treated fairly and put in a position to make reasonably informed investment decisions suitable to their needs and risk tolerances (Capital Alternatives at para. 57). In furtherance of those objectives, Alberta securities laws set out requirements and principles of conduct for the sale of securities.
During the period relevant to the allegations of illegal trades and distributions of Arbour Preferred Shares, section 75(1)(a) of the Act provided that a person or company must not trade in a security unless registered to do so with the Executive Director. This registration requirement was intended to provide investors with the benefit of the involvement of a trained individual – a registrant – knowledgeable about the capital market, the particular securities being sold and the particular investor's financial position, investment objectives and risk tolerances.
Section 110(1) of the Act provides that a person or company must not distribute a security unless a preliminary and final prospectus have been filed and receipted by the Executive Director. This prospectus requirement is intended to assist investors with making informed investment decisions through the provision of a prospectus containing full, true and plain disclosure of all material facts relating to the securities offered and the issuer of the securities. An issuer is defined in section 1(cc) of the Act as a person or company that has outstanding securities, or is issuing or proposes to issue securities.
When assessing the applicability of the registration and prospectus requirements, we consider what constitutes a "trade" and a "distribution" within the meaning of the Act.
Section 1(jjj) of the Act defines "trade" to include "any sale or disposition of a security for valuable consideration" (section 1(jjj)(i)) and "any act, advertisement, solicitation, conduct or negotiation made directly or indirectly in furtherance of" any such sale or disposition (section 1(jjj)(vi)).
"Distribution" includes "a trade in securities of an issuer that have not been previously issued" (section 1(p) of the Act).
There was no dispute, and we find, that the Arbour Preferred Shares were securities under (at least) two of the categories of "security" as defined in the Act – "any document, instrument or writing commonly known as a security" (section 1(ggg)(i)); and any share or stock (section 1(ggg)(v)).
There was no dispute that Arbour sold the Arbour Preferred Shares to investors and for the amounts set out in the Arbour OMs – Arbour thus initially received the proceeds from the sale of the Arbour Preferred Shares. The Arbour OMs were Arbour's documents and it bore direct responsibility for them. There was no dispute that the sales of the Arbour Preferred Shares
by Arbour were trades under section 1(jjj)(i) of the Act and, as newly issued securities, distributions of securities under section 1(p). We so find.
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Morice, as president or CEO (or both) of Arbour, signed the Arbour OM certificates and Distribution Reports (in one such report he did not indicate his position with Arbour), was primarily responsible for the content of the Arbour OMs, and authorized, permitted or acquiesced in Arbour's selling of the Arbour Preferred Shares. These were acts in furtherance of sales of such securities. We find that Morice engaged in trades of Arbour Preferred Shares within the meaning of section 1(jjj)(vi) of the Act. Because the Arbour Preferred Shares were newly issued securities, we also find that Morice engaged in distributions of such securities under section 1(p).
Brost, we have found, was principally responsible for resurrecting Arbour – transforming it from a bankrupt shell public company to a going concern raising millions of dollars through sales of Arbour Preferred Shares to public investors. We have also found that Brost exerted significant control over Arbour's affairs certainly in its early stages and in all major decisions involving Arbour, including its fundraising activities. Brost was involved in the decision to raise money through the sale of Arbour preferred shares to IFFL members, which provided IFFL structurists with an RRSP-product to sell to investors. Brost had a role in preparing the Arbour OMs, involved (at least) in some general discussions about the structure of the preferred share offering. Brost was also actively involved in recruiting and appointing both Weis and Morice as directors of Arbour and Morice as its president. Brost could, and did, exert control over Arbour affairs through Weis and Morice, primarily through Morice.
Brost, we have found, was also the guiding and controlling mind of IFFL. He directly promoted the sale of Arbour Preferred Shares by providing to IFFL members information about investing in Arbour, including the Brost-authored IFFL List of Companies mentioning Arbour. Brost indirectly promoted the sale of Arbour Preferred Shares by providing information about investing in Arbour at IFFL structurist conferences. IFFL structurists, in turn (whether explicitly or implicitly directed to do so by Brost), solicited IFFL members to invest in Arbour by means including the Brost-authored IFFL List of Companies mentioning Arbour. Brost, IFFL and (in turn) each IFFL structurist received commission money based on the amount of money IFFL members invested in Arbour Preferred Shares through that structurist. Arbour itself did not advertise or otherwise promote the sale of the Arbour Preferred Shares to investors. Rather, IFFL members, as directed by IFFL structurists or other personnel, contacted Arbour directly and requested an offering memorandum to subscribe for Arbour Preferred Shares. The selling efforts of Brost and his organization IFFL were very successful – the majority of the Arbour Preferred Share purchasers were IFFL members, with more than half of the sales – totalling over $25 million – occurring in Alberta to Alberta investors.
The evidence is overwhelming that Brost and his organization IFFL engaged in acts in furtherance of sales of Arbour Preferred Shares; therefore, they engaged in trades as defined in section 1(jjj)(vi) of the Act. We so find. Because the Arbour Preferred Shares were newly issued securities, we also find that Brost and IFFL engaged in distributions of such securities under section 1(p).
It is clear from the evidence that none of Arbour, Morice, Brost and IFFL was registered with the Executive Director during the time the Arbour Preferred Shares were traded, and that no prospectus was filed or receipted by the Executive Director for the distribution of the Arbour Preferred Shares.
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Therefore, unless exemptions from the registration and prospectus requirements of the Act applied to the trades and distributions of the Arbour Preferred Shares, Arbour, Morice, Brost and IFFL have contravened sections 75(1)(a) and 110(1) of the Act.
Recognizing that not all investments or every investor may require the full protection provided by registration and a prospectus, Alberta securities laws contain a number of exemptions from these requirements. These exemptions have been crafted to eliminate some of the investment's risk by stipulating terms that address attributes of the individual investor (such as investor sophistication, financial resources or relationship to the issuer), address the nature of the security itself, or provide alternative sufficient information about the offering and the issuer to enable eligible investors to make informed investment decisions.
Because the exemptions relieve compliance from two of the fundamental requirements of the Act, the issuer or a person seeking to rely on an exemption to trade and distribute securities is responsible for ensuring that the exemption is available for each particular trade or distribution at the time of the trade or distribution, and ensuring strict compliance with all of the requirements, conditions and restrictions associated with the relied-on exemption (Re InstaDial Technologies Corp., 2005 ABASC 965 at para. 61; Re Euston Capital Corp., 2007 ABASC 75 at paras. 103,
115-17, 119; and Re Bartel, 2008 ABASC 141 at para. 115).
There was no dispute that Arbour, Morice, Brost and IFFL purported to rely primarily on the OM Exemption to trade and distribute the Arbour Preferred Shares to investors.
The OM Exemption requirements were set out in MI 45-103 until 14 September 2005, when NI 45-106 came into force. During the period relevant to the allegations of illegal trading and distributing, the OM Exemption requirements in section 2.9 of NI 45-106 were comparable to those in MI 45-103 – there were minor differences in wording (in our view, of no significant effect) and differences in section numbers. That being the case, and given that the first two Arbour OMs were governed by MI 45-103, we set out its requirements.
Sections 4.1(3) and (4) of MI 45-103 exempted a trade and distribution from the registration and prospectus requirements of the Act if, among other requirements: (i) the trade was "by an issuer in a security of its own issue"; (ii) the issuer delivered to each purchaser a disclosure document called an "offering memorandum" in the required form; (iii) the issuer obtained from each purchaser a signed risk acknowledgement in the required form; and (iv) each purchaser either invested no more than $10 000 in the offering or qualified as an "eligible investor".
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Section 4.2 of MI 45-103 prescribed that an offering memorandum was to be in the "required form" (in this case, because Arbour was a reporting issuer and thus a "qualifying issuer", Form 45-103F2 Offering Memorandum for Qualifying Issuers ("Form F2")). As the Commission commented in Capital Alternatives at para. 75, "[t]he offering memorandum is . . . the foundation of the OM Exemption". Offering memoranda are neither vetted by the Commission nor receipted by the Executive Director. Consequently, there is a heavy onus on those relying on an offering memorandum to ensure that it contains information that is consistent and accurate in all material respects.
Form F2 prescribed the content of an offering memorandum for qualifying issuers. This included: (i) a detailed breakdown of how money raised in the offering was to be used; (ii) a business summary, namely a brief description of the business intended to be carried on by the issuer in the ensuing 12 months; (iii) information about each director, senior officer, "promoter" and "principal holder" of the issuer; and (iv) a discussion of relevant risk factors related to the investment offered, the issuer and the issuer's industry.
Sections 4.4(1) and (2) of MI 45-103 stipulated that an offering memorandum must be certified – as "not contain[ing] a misrepresentation" – and signed by the issuer's CEO and CFO (or persons so acting), certain (or all) directors and each promoter. The instructions for Form F2 included a reminder that it was an offence to make a misrepresentation in an offering memorandum.
Section 4.4(3) of MI 45-103 further stipulated that an offering memorandum must be true (free of misrepresentations) when signed by the designated individuals and must remain true when the offering memorandum is delivered to the purchaser. Under section 4.4(4), if an offering memorandum ceased to be true after delivery to a purchaser, the issuer was prohibited from concluding the transaction unless the purchaser received an updated offering memorandum containing a newly signed certificate and the purchaser signed a new purchase agreement.
Under section 7.1(1) of MI 45-103, on completion of a distribution of securities made in reliance on the OM Exemption (as well as certain other exemptions not in issue here), an issuer was required to file, within 10 days, a Distribution Report, signed and certified as true by an individual acting on behalf of the issuer. The Distribution Report was to report: information about the issuer; details of the distribution or distributions, including all distribution dates, the number, type and value of the securities distributed and identification of the exemption relied on; and commissions and finders' fees.
As noted, offering memoranda must be certified that they do not contain misrepresentations. In addition to that required certification by the proper signatories, Alberta securities laws, in furtherance of the public interest, prohibit certain capital market misconduct by those involved in securities transactions.
Section 92(4.1) of the Act (previously section 92(3)(c)) prohibits the making of untrue or misleading statements in connection with securities transactions.
Until 7 June 2005, section 92(3)(c) of the Act provided:
. . . no person or company, with the intention of effecting a trade in a security or exchange contract, shall
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. . .
make a statement that the person or company knows or ought reasonably to know is a misrepresentation, . . .
Misrepresentation is defined in section 1(ii) of the Act as:
an untrue statement of a material fact, or
an omission to state a material fact that is required to be stated, or
an omission to state a material fact that is necessary to be stated in order for a statement not to be misleading; . . .
The definition of misrepresentation requires that the statement or omission be in relation to a material fact. A material fact is defined in section 1(gg) of the Act. Until 7 June 2005, the definition stated that a fact is material when it: (i) "significantly affects" the market price or value of the securities; or (ii) "would reasonably be expected to have a significant effect on the market price or value of the securities". The former is objective; the latter is objective from the perspective of a reasonable investor. As of 8 June 2005, the former element was removed, leaving only the latter.
Effective 8 June 2005, section 92(3)(c) of the Act was repealed and replaced with section 92(4.1), which states:
No person or company shall make a statement that the person or company knows or reasonably ought to know
in any material respect and at the time and in the light of the circumstances in which it is made,
is misleading or untrue, or
does not state a fact that is required to be stated or that is necessary to make the statement not misleading,
and
would reasonably be expected to have a significant effect on the market price or value of a security or an exchange contract.
This Commission has concluded that the replacement of section 92(3)(c) of the Act by section 92(4.1), in conjunction with the amendment to the definition of "material fact", generally had no significant or substantive effect (Capital Alternatives at para. 69; and Re Maitland Capital Ltd., 2007 ABASC 357 at para. 153).
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To establish a misrepresentation under either section 92(3)(c) or 92(4.1) of the Act, it must be proved that: (i) a statement was made by a respondent; (ii) the respondent knew or reasonably ought to have known that the statement was, in a material respect, untrue or omitted a fact required to be stated or necessary to make the statement not misleading; (iii) the respondent knew or reasonably ought to have known that the statement would reasonably be expected to have a significant effect on the market price or value of a security; and (iv) in the case of a statement to which section 92(3)(c) applied, it was made with the intention of effecting a trade in a security.
Staff submitted that "Arbour failed to include certain information and misstated other information in each of the Arbour OMs", including: no reference to Merendon; failure to disclose Arbour's listing status; failure to file on SEDAR the incorporated-by-reference 2004 AIF; misleading disclosure about, and failure to disclose changes in, Arbour's directors and officers; misleading information as to the use of $10 million of the proceeds; inconsistent statements regarding the purchase price of COREL; failure to disclose certain events that required an updated offering memorandum; failure to disclose the Sedalia participation agreement and the existence of Arbour US; insufficient disclosure about Arbour's offshore oil and gas acquisitions; failure to incorporate by reference updated MD&A; and failure to disclose accurately the number of Arbour Preferred Shares distributed. Staff emphasized that an issuer purporting to rely on the OM Exemption must use a complete and accurate offering memorandum with proper certification, both updated as needed.
Staff submitted that the Arbour OMs were so deficient – non-compliant with the OM Exemption requirements and containing misrepresentations and false certificates – that the OM Exemption was not available for trades and distributions of the Arbour Preferred Shares purportedly made under the OM Exemption. To that end, Staff contended that the deficiencies in the Arbour OMs went to the core of what an offering memorandum is intended to do – provide investors with fair and reliable information about the issuer of the investment on offer, its management, its business and objectives, and how investor money will be used – and fatally undermined the intent of the OM Exemption. Therefore, given that no prospectus was filed and receipted and none of Arbour, Morice, Brost and IFFL was registered under the Act to trade in securities, Staff submitted that their trades and distributions of Arbour Preferred Shares purportedly made under the OM Exemption were illegal and contrary to sections 75(1)(a) and 110(1) of the Act.
Concerning the misrepresentations or untrue or misleading statements alleged under section 92(4.1) of the Act (and its predecessor), Staff contended that Arbour (as the issuer) and Morice (as the individual at Arbour responsible for preparing the Arbour OMs) made each of the noted misstatements or omissions in the Arbour OMs. Staff also contended that Arbour and Morice knew, or reasonably ought to have known, such misstatements or omissions were in some material respect misleading, untrue or omitted a fact necessary to make the statements not misleading. Staff further contended that, as the Arbour OMs were used to sell Arbour Preferred Shares, such misstatements or omissions were made with the intention of effecting trades in
securities. Finally, Staff contended that such misstatements or omissions either alone or in combination would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares. Thus, Staff submitted, Arbour and Morice contravened section 92(3)(c) of the Act until 7 June 2005, and section 92(4.1) from 8 June 2005.
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Morice acknowledged the inaccuracy of some of the information contained in the Arbour OMs. However, he submitted that errors and omissions in the Arbour OMs did not constitute "misrepresentations" within the meaning of the Act. Morice distinguished the facts here from those in Capital Alternatives, and argued that the "few faults" in the Arbour OMs "pointed to by Staff that are supported by the evidence" were not material and certainly not "'so serious and pervasive as to undermine' the foundation of the OM Exemption legitimizing the distributions in this matter".
Morice further argued that investors did not rely on the Arbour OMs when they purchased Arbour Preferred Shares. Rather, "[t]hey were all attempting to get their money 'off shore' into gold backed, managed accounts that would give them five or six times the rate of return they could expect on a conservative investment in Canada". Morice noted that almost all of the investor witnesses "were aware that Merendon had some involvement in that plan". Morice also noted that no investor witness gave evidence that they were in any way misled or deceived by any information in the Arbour OMs; or that, if they had been told their money would be paid to Merendon, they would have altered their investment decisions. Thus, Morice contended, any disclosure defects in the Arbour OMs were not material – would not reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares.
Morice submitted that, although the "material fact" definition was incorporated into section 92(4.1) of the Act, there are "differences in approach and meaning" between sections 92(3)(c) and 92(4.1), "particularly in the giving and taking of legal advice as to inclusion or exclusion of certain facts". No elaboration on this point was forthcoming.
Morice further submitted that he should not be found to have contravened section 92(3)(c) of the Act or section 92(4.1) because one or more of the following applies to each of the alleged misrepresentations, or untrue or misleading statements: the statements or omissions would not reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares; the statements or omissions were mistakes or oversights or matters about which Morice had no, and ought not to have had, knowledge; and the statements or omissions were made by Morice on legal advice, on which Morice reasonably relied. Morice emphasized that the Arbour OMs "were prepared under the supervision and advice of a senior securities lawyer" – Skeith – who was involved "with Arbour, Brost, Strashok, Weis, and Sorenson" before being involved with Morice. Morice pointed out that Skeith believed, based on the information available at the time, that the Arbour OMs were accurate and complied with the OM Exemption requirements.
As noted, Brost and IFFL did not participate in the Merits Hearing and Arbour did not participate in the majority of the Merits Hearing. None of them made submissions.
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We review each of the three Arbour OMs in turn to determine whether any (or all) of them contain misrepresentations within the meaning of the Act and, if so, whether any (or all) of them are so deficient as to render the OM Exemption unavailable for the trades and distributions of the Arbour Preferred Shares made in reliance thereon.
Morice suggested a requirement for evidence from investors indicating that they would not have purchased Arbour Preferred Shares had they had been accurately informed, and a requirement for expert evidence as to the effect of any misrepresentations in the Arbour OMs on the market price or value of the Arbour Preferred Shares.
We disagree. Common-sense inferences about materiality may suffice in certain cases (Sharbern Holding Inc. v. Vancouver Airport Centre Ltd., 2011 SCC 23 at paras. 58, 61), such as this proceeding.
Indeed, as an expert tribunal with specialized knowledge of the Alberta capital market and securities regulation, we are well positioned and able to draw inferences as to the objective view of a reasonable investor. This includes a determination as to whether untrue or omitted facts would reasonably be expected to have a significant effect on the market price or value placed on securities by reasonable investors – a proxy for this is, essentially, determining whether there is a substantial likelihood that such facts would have been important or useful to a reasonable prospective investor in deciding whether to invest in the securities on offer at the price asked (Capital Alternatives at para. 239; and Sharbern at para. 61). The OSC recently described its role as a specialized tribunal capable of making determinations of what is a material fact without the aid of experts or investor witnesses (Re Coventree Inc. (2011), 34 OSCB 10209 at paras. 157-58):
The materiality standard applicable in this case is an objective test based on reasonable expectation. Determining questions such as whether a fact is a material fact, whether a material change has occurred, the effect of events or developments on the market price or value of securities and the adequacy of disclosure made, are matters squarely within our expertise as a specialized tribunal. While the evidence of experts, shareholders or investors may be relevant or useful, we do not need such evidence in order to make these decisions (see Re Donnini (2002), 25 OSCB 6225 at para. 123, [Rex Diamond Mining Corp. v. Ontario Securities Commission, 2010 ONSC 3926 (Div. Ct.)] at para. 3 and [Re Biovail Corporation (2010), 33 OSCB 8914] at para. 80). No evidence of experts or of Coventree public shareholders was introduced. We did hear evidence from a number of individuals involved in the purchase of ABCP [asset-backed commercial paper] by investors.
In Rex Diamond [at para. 3], the Court recognized the [OSC's] expertise when it stated that "whether a material change occurred is a matter that is central to the expertise of the [OSC]". The same principle applies to the [OSC's] determination of whether a fact constitutes a "material fact".
Our role is similar; we adopt the OSC's reasoning on this point.
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That said, we are cautious not to use hindsight in our assessments of materiality, and we do not hold Arbour to a standard of perfection. As the OSC commented in Re YBM Magnex International Inc. (2003), 26 OSCB 5285 at para. 90: "Assessments of materiality are not to be judged against the standard of perfection or with the benefit of hindsight. It is not a science and involves the exercise of judgement and common sense."
Securities regulation does not focus on what the market or investors do with mandated information provided to them. Rather, the objective of securities regulation is to oblige those who seek money from public investors and the capital market to provide current, truthful and accurate information in prescribed formats, which can then be used by those in the capital market as a basis for making reasonably informed investment decisions. That a particular investor or investors may not read or rely on such information in making investment decisions does not relieve an issuer of its obligations to provide accurate and reliable information and to comply with Alberta securities laws when soliciting money from the public. The expectation is that issuers relying on the OM Exemption will use offering memoranda containing the prescribed content, which is both consistent and accurate in all material respects, regardless of investor reliance.
No Reference to Merendon – Use of Proceeds, Business Summary, Risk Factors
In the "[d]escription of intended use of available funds" at section 1.2, Arbour disclosed that $32 379 071 of the maximum offering would be used for "[a]cquisitions of technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions". Another $400 000 was to be applied to "working capital".
In section 2.1 "Business Summary", under Item 2 "Information About Arbour Energy Inc.", Arbour disclosed that it "was established" in April 2009 to carry on oil and gas exploration and development. It discussed its few oil and gas holdings or ventures. These included what was described as Arbour's "preliminary agreement" reached on 31 May 2004 to acquire a producing oil and gas property from Crazy Hill at an agreed purchase price of $1 million ($350 000 and 650 000 Arbour common shares), with a closing scheduled for 31 July 2004. The evidence was that the Crazy Hill acquisition was still being negotiated at the date of OM 1 and did not close until 1 November 2004.
In sections 8.1 and 8.2 – "Risk Factors" and "Industry Conditions" – Arbour provided a number of what appeared to be boilerplate risk factors and industry conditions applicable to issuers carrying on oil and gas exploration and development operations.
The evidence was that Arbour started advancing to Merendon money raised from the sale of Arbour Preferred Shares shortly after receipt from investors. The first advance was made on 27 July 2004 and frequent advances continued until the last of the $10 Million Loan funds were advanced on 8 December 2004.
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Form F2 – and thus the OM Exemption – specifically required disclosure of how money raised was to be used by the issuer. OM 1 stated that there was no minimum offering and that "funds invested are available to Arbour and need not be refunded to the subscriber". Section 5.2 of OM 1, however, provided that the gross proceeds would "be released to [Arbour] for its use" two days after "Closing". Therefore, it is clear that Arbour was not entitled to use invested money while in the course of selling the Arbour Preferred Shares under OM 1, until each stage of the distribution was complete. Arbour's advancement of loan money to Merendon within two weeks of the date of OM 1 showed that Arbour made almost immediate use of investor money, and then continued to make such advances, without regard for the wording of section 5.2 of OM 1 – according to the evidence, the first closing was on 20 September 2004, with subsequent closings approximately every month after that.
There was also a lack of detailed description as to how the money raised was to be expended. OM 1 contained no disclosure that Arbour's intended use of proceeds was to loan
$10 million to Merendon. The use to which Arbour put the money raised almost immediately and continuing throughout the currency of OM 1 – the $10 Million Loan to Merendon – was not consistent, or sufficiently so, with its disclosed intended use of proceeds in OM 1. Contrary to Arbour's disclosure, the proceeds were not used as "surplus funds placed in short term investments", nor could it be said they were used for "[a]cquisitions of technologies and properties in the oil and gas sector". The $10 Million Loan was not "short term" – it had a 10-year term with no apparent ability to demand immediate or early repayment. We do not accept Morice's apparent contention that the money loaned to Merendon was somehow related to the acquisition of oil and gas technologies and properties because Merendon and Sorenson would use their influence to assist Arbour in acquiring oil and gas assets or contacts (particularly international ones). Nor do we accept that the $10 Million Loan to Merendon, tied as it was to an option to convert to a 5% stake in TRL, could be accurately characterized at the time of OM 1 as money expended for the acquisition of oil and gas technology – the option to convert was at that time too speculative.
We find there was an omission to disclose that Arbour intended to use the proceeds raised almost immediately and continuing throughout the currency of OM 1 to make the $10 Million Loan to Merendon – that omission rendered misleading what was said about use of proceeds. We also find untrue and misleading Arbour's statement that money raised was intended for acquisitions of oil and gas technologies and properties with surplus funds placed in short-term investments.
We find that these matters were material facts required to be disclosed or disclosed accurately. The use to which an issuer proposes to put money raised is obviously one of the most important factors considered by reasonable investors in deciding whether to invest in the issuer's securities. Such decisions would ultimately reasonably be expected to have a significant effect on the market price or value attributed to the securities. As this Commission noted in Re Dobler, 2004 ABASC 927 (at para. 220):
. . . Disclosure of the use of proceeds of an offering of securities has long been a key element of prospectuses and other offering documents, an element taken seriously by securities regulators and market participants. This is so irrespective of whether there is already in existence a market for securities of the class being offered. The assumption underlying the requirement, and the
seriousness with which it is taken, is that investors being asked to put money in a company, and market participants observing the process, care about how the money will be spent. Different proposed uses of proceeds may well affect investors' willingness to invest, and the prices they are willing to pay. . . .
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For these reasons, we find that OM 1 contained misrepresentations about Arbour's intended use of proceeds – precisely when, where and how investor money was to be applied –and so breached the requirements of Form F2.
Form F2 also explicitly required disclosure of the business to be carried on by the issuer over the ensuing 12 months. OM 1 disclosed that Arbour had originally been established to carry on oil and gas exploration and development, that Arbour had sought bankruptcy protection in July 2003, and that the proceeds of a private placement announced in February 2004 had allowed Arbour to settle with its creditors and to deal with current obligations. However, no mention was made that, at the date of OM 1, Arbour's intended business activity – or a significant one – would be the raising of capital to provide funding to Merendon, which might at some point result in Arbour's acquiring an interest in unproven and unvalued oil sands technology. It is clear that, at the date of OM 1, oil and gas exploration and development activities were not Arbour's focus – although Arbour had a few oil and gas holdings or ventures, those comprised an insignificant part of its business operations. Indeed, despite disclosure that Arbour would use money raised to "hire competent staff on a full time basis to properly evaluate and exploit larger opportunities", Arbour apparently maintained a very small complement of employees seemingly without any or much expertise pertaining to the oil and gas sector, and Arbour's new management was also apparently without such expertise.
In our view, this disclosure in OM 1 gave an untrue and misleading picture of Arbour's intended business activity over the ensuing 12 months. Because the disclosure did not provide prospective investors with the truth about Arbour's business, prospective investors had no understanding of what, in fact, they were investing in and where, in fact, their invested money would be going. This disclosure did not inform investors that a significant percentage of their money – instead of being used to acquire oil and gas technologies and properties for the purposes of exploration and development – would be paid to Merendon to use as it saw fit (the loan was, after all, a "funding loan"). It is evident, and we find, that disclosure of the true facts would reasonably have had a significant effect on the market price or value of the Arbour Preferred Shares; such disclosure was material – that is, it would have been of importance to a reasonable investor considering whether to purchase Arbour Preferred Shares.
Indeed, we find it interesting that the proposed $1 million Crazy Hill acquisition – a relatively minor proposed monetary transaction – was among the oil and gas holdings or ventures disclosed in OM 1. In contrast, OM 1 made no mention of any aspect of Arbour's most significant proposed monetary transaction – the $10 Million Loan to Merendon: Arbour's very recent commitment (evidenced by the Letter of Intent dated 5 and 9 July 2004) to loan Merendon (a private company and the subject of past regulatory sanction) $10 million for a 10-year term, at the time unsecured and with no formal loan agreement; Arbour's intention to start sending money to Merendon almost immediately, and Arbour's obligation to advance the entire $10 million by 31 December 2004 in fulfilment of the Letter of Intent; and Arbour's recently-acquired option to acquire 5% of TRL (part of Merendon's 25% interest). This was a misleading omission. We
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have no doubt that information about this very significant loan commitment and its circumstances – involving Merendon, an entity familiar apparently to most IFFL members –would reasonably be expected to affect significantly reasonable investors' investment decisions, including the market price or value they would assign to the Arbour Preferred Shares. In short, this information was material.
For these reasons, we find that the untrue and misleading disclosure in OM 1 of the material facts about Arbour's intended business activity over the ensuing 12 months were misrepresentations in breach of Form F2 requirements.
The risk factor disclosure in OM 1 was uninformative and largely irrelevant. It provided boilerplate discussion about risk factors and industry conditions applicable to issuers carrying on oil and gas exploration and development activities, with no consideration given to the information that would be useful and pertinent to prospective investors considering the purchase of Arbour Preferred Shares. The risks disclosed in OM 1 did not, in our view, adequately or suitably warn prospective investors of the risks specific to Arbour and the way in which Arbour planned to conduct its business. There was no discussion of the uncertainties and risks associated with the $10 Million Loan, including: no formal loan agreement; little or no due diligence conducted on Merendon (a mining entity, whose assets were of uncertain value and located for the most part offshore); Arbour's intention to start sending money to Merendon almost immediately; and Arbour's obligation to advance the entire $10 million by 31 December 2004 with no security, the risks of default, and the potential obstacles to recalling or enforcing repayment of the $10 million. There was also no discussion of the uncertainties and risks associated with the possible acquisition of oil sands technology. Such risks would include those related to: stage of development; permits and licenses; performance failure; lack of contracts for service; changes in technology; competition; product defect; potential third-party infringement; and loss of exclusivity. These omissions were misleading.
These omissions were also materially misleading. We do not doubt that prospective investors presented with the real risks relevant to Arbour and its intended business would have reasonably assessed the investment merits of Arbour very differently and reached markedly –significantly – different conclusions as to the market price or value of the Arbour Preferred Shares.
For these reasons, we find that the risk factor disclosure in OM 1, which omitted to disclose relevant material risks, misled prospective investors and was a misrepresentation in OM 1 in breach of Form F2 requirements.
Listing Status
Form F2 and, therefore, the OM Exemption, required that general information about the issuer, including "[w]here currently listed or quoted", be disclosed in an offering memorandum. OM 1 disclosed that Arbour common shares were listed for trading on the CNQ (at that time an alternative exchange for micro-cap and emerging companies with less stringent listing requirements and generally less-liquid trading of securities than on the Exchange). However, OM 1 did not disclose that trading in Arbour common shares had been suspended by the
Exchange as of 17 June 2004. As discussed above, the Exchange imposed the suspension because it was reviewing Arbour's affairs and asking questions.
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Information about whether an issuer's securities are listed on an exchange or quoted on a quotation and trade reporting system is important for prospective investors in that such information concerns the liquidity of the issuer's securities and indicates whether the issuer is subject to scrutiny and regulation by the exchange or quotation system. It is common sense, and we find, that the market price or value of a security would reasonably be significantly affected by information as to whether and where an issuer's securities are listed for trading and the status of that listing – this is material information, information that reasonable investors would find important in making investment decisions.
A suspension by the Exchange can occur for a variety of reasons, such as violating rules or failing to meet financial specifications of the Exchange. In this case, it occurred because Arbour's circumstances appeared to warrant de-listing, but the Exchange was prepared to give Arbour an opportunity to satisfy the Exchange's concerns and, if necessary, to reorganize Arbour's affairs. A suspension prevents further trading of the listed securities until the circumstances giving rise to the suspension have been settled to the satisfaction of the Exchange. A suspension does not affect the listing of the securities; de-listing terminates the listing agreement between the issuer and the Exchange, resulting in the permanent removal of the securities of a listed company from the Exchange so that the securities can no longer trade on the Exchange.
At the time of OM 1, Arbour common shares were suspended from trading but were still listed for trading on the Exchange, and Arbour was still a listed company bound by its listing agreement with the Exchange. Thus, Arbour's disclosure of the trading status of its listed securities in OM 1 was incomplete and misleading, giving no hint that, for some regulatory reason, the Exchange had suspended Arbour common shares from trading on its platform. Had information about Arbour's suspension been given, a reader of OM 1 could reasonably have concluded that Arbour was facing a regulatory issue, such as non-compliance with Exchange requirements.
Arbour was a recently reactivated shell company embarking with new management on a new business plan. That the Exchange had decided to suspend Arbour common shares from trading would raise a "red flag" for many investors, and would be a fact that would – along with any explanation given – have been useful to a reasonable investor considering whether to invest in securities of Arbour. We think it obvious that disclosure of the Exchange's suspension of Arbour common shares from trading was material information – reasonably likely to affect significantly an investment decision, including the price that an investor would be willing to pay for, or the value that an investor would attribute to, the Arbour Preferred Shares (particularly given that the Arbour Preferred Shares were convertible to common shares on a one-for-one basis). The omission of such disclosure to investors who were being offered Arbour Preferred Shares under OM 1 was, we find, a misrepresentation and so breached the requirements of Form F2.
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Arbour applied to the Exchange to de-list its common shares, which request was granted on 21 July 2004. Morice suggested that, because Arbour common shares had been de-listed from the Exchange by the date of completion of its first distribution of the Arbour Preferred Shares – on 20 September 2004, according to the first Distribution Report – its listing status reference was correctly disclosed in OM 1. We disagree. It was not only Arbour's current listing status that mattered, but what led to that – in this case, the suspension by the Exchange, Arbour's request to de-list and the subsequent de-listing. In our view, especially given the right to convert the Arbour Preferred Shares to common shares, the suspension by the Exchange and Arbour's request to de-list and the reasons therefor were material information that should have been disclosed in OM 1 to prospective investors. Further, the actual de-listing and the reasons therefor were material information – for much the same reasons as set out above regarding the suspension by the Exchange – that should have been disclosed to prospective investors as a change in a revised OM 1, but were not so disclosed, thus breaching Form F2 requirements. We so find.
Consistent with these findings is the guidance provided to issuers in making materiality determinations in National Policy 51-201 Disclosure Standards ("NP 51-201"). NP 51-201 informs issuers that "de-listing of the company's securities or their movement from one quotation system or exchange to another" is an example of an event that may be material and therefore publicly disclosable.
2004 AIF
The OM Exemption provides for two forms of offering memoranda – one for non-qualifying issuers and one for qualifying issuers. As noted, offering memoranda are disclosure documents that can be used in some circumstances as a simpler alternative to the prospectus process. As such, an offering memorandum must contain sufficient – and accurate – information to assist prospective investors in making informed investment decisions.
Non-qualifying issuers – those with a less-extensive continuous disclosure record – were required (by MI 45-103), if relying on the OM Exemption, to use Form 45-103F1 ("Form F1"). An offering memorandum prepared in accordance with Form F1 required inclusion of much more extensive information about the business of the issuer – structure, development, long-term objectives and key terms of all material agreements (including any loans) – and about directors, management, promoters and principal holders, as well as the inclusion of specified financial statements.
Section 2.2 of Form F2, and, therefore, the OM Exemption, required qualifying issuers to incorporate the issuer's disclosure document (one such being the issuer's AIF) on which the issuer relied to meet the definition of qualifying issuer. Form F2 stated that a qualifying issuer not wishing to incorporate by reference the prescribed "parts of its continuous disclosure base" must use Form F1. This was because Form F1 required much of the incorporated information to be in the offering memorandum itself. Either way, prospective investors were thus given information considered important to their making of informed investment decisions.
Form 51-102F2 of National Instrument 51-102 Ongoing Requirements for Issuers and Insiders explained that an AIF "is a disclosure document intended to provide material
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information about [the issuer] and its business at a point in time in the context of its historical and possible future development" (emphasis added). Form 51-102F2 instructed an issuer preparing its AIF to "[f]ocus [the] AIF on material information", that is, "[w]ould a reasonable investor's decision whether or not to buy, sell or hold securities in your company likely be influenced or changed if the information in question was omitted or misstated?"
OM 1 was a Form F2 offering memorandum. Arbour purported to rely on its 2004 AIF to meet the definition of "qualifying issuer" and, as such, entitled to use the abbreviated Form F2 available for such issuers. OM 1 stated that Arbour's 2004 AIF (dated 14 July 2004; the same date as OM 1) was available for viewing on SEDAR by prospective investors. However, the evidence is clear – and there was no dispute – that the 2004 AIF had not been filed on SEDAR and thus was not available for viewing on SEDAR as of 14 July 2004 as claimed. Indeed, the evidence was that Arbour's 2004 AIF was never filed on SEDAR.
As discussed, the disclosure in OM 1 about Arbour's intended business activity was untrue and misleading – prospective investors were given no understanding of what, in fact, they were investing in and where, in fact, their invested money would be going. That would not have been the case had either a Form F1 offering memorandum (completed as prescribed) been used or Arbour's 2004 AIF (completed as prescribed) been available for viewing on SEDAR. Either would have provided to prospective investors, among other things, the key terms of all material agreements to which Arbour was a party – namely Arbour's very recent unsecured $10 Million Loan to Merendon for a 10-year term, with no apparent ability to demand immediate or early repayment, no formal loan agreement in place and the entire $10 million to be advanced by 31 December 2004. It is evident, and we find, that this information would have been important to reasonable investors making investment decisions and would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares. Therefore, the inability to view Arbour's 2004 AIF on SEDAR rendered OM 1 deficient in providing material information about Arbour's business by effectively depriving investors of material information to which they were entitled.
For these reasons, Arbour's representation that the incorporated-by-reference 2004 AIF in OM 1 was available for viewing on SEDAR was an untrue statement of a material fact, an effective omission of material facts required to be stated and thus a misrepresentation in OM 1 in breach of the requirements of Form F2. We so find.
Directors
Item 3 of Form F2 mandated that information about directors (and senior officers) be included in an offering memorandum. The identities of and other details about an issuer's directors – the individuals charged with responsibility for overseeing the issuer's management and business – are generally viewed as material information. Indeed, NP 51-201 informs issuers that "changes to the board of directors or executive management" are examples of events that may be material and therefore publicly disclosable.
When securities are being sold pursuant to the OM Exemption, changes in circumstances may occur that result in the facts disclosed in the offering memorandum becoming untrue or
misleading. When that happens, the issuer cannot accept any new subscriptions from purchasers until the issuer has amended the offering memorandum and a new certificate has been signed.
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OM 1 identified Arbour's directors as Morice, Strashok and Weis. Strashok was a director of both Arbour and Merendon at the time. On 9 September 2004 Strashok officially resigned from the Arbour board of directors and was replaced by Wigmore (a former director and president of Merendon). Despite continuing sales of Arbour Preferred Shares under OM 1 from this date, OM 1 was never revised or updated to disclose this change in Arbour's directors. From this date, the director disclosure in OM 1 was untrue and misleading.
It is not unusual for investors considering an investment in a recently reactivated –essentially start-up – entity, such as Arbour, with little or no existing business and operating history, to base their investing decisions largely on the reputation, background and experience of the entity's directors and senior officers. We think it obvious that reasonable investors in making investment decisions would want to know the identity, reputation, background and experience of those who have accepted responsibility for overseeing the management and affairs of the company in which the investors are being solicited to invest their money and trust. We find this is material information – information that would reasonably be expected to significantly affect the market price or value of the securities being offered.
For these reasons, we find that the materially untrue and misleading director disclosure from 9 September 2004 in OM 1 was a misrepresentation in breach of Form F2 requirements, or alternatively that Arbour's failure to revise the director disclosure in OM 1 from that date, while continuing to sell Arbour Preferred Shares under OM 1, was in breach of Form F2 requirements.
In addition to the substantive defects in OM 1 found above, Arbour failed to comply with other, albeit less substantive, requirements of the OM Exemption in relation to OM 1.
The OM Exemption required, under section 4.7 of MI 45-103, that a copy of the offering memorandum and any update being relied on be filed with the Commission within 10 days of each distribution under the offering memorandum. The evidence was that Arbour never filed OM 1 with the Commission.
The OM Exemption requires that Distribution Reports be filed within 10 days of completion of a distribution. The evidence was that Distribution Reports for distributions made under OM 1 were all filed late.
The OM 1 certificate signed by Morice stated that OM 1 did not contain a misrepresentation. For the foregoing reasons, it is clear, and we find, that Morice signed a false certificate.
We find these other deficiencies were all contrary to MI 45-103.
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For the reasons given, we find that OM 1 contained significant defects –misrepresentations – and that there were other deficiencies in or associated with OM 1. OM 1 failed to comply with key requirements of Form F2 and other requirements of the OM Exemption. In the result, while OM 1 was being used to trade and distribute Arbour Preferred Shares to investors, it misrepresented key – material – information about Arbour, its business and its intended use of the money raised. The very reason for which an offering memorandum is mandated under the OM Exemption – to provide investors with all material facts needed to enable informed investment decision-making – was thwarted.
In conclusion, we found numerous breaches – misrepresentations, a false certificate, no filing of OM 1 with the Commission, and late filing of Distribution Reports – of the OM Exemption requirements in connection with the trades and distributions of Arbour Preferred Shares made using OM 1. Some of the breaches in isolation might be considered formal or technical breaches, but, when considered in their totality, OM 1 was seriously and substantively non-compliant with the OM Exemption requirements.
No Reference to Merendon – Use of Proceeds, Business Summary, Risk Factors
As with OM 1, OM 2's stated maximum offering was 25 million Arbour Preferred Shares for maximum proceeds of $33 750 000. Morice explained that OM 2 was "just a continuation" of OM 1 – apparently intended to raise, together, a total of $33 750 000, not $67 500 000.
In the "[d]escription of intended use of available funds" at section 1.2 of OM 2, Arbour disclosed that $14 685 000 of the maximum offering would be used for "[a]cquisitions of further technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions". Of the balance, $10 million would be applied to "Loan/Option Re Tarsands Technology" (the $10 Million Loan/TRL option);
$7 million to "Share Purchase: Canadian Oilsands Recovery Ltd." (COREL); $400 000 to "working capital"; and the remaining $890 000 to three identified oil and gas holdings or ventures.
This disclosed use of proceeds did not truthfully or completely disclose how money raised was to be used by Arbour, as specifically required by Form F2 and, thus, by the OM Exemption.
At the date of OM 2, the $10 Million Loan had already been fully advanced to Merendon; none of the money raised under OM 2 from the sale of Arbour Preferred Shares would be used for that purpose. Stating that proceeds were going to be used for the $10 Million Loan was clearly untrue and misleading – an offering memorandum is a forward-looking, not historical, disclosure document. Some of this inaccuracy may have occurred because OM 2 was essentially a continuation of the offering under OM 1, but that was also not made clear by OM 2. For the reasons given in connection with OM 1, we find that this matter – a use of proceeds matter – was a material fact that was required to be disclosed or disclosed accurately. This was, therefore, a misrepresentation.
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As in OM 1, section 5.2 of OM 2 stated that gross proceeds would "be released to [Arbour] for its use" two days after "Closing". However, Arbour began advancing loan money to Merendon on 1 February 2005, and then continued to make frequent such advances to Merendon, without regard for the wording of section 5.2 of OM 2 (according to the evidence, the first closing for OM 2 was on 31 January 2005, with subsequent closings approximately every month after that). Further, OM 2 failed to disclose Arbour's intention to pay most of the money raised under OM 2 (after accounting for the $10 Million Loan) to Merendon under the $45 Million Loan arrangement. The use to which Arbour almost immediately put the money, and continuing until it had advanced approximately $20 million by the date of OM 3, was in no way consistent with Arbour's disclosed intended use of proceeds in OM 2. Contrary to Arbour's disclosure, the proceeds were not used as "surplus funds placed in short term investments", nor could it be said they were used for the "[a]cquisitions of further technologies and properties in the oil and gas sector". The $45 Million Loan was not "short term", indeed it had no term at the time of OM 2; and we note that the $45 Million Loan Agreement executed in early 2006 provided for a maturity date of 31 December 2015. We do not accept Morice's apparent contention that the money loaned to Merendon was somehow related to the acquisition of oil and gas technologies and properties because Merendon and Sorenson would use their influence to assist Arbour in acquiring oil and gas assets or contacts. Nor do we accept that the $45 Million Loan to Merendon could be accurately characterized at the time of OM 2 as money expended for the acquisition of further oil and gas technology. It is true that the TRL transaction completed in March 2007 extinguished the amounts loaned by Arbour to Merendon under the $45 Million Loan. However, at the time of OM 2 and indeed in early 2006 when the $45 Million Loan Agreement was executed, the money loaned was to be used for working capital and was not tied to the TRL transaction.
We find there was an omission to disclose that Arbour intended to use the proceeds raised almost immediately and continuing throughout the currency of OM 2 to make advances under the $45 Million Loan arrangement to Merendon – that omission rendering what was said about use of proceeds misleading. We also find Arbour's statement that money raised was intended for acquisitions of further oil and gas technologies and properties with surplus funds placed in short-term investments to have been untrue and misleading. For the reasons given in connection with OM 1, we find that these use of proceeds matters were material facts that were required to be disclosed or disclosed accurately. These were, therefore, misrepresentations.
Another indication of Arbour's lack of regard in ensuring true and complete disclosure in OM 2 was the representation that $7 million would be applied to the purchase of COREL. Contradictory information was found in the business summary at section 2.1, which stated the correct purchase price – $5.3 million plus 5 million Arbour common shares. This confusing information in OM 2 – the cash portion of the COREL purchase price given as $7 million or
$5.3 million; and uncertainty as to whether Arbour common shares were involved – made it impossible for prospective investors to ascertain the amount of money raised under OM 2 which would be used to purchase COREL. Morice indicated that the stated $7 million included anticipated $1.7 million "plant" construction costs; were that so, it was not stated in OM 2. In any event, the $7 million representation was untrue, and, read in conjunction with the other purchase price information, misleading. That said, we are not convinced that this untrue and
misleading information in and of itself was material. Accordingly, it was not a misrepresentation.
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In sum, we find that OM 2 contained misrepresentations about Arbour's intended use of proceeds – precisely when, where and how investor money was to be applied – and so breached the requirements of Form F2.
As in OM 1, OM 2 disclosed, under section 2.1 "Business Summary", that Arbour had been established in April 2001 to carry on oil and gas exploration and development. However, no mention was made that, at the date of OM 2, Arbour's intended business activity would be the raising of capital to provide funding to Merendon, which might at some point result in Arbour's acquiring an interest in unproven and unvalued oil sands technology. OM 2 did disclose that in August 2004 (this was untrue, as the Letter of Intent was executed in July), Arbour had "entered into a loan/option agreement with an arm's length private Alberta company" to loan it
$10 million, with "the option to convert the loan into an interest in proprietary oilsands recovery technology plus 5,000,000 common shares". However, no disclosure was made that the borrower was Merendon. OM 2 further disclosed that in January 2005 Arbour had acquired all of the shares of COREL (with two sets of information disclosed for the purchase price, as set out earlier), but failed to disclose that Merendon was one of the vendors. OM 2 also failed to disclose that Arbour had agreed to loan Merendon up to a further $45 million, with the first advance of $900 000 to be made on 1 February 2005 on the basis of a verbal agreement or "handshake" and with no security or formal loan agreement in place.
As was the case with OM 1, this disclosure in OM 2 gave an untrue and misleading picture of Arbour's intended business activity – the stated oil and gas exploration and development activities were not Arbour's focus – and omitted to state with whom Arbour was or would be conducting the majority of its business. This disclosure did not inform prospective investors that most of the money raised would be paid to or invested in Merendon, a private mining company whose assets were of uncertain value and located for the most part offshore – a link to the international side as represented to IFFL members. We think it evident that disclosure of the true facts about Arbour's intended business activity – including Merendon's identity and involvement in the transactions disclosed, and the very significant commitment to loan up to a further $45 million to Merendon without security or a formal loan agreement – would have been important information to a reasonable investor considering whether to purchase Arbour Preferred Shares. We so find. In other words, such disclosure was material – would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares.
For these reasons, we find that the untrue and misleading disclosure in OM 2 of the material facts about Arbour's intended business activity over the ensuing 12 months were misrepresentations in breach of Form F2 requirements.
The risk factor disclosure in OM 2 contained the same uninformative and largely irrelevant boilerplate discussion about risk factors and industry conditions applicable to issuers carrying on oil and gas exploration and development activities, misleading prospective investors as to the risks associated with Arbour's actual and intended business activity. Most important, and similar to OM 1, there was no discussion of the uncertainties and risks associated with what
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was now a potential unsecured $55 million being loaned without a formal loan agreement or agreements to a private company whose assets were of uncertain value and located for the most part offshore (the formal loan agreement for the $10 Million Loan was not executed until approximately May 2005; the formal loan agreement for the $45 Million Loan was not executed until early 2006).
For the reasons given in connection with OM 1, we find that the risk factor disclosure in OM 2, which omitted to disclose the relevant risks, materially misled prospective investors. Therefore, OM 2 contained a misrepresentation in breach of the requirements of Form F2.
2004 AIF
As in OM 1, OM 2 stated that Arbour's 2004 AIF – as discussed above, Arbour's qualifying disclosure document – was available for viewing on SEDAR by prospective investors. As of the date of OM 2, the 2004 AIF still had not been filed on SEDAR and thus was not available for viewing on SEDAR as claimed; in fact, as noted, Arbour's 2004 AIF was never filed on SEDAR.
For the reasons given in connection with OM 1, Arbour's representation that the incorporated-by-reference 2004 AIF in OM 2 was available for viewing on SEDAR was an untrue statement of a material fact, an effective omission of material facts required to be stated and thus a misrepresentation in OM 2 in breach of the requirements of Form F2. We so find.
Intervening Events
After the issuance of OM 2 four intervening events occurred: (i) in January 2005 Arbour entered into a participation agreement with respect to an oil and gas property near Sedalia, Alberta; (ii) Arbour established a US subsidiary – Arbour US; (iii) Arbour concluded negotiations with respect to oil and gas properties located in Southeast Asia; and (iv) a preliminary agreement was reached for Arbour to acquire the Malaysian subsidiary of an international company which had properties in Myanmar. If these transactions were material facts, then OM 2 was required to be updated to include these new material facts. OM 2 was not so updated.
Arbour issued news releases announcing all four events. On 23 February 2005 Arbour announced the establishment of Arbour US – a Nevada subsidiary to which it had "agreed to transfer all future acquired technology and oil & gas activity pertaining to the United States" (emphasis added) – and details of the Sedalia participation agreement, including Arbour's planned budget of approximately $175 000 for the first of up to eight wells. On 31 August 2005 Arbour announced the conclusion of negotiations "whereby Arbour will enter into not one, but several substantial oil and gas transactions" (emphasis added) in Southeast Asia and a first right of refusal to participate in "other international bids being made in India, Africa and the Middle East". On 16 and 27 September 2005 Arbour announced a preliminary agreement to acquire the Malaysian subsidiary of an international company (pending due diligence review) for
$25 million plus 60 million Arbour common shares, which could result in a change in control of Arbour.
It is apparent that Arbour itself believed all four events were significant enough to be publicized to the investing public through news releases. We conclude, therefore, that Arbour considered this information material – that it would reasonably be expected to significantly affect the market price or value attributed by investors to its securities.
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Arbour also apparently thought that information about the Sedalia participation agreement and the establishment of Arbour US was significant enough to be publicized to the investing public in Arbour's 2004 MD&A (for the year ended 31 December 2004; filed on SEDAR on 18 May 2005). Arbour further believed that its preliminary agreement to acquire the Malaysian subsidiary was a material fact because Arbour filed a material change report advising of this material change, which it said occurred on 16 September 2005.
We conclude this information was material. We think it evident that investors, in deciding whether to buy, sell or hold securities and what price or value to place on the securities, would want to know that the issuer was establishing a foreign subsidiary for the purpose of vending-in apparently significant assets, or that the issuer (an oil and gas exploration development company) would soon be participating in the drilling of a well or wells. We think it also evident that prospective investors would want to know about agreed-upon multiple, significant and relevant offshore transactions and a pending transaction that would result in a change in control of the issuer.
While this material information was publicly disclosed in the mentioned news releases and Arbour filings, it was not contained in an updated OM 2 (either directly or through incorporation by reference). From the occurrence of the first intervening event, purchasers of Arbour Preferred Shares under OM 2 would not have had certain or all of this material information disclosed to them when making their investment decisions. If material information is omitted from an offering memorandum, it is no answer to suggest that investors being sold securities in reliance on the OM Exemption could find this information in other public disclosure of the issuer. When making investment decisions, prospective investors are entitled to rely on the offering memorandum provided to them with its accompanying certification by the issuer's principals that there are no misrepresentations in the offering memorandum – no untrue statements or misleading omissions of material facts.
For these reasons, we find that, beginning with the occurrence of the first intervening event, the omission from OM 2 of this material intervening event information constituted a misrepresentation or misrepresentations in breach of Form F2 requirements, or alternatively that Arbour's failure to revise OM 2 from the occurrence of the first intervening event, while continuing to sell Arbour Preferred Shares under OM 2, was in breach of Form F2 requirements.
In addition to the substantive defects in OM 2 found above, Arbour continued its noncompliance with other requirements of the OM Exemption: OM 2 was never filed with the Commission; Distribution Reports for distributions made under OM 2 were all filed late; and, given our findings above that OM 2 contained misrepresentations, Morice again signed a false certificate.
We find these other deficiencies were all contrary to MI 45-103.
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For the reasons given, we find that OM 2 contained significant defects –misrepresentations – and that there were other deficiencies in or associated with OM 2. OM 2 failed to comply with key requirements of Form F2 and other requirements of the OM Exemption. In the result, while OM 2 was being used to trade and distribute Arbour Preferred Shares to investors, it misrepresented key – material – information about Arbour, its business and the use to which it intended to put the money raised. The very purpose of an offering memorandum, as mandated under the OM Exemption – to provide investors with all material facts needed to enable informed investment decision-making – was defeated.
In conclusion, we found numerous breaches – misrepresentations, a false certificate, no filing of OM 2 with the Commission, and late filing of Distribution Reports – of the OM Exemption requirements in connection with the trades and distributions of Arbour Preferred Shares made using OM 2. Some of the breaches in isolation might be considered formal or technical breaches, but, when considered together, OM 2 was seriously and substantively non-compliant with the OM Exemption requirements.
No Reference to Merendon – Use of Proceeds, Business Summary, Risk Factors
OM 3's stated maximum offering was $20 250 000. In the "[d]escription of intended use of available funds" at section 1.2 of OM 3, Arbour disclosed that $3.5 million of the maximum offering would again be used for "[a]cquisitions of further technologies and properties in the oil and gas sector with surplus funds placed in short term investments until required for appropriate acquisitions". In addition, $15 million was to be applied to a "Work program for Myanmar, if that acquisition proceeds", with $637 500 being applied to "working capital".
Like OM 1 and OM 2, OM 3 did not truthfully or completely disclose how money raised was to be used by Arbour, as specifically required by Form 45-106F3 ("Form F3", Form F2's successor) and, thus, by the OM Exemption.
As in OM 1 and OM 2, there was a provision (section 5.3 of OM 3) that gross proceeds would "be released to [Arbour] for its use" two days after "Closing". By the time of OM 3, Arbour knew that it would continue to make use of investor money soon after its receipt by advancing that money to Merendon under the $45 Million Loan. Indeed, Arbour began advancing loan money to Merendon on 29 September 2005, and continued to make such advances to Merendon, without regard for the wording of section 5.3 of OM 3 (according to the evidence, the first closing for OM 3 was on 30 September 2005, with most subsequent closings every two weeks or so). As in OM 2, OM 3 failed to disclose Arbour's intention to pay most of the money raised under OM 3 to Merendon under the $45 Million Loan arrangement. Approximately $8.6 million – for a total of some $38.6 million – was advanced from Arbour to Merendon between the date of OM 3 and the end of November 2005 (when Arbour was ordered by the Commission to stop selling its securities). For the reasons given in connection with OM 2, this almost immediate and continuing use of the money raised was in no way consistent
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with OM 3's disclosed intended use of proceeds – the proceeds were not used as "surplus funds placed in short term investments", nor could it be said they were used for the "[a]cquisitions of further technologies and properties in the oil and gas sector". We elaborate. Despite Morice's apparent claim that Merendon and Sorenson would use their influence to assist Arbour in acquiring oil and gas assets or contacts (particularly international ones), there was no evidence that any of Arbour's disclosed prospects materialized at the instance of Sorenson, and Sorenson denied offering to use, or having, "influence or clout in the international oil business". Moreover, Arbour would not have had sufficient money at its disposal with which to take advantage of any such oil and gas prospects because most of the money raised though the Arbour OMs had been paid to Merendon.
We find there was an omission to disclose that Arbour intended to use the proceeds raised almost immediately and continuing throughout the currency of OM 3 to make advances under the $45 Million Loan arrangement to Merendon – that omission rendering what was said about use of proceeds misleading. We also find Arbour's statement that money raised was intended for acquisitions of further oil and gas technologies and properties with surplus funds placed in short-term investments to have been untrue and misleading. For the reasons given in connection with OM 1, we find that these use of proceeds matters were material facts that were required to be disclosed or disclosed accurately. These were, therefore, misrepresentations.
There was contradictory information in OM 3 relating to the use of money raised under OM 3 for the Myanmar work program. Section 1.2 stated that $15 million from the available money raised was to be applied to the Myanmar work program. However, section 2.1, in summarizing the acquisition of the Malaysian subsidiary, stated that the acquisition cost was to be $25 million plus 60 million Arbour common shares. Prospective investors reading OM 3 would not know whether $15 million or $25 million was intended to be paid, or whether the
$15 million towards the work program was in addition to the acquisition cost of $25 million (and, if the latter, how Arbour would fund the $25 million acquisition cost). Further, Wigmore said that, if money were sent to Myanmar, it would "flow through the Merendon account", another fact not disclosed in OM 3. All of this was, we find, misleading. We think it obvious that accurate and complete disclosure about Arbour's use of proceeds in relation to the Myanmar work program – given the amounts involved and Arbour's apparent plan to flow the proceeds through Merendon – would have been useful information to a reasonable investor considering whether to purchase Arbour Preferred Shares. In other words, such disclosure was material –would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares. We therefore find this a misrepresentation.
In sum, we find that OM 3 contained misrepresentations about Arbour's intended use of proceeds – precisely when, where and how investor money was to be applied – and so breached the requirements of Form F3.
As in OM 1 and OM 2, OM 3's section 2.1 "Business Summary" disclosed that Arbour had been established in April 2001 to carry on oil and gas exploration and development, but again made no mention that, at the date of OM 3, Arbour's intended business activity would be the raising of capital to provide funding to Merendon, which might at some point result in Arbour acquiring an interest in unproven and unvalued oil sands technology.
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OM 3 contained the same disclosure as in OM 2 regarding a $10 million loan "with an arm's length private Alberta company". This time, however, Arbour did identify Merendon as that private company in Arbour's 2004 MD&A incorporated by reference into OM 3. OM 3 still failed to disclose that Arbour had agreed to loan Merendon up to a further $45 million, on the basis of a verbal agreement or "handshake" in January or February 2005 and with no security or formal loan agreement yet in place (the $10 Million Loan was formally documented by the time of OM 3, but not the $45 Million Loan). OM 3 also failed to disclose that approximately
$20 million under the $45 Million Loan had already been advanced to Merendon, with further money to be advanced.
Two paragraphs of section 2.1 of OM 3 discussed, in general terms, what appeared to be significant and material international oil and gas transactions entered into or contemplated by Arbour in Southeast Asia and Myanmar (as noted, Arbour had filed a material change report in respect of the proposed latter acquisition). The disclosure about the "two substantial oil and gas transactions" in Southeast Asia was not, in our view, particularly informative. The description of a $25 million plus 60 million Arbour common shares purchase price for the Malaysian subsidiary in Myanmar was certain to attract attention, and the disclosure of supposedly significant proven oil and gas reserves lent a sense of legitimacy. Beyond that, little or no specific information was provided with respect to key facts such as: the identity of the other parties to the transactions; the specific locations of the oil and gas properties in question; the number of wells involved; estimates of reserves; the costs involved; terms of any rights of first refusal; the purchase prices for the Southeast Asian assets; and how the purchase price for the Malaysian subsidiary was reached. That said, accompanying statements (for the Southeast Asian transactions concerning "substantiating reserve estimates" before "formal contracting"; and for the Myanmar acquisition concerning "due diligence" and "significant work" yet to be done) render it difficult to find that this disclosure was misleading, and we do not.
Nevertheless, as was the case with OM 1 and OM 2, the disclosure in OM 3 gave an untrue and misleading picture of Arbour's intended business activity and with whom it was or would be doing the majority of its business – the disclosure did not inform prospective investors that most of the money raised would be paid to or invested in Merendon, a private mining company whose assets were of uncertain value and located for the most part offshore. We think it evident, and we find, that disclosure of the true facts about Arbour's intended business activity
Arbour's very significant commitment to continue to advance money raised to Merendon without security or a formal loan agreement – would have been useful to a reasonable investor contemplating the purchase of Arbour Preferred Shares. In other words, such disclosure was material – would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares.
For these reasons, we find that the untrue and misleading disclosure in OM 3 of the material facts about Arbour's intended business activity over the ensuing 12 months were misrepresentations in breach of Form F3 requirements.
The risk factor disclosure in OM 3 contained, but for one pertinent addition, the same uninformative and largely irrelevant boilerplate discussion about risk factors and industry
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conditions applicable to issuers carrying on oil and gas exploration and development activities, misleading prospective investors as to the risks associated with Arbour's actual and intended business activity. Most important, and similar to OM 1 and OM 2, there was no discussion of the uncertainties and risks associated with what was now a potential unsecured $55 million being loaned to a private company whose assets were of uncertain value and located for the most part offshore and in the absence of a formal loan agreement covering most of that $55 million (the formal loan agreement for the $10 Million Loan had been executed in approximately May 2005, but the formal loan agreement for the $45 Million Loan was not executed until early 2006). Not included in the risk factor disclosure was a discussion of the risks associated with acquiring and holding oil and gas properties located outside North America.
For much the same reasons given in connection with OM 1 and OM 2, we find that the risk factor disclosure in OM 3, which omitted relevant risks, materially misled prospective investors. Therefore, OM 3 contained a misrepresentation in breach of the requirements of Form F3.
Directors and Officers
OM 3 did not explicitly identify Hobbs as a senior officer of Arbour, despite her appointment as Arbour's CFO in August 2005. However, Hobbs did sign the OM 3 certificate in her capacity as CFO, so there was some disclosure in OM 3 that she held that position at that time. That said, there was no discussion of Hobbs's background or experience. Section 3.2 of OM 3 directed readers to Arbour's incorporated-by-reference 9 September 2005 AIF (the "2005 AIF") and to a Management Information Circular dated 5 November 2004 (not incorporated by reference) for more information about Arbour's directors and senior officers. The former included no mention of Hobbs; we received no evidence about the latter (and we have already noted the importance of including mandated information in offering memoranda). As earlier discussed in connection with OM 1, any investor making an investment is risking money and giving trust. And it is not unusual for investors considering an investment in an essentially startup issuer, such as Arbour, to base their investing decisions largely on the reputation, background and experience of the issuer's senior officers and directors. We think it evident that reasonable investors in making investment decisions would want to know not only the identity but also the reputation, background and experience of those who will be running the issuer's business. Indeed, we think background information about Hobbs – who occupied the key corporate position of Arbour's CFO – would have been particularly important information for prospective purchasers of Arbour Preferred Shares because there were only two senior officers at Arbour –Morice and Hobbs. We find that bankground information about Hobbs, which was omitted, was material information – information that would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares. We, therefore, find that these omitted material facts were a misrepresentation in breach of the requirements of Form F3.
Arbour director Wigmore had been a director and the president of Merendon, an issuer that was subject to a two-year denial of exemptions order issued by the Commission in October 2000. Despite this, Arbour's 2005 AIF, incorporated by reference into OM 3, stated in section 8.2 that no Arbour director or officer:
. . . within the 10 years before the date of this AIF, has [been] a director or officer of any other issuer that, while that person was acting in that capacity . . . was the subject of [an] order that
denied the other issuer access to any exemptions under Canadian securities legislation, for a period of more than 30 consecutive days . . .
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By its incorporation, this became an untrue statement in OM 3. The reasons given above regarding the materiality of senior officers' and directors' reputations, background and experience are equally applicable to their regulatory history. Common sense tells us that investors would have considered information about a director's unfavourable history with securities regulators to be relevant – indeed of high importance – in making a decision whether to purchase Arbour Preferred Shares, and at what price. That information was, we find, obviously material – would reasonably be expected to have a significant effect on the market price or value of the Arbour Preferred Shares. This untrue material statement was, therefore, a misrepresentation in breach of Form F3 requirements.
Other Alleged Disclosure Failures
Arbour's 2004 MD&A, incorporated by reference into OM 3, contained sufficient disclosure of Arbour's participation agreement with respect to an oil and gas property near Sedalia, Alberta and the establishment of Arbour US. Accordingly, we find no misrepresentation on this ground.
According to Chute, a revised version of Arbour's 2004 MD&A was filed at the end of May 2005 but not incorporated by reference into OM 3. Because that revised document was not in evidence, we could not assess whether the revised information it contained was different in any material way from that contained in Arbour's incorporated-by-reference 2004 MD&A. Therefore, there is insufficient evidence to find a misrepresentation on this ground.
OM 3 disclosed in section 4.1 that Arbour had 28 165 638 Arbour Preferred Shares outstanding as at 31 August 2005. The exact number of Arbour Preferred Shares issued and outstanding as at 31 August 2005 has not been established to our satisfaction. Accordingly, we have insufficient evidence from which to conclude that this disclosure in OM 3 was untrue or that the discrepancy claimed was, in and of itself, material, thus amounting to a misrepresentation.
In addition to the substantive defects in OM 3 found above, Arbour continued its noncompliance with other requirements of the OM Exemption: all but one of the Distribution Reports for distributions made under OM 3 were filed late; and, given our findings above that OM 3 contained misrepresentations, Morice again signed a false certificate.
We find these other deficiencies were all contrary to NI 45-106.
For the reasons given, we find that OM 3 contained significant defects –misrepresentations – and that there were other deficiencies in or associated with OM 3. OM 3 failed to comply with key requirements of Form F3 and other requirements of the OM Exemption. In the result, while OM 3 was being used to trade and distribute Arbour Preferred Shares to investors, it misrepresented key – material – information about Arbour, its business and its intended use of the money raised. The very reason for mandating an offering
memorandum under the OM Exemption – to provide investors with all material facts needed to enable informed investment decision-making – was frustrated.
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In conclusion, we found numerous breaches – misrepresentations, a false certificate and late filing of Distribution Reports – of the OM Exemption requirements in connection with the trades and distributions of Arbour Preferred Shares made using OM 3. Some of the breaches in isolation might be considered formal or technical breaches, but, when considered in their totality, OM 3 was seriously and substantively non-compliant with the OM Exemption requirements.
Although it is expected that all trades and distributions of securities made in reliance on a registration or prospectus exemption will comply strictly with the requirements of the exemption, there may be circumstances in which deficiencies and non-compliance attract liability but may not preclude reliance on the OM Exemption. However, that is not the case here.
For the reasons given, we found that all three Arbour OMs contained significant defects –misrepresentations – and that there were other deficiencies in or associated with all three Arbour OMs. None of the Arbour OMs complied with key disclosure requirements of the OM Exemption; we agree with Staff that "a culture of falsehoods . . . permeate[d]" the Arbour OMs. The Arbour OMs' muddled disclosure not only badly informed prospective investors but also gave them untruths and misled them. In the result, the Arbour OMs, while being used to trade and distribute Arbour Preferred Shares to investors, misrepresented material facts about Arbour, its business and the use to which it intended to put the money raised. Among the misrepresentations found, the most critical was the lack of disclosure that Arbour's intended use of proceeds, and its intended business activity, was to provide Merendon – a private mining company whose assets were of uncertain value and located for the most part offshore – with some $38.6 million (84%) of the approximately $45.5 million raised, without typical commercially reasonable terms and conditions (and Arbour paid another $5.6 million to purchase COREL, of which Merendon was the majority shareholder). The significant defects and other deficiencies found defeated the very purpose of the Arbour OMs – to provide prospective Arbour investors with accurate, complete and accessible disclosure of material facts on which to make informed investment decisions. We consider the Commission's words in Capital Alternatives (at para. 281) apposite:
The offering memorandum is the core investor protection mechanism on which the OM Exemption is built; we stated above that it was the foundation of the OM Exemption. We consider that the defects in the OMs were so serious and pervasive that they fatally undermined that foundation in this case.
As a result of the serious and pervasive failings of OM 1, OM 2 and OM 3, we find that the OM Exemption to the registration and prospectus requirements was not available to qualify the trades and distributions of Arbour Preferred Shares purporting to rely on that exemption.
As we found above, there was no registration and prospectus here. The OM Exemption was not available (and no other registration and prospectus exemptions were shown to have been available). Accordingly, we find that the trades and distributions of the Arbour Preferred Shares
made by Arbour, Morice, Brost and IFFL contravened sections 75(1)(a) and 110(1) of the Act and were, therefore, illegal.
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As discussed above, both sections 92(3)(c) and 92(4.1) of the Act prohibit a person or company from making materially untrue or misleading statements. Section 92(3)(c) was in force until 7 June 2005, with section 92(4.1) in force from 8 June 2005. OM 1 was dated 14 July
2004; OM 2 was dated 19 January 2005; and OM 3 was dated 26 September 2005. Therefore, section 92(3)(c) would have applied to distributions under OM 1 and some of the distributions under OM 2, with section 92(4.1) applying to the remaining distributions under OM 2 and to the distributions under OM 3.
The issue before us in this context is whether Arbour or Morice (or both) contravened section 92(3)(c) of the Act by making (before the amendment of section 92) each of the materially untrue or misleading statements (or materially untrue and misleading statements) in OM 1 and OM 2 found above, and contravened section 92(4.1) by making (after the amendment of section 92) each of the materially untrue or misleading statements (or materially untrue and misleading statements) in OM 2 and OM 3 found above. Staff's allegations here largely involve the same facts as their allegations relating to the defects in the Arbour OMs.
Arbour issued the Arbour OMs; accordingly, the statements therein, including the statements at issue here, were made by Arbour. Morice, as Arbour's president and CEO, personally signed and certified as being free of misrepresentations each of the Arbour OMs. Thus, the statements in the Arbour OMs, including the statements at issue here, were also made by Morice.
Section 92(3)(c) of the Act applied only to untrue or misleading statements made with the intention of effecting trades in securities. In this case, because Arbour was purportedly relying on the OM Exemption to trade and distribute the Arbour Preferred Shares, the content of OM 1 and OM 2 was obviously intended to effect trades in the Arbour Preferred Shares.
Morice suggested that investors did not rely on the Arbour OMs when they purchased Arbour Preferred Shares. Rather, "[t]hey were all attempting to get their money 'off shore' into gold backed, managed accounts that would give them five or six times the rate of return they could expect on a conservative investment in Canada", and "Arbour investors wanted and expected their money to be moved offshore to entities backed by [Merendon] and [Sorenson's] gold".
We disagree. Investor motive or understanding is not relevant to the issue of whether Arbour met its regulatory obligations under Alberta securities laws. Alberta securities laws regulate trading in securities. One principal protective tool for achieving this is the establishment of disclosure requirements, with the objective that investors will be provided with complete and accurate information to assist them in making informed investment decisions. Whatever motives or understandings prospective investors had when they decided to purchase
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Arbour Preferred Shares did not deprive them of fundamental protections to which they were entitled under Alberta securities laws. Indeed, had proper disclosure been made in the Arbour OMs, many of the Arbour investors might have refrained from purchasing Arbour Preferred Shares and avoided financial losses – devastating losses in some cases (according to investor witness testimony).
We accordingly find that the materially untrue or misleading statements (or materially untrue and misleading statements) in OM 1 and OM 2 found above were made with the intention of effecting trades in securities.
Both sections 92(3)(c) and 92(4.1) of the Act require an element of knowledge – that the maker of the statements knew or reasonably ought to have known that the statements: were untrue or misleading; and were material, namely would reasonably be expected to have a significant effect on the market price or value of the securities.
We consider whether Arbour and Morice had the requisite knowledge concerning the materially untrue or misleading statements (or materially untrue and misleading statements) in the Arbour OMs found above. Arbour as a corporation carried on its activities through individuals. Morice was the Arbour principal primarily responsible for the disclosure in the Arbour OMs; therefore, what Morice knew or reasonably ought to have known can equally be attributed to Arbour.
No Reference to Merendon – Use of Proceeds, Business Summary, Risk Factors
There is no question that Arbour and Morice knew Merendon was the intended recipient of what eventually amounted to some $38.6 million of the approximately $45.5 million raised from the sale of the Arbour Preferred Shares. Cash advances to Merendon authorized by Morice commenced within two weeks of the date of OM 1 and continued throughout the currency of OM 2 and OM 3. There is no question that Arbour and Morice knew that Arbour's business over the respective 12-month periods from the dates of the Arbour OMs was to raise capital to provide funding by way of loans to Merendon. That was the plan; that was what happened. Arbour and Morice clearly knew that Arbour's business focus was not oil and gas exploration and development activities.
Turning to the claimed purported "short term" nature of, first, the $10 Million Loan and second, the $45 Million Loan, this was not a reasonable position and was not supported by the evidence.
Negotiations for the $10 Million Loan commenced in early May 2004. At the date of OM 1 (14 July 2004), Arbour (per Morice) and Merendon (per Sorenson) had entered into the Letter of Intent dated 5 and 9 July 2004 whereby Arbour proposed to lend Merendon $10 million for a term of 10 years. There was no suggestion in either the Letter of Intent or the subsequently-papered 10 July 2004 $10 Million Loan Agreement (executed by the same individuals in approximately May 2005) that this loan to Merendon was to be anything other than a 10-year loan, with no apparent ability to demand immediate or early repayment – in other words, it was a long-term loan or investment. There was also no security or other enforceable means in place to
ensure that this money Arbour was sending offshore to Merendon could be recalled or recovered. Morice, involved as he was with the $10 Million Loan transaction, knew these things.
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Similarly, by the date of OM 2 (19 January 2005) Arbour (per Morice) and Merendon (per Sorenson) had entered into a verbal agreement whereby Arbour proposed to lend Merendon an additional $45 million with no fixed term. The eventually-papered 1 January 2005
$45 Million Loan Agreement executed by Arbour (per Morice) and Merendon (per Sorenson) in early 2006 provided for a maturity date of 31 December 2015, with no apparent ability to demand immediate or early repayment. This, too, was a long-term loan or investment. Once papered, the $45 Million Loan was only partially secured; until then, it had been unsecured.
Morice himself admitted that Arbour had an opportunity to pursue a certain international transaction, but, because the money was offshore with Merendon, Arbour found itself in a "spot"
it was unable to recoup the money it had advanced to Merendon and could not proceed.
Further, Merendon and Sorenson did not view the $10 Million Loan or the $45 Million Loan as a short-term loan or investment. The money, as provided for in the associated loan agreements, was to be used by Merendon for working capital to fund its operations, not to be held by it as short-term loans or investments. Consistent with this position, the Merendon Financial Statements recorded all money received under the $10 Million Loan and the
$45 Million Loan as long-term debt.
We find that Arbour and Morice knew or reasonably ought to have known that the
$10 Million Loan and the $45 Million Loan were not short-term loans or investments.
We cannot fathom how Morice could have certified the veracity of the use of proceeds, business summary and associated risks disclosure in the Arbour OMs when he knew full well that the intent was for Arbour to advance most of the money raised from the sale of the Arbour Preferred Shares to Merendon without any apparent ability to demand immediate or early repayment – and without the benefit of security or, initially, formal loan agreements (elements present in most other arm's-length commercial transactions). It is clear, and we find, that Morice and, through him, Arbour knew that this disclosure was untrue and misleading. Further, Arbour and Morice had no reasonable basis for concluding that Arbour's actual intended use of proceeds, true business and the attendant risks were not disclosable material facts. These facts were material – would reasonably have been expected to have a significant effect on the market price or value of the Arbour Preferred Shares – and Arbour and Morice knew or reasonably ought to have known this. We so find.
Listing Status
Arbour and Morice clearly knew Arbour's listing status history. There was evidence of Morice being involved in making the de-listing application to the Exchange.
Arbour and Morice also knew or reasonably ought to have known that the misleading information about Arbour's listing status would reasonably be expected to have a significant effect on the market price or value of Arbour Preferred Shares.
2004 AIF
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Arbour and Morice knew or reasonably ought to have known that Arbour's 2004 AIF, disclosed in OM 1 and OM 2 as being available for viewing on SEDAR, was not filed on SEDAR at the time. We reject Morice's contention that Arbour's legal counsel was responsible for filing the 2004 AIF; that responsibility was ultimately Morice's. Morice, who was certifying the information in the Arbour OMs, should have checked to ensure that all documents incorporated by reference were in fact filed on SEDAR. This is particularly true of the critical 2004 AIF, on which document Arbour purported to rely to meet the definition of "qualifying issuer" under MI 45-103, entitling Arbour to use the less detailed disclosure Form F2. As noted by this Commission in Maitland Capital (at para. 138): "[S]enior officers and directors of issuers are accountable for acts committed under their watch. Attempting to shirk this responsibility is conduct inconsistent with the duties of officers and directors."
Arbour and Morice also knew or reasonably ought to have known that the untrue and effectively misleading information about Arbour's 2004 AIF being available for viewing on SEDAR would reasonably be expected to have a significant effect on the market price or value of Arbour Preferred Shares.
Directors and Officers
Arbour and Morice (who was a director and the president and CEO of Arbour) knew or reasonably ought to have known that: Strashok had resigned as an Arbour director and had been replaced by Wigmore during the currency of OM 1; and Hobbs was Arbour's CFO when OM 3 was being used to raise money.
Wigmore clearly knew of the denial-of-exemptions order issued by the Commission against Merendon, as he was its president and a director at the time. Morice acknowledged in the Morice Interview that he had not asked Wigmore whether he ever had any issues with any securities regulatory authority. We accept that Morice – and, therefore, Arbour – may not have known of Wigmore's regulatory history with the Commission. However, Morice should have made the necessary inquiries; he – and, therefore, Arbour – reasonably ought to have known. OM 3 incorporated by reference Arbour's 2005 AIF, which specifically stated that no officer or director of Arbour had been a director or officer of any other issuer that had been the subject of an exemptions ban within 10 years of the date of the 2005 AIF. It was incumbent on Morice, as Arbour's senior executive officer, to ask this question of each of Arbour's officers and directors before permitting Arbour to make such a statement in its 2005 AIF. That Morice neglected to do so is no excuse.
Arbour and Morice also knew or reasonably ought to have known that such untrue and misleading information about Arbour's directors and officers would reasonably be expected to have a significant effect on the market price or value of Arbour Preferred Shares.
Intervening Events
Arbour, as a party to the Sedalia participation agreement and the offshore negotiations and agreements, and as the creator of Arbour US, clearly knew of these transactions. As Arbour's most senior officer, Morice was involved in, and thus would have been keenly aware of, these transactions.
Arbour and Morice also knew or reasonably ought to have known that misleading information about these transactions would reasonably be expected to have a significant effect on the market price or value of Arbour Preferred Shares.
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Conclusion
We have found that Arbour and Morice made the materially untrue or misleading statements (or materially untrue and misleading statements) in the Arbour OMs found above. We also have found, for purposes of section 92(3)(c) of the Act, that the materially untrue or misleading statements (or materially untrue and misleading statements) in OM 1 and OM 2 found above were made with the intention of effecting trades in securities. We further find that, contrary to sections 92(3)(c) and 92(4.1), Arbour and Morice made each of the materially untrue or misleading statements (or materially untrue and misleading statements) in the Arbour OMs found above when Arbour and Morice respectively knew or reasonably ought to have known such statements: (i) were untrue or misleading (or both); and (ii) would reasonably be expected to have a significant effect on the market price or value of Arbour Preferred Shares.
In Kerr v. Danier Leather Inc., 2007 SCC 44, the Supreme Court of Canada considered the application of the business judgment rule to decisions made regarding disclosure under securities laws. In finding that the rule did not apply, the court stated (at para. 54-55):
. . . disclosure is a matter of legal obligation. The Business Judgment Rule is a concept well-developed in the context of business decisions but should not be used to qualify or undermine the duty of disclosure. . . .
. . . the disclosure requirements under the Act are not to be subordinated to the exercise of business judgment. It is for the legislature and the courts, not business management, to set the
legal disclosure requirements. [Emphasis in original.]
We question, on the evidence before us, whether Arbour directors or officers –specifically Morice – applied an appropriate measure of prudence and diligence in assessing materiality or in deciding related disclosure issues. In any event, it is for the legislature and adjudicators, not a company's directors or officers, to set legal disclosure requirements, and the materiality assessments and disclosure decisions of Arbour directors and officers cannot override the dictates of Alberta securities laws. Thus, the business judgment rule does not excuse any deficiencies in the Arbour OMs.
Morice contended that he should not be found liable for any misstatements in the Arbour OMs because he relied on legal advice given to him by Skeith to ensure that the Arbour OMs complied with the OM Exemption requirements. Arbour made no submissions, but we will assume that if this legal advice protection is available to Morice then it may also be available to Arbour.
As discussed above, it is well established that a person trading or distributing securities is responsible for determining whether an exemption is available; it is inappropriate for the person to assume an exemption's availability. Given these principles and the facts we have found here,
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we are disinclined to find any circumstances that would somehow diminish Arbour's and Morice's responsibility for their contraventions of the Act. Such circumstances, if applicable, would arguably more properly be considered as mitigating factors when a hearing panel is deciding what, if any, sanctions are required in cases of proven contraventions of Alberta securities laws (Re Jennix, 2009 ABASC 368 at para. 72).
It is also a well-established principle that officers and directors are responsible for ensuring that their issuer complies with securities laws, including disclosure obligations. Morice was Arbour's most senior officer, charged with the responsibility of preparing the Arbour OMs for Arbour's use in raising money from the public using the OM Exemption. As such, Morice had a duty to ensure that the investing public was provided with the proper disclosure. As the Commission stated in Capital Alternatives (at para. 288):
Officers and directors need not be familiar with every detail of every law that governs the affairs of their company, but that does not relieve them of compliance responsibilities. They must act reasonably to inform themselves or satisfy themselves that those on whose advice they rely are informed. They must act diligently with a view to ensuring compliance. Above all, they must conduct themselves in good faith in a manner consistent with the spirit of applicable laws. In this case, as discussed, what transpired was contrary to the letter and the spirit of Alberta securities laws.
Skeith, a securities lawyer for more than 20 years, assisted Morice with the preparation of each of the Arbour OMs. Legal counsel's role is to provide advice; however, the final decision as to what disclosure will be made in offering documents such as offering memoranda remains with the issuer – and its officers and directors. Skeith, in agreeing with the proposition that offering memoranda disclosure is ultimately the issuer's responsibility, answered the panel's questions as follows:
Q And you gave [Arbour] advice that they should disclose this agreement or not disclose this agreement?
A Well, I set out the parameters as, you know, basically, here's a -- the definition of materiality, and here's risks and whatever. You know, what's [Arbour's] plan? What's [Arbour's] assessment? And this is where we ended up.
Q And that determination was made by the client?
A Yes I give advice, I can't make the final decision.
Q Right. And while we're on the topic, is it fair to say that the disclosure in all of these [offering memoranda] is the responsibility of the issuer?
A Yes.
Even if we were to accept that Morice's reliance on legal advice could be a complete answer to a failure to comply with Alberta securities law requirements, there are certain criteria that a respondent must satisfy in order to avail oneself of such a defence (Re Mega-C Power Corp. (2010), 22 OSCB 8290 at para. 261; and Jennix at paras. 99-102):
the lawyer had sufficient knowledge of the facts on which to base the advice;
the lawyer was qualified to give the advice;
considering all the circumstances the advice was credible; and
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the respondent made sufficient inquiries, properly applied the advice and reasonably relied on the advice.
In our view, Morice has failed to satisfy all of these criteria.
First, there was little evidence of the discussions that took place between Skeith and Morice as they prepared the Arbour OMs, what information was provided to Skeith and what specific legal advice was sought from Skeith. Indeed, we received no evidence of discussions that took place between Skeith and Morice concerning certain alleged disclosure failings.
Skeith produced his Arbour file during his testimony, but it contained virtually nothing showing what information he had been given by Arbour and Morice, or what specific legal advice Skeith provided and on what issues. For example, Skeith's file before us contained no documentation recording instructions received or advice given. Further, there were no draft Arbour OMs with mark-ups included.
Moreover, Skeith could not recall what advice he gave Arbour and Morice in certain instances. For example, Morice suggested that Arbour's failure to disclose Merendon's name in OM 2 was based on legal advice that there was no legal requirement to do so – Morice said that Merendon was a "very private company" which "wouldn't want us using their name in an [offering memorandum] if it wasn't required". Skeith, however, could not recall the specific advice he gave regarding Arbour's decision not to name Merendon in OM 2 but instead refer to it as a "private Alberta company". Skeith also could not recall whether he explained the implications of the Arbour OM certificates to the Arbour officers and directors who signed them.
Nor did we have the benefit of Morice's testimony as to what legal advice he and Arbour received from Skeith, what information he and Arbour provided to Skeith, or the extent of the materiality discussions.
The evidence also does not establish that Skeith was apprised of and understood all the facts when he gave the legal advice he did to Arbour and Morice.
Skeith testified that he drafts the "framework" of an offering memorandum for a client, but relies on the client to provide him with "the information that is relevant to their specific case, and we work together to ensure that the form requirements are met". Skeith also confirmed that, as legal counsel, he explains to a client what a material fact is, but then relies on the client to provide him with all the material facts that are ultimately disclosed in an offering memorandum. In cross-examination, Skeith explained his legal counsel role as follows:
Q But we'll agree, can we not, sir, that the best you can do as counsel is provide the framework for the document. You're not responsible for the intimate details of the business, the risk and the use to be made of funds; is that correct?
A Correct.
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Q You need that information from the issuer from the issuer's management. A Yes.
Q So your recommendations with respect to what goes into an [offering memorandum] are only as good as the information you get from the issuer.
A Correct.
Q I'm talking about the detailed information, not the generalities. A Correct.
Q And in this case with respect to OM 1, OM 2 and OM 3 -- and those are the three offering memoranda that [counsel for Morice] took you to -- you were getting that information from, among others, [Morice].
A Among others, yes, yeah.
Skeith stated that his practice with offering memoranda is to ask clients at each closing whether the particular offering memorandum is "still current". If not, an amended or new offering memorandum would have to be prepared.
Skeith said that he based his advice on what he was told by Morice. Skeith confirmed that, while perhaps not "misled" by Morice, he was "not informed" about certain matters.
For example, Skeith was not told and was not aware that most of the money raised from the trades and distributions of the Arbour Preferred Shares was sent to Merendon on or shortly after receipt. Skeith's understanding, from what Morice told him, was that, despite the 10-year term specified in the Letter of Intent, the money would go down to Merendon on "a short-term loan facility and -- in the normal course of business, and it was simply money going down, money coming back" and "would be called back when [Arbour] found an oil and gas property to buy". Skeith also understood, based on what Morice told him, that the parties were not "really going to enact the [Letter of Intent]", presumably suggestive of a rationale for believing that there was no need to disclose the 10-year $10 Million Loan to Merendon and of a misinformed basis for Morice's claimed receipt of legal advice that the $10 Million Loan (or it and the $45 Million Loan) would be effectively disclosed under the description "short term investments" in the Arbour OMs. Skeith further stated that he did not ask Morice what the security was for the
$10 Million Loan. When asked if he discussed with Morice the commercial feasibility or appropriateness of this arrangement, Skeith testified that "my client didn't seem to have any concerns, so I didn't". Skeith was also not aware that SGD had a general security agreement against Merendon's assets that pre-dated the loan advances Arbour made to Merendon.
Skeith agreed that, "with hindsight, I'd probably put it in now", with "it" referring to Arbour investor money "being lent, on a short-term basis, to a mining entity with offshore interests, with no security, no loan agreement and no valuation". Skeith himself acknowledged that, had he been in possession of all the relevant information regarding the arrangement between
Arbour and Merendon, he would have identified Merendon and included more disclosure in the Arbour OMs about the $10 Million Loan and the $45 Million Loan. Skeith's testimony on this point was:
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Q And did you not think it would be of interest to an investor to know that there was this loan that had been agreed to and was an unsecured loan?
A Yes, if -- my information was that we were going to send the money down, and it was going to be a loan, yes, then obviously that's a material fact that should have been disclosed, yes.
In conclusion, we find that Skeith clearly did not have sufficient knowledge of all the facts on which to base his legal advice to Arbour and Morice as to what material facts were required to be included in the Arbour OMs. That said, we are disappointed that a senior experienced securities lawyer such as Skeith did not question, or express concern about, the apparent disconnect between the disclosure made in the Arbour OMs and the other documents he saw at the time or later came to know about. We find that Arbour and Morice did not give Skeith sufficient information about Arbour's plans and transactions. It was the responsibility of Arbour and Morice to provide all the facts – in failing to do so, they cannot now claim to have reasonably relied on any ill-informed legal advice so generated. In short, legal advice generated in such circumstances is suspect – it is not advice on which a respondent can claim reasonable reliance in defence of allegations.
In the circumstances, the legal advice received and applied by Arbour and Morice does not in any way excuse – nor lessen their responsibility for – materially untrue or misleading statements (or materially untrue and misleading statements) in the Arbour OMs found above.
Staff alleged that Brost and IFFL breached section 75(1)(b) of the Act by acting as advisors without being registered to advise in securities. Staff's allegation relating to advising is "with respect to the purchase by [IFFL] members of a very select group of securities, one of which was Arbour". As particulars, Staff stated that IFFL represented itself as an "educational institute" and solicited members from meetings and seminars it held "for the stated purpose of promoting international investment".
During the period relevant to the allegation of unregistered advising, section 75(1)(b)(i) of the Act prohibited a person or company from acting as an advisor if not registered with the Executive Director to do so, unless an exemption applied.
Section 1(a) of the Act defined "advisor" (now "adviser") as "a person or company engaging in or holding out the person or company as engaging in the business of advising others with respect to investing in or the buying or selling of securities or exchange contracts".
In Kustom Design, this Commission discussed the nature of activity that would constitute "advising" (at paras. 216-19):
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In Re Costello [(2003), 26 OSCB 1617], the OSC ruled (at para. 25): "The trigger for registration as an adviser is not doing one or more acts that constitute the giving of advice, but engaging in the business of advising." In determining whether a person or company engaged in the business of advising, advising need not be the only business activity that the person or company is conducting. Typically, though, isolated pockets of providing advice on specific investments or securities will not evidence that advice had been given for a business purpose. Further, it is unnecessary that any person followed or acted on the advice; the focus is on the action of giving the advice.
In Re Donas, 1995 LNBCSC 18, the BCSC described the nature of communicating advice:
. . . The concise Oxford Dictionary of Current English (1990 ed.) defines "advice" as "words given or offered as an opinion or recommendation about future action or behaviour . . .".
. . .
As indicated by the definition of "advice", the nature of the information given or offered by a person is the key factor in determining whether that person is advising with respect to investment in or the purchase or sale of securities. A person who does nothing more than provide factual information about an issuer and its business activities is not advising in securities. A person who recommends an investment in an issuer or the purchase or sale of an issuer[']s securities, or who distributes or offers an opinion on the investment merits of an issuer or an issuer[']s securities, is advising in securities. . . .
This Commission recently commented on activity indicative of advising in Re Global Trading Center LLC, 2009 ABASC 614 (at paras. 32-33):
The determination of whether a person is "advising", for purposes of the Act, involves two considerations, described as follows by D. Johnston and
K.D. Rockwell in Canadian Securities Regulation, 4th ed. (Markham: LexisNexis, 2006) at 359:
First, did the purported adviser express an opinion or make a recommendation? Merely reciting facts does not make one an adviser; recommending an investment or opining on the investment merits of an issuer or securities is advising. Second, did the purported adviser offer the recommendation in a way which reflected a business purpose? [Emphasis in original.]
As to whether the person is in "the business of advising", this in our view connotes elements both of intended profit and a degree of organization, repetition or regularity – neither a gratuitous provision of advice nor a merely isolated act or incident would generally suffice to evidence a business.
Thus, the mere providing of factual information about a proposed investment does not constitute advising. Rather, advising involves a business of providing subjective views, opinions and recommendations on the merit or value of a specific investment or security to a person or company.
Therefore, an allegation of unregistered advising can be sustained only if the evidence is sufficient to prove that a person or company – in a manner indicating a business purpose –offered an opinion on the merits of investing in the issuer or the securities being offered, or
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recommended the purchase or sale of securities of a particular issuer. Advising entails subjective observations on the value of a particular investment in securities. Providing facts about an issuer, its business or its securities is not advising within the meaning of the Act. Nor is providing an opinion or recommendation regarding securities without commercial – business –hallmarks such as organization, repetition, regularity and compensation.
Accordingly, to sustain the allegation of unregistered advising, we must find that Brost and IFFL offered opinions on the investment merits of a particular issuer or security or recommended an investment in a particular issuer or security. We also must find that any such opinions or recommendations (or both) were given for a business purpose. Finally, in the event we find that Brost and IFFL engaged in advising, we must then conclude that none of the statutory exemptions were available to either of them when they gave the investment advice to investors.
Staff submitted that IFFL, although purporting "to be merely an educational institute", acted through its structurists to promote and provide "advice with respect to the sale of a select group of securities to its members, including the [Arbour Preferred Shares]". Staff pointed to the testimony of the investor witnesses, all of whom testified regarding investments in securities promoted by IFFL. Staff also highlighted that IFFL structurists assisted investors with various aspects of their investments, including paperwork, and gave them advice about financing their investments through RRSPs or home equity lines of credit.
Staff contended that Brost and IFFL attempted to give the appearance that they were not offering investment advice about securities despite, according to Staff, evidence showing the focus of Brost's and IFFL's activities as the giving of investment advice about particular securities. Staff also pointed to certain evidence indicating that IFFL structurists received financial benefits – commissions – for giving investment advice on certain securities.
Staff submitted that Brost was personally involved in IFFL's activities and had, in fact, created IFFL "for the purpose of promoting and selling to IFFL members securities of companies controlled by him or his associates".
As noted, Brost and IFFL did not appear at the Merits Hearing, nor did they make written or oral submissions on any of Staff's allegations against them.
It became apparent from the evidence that Brost and IFFL made efforts to avoid appearing as though Brost or IFFL structurists were offering investment advice or recommendations on particular issuers or securities to IFFL members and potential members. IFFL's official mandate was to educate investors – it provided, in its words, "an exclusive education service in which [IFFL] educate[s] individuals and provide[s] effective education options on an array of financial matters" (emphasis in original). However, in reality, IFFL and
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Brost were recommending the purchase of securities in Brost-connected entities, while encouraging and assisting investors to make such investments. As we conclude below, the substance of the activities carried on by Brost and IFFL structurists was more than "educational"; IFFL's primary business activity was to promote and sell to IFFL members securities of Brost-connected entities.
The evidence demonstrates that IFFL, through its structurists and under the control and direction of Brost, was very successful in convincing investors that enrolment as an IFFL member would entitle them to participate in highly lucrative investment opportunities and to minimize or eliminate taxation payments. Investors believed that by joining IFFL and investing in IFFL-touted securities they would be participating in investments and tax breaks otherwise only available to a small group of wealthy people and entities (notably, banks and the government).
Under the IFFL process, investors were invited to attend one or more initial contact meetings at which Brost or an IFFL structurist would discuss general financial concepts and provide a basic description of the IFFL investment program – supposedly using non-standard methods of investing to achieve exceptionally high rates of return only from investments recommended by Brost or IFFL. The rates of return were considerably more than those available on investments offered through more conservative investment channels. These initial meetings emphasized means to achieve "financial freedom", including how IFFL could educate its members about strategies used by banks to earn large profits by holding their money offshore and sheltering returns from tax. Because non-IFFL members were not given the specifics about particular investments, the most significant factor influencing investors' desire to join IFFL was this "carrot" of access to the investments purportedly offering extraordinarily high and tax-sheltered returns through the "international side". We conclude that this was a deliberate tactic by Brost and IFFL to intrigue and entice investors to invest in securities recommended by Brost and IFFL.
After becoming an IFFL member, the member would receive an IFFL List of Companies to consider as possible investments. Although the companies on IFFL Lists of Companies changed over time, there was a pattern. Each IFFL List of Companies would include several well-known blue chip companies and typically one specific entity (such as Arbour, Strategic, Quattro, Rapid Express and Merendon Nevada) previously unknown to the prospective investors; the latter entity was a Brost-connected entity and was the only one for which the highly-touted and, by then, highly-desired "international side" was available.
Therefore, we conclude that the IFFL Lists of Companies were a pretence. There was never any intention that IFFL members would invest in the identified well-known companies. IFFL members were steered to the Brost-connected entities, which were recommended by Brost and IFFL. Brost authored the IFFL Lists of Companies. IFFL structurists followed Brost's recommendations in advising potential investors that the Brost-connected entity on each IFFL List of Companies was the only investment capable of generating the touted extraordinary returns and minimizing the taxation payable on their gains. IFFL structurists only earned commissions for sales of securities of the Brost-connected entities.
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Our view is strengthened by the fact that Arbour did not promote or advertise its securities in any way, yet had so much money coming in from investors that even its president, Morice, was surprised. There were no reasons for Arbour's popularity other than the IFFL presentations and letters. We find this was not merely a coincidence – investors were obviously directed to the Arbour Preferred Shares, which were recommended to them.
The IFFL Lists of Companies authored by Brost provided only the name and contact information of potential investments. All other discussions between structurists and IFFL members focused on providing information about the listed Brost-connected entities. It is, therefore, not surprising that we did not hear from any IFFL members who invested in securities of any of the identified well-known companies, such as Canadian Tire or Berkshire Hathaway. We did hear that almost all purchasers of Arbour Preferred Shares were IFFL members or were family or friends of members. We conclude that the inclusion of the well-known companies on the IFFL Lists of Companies given to IFFL members was mere window-dressing. That inclusion was an attempt to add legitimacy to the Brost-connected entities on the IFFL Lists of Companies by suggesting their comparables were the well-known companies. It was also an attempt to create the impression that Brost and IFFL were not advising IFFL members by giving them recommendations to buy a particular security of a particular issuer.
Against this backdrop, predictably, we heard investor witness testimony that they never seriously considered any investment from an IFFL List of Companies other than the one that provided the international benefits.
For example, investor witness KA said that he would not have chosen to invest in any company that did not offer the international opportunity because he wanted the higher return – he wanted to be able to participate in opportunities similar to those in which the banks make money. Investor witness DRA said that his interest was in investing in the companies offering the international side that IFFL structurists advised him were paying returns of 30 to 40%. Investor witness KA described IFFL as "actively involved in orchestrating your investment" and bringing the opportunity "to your attention, they advised you to make it, they assisted you in executing the making of that investment".
There was evidence that structurists expressed opinions on the merits of the Brost-connected entities, rather than providing merely factual information. Investor witness SC testified that her structurist recommended three different investments to her and her husband. According to SC, the structurist then opined on the risk level of the targeted investments, ultimately advising that Brost-connected Rapid Express was the least risky of the three investments. On the basis of that advice, SC and her husband invested money in Rapid Express.
IFFL structurists gave various other investment advice to IFFL members, such as how to use leveraging strategies to fund their purchases of the recommended securities. Investor witness SC testified that her structurist asked her for information about her net worth and assets and advised her how to finance any investment she made through IFFL by taking out a home equity line of credit or using existing RRSP funds.
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Therefore, contrary to Brost's and IFFL's carefully worded documents provided to individuals who became IFFL members – cautioning that IFFL was not providing "advice on specific securities", distributing securities or soliciting an investment in securities – we find that Brost and his organization IFFL were recommending that IFFL members purchase securities of the Brost-connected entities.
Based on all the evidence before us, we conclude that Brost and IFFL deliberately "educated" investors to believe that they would be short-sighted or financially foolish if they did not join IFFL to take advantage of the international side of investments being offered only through IFFL. These investors were persuaded that they would make substantial money and, at the same time, protect that money by moving it offshore – out of the reach of "regulators" and tax collectors. A crucial part of Brost's and IFFL's scheme was to emphasize repeatedly the advantages of the international side so that, when an IFFL member was presented with the various "options" on an IFFL List of Companies, the only decision the member would make would be to invest in the domestic Brost-connected entity offering the "very unique, highly profitable and tax avoidance" international option. Predictably, many IFFL members – some unsophisticated, inexperienced and vulnerable – followed this advice and decided to invest in the Brost-connected entities offering the "international" component, such as Arbour and Rapid Express.
We find that IFFL members were deliberately steered by Brost and IFFL to invest only in Brost-connected entities. We find that Brost and IFFL gave opinions on the investment merits of the Brost-connected entities and securities and recommended that investors invest in those entities and securities.
We also conclude from the evidence before us that Brost and IFFL clearly had a business purpose in providing the opinions and recommendations on securities that they did. IFFL, solely owned and operated by Brost, received money from people when they joined IFFL, as well as from anticipated annual renewal fees. People understood they had to join IFFL to access the touted securities. IFFL structurists received a commission payment when a person joined IFFL as a member; they received a much more significant commission when that member then invested in one of the domestic entities offering an international component, such as Arbour. Brost and IFFL also received money when IFFL members invested in the Brost-connected entities recommended by Brost and IFFL.
While there may have been an educational component to the advising activities of Brost and IFFL (and we make no comment on the quality of such education), it is not necessary that advising be their sole business activity (Kustom Design at para. 216). Brost and IFFL clearly intended to profit from their advising activities, and those activities had a distinct degree of organization, repetition and regularity over several years.
We conclude that Brost and IFFL offered their opinions and recommendations on particular issuers and securities to investors for a business purpose.
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We conclude that IFFL was organized and operated solely for the purpose of influencing investors to join IFFL so that they would invest in the securities of Brost-connected entities recommended by Brost and IFFL. Brost engaged in his own advising activity through, for example, presentations and letters. He was also responsible for IFFL's actions. In the course of giving opinions and recommendations on issuers and securities, Brost and IFFL collected substantial money and paid structurists handsomely for funnelling investor money into the designated international investments. Accordingly, both parts of the test required to find advising in securities are met.
Brost and IFFL were well aware of Alberta securities laws surrounding advising, having given the Brost Undertaking and the IFFL Undertaking to the Commission in 2004 to refrain from engaging in certain trading or advising activities. We conclude that Brost and IFFL tailored the IFFL documents and added well-known companies' names to the IFFL Lists of Companies given to investors as ruses to avoid regulatory attention and deflect concern that they were providing unregistered advice in breach of the Brost Undertaking and the IFFL Undertaking.
Advising under the Act does not require the use of words such as "I advise you to . . ." or "I recommend that you . . .". Advising can also encompass, as here, intentionally guiding – or pushing – investors into particular securities investments. Thus, despite their attempts at pretence and their claims not to be advising, the evidence is clear, and we find, that Brost and IFFL were engaged in advising in securities.
Brost and IFFL were not registered as advisors under the Act. Therefore, unless they had an exemption available to them, they will have engaged in unregistered advising in securities.
Alberta securities laws provide some limited exemptions from the advisor registration requirement. During part of the time in issue here, these exemptions were set out in section 85 of the Act; from 14 September 2005, they have been set out in section 3.7 of NI 45-106.
There is no evidence that any of those exemptions were applicable and, as Brost and IFFL did not participate in the Merits Hearing, we received no evidence or submissions from them relating to reliance on any such exemptions.
We conclude that no exemptions were available to Brost or IFFL for their advising activities.
As discussed, we have found that Brost and IFFL were engaged in advising in securities. We have also concluded that none of the exemptions were available to Brost or IFFL for their advising activities.
We therefore conclude and find that Brost and IFFL contravened section 75(1)(b)(i) of the Act by acting as advisors in Alberta without being registered to do so.
Since 8 June 2005, sections 93.1 and 93.2 of the Act provided:
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A person or company shall comply with decisions of the Commission or the Executive Director made under Alberta securities laws.
A person or company that gives a written undertaking to the Commission or the Executive Director shall comply with the undertaking.
Section 1(n) defines "decision" as:
. . . a direction, decision, order, ruling or other requirement made by the Commission or the Executive Director, as the case may be, under a power or right conferred by this Act or the regulations . . .
While there was no express statutory requirement before June 2005 that Commission orders or undertakings given to the Commission be complied with, we consider any failure to comply either with a Commission order or an undertaking given to us as conduct contrary to the public interest.
The Brost Undertaking stated that Brost, as president and CEO of IFFL, had "substantial influence and control over the operations of IFFL and the activities of its facilitators, structurists and independent agents". In the Brost Undertaking, Brost stated that he would not "directly or indirectly, cause, encourage, instruct, allow, condone or participate in any trading in securities or acting as an advisor . . . by myself, IFFL or any [of] IFFL's facilitators, structurists or agents". The undertaking specifically referred to (without limiting its generality) securities of Quattro, Consumer Debt Recovery Trust/Heritage Financial and SGD.
The IFFL Undertaking, signed by Brost as president and CEO, stated that IFFL would not trade in securities or act as an advisor – specifically (but not limited to) securities of Quattro, Consumer Debt Recovery Trust/Heritage Financial and SGD.
The Undertaking Order accepted the Brost Undertaking and the IFFL Undertaking, among others.
We earlier found that Brost and IFFL engaged in illegal trades in and distributions of Arbour Preferred Shares. We also found that Brost and IFFL acted as unregistered advisors in relation to Arbour Preferred Shares and other securities, contrary to Alberta securities laws. While some of this activity pre-dated the enactment of sections 93.1 and 93.2 of the Act, the same activity continued from 8 June 2005.
This illegal activity by Brost and IFFL on and after 8 June 2005 was contrary to the Brost Undertaking, the IFFL Undertaking and the Undertaking Order. It is clear, and we find, that Brost and IFFL thus contravened sections 93.1 and 93.2 of the Act.
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Staff alleged a contravention of section 93(b) of the Act (the successor to section 93(c)) by way of "a course of conduct relating to the securities of Arbour" that "perpetrated a fraud on the [Alberta] Arbour investors" – "[t]he Respondents['] conduct placed the pecuniary interests of the Arbour investors at risk and caused them to invest in Arbour without any or any sufficient disclosure of the use to be made of their invested funds" when the intention was to move money raised from the sale of Arbour Preferred Shares offshore to Merendon and other entities owned or controlled by, or under the direction of, some of the Respondents. Staff set out several particulars of the allegedly fraudulent conduct in the Notice of Hearing.
Staff claimed that the fraud alleged started from the time of Arbour's resurrection in early 2004. Staff contended that subjective knowledge on the part of the Respondents can be inferred from the prohibited act and surrounding circumstances.
There was some initial uncertainty as to the parameters of Staff's fraud allegation. Staff clarified this in both written and oral submissions, stating that "the prohibited act or deceit involved the distribution of funds from the sale of Arbour [P]referred [S]hares to Merendon and other entities owned or controlled by Brost and/or Sorenson, without any or any sufficient disclosure to the investors".
In Staff's words:
[T]he allegation of the fraud is that funds were raised through Arbour from IFFL members, and those funds were then transmitted or funneled to Merendon under unsecured agreements, undocumented agreements; and then, in some respects, those funds were funneled back to investors; True North, Grovenor, La [Conxion]. That's the fraud concept.
The mechanics of it, though, can be taken into smaller chunks or bite-sized chunks. In order for there to be a fraud, there has to be a deceptive act. The deceptive act is not confined to the large-scale fraud. There has to be a deceptive act that enables the fraudulent conduct to happen, and the deceptive act is the failure to disclose in the [Arbour] OMs what's actually happening with the money.
In a nutshell, Staff contended that the alleged fraud involved deficient disclosure that money raised through the sale of Arbour Preferred Shares was destined for entities, including Merendon, that were owned or controlled by Brost or Sorenson (or both). Staff explained that, as the evidence demonstrates, this disclosure failure was tied to all of the Respondents "because the disclosure issue helps perpetrate the fraud [and] these people were all acting in concert; that Sorenson, Brost, Morice, Arbour were all jointly involved in a program". Therefore, the lack of proper disclosure by Arbour and Morice in the Arbour OMs was, according to Staff, "the linchpin to the fraud". Staff also pointed to evidence of "significant deprivation" occasioned to investor witnesses.
Staff argued that, if Morice's defence was that all Arbour investors knew exactly where their money was going, then Morice should have asked the investor witnesses about that and
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proved it at the Merits Hearing, which he did not. Staff emphasized that, even if all Arbour investors knew about and were determined to access "the international 'accounts'", that did not mean they also knew their money was being paid to Merendon via unsecured and undocumented "loans" for unproven assets. Further, Staff questioned how Morice could know prospective Arbour investors' state of knowledge when he admitted that he did not know what IFFL told prospective Arbour investors, knew there was nothing in the Arbour OMs about loaning most of the proceeds raised to Merendon and did not tell them anything himself.
Staff submitted that the evidence proves that Merendon and Sorenson were involved in the fraud from the initial deceptive act of Arbour's resurrection to facilitate sales of Arbour Preferred Shares to investors to improper disclosure through to the distribution of Arbour investor money to and through Merendon. In the alternative, Staff submitted that Merendon and Sorenson, even if found to lack "actual involvement" in the fraud, would be caught by the fraud provisions in the Act because Merendon and Sorenson knew or reasonably ought to have known of the fraud being committed by Brost and IFFL regarding Arbour's use of investor money.
Arbour, Brost and IFFL made no submissions.
As was a theme throughout his submissions, Morice emphasized that he became involved only after "the framework of the arrangement with [Merendon was] a done deal" (through a lawyer), the Arbour board of directors had already been chosen by the time and:
Financial information has been -- has been disclosed that would indicate that Merendon is an extremely viable concern, worth billions of dollars. Representations are out there that everything is backed by gold deposits. And there's no indication at the time that there is anything wrong, anything amiss or anything wrong in the house.
Morice emphasized that he and Arbour should be viewed separately – Arbour's participation started much "earlier [and] on a different level".
Morice acknowledged that there had been a fraud perpetrated on Arbour investors; however, he pointed to such fraud as being perpetrated by some or all of IFFL, Brost and Sorenson (and, presumably, Merendon), not by Morice. Despite agreeing that a fraud had occurred, Morice disagreed with Staff's characterization of the prohibited act or act of deceit in this case, arguing instead that the "deceit was telling [Arbour investors] they were going to get offshore managed accounts" with "huge interest rates" from SGD.
Morice argued that Staff had committed to a theory of the fraud early on, then "had to stick with that position, and really, they're just trying to integrate it" with the evidence. Morice addressed Staff's theory of fraud as he understood it. Morice characterized the prohibited act alleged by Staff as Arbour's failure to identify Merendon in the Arbour OMs as the recipient of money raised by Arbour through the sale of Arbour Preferred Shares. Morice submitted, however, that there was no prohibited act through deception in the Arbour OMs because "the overwhelming weight" of the evidence demonstrates "that the Arbour investors not only knew that their money would be going to either Merendon or some other Brost/Sorenson entity such as
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SGD, that was their primary reason for making the purchase of Arbour shares". Morice emphasized that investors were not seeking to invest in Arbour, but were seeking the high returns touted as stemming from the "international side" and the "managed accounts", which were to be obtained as adjuncts to the Arbour investments. Therefore, according to Morice, the prohibited act theorized by Staff was not a prohibited act because Arbour investors had not been relying on the Arbour OMs when they made their investment decisions; rather, they had relied on – and were deprived through – the information they received from Brost and IFFL.
Morice acknowledged that his own involvement relating to the sale of Arbour Preferred Shares "was assisting in the preparation" of the Arbour OMs. Morice admitted that it would be possible to attribute to him knowledge of prohibited acts engaged in by others, but that the evidence did not support such attribution here.
Merendon and Sorenson agreed with the parameters for finding fraud and agreed with Staff that there is breadth in the factor of whether a person knew or ought to know a fraud would be perpetrated. However, Merendon and Sorenson did not agree with Staff that the required "deceptive act" was as broad as contended by Staff. Merendon and Sorenson submitted that Staff's fraud allegation was limited to alleged deceptive and deficient disclosure in the Arbour OMs, in which Merendon and Sorenson had no role and for which they were not responsible. Their contention was that "Merendon and Sorenson didn't engage or participate in any act, practice or course of conduct relating to a security at all. They weren't involved in the transaction between Arbour and investors." That is, Merendon and Sorenson submitted that, because they had no role or involvement with the Arbour OMs' disclosure or with any of the sales of Arbour Preferred Shares to investors, they had not engaged in any prohibited acts relating to Arbour securities.
Sorenson acknowledged that he knew IFFL was involved in raising money for Arbour, but argued that such knowledge did not constitute a contravention of the Act. As counsel for Merendon and Sorenson stated: "If you're participating with Milowe Brost and he's committing an offence, that's one thing; but if you're doing a transaction, and he happens to be involved on the other side, it's quite another thing." Merendon and Sorenson likened their lack of involvement in the transaction relating to the security to the lack of involvement of "Arbour as a landlord or the person that Arbour was paying to empty their garbage pails" in the transaction relating to the security – there simply was, Merendon and Sorenson claimed, no participation by them in the impugned transactions.
In a similar vein, Merendon and Sorenson disclaimed responsibility for what Arbour did with the money raised through the OMs – Merendon and Sorenson submitted that they "weren't responsible for what Arbour did with its funds. . . . Merendon was responsible for what Merendon did with its funds." They emphasized that Merendon's directors have a responsibility to Merendon shareholders, while Arbour's directors were the ones with a responsibility to Arbour shareholders, including the responsibility to conduct proper due diligence. In any event, Merendon and Sorenson disputed Staff's characterization of the use of funds as part of the alleged prohibited act, arguing that a finding of fraud would first require a finding of participation in an act, practice or course of conduct relating to a security.
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Merendon and Sorenson contended that Staff had not proved that Merendon and Sorenson committed any fraudulent act. In the alternative, Merendon and Sorenson submitted that they had "rebutted, on the evidence, any inference of recklessness through the clear evidence of the course of investigation embarked upon by Sorenson and [Merendon] once they were alerted to potential issues with SGD and Arbour after the fact".
Before 8 June 2005 the provision in the Act dealing with fraud was section 93(c). It stated:
93 No person or company shall, directly or indirectly, trade in or purchase a security or an exchange contract if the person or company knows or ought reasonably to know that the trade or purchase does one or more of the following:
. . .
(c) perpetrates or may perpetrate a fraud.
Section 93(c) of the Act was replaced, effective 8 June 2005, by section 93(b), which provides:
93 No person or company shall, directly or indirectly, engage or participate in any act, practice or course of conduct relating to a security or exchange contract that the person or company knows or reasonably ought to know will
. . .
(b) perpetrate a fraud on any person or company.
Section 93(c) of the Act was reworded to make clear that the legislature intended the provision to have broad application to dishonest acts involving securities. However, we conclude that the inclusion of "indirectly" and "trade" (which includes acts in furtherance of the sale of securities) in the predecessor provision provided for a similarly broad application. In any event, the amendment to section 93 would not result in any substantive difference for purposes of this proceeding. It is also noteworthy that under both provisions liability will be found where persons or companies reasonably ought to know that their conduct perpetrates a fraud on another.
The parties agreed on the applicable law and principles, as set out in Capital Alternatives at para. 308 (we note this approach was confirmed in a recent Commission decision, Re Shire International Real Estate Investments Ltd., 2011 ABASC 608 at para. 168):
The term "fraud" is not defined in the Act. The gist of the meaning is not, however, difficult to discern. Johnston and Rockwell [Canadian Securities Regulation, 4th ed. at 420] point to the elements of fraud as enunciated at common law by the Supreme Court of Canada in R. v. Théroux, [1993] 2 S.C.R. 5 at 27, which has been adopted in the context of securities regulation (for example, in Anderson v. British Columbia (Securities Commission), 2004 BCCA 7 at para. 27):
. . . the actus reus of the offence of fraud will be established by proof of:
the prohibited act, be it an act of deceit, a falsehood or some other fraudulent means; and
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deprivation caused by the prohibited act, which may consist in actual loss or the placing of the victim's pecuniary interests at risk.
Correspondingly, the mens rea of fraud is established by proof of:
subjective knowledge of the prohibited act; and
subjective knowledge that the prohibited act could have as a consequence the deprivation of another (which deprivation may consist in knowledge that the victim's pecuniary interests are put at risk).
Once the elements required for a finding of fraud have been established, a respondent's intention or motivation is irrelevant. As a majority of the Supreme Court of Canada, in discussing the criminal test for fraud in R. v. Zlatic, [1993] 2 S.C.R. 29, noted (at 43):
Where the conduct and knowledge required by these definitions are established, the accused is guilty whether he actually intended the prohibited consequence [i.e. deprivation of another] or was reckless as to whether it would occur.
To find the actus reus of fraud, it must be proved that that there was a "prohibited act" –"dishonest act" – that resulted in "deprivation" to another.
The first requisite of the actus reus – the prohibited act – is proof of "deceit", "falsehood" or "other fraudulent means".
"Deceit" or "falsehood" is established when it is proved that the person represented a certain situation was something other than what it really was (Théroux at 17).
"Other fraudulent means" is the catch-all concept, designed to capture a wide range of dishonest commercial acts which appear to be neither deceit nor falsehoods but, when viewed objectively, would be considered dishonest acts by a reasonable person. Examples of conduct found to constitute "other fraudulent means" include personal use of corporate money, failure to disclose important facts, unauthorized diversion or taking of money or property, and the unauthorized use of investor money (Théroux at 16-17; and R. v. Currie, [1984] O.J. No. 147 (C.A.)).
The second requisite of the actus reus – deprivation – is proof that there was detriment (actual loss), prejudice or risk of prejudice to the economic interests of another or others. The concepts of "prejudice" and "risk of prejudice" require only that another was or others were put at risk of economic loss; no actual loss need be proved. It is also not necessary in proving deprivation that the transgressor ultimately benefited or received an economic profit or gain. Thus, in transactions involving securities, if an investment is made and a dishonest act is
involved, prejudice to the investor will be found even when the investor suffered no direct financial loss (Théroux at 16-17).
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To find fraud, there must also be proof that the person had subjective awareness of the person's prohibited act and that such act placed another's or others' economic interests at risk.
In many cases involving allegations of fraud, a panel will reach conclusions based on inferences reasonably drawn from the evidence. Further, given the nature of fraud, it is unnecessary to prove what the transgressor was thinking at the time the dishonest act was committed – subjective knowledge can be inferred from the prohibited act and surrounding circumstances, unless there is some plausible explanation that casts doubt on the inference. The Alberta Court of Appeal has confirmed that the trier of fact can infer subjective knowledge from the totality of the evidence (Brost at para. 48).
An honestly-held hope or belief that no deprivation or risk of deprivation would result from the dishonest act does not save a dishonest act from being found a fraud. As a majority of the Supreme Court explained in Théroux (at 23-24):
A person who deprives another person of what the latter has should not escape criminal responsibility merely because, according to his moral or her personal code, he or she was doing nothing wrong or because of a sanguine belief that all will come out right in the end. Many frauds are perpetrated by people who think there is nothing wrong in what they are doing or who sincerely believe that their act of placing other people's property at risk will not ultimately result in actual loss to those persons. If any offence of fraud is to catch those who actually practise fraud, its mens rea cannot be cast so narrowly as this. As stated in R. v. Allsop [(1976), 64 Cr. App. R. 29], approved by this court in Olan, [[1978], 2 S.C.R. 1175] at p. 1182:
Generally the primary objective of fraudsmen is to advantage themselves. The detriment that results to their victims is secondary to that purpose and incidental. It is "intended" only in the sense that it is a contemplated outcome of the fraud that is perpetrated.
To find that a corporation contravened section 93(c) of the Act, or its successor section 93(b), it need only be proved that the corporation's directing minds knew or reasonably ought to have known that the acts of the corporation perpetrated a fraud.
The first step in our analysis of the fraud allegation is to consider whether a prohibited act was committed.
As noted above, Staff contended that the Respondents committed a series of prohibited acts, which involved Brost, IFFL, Merendon and Sorenson – with the input and assistance of Arbour and Morice – raising money from the sale of Arbour Preferred Shares to investors (primarily IFFL members) and then moving that money offshore to Merendon and to other Brost/Sorenson Entities, all without any (or sufficient) disclosure to the investors and with the knowledge that investor money was thereby put at risk.
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Despite Morice's contention that the prohibited act was different from that argued by Staff, we consider the allegations in the Notice of Hearing broad enough to encompass Staff's characterization of the prohibited act. Indeed, we conclude that there is clear and compelling evidence to support Staff's position. As particularized below, the totality of the evidence persuades us on the balance of probabilities that each of the Respondents engaged in an ongoing course of conduct, involving at least indirect trading in (including acts in furtherance of sales of) securities, that can be variously described as deceit, falsehoods or other fraudulent means.
The evidence establishes – and we find – that Brost and Sorenson acted in concert for the common purpose of obtaining substantial amounts of investor money to be funnelled to Brost/Sorenson Enterprises in ways that would benefit them personally and put investor money at risk. The evidence also establishes – and we find – that Brost and Sorenson were together the masterminds behind the underlying investment scheme, with each having a distinct role in its execution. Their scheme involved the use of IFFL, Merendon and Arbour (through Morice), with the sale of the Arbour Preferred Shares to investors as the source of money that would eventually make its way to Brost/Sorenson Entities for Brost's and Sorenson's personal benefit. We now set out some of that evidence.
A Close Personal and Business Relationship
Despite Sorenson's denial, we find the evidence as a whole clearly establishes that Brost and Sorenson had a very close personal and business relationship indicative of a common enterprise between them. Examples from the evidence include:
They had a long-standing personal and business relationship, which originated with the formation of SGD in 1999 and continued throughout the Arbour transactions and beyond.
They were equal shareholders in SGD from soon after SGD's inception, and continued to be so throughout the Arbour transactions and beyond.
We have found that, notwithstanding any other SGD shareholders (SGD's presidents were mere figureheads), SGD's real decision-making rested jointly with Brost and Sorenson; Brost and Sorenson were the controlling minds of SGD and only they had actual or de facto control over SGD's operations:
Both Brost and Sorenson took deliberate steps to ensure their names were not publicly tied to or associated with SGD. As Hoffman testified: "Sorenson had his name on title a very little but controlled -- controlled a lot". Sorenson explained to Hoffman his displeasure about he and Brost being personally named as SGD shareholders in a 20 May 2005 recorded conversation:
Sorenson: Well it would have been even better if you would have put them [in context, the SGD shares] in the name of your company. Except they are not in the name of your
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company they're in your direct Owen Hoffman name. So if anybody was going to investigate SGD it would take them about a half an hour to determine that you're a shareholder, I'm a shareholder and Milowe is the shareholder and Graham [in context, Blaikie] merely holds shares in trust for us. So there's no -- there's no secrecy that SGD is technically because you are a Canadian citizen and as is Milowe and you are a Canadian resident that SG -- the whole entire SGD company is basically an onshore company and I am the manager.
. . .
SORENSON: [Adair] went over to Nassau provided the instructions as sole director and changed it from the corporation to personally the three people.
HOFFMAN: I thought you knew that?
SORENSON: I don't want my f**king name on that document, nor should you.
. . .
SORENSON: And I thought that what [Adair] had done is transfer that situation to Graham so that if you did a corporate search you would find Graham as the President, sole director and officer of the company and the sole shareholder, that's what you would find. Then moving beyond that there would be a private trust agreement between Graham, you, me and Milowe where we knew whatever interest Graham was holding was held for us respectively, do you know what I mean? Graham doesn't hold anything [inaudible] you know he's basically got the shares [inaudible], which interestingly enough if you look at the Pennsylvania records before they were wiped off the web now you know why they served [Adair] because the search SGD came up with [Adair's] name, knew he was in the United States and searched, had you or I or Milowe been residents of the United States -- . . .
We would have been served --
Brost and Sorenson handpicked and appointed the four SGD presidents, all of whom took their instructions for running SGD's operations and affairs from Brost, Sorenson or both.
None of the SGD presidents were involved in soliciting the investor money that flowed through SGD to Merendon; rather, all solicitation activities were carried out by Brost and his companies.
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Brost and his associates, notably his wife Elizabeth Brost, were responsible for the day-to-day administration of the SGD managed accounts.
Although Sorenson denied any role in SGD decision-making, it is clear –and we find – that he was very much in control of significant decisions made regarding SGD operations in that Sorenson (among other things):
approved all SGD redemption requests for money by approving all payments back to SGD by Merendon;
handled, with Blakey and Adair, the negotiation and signing of the 2005 SGD/Merendon/Eiger Loan Agreement, without Blaikie's involvement, even though Blaikie was SGD's president and sole director at the time;
was the one Blaikie contacted whenever he needed advice about SGD's affairs; and
controlled Merendon Honduras and the Merendon Honduras compound where the SGD offices were located.
Brost's and Sorenson's worlds had remarkable overlap:
The same legal counsel provided legal services for both:
Skeith acted as legal counsel for Merendon, for Capital Alternatives and for Strategic; and
Blakey provided legal services to IFFL, to Merendon and to SGD.
Brost's companies, IFFL and Capital Alternatives, raised money from investors that was used to fund or acquire various ventures owned or operated by Sorenson and Merendon – two examples were SGD and Strategic (which acquired or was looking to acquire Merendon holdings in Stone Mountain and Magna North).
There were interconnecting close associates of the two:
Brost, Strashok, Weis and Wigmore attended Sorenson's 2003 wedding in Honduras;
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Weis (a long-time friend and business associate of Brost) and Wigmore (a long-time friend of Sorenson and variously a director or officer of Merendon and Stone Mountain) were Arbour directors at the same time;
Strashok was Merendon's legal counsel and a director of Merendon, Stone Mountain and Arbour; and
E) Regier, a long-time Brost associate, attended IBG meetings in Honduras, was an officer of Strategic (thus was involved in its activities) and forwarded investor money from Arbour to Merendon.
Although Sorenson disputed the existence of IBG, testifying that it was a "figment of [Brost's] imagination", we have found that IBG did exist – perhaps not as a formal corporate entity but certainly as an organized group led by Brost and Sorenson. We have also found that IBG's purpose was to control and keep track of the multitude of entities in which Brost and Sorenson were involved – the Brost/Sorenson Entities. The IBG meetings also evidenced an active and close business association between Brost and Sorenson in early 2007, including that they were – and we find – the controlling minds of IBG. For example:
The initial meeting, which included Sorenson and Brost as attendees, was held at Sorenson's Merendon Honduras compound from 8 to 11 February 2007.
We have found that the February IBG Minutes are at least mostly accurate, including their representations that Sorenson participated in most of the IBG discussions and votes. We have also found that the March IBG Minutes are at least mostly accurate, including their representations that Sorenson participated in most of the IBG discussions and votes on the days he attended. These minutes recorded that, with three exceptions, all resolutions were made by either Brost or Sorenson, executive summaries of certain projects were to be prepared for the IBG Advisory Committee of which Brost and Sorenson were members, and many of the discussions focused on their company SGD.
Sorenson was intimately familiar with Brost's IFFL organization. In a 24 March 2005 conversation Sorenson informed Hoffman that IFFL had "59 structurists, 225 agents, 176 prospects. According to his business development [inaudible] they're writing an average of between 8 and 10 contracts per day for an average of between 50 thousand and 100 thousand [presumably dollars]".
Associates and an investor witness offered up various descriptions of the interaction between Brost and Sorenson suggestive of a close personal and business relationship:
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Morice believed Brost and Sorenson "had a very integrated business relationship and kind of worked as a team".
Wigmore understood Brost was involved in SGD, raising money for Merendon and Sorenson.
Hoffman testified that Brost and Sorenson were "[v]ery much partners and friends".
Regier considered them "50/50 partners" and heard Sorenson refer to Brost as his partner and equal partner.
Skeith testified that in early May 2004 Brost, Strashok and Sorenson appeared to know each other and to be comfortable with each other.
Investor witness DRA understood that Brost and Sorenson had "a business relationship", and said that Brost at IFFL meetings would sometimes "kind of talk about how he had to be negotiating with [Sorenson] about certain rates of return".
When together, Brost and Sorenson acted in a manner suggestive of a close personal and business relationship:
Sorenson acknowledged that he personally spoke with both of Brost's cardiologists when Brost had heart issues.
Sorenson acknowledged he was the guarantor on "a couple of credit accounts" that Brost and his family had in Honduras.
Sorenson acknowledged that Brost attended "as an honorary guest at a couple" of Merendon board of directors' meetings.
In a DVD entitled "Merendon Dec 2004", Sorenson informed the SGD investor tour group gathered in his office in Honduras (which gathering Brost eventually joined) that he and Brost "enjoyed each other", and described how "we" produced a "gold-backed fund [in context, SGD]".
In a DVD entitled "Honduras - Merendon Mining Due Diligence Trip -Feb 2006", during the excerpt from the group dinner at Sorenson's home in Honduras, Sorenson (with Brost sitting beside him) referred to how "we are grateful obviously to you folks" and assured them "we're working hard". Sorenson attributed success to "Milowe's leadership" combined
with "our development of the mining company". The two joked that they were like "Butch Cassidy and the Sundance Kid".
Underlying Investment Scheme
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The evidence as a whole leads us to conclude, and we find, that Brost and Sorenson, acting in concert, were instrumental in devising – were the masterminds behind – an investment scheme to raise money from the sale of securities of a public company and then to divert forthwith money paid into that public company to Brost/Sorenson Entities. We find, on the totality of the evidence, that the scheme's establishment and intended operation was as follows:
Brost and Sorenson developed an investment scheme to raise money from investors that would be used to fund mining and other ventures of Sorenson and Merendon, to pay generous commissions to Brost and IFFL, and to pay high purported administrative expenses to a Brost-connected entity or entities. Public investors would be lured by the prospect of moving their money offshore into "managed international accounts" that were to pay fantastic guaranteed rates of return, supposedly backed by Merendon's "gold". Brost would be responsible for marketing the investment (the investment originally to be SGD). Brost created IFFL (after Capital Alternatives ran into regulatory trouble) for the purpose of promoting and selling to IFFL members securities of companies controlled by him, Sorenson or other associates. Sorenson would be responsible for providing the enterprises that would lend legitimacy and attraction to the investment –Merendon's gold mining operations.
Brost and IFFL needed a way to access more of IFFL members' money – namely their RRSP holdings, referred to as "low hanging fruit". Because Brost understood that shares of a public company were an RRSP-eligible investment, he wanted to take over a public company in which IFFL members could invest their RRSP money. Brost, in an 8 June 2005 taped conversation with Hoffman, confirmed that, if "we're going to keep going in the direction we're going" and access RRSP money, "we're going to have to use a public company".
This refinement would have public investors enticed by the promise of investing in a single Canadian company but receiving not only shares of a Canadian exchange-listed company (the desired RRSP-eligible investment) but also an international investment. The latter component would involve moving money offshore out of the reach of taxing authorities into managed accounts that would provide exceptionally high guaranteed returns, again theoretically backed by Merendon's gold.
The securities would be sold to investors using offering memoranda in an attempt to make the investment appear legal and genuine. We believe Brost and Sorenson realized that, given the growth of IFFL and the exorbitant amount of money it was raising, it was becoming vital that it legitimize its operations. A conversation took place between Sorenson and Hoffman on 3 July 2004 about the need to make IFFL's fundraising activities appear legally compliant:
Hoffman . . . when we first started and as you know when you first start any organiz -- any company you push whatever rule is necessary into the ditch so you can keep going.
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Sorenson Yeah.
Hoffman And we pushed most of them if not in the ditch, off in the field, fine but now it's reached a different level and with the num -- the volume of money and everything else that he's [in context, Brost's] talking and then the -- the size of his organization [in context, IFFL] and the profile has come up, you're now on the radar especially Milowe, you know.
Sorenson M-hmm.
Hoffman And it's time to make it compliant . . . .
Investors were not to learn much about the investment from reading the disclosure in the offering memorandum, it being provided only to appear to comply with securities laws, not to inform. The more alluring information would be provided outside the disclosure documents by IFFL structurists in group and one-on-one meetings with investors. Brost, IFFL and its structurists would receive healthy commissions for their selling efforts.
The public company would be controlled by Brost and Sorenson, although that would not be made known to investors providing the money. Brost and Sorenson, as the true intended recipients of investor money, did not want any connection to them to be made. Therefore, all of the public company directors would be Brost and Sorenson nominees. The individual selected as president need not have much (or any) relevant business or capital-market experience as he merely needed to follow and implement Brost's instructions. The public company would be a shell with little in the way of real operations or personnel; its core business was to receive investor money, which would be paid ultimately to Brost/Sorenson Entities.
Investor money would be transferred forthwith from the public company's coffers to Merendon, to be disbursed to the scheme's various participants. To lend a semblance of legitimacy to the movement of money to Merendon and stave off possible audit or regulatory scrutiny, Sorenson would provide an asset or assets that would be sold to the public company for an amount that would largely offset the money paid out to Merendon; however, the sale amount of any such asset would be far greater than the actual value of the asset. Also, Sorenson and Merendon might retain a right in any such asset in case the asset proved to have value. Sorenson and Merendon would receive the investor money for the use of themselves and others involved in the scheme, and the public company would be left with assets of little or questionable value.
Execution of the Investment Scheme
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We find the evidence as a whole clearly establishes that Brost, IFFL, Sorenson and Merendon, with the critical assistance of Arbour and Morice, engaged in activities for the purpose of obtaining investment money from the sale of Arbour Preferred Shares and converting it to their own use. We find that millions of dollars raised from unwitting investors were invested in Arbour without any disclosure to them of the master plan – to collect RRSP and other money, funnel the money to Merendon, and there, beyond the scrutiny of others, disburse the dollars to other entities, primarily Brost/Sorenson Entities. Morice and Arbour were, we find, at best wilfully blind dupes in the early days of the scheme, and certainly at some point, common sense tells us, they became willing accomplices in the scheme. We also find that the Arbour and Merendon transactions were shams, with values concocted by Brost, Sorenson or both to justify the flow of money to Merendon and elsewhere. Deceit, falsehoods and other fraudulent means were, we find, all actively employed by the Respondents in successfully implementing this complex scheme. The result was that Sorenson became, as he told IFFL members, "a very wealthy man", as did his personal and business associate Brost.
We set out here the more salient aspects of the evidence that have led us to these findings, including evidence of each Respondent's respective role in the fraudulent activities:
Arbour was resurrected purely to support the investment scheme devised by Brost and Sorenson:
Although Brost never held any official position with Arbour, he was principally responsible for its resurrection and (with the caveat noted below) ultimately responsible for its ongoing activities:
In the summer of 2003 Brost began searching for a public company that could be used as an RRSP-eligible investment vehicle for IFFL members. He (and Sorenson, as discussed below) eventually identified Arbour as an ideal public company and took control of it. We find that Brost, who would be marketing the investment, did not want it known that he had any control or direction over the public company and so arranged for others to serve in official roles.
Brost told Hoffman, in an 8 June 2005 conversation, that Houston had been given the responsibility in the summer of 2003 of finding a public company that IFFL could use as the investment vehicle to access RRSP money. When Houston had not yet found a public company by November 2003, Brost had given Houston two names; we think it reasonable to infer – and do – that one such name was Arbour.
Houston then contacted Strashok and began the negotiations for Arbour's control. When his efforts were
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failing, Brost stepped in to complete the negotiations and recruited his long-time friend Weis to become an Arbour director and provide the $300 000 required for Arbour's reorganization and change of control. He also recruited Morice, a business associate, to become a director and the president of Arbour. Weis and Morice were Brost's nominees on the Arbour board of directors.
Although never holding any official position with Arbour, Brost exerted significant control over its operations and finances, through his long-time friend Weis and business associate Morice and otherwise:
Skeith described Brost as the controlling mind of Arbour at the beginning of 2004, and referenced Brost's participation in various Arbour matters, including the selection of Arbour's new directors, involvement in early negotiations of the loan transactions between Arbour and Merendon, and the preparation of OM 1.
Brost retained Expedia to provide administrative services to Arbour.
Regier testified that Brost appeared to be the one running Arbour, with Morice taking instructions from Brost.
Brost was involved in discussions about the terms for the issuance of the Arbour Preferred Shares, and the use to be made of the money raised:
Brost told Morice that "the key for them was that money get parked offshore right away" and then significant money would be made available to Arbour;
Brost told Morice that an offering memorandum was to be used in raising money from the sale of the Arbour Preferred Shares;
Morice then worked with Skeith to draft the required offering memorandum, at – we believe and find – Brost's direction;
Brost told Morice that, if Arbour did not send the money raised to Merendon, "the money would stop" coming from IFFL members; and
We have found that Brost for all intents and purposes instructed Morice that Arbour was to lend money to Merendon.
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Brost was involved in discussions about the calculation and payment of the interest owing on money loaned to Merendon.
IFFL provided Arbour with $25 000 – "basically . . . seed money" – until investment money started coming in to Arbour.
Although Sorenson never held any official position with Arbour, he too had some involvement in Arbour's resurrection and restructuring. His role, however, was minimal, in keeping with limitations caused by his previous regulatory difficulties and with the separate roles to which he and Brost agreed – Brost being responsible for raising money and Sorenson for providing the enterprise or enterprises to receive that money. We find that Sorenson also had ultimate responsibility for Arbour's ongoing activities in one sense – he was prepared to exert his influence on those activities should the scheme not unfold as anticipated. We also find that, like Brost, Sorenson did not want it known that he had any control or direction over the public company and so arranged for others to serve in official roles:
Sorenson commenced negotiations with Strashok, in the summer of 2003, to take control of Arbour. As noted, we think it no mere coincidence that, immediately after Sorenson failed in his bid for Arbour, Brost, "out of the blue" pursued Arbour as the RRSP-eligible investment vehicle for IFFL members.
Skeith testified that Sorenson had some involvement in some of the discussions taking place involving Arbour's reactivation, and Sorenson's name appeared in one time entry in the April 2004 Skeith Account.
Morice understood that Sorenson was one of the "key players" in Arbour's reactivation, and that Sorenson and Brost had a "master plan" for Arbour.
We have found that Wigmore (a long-time Sorenson associate) was Sorenson's nominee on the Arbour board of directors. This was indicative of Sorenson exerting influence, or having the ability to exert influence, in the management of Arbour.
Sorenson was fully aware that Arbour would be, and was, raising money from IFFL members and that money would then flow to his company Merendon under the guise of loans and asset acquisitions.
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Brost and Sorenson referred to Arbour as Brost's public company and acted as if Arbour were under their control and direction:
In the Hoffman Tapes, Brost told Hoffman that the Commission employees were "being a**holes" for cease-trading Arbour and making his attempts to "move cash flow forward" a "hell of a challenge".
In a 3 July 2004 conversation, only weeks after Arbour's reactivation, Sorenson told Hoffman that Brost had received approval, referring to what Brost was doing with Arbour.
Later in the same conversation, Sorenson discussed with Hoffman Brost's "public company" (which Sorenson agreed was a reference to Arbour) and that Brost had "a tremendous amount of money backstopped in the pipeline" which would lead, or contribute, to a "very lucrative month" for Merendon.
The February IBG Minutes – from the meeting which both Brost and Sorenson attended – discussed many private and confidential matters concerning Arbour, even though no Arbour representative was in attendance. Matters discussed included Arbour's trading halt and reasons for it, Arbour's loan to Merendon reputed to be
$42 million, an unexecuted contract between Arbour and Merendon for the TRL technology, Merendon's receipt of offers for that technology and Morice's failure to move forward with the TRL contract. The IBG Advisory Committee resolved that, if Morice did not fight the Commission, get the stock trading again and finalize the TRL contract, a new president would be chosen for Arbour. As noted above, we do not believe Sorenson's contention that he was not involved in this discussion, given his obvious interest in matters relating to Merendon and the company – Arbour
– that was providing Merendon with substantial amounts of money. We find that Sorenson and Brost were active participants in discussing the many Arbour matters raised at the February IBG Meeting, and take this as evidence of their continuing control over Arbour's activities.
Arbour did not advertise or otherwise promote the sale of the Arbour Preferred Shares to investors; rather, Brost and IFFL provided the majority of Arbour investors from IFFL's membership:
Brost told Morice that money would be raised for Arbour from IFFL members.
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IFFL members were advised by IFFL structurists that investing in Arbour Preferred Shares would give them both a domestic investment in a Canadian oil and gas publicly-listed company and an international investment with the promise of an offshore managed account. As well, interest on the investment would not be subject to taxation. A small portion of the money invested was to remain in Arbour, with the larger amount (less commissions and administrative expenses) invested in the offshore managed account.
The clear message to IFFL investors was that IFFL, Merendon, SGD and Arbour, among others, were integrally related. Sorenson thanked IFFL members "for making me a very rich man", conveying the impression –which we conclude was accurate – that their money had made him a success.
Without any solicitation from Arbour, IFFL members directly contacted Arbour, a recently reactivated (from bankruptcy), essentially shell company, to request the offering memorandum required to complete their purchases of Arbour Preferred Shares.
Most of the investor witnesses did not rely on information in the Arbour OMs when making their decisions to invest in Arbour, relying rather on verbal advice received from IFFL structurists. Morice said that he did not know what prospective Arbour investors had been told, and that he did not tell any Arbour investor about the loans to Merendon.
Brost's and IFFL's solicitation efforts on behalf of Arbour listed for trading on the CNQ were remarkably successful. They raised approximately
$45.5 million in just under one and one-half years.
The transactions between Arbour and Merendon were sham transactions – not papered, or appropriately papered, until much later – to justify the movement of investor money from Arbour to Merendon. Those transactions were orchestrated and implemented by Brost and Sorenson, who were at pains to create and maintain the fiction that their respective companies, IFFL and Merendon, were not connected. Morice's participation as Arbour's president was essential to provide the scheme with a semblance of legitimacy and an appearance of independence from Brost (whose organization IFFL was raising the money) and from Sorenson (whose company Merendon was to be the recipient of that money through loans and sales of rights to oil sands technology):
In a 13 October 2005 conversation with Hoffman, Sorenson emphasized the necessity of the illusion of separation between Merendon and IFFL –
"no matter what -- what happens Merendon's got to stay over here and marketing [has] got to stay over there".
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When Morice first joined Arbour, he was told by Brost (who had no official position with Arbour) that Merendon would be amenable to having Arbour loan money to Merendon.
Morice, as president and CEO of Arbour, had primary responsibility for Arbour's business and operations. Yet he did not question when Brost for all intents and purposes instructed him to loan money to Merendon; indeed, he blindly complied with Brost's instructions even though he knew that Brost had no official role with Arbour. Morice also knew little about Sorenson or about Merendon's financial viability – they were strangers to him. These factors should have raised red flags for Morice.
Morice himself was surprised by Brost's and IFFL's success in raising such a significant amount of capital.
The evidence suggests that few, if any, negotiations occurred before the Letter of Intent was agreed to by Morice. This was a very material contract for Arbour – a recently reactivated, essentially shell company with few assets committing to a $10 million loan. Yet very little, if any, due diligence was conducted by Arbour and Morice on Merendon and Sorenson. Morice knew that Merendon's assets were located for the most part offshore, that it was a mining exploration enterprise and that Arbour's money was being sent offshore. In our view, Morice's, as president and CEO of Arbour, should have perceived the potential for fraud in agreeing to loan $10 million to an unknown offshore company (Merendon) arranged by the same person (Brost) who was raising a very substantial amount of money for Arbour, an essentially start-up company with a yet to be determined business plan. That potential was heightened by the fact that Brost – to conceal his pivotal role in Arbour's business decisions – did not want his name associated with Arbour. With this knowledge, and also knowing there was no security for the significant $10 Million Loan Arbour would be making, Morice executed the Letter of Intent on behalf of Arbour. In our view, Morice had a duty to ensure adequate safeguards were in place so that the money being raised from Arbour investors could not be used for an improper purpose. However, Morice did little in the way of due diligence to substantiate Merendon's worth, which had been represented to him to be "$2 billion". Morice did confirm that he had seen Merendon's internal financial statements at the time Arbour entered into the verbal deal with Merendon, which showed assets of over $1 billion, based on the value of its mining ventures. As noted, these were, it seems, the 2003 Merendon Financial Statements, which also showed liabilities of over $1 billion. Morice also recalled that the financial statements he reviewed showed that Merendon did not have any significant income
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being produced from those assets, but said that he was not concerned because the income statement did not show gold sales not yet made, and he had seen what he believed was about $1 million worth of gold in Merendon's vault in Tegucigalpa. Also as noted, Morice's evidence does not accord with the 2003 Merendon Financial Statements, which showed income from gold and jewellery sales of US$474 332 before expenses. Morice apparently never questioned why a company worth "billions" needed to borrow money from Arbour for a 10-year term that was to be used for funding or working capital. He also apparently did not see the need to ensure that the loan was well secured, even though he recognized the risks of lending money to offshore entities. With Morice executing the Letter of Intent on behalf of Arbour and Sorenson on behalf of Merendon, the semblance of an arm's-length transaction was perfected.
When the $10 Million Loan Agreement was finally executed in approximately May 2005 (backdated to 10 July 2004) it was done at the behest of Arbour's auditors, not Morice. Again, there was little evidence of any negotiations taking place. The security provided in the $10 Million Loan Agreement was a 5% interest in TRL, which Merendon had purchased for a mere $100 less than one year before Arbour's first advance of the loan money. Arbour and Morice did not take the commercially prudent and reasonable step of obtaining a valuation of the TRL technology to ascertain whether the value of a 5% interest in TRL would support the $10 Million Loan. While Morice said that he and Arbour were always interested in acquiring the TRL technology, Morice apparently formed his opinion that the TRL technology was valuable on nothing more than what Sorenson told him (and there was no evidence before us that Sorenson had any reasonable basis for what he told Morice).
In January 2005 Morice, again on behalf of Arbour, agreed to purchase COREL. Once again, Morice did not take the commercially prudent and reasonable step of obtaining a valuation of COREL. There was also no evidence as to how the purchase price was determined or what negotiations took place. Indeed, the evidence suggested a "done deal", with nothing to negotiate. What is known is that Merendon purchased its interest for $52 in 2003, and there was no evidence of any significant steps being taken to advance COREL's commercial viability from that date until COREL was sold to Arbour.
Between February and the end of November 2005 Arbour continued to advance further money to Merendon. Inconsistent with normal commercial practices, these substantial advances of money – totalling some $28.6 million – were initially neither documented nor secured in any fashion. In early 2006, after all of the some $28.6 million had been advanced, the $45 Million Loan Agreement was executed. The security provided was a guarantee and general security agreement from Merendon
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Ecuador, an offshore entity that had earned virtually no income in 2005 and whose major asset was the Tena Concessions purchased by Merendon for less than $800 000 a year or two earlier. As with the TRL technology and COREL, Morice and Arbour did very little, if any, due diligence to assess the value of Merendon Ecuador. Morice's explanation as to why Arbour continued these undocumented and unsecured loan advances to Merendon indicated to us a non-arm's-length commercial transaction:
Q Did you ask for additional security on the loan?
A There was continued ongoing discussion about security, but the reality is all of the deposits were in countries likes [sic] Honduras and Venezuela and Peru and Ecuador, so having copious paper wouldn't necessarily mean much anyway. It was an issue of trust and our final judgment as to whether or not we trusted the international network, and we did.
. . .
Q Why didn't you paper or document these transactions at the time the money was advanced to Merendon?
A You know, essentially it, it was a trust situation, the, the assets of Merendon are located in places like Honduras and Ecuador and Peru and Venezuela, so in terms of collecting, we could have had the greatest security in the world and not been able to do anything with it, so that's probably a feeble excuse, but the bottom line is we were busy and everything started, and, and, you know, it was a challenge for us just to keep up with the day-to-day stuff.
Again with little or no evidence of negotiations or of how the decision was reached, in March 2007 Morice on behalf of Arbour agreed to purchase Merendon's 25% interest in TRL for, we think no coincidence, the exact amount of the money already advanced to Merendon under the
$45 Million Loan – some $28.6 million. Indeed, at Merendon's request, the TRL Share Purchase Agreement provided for an upward adjustment in purchase price – to $50 million – in the event the valuation of the TRL technology resulted in a higher value than the originally agreed purchase price. There was, we think notable, no corresponding provision for downward adjustment of the purchase price in the event the valuation resulted in a lower value.
No valuation was completed for the TRL technology although a valuator had been retained and commenced work on a valuation; Arbour stopped responding to the valuator's requests for information and the valuation was never completed. This was around the same time (February 2007) that the February IBG Minutes recorded that "either the President of Arbour finalizes the TRL contract . . . or a new president will be chosen for Arbour who will then proceed accordingly". A year earlier Sorenson
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informed a group of SGD and Base Metal investors during a tour of Merendon Honduras that he had talked with Brost about Arbour and assured the group that, although he was not happy with Arbour's management, he would not allow Arbour to fail. We find it reasonable to infer from these facts that Morice was instructed by Brost, Sorenson or both to finalize the TRL sale without a valuation. We further find that Morice did as he was told, with no consideration of the transaction's commercial reasonableness or of the best interests of Arbour and its shareholders.
No due diligence or valuation was ever completed for the TRL technology or COREL. We think it reasonable to infer from the totality of the evidence that there was never any intention on the part of Merendon that any valuation would be completed. There was no evidence before us of Merendon insisting on a valuation, and we think for good reason: we believe that any valuation completed would not have supported the money paid for COREL or for the TRL technology (which was, at best, in an infancy stage, with no reasonable assurance of commercialization established). The evidence was that the TRL technology was inherently speculative. Chow, the ARC representative, did little to confirm the value of the TRL technology, acknowledging that it was "very much" in the experimental stage at the time of his report in November 2005 and still was years later, including at the date of the Merits Hearing. In terms of bitumen recovery, only one of five samples tested showed better recovery using the TRL technology than the caustic or water then currently in use, and then only by 3%. The other four samples saw better recovery with the caustic or water applications. Chow also acknowledged that cost calculations would have to be performed to commercialize the process; there was no evidence that had been done. Although there was evidence of other interest in TRL, no one other than Arbour made an offer for either the TRL technology or COREL.
There were interest payments made on the $10 Million Loan – some
$77 000 for the period ended 31 December 2004 and approximately
$750 000 in March 2006. However, the evidence was that these payments did not come from Merendon – neither payment is recorded as a disbursement in the Merendon Financial Statements; and the second payment was made by Adair with, we find, investor money. Further, while (according to Merendon) these interest payments stopped when Arbour failed to complete the valuation of the TRL technology, we have inferred there was never any intention on the part of Merendon that any valuation would be completed.
Officers and directors are entitled to make rational business judgments and take calculated risks, all with a view to the best interests of their company and shareholders. Not all commercial ventures will be successful; risk-
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taking is a key part of commercial activity and undertaken with a view to profit. But a reasonable degree of care and diligence is expected and required. In this case, Morice exercised no sound or reasonable business judgment, nor rational decision-making. Before agreeing to purchase the TRL technology and COREL, Morice should have had reasonable grounds for forming the belief, and believing, that it made commercial sense for Arbour to purchase the TRL technology and COREL. No one pays millions of dollars without a reasonable expectation of an economic benefit in return. Morice, with no previous experience in the valuation of oil sands technologies such as the TRL technology, completely failed to ascertain the commercial viability of the TRL technology and COREL before committing Arbour to make large cash outlays. He committed Arbour to advancing large sums of money to an offshore entity, while appreciating the risks involved with repatriating the money in the event of default. He should have asked incisive questions; it was not enough to rely on Sorenson's claims or on the supposed interest shown by other entities. If after asking searching questions Morice still could not determine the commercial viability or value of the TRL technology, he should have ensured that Arbour retained independent experts to provide satisfactory answers to such questions on which he could reasonably rely. It is clear that Morice never did ask probing questions or receive answers on which he could base commercially reasonable decisions and judgments. Morice should at least have been suspicious that Brost and Sorenson were using him and Arbour for an improper purpose. Instead, he operated initially as a puppet whose strings were being pulled by others, eventually as a willing participant in the scheme, all to the detriment of Arbour and its shareholders.
Arbour carried on little in the way of real operations; its core function was to act as the recipient and conduit of money for Merendon, which ultimately was to make its way to Brost, Sorenson or Brost/Sorenson Entities:
Given the reality of its operations, Arbour had few employees; perhaps only one or two had some oil and gas experience. Neither Morice nor Hobbs apparently had relevant oil and gas or much, if any, capital-market experience.
As of the date of OM 1, Arbour had a two oil and gas ventures in or nearing production – one not valued that generated revenue of approximately $4000 per month, the other acquired for $50 000 which "should be in production within 60 days".
As of the date of OM 2, Arbour (in addition to the previous two ventures) had acquired: the Crazy Hill property for $1 million (for which it paid
$350 000 and 650 000 common shares); and an additional interest in three gas wells for $175 000 and 150 000 common shares.
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As of the date of OM 3, Arbour had acquired a participation interest in Sedalia, as well as agreements to acquire oil and gas properties in Southeast Asia and Myanmar. We note that this latter transaction again apparently involved Brost-connected entities.
The one promising oil and gas transaction – Crazy Hill – was effectively reversed (Arbour was paid the same purchase price it had paid to acquire the property one year previously), with the sale proceeds ending up in the hands of Sorenson and Merendon, ostensibly to offset outstanding money on the COREL transaction even though at the time Merendon owed Arbour some $38 million. A joint venture to operate the Crazy Hill property was ultimately entered into between Vogel (5% interest), who was or had been a Merendon director, and Sorenco (owned by Ken Sorenson (51% interest) and Merendon (49% interest)).
Morice never questioned the authority of Regier – who was associated with Brost and IFFL but not with Merendon or Arbour – to request millions of dollars from Arbour so that Regier (not Morice or anyone from Arbour) could send it to Merendon. We find such action further indicative of Morice's unfaltering willingness to follow Brost's instructions and not ask questions that might lead to unfavourable or unwelcome answers. It also demonstrated to us that Morice, despite being the president and CEO and a director of Arbour, was not Arbour's guiding mind.
Most of the investor money received by Arbour was almost immediately diverted to Merendon, with no reasonable prospect of recovery:
Of the approximately $45.5 million raised by Arbour from the sale of the Arbour Preferred Shares, over $38 million was loaned to Merendon and a further $5.3 million was expended on acquiring COREL from Merendon and its three partners.
Merendon's operations depended on the receipt of this money from Arbour:
Regier testified that the goal was to get $2 million per month to Merendon, to be met with money raised from sales of Arbour Preferred Shares. Sorenson denied this in his testimony, although he earlier, on 15 November 2006, told Hoffman that he had – we infer, from the evidence as a whole, during the Arbour fund-raising efforts – given Brost a budget:
. . . he [in context, Brost] gets so mad at me and I just say look you either f**king tow [sic] the line with me or I'm gone. Now he doesn't tell me how much money he's sending me, I give him a budget and I say either give me this f**king money
every month, you miss one month you're done I go to your membership and say you're finished . . . .
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Brost acknowledged that his fundraising efforts on behalf of Arbour were critical to Merendon. He told Hoffman, on 8 June 2005, that "in all fairness to Gary [in context, Sorenson] we had some difficulty with our public company in the month of May, we literally lost all cash flow . . . . So he has a quantum cash flow problem".
Brost related to Hoffman, in a 14 July 2005 conversation, that Sorenson was "put on notice" when Arbour was cease-traded because the cash flow from Arbour to Merendon "just went plop".
Kendall, in a 25 May 2005 conversation with Hoffman, discussed Merendon's cash flow problem:
There was a black hole and any money that comes into Gary you have very little chance of getting it back because he -- he
-- he's SGD's biggest problem, or Merendon's biggest problem is that they haven't got a cash flow.
Arbour money was used not only to finance Merendon's operations and ultimately Sorenson personally but also to fund other Brost/Sorenson Entities:
Arbour investor money was forwarded to Merendon by Morice with the assistance of Regier, who had no formal connection to Arbour or Merendon. Once the money reached Merendon, it was further distributed among Merendon and several other accounts and entities.
Following the first two of the Brost/Regier Distribution Instructions, Merendon transferred Arbour investor money to La Conxion, a Brost-related entity.
The Brost/Regier Distribution Instructions then changed, requesting that Arbour investor money be wired, not to La Conxion, but to True North, another Brost-related entity. This, in our view, explains why there were only two payments from Merendon to La Conxion – any other payments originally contemplated to be made to La Conxion may well have been included in the several larger transfers of money from Merendon to True North.
The evidence was that Sorenson knew a great deal about True North and its connection to Brost:
Sorenson knew True North was a company in Brost's orbit that allegedly had a financial relationship with SGD because that was
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how Sorenson explained Merendon's payments to True North. Because of this relationship, Merendon could somehow retire a portion of its SGD debt by paying True North directly. This was, we note, not supported by evidence of any agreement between True North and SGD, or any written confirmation from either SGD or True North of either the payments towards or corresponding reductions in Merendon's SGD debt.
Sorenson knew on 19 February 2005 that Brost had "over 9 million dollars trapped in True North", and Sorenson was not pleased that Merendon had not "seen that money". Sorenson referred to the
$9 million as "client monies" and commented that Merendon had seen "replacement money coming out of Arbour". Sorenson's expectation of receiving $9 million in "client monies" from True North indicated to us – and we find – that Merendon and Sorenson had a business relationship with True North. The reference to replacement money from Arbour also indicated to us – and we find
– that Arbour investor money was being used to replace money held up in True North. This, in turn, supported Regier's testimony that True North was basically an account used to route money back to IFFL investors, and was part of a Ponzi scheme that included Arbour.
In a handwritten memo to Sorenson, Jack Wolfe detailed a series of payments made or owing to True North from money received from Arbour during the period 27 July to 16 September 2004.
Merendon US bank account records showed that Merendon transferred almost US$3.2 million to True North in 2005.
Sorenson's claim that he never spoke to Brost about Merendon's business transactions with Arbour was not, in all the circumstances, credible:
In the 3 July 2004 conversation referred to above Sorenson expressly discussed Arbour as "Milowe's public company" and discussed how "Pub Co." could raise money for Brost and how Brost's structurists would then work for "Pub Co."
Despite any claim to the contrary by Sorenson, he was aware that Brost was involved in Arbour's raising of money by selling Arbour Preferred Shares, and that the money from those sales was being sent to Merendon. Sorenson expressly referred to such facts in conversations with Hoffman:
Almost two months before the first of the Arbour investor money was sent to Merendon, Sorenson received from
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Hoffman a 13 May 2004 letter that spoke of Arbour using Brost's salespeople to solicit investors to purchase "preferred share[s] or something similar" with registered funds, which funds would then be invested in an entity called Dorlan and subsequently in SGD, for eventual distribution to Merendon. Sorenson discussed the Dorlan concept with Hoffman on 3 July 2004 and again on 22 October 2004.
In a 3 July 2004 conversation Sorenson noted that "Milowe got approval for this public company, yesterday. . . .
[E]verything [got] done last week and got the letter of approval Friday morning", and that the "tremendous amount of money backstopped in the pipeline" would contribute to a "very lucrative month" for Merendon.
On 19 October 2004 Sorenson discussed with Hoffman a conversation Sorenson had with Adair about Brost selling Arbour Preferred Shares using an offering memorandum and that "the whole organization of [IFFL] was going to be converted to basically an agency who's selling preferred shared in Arbour".
In a 19 February 2005 conversation Sorenson again referred to Brost using an offering memorandum in connection with Arbour, commented that Merendon was seeing "replacement money coming out of Arbour", and said that Brost had asked him what was "the largest amount of single deposits [Merendon] could accept", which would be "coming from Arbour", to which Sorenson said he told Brost "I said make it whatever you [Brost] want, don't matter."
The disclosure provided by Arbour to prospective investors in the Arbour OMs contained significant defects – misrepresentations – and other deficiencies (as found above):
The defects in this disclosure were serious and pervasive. Morice knew that the Arbour OMs did not disclose the involvement of Brost or Sorenson at all, and did not discuss the true extent or manner of Merendon's involvement. Investors who relied, or could have relied, on the disclosed information were, or would have been, misled as to what the Arbour investment entailed and how their money would be used.
Brost told Morice that an offering memorandum would be used to sell the Arbour Preferred Shares, and Morice then worked with Skeith to draft the
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required offering memorandum at, we have found, Brost's direction. Morice took this direction, even though Brost had no official role with Arbour. Morice signed each of the Arbour OMs, and, on behalf of Arbour, falsely certified that they contained no misrepresentations. Morice was also responsible for filing the Arbour OMs with the Commission; as found above OM 1 and OM 2 were not so filed.
Morice explained that the reason for failing to include disclosure about Merendon in the Arbour OMs was because Merendon was "very private" and would not have wanted disclosure about it in the Arbour OMs. We infer from the evidence that Morice learned of this from either Brost or Sorenson. Among that evidence is a 19 February 2005 conversation between Sorenson and Hoffman, in which Sorenson indicated that structures had been put in place so no one could "find out information that we didn't want out there in the general public arena", and that, because Brost was using an offering memorandum to sell Arbour Preferred Shares, "we have to be a lot more careful as to what information is contained in any of Milowe's literature".
There was a suggestion by Merendon and Sorenson that Brost carried on a deception within a deception, funnelling more money to his own ventures than to Merendon or Sorenson and thus that Merendon and Sorenson were also "victims". Brost may very well have done so, but any such duplicity would not excuse Merendon or Sorenson for any prohibited acts we find they engaged in while executing this scheme.
Arbour made loans to and bought assets – not oil and gas properties but unproven and unvalued technology – from Merendon and Sorenson using money raised from Arbour investors. All of these transactions involved millions of dollars, little or no due diligence, no valuations, over-priced assets and back-dated loan agreements. Brost and Sorenson successfully stripped Arbour, a public company, of its substantial investor-sourced revenue, leaving it with technology of questionable commercial value and use, with little or no effective means to recover that money. The Arbour OMs did not disclose any of this and no Arbour investor was ever told that this was what their money was, in reality, being used to fund. In the end, Arbour was left with little money to enable it to develop the oil and gas business, and thus generate returns for its shareholders, in accordance with the plan set out in the Arbour OMs.
In conclusion, we find the evidence in totality clearly establishes that each of the Respondents engaged in acts that can be variously described as deceit, falsehoods and other fraudulent means that converted Arbour investor money to the Respondents' benefit: Brost, IFFL, Sorenson and Merendon received direct monetary rewards; Arbour and Morice apparently the hope of future economic rewards. Arbour, a public company, was the vehicle used to divert investor money to Brost/Sorenson Entities without sufficient disclosure to investors.
In summary, we find that each of the Respondents engaged in prohibited acts within the meaning of Théroux.
The second step in our analysis of the fraud allegation is to consider whether the Respondents' prohibited acts found above caused deprivation, whether that be actual loss to another or the placing of another's economic interests at risk.
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There is clear and compelling evidence, and we find, that the Respondents' prohibited acts found above did cause deprivation – not only placing the economic interests of all investors in Arbour Preferred Shares at risk, but also causing actual financial loss to many, if not all, of them. The investor witnesses all sustained financial losses, in some cases devastating losses. It appears that those who invested in Arbour Preferred Shares have lost some, if not all, of the money they invested and have failed to receive any, or all, of the promised returns. And recouping any of these losses seems doubtful.
[1000] Of the approximately $45.5 million raised by Arbour through the sale of the Arbour Preferred Shares, some $38.6 million made its way to Merendon. The Merendon Financial Statements indicated that, despite this infusion of investor money, Merendon had no revenue in 2004 and only $9286 in revenue in 2005, and ended 2005 with a deficit of $23 072 103. The
$38.6 million transferred to Merendon is perhaps irretrievably lost – tracing that money, with a view to its recovery, would undoubtedly be most difficult (time-consuming and costly) and might well prove fruitless.
[1001] The TRL technology and COREL interest acquired by Arbour from Merendon for that
$38.6 million had yet to be valued or proven commercially viable as at the date of the Merits Hearing. Merendon itself had paid only $100 and $52 for these interests, respectively. Arbour appears to have been an inactive company for some time.
[1002] As noted, Morice suggested that his actions did not deprive Arbour investors. He argued that those who invested in the Arbour Preferred Shares had not relied on the Arbour OMs when investing but, rather, had relied on – and were deprived through – the information they received from Brost and IFFL. We disagree with Morice; we find that his prohibited acts did deprive Arbour investors. The Arbour OMs, with their substantively defective disclosure, were an integral part of the fraudulent investment scheme in which all of the Respondents participated. None of the investors in Arbour Preferred Shares were made aware of the true nature of their investments in Arbour by any of the Respondents in any way, including through the Arbour OMs. Arbour investors were not made aware that Arbour was a recently reactivated shell company – a conduit for money going to Merendon – without any realistic prospects or value. Arbour investors were not told that their money was actually being funnelled directly to Merendon via loans – at times unsecured and undocumented – in exchange for assets of uncertain and unproven value, then further distributed to others in the scheme. Arbour investors were not told that their managed accounts were fictitious and contained no money. There was no evidence that Arbour investors knew or expected what was planned for and actually happened with their money. Had they been so informed, we are certain that they would not have purchased the Arbour Preferred Shares.
[1003] In summary, we find that the Respondents' prohibited acts found above caused deprivation within the meaning of Théroux.
Brost and IFFL
[1004] IFFL acted solely through Brost and shared his knowledge.
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[1005] As discussed above, Brost was one of the masterminds of the investment scheme involving Arbour. In furtherance of that scheme, Brost was primarily responsible for the resurrection of Arbour so that it could operate as an RRSP-investment vehicle. He played an integral role in setting up the infrastructure to resurrect Arbour, including recruiting two of the three directors as his nominees (one of whom he appointed as Arbour's president) and procuring the funding necessary to effect the change in control. Brost and IFFL promoted the sale of Arbour Preferred Shares and provided the majority of the investor victims from the membership of IFFL. Brost and IFFL knew that offering the "international" side of the investment providing "managed accounts" that would generate returns from 20 to 40% per year was a fiction, designed to lure investors.
[1006] Brost told Morice that an offering memorandum would be used to sell the Arbour Preferred Shares and told Morice to prepare the required offering memorandum. Brost knew that any offering memoranda used by Arbour would not provide accurate and complete disclosure of Arbour's business and the use of proceeds. Brost told Morice that the money raised by Arbour was to be loaned forthwith to Merendon. Brost told Morice to pursue acquiring the TRL technology and COREL from Merendon and Sorenson, which involved loaning exorbitant amounts of money without proper (if any) security or documentation.
[1007] Brost instructed Regier to pick up investor money from Morice at Arbour, then send the money to Merendon, some accompanied by Brost/Regier Distribution Instructions. Those directed that portions of the money be sent on to entities controlled by Brost, such as La Conxion and True North. Brost knew there was never any intention that money raised from Arbour investors would be used by Arbour to develop a legitimate business. Arbour's business was to raise money for Brost, Sorenson and Brost/Sorenson Entities. Brost knew that none of the reality was disclosed to investors; he knew that what was disclosed to investors was false and misleading.
[1008] The evidence is clear – and we find – that Brost and IFFL (through its guiding mind, Brost) had the requisite subjective knowledge of the prohibited acts.
[1009] We also have no doubt – and we find – that Brost and IFFL were fully aware that their prohibited acts within this scheme not only would put investor money at risk but also would deprive investors of their money. Financial losses to Arbour investors were the reasonably foreseeable result of sending the investment proceeds to Merendon. Brost and IFFL were aware that Merendon was an entity with the majority of its holdings offshore, virtually no income, and operating deficits in the parent and most of the subsidiaries. Brost and IFFL were also aware that Arbour investor money diverted to Merendon and beyond would essentially be exchanged for assets of unproven and uncertain value. Financial losses (in at least some cases devastating losses) to Arbour investors have become, with the passage of time, no longer a risk but a fact, and recouping any of these losses seems doubtful.
[1010] In conclusion, we find from the totality of the evidence that Brost and IFFL also had the requisite subjective knowledge that they put investors' pecuniary interests at risk through their "prohibited acts".
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Sorenson and Merendon
[1011] Merendon acted solely through Sorenson and shared his knowledge.
[1012] The evidence establishes that Sorenson acted in concert with Brost as the other mastermind of the investment scheme involving Arbour and the sale of Arbour Preferred Shares. Sorenson had some involvement in securing Arbour and resurrecting it as an investment vehicle used by Brost to access IFFL members' RRSP money. We find that Sorenson ensured the appointment of Wigmore, his long-time associate, as Sorenson's nominee director on the Arbour board of directors. Sorenson knew what was happening with Arbour – we have concluded that he knew Brost and IFFL were going to raise money through the sale of Arbour Preferred Shares using an offering memorandum or memoranda, commencing in 2004. Sorenson also knew that Merendon and he were going to be the main beneficiaries of the money that he would share with connected entities such as True North, La Conxion and SGD.
[1013] Even though Sorenson was not involved in drafting the Arbour OMs or may have never seen or read one, we are convinced he knew that whatever Arbour was disclosing to investors who purchased Arbour Preferred Shares would not completely and accurately describe the true use that was going to be made of their money. He knew Arbour investors would not be told their money was going to be siphoned off – diverted – to Merendon unsecured (or both unsecured and undocumented). He also knew Arbour investors would not be told that Merendon would then send a portion of that money back to entities connected to Brost, whose organization IFFL had recommended they purchase Arbour Preferred Shares in the first instance. Sorenson also knew Arbour investors would not be told that Merendon would sell Arbour unproven and unvalued technology for millions of dollars, leaving Arbour and its investors with little money and likely worthless technology. As with Brost, Sorenson knew there was never any intention that money raised from Arbour investors would be used by Arbour to develop a legitimate business; Arbour's business was to raise money for Brost and Sorenson and Brost/Sorenson Entities.
[1014] Indicative of the depth of Sorenson's knowledge and state of mind was a 26 April 2006 conversation he had with Hoffman:
Sorenson You've heard me say it before, I'll say it again, you know we have tremendous responsibility for a tremendous amount of people for a tremendous amount of accounts. It [doesn't] matter whether Owen Hoffman [likes] Gary Sorenson or doesn't, you were involved you may not be involved today but you were involved. It doesn't matter whether Milowe Brost likes Steve Kendall or Chris Houston or anybody you understand what I mean? Every single f**king one of us has got to face the truth.
Hoffman We're tied with an umbilical cord--
Sorenson Truth is united we stand, we separate I start going to f**king agencies and saying that f**king Owen Hoffman is a f**king a**hole, you know. They don't give a f**k if you're an a**hole, they don't care. They want the package and
you're going down with me and I'm going down with you and you know we're all going to be on a f**king exercise yard together.
Hoffman Good visual. Did--that's why I've been following Milowe's trials and tribulations with the [Commission].
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Sorenson That's why we have to clean up SGD . . . .
[1015] The evidence is clear – and we find – that Sorenson and Merendon were knowledgeable, active and essential participants in an almost $46 million fraud involving the sale of Arbour Preferred Shares. The evidence is clear – and we find – that Sorenson and Merendon (through its directing mind, Sorenson) had the requisite subjective knowledge of the prohibited acts.
[1016] We also have no doubt – and we find – that Sorenson and Merendon were fully aware that their prohibited acts within this scheme not only would put Arbour investor money at risk but also would deprive investors of their money. Financial losses to Arbour investors were the reasonably foreseeable result of sending the investment proceeds to Merendon. Sorenson and Merendon were all too aware that Merendon was an entity with the majority of its holdings offshore, virtually no income, and operating deficits in the parent and most of the subsidiaries. Sorenson and Merendon also knew that the TRL technology they had sold to Arbour was of questionable value – certainly not the value paid by Arbour. The TRL technology and COREL were highly unlikely to generate significant revenue for Arbour and its investors (and, if such revenue were generated, Sorenson and Merendon retained a continuing interest). The course of conduct undertaken by Sorenson and Merendon placed Arbour investor money at serious risk of loss. As noted above, financial losses to Arbour investors have become a fact, and recouping any of these losses seems doubtful.
[1017] In conclusion, we find from the totality of the evidence that Sorenson and Merendon also had the requisite subjective knowledge that they put investors' pecuniary interests at risk through their "prohibited acts".
Arbour and Morice
[1018] Morice and Arbour were, as Staff phrased it "key cogs in the fraud machinery". Arbour acted under the direction of Morice and Brost and, therefore, shared their knowledge.
[1019] While it is possible that Morice in the beginning may not have known what Brost and Sorenson were intending, we believe that Morice's suspicions ought have been aroused very soon after assuming the role of president of Arbour. He knew or should have known almost immediately that something improper was happening and that Arbour was being used for an improper purpose. In our view, Morice was in a good position to detect what was true and what was not. He knew or should have known that taking instructions from Brost, an individual external to Arbour, was highly unusual. Morice also knew or should have known that Brost's particular directions were not commercially prudent or reasonable – certainly not in the best interests of Arbour and its shareholders.
[1020] Morice knew that massive amounts of IFFL investor money were flowing into Arbour, as predicted by Brost. Morice admitted that he knew this was unusually successful fundraising, as it clearly was, particularly for a recently reactivated shell company with no proven management
team. He was told by Brost that the overall plan was to target IFFL members' RRSP money and move that money through Arbour to obtain "managed accounts" offshore backstopped by Merendon, a supposed $2 billion organization. In the Morice Interview he told Staff:
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Q Your investors would have desired to invest in Evergreen Trust over a, a chartered bank? A Yes.
Q Why do you think that they would prefer, did they tell you that? How was that communicated to you by the investors?
A Well, I mean, their objective was to get an account offshore that they could manage, that was the, you know, not having been a member, I'm saying that was my understanding, and that -- well, just to start from the beginning, virtually all or certainly over 90 percent of funds raised came out of our registered retirement savings plan.
So the people involved normally had a, an unsatisfactory experience with formal investment counsel[l]ing, and were determined to make their own decisions on how their money would be placed, and so the option of, of utilizing the RRSP was to cash it in, at least offshore, using it offshore was to cash it in, pay 35 percent tax and take the net offshore.
Arbour, the initial strategy was to make a qualified investment in Arbour, park the money offshore, have what was represented to me to be a $2 billion organization offshore backstopping Arbour to go get some valuable oil and gas properties, and that was the commitment made to me when I joined Arbour.
Q That commitment, who was that made to you by? A That would have been Milowe.
Q So did -- when this company was set up, did Milowe Brost basically tell you where the money was supposed to go, what you were supposed to do with it once it was raised?
A Well, it, it, it was a structure to move the money offshore, so there was an agreement that it would be parked short term, but there was also a commitment that it would be available to make, you know, deals that would allow Arbour to be a solid vibrant oil and gas company.
Q So my understanding, then, is that the investors, through IFFL, wanted to make an investment offshore, and Arbour was the vehicle to do this. Originally you were planning to put the money in this Evergreen Trust until you located some oil and gas investments?
A Right.
Q Only instead, the money went to [Merendon] and was parked there?
A Yeah, I mean, they had a structure of moving money internationally, you know, it's almost impossible to do today, but back then they had been doing it for five or six years, so, you know, they had [a] mechanism to do it that, you know, was convenient, maybe too convenient.
[1021] Morice knew what Arbour was doing, and he knew what was said and not said in the Arbour OMs. We find that Morice should have known – and at some point must have known –
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that the disclosure in the Arbour OMs was false and misleading. Morice knew that Arbour was selling preferred shares, not offshore managed accounts. Morice knew or should have known that representations in the Arbour OMs were false. Yet he did not question any of this, or even seek the advice of his company's lawyer Skeith. To rationalize not disclosing the $10 Million Loan to Merendon, Morice said that he believed the $10 Million Loan was "short term" and could be recalled at any time, with Sorenson committed to using his influence and contacts to arrange international oil and gas deals for Arbour. Such an explanation defies belief: the Letter of Intent called for a 10-year term; there was no mechanism to force the return of the money, which was quickly flowing offshore; and Sorenson was involved in junior mining activities, not international oil and gas ventures. Sorenson himself said that he had made no such commitment, nor was the loan to be a short-term obligation (it was destined to be used as working capital). Morice also knew that no disclosure was made of the continuing unsecured and undocumented payments made from and raised under OM 2 and OM 3, although Arbour disclosed it had made the $10 Million Loan. Morice and Arbour were fully aware that the majority of the money raised from the sale of Arbour Preferred Shares was diverted to Merendon.
[1022] Morice, on behalf of Arbour, advanced millions of dollars to Merendon on what he knew or ought to have known could not possibly be commercially prudent or reasonable conditions. Morice, on behalf of Arbour, purchased for millions of dollars technology on what he knew or ought to have known could not possibly be commercially prudent or reasonable conditions. In respect of the TRL and COREL transactions, little (if any) due diligence was completed on Merendon and no valuations were in hand before Morice agreed to Arbour committing to exorbitant purchase prices.
[1023] In conclusion, when viewed in its totality, the evidence is clear – and we find – that Morice and Arbour (through its directing minds, Morice and Brost) knew or reasonably ought to have known that Morice and Arbour were being used to divert to Merendon money raised through the sale of Arbour Preferred Shares and that such diversion was implemented for an improper purpose. The evidence is clear – and we find – that Morice and Arbour (through its directing minds, Morice and Brost) had the requisite subjective knowledge of the prohibited acts.
[1024] We also have no doubt, and we find, that Arbour and Morice should have been fully aware – and at some point were fully aware – that their prohibited acts within this scheme not only would put Arbour investor money at risk but also would deprive investors of their money. Morice was fully aware of the risks of sending money to Merendon, an entity with the majority of its holdings offshore. He told Staff that any security given by Merendon on the transactions would effectively have been useless, given that the majority of its assets were located in countries like Honduras, Peru, Ecuador and Venezuela. There was no evidence that Morice and Arbour understood the commercial viability of the technology Arbour was buying; there is every reason to conclude that they did not. The course of conduct undertaken by Arbour and Morice, who should have been acting in the best interests of Arbour and its shareholders, placed Arbour investor money at serious risk of loss. As noted above, financial losses to Arbour investors have become a fact, and recouping any of these losses seems doubtful.
[1025] In conclusion, we find from the totality of the evidence that Arbour and Morice also had the requisite subjective knowledge that they put investors' pecuniary interests at risk through their "prohibited acts".
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[1026] The totality of the evidence clearly establishes, and we find, that the Respondents perpetrated a deliberately complex, coordinated, far-reaching and massive – almost $46 million –fraudulent investment scheme, with the sale of Arbour Preferred Shares through the Arbour OMs at its centre. All of the Respondents were separate but necessary cogs in the fraud machinery: Brost used IFFL as the marketing machine that provided hundreds of investor victims; Sorenson used Merendon to provide the illusion that an arm's-length enterprise was conducting normal-course business transactions with Arbour in an attempt to justify to any inquiring auditor or regulator the flow of money out of the public company; Arbour was resurrected to become the much desired RRSP-eligible investment vehicle; and Morice was the unquestioning, willing and compliant public company insider who acquiesced in and embraced the scheme, thus facilitating the diversion of investor money from Arbour to Merendon and then on to Brost/Sorenson Entities.
[1027] We find from the totality of the evidence, including the more specific aspects discussed above, that the Respondents knowingly deceived investors, and were fully aware that their deceit, falsehoods and other fraudulent means could (in fact were intended to) entice investors to purchase Arbour Preferred Shares and that a foreseeable – indeed, likely – consequence would be the risk of financial deprivation or actual deprivation for those investors.
[1028] We therefore find that the Respondents engaged in a course of conduct that perpetrated a fraud on investors.
[1029] We have set out our reasons for upholding Staff's allegations that the Respondents contravened Alberta securities laws in several respects. We now turn to Staff's allegation that, in engaging in such misconduct, the Respondents also acted contrary to the public interest.
[1030] We have found that Arbour, Morice, Brost and IFFL engaged in illegal trades in and distributions of Arbour Preferred Shares by trading in and distributing those shares without registration and a prospectus or exemptions from the registration and prospectus requirements.
[1031] The registration and prospectus requirements are among the most fundamental of protections offered by Alberta securities laws. As such, they are crucial to the Commission's mandate to protect investors (by giving them the opportunity to make informed investment decisions) and to foster a fair and efficient capital market.
[1032] The registration requirement is intended to ensure that salespeople with whom prospective investors interact show a certain degree of proficiency, have appropriate ethical standards, and will learn and consider each investor's investment objectives, risk tolerance and
financial situation. The prospectus, as a comprehensive disclosure document, is intended to ensure that prospective investors learn information about the investment being offered (including its risks and benefits) and the entity offering it, so that the investors are well positioned to make informed investment decisions.
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[1033] In circumstances in which these protections are considered unnecessary, securities regulatory authorities allow exemptions from the registration and prospectus requirements. The availability of this "exempt market" is important in Alberta and elsewhere, as it enables companies to raise capital with a timely and less expensive alternative to a prospectus and allows investors to participate in certain opportunities, while still providing the level of investor protection appropriate in the particular circumstances.
[1034] Investors who do not receive the fundamental protections afforded by a registered salesperson's involvement and a prospectus (and are not otherwise protected and therefore able to invest under an exemption) are at risk of the harm that may result from ill-informed and unsuitable securities investments. Such a result harms not only those particular investors, but also the confidence of those and other investors in our capital market. Abuses of the exempt market system also may make it more difficult and expensive for issuers legitimately using exemptions to find investors, thus causing further harm to our capital market and confidence in that market.
[1035] We conclude that individual investors and the Alberta capital market in general were harmed by the illegal trades in and distributions of Arbour Preferred Shares by Arbour, Morice, Brost and IFFL. We find that Arbour, Morice, Brost and IFFL all exhibited a serious disregard for the basic principles of Alberta securities laws by engaging in such illegal conduct.
[1036] Therefore, we find that the illegal trades in and distributions of Arbour Preferred Shares by Arbour, Morice, Brost and IFFL were also clearly contrary to the public interest.
[1037] We have already commented on the importance of the exempt market in Alberta. The offering memorandum is a valuable tool in the exempt market system. It allows issuers a timely and less expensive alternative to a vetted prospectus, yet still provides prospective investors with material information of assistance in making informed investment decisions.
[1038] We have concluded that the Arbour OMs were riddled with problems, many of which rose to the level of misrepresentations. It would be unreasonable to expect perfection in an offering memorandum; however, the Arbour OMs were completely unacceptable. Prospective investors would not have been – and were not – assisted in making informed investment decisions by the disclosure in the Arbour OMs.
[1039] As noted, the misuse of exemptions – and the corresponding risk to investors (whether potential or actual) – has implications for the vibrancy of the exempt market and confidence in the Alberta capital market as a whole.
[1040] Consequently, we find that the misrepresentations, or materially untrue or misleading (or both) statements, in the Arbour OMs – which we have found Arbour and Morice made in breach of section 92(4.1) of the Act (and its predecessor) – also constituted conduct contrary to the public interest by Arbour and Morice.
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[1041] The advisor registration requirements are also an important component of Alberta securities laws. Registered advisors, who meet certain educational and ethical standards, are better able to determine the investment needs and objectives of, and the suitability of proposed investment products for, prospective investors. Thus, prospective investors who rely on a registered advisor's investment advice are assisted in making informed investment decisions.
[1042] We have found that Brost and IFFL engaged in unregistered advising in securities. They advised prospective investors to invest in the highly questionable Arbour Preferred Shares, among other securities. These investments were clearly not suitable for any prospective investors, even had Brost and IFFL considered each investor's investment objectives, risk tolerance and financial situation. Although certain of the investor witnesses have received some money back from the investments they made on advice from Brost, IFFL or both, the majority of investors apparently have not received, and will not receive, money back from such investments. The total amount raised through the sale of the Arbour Preferred Shares was approximately
$45.5 million, with the majority of the purchasers being IFFL members. We received no evidence as to the amounts raised by IFFL from sales of other Brost-connected entities; however, according to Sorenson, IFFL raised some $97 million in 2006. Brost's organization IFFL was a massive enterprise, created and operated not in investors' best interests but to further Brost's and IFFL's interests. Through this serious misconduct, Brost and IFFL exposed the investors they advised to considerable risk and caused actual and significant financial harm to, it seems, many of them. Their unregistered advising also damaged the reputation of, and impaired confidence in, the Alberta capital market.
[1043] Because Brost and IFFL had entered into the Brost Undertaking and the IFFL Undertaking, respectively, we conclude that they were well aware of the existence, scope and importance of Alberta securities laws prohibiting unregistered advising. Exacerbating Brost's and IFFL's misconduct was their use of documents and presentations in an attempt to obfuscate the fact that they were advising in securities.
[1044] Accordingly, we find that Brost's and IFFL's unregistered advising was also contrary to the public interest.
[1045] Even without sections 93.1 and 93.2 of the Act (which came into force after some of the misconduct here had occurred), we expect – and demand – compliance from market participants giving an undertaking to the Commission or being the subject of a Commission order.
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[1046] Brost's and IFFL's defiance of the Brost Undertaking and the IFFL Undertaking, respectively – and the accompanying Undertaking Order – indicates to us that they have no respect for the Commission and its processes or, more generally, for Alberta securities laws. This is an extremely serious matter, as respect for Alberta securities laws and those who enforce them is a critical element of our capital market system. We cannot, and will not, tolerate such disdain for Alberta securities laws and the investors we seek to protect.
[1047] Therefore, we find that Brost's and IFFL's flaunting of the Brost Undertaking and the IFFL Undertaking, respectively, and their contempt for the Undertaking Order also constituted conduct contrary to the public interest.
[1048] Fraud is "one of the most egregious securities regulatory violations" and is both "an affront to the individual investors directly targeted" and something that "decreases confidence in the fairness and efficiency of the entire capital market system" (Capital Alternatives at para. 308, citing Johnston & Rockwell, Canadian Securities Regulation, 4th ed. at 420).
[1049] We have concluded that each of the Respondents engaged in fraudulent conduct. In our view, fraud, by its very nature, will always be contrary to the public interest. That position is strengthened in the circumstances here when we consider the many layers of complexity of the fraud involving the Arbour Preferred Shares and the use of the proceeds from the sale of those shares.
[1050] In addition to placing specific investors at risk and denying them the opportunity to make informed investment decisions, the Respondents' fraudulent actions seriously impaired the reputation of the Alberta capital market and investor confidence in that market.
[1051] There is no question that each of the Respondents' fraudulent conduct was also contrary to the public interest, and we so find.
[1052] We have found that:
Arbour, Morice, Brost and IFFL breached section 75(1)(a) of the Act by trading in Arbour Preferred Shares without registration or exemptions;
Arbour, Morice, Brost and IFFL breached section 110(1) by distributing Arbour Preferred Shares without a prospectus or exemptions;
Brost and IFFL breached section 75(1)(b)(i) by acting as advisors without registration or exemptions;
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Arbour and Morice breached section 92(4.1) (and its predecessor) by making statements in the Arbour OMs that they knew or reasonably ought to have known were untrue or misleading;
Brost and IFFL breached sections 93.2 and 93.1 by failing to comply with the Brost Undertaking and the IFFL Undertaking, respectively, and the Undertaking Order accepting those undertakings;
the Respondents breached section 93(b) (and its predecessor) by perpetrating a fraud on Alberta investors; and
in so doing, the Respondents engaged in conduct contrary to the public interest.
[1053] It remains to be determined what, if any, orders for sanctions and costs ought to be made against the Respondents. This proceeding will thus move to the Sanction Hearing for that purpose.
[1054] We direct that Staff provide to the panel (through the Commission Registrar) and to the Respondents any written submissions that Staff wish to make on the issue of appropriate orders by 16:00 on Wednesday 16 May 2012.
[1055] The Respondents may each reply in writing to Staff's submissions. Any such written submissions must be provided to the panel (through the Registrar), to Staff and to each other Respondent by 16:00 on Wednesday 4 July 2012.
[1056] Staff may reply in writing to any such written submissions by the Respondents, such reply to be provided to the panel (through the Registrar) and to the Respondents by 16:00 on Monday 23 July 2012.
[1057] If any party wishes to make supplementary oral submissions or to adduce evidence on the issue of appropriate orders, the panel will hold an in-person hearing session on Wednesday 5 September 2012 commencing at 9:00. A party requesting such an in-person hearing session must advise the Registrar by 16:00 on Monday 30 July 2012, indicating whether that party proposes to adduce evidence (via witnesses or otherwise) and the amount of hearing time that
party expects to require. Even if no party requests such an in-person hearing session, one may be required by the panel. The Registrar will inform the parties as to whether an in-person hearing session will proceed.
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30 March 2012
"original signed by" Glenda A. Campbell, QC
"original signed by" Neil W. Murphy
"original signed by" Karen A. Prentice, QC
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