The Queen v. Colpitts

SUPREME COURT OF NOVA SCOTIA

Citation: R v. Colpitts, 2018 NSSC 40

Date: 2018-03-09

Docket: Halifax, Nova Scotia, CRH No. 346068

Registry: Halifax

Between:

Her Majesty the Queen

v.

Robert Blois Colpitts and Daniel Frederick Potter

LIBRARY HEADING

The Honourable Justice Kevin Coady

Judge:

Heard:

November 16, 2015 to November 7, 2017, in Halifax,

Nova Scotia

March 9, 2018

Written Decision:

Subject:

Criminal law; securities; conspiracy; fraud; intent to defraud;

fraudulently affecting the public market price of shares; co-

conspirators’ exception to the hearsay rule; Section 465(1)(c)

– conspiracy to commit market fraud contrary to s 380(2);

Section 465(1)(c) – conspiracy to commit fraud contrary to

s. 380(1)(a); Section 380(2) – market fraud; Section 380(1)(a)

– fraud on the public over $5,000; Section 380(1)(a) – fraud

on persons both known and unknown, over $5,000.

The defendants were charged with fraud and conspiracy to

commit fraud related to the market price of Knowledge House

Inc. (“KHI”) shares on the Toronto Stock Exchange. It was

alleged that between January 2000 and August 2001, the

defendants, together with B. Clarke and ten unindicted co-

conspirators, developed and implemented a sophisticated

Summary:

market manipulation scheme to artificially maintain the price

of KHI shares to counteract the impact of the dot-com crash,

attract new investment, maintain access to credit sources, and

protect their personal net worth. It was alleged that the

defendants and other conspirators defrauded numerous

individuals and financial institutions of amounts in excess of

$20 million.

(1) Were the defendants (or any of them) guilty of

Issues:

conspiracy to commit market fraud contrary to s. 380(2)?

(2) Were the defendants (or any of them) guilty of

conspiracy to commit fraud contrary to s. 380(1)(a)?

(3) Were the defendants (or any of them) guilty of market

fraud contrary to s. 380(2)?

(4) Were the defendants (or any of them) guilty of fraud on

the public over $5,000 contrary to s. 380(1)(a)?

(5) Were the defendants (or any of them) guilty of fraud on

persons both known and unknown over $5,000 contrary to

s. 380(1)(a)?

The Crown proved beyond a reasonable doubt that the

defendants, together with Clarke and ten unindicted co-

conspirators, developed and implemented a multi-faceted

scheme to manipulate the KHI share price on the Toronto

Stock Exchange. The conspirators employed a variety of

manipulative techniques to artificially maintain the KHI share

price including buy-side domination, sell-side suppression,

material non-disclosure, undisclosed incentives, parking

stock, and high closing the stock.

Result:

The Crown proved beyond a reasonable doubt that the

defendants, together with the other conspirators, acted with an

intention to defraud. Their objective was to artificially

maintain the KHI share price – creating a false impression of

retail demand for the stock – for the specific purpose of

attracting new investors. They suppressed sales and regularly

high-closed the stock in advance of large investments to

ensure that the deals would close.

From March 2000 to August 2001, the conspirators spent

more than $11 million buying over 50% of the KHI shares

that crossed the Exchange. Their conduct, which largely

immunized the stock against the significant downward

pressure on the share price caused by the dot-com crash,

created an artificial price for KHI shares.

The actions of the defendants not only put the economic

interests of existing and potential KHI shareholders at risk,

but caused significant economic loss to numerous investors,

known and unknown, and financial institutions.

In accordance with the Kienapple rule against multiple

convictions for the same wrongdoing, each defendant was

convicted of conspiracy to commit market fraud contrary to

s. 380(2) and market fraud contrary to s. 380(2).

THIS INFORMATION SHEET DOES NOT FORM PART OF THE COURT'S DECISION.

QUOTES MUST BE FROM THE DECISION, NOT THIS LIBRARY SHEET.

SUPREME COURT OF NOVA SCOTIA

Citation: R. v. Colpitts, 2018 NSSC 40

Date: 2018-03-09

Docket: Halifax, Nova Scotia, CRH No. 346068

Registry: Halifax

Between:

Her Majesty The Queen

v.

Robert Blois Colpitts and Daniel Frederick Potter

Decision on the Prosecution

The Honourable Justice Kevin Coady

Judge:

Heard:

November 16, 2015 to November 7, 2017, in

Halifax, Nova Scotia.

March 9, 2018

Written Decision:

Counsel:

James Martin, Mark Covan and Scott Millar, for the Crown

Brian H. Greenspan and Jane O’Neill, Q.C. for Daniel Potter

R. Blois Colpitts, Self-Represented

Page 2

By the Court:

Introduction

[1] The saga of Knowledge House Incorporated (“KHI”) has dominated

discussion in the business and investment community in Nova Scotia for the past

17 years. This publicly-traded e-learning company collapsed in August 2001,

resulting in significant financial losses to both individuals and financial

institutions. Daniel Potter was KHI’s Chief Executive Officer. Blois Colpitts was

legal counsel and Lead Director. Bruce Clarke was an investment advisor at the

Halifax office of National Bank Financial Ltd. (“NBFL”) where KHI insiders

conducted much of their securities business.

[2] The circumstances surrounding the demise of KHI attracted the attention of

the Nova Scotia Securities Commission. The Commission investigator concluded

that several KHI officials, including Messrs. Potter, Colpitts and Clarke, may have

been involved in a scheme to manipulate the price of KHI shares on the Toronto

Stock Exchange (“TSX”) in 2000-2001. These concerns resulted in a referral in

2003 to the RCMP for the purposes of a criminal investigation. On March 17,

2011, the Crown preferred an indictment against all three, alleging fraud and a

conspiracy to commit fraud related to the market price for KHI shares. The years

between preferring the indictment and the start of the trial on November 16, 2015

were consumed by various pre-trial applications, mostly concerning disclosure

issues.

[3] This has been an extremely lengthy, complex and challenging trial. The

Crown called 57 witnesses and Mr. Colpitts called 18 witnesses, including himself.

Mr. Potter elected not to call evidence. Mr. Clarke entered a guilty plea in the

early weeks of the trial and was sentenced to three years’ incarceration. The

evidence and submissions consumed in excess of 160 trial days over a two-year

period. Additionally, the defendants advanced 16 mid-trial applications. The

parties exhibited thousands of documents contained in 184 exhibits, including

Exhibit 1, which contains 5,672 electronic documents and over 800

communications. The evidence lacked narrative, as most of the testimony

consisted of commentary on the documentation. At the conclusion of evidence, the

parties filed post-trial briefs and made oral submissions. The Crown’s post-trial

brief was 247 pages in length.

Page 3

[4] The events surrounding the demise of KHI also resulted in several civil

actions brought by and against a number of KHI insiders including Mr. Potter and

Mr. Colpitts. Those actions were heard and decided in 2012. They produced

voluminous documentation that formed part of the evidence in this criminal trial.

History of KHI

[5] In order to fully understand this lengthy and complex prosecution, it is

helpful to review the history of KHI. This company was founded by Dr. Bernard

Schelew in 1984 as Knowledge House Publishing Limited. In 1988, the company

obtained a listing on the Montreal Stock Exchange. Daniel Potter was a member of

the Board of Directors at that time.

[6] In 1991, Daniel Potter and Gary Blandford founded a company called the

Information Technology Institute (“ITI”). Its purpose was to educate post-graduate

students in information technology systems. In 1998, Mr. Potter sold his interest in

ITI to Torstar, resigned from the Board and took a controlling interest in KHI. Mr.

Colpitts, the company’s legal counsel, assumed Mr. Potter’s seat on the Board of

KHI.

[7] With Mr. Potter as Chief Executive Officer, the company reinvented itself.

It transitioned from a medical education software developer to “a learning,

performance support and information technology company.” The vision for KHI

was the complete overhaul of the K-12 and post-secondary education system

through the introduction of collaborative, problem-based learning programs.

[8] Although management’s end goal was for KHI to be a pure e-learning

company, the business began as a provider of school technology infrastructure. In

the summer of 1999, KHI acquired Micronet Information Systems Limited and

Innovative Systems Limited, two Nova Scotia companies with lucrative

government contracts to supply computer hardware, software, warranty support,

and installation services to a K-12 public education system. These contracts,

which were good until early 2001, provided KHI with an early revenue stream.

Also in 1999, KHI acquired Silicon Island Art & Innovation Centre Limited and

the Centre for Distance Education (“CD-Ed”). The former was a business

incubation centre while the latter was a distance learning centre.

[9] The acquisitions of these companies were not done with cash. Instead, their

principals received large blocks of KHI shares (4.5 million plus) that were to be

held in escrow and they agreed to become employees of KHI. They were also

Page 4

provided with warrants which gave them the opportunity to purchase further KHI

shares from treasury in the future at an agreed-upon price.

[10] In addition to the government contracts, KHI brought in significant revenue

through a limited partnership offering (the “KHLP” or “LP”). Limited partnership

units were sold to investors throughout 1998 and 1999, raising $3.45 million for

the company. The revenues were earmarked to finance research and development

of KHI’s proprietary learning programs. Other smaller sources of revenue for the

company included tuition sales of career skill development courses offered by CD-

Ed and rental revenue from Silicon Island.

[11] By the end of 1999, KHI had grown from less than 20 employees to 120. At

that time, as a result of restructuring of Canadian capital markets, the Montreal

Stock Exchange ceased trading in equities. Notwithstanding KHI’s small

shareholder base, the company began trading on the Toronto Stock Exchange on

December 6, 1999. One week later KHI entered into an agreement with the

Ashford Group, builders and operators of technologically-advanced schools in

Nova Scotia. Under the agreement, KHI, in partnership with IBM Canada

Limited, would provide technology and services for 15 schools being constructed

in 2000. The agreement was valued at $17.6 million, plus additional annual

amounts of approximately $750,000 for 20 years, for maintenance and updating of

technology in the schools. On January 21, 2000, KHI also reached an agreement

with the Strait Regional School Board to collaborate in developing a new

curriculum for distributed learning environments.

[12] The early success of KHI was closely followed in the local press. For

example, the Halifax Chronicle Herald published an article in its March 30, 2000,

issue entitled, “Knowledge House Embarks on Road Show with IBM; Halifax

Firm High on Learning”. In later editions, articles with the following headlines

appeared: “Lifelong Learning – Dan Potter of Knowledge House on a Mission to

Market Education” and “Firm Taking High School High Tech”. The future for

KHI looked bright.

[13] In March 2000, the “tech bubble”¹burst, causing public interest in

technology stocks to decline dramatically. Starting in April 2000, stock prices in

the technology sector would fall until well into 2001.

¹Also known as the “dot-com bubble”.

Page 5

[14] On March 23, 2000, KHI released its annual report for the fiscal year ending

December 31, 1999. The company’s revenue for that period was $18,238,000 – a

dramatic increase over the $813,319 reported the previous year. KHI reported a

profit of $528,000, up from $123,390 the previous year. On March 29, 2000, KHI

announced a strategic national partnership with IBM Canada to work together to

jointly market, install, and support their collective portfolio of offerings.

[15] On May 25, 2000, KHI released its first-quarter results. Revenue for the

three-month period was $7,582,724 compared with $364,587 in the first quarter of

the previous fiscal year. Net earnings were $102,070 as compared with $75,796 in

1999. On August 25, 2000, KHI released its second-quarter financial results for

the period ending June 30, 2000. Revenue was $15,397,712 compared with

$979,394 the previous year. Profits increased to $105,000 compared with $55,111

in the second quarter of the previous year.

[16] The months of August and September 2000 saw three individuals make

significant pre-arranged market purchases of KHI stock. On August 3, Derek

Banks, through his company Plastics Maritime, purchased $1 million worth of

shares from Mr. Potter’s RRSP account. Between August 29 and September 8,

Ben Barthe, a German investor, purchased $1.7 million worth of shares. On

September 7, 2000, David Fountain, through his company Longwood Investments,

purchased approximately $2 million worth of shares.

[17] In October 2000, Dr. Lutz Ristow, a friend of Ben Barthe, became interested

in investing in KHI. On November 15, 2000, the two friends signed a Subscription

Agreement under which they agreed to purchase 500,000 units of KHI for a total

price of $3,250,000. Each unit was comprised of one KHI common share and one

warrant to purchase another KHI share from treasury at a later date. The parties

agreed that the investment would be paid for in four equal installments of

$812,500, payable on November 15, 2000, February 15, 2001, May 15, 2001, and

August 15, 2001.

[18] KHI released its third-quarter financial results on November 20, 2000.

Revenue for the period ending September 30, 2000, was $12,540,842 as compared

with $3,493,087 in the previous fiscal year. Net earnings were down somewhat.

KHI attributed the level of net income to the fact that the company had grown

rapidly over the previous two years and had invested in increased staff and

infrastructure. By the end of 2000, publicly-available information suggested that

all was well at KHI. Despite the dot-com crash in March, the stock price had

Page 6

remained relatively stable. The company was receiving positive attention in the

local media. Significant investments by Mr. Fountain, Mr. Banks, Dr. Ristow and

Mr. Barthe were in place. On the outside, KHI appeared to be an “up-and-comer”

that was beating the odds. Behind closed doors, however, the company was in

financial distress.

[19] On January 15, 2001, Mr. Potter circulated a memo to KHI Directors

advising them they urgently needed to raise $3 million in new equity to support the

company’s growth and operations. He explained that the company had made a

“significant error” during 2000 by directing too much of its new investments to

market (non-treasury) share purchases. Of the $14 million in new block share

purchases received in 2000, only $2.5 million was invested in the treasury of the

company. Mr. Potter further advised that on December 15, 2000, Royal Bank of

Canada had reduced KHI’s operating line of credit from $3.5 million to $500,000.

This development added urgency to the need for new investment in the company.

KHI struggled to attract new investors and, as time went on, the company’s

financial situation became dire. Meanwhile, in April 2001, Mr. Potter was named

Chairman of Nova Scotia Business Inc., the agency in charge of using taxpayers’

money to help businesses.

[20] Having been unable to raise the necessary capital itself, KHI announced on

August 17, 2001, that it had entered into an engagement agreement with IBK

Capital Corp of Toronto. IBK would raise up to $5 million on KHI’s behalf by

way of private placement of common shares or other securities. The news was not

favourably received. That morning, several KHI shareholders received margin

calls as a result of the collapse in the share price of ITI, Mr. Potter’s former

company. KHI’s own stock price began a free fall, from which it never recovered.

On September 13, 2001, KHI announced that it could not continue its operations

due to a lack of available financing. Unable to make payroll, the company closed

its doors.

The Charges Against Messrs. Potter and Colpitts

[21] The Crown alleges that Mr. Potter, Mr. Colpitts, and Mr. Clarke, along with

ten other co-conspirators, developed and implemented a plan to artificially

maintain the share price of KHI stock throughout 2000 and 2001. These KHI

insiders and shareholders focused their efforts on maintaining the KHI stock prices

rather than enhancing the company’s product. Their alleged activities resulted in

the following charges being preferred against Mr. Potter and Mr. Colpitts:

Page 7

Bruce Elliott Clarke, Robert Blois Colpitts and Daniel Frederick Potter of Halifax,

Province of Nova Scotia, stand charged:

THAT between the 1st day of January, 2000, and the 13th day of September,

2001, at or near Halifax in the Regional Municipality of Halifax, Province of

Nova Scotia and elsewhere in the Province of Nova Scotia, and at or near

Montreal in the Province of Quebec, and at or near Toronto in the Province of

Ontario, and elsewhere in Canada and places outside of Canada:

1.

They did unlawfully conspire together with Bruce Elliott Clarke, Robert

Blois Colpitts and Daniel Frederick Potter, the one with the other or others of

them, and with person or persons unknown or unnamed, by deceit, falsehood or

other fraudulent means, with intent to defraud, to unlawfully affect the public

market price of shares of Knowledge House Incorporated contrary to Section

380(2) of the Criminal Code and did thereby commit an offence contrary to

Section 465(1)(c) of the Criminal Code.

2.

AND FURTHERMORE BETWEEN THE SAME DATES AND AT

PLACES AFORESAID they did, by deceit, falsehood or other means, with intent

to defraud, affect the public market price of shares of Knowledge House

Incorporated, contrary to Section 380(2) of the Criminal Code.

3.

AND FURTHERMORE BETWEEN THE SAME DATES AND AT

PLACES AFORESAID they did by deceit, falsehood or other fraudulent means

defraud the public in respect of the market for shares of Knowledge House

Incorporated, of a sum exceeding five thousand dollars, contrary to Section

380(1)(a) of the Criminal Code.

4.

AND FURTHERMORE BETWEEN THE SAME DATES AND AT

PLACES AFORESAID they did by deceit, falsehood or other fraudulent means

defraud persons, both known and unknown, in respect of the market for shares of

Knowledge House Incorporated, of a sum exceeding five thousand dollars,

contrary to Section 380(1)(a) of the Criminal Code.

5.

[Omitted, as it relates to Mr. Clarke only.]

6.

They did unlawfully conspire together with Bruce Elliott Clarke, Robert

Blois Colpitts and Daniel Frederick Potter, the one with the other or others of

them, and with person or persons unknown, or unnamed, by deceit, falsehood or

other fraudulent means, to defraud the public, and persons both known and

unknown, in respect of the market for shares in Knowledge House Incorporated,

of a sum exceeding five thousand dollars, contrary to Section 380(1)(a) of the

Criminal Code and did thereby commit an offence contrary to Section 465(1)(c)

of the Criminal Code.

[22] The Crown alleges that from January 2000 until the collapse of KHI in

August 2001, these defendants maintained the price of the stock at an artificially

high level. The Crown alleges these actions were taken to maintain access to credit

Page 8

sources, to entice new investments and to protect the defendants’ personal net

worth. The Crown alleges the defendants utilized the following techniques:

1) Market Domination:

[23] Domination of the buy side involves the intentional maintenance of the stock

price by purchasing a high percentage of the shares offered for sale by retail

shareholders. This conduct compensates for a lack of retail demand and creates a

misleading impression of liquidity in the market. Unsuspecting investors who

assume that the current price is the product of genuine supply and demand are

duped into paying more for the stock than they otherwise would. Price and

liquidity are key considerations for investors and manipulative market domination

creates misleading impressions of both. The Crown’s expert, Langley Evans,

described market domination at paras. 51 and 52 of his report:

With sufficient financial resources, it is possible to artificially influence the price

by overwhelming the market and buying all the stock made available. One person

or a group with sufficient money can buy enough of the stock to move the price

up or maintain price at the level of their choosing for as long as their financial

capacity allows.

For very large publicly traded companies, such as a large chartered bank in the

Canadian markets, the amount of buying required to move the price can make

manipulating the price an impractical undertaking. However, for the securities of

smaller public companies that are more thinly traded (i.e. illiquid), it can be

feasible to influence the price and do so with far less funding. For this reason,

targets of stock manipulation are frequently micro-cap or small cap public

companies.

[24] Mr. Evans recognized in his testimony, however, that purchasing a high

percentage of the shares available on the market is entirely lawful if those

purchases are made for legitimate investment purposes. After all, every legitimate

trade can have an impact on share prices. It is only where the purchases are made

with the primary intent of affecting the stock price that they become manipulative.

2) Sales Suppression

[25] Suppression of the sell side means taking steps to ensure that as little stock is

sold as possible. Sales suppression eliminates downward pressure on the share

price by preventing existing shareholders from selling their shares on the market.

This can be accomplished by way of incentives, pressure tactics, ignoring sell

Page 9

orders, collusion among large shareholders, requiring permission before selling and

withholding share certificates. The Crown’s expert discussed this technique at

para. 58 of his report:

Selling stock puts downward pressure on the stock price, so any selling activity is

contrary to persons who wish to artificially raise or maintain the stock price.

This technique interferes with the natural laws of supply and demand and lends to

the impression that investors are confident with their investment.

3) High Closing the Stock:

[26] The closing price of a stock is the final price at which a security is traded on

a given day. It represents the most up-to-date valuation of a security until trading

commences on the next trading day. High closing refers to the practice of entering

the market, usually late in the day, and purchasing (or offering to purchase) stocks

at increasing prices to give a false impression of favorable performance. The

closing price is important to investors for at least two reasons. First, regardless of

how well a stock performs throughout the day, it is the closing price that is

published in the media. Second, the closing price is used to set a stock’s value for

margin account purposes. The Crown’s expert discussed high closing at para. 38

of his report:

Closing prices are particularly important because they are used for margin

calculations and portfolio valuations, and are widely publicized in market

information systems and financial newspapers. This makes affecting the closing

price an attractive objective to persons wishing to manipulate the market of a

specific securities [sic]. The technique of ‘high closing’ is often used to meet this

objective. High closing is the practice of entering one or a series of orders for the

purpose of raising the closing trade price or the closing bid price for the security

from what it would otherwise be if left to the ordinary forces of supply and

demand.

The most dramatic and easily recognizable examples of high closing involve

purchase orders that are entered very near the end of a trading session and that

increase the last trade price for the security by a significant amount.

[27] Not every instance of the market closing high is a manipulation. A stock

might end on an uptick any given day, purely by chance.²A legitimate bid

²An uptick is when the stock trades at a higher price than that of the previous trade.

Page 10

entered early in the trading day might not be hit until minutes before the market

closes. Manipulative intent can be demonstrated through direct evidence in the

form of statements of intention, or it may be inferred through the surrounding

circumstances, such as frequency, patterns and context. The advantage gained by

high closing is short-lived because the market starts fresh the next day.

Consequently a pattern of high closing is required to maintain an artificially high

stock price over a period of time.

4) The Use of Margin Accounts:

[28] In addition to allowing clients to purchase shares with cash, many

brokerages offer margin accounts. Trading on margin plays a significant role in

this trial and warrants a detailed explanation. Margin trading allows clients to buy

securities with borrowed money. The collateral for the borrowed funds is the

securities in the investor’s account. Trading on margin increases an investor’s

purchasing power, enabling them to buy more stock than they can afford to pay for

out of pocket. Margin trading is a double-edged sword. It can lead to greater gains

when stock values increase. It also exposes the investor to far more substantial

losses when values drop.

[29] To buy securities on margin, you must sign a margin agreement with your

dealer and deposit enough cash or securities to meet the margin requirement for the

securities you intend to purchase. The margin requirement dictates the minimum

amount of equity that a client must contribute toward the purchase. It is usually

expressed as a percentage of the current market value of the particular security.

Margin requirements are set by the Investment Industry Regulatory Organization

of Canada. In 2000-2001, they were set by its predecessor, the Investment Dealers

Association. The margin requirements set by these bodies are only minimums,

however, and individual brokerages may set more conservative requirements. Any

equity available that exceeds the margin requirements for the securities in the

account is known as excess margin. Excess margin can be used to purchase new

securities or to add to an existing position.

[30] Margin account holders must always maintain adequate margin in the

account to meet margin requirements or they are at risk of receiving a margin call.

A margin call is a demand that the investor deposit additional cash or securities to

bring the account back up to the margin requirement. The dealer reserves the right

to sell the securities in a margin account in order to bring the account back to good

standing. Once you receive a margin call, you must decide whether to deposit

Page 11

sufficient cash or securities into the account or to liquidate some of your shares. If

you fail to respond to the margin call, the investment dealer is entitled to sell some

of the securities in the account.

[31] One way to lower the risk of a margin call is to maintain a diversified

portfolio in your account. If a single stock represents a significant percentage of

your portfolio, you have what is known as a concentrated position. Maintaining a

concentrated position presents an increased risk because a drop in the stock’s value

– suggesting reduced demand in the market – can trigger a chain reaction. The

drop in the share price may bring the account below the margin requirement,

resulting in a margin call. If you are unable to respond to the margin call by

depositing cash or marginable securities into the account, your dealer may sell off

some of your stock. Depending on the liquidity of the stock, adding more shares to

the sell side of the market may increase downward pressure on the share price,

further reducing the margin in your account, and so on.

[32] The theory of the Crown is that the defendants and the alleged co-

conspirators used their margin accounts to dominate the market, and that, when

necessary, they worked to raise the price of the stock to avoid margin calls on their

highly-concentrated accounts.

5) The Use of Nominees

[33] Nominees can be used to disguise the true nature of trading. The Crown’s

expert described this technique at paras. 53-55 of his report:

Nominees can be used to disguise the true nature of the trading. If all the trading

emanated from one account, a manipulative scheme might become obvious and

easily detected. However, if the activity is spread among several accounts, it can

appear that the trading is coming from independent decisions, and lending more

of an impression of consensus on the security’s pricing in the market.

Fragmenting the trading into different accounts can also circumvent insider trade

reporting requirements. Securities Acts typically require directors, officers or

shareholders of greater than 10% to publicly report their trading, either 10 days

after month end or 10 days after the trade, depending on the jurisdiction. By

using nominee accounts in the names of persons outside these categories, the

insider reporting requirement can be avoided and help keep trading by insiders

hidden from public view.

Nominees can vary widely in their knowledge of a manipulative scheme ranging

from little or no knowledge to completely informed and active participants.

Nominees are, however, generally at least aware that their accounts are being used

Page 12

in some way for trading in the security. Where a scheme relies heavily on the

trading by a specific account or a handful of specific accounts, those accounts are

sometimes referred to, in trading street slang, as the ‘box account’ or ‘box

accounts’.

[34] The use of nominees by the defendants forms part of the Crown’s theory of

manipulation.

6) Parking Stock:

[35] Parking stock can be seen as a sub-category of sales suppression. It refers to

placing large blocks of stock in the account of a complicit nominee or an unwitting

client and ensuring that the stock never gets sold. The Crown’s expert discussed

this practice at para. 56 of his report:

This technique is a variation on the use of nominees and requires the assistance of

a broker participating in the scheme. The broker buys and holds stock without the

knowledge or consent of the accountholder. The stock purchases can be used to

support the market and holding the stock in the account assists in restricting the

supply of stock during the period of the manipulation. To park stock, typically

the accountholder is vulnerable through a combination of complacency, lack of

sophistication, or dependency on the broker.

[36] This technique fulfills a manipulative agenda in that it responds to a market

where there are few, if any, buyers in the market for a particular stock.

7) The Use of Incentives:

[37] The stock market is meant to be comprised of independent buyers and sellers

making decisions based on legitimate investment goals. When a conspirator offers

incentives either to buy or to refrain from selling, the recipient is no longer making

investment decisions based solely on the stock itself, but on other considerations as

well. If an incentive is not disclosed, the public is duped and the fair market

breaks down. The Crown’s expert discussed incentives at para. 57 of his report:

Creating artificial demand for the stock by providing financial incentives can also

advance a manipulative agenda. Incentives can take different forms, such as

making stock available at far below the quoted market in return for an agreement

to make further market purchases of the security. Alternatively, existing investors

who are potential sellers can be provided financial inducements to refrain from or

delaying [sic] selling their stock.

[38] Langley Evans gave evidence on this technique as follows:

Page 13

[If] the agenda is to artificially increase or maintain the price at a level higher than

what it would be otherwise, you would see incentives provided to buy and

penalties for selling or incentives not to sell. And those would be all ways of

artificially influencing the supply or constraining it and enhancing the demand.

8) The Use of a Box Account:

[39] In 2000-2001, Bruce Clarke was an investment advisor at NBFL’s Halifax

office. His son, Steven Clarke, also worked at NBFL providing administrative

support to his father. Bruce Clarke was the investment advisor for Mr. Potter, Mr.

Colpitts and the majority of the alleged co-conspirators. Mr. Clarke owned a

private investment company named 2317540 Nova Scotia Limited. It held a

margin account at NBFL that has become known as “the 540 account”.

Historically, this account was relatively inactive.

[40] The Crown alleges that between January and March 2000, the alleged co-

conspirators (known as the “control group”) infused the 540 account with cash and

securities to enable it to buy and sell KHI shares in the coming months. It is

alleged that the alleged co-conspirators used this account as their principal box

account to manipulate the price of KHI stock on the Toronto Stock Exchange.

They often referred to it as “the orderly market account”.

[41] The Crown alleges that Mr. Potter controlled the 540 account and, as such, it

was his nominee account. By using the 540 account to make purchases, the

defendants were able to soak up any KHI shares coming to the market while

avoiding insider reporting requirements.

9) Non-Disclosure of Material Information:

[42] Investors’ decisions to buy, sell or hold must be fully informed. An investor

has the right to know the material facts surrounding the business of a company and

its stock. This right is protected by legislation. The Crown’s expert described

material disclosure as follows:

As a reporting issuer, KHI had continuous disclosure obligations, which included

preparing and distributing financial statements and making timely announcements

of any material changes in KHI affairs. Canadian reporting issuers must file all

materials related to their continuous disclosure obligations of SEDAR.

Page 14

SEDAR is an organization that collects all publicly-available information for

publicly-traded companies in Canada.

[43] Non-disclosure of material information is an offence under securities law,

but it is also a means by which a company can maintain the price of a stock. For

example, if information that might induce a shareholder to sell is not disclosed, this

can be a form of sales suppression.

The Alleged Co-Conspirators

[44] The Crown alleges that the 13 members of the “control group” collectively

utilized the above techniques to manipulate the price of KHI stock on the Toronto

Stock Exchange. This is not to suggest that all alleged co-conspirators utilized all

of these techniques throughout the indictment period. The Crown alleges that each

person in this group did something that contributed to the overall goal of the

conspiracy, that being to illegally maintain the market price of KHI shares on the

Toronto Stock Exchange. So who are the alleged co-conspirators?

[45] Daniel Potter was the President and Chief Executive Officer of KHI. The

Crown considers him to be the primary participant in this conspiracy. They allege

that “he created it, he directed it and he controlled it.”

[46] On March 8, 2000, Mr. Potter signed a “Guarantee Agreement” with NBFL

in which he “unconditionally guarantees to National Bank Financial Ltd. all

current and future debts and liabilities” of several individuals and private

companies. The list is as follows:



Ronald Richter of Middleton, Nova Scotia

John F. Sullivan and Linda Sullivan of Guysborough, Nova Scotia

Starr’s Point Capital Incorporated

Gramm & Company Incorporated

3020828 Nova Scotia Limited

2532230 Nova Scotia Limited

Knowledge House New Technology Limited Partnership

Page 15

Mr. Richter is Mr. Potter’s brother-in-law. Mr. Sullivan was a former

superintendent of the Strait Regional School Board who took a position with KHI.

The Limited Partnership was a subsidiary of KHI and the four companies were

controlled by either Mr. Potter or his spouse, Fiona Imrie.

[47] The Court heard evidence that the accounts covered by the cross-guarantee

were treated as one account for margin purposes. The Crown alleges that this

cross-guarantee allowed Mr. Potter access to these margin accounts and this

arrangement meant that under-margin accounts could be balanced by above-margin

accounts. It is the Crown’s theory that this guarantee gave Mr. Potter greater

flexibility in implementing manipulative techniques. In addition, Mr. Potter had

his own account for which he was personally responsible.

[48] Blois Colpitts, in 2000-2001, was a very successful securities lawyer at

Stewart McKelvey Stirling Scales. He was legal counsel to KHI and was its Lead

Director and Chair of its Audit Committee. The Crown alleges that whenever Mr.

Potter had a problem that needed fixing to ensure the object of the conspiracy

continued, Mr. Colpitts stepped in to try and resolve it.

[49] Bruce Clarke was an investment advisor in the Halifax office of NBFL in

2000-2001. In the 1980s and early 1990s, Mr. Clarke worked as an investment

advisor together with David Mack at a company known as J.D. Mack. Although

the firm was named after Mr. Mack, Bruce Clarke was the controlling shareholder

and Chief Financial Officer. In 1995, when J.D. Mack could not meet its capital

requirements, the Canadian Investor Protection Fund took control of the firm.

Bruce Clarke was disciplined by the Montreal Stock Exchange and J.D. Mack was

acquired by Lévesque Beaubien Geoffrion in a mandated acquisition. Lévesque

Beaubien Geoffrion was eventually absorbed by NBFL.

[50] The Crown says Bruce Clarke was the broker who implemented the majority

of the trading activity in the alleged conspiracy. A broker with access to a public

market was an essential piece in the price maintenance scheme. The Crown

alleges that he was in the hands of Messrs. Potter and Colpitts and, as such,

managed the trading in all NBFL accounts for all of the alleged co-conspirators. It

further alleges that his trading in these accounts dominated the buy side of the KHI

market, pushing back the sell side which, if left unattended, would have driven

down the price of the stock. Much of this buying was conducted through his 540

account.

Page 16

[51] Steven Clarke is Bruce Clarke’s son and, in 2000-2001, was his employee at

NBFL. He testified for the Crown. The Crown alleges he assisted in the

conspiracy by entering orders at his father’s direction and regularly updating Mr.

Potter on the status of the cross-guaranteed accounts and the margin available for

purchasing KHI stock when there were no buyers in the market.

[52] Calvin Wadden became part of KHI when he sold his share of Micronet to

KHI in return for shares and a job. No cash changed hands. The Crown alleges

that he was aware of the manipulation and, from time to time, participated fully.

On the other hand, Mr. Wadden wanted to sell his shares to fund other projects.

This dichotomy created considerable conflict between him and the other alleged

co-conspirators.

[53] Raymond Courtney became part of KHI when he sold his share of Micronet

to KHI in return for shares and a job. No cash changed hands. The Crown alleges

that his primary role in the conspiracy was to buy shares off the market.

[54] Ken MacLeod, along with Donnie Snow, was the former owner of Silicon

Island Art & Innovation Centre Limited and the Centre for Distance Learning. He

sold his company to KHI and in return received KHI shares, an executive position

and a seat on the Board of Directors. The Crown alleges that Mr. MacLeod was a

“core member of the conspiracy” and for the most part he was used by Mr. Potter,

Mr. Colpitts, Mr. Clarke and Mr. Wadden as a primary source to buy excessive

sell-side pressure on KHI stock through his account named “FutureEd.com”.

[55] Eric Richards was an investment advisor at Bank of Montreal Nesbitt Burns

(“BMO NB”) in 2000-2001. He was responsible for the investment accounts of

Mr. Wadden, Mr. Courtney and a local businessman, Steve Tsimiklis, who had

significant holdings in KHI. The Crown says Mr. Richards knew there was no

market for KHI shares and accepted that any sales must be conducted with the buy

side arranged.

[56] Steve Wilsack and Craig Dunham sold their company, Innovative Systems

Limited, to KHI and received KHI shares as payment. The Crown’s theory is that

Mr. Wilsack was involved in buying KHI shares on the market at increasing prices

at the request of other members of the conspiracy. Additionally, he sought

permission before attempting to sell his KHI shares.

[57] Gerard McInnis, in 2000-2001, was KHI’s Senior Vice-President Finance

and Accounting. The Crown’s theory is that in the Spring of 2001, Mr. McInnis

Page 17

agreed to participate in a “warrant swap” deal to obtain KHI warrants that were

then used as leverage to provide buying support for KHI shares.

[58] Jack Sullivan and Jack Hill are also alleged to have participated in the

Spring 2001 warrant swap deal concocted by Mr. Wadden. The theory of the

Crown is that they acquired warrants for one cent and then exercised the warrants

for $1.50 to acquire KHI shares from treasury. A condition of the deal was that

once the KHI shares were in their margin accounts, the three would each borrow

against those shares to buy 20,000 KHI shares off the market.

[59] Shirley Locke, in 2000-2001, was an investment advisor and branch

manager of BMO NB’s Halifax office, and a good friend of Mr. Colpitts. The

theory of the Crown is that she encouraged her clients to buy KHI when Mr. Potter

and Mr. Colpitts needed someone to “soak up selling pressure.”

[60] Dr. Bernard Schelew founded the company that would become KHI. When

he left the company, he held 1,241,725 shares. The Crown says that the defendants

strongly discouraged Dr. Schelew from selling his shares. When he would not

listen, the defendants revealed what they had been doing to support the market and

Dr. Schelew became involved in the conspiracy, purchasing more shares to

maintain the stock price.

[61] The Crown called evidence from only two of the above conspirators: Steven

Clarke and Gerard McInnis. Mr. Colpitts testified on his own behalf and called

evidence from Bernard Schelew and Shirley Locke. While the defendants take

issue with the Crown not calling additional co-conspirators, the Crown makes no

excuses for that decision. The Crown relies on the co-conspirators exception to the

hearsay rule to introduce contemporaneously-made correspondence between the

alleged co-conspirators in 2000-2001. The Crown views the correspondence as

more reliable than what the conspirators might say in oral testimony. After all,

these exchanges were made over 15 years ago and the human memory may not be

able to recover the detail outlined in the correspondence. There is also the danger

the conspirators might not be forthright given their status as unindicted co-

conspirators. Furthermore, if the defendants felt that any of the individuals who

were not called had information friendly to the defence, they had the option of

calling those individuals.³

³On this point, see R. v. Cook, [1997] 1 S.C.R. 1113, [1997] S.C.J. No. 22, at para. 39.

Page 18

The Evidence

[62] The Crown’s case against the defendants is built on hundreds of

communications, a Match Trade Report (“MTR”) containing a historical record of

every trade of KHI stock on the TSX during the relevant period, charts and

summaries prepared by RCMP investigator Ian Black in relation to the trading of

KHI, and opinion evidence from its expert, Langley Evans, who was provided with

the MTR and materials prepared by Ian Black.

[63] The defendants do not challenge the authenticity of the communications.

They do not deny that the transactions described in those documents and confirmed

by other evidence did indeed take place. They disagree, however, with the

interpretation the Crown has placed on those communications and transactions, and

the intent imputed to the defendants pursuant to that interpretation. According to

the defendants, everything they did was legal and consistent with standard industry

practice for management and insiders of a small-cap public company. With respect

to allegations of high closing, they say that any illegal activity by Bruce Clarke

was done without their knowledge.

[64] The defendants also argue that the MTR – prepared without reference to

order tickets or contemporaneous market depth information – does not paint an

accurate picture of the market as it appeared to investors at the relevant times.

According to the defendants, this deficiency makes the MTR, and the evidence of

Mr. Black and Mr. Evans by extension, completely unreliable. In relation to Mr.

Evans, they also say that his report was riddled with errors and that his conclusions

are based on incomplete information. For this reason, they say his evidence should

be rejected in its entirety.

[65] I will begin by reviewing the Crown’s case against the defendants. I will

then review the evidence led by Mr. Colpitts, and the defence submissions in

relation to the alleged frailties of Crown’s case.

The Crown’s Case

[66] It is necessary to review the most important evidence led by the Crown in

some detail in order to provide the necessary background for the defence evidence

and submissions, and the Court’s analysis.

The conspiracy begins

Page 19

[67] The Crown says the conspiracy began on December 1, 1999 when, in

anticipation of KHI stock moving to the TSX on December 6, Dan Potter sent an e-

mail to KHI senior vice-presidents, directors and Calvin Wadden about the “Share

the Future Program”. In the e-mail, Mr. Potter stated, “I am initiating a push to

create overall increased demand for KHI shares on the market – my personal target

is to have an average of 10,000 shares a day trading on the exchange by the end of

Jan. 2000.” On the same day, Mr. Potter sent an e-mail to Dr. Bernard Schelew:

From the memo below you'll see that I am working to get the stock to progress to

the next level. As part of this process, I will be asking each Director to help

facilitate buy-side activity in the stock- it is a good time to do this for our

respective friends and network because that [sic] stock has consolidated strongly

around the $4.00 level and increased activity will tend to bring that up.

In discussing this program with Bruce and David, they advised that Anthony

[Phelips] wanted to sell 200,000 KHI shares - I assume that this may be connected

to his investment your new company. I am asking you to help me in our

initiative at this time and NOT to put sell-side pressure on the stock at this

time. It will [sic] fine as we (with your help) find new buyers for the KHI shares,

that Tony and anyone else wishing to invest in your company, sell so that they

may do so. Right now, however, the emphasis needs to be on the "Goose that lays

the Golden Eggs – KHI”)!

Please confirm that you can keep Tony's shares from becoming a burden to

the efforts I have initiated with David, Bruce and others to have the KHI

stakeholders work together and support the company in this initiative.

[Emphasis added]

[68] According to the Crown, these e-mails show Dan Potter’s plan to get

insiders to purchase stock with the objective of increasing the price. In addition,

the e-mail to Dr. Schelew was the first example of Mr. Potter attempting to

suppress sales of stock by KHI shareholders.

[69] On December 9, Dan Potter e-mailed Bruce Clarke and told him that

Bernard Schelew had spoken with Mr. Phelips who said he would “meditate on it”

and call him back about his shares. One week later, Dr. Schelew e-mailed Mr.

Potter and told him Mr. Phelips had decided “for tax reasons” to wait until January

to sell 50,000 shares. Dr. Schelew added, “Actually, he may not sell KHI at all but

may hang in.” Dan Potter replied to Dr. Schelew on December 16, and wrote, in

part:

Page 20

By a copy of this to Bruce Clarke, I’m advising him of Tony’s decision. Please

ensure that, when his selling intent wells up again, that we have lots of advance

notice.

[70] On December 6, 1999, KHI’s first day on the TSX, the stock traded between

$4.15 and $4.30. By December 29, the stock reached $6.75 before closing the

month at $6.25. For the month of December, 353,752 shares of KHI crossed the

Exchange. Suspect accounts⁴purchased 23,300 of those shares.

[71] As it transpired, on January 6, Anthony Phelips did sell 45,800 of his

200,000 shares. All but 300 were purchased by clients of Shirley Locke. Her

clients also bought 32,200 shares from 3027748 Nova Scotia Limited, a company

associated with Donnie Snow and Ken MacLeod. According to the Crown, this

was because Shirley Locke was helping the defendants find buyers so that the

share price would not go down.

Donnie Snow sells one million KHI shares

[72] Donnie Snow, together with Ken MacLeod, was the former owner of CD-Ed

and Silicon Island. Unlike Mr. MacLeod, Mr. Snow decided that he did not want

to remain an employee of KHI. Instead, he preferred to sell his shares and pursue

other opportunities. The plan, as set out by Dan Potter in an e-mail, was for Mr.

Snow to sell 1 million shares of KHI at $5.90 to Charles Keating on the TSX.

Bruce Clarke would act as Mr. Keating’s broker. To come up with the 1 million

shares, Donnie Snow would sell 840,000 shares and exercise warrants on a further

160,000. Mr. Potter explained that in order to effect the transaction, the balance of

the escrow on the shares of Mr. Snow and Mr. MacLeod would have to be

released. In the spirit of fairness, the balance of Ray Courtney and Calvin

Wadden’s shares would also be released from escrow.

[73] On January 11, Mr. Snow sold 1 million of his KHI shares to Charles

Keating for $5.9 million. Due in large part to that transaction, 1,574,525 shares of

KHI crossed the Exchange during the month of January. Suspect accounts

purchased 238,300 shares. Bruce Clarke, using the account he shared with his wife

(the “Clarke joint account”), purchased 21,100 shares at prices ranging from $5.90

to $7.10. Without accounting for any commissions, Bruce Clarke personally spent

$178,280 buying KHI during January.

⁴The term “suspect accounts” will be used throughout this decision to refer to accounts connected to the alleged

conspiracy.

Page 21

[74] As Mr. Potter set out in his December 1, 1999 e-mail, his goal was to have

10,000 shares trading daily by the end of January. Out of 20 trading days in

January, over 10,000 shares traded on 13 of those days. The plan was working.

Dan Potter directs Craig Dunham and Steve Wilsack to Bruce Clarke

[75] Gerard McInnis testified that Steve Wilsack and Craig Dunham had

shareholder loans payable to the company as a result of purchase adjustments

arising from the acquisition of their companies and KHI had decided to accept

shares as payment for those debts. To that end, Mr. McInnis e-mailed Messrs.

Wilsack and Dunham, with copies to Dan Potter and Calvin Wadden, on February

25, writing in part:

Spoke with Andrew Burke⁵today and he asked for you each to contact him

regarding making arrangements for you to take possession of the shares we

released from escrow to allow you to pay off your shareholder loan. … I had

recommended that you deliver the shares to Bruce Clark [sic] at National Bank

who would hold them in trust, sell them into an orderly market and forward

proceeds to us. If you choose to use your own broker we will allow this, however

we still request you co-ordinate the sale with Calvin so they can be sold in an

orderly manner as to not disrupt our market position.

[76] Mr. Potter replied the same day, writing “Sorry for the back seat driving but

we should insist on Bruce doing the selling!” Following Mr. Potter’s instructions,

Mr. McInnis e-mailed Wilsack and Dunham back right away:

I apologize for flip-flop on this one..but upon speaking with Dan again he was

more insistent on having you deliver the shares to Bruce Clarke and having Bruce

manage the selling transactions. I would be pleased if you would honor this

request.

[77] The Crown says this was an early example of a pattern throughout the

indictment period of Dan Potter convincing or requiring shareholders to place their

shares with Bruce Clarke so that the defendants, through Mr. Clarke, could

effectively control the trading of KHI stock. In other words, to the greatest extent

possible, no one was going to sell KHI shares without the defendants’ knowledge

and approval.

⁵At the time, Andrew Burke was an associate at Stewart McKelvey who often did work for Mr. Colpitts.

Page 22

Staffing Strategists deal

[78] By February 2000, Dan Potter was in the process of finalizing a deal to

invest in Atlantic Canada Careers Inc. (“ACC”) and Wilson Associates Inc., two

companies founded by Jim Wilson. Mr. Wilson testified that Wilson Associates

was an executive recruitment company that recruited senior executives for

businesses in Atlantic Canada and, eventually, across the country. ACC was an

internet recruitment advertising company owned by Wilson Associates.

Companies would place advertisements on the ACC website which gave them a

greater reach than traditional newspaper ads.

[79] Jim Wilson testified that he met Dan Potter in 1999 when their children were

attending the same school. He met Mr. Colpitts socially in late 1999 through Mr.

Potter. The business relationship between Mr. Wilson and Mr. Potter began when

KHI used ACC to post recruitment ads for KHI. Mr. Potter was pleased with the

results and had several discussions with Mr. Wilson about ACC’s business model.

He asked Mr. Wilson about his vision for the company and Mr. Wilson told him

that he wanted to grow the business. They continued their discussions until they

devised a plan where Mr. Potter would take an equity position in the company and

they could execute on the growth plan together.

[80] They agreed that Mr. Potter would pay $100,000 in cash, and another

$800,000 in shares of KHI that would be deposited into an account with Bruce

Clarke at NBFL. Wilson Associates and ACC would be collectively renamed

Staffing Strategists, Inc. The new company would be an executive search and

recruitment advisory business using the internet to give hiring organizations direct

access to target candidates.

[81] Mr. Wilson testified that his understanding was that he would be able to sell

the Knowledge House shares when Staffing Strategists needed cash for expansion.

According to Mr. Wilson, that’s not how things played out. Instead, when he

called Bruce Clarke to try and sell KHI shares, Mr. Clarke told him that he

shouldn’t sell, and should instead borrow against the shares to raise working

capital. Mr. Wilson testified that whenever the company found itself in need of

cash or subject to a margin call from National Bank, Mr. Potter and Mr. Clarke

would come up with a way to infuse some cash or bring the account back on side

without the sale of KHI shares. For example, in January 2001, when Staffing

Strategists needed cash, Mr. Potter and Mr. Clarke arranged for a transfer of

95,000 shares of Anitech Enterprises into the account from a relative of Dan Potter.

Page 23

Staffing Strategists then sold those shares for $1.05 per share. In March 2001, the

account received a margin call for $155,000. According to Mr. Wilson, either

Blois Colpitts or Dan Potter came up with an opportunity for the company to

acquire warrants from Ken MacLeod. The idea was that Staffing Strategists could

buy the warrants at a penny per share for $2,400, then execute them at $1.50 when

the stock was trading at around $5.40. In other words, Staffing Strategists was able

to acquire 240,000 shares at $1.51 per share while the market value was $5.40 per

share. This had the dual effect of bringing the account back on side while creating

an additional $100,000 of excess margin that the company could use to fund its

operations.

[82] Despite further attempts by Mr. Wilson and Laura Quartermain, Staffing

Strategists’ VP Finance, to sell KHI shares, there were no sales of KHI from the

account. Ms. Quartermain testified that Bruce Clarke was always willing to assist

when the request was to draw on the margin account, but he would not execute

orders to sell shares. She further testified that whenever the company needed cash,

Dan Potter and Blois Colpitts would come up with other options, including a short

term personal loan from Dan Potter’s wife, Fiona Imrie.

[83] Unable to sell before the price of KHI tanked in August 2001, Staffing

Strategists was left with a $776,000 debt to NBFL (50% of which belonged to Mr.

Potter) that ultimately doomed the company.

Trading volumes and share price for February 2000

[84] During February 2000, 348,069 KHI shares crossed the Exchange. Suspect

accounts purchased 63,000 shares. From February 2 to February 11, the Clarke

joint account and the Bruce E. Clarke account spent a combined $253,475

acquiring KHI shares. Accordingly, for the months of January and February 2000,

Bruce Clarke personally spent a staggering $431,755 acquiring KHI shares

(without accounting for commissions). In terms of the share price, the stock closed

on February 1 at $7.25, the highest price it would reach for that month. The price

dropped through the month and closed on February 29 at $6.60.

Loading the 540 account and the dot-com crash

[85] March 2000 was a particularly important month in the Crown’s case for two

reasons: KHI insiders loaded the 540 account with shares and cash so that it could

start trading in KHI, and the “tech bubble” burst.

Page 24

[86] As of December 31, the 540 account – a corporate account belonging to

Bruce Clarke – contained cash ($169.21) and securities (12,970.34) amounting to

$13,139.55 in value. It did not hold any KHI shares, but contained several stocks

ranging in value from a low of six cents to a high of $1.48. On March 3, 2000,

Dan Potter authorized the transfer of $100,000 to the 540 account from the NBFL

margin account of 2532230 Nova Scotia Limited (the “230 account”), a company

owned by Mr. Potter’s wife. Bruce Clarke was the investment advisor on the

account. Six days later, the 540 account received 220,000 shares of KHI as a

“loan” from Calvin Wadden. As a result of both transactions, the account’s equity

increased from just over $13,000 to more than $1.6 million. With KHI’s margin

requirement of 50%, the 540 account acquired $850,000 in loan-value-based

buying power and immediately started buying KHI stock.

[87] According to the Crown’s expert, Langley Evans, the 540 account was

clearly a nominee for the control group. He wrote, at para. 106 of his report:

Clarke’s status as a registered broker, combined with the receipt of assets from

KHI insiders and associates coincident with the start of heavy KHI trading

activity by the 540 account … lead me to the opinion that the 540 account was a

nominee for the Group. The activity in the 540 account in the following months

is also consistent with playing a nominee role in the Group’s trading. All these

factors surrounding the 540 account are indicators consistent with a manipulative

agenda. Clarke appears to be a fully knowledgeable and willing participant in the

Group’s agenda.

[88] Just as the 540 account was getting on its feet, the “tech bubble” burst.

Interest in technology stocks plummeted. The Court heard evidence that from

1995 until March 2000, investors were throwing money at anything and everything

related to technology or the internet. Venture capital for technology-related

companies was widely available, making financing relatively easy for untested

business models. A tech company could go public without a proven track record

of profitability and be rewarded with a high stock market valuation. These

valuations were not based on fundamentals like cash flow and profit record, but on

metrics like website traffic. Stock prices in the technology sector climbed and

climbed.

[89] This exuberant market lasted until March 2000, when the consensus

emerged that most of these companies had been significantly overvalued. Once the

market returned to more traditional ways of valuing stocks, the valuations for many

tech companies dropped and the market crashed. In other words, the bubble burst.

Page 25

Many of the same companies that had thrived in the earlier boom market failed

when their businesses proved unsustainable and they could no longer obtain

financing.

[90] From this point forward, the Crown says there was tremendous pressure on

KHI insiders to keep the stock price from plummeting like so many others had.

Trading volumes and share price for March 2000

[91] During March, 735,052 KHI shares crossed the Exchange. The stock traded

in the $6.00 to $7.00 range until March 23, when KHI released positive financial

results. The market reacted, driving up the share price. Trading volumes increased

significantly over the next eight days, with the price reaching a high of $9.85 on

March 29. On March 31, the stock closed at $8.40.

[92] Suspect accounts⁶spent $738,971 buying KHI stock in March. The 540

account alone spent over $500,000. In his report, Langley Evans described the

trading by the 540 account during March as “suspicious”. He explained at paras.

104-105:

The early trading by the 540 account is fortuitous. Between March 3 and March

24, the 540 account accumulates over 30,000 KHI shares at prices between $6.35

and $6.75. KHI released encouraging financial results on March 23. The market

responded favourably to these results and price for KHI shares increased

significantly. From March 28 to 31, the 540 account is a net seller of several

thousand shares at prices ranging from $7.35 to $8.75.

This trading is suspicious. Given that the trading immediately precedes the

favourable announcement of company profits combined with Clarke’s association

with insiders of KHI, the activity raised the prospect of illegal insider trading (i.e.

trading with knowledge of undisclosed material information.

Eric Richards joins BMO Nesbitt Burns

[93] In April 2000, Eric Richards, an investment advisor with Financial Concepts

Group, joined Bank of Montreal Nesbitt Burns. Several individuals from BMO

NB were called as witnesses in this trial. Bruno Falvo, a member of the Risk

Management Group at the relevant time, testified that he became aware of KHI in

⁶The 540 account, Sandra Clarke, Clarke joint account and Starr’s Point Capital.

Page 26

April 2000 when he learned that Mr. Richards, a new investment advisor, wanted

to bring in several heavily margined client accounts containing concentrated

holdings in KHI. These included the accounts of Calvin Wadden, Ray Courtney

and Steve Tsimiklis. Due to the size of the loans and the degree of concentration,

the accounts could not be transferred in without review and approval by the Risk

Management Committee.

[94] Mr. Falvo looked into KHI stock and reported to Charyl Galpin, Chief

Admin Officer and Chair of the Risk Management Committee, that the stock was

very illiquid, trading only 3,000-10,000 shares per day. Mr. Falvo testified that a

stock would not be considered liquid unless it was trading at least 100,000 shares

per day. He described KHI as “not very liquid at all.” After hearing from Mr.

Falvo, Charyl Galpin e-mailed Carole Cushing, Atlantic Divisional Manager, on

April 27, 2000 and indicated that due to the limited liquidity, BMO NB should

contemplate granting no loan value on KHI. Carole Cushing replied:

Please grant the margin as these are principals of the firm, slowly liquidating this

year to diversify. There is a good book behind these positions. If we have

problems going forward we can always discuss, but I think this is a case where we

should grant the margin while we get this business done.

[95] Although the Risk Management Committee decided not to accept the margin

loans, Carole Cushing successfully convinced Gilles Ouellette, head of the Private

Client Group, to accept the accounts on the basis that Mr. Wadden and Mr.

Courtney intended to sell 200,000 shares of KHI by the end of June 2000 and to

have liquidated a total of 500,000 shares each by the fall. The acceptance was

conditional, however, on elimination of the loans by the end of June.

Trading volumes and share price for April 2000

[96] The stock opened on April 3, 2000 at $8.55, the high price for the day, and

closed at $7.60. For most of the month, it traded between $7 and $8, but by April

25 had dropped back down in the $6.00-$7.00 range. On April 28, with significant

buying by the 540 account, the stock closed at $7.20.

[97] By the end of April, the effects of the tech crash were becoming apparent.

The number of shares crossing the Exchange was 290,775, a 60% drop from the

previous month. The 540 account was a heavy purchaser, spending over $1

million buying KHI shares. The Clarke joint account spent $5,086. Together,

Page 27

these accounts purchased just under half of the KHI shares that crossed the

Exchange.

Trouble in paradise and an investment on the horizon

[98] By May 2000, the Crown says, cracks were forming in the relationship

between Dan Potter and Calvin Wadden. E-mails suggest that Mr. Wadden

planned to leave KHI by June. On May 4, he e-mailed Mr. Potter about

“supporting the market” and expressed some irritation that he had not been

informed that the 220,000 shares he loaned to the 540 account were going to be

used as security to purchase over a million dollars’ worth of KHI shares. He also

stated:

As I told you and Ray in April I have committed to my partners to support the

company and not place pressure on the market but I fully expect that if

opportunities arise to sell stock we are the three people to be offered the sale first.

It has been my position for some time that I will need to sell stock by the end of

June. I am still working under these timelines.

[99] Dan Potter replied with a proposal that Messrs. Potter and Wadden, along

with Ray Courtney, would provide equal support to Bruce’s ‘orderly market’

account with 100,000 KHI shares each. Under this arrangement, Calvin Wadden

would get 120,000 of his 220,000 shares back. Mr. Potter indicated that Mr.

Courtney had already agreed to this idea.

[100] Adding to Dan Potter’s problems, Bernard Schelew, the founder of the

company, wanted to unload a million shares in KHI. He e-mailed Mr. Potter on

May 23, 2000, setting out a schedule of how he would like to sell his holdings.

Dan Potter forwarded the e-mail to Blois Colpitts with the message “fyi.”

[101] But it wasn’t all bad news for KHI. On May 24, 2000, Dan Potter e-mailed

Gerard McInnis and Blois Colpitts, informing them that “[a] German investor

group led by Mr. Michael (Ben) Barthe is interested in investing in a minimum of

500,000 treasury shares of KHI. His group is willing to make a long term

commitment to hold the stock, but wants a discount of 20% to the current market.”

The e-mail went on to discuss possible structures for the deal. A draft term sheet

was prepared, contemplating a $3.5 million investment by Mr. Barthe.

Trading volumes and share price for May 2000

Page 28

[102] Trading volumes in May dropped a further 65%, with only 104,805 KHI

shares crossing the Exchange. The 540 account was a constant buyer, spending

$285,149 to purchase 39.1% of the total shares traded. The share price remained

fairly stable with the stock trading between $6.50 and $7.25 before closing the

month at $6.90.

Calvin Wadden gets his 120,000 shares back – from Dan Potter

[103] On June 6, 2000, Dan Potter arranged for Calvin Wadden to get his 120,000

shares back from the 540 account. He e-mailed Bruce Clarke authorizing the

transfer of 120,000 shares from the account of 3020828 Nova Scotia Limited, an

account owned by Mr. Potter. Bruce Clarke followed up with a letter to Calvin

Wadden, copied to Dan Potter confirming that 120,000 of the 220,000 shares Mr.

Wadden loaned to the 540 account in March were being returned to him, and that

100,000 shares remained in the account.

[104] According to the Crown, the fact that Dan Potter used his own shares to

replace the shares that Mr. Wadden had loaned to the 540 account is clear evidence

that Mr. Potter controlled the 540 account and was aware of everything it was

doing.

Ben Barthe investment – market or treasury?

[105] At the same time, Gerard McInnis was discussing the excess of sellers (the

“seller overhang”) in the market with Dan Potter. In other words, there were more

sellers than buyers. On June 6, Mr. McInnis e-mailed Mr. Potter with the subject

“status of German Investor”, writing in part:

You indicated briefly that you think he went for the $7 shares, $10 warrants.

What is status?

Re from treasury or from market. I know you are in constant contact with Bruce.

My understanding is that there is big overhang in the market and moving some of

these shares out from market would be good. Are you not concerned with the

overhang or why would he (German) be opposed to some from market? I also

believe the cash inside the company is good too! I presume that is your concern.

[106] Dan Potter replied the next day:

Page 29

Still feeling positive about German investor group at 7 and 10 as offered. They

want treasury and I don't want to question that both for optical and cash in

company reasons.

The overhang in the market is significant but not that BIG! We are working on

that as well. …

[107] According to Mr. Potter’s reply, Ben Barthe wanted his investment to go to

the company’s treasury, where it could be used to fund operations, rather than

going into the pockets of other shareholders through a trade on the Exchange.

Steve Wilsack wants to sell

[108] By this point in June 2000, Steve Wilsack had decided to leave KHI and he

wanted to get his hands on the rest of his KHI share certificates. To that end, he

sent an e-mail to Gerard McInnis on June 6. Mr. McInnis tried to dissuade him

from selling until September, writing, “You have had sufficient shares released to

allow for proceeds to paydown the loans. Dan does not want to see any more

pressure on the stock (sell side) if possible until Sept. However if you need to sell

more to raise the needed cash we would ask you co-ordinate with Bruce Clark

[sic].” Mr. Wilsack was clearly unhappy with this response, writing on June 8:

On a related note, I will co-ordinate with Bruce as much as possible the sale of

shares to pay off this debt. As for the release of the rest of the stock, I may have to

sell some stock due to my present financial situation and a renovation project I

already started. At no time was there a mention of a condition about holding the

stock until September as part of my settlement. As of yesterday, this was the first

mention of this. I will also need funds for a source of income for the short time

period.

When I drop of [sic] the final amount of $141,475.50, (planning next week), I will

pick up the balance of my share certificates.

[109] At this point, Dan Potter stepped in, inviting Mr. Wilsack to come to his

home. On June 18, Mr. Wilsack wrote to Mr. Potter, suggesting he’d had a change

of heart:

Thanks for KHI update today. Your deck is quite relaxing too!! As always I

enjoyed our chat… Further to our conversation regarding my shares, I will set up

an account with Bruce this week. I plan to settle my outstanding balance with

KHI with a stock exchange. I will work with Bruce with any further liquidation

of stock until the end of September. At that time, I will have the option of

transferring my stock to another broker or continue on with Bruce. I will also

give further consideration to Deteck. All the best dan.”

Page 30

[110] The Match Trade Report shows sales by Steve Wilsack prior to his meeting

with Mr. Potter. From the date of the meeting until September, Mr. Wilsack did

not sell any more shares, despite his reported high need for cash.

[111] The Crown submits that the reason Dan Potter did not want anyone selling

until September is obvious: he was trying to keep the share price stable in

anticipation of the deal with Ben Barthe. To accomplish this, he needed to keep

sellers he knew about off the market, while inducing Bruce Clarke and other

insiders to buy up as many shares as possible from retail sellers that he could not

control.

The 540 runs out of buying power

[112] During the early days of June, Bruce Clarke, using the 540 account, was a

frequent purchaser of shares. But the account only had so much buying power.

According to the Crown, when the account was nearing its limit, Mr. Clarke

decided to use a client account to buy a substantial number of KHI shares without

that client’s knowledge and contrary to his instructions.

[113] In 2000, Lowell Weir was the President of Enervision, a public company

that had an investment account with Bruce Clarke. Mr. Weir testified that

Enervision typically had $600,000 to $700,000 invested in certificates of deposit or

GICs. During his direct examination, he explained that Bruce Clarke had

encouraged him to invest in public stocks. Mr. Weir agreed, but told Mr. Clarke

that he was only interested in liquid, blue chip stocks. The money in the account

was the company’s working capital and he could not afford any losses. Mr. Weir

testified that he was out of town during June, and when he returned, he learned that

Mr. Clarke had used the Enervision account to purchase $203,680 worth of KHI

shares. He testified that he told Mr. Clarke to stop buying KHI and when he later

tried to sell the shares, Mr. Clarke put him off. He did manage to sell some shares

in November 2000, when Mr. Clarke used another client account to purchase them.

On cross-examination, Mr. Weir clarified that he had understood that some KHI

shares would be purchased in June but that it was not going to be all KHI, and not

in the numbers purchased.

[114] Mr. Potter’s wife’s account, the 230 account, was also a heavy purchaser in

June 2000. According to the Crown’s theory, with the 540 account near its margin

limits, the 230 account entered the market and became the primary purchaser for

the group. From June 14 to June 29, the 230 account spent $212,355 acquiring

shares.

Page 31

Trading volumes and share price for June 2000

[115] During the month of June, 157,200 shares crossed the Exchange. Suspect

accounts⁷purchased 57.7% of the total shares. Together with the Enervision

purchases, the total spent was $611,480. In terms of the share price, the stock

closed on June 1 at $6.70. In the weeks that followed, it traded between $6.40 and

$7.50, closing at $6.95 on June 30, 2000.

[116] Despite the BMO NB deadline of June 30 to clear the margin loans on the

accounts of Calvin Wadden and Ray Courtney, neither sold any shares during the

month of June. The Crown says this is because Shirley Locke and Eric Richards

were working with the defendants to avoid putting sell-side pressure on the stock.

BMO NB continues to push for margin loans to be paid off

[117] In early July, Risk Management at BMO NB was still pushing to have

Calvin Wadden and Ray Courtney clear their margin debts of $2.3 million. Carole

Cushing managed to hold them off with assurances that the clients planned to

deposit $1 million which would reduce the loan to $1.3 million. She asked for a

one-month extension to pay off the rest. According to Ms. Cushing, the $1 million

was going to come from KHI, and the company would decide during the following

week’s Board meeting whether it would put the money directly into the accounts or

set up a guarantor account with $1 million. She said the clients and company were

aware that a failure to provide the funds would result in a margin call. Charyl

Galpin told Gilles Ouellette that she could support it “as long as we agree that after

July 31st there will be no more extensions.” Gilles Ouellette agreed.

[118] In the weeks that followed, Carole Cushing, Eric Richards and Shirley

Locke exchanged e-mails about the situation, with Ms. Locke advocating on behalf

of Mr. Wadden and Mr. Courtney. On July 10, she wrote the following to Carole

Cushing:

I actually believe that allowing no margin on this is actually not very fair as well.

I think that they should at least allow something. This doesn't mean we don't

follow the second route of having the third party but I can well understand why

the client would feel a bit hard done by.

The $1 million deposit by KHI never materialized.

⁷Clarke joint account, 540 account, Blois Colpitts, Enervision and 230 account.

Page 32

Craig Dunham wants to sell

[119] According to a series of e-mails sent in July, an agreement had previously

been reached between Craig Dunham and KHI that if he decided to leave the

company, all of his shares would be delivered to him by June 30, 2000, rather than

released from escrow in stages over a five-year period. On July 28, 2000, Mr.

Dunham contacted Blois Colpitts and explained that he had been trying to get his

shares handed over since June 30, and that he had planned his new home

construction around the shares being delivered at that time. The Crown says that

the reason for the delay in getting Mr. Dunham his shares was that the defendants

did not want him to start selling before the Barthe deal closed.

Calvin Wadden goes “off the rails”, retains a lawyer

[120] In July 2000, the relationship between Calvin Wadden and KHI imploded.

Harold Greenwood, a former employee of KHI and a friend of Mr. Wadden,

testified that at some point, likely in June 2000, Mr. Wadden told him he wanted to

divest his shares and sever his relationship with KHI. Mr. Wadden told him he

was becoming frustrated with the direction of the company and with his inability to

sell the stock. Mr. Wadden asked Mr. Greenwood to help him, as a friend, to

approach Dan Potter about what could be done to sell his shares. When asked

whether he told Mr. Wadden to simply go to the market and put in an order to sell,

Mr. Greenwood said they discussed it but Mr. Wadden said he was experiencing

some difficulty having his orders executed.

[121] Hal Greenwood testified that one of the first things they did was contact Mr.

Potter to see if he could help them understand why there was a problem with

selling shares. He said there were a number of discussions with Mr. Potter as to

what could and could not be done with the shares and that at one point, Mr. Potter

told him that all he had to do to stop Calvin Wadden from selling was to make the

right phone calls. According to Mr. Greenwood, he and Mr. Wadden eventually

decided to hire a lawyer. Dan Potter did not cross-examine Mr. Greenwood on his

evidence.

[122] On July 17, Brian MacLellan, a lawyer at Merrick Holm, e-mailed Calvin

Wadden confirming his retainer and instructions to enter an agreement to sell Mr.

Wadden’s KHI shares on the TSX. Mr. MacLellan e-mailed Blois Colpitts the

same day and the two lawyers began drafting term sheets for the purchase of Mr.

Wadden’s shares. As the term sheets evolved, the purchaser was identified as

Starr’s Point Capital Incorporated, a holding company owned by Dan Potter. The

Page 33

term sheet also contemplated the return to Calvin Wadden of the 100,000 shares he

had loaned to Bruce Clarke’s 540 account. On July 20, 2000, Mr. MacLellan

wrote to Bruce Clarke at NBFL requesting the return of the 100,000 shares. He

noted that Calvin Wadden had made similar requests on July 14 and July 17.

[123] While Mr. MacLellan was negotiating with Mr. Colpitts, he received a letter

from Michael Meredith, counsel for BMO NB, informing him that BMO NB was

not willing to extend the liquidation deadline beyond July 31, 2000 and would

commence liquidation of Calvin Wadden’s KHI holdings on August 1, 2000.

Bruce Clarke starts buying with the Union account

[124] In July 2000, Bruce Clarke purchased KHI shares with an account associated

with the Local 83 and 1392 Welfare Plan Trust Fund (the “Union account”).

Locals 83 and 1392 were two Nova Scotia unions affiliated with the United

Brotherhood of Carpenters and Joiners of America. The revenue generated from

the investment account was used to provide benefits to union members. Bruce

Clarke had been the investment advisor for the Union account since the 1980s.

[125] The Union account was a discretionary trading account subject to a

statement of investment policies that was reviewed and approved by the Board of

Trustees. The Court heard evidence that the Board had approved a portfolio

consisting of 10% cash, 30% equities and 60% fixed income, and that the

investment advisor for the account would be expected to take positions in

Canadian securities that would provide a reasonable return with only a moderate

risk. Allan Rodgers, former Trustee for the Local 83 and 1392 Welfare Plan Trust

Fund, testified that the Board of Trustees would not have allowed Mr. Clarke to

purchase speculative education technology stocks. Langley Evans discussed the

Union account trading in his report at para. 113:

The Union Local 73 and 1392 Carpenters Welfare Plan had a brokerage account

with NBFL (the Union account) for several years. Clarke was the broker for this

account and discretionary control over the account. This client appears to have

relied entirely on Clarke’s advice. This client account fits the profile of an

account that could be used to “park” stock.

[126] From July 24 to July 26, Bruce Clarke used the Union account to purchase

$30,335 worth of KHI stock.

Negotiations with Derek Banks

Page 34

[127] While all of this was going on, a potential solution to the Calvin Wadden

and Ray Courtney margin loan problem emerged in the form of an investor named

Derek Banks. Mr. Banks was the owner of a company called Plastics Maritime

that he sold in 1997, after which he became a client of Shirley Locke.

[128] After selling his business, Derek Banks did some of his own investing. He

testified that he first came into contact with Shirley Locke in 1998, not long after

he sold his business. She recommended that he invest in the KHLP, which he did

on December 1, 1999. About six months later, he heard from Shirley Locke again

in relation to a potential investment opportunity. Ms. Locke told him that there

were two employee investors at KHI who were having financial problems. She

said these individuals, Ray Courtney and Calvin Wadden, had sold their businesses

to KHI and then spent too much money, taking out margin loans with BMO that

were now being called. He explained that the suggested investment was a $2

million loan with interest, plus a fee in the form of KHI shares.

[129] After speaking to Shirley Locke, Derek Banks was contacted by Blois

Colpitts. They discussed the investment and Mr. Banks then conducted his own

research into the company. After determining that BMO would not accept KHI as

security, Mr. Banks told Mr. Colpitts that he was not interested in the deal. Shirley

Locke called him again soon with another alternative -- purchasing $2 million

worth of shares directly from Calvin Wadden and Ray Courtney. Mr. Banks said

he was not interested in spending that much, but that he might consider $1 million.

He then contacted Mr. Colpitts again.

[130] Following several meetings with Dan Potter, Gerard McInnis and Jack

Sullivan, Mr. Banks agreed, in negotiations with Blois Colpitts, to purchase $1

million worth of shares from Ray Courtney and Calvin Wadden with an option⁸to

purchase more shares from them if he wished. Mr. Banks further testified that

Shirley Locke was very involved in the negotiations, constantly asking how things

were going and encouraging him to make the investment.

Trading volumes and share price for June 2000

⁸Options give the optionee the right, but not the obligation, to purchase shares at a particular price within a particular

time frame.

Page 35

[131] In July 2000, 98,075 KHI shares crossed the Exchange. Suspect accounts⁹

were active purchasers, spending over $300,000. From early July until the end of

the month, the stock price ranged from $6.30 to $6.90, frequently trading between

$6.60 and $6.75. On July 31, the 540 account and the Clarke joint account bought

every share on the market and trading closed at $6.70.

The Banks transaction goes ahead, with one change

[132] Derek Banks testified that right up until he made his purchase, he understood

that he would be buying his shares from Calvin Wadden and Ray Courtney in a

private sale. On the day of the closing, however, he spoke with Blois Colpitts who

told him that the deal would instead be done on the Exchange through BMO NB

and that the shares would be coming from Dan Potter’s pension fund. When Mr.

Banks asked why, he was told that it would be easier for Dan Potter to resolve Mr.

Wadden’s and Mr. Courtney’s financial problems.

[133] The Sales Terms prepared for the deal indicated that on August 3, 2000,

Plastics Maritime Limited would purchase 156,250 common shares of KHI at a

price of $6.40 per share, for a total of $1 million. Mr. Banks would also be entitled

to options on 210,000 common shares at an exercise price of $3.50.

[134] In the days leading up to the Banks transaction, the 540 account was a very

active buyer. On July 31, the 540 and the Clarke joint account bought every share

that was sold. On August 1, the 540 and the Clarke joint account were the only

purchasers, other than the market maker¹⁰who picked up an odd lot of 105 shares.

On August 2, the 540 bought 3,700 out of 5,700 shares. The Crown says this

buying activity was intended to keep the price up before the deal closed. The

Banks transaction took place on August 3, with Mr. Banks, through his Plastics

Maritime account, purchasing 156,250 shares of KHI from Dan Potter’s RRSP.

Dan Potter goes on a buying spree

[135] With $1 million from Derek Banks, Dan Potter went on a spending spree

buying up KHI shares. From August 4 to August 18, he purchased 143,800 shares

of KHI. Many of these purchases were from suspect accounts. Mr. Potter also

⁹Clarke joint account, 540 account, 230 account, Meg Research, Union account and FutureEd.com.

¹⁰The “market maker” is a concept that will be discussed in greater detail later. For now, it will suffice to say that

the market maker is an individual appointed and regulated by the Toronto Stock Exchange who is responsible for

supporting an orderly market for the stock.

Page 36

purchased several thousand shares from the BMO NB Error Account run by Bruce

Ewing, the trader assigned to liquidate the Wadden/Courtney shares. Almost all of

Mr. Potter’s purchases were at prices higher than the $6.40 paid by Mr. Banks,

with the highest price being $6.75 per share. Langley Evans said the following at

paras. 128 and 129 of his report about Dan Potter’s purchases during this period:

The transactions from August 4 to 18 show a very high level of coordination in

trading among the Group accounts. The Potter RSP redistributes the $1 million

proceeds received from the Banks transaction by making market purchases of

KHI shares from other Group accounts including:

•

$300,000 from Courtney

$50,000 from Wadden

$168,000 from the 540 account

$100,000 from Colpitts

The Group accounts eventually benefit from about two-thirds of the proceeds

from Banks purchases. The money received by the 540 account and Colpitts

accounts is timely because both are at or near their margin limits at the time of

these transactions. The rest of proceeds are used by Potter’s RSP account to

support the KHI market. The transactions among the Group accounts have the

appearance of pre-arranged trading, and give a misleading appearance as to the

strength of the market during this period.

Barthe term sheet is executed

[136] A term sheet dated August 4, 2000 was signed by both Dan Potter and Ben

Barthe. Mr. Barthe agreed to purchase 250,000 common shares of KHI from Dan

Potter or his designates on the TSX at a price of $6.80 per share, and would receive

options on 150,000 common shares at $4.00 per share, for a total purchase price of

$1.7 million. The trade date to be “no later than August 31, 2000.” This was a

significant change from the treasury purchase that Ben Barthe had initially

requested. Diverting this investment to the market meant that the $1.7 million

would go to Mr. Potter and not into the company to fund its operations.

Blois Colpitts drafts a letter for the 540 account

[137] Having received no response from Bruce Clarke to his earlier inquiry, Brian

MacLellan sent a letter on August 2, 2000, to Eric Hicks, the Branch Manager of

the NBFL’s Halifax branch, in relation to the return of Mr. Wadden’s 100,000

shares. Mr. MacLellan testified that two days later he spoke with Blois Colpitts

Page 37

who told him that National Bank had referred the issue to its legal counsel, who

would respond. Also on August 4, Blois Colpitts sent an e-mail with the subject

“2317540 Nova Scotia Limited” to Bruce Clarke, copied to Dan Potter:

here is the letter to send this morning:

2317540 Nova Scotia Limited

August 4, 2000

…

Mr. Brian MacLellan, Q.C.

…

Dear Mr. MacLellan,

RE: Calvin Wadden – Knowledge House Inc. – 100,000 Common Share

Certificate

Further to your letter of July 20, 2000 to Bruce Clarke and August 3, 2000 to Eric

Hicks at National Bank Financial Inc., we are writing by way of response.

We had not responded earlier as 2317540 Nova Scotia Limited had understood

that you were in discussions for your client which may have led to substituted

security being generated.

As you may be aware the certificate reference in your letter was deposited by your

client as security for the margin account of 2317540 Nova Scotia Limited to

facilitate market purchasing for the account of 2317540 Nova Scotia Limited.

This certificate is not connected to your clients’ margin account at National Bank

Financial Inc. and it can only be released when the account can be liquidated or

when substitute security is provided.

This was a private transaction between 2317540 Nova Scotia Limited and is not

connected to his dealings with National Bank Financial Inc.

Yours truly,

2317450 NOVA SCOTIA LIMITED

BY: Bruce Clarke, President

BC/cc: Eric Hicks, National Bank Financial Inc.

Page 38

Bruce Clarke sent an identical letter to Brian MacLellan later that day.

[138] Brian MacLellan was shown the e-mail from Blois Colpitts to Bruce Clarke

while he was on the stand. He testified that he was not aware that the letter he

received was prepared by Mr. Colpitts, not Mr. Clarke.

Ken MacLeod starts to buy

[139] In August 2000, Ken MacLeod opened a margin account with NBFL called

FutureEd.com. On August 17, he e-mailed Bruce Clarke, authorizing him to

purchase up to 40,000 shares of KHI “[t]o give you a bit of breathing room on

damage control.” He e-mailed Clarke again the next day, authorizing another

20,000 to 25,000 shares. From August 17 to August 23, the FutureEd.com account

bought 64,000 shares at a cost of $410,710.

[140] The Crown says the timing Mr. MacLeod’s buying was deliberate. With the

Barthe investment deal soon to close and Dan Potter’s $1 million almost

exhausted, Mr. MacLeod had to take over buying for the group in order to keep the

price up.

High closing pattern begins

[141] On Friday, August 18, at 15:58:41, less than two minutes before trading

closed, Dan Potter bought shares from AI Enterprises, a company belonging to

Bernard Schelew’s brother and father. This trade raised the share price from $6.30

to $6.40, where it closed. The next trading day, August 21, FutureEd.com

purchased shares at 15:44:25 that raised the price from $6.35 to $6.50, where it

closed. On August 22, at 15:58:40, less than two minutes before the end of

trading, FutureEd.com bought shares from AI Enterprises that raised the share

price from $6.30 to $6.50, where it closed. Finally, on August 23, at 15:58:50,

Bruce Clarke bought 10,000 shares from AI Enterprises, raising the share price

from $6.25 to $6.45, where it closed. The Crown says these transactions were no

coincidence. Langley Evans wrote at paras. 131 and 132 of his report:

High-closing transactions by Group accounts become a pattern with occurrences

on August 18, 21, 22 and 23. These high close transactions occur in four

consecutive trading sessions and coincide with final discussions with Barthe on

his eventual market purchases. I am of the opinion that these high closes were not

a coincidence, and these trades appear to be deliberately setting the stage for the

large purchases that follow.

Page 39

In my opinion, the market price of KHI shares would have been significantly

lower by August 25, 2000 without the intervention of Group in KHI market

during this period. … This activity contributed to an artificially high price for

KHI and a misleading appearance of the strength of the market for KHI shares.

Absent this activity, in my opinion, the KHI trading price would have been

significantly lower.

Fiona Imrie’s account helps Clarke buy during the blackout period and Barthe

purchases begin

[142] From August 18 to August 25, 2000, KHI insiders were in possession of not-

yet-public information about the company and were in a blackout period.

According to the Crown’s theory, with KHI insiders unable to trade and the 540

account near its margin limits, the defendants had to find a way to keep buying the

stock. Their solution involved a series of transactions between Bruce Clarke’s

personal account and the account of Fiona Imrie, Dan Potter’s wife. First, a

Province of Nova Scotia bond was sold out of Ms. Imrie’s RRSP account,

generating $223,920. Those funds were used to buy a block of 204,000 Anitech

shares for $1.40 per share from Bruce Clarke. Mr. Clarke then used the cash from

the Anitech sale ($282,743.40) to go on a KHI buying spree, spending $283,360

between August 23 and August 28, the day before the Barthe investment.

[143] Although the term sheet contemplated a purchase by Ben Barthe of 250,000

common shares from Dan Potter at $6.80 per share, that is not what happened.

Instead, Mr. Barthe’s money was used to buy shares from many different sellers on

the TSX from August 29 to September 7. Over 85% of the proceeds were directed

to accounts belonging to alleged unindicted co-conspirators like Ray Courtney,

Steve Wilsack and Craig Dunham, who, according to the Crown, were being

rewarded by Dan Potter for having complied with his instructions to wait until the

fall to sell stock.

[144] Blois Colpitts sold 73,300 shares to Mr. Barthe, but not before purchasing

43,300 from Mr. Clarke. The Crown points out that Bruce Clarke could not sell

directly to Mr. Barthe without obtaining his consent (due to Clarke’s position as a

pro trader), so he sold instead to Mr. Colpitts, who could then sell to Mr. Barthe.

This sale to Mr. Colpitts generated cash that Mr. Clarke then used to buy back the

Page 40

204,000 Anitech shares from Fiona Imrie’s account for $287,640, resulting in a

profit to her account of several thousand dollars.

[145] Also included among the lucky participants in the Barthe deal was Calvin

Wadden, who had reconciled with Dan Potter on or around August 24. On August

29, Mr. Wadden’s wife’s account sold 27,600 shares to Ben Barthe at $6.55 per

share ($180,780). The next day, Bruce Clarke finally returned the remaining

100,000 shares that Mr. Wadden had loaned to the 540 account in March, despite

having refused to return them only weeks earlier when contacted by Mr. Wadden’s

counsel. The 100,000 shares were actually transferred from the account of Ken

MacLeod.

[146] Langley Evans commented on the significance of the change from treasury

to market purchases at para. 139 of his report:

I find it significant that the Potter-led negotiations with Barthe and others directed

the purchases to the marketplace where the Group accounts directly benefited

from the proceeds. It would have been entirely feasible for these monies to be

directed to a private placement of KHI treasury shares, where KHI could have

used the funds to run the company. The choice of directing new investment

towards market trading and price support instead of financing KHI was later

acknowledged by Potter as a mistake in his January 15, 2001 memo to the KHI

board.

Trading volumes and share price for August 2000

[147] The stock closed on August 1 at $6.60. For the rest of the month, the stock

traded in the range of $6.00 to $6.80, closing on August 31 at $6.65. In total,

718,811 shares crossed the Exchange in August. After removing 465,250 shares

representing large prearranged transactions rather than true retail trade, the total

volume of shares was 253,561. Of that, the suspect accounts purchased 221,500

(87.4%), spending over $1.4 million. Out of 22 trade days, suspect accounts were

involved in five alleged high closes.

David Fountain invests

[148] David Fountain is a private investor and well-known Halifax philanthropist.

In the summer of 2000, he decided to invest in KHI through a purchase on the open

market. Mr. Fountain testified that he contacted his broker, Tom Purves, and told

him he wanted to invest a specific dollar amount. On September 7, 2000, Mr.

Page 41

Fountain’s investment company, Longwood Investments, purchased 300,000

shares – 150,000 from the 540 account and 150,000 from Knowledge House New,

at $6.65 per share, for a total investment of just under $2 million. Mr. Fountain

testified that he did not know who he was purchasing the stock from, he simply

had his broker place the order on the market.

Trade volumes and share price for September 2000

[149] During the month of September 2000, 531,516 KHI shares crossed the

Exchange. With the 540 account reducing its margin loan by more than $900,000

through the Fountain sale, it re-entered the market as a heavy purchaser, spending

$462,030. Despite pressure from BMO NB to clear his margin loans, Calvin

Wadden bought 10,000 shares at $6.40 per share. The Union account spent

$37,866.

[150] Also during September, suspect accounts were involved in alleged high

closes on eight out of 20 days (40%). The Crown says these high closes were

intended to keep the stock price up while Dan Potter was negotiating a $3.25

million private placement by Ben Barthe and his friend, Dr. Lutz Ristow.

The Barthe/Ristow deal takes shape and Dr. Schelew wants to sell

[151] On October 22, 2000, Dan Potter e-mailed Gerard McInnis and others,

copied to Blois Colpitts and Jack Sullivan, setting out the terms for a private

placement of common shares from treasury agreed to by Dr. Lutz Ristow and Ben

Barthe. The e-mail indicated that Dr. Ristow and Mr. Barthe agreed to purchase

500,000 common shares from treasury at $6.50 per share ($3.25 million). They

would also receive a warrant on 500,000 additional shares at $6.50 per share.

Payment would be made in four installments of $812,500 occurring on November

15, 2000, February 15, 2001, May 15, 2001, and August 15, 2001. Potter further

indicated:

Although it wasn't absolutely confirmed, the clear understanding was the [sic]

Lutz/Barthe would open an account with Bruce Clarke at NBF in which to

purchase and hold the shares.

Page 42

[152] Dr. Lutz Ristow testified that when he and Mr. Barthe first met with Dan

Potter, Mr. Potter wanted them to buy existing shares, but Dr. Ristow refused. He

explained that he only invests in treasury shares so that his money goes to the

company, rather than into the pockets of existing shareholders.

[153] With negotiations ongoing with the Germans, Bernard Schelew e-mailed

Dan Potter, Gerard McInnis, Blois Colpitts, David Mack, and Bruce Clarke on

October 28, 2000 with the subject, “Share Liquidation Strategy+Plan”. In the e-

mail, Dr. Schelew explained that he had decided to personally finance Handsmiths,

his new company, and, to that end, he intended to sell over 1.3 million KHI shares.

He said he would sell the shares in a block at $6.00 per share and would actively

seek private and institutional investors. He attached a letter he intended to send to

institutional investors advising of his desire to sell. Dr. Schelew added that from

November 2000 to March 2001, he intended to sell 10,000 shares per week, “so

long as it does not put too much downward pressure on the stock.”

[154] Dan Potter responded on October 30 indicating that he and Dr. Schelew had

spoken that day and had agreed that KHI management would take on the job of

finding a buyer for Schelew’s shares rather than him sending out a letter.

Trading volumes and share price for October 2000

[155] During October 2000, 147,921 KHI shares crossed the Exchange. The 540

account, the only suspect account buying, was very active, spending $641,447 to

purchase 63.4% of the total shares traded. The stock opened on October 2 at

$6.70 and closed at $7.00. For the rest of the month, the stock traded between

$6.50 (the price offered to the German investors) and $7.10.

[156] With the Barthe/Ristow deal set to close in November, the high closing

pattern increased in October. On 12 out of 21 trading days (57%), suspect

accounts were involved in alleged high closes.

Pressure from all sides

[157] November 2000 was a very busy month for KHI. On November 5, Gerard

McInnis e-mailed Dan Potter about a number of finance-related matters, with the

subject “Wise Counsel required”. In the e-mail, Mr. McInnis queried whether the

German investors should be offered options with their shares instead of warrants in

order to address the seller overhang. He also pointed out that Blois Colpitts was

concerned about the optics of using warrants as incentives on the treasury deal,

Page 43

writing, “concern is that need for the warrants indicates current trading price is too

high.”

[158] At this point in late 2000, a deal was in the works wherein McKenzie

College would acquire CD-Ed from KHI while KHI acquired shares in McKenzie

College. Gerard McInnis wrote, in part:

Blois says "he will not approve" the deal as contemplated. Thinks if we give them

KHI shares … the shares will need to be escrowed. This was not contemplated in

the agreement we made with McK when they approved the deal. I understand the

problem of having KHI shares come to market as we need to eat them.

[159] On November 13, 2000, Bruce Clarke e-mailed Dan Potter to advise that his

accounts at NBFL had gone under margin by $20,000 and they needed to talk

about it before head office called Mr. Clarke the next morning. At this point, even

small fluctuations in the stock price had significant consequences for Dan Potter

and others holding large concentrations of KHI. To avoid a margin call, Dan

Potter sold several bonds from his account the next morning.

[160] Adding to his problems, Dan Potter received an e-mail from Calvin Wadden

informing him that Steve Tsimiklis, a KHI shareholder, “would like to have some

type of proposal for liquidity.” Mr. Potter indicated that there was no liquidity

solution at the moment, adding:

As you know, we are closing on a $3,250,000 treasury issue to our German

friends- we are hoping to get this completed (closed) on Mon. or Tues. (Nov. 20

or 21). The price of this issue is $6.50 per share. If the market is driven down in

advance of this issue it is quite likely that the investors will not close. This would

be most harmful for the company and all of its shareholders, including Steve.

Hopefully, he can be convinced to proceed with care, prudence and caution.

[161] One week later, having gotten no traction with his earlier e-mail advising of

his intention to sell 10,000 shares per week, Bernard Schelew wrote to David Mack

and Bruce Clarke, with a copy to Dan Potter:

During the month of November, I note that 161,800 shares of KHI have been sold

for a total transactional value of $1,061,105. I also note that during the month of

November, 0 shares of my KHI have been sold.

…

Starting Monday, November 27th, I instruct you to sell 10,000 shares/week from

my non-RRSP account. You can arrange this sale anyway you see fit during the

Page 44

week. I must also tell you that there will be no leaway [sic] given with these

instructions. If you get behind by 1 week, I will have no choice but to move the

shares to another brokerage house.

Sorry about this but that’s the way it is. My situation is getting very tight.

The same day, Dan Potter forwarded Dr. Schelew’s e-mail to Blois Colpitts, and

wrote, “We need to talk about this! Unbelievable!”

[162] On November 24, Dr. Schelew e-mailed Mr. Potter, attaching a spreadsheet

detailing all KHI sales from January 1 onward. He wrote, “Of the $33 million KHI

share $ value transacted, could you tell me the $ value of shares sold by insiders,

i.e., Calvin, Ray, Ken, Donnie?”

[163] The Crown says that in the e-mails that follow, Dan Potter “pulled back the

curtain” on the conspiracy and revealed to Schelew that, contrary to what the

trading volumes suggest, there was no retail demand for the stock. The market

activity wasn’t real; it was a product of the conspirators’ efforts. The Crown

argues that this Court could find a conspiracy on the basis of these e-mails alone.

[164] The first e-mail was sent by Dan Potter to Dr. Schelew on November 24,

2000, with a copy to David Mack. He set out all of the purchases and sales by KHI

insiders since January 11, 2000, noting that only Donnie Snow had been a net

seller. He then advised Dr. Schelew:

In my opinion you should either be buying or supporting the buying of shares in

the coming week and beyond. If you insist on selling shares (without having the

buy-side arranged) as you have previously indicated, then I'd say all of our good

work in attracting investors over the last several months may well prove to have

been in vain. Now, more than ever, we need to work co-operatively to protect the

interests of KHI shareholders, including you and the people you have brought into

the company over the years. In this regard, I should add that Steve T warned us

that he has to sell 50,000 shares by Dec. 1.

I want to also say that I fully appreciate the pressure you are under to support and

fund Handsmiths - I sincerely feel your pain in this area.

I hope common sense and enlightened self-interest prevails.

[165] Bernard Schelew responded on the same day, noting that according to Mr.

Potter’s numbers, the net value of KHI shares bought by insiders or long-term

investors was approximately $12 million. He asked, “Is it correct to say that this

$12,000,000 was used to support the stock from unknown street sellers?” Before

Dan Potter could respond, Dr. Schelew e-mailed him again. He expressed his

Page 45

belief that KHI was “fundamentally strong” and would “prove its business model

over the next 12 months.” He wrote that “the selling pressure on the stock was

temporary” and that Mr. Potter had “done a super job of eliminating this downward

pressure.” He pointed out that Mr. Potter had been aware of his interest to sell

since the summer, but that none of his shares had been sold, with Mr. Potter telling

him to take his turn in the queue and that “the squeaky wheel gets the grease” and

so on. Dr. Schelew went on to note:

4. Although Handsmiths has a much less certain future than Knowledge House, I

am prepared to bridge finance the company (to the tune of $2 million) thinking

that by the second or third quarter I can bring outside investors in. The cash I need

is for survival. I believe in my story enough to back it.

5. Although Knowledge House has a much more certain future, you have

indicated to me that my 10,000 shares/week will be the straw the [sic] breaks the

camel's back and the stock could fall dramatically. This indicates to me that,

although the board and management fully believe that the situation is temporary,

further investment in KHI to support the stock (we're not talking survival here) is

too risky for them. Fair enough. It is too risky for me! Everyone has their limits.

…

So lets continue with the plan to sell 10,000 shares/week as outlined. I'll continue

to work with you to incent the sale of a large block.

[166] Dan Potter responded on November 25, with a copy to David Mack and

Bruce Clarke, writing in part:

Your analysis that leads you to the conclusion that you or any other major, non-

retail KHI shareholder can achieve liquidity next week in [sic] completely wrong-

there is NO WAY that can happen. You have seen the stock trade down to $6.00

in the last several sessions. There is at least 30,000 shares of pressure on the

market as of Friday PM, not including Steve T's 50,000 to come next week. You

will ABSOLUTELY FOR SURE CRASH THE STOCK IF YOU ACT ON

YOUR FLAWED ANALYSIS -ABSOLUTELY FOR SURE! "Management and

directors" cannot and will not be magically buying. You need to understand and

believe this fundamental truth -there currently is no buying power in the KHI

network. There can be again, if we are given the chance and support to go out a

find more investors - but there is none now!

As I mentioned to you before by telephone, it is most unfortunate that you have

seen fit to include Bruce Clarke [sic] your communications re liquidity. It only

serves to put more pressure of [sic] him - a person who has undertaken huge

personal risks to invest in the company. It is grossly unfair to him, grossly unfair

and I must say it is very upsetting to me to see you continue to include him in this

dialogue.

Page 46

I'm sure that it's somewhat true that "desperate people do desperate things". But I

[sic] will be a sad irony if, in your desperation, to support Handsmiths, you, in

fact, destroy the real source of your own financial well-being- your KHI shares!

I'll continue to do my best to run the company in the interests of all shareholders

as long as I have the support of the "founding" shareholders with the biggest

stakes, but, if and when that cracks, all bets are off.

I'm going to send an email (by noon tomorrow- Sunday) outlining the situation

and my recommended action to each of the major shareholders with "founders

shares" -you, Calvin, Ray and Ken with a recommended joint plan for cooperative

action to support and protect the KHI stock over the coming weeks while we are

bringing in more new investors. I strongly recommend that you keep an open

mind to my recommended plan of action.

If the major shareholders who have liquidity needs don't realize that this is not the

moment for demanding liquidity, but rather the moment for coming to the aid of

the company, then tens of millions of dollars in shareholder value will, I'm sure,

be lost, including the value of each of such major shareholders. If cool heads

prevail, we'll have future liquidity events for all- if there is no co-operation and

concerted supportive action now, there will be no such future events.

All of which is put to you with the utmost respect and in what I sincerely regard

to be your own interests.

[167] Blois Colpitts, who had obviously received a copy of the e-mails, was

irritated by a comment from Dr. Schelew that Colpitts had netted out $50,000. He

wrote to Dan Potter on November 26:

Can you make sure that Bernie understands that my sales (aside from the

$150,000 swap for Solutioninc) was relieving the margin pressure incurred in (i)

exercising options to put money into the company- $250,000; and (ii) buying

shares on margin to support the market- nearly $800,000 in total.

He should also understand that some of the trades he totals included moving KHI

shares into my wife's RRSP, kid's RESPs and my mother's RRSP to relieve some

of the margin pressure. It is still there as you know.

He should also understand that sales made were in conjunction with Barthe,

Banks (not Fountain) that I spent the whole summer working on - to the exclusion

of any vacation with the kids.

Geesh

He wrote again that day, “I also forgot my $200,000 of LP units – he wouldn’t

even participate.”

The best of times, worst of times

Page 47

[168] On November 26, Dan Potter made good on his statement to Dr. Schelew

and prepared an e-mail outlining his recommended plan of joint action. He sent

the following e-mail to Ray Courtney, Ken MacLeod, Calvin Wadden and Bernard

Schelew, with the subject, “Major Shareholder Co-operation and Help needed to

Support KHI”. Due to the importance of this e-mail to the Crown’s case, it is

reproduced in full below:

I am putting the situation below to the 4 of you because together the 5 of us

represent the major "founding" shareholders of KHI. I am not including those

who have purchased major blocks over the past several months for the simple

reason that they bought as investors and do not expect to be leaned on for every

need of the company. To do this would only alienate them at this time.

THE CURRENT SITUATION

It [sic] the best of times and the worst of times.

The best of times, because the company is entering a phase in its development and

growth where substantial, high potential and valuable products are being brought

to market: the GB, the KEY Certification program, Smarter Teams, Leadership

Online, etc. With any luck at all, by the end of Q1 2001, we can expect most of

these to have been bought in significant ways in corporate, education and

government markets.

The worst of times, because notwithstanding our success in bringing over $9

million in new investment to the company (about $4.5 million to each of the

market and the treasury) since July – the most [sic] one of the most difficult stock

market environments for small cap companies in over 10 years, the current retail

market for KHI shares (like most other small caps) is almost non-existent. We

have to go out and work hard every day just to generate enough demand to meet

retail sellers. In fact, our sources of buying currently are exhausted. We need

some more new investment.

We have good potential - one fellow, Doug Rudolph, an accountant and financial

advisor, who Ray brought to the table, believes he can place between 200,000 and

300,000 shares over the next 2 to 3 months. He needs an option incentive program

to do this on our behalf. Also, a friend of mine who just sold his stake in his

education company in Atlanta for $35 million US is coming to CCEM this week

to talk about a deal to become involved in KHI. Further, our Canaccord friend,

Ron Sedran, is coming to Hfx this week as well to see us - as the market improves

and we get our products out over the next couple of months, will be in a good

position to be able to access Bay St. involvement and support as well.

In the meantime, however, there is significant pressure on the market. As you

have seen there has been increasing retail selling over the last couple of weeks.

This is [sic] driven the price down and has exhausted buying support. Bruce Clark

[sic] now owns over 265,000 shares and is fully leveraged. As of Friday

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afternoon, there was up to 30,000 shares on the ask side on the market. Further,

Steve Tsmikilis, who still owns over 150,000 shares (we placed 50,000 of his with

Barthe in Aug.) has advised that he needs to sell 50,000 more by Dec. 1 to finance

a real estate project. He has been good about communicating his situation, but I

have now [sic] doubt that he will start putting shares in the market soon. In fact,

he started several days ago until Calvin personally bought 10,000 shares from him

and convinced him to stop and work with us.

We all know that each of us is highly leveraged. Ken has bought over 135,000 on

margin since Aug. I have a $1.3 million margin loan with virtually no buying

room left, Calvin needs to have funds to pay down high margin loans and do

projects, Ray needs to pay down his margin and other loans. Bernard needs to

finance Handsmiths. These are all valid needs for liquidity, but in the current

conditions, we really need to be more concerned about protecting the value of our

KHI shares -without support from us, it is clear that there will be further price

erosion and, in fact, the market could fall significantly and rapidly in the next few

days. Unless we all put our liquidity requirements aside for the short term and

turn our attention to finding ways of supporting the shares in the market, there

will be no liquidity opportunities for any of us worth having.

RECOMMENDED PLAN OF JOINT ACTION

In the short term, I propose that:

We each agree to buy 10,000 of Steve T's shares this coming week.

Bernard lend 100,000 shares to Bruce Clarke's company for an interim period. I'd

ask that Ray agree to put 100,000 shares with Bruce to replace Bernard's as soon

as he (with our help) can get BMO Nesbitt Burns to release 100,000 from his

margin arrangements at that brokerage. For information, I have already provided

Bruce with 120,000 shares months ago plus $100,000 in cash, which he still has

and Ken has provided 100,000 shares which he still has. Calvin had provided

100,000 shares before Ken for several months.

That we each agee [sic] to write options on 30,000 of our shares for 4 years at

$6.50 (for a total of 150,000) to provide a package to Doug Rudolph. In fact, the

options would be nominally for 2 years, renewable for another 2 provided the

shares had a market value at that time of at least $9,00 [sic] per share. This is a

feature to keep him from being forced to sell the shares to pay for the option price

at the end of two year [sic]. He requested it and I think it's a good idea. The

understanding would be here that he would find a buyer for 2 shares for each

share optioned to him- in other words, for 150,000 options, he would have to

place 300,000 shares. These purchases would support the retail market. For

information I provided options of 210,000 of my shares at $3.50 for 2 years to

Banks and on a further 150,000 at $4.00 to Barthe earlier in the year. For

information, your RRSP can write such options if you have KHI shares in an

RRSP.

Page 49

That we agree on a formula for sharing in liquidity opportunities going forward

and each agree not to sell any otherwise than as arranged under this arrangement.

In this regard, I committed to Calvin some time ago that he would get the first

200,000 share liquidity arranged by the company above the needs of the retail

market. I think we should stick to this and give the next 100,000 to Bernard

because of his high need and, thereafter we would each have the right to share

equally over the next period of time- say two years. I'm not talking about any

formal legal agreements here -just sensible, honorable gentleman's agreement

among 5 business people with a huge business interest in common working

together in a fair and straightforward way.

Unless we do something in a united way like this, I'm afraid it's going to be a case

of: "United we stand, divided we fall!". And, if we fall, we'll all fall with a heavy

thud! And so will the other shareholders.

I'd urge each of you to respond positively to this, bearing in mind that the stakes

are big and the market will [sic] unforgiving if we are unable to act strongly

together.

I am going to be extremely busy for the next 3 days with the CCEM. I'd ask that

each of you respond to this email (copying each of us) as soon as possible. We

need to be able to give some direction and support to Bruce before the market

opens on Monday (tomorrow).

[169] Responses from the group were largely positive. Calvin Wadden agreed to

buy some of Steve Tsimiklis’s shares, noting that he and Mr. Tsimiklis had agreed

that “[Tsimiklis] will sell stock on the market unless he can get the 50,000 shares

he requires by Friday.” Mr. Wadden also recommended an escrow agreement

preventing the five major shareholders from selling more than 5,000 shares per

month. Ray Courtney responded that he would provide a 100,000 share certificate

to Bruce Clarke “to support the market”. Ken MacLeod was also on board.

Bernard Schelew, on the other hand, was not interested. He explained that both he

and his company faced “financial meltdown” unless he took action. He maintained

his direction to David Mack to sell 10,000 shares per week, noting that Mack “can

sell 2,000/day or whatever. (As you know, KHI trades on average 100,000

shares/week).”

Trading volumes and share price for November 2000

[170] Trading opened on November 1 at $6.65 and closed at $6.70. Leading up to

the German investment on November 23, the stock price stayed relatively stable,

trading in the range of $6.30 to $6.70, but always closing at $6.50 or higher. For

the rest of the month, the stock dipped slightly, closing several times at $6.40. On

November 30, the stock closed at $6.45. The Crown says it was no coincidence

Page 50

that the closing price never dropped below $6.50 (the price to be paid by Ristow

and Barthe) until immediately after the deal closed. Out of 20 trading days,

suspect accounts were involved in alleged high closes on 13 of them (65%).

[171] During the month of November, 228,340 shares of KHI crossed the

Exchange. Suspect accounts¹¹were very active buyers, spending just over $1

million and acquiring 77% of the total shares traded.

Dan Potter tries to manage Bernard Schelew

[172] On December 1, Bernard Schelew e-mailed Dan Potter requesting that KHI

purchase 23,000 shares from him in order to assist him to keep his company going.

He indicated that it “would satisfy Handsmiths [sic] immediate needs and

encourage me to sign the gentlemans [sic] agreement that we spoke of yesterday.”

Dan Potter forwarded the message to Blois Colpitts and wrote, “SHIT!” He

replied to Dr. Schelew on December 3:

We're backsliding here!

When we left our 4 hour meeting the other day, you said you were on-side with

the orderly selling agreement and were going away to see if you could contribute

50,000 shares. Your request that we "arrange to take [23,000] shares" comes as a

real surprise after all the discussions we had and agreements we reached during

our discussion.

On the strength of the agreement among all 5 major shareholders, Calvin and I

were able to get Steve Tsmikilis to agree not to sell 50,000 shares in the market,

but rather wait and work with us! It was crucial to his decision that the major

shareholders have an agreement only to sell according to an agreed plan. If there

is in fact no such agreement, he'll bolt for sure!

All the other major shareholders are on-side with the agreement idea. Please do

the right thing and work with me on these [sic]. I really need to direct my

attention to running the company and selling shares to new investors. With your

help, this can be a big success. Without your co-operation, it can't work.

By the way, last week I scrounged and (including kids RESPs) and [sic] bought

13,000 shares. Ken authorized the purchase of 10,000. These are all to support the

retail market.

¹¹The 540 account, the Union account, FutureEd.com, Clarke Joint account, Calvin Wadden accounts and Daniel

Potter.

Page 51

[173] The two men continued back and forth, with Dan Potter forwarding an e-

mail to Blois Colpitts and writing, “He just doesn’t get it! At least we’re talking

and we’ll get him to the right answer eventually!” But Bernard Schelew persisted,

writing Dan Potter a lengthy e-mail outlining his interpretation of their discussions

to date, and proposing what he considered to be a plan that would satisfy the needs

of both parties. Dan Potter forwarded the e-mail to Blois Colpitts and wrote:

What a high maintenance fellow he has turned out to be. This is a classic case of

someone who "just doesn't get it!"

…

As much as I hate to bother you on this, it seems clear that we need to work on

him together. …

[174] On December 13, Dan Potter sent an e-mail to Bernard Schelew confirming

that Messrs. Potter, Schelew and Colpitts had met in person and that “all of the

major shareholders have now reached a deeper mutual understanding of all the

issues and opportunities presented by our big ownership positions in KHI.” He

went on to note:

Ray Courtney is providing 100,000 shares for Bruce’s investment account.

However, there will be some time lag – up to a couple of weeks or so in getting

this completed, so it would be most helpful if you could provide 50,000 shares to

Bruce at this time. The logistics of this can be worked out between David and

Bruce upon your instructions to David. Your prompt attention to this will be

greatly appreciated.

KHI decides to wind up the KHLP

[175] In December 2000, KHI management was considering whether to wind up

the limited partnership. Under the subscription agreement for the LP units, KHI

had a call option to acquire the units in exchange for KHI shares. The call option

did not contain any restrictions on the trade of KHI shares issued in satisfaction of

the call option price. In other words, once the LP units were converted to shares,

the unitholders would be free to trade their shares as they wished.

[176] Gerard McInnis was concerned about the possibility of almost 650,000

shares coming to market and he recommended that KHI formally escrow the shares

for a period of twelve months. He suspected that “this will not be totally palatable

to the unit holders” but “liquidity is an issue right now and it is in their best

interests and the best interests of all shareholders that these new shares not be

Page 52

immediately freely tradeable.” Dan Potter was initially reluctant to do a formal

escrow, pointing out that there was a very small group of unitholders and “all can

be kept on-side informally. The obligation to keep these holders from selling will

rest with Blois and me.”

[177] Also on December 12, Gerard McInnis contacted Jim Cruickshank at

Stewart McKelvey and asked for advice, noting that “it is not entirely clear to me

where we have the right to impose a restriction on these shares.” Mr. Cruickshank

responded that “KHI has no right to force the escrow conditions” and that some

limited partners may refuse to accept the deal. The next day, Blois Colpitts

suggested that the TSX might consider the wind up to be a private placement and

impose a six-month hold period. In his view, “that may be a softer way to impose

a hold period.”

[178] When it appeared that the TSX would not issue a hold period, KHI

management decided to impose a six-month contractual hold period on the shares.

Under the terms of the hold period, the shares could be margined but not sold. The

decision was made not to have the shares legended, which would alert financial

institutions who might accept the shares as security that they could not be sold

until the hold period expired.

[179] At paras. 157-158 of his report, Langley Evans described the six-month

trade restriction as “unusual” and “consistent with a manipulative agenda”:

Imposing trading restrictions at the time of the sale of a security is common. Hold

periods due to regulatory requirements or as a contractual term of the purchase are

typical examples. However, imposing these restrictions after the purchase and just

prior to issuing the shares is unusual. There is no record of putting this change to

a vote by the unit holders. The exception to allow use of the shares as collateral is

also unusual.

These restrictions were consistent with a manipulative agenda in two important

ways. They keep the shares from being sold for at least 6 months. At the same

time, the shares can be used as collateral in margin accounts. The Group was

under financial pressure from extensive margin loans at this time. The depositing

of these shares would have provided additional equity to the Group’s margin

accounts and supplied additional potential buying capacity the Group could use

for supporting KHI’s price.

[180] At least one unitholder expressed concern and frustration upon learning of

the hold period on the shares. Ros Aylward, accountant for unitholder David

Thomas, contacted Gerard McInnis and pointed out that there had been no mention

Page 53

of any restriction in the initial LP subscription agreement. She added that, under

the terms of the document, if the call option was not exercised until after December

31, 2000, the unitholders would be entitled to shares equalling 130% of the

purchase price, and, as such, “it would seem to me that since the call option

restriction is pushing the liquidity date until 2001, that it is reasonable to expect

130% be returned.” Dan Potter advised Gerard McInnis to tell Ms. Aylward that

all other unitholders had agreed to the restriction and that it was a reasonable

measure given the current market conditions. During her testimony, Ros Aylward

described herself as “thoroughly unimpressed” with the sales restriction in the call

notice. When asked what her client, Mr. Thomas, decided to do, she testified as

follows:

I believe at that point it was almost being forced upon us because we were given

to believe all other unitholders had proceeded in allowing it and we didn’t really

have much other option.

[181] Dave Thomas also testified. When asked if he recalled the contractual trade

restriction, he testified:

A. Yes, I do. I recall it. I recall a discussion with Ros about it basically. And I

cannot recall that I had further conversations with anyone from Knowledge

House, but I certainly recall growling at Ros about it.

Q. Can you explain why -- why would you be growling at Ros about that?

A. Well I just felt it was an unreasonable term. And I believe I -- we discussed it

and Ros was going to inquire further with regard to this clause.

…

Q. Prior to learning of this restriction, what were your plans for these shares?

A. My plan was to sell them. Basically my view was that Knowledge House had

sort of taken a much broader mandate than they had been given with regard to

what their plans were and so I just felt that it was probably an investment that we

should exit at the earliest opportunity. Also it wasn't particularly easy to get

information.

Mr. Thomas further testified that he was never able to sell the KHI shares in

relation to the LP and that he had to write off the investment as a loss.

Steve Wilsack’s settlement letter

[182] On December 12, Andrew Burke from Stewart McKelvey e-mailed Cate

MacNutt, Senior Vice-President of Corporate Services at KHI, with a copy to

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Gerard McInnis, in relation to a settlement letter for Steve Wilsack. It stated, in

part:

I have not made any further changes to the letter and assume that Gerard will

insert the "gentleman's agreement" language as he feels is appropriate, given that

it is intended to be soft/non-legal and he would have a feel for what will sell. I

understand that you will put the letter on your letterhead and Gerard will bring it

to closing (which is in your building). Let me know if you would prefer

otherwise.

[Emphasis added]

[183] Gerard McInnis then e-mailed Cate MacNutt:

Cate please tuck this in at the end ..

re Gentleman's agreement

Steve, as per your discussions with Dan we understand it [sic] your intention to

hold your shares as an investment for the time being and otherwise manage your

account as necessary on advice from your financial advisor, Bruce Clark [sic], at

National Bank Financial.

[184] Cate MacNutt prepared the letter to Steve Wilsack the next day, using the

language suggested by Mr. McInnis in the final paragraph. The Crown says Blois

Colpitts, in his role as counsel to KHI, later relied on this “soft/non-legal”

paragraph to threaten Mr. Wilsack with legal action if he sold any shares.

Dan Potter advises Gerard McInnis to “rag the puck”

[185] On December 17, Gerard McInnis e-mailed Dan Potter in relation to CD-Ed

share options:

We are "sitting on" the Treasury Direction (yet have banked the funds). I am

getting calls literally 2 an hour about status. I appreciate there is no market for

their shares but they have legal right to the shares as purchased via exercise of

their options. Blois has asked that I "lag [sic] the puck" which we have been doing

but will need to release the direction soon. Any advice

[186] Mr. Potter replied:

It’s a hassle, but the longer you can rag the puck the better. Not a great answer.

I’ll keep thinking.

Page 55

Bruce Clarke updates Dan Potter on “managed account”

[187] On December 21, Bruce Clarke sent Dan Potter an e-mail updating him on

the 540 account’s holdings:

Hello Dan,

Here is a quick analysis of the managed account taking into consideration todays

purchases and the receipt of 100,000 shares.

Total number of shares held

Market Value at $6 per share

Account Debit Balance

Loan Value at 50% of Market Value

Excess Margin

622,870

3,737,220

1,806,000

1,868,610

62,610

This does not include 200,000 shares of CrossOff I hold in the account.

Bruce

Trading volumes and share price for December 2000

[188] Trading opened on December 1 at $6.20 and closed at $6.40. From then

until December 29, the stock traded primarily between $6.00 and $6.50, although it

did briefly drop down to $5.50 on December 27. During December, 255,502

shares crossed the Exchange. Suspect accounts¹²were heavy buyers, spending a

total of $880,286 and acquiring 60% of the total shares traded. In addition, group

members were involved in alleged high closes on 14 out of 19 trading days

(73.7%).

Dan Potter comes up with “Project One Million”

[189] On January 14, 2001, Dan Potter e-mailed Ray Courtney, Ken MacLeod,

Calvin Wadden, and Bernard Schelew, advising of an initiative -- “Project One

Million” -- to attract new investors to KHI and raise equity for treasury. He asked

that each recipient participate and agree to provide options to new investors on

200,000 of their shares at $3.50 per share. He also “suggested” that each agree to

¹²The 540 account, Union account, FutureEd.com, Daniel Potter, Calvin Wadden accounts and Ray Courtney

accounts.

Page 56

buy 25,000 shares personally and commit to finding buyers for at least 10,000

more.

[190] The next day, Dan Potter sent a memo to KHI Directors with the subject

“Requirement for Equity Investment”. The lengthy memo explained that since the

public capital markets were virtually closed for companies at KHI’s type and stage

of development, the most appropriate option was to look to existing stakeholders to

help raise the needed investment. Mr. Potter noted that during the previous year,

only $1 million in new funding was raised toward the $5 million expended by KHI

and KHLP on research and development. The remaining $4 million came out of

the equity and working capital base of the company. He continued:

In retrospect, given how long the bear market has continued, we made a

significant error last year by directing too much of the new investment we

were able to attract to Knowledge House to market (non-treasury) share

purchases. Essentially, during 2000 we attracted almost $14 million in new block

share purchases. Approximately $10 million has gone into market transactions

and only $2.5 million has to date been invested in the treasury of the company (a

further $1.6 million will be paid into treasury over the next 7 months under the

Barthe/Ristow subscription agreement). On the other had [sic], this has had the

desirable effect of providing investor support for company's market capitalization.

The price of KHI shares declined only $.15 on a year-over-year comparison

(Dec. 31 2000 compared to Dec. 1999). This is in an environment where the

market value of many comparable companies declined sharply, often by

amounts well in excess of 50%.

Adding urgency to the need for new equity is the recent reduction in our bank

operating credit lines … While, as noted below, we have taken some steps over

the last three weeks to cope with the current situation, in order to solve the

financial crunch currently facing the company, new equity investment in the order

of $3 million is needed very soon - ideally, a significant portion of [sic] should be

obtained by the end of January.

[Emphasis added]

[191] Mr. Potter’s memo went on to explain that during the prior year and a half,

KHI had operating credit facilities with Royal Bank totalling $3 million - $500,000

as a base operating line and $2.5 million secured by receivables. But this situation

had changed significantly in mid-December:

In mid-December [the bank] advised that company's operating credit would be

restricted to the base $500,000 on the basis that our contract receivables from

major school projects was coming to and [sic] end. The bank indicated that [sic]

Page 57

order for it to provide more conventional receivables financing in our technology

solutions business we would need approximately $2 million in additional equity

in that business.

This significant change in credit availability has created a real cash crunch. Over

the last several weeks the company has been put on credit hold by a number of its

technology suppliers. This seriously impairs our ability to execute new business

and makes working capital extremely tight in relation to meeting other

commitments including, payroll, trade payables, etc.

[192] Mr. Potter added that the company had received some assistance from Dr.

Lutz Ristow, who had agreed to make his February 2001 installment of $812,500

several weeks early.

Clients want to sell, Clarke uses his own account and FutureEd.com to soak up the

pressure

[193] Consistent with Dan Potter’s January 14 request that the major shareholders

agree to buy more shares, Ken MacLeod e-mailed Bruce Clarke on Friday, January

19, authorizing him to purchase up to 30,000 shares “to relieve some of the

pressure that the market is presently applying to KHI stock.”

[194] One of Bruce Clarke’s clients, Lowell Weir, also e-mailed him on January

19:

Bruce: I am very nervous on Knowledge House. If the stock falls below $5.00

dollars, I would like the holdings of EnerVision sold immediately at market. In

addition I want the same to apply to the Knowledge House stock held by

Blackwood Holdings, and any other held by my wife and children and myself

directly or through RRSP.

Although the stock dropped below $5 that same day, and on several other

occasions in the ensuing days and months, Bruce Clarke did not sell any shares for

Mr. Weir.

[195] In addition to Lowell Weir, Odilia MacDonald, another client of Mr. Clarke,

wrote to him on January 19 and instructed him to enter a market order¹³for the sale

of all of her KHI shares as of market opening that day. Lynn MacDonald, assistant

to Mr. Clarke, responded on his behalf, indicating that the market was very feeble

¹³A market order is an order that instructs the investment advisor to buy or sell shares at the best available price at

that time.

Page 58

but he was working to get her out of at least 5,000 shares that day. Lynn

MacDonald wrote again a few hours later to advise that 5,000 shares had been sold

at $5.00 per share and that Mr. Clarke was continuing to work on selling the rest.

On the following Monday, Odilia MacDonald e-mailed Bruce Clarke as follows:

Bruce: 51,945 KHI shares were traded on January 19. How is it possible that my

shares were not all traded when I put in a market order before opening on Friday?

After discussions with another broker, I learned it would be impossible for stock

to close at $5.60 on Thursday when I had a sell order in for shares at 5.40-5.50.

I’m feeling less than confident that my interests are being addressed.

[196] Mr. Clarke replied later that day:

During the day on Friday, we sold your shares in your non-registered account at

two different times: the first was the 5,000 at approximately 1:30 in the afternoon

and the remaining 344 was sold at approximately 4:30 in the afternoon; all at

$5.00 per share.

Do you want me to [sic] the shares in the RRSP account as well?

[197] She replied, “Yes, as previously indicated, I want all of my KHI shares sold.

I’m assuming that will be taken care of before closing today.” Mr. Clarke

responded:

You sold your 2556 of KHI @ $5.10 on opening this morning. This completes the

sale in both your registered and non-registered accounts.

I do apologize for the misunderstandings I had, but I do try to work at all times

with the client’s best interest in mind.

[198] The MTR indicates that Bruce Clarke used his own account and Ken

MacLeod’s FutureEd.com account to buy Ms. MacDonald’s shares.

Dan Potter drafts memorandum for $2 million treasury issue

[199] On January 24, Dan Potter drafted a memo titled “$2.0 Million Treasury

Issue – 400,000 Common Shares at $5.00”. The memo contemplated the issuance

of 400,000 shares from treasury at $5 per share. As an incentive, the five major

shareholders would each offer options on 180,000 of their shares at $2.50 per share

for a term of two years. The document also stated that the major shareholders

would enter into a “managed selling agreement” to control any future selling of

KHI, and “they will also collectively provide option incentives … to persons who

provide market support and liquidity for the Company’s shares.”

Page 59

Trading volumes and share price for January 2001

[200] Trading opened on January 1 at $6.00 per share, and closed the day at the

same price. In the weeks that followed, the stock traded between $4.50 and $6.25.

During the month of January, suspect account purchasing and alleged high closing

reached an all-time high. In total, the suspect accounts¹⁴spent $1,715,849, and

purchased 68.6% of the total shares.¹⁵The alleged high closing purchases also

reached an all-time high, with suspect accounts involved alleged high closes on 17

out of 22 trading sessions (77.27%).

Steve T. receives options in exchange for not selling

[201] On Tuesday, February 6, Dan Potter e-mailed Blois Colpitts indicating that

Steve Tsimiklis had called to say that his father and brother were telling him that

“if he doesn’t have a document” by Thursday, February 8, “selling will begin.”

Mr. Potter requested that Mr. Colpitts prepare a draft and send it to him by the next

night. The next day, he e-mailed Mr. Colpitts again, stating, “As per e-mail

attached, we NEED to have the document done for tomorrow afternoon – he will

drive us crazy if we don’t.”

[202] On February 8, Mr. Colpitts e-mailed Mr. Potter an option agreement for

Steve Tsimiklis. The agreement contemplated that Mr. Tsimiklis would receive

options on 123,870 KHI shares at an exercise price of $0.50 if Mr. Tsimiklis would

abstain from trading any of his KHI shares. Since this was a private transaction

conducted outside the TSX, the KHI market price would be unaffected and the

investing public would be unaware that Mr. Potter was willing to sell his shares for

$0.50.

Calvin Wadden installed as “Administrator”

[203] On February 8, Calvin Wadden e-mailed Dan Potter, subject “Market

support”:

I have been speaking with Ray, Blois and Ken throughout the day and they have

been in supporting the market. Ray and I would really like to get the stock to

¹⁴Clarke joint account, Blois Colpitts, FutureEd.com, Daniel Potter, 230 account, 540 account, Union account, Bruce

Clarke, Calvin Wadden accounts and Ray Courtney accounts.

¹⁵The Crown’s expert, Ian Black, calculated suspect purchases of $1,828,934.02 (75%) but included $113,085.05 in

purchases by Laurie Stevens. These transaction will be discussed later in this decision.

Page 60

$5.45 and try to solicit more support from the group going forward. If we can get

to $5.45 - $5.50 I would like to see each of us put 5,000 shares into the support

side and try to inch up toward $6.00 to $6.50 until we get some positive news on

the street.

If we could come up with a formula to provide support say 5,000 shares each at

every $.15-.20 gain forward we could be building some reserve and give each of

us some breathing room until we attract substantial buyers. I think this along with

the options would be [sic] be a strong sign for the major shareholders who are at

the sidelines.

Ray and Ken each purchased 4,000 shares today and have agreed to pick up an

additional 1,000 shares each by the close. Blois and I bought as well. Aside from

all the hard feelings it was good to see the teamwork this afternoon.

I have spoken to Stewart from Assante(FCG) and he has agreed to work with me.

I really think he was sincere but someone is still in the market. Can you make

time for me to arrange a pep talk for Eric and Stewart some time next week? Ray

and I think if we can turn Eric into a supportet [sic] we are clear sailing.

[204] Dan Potter forwarded the e-mail to Blois Colpitts and wrote, “FYI – good to

see!” He then e-mailed the five major shareholders, attaching Calvin Wadden’s

earlier e-mail, to confirm the formalization of an agreement for Mr. Wadden to

take on an investor relations role with the company for $5,000 per month. The role

would include “overall co-ordination of the day to day retail market”, acting as the

“Administrator” under the managed selling agreement, acting as the co-ordinator

of the major shareholder group, and “acting as main day-to-day coordinator with

the market makers in KHI shares, including Bruce Clarke and any others that are

brought in from time to time.”

Bernard Schelew joins in on the buying

[205] Notwithstanding his November plan to sell 10,000 shares per week, as of

February 2001, Dr. Schelew had not sold any shares. At that time, instead of

selling, Dr. Schelew spent $110,000 acquiring more KHI shares. In an e-mail to

Dan Potter, he stated, “I will purchase 11,000 of KHI from Handsmiths in the next

two months adding another $55,500…” He added, “After reviewing my financial

situation, I’m afraid I can’t participate in any more rounds of buying.”

[206] Dr. Schelew also helped Calvin Wadden narrow down the identity of a

shareholder selling 5,000 shares from a CIBC account, telling Mr. Wadden that he

checked with his friend Pat, who denied that it was her.

Dan Potter updates the Board of Directors

Page 61

[207] On February 21, Dan Potter circulated a memo in advance of the February

26 KHI Board of Directors meeting. The memo outlined a series of operational

steps the company had taken to address the “financial crunch” it had experienced

for the previous eight weeks. The memo also set out several steps taken at the

shareholder and investor level including reaching a “Managed Selling Agreement”

and a “market support arrangement” among the five largest shareholders. The

memo further noted that the company had obtained commitments for $1.25 million

of the $2 million private placement but that KHI’s future was in jeopardy unless it

secured the remaining $750,000.

Trading volumes and share price for February 2001

[208] Trading opened on February 1 at $5.30 and closed at $5.25. Although the

stock dipped to $4.70 on February 7, it recovered (with significant suspect account

purchasing) to trade between $5.05 and $5.80 before closing the month at $5.60.

[209] In February 2001, 201,360 shares crossed the Exchange, with suspect

accounts¹⁶purchasing over 70% at a total cost of $770,109.20. Out of 19 trading

days, suspect accounts were involved in 13 alleged high closes (68%).

Calvin Wadden’s “latest brainwave”

[210] On March 1, 2001, Ken MacLeod e-mailed the major shareholders, outlining

Calvin Wadden’s “latest brainwave” that one of the five of them sell the bulk of his

shares “for a song” to either Charlie Keating or David Fountain (outside the

Exchange) in order to lower the purchaser’s average cost per share. With 800,000

shares and a debt of $1.5 million, MacLeod indicated that he might entertain

selling his shares for $1.90 per share. Dan Potter replied that Calvin Wadden had

volunteered to sell his 1.4 million shares at $1.83 to incent Mr. Keating or Mr.

Fountain to contribute $1 million to the private placement. While Mr. Potter

wasn’t sure that either would be interested, he said he would run it up the pole with

them. Before he did, however, he asked that any other interested group members

“put their hand up”, or suggest another approach. He concluded with a “strong

recommendation” that the five major shareholders “as a team, commit to buy 5,000

more shares while we work all the options.”

¹⁶Clarke joint account, 230 account, FutureEd.com, Daniel Potter, Bruce Clarke, Calvin Wadden accounts, Ray

Courtney accounts, Fiona Imrie and Bernard Schelew.

Page 62

[211] The next day, Ken MacLeod e-mailed Bruce Clarke to authorize him to buy

up to 5,000 shares. Also on March 2, Calvin Wadden e-mailed the group and

indicated that he was not willing to offer his shares to Charlie Keating or David

Fountain unless all five members of the group were contributing to the “market

support” efforts. Over the next few days, a new plan developed for Bernard

Schelew and Ken Macleod to offer to sell a combined 1.3 million shares at $1.83

per share (with unnamed others contributing a further 100,000 shares) to Charlie

Keating in exchange for his agreement to subscribe for $1 million to the private

placement. Again, because this was a private transaction, the KHI market price

would be unaffected and the public would not know that major shareholders were

willing to let go of their shares for $1.83. Dan Potter e-mailed the proposal to

Charlie Keating on March 7.

Keeping employee shares off the market

[212] On March 3, 2001, in response to an e-mail from Gerard McInnis cautioning

that a number of employee options would soon expire (and therefore would likely

be exercised), Dan Potter wrote:

I think we have now decided to deal with this on a case by case basis until we get

a little further along – having said this, we definitely are going to tell anyone who

requests/demands to exercise that it’s not on for now.

I have no problem dealing with anyone who becomes the least bit demanding.

Group members round out the private placement

[213] On March 9, Dan Potter sent a memo to the KHI Board of Directors that

listed the investors expected to subscribe for the $2 million private placement. In

addition to the $1.25 million already secured from David Fountain, Derek Banks

and Dan Potter, $400,000 would come from Blois Colpitts, Ray Courtney, Ken

MacLeod and Calvin Wadden, each of whom had confirmed $100,000

contributions. The remaining $350,000 would come from Eric Romanowsky,

Doug Rudolph and Laurie Stevens. Three days later, Ray Courtney e-mailed Dan

Potter and told him that he had no way to participate in the private placement. By

the end of the month, however, Mr. Courtney agreed to have shares released from

BMO NB so that he could afford to contribute.

Dan Potter’s accounts slip under margin

Page 63

[214] On March 19, Steven Clarke e-mailed Dan Potter:

I've attached an updated portfolio overview, currently with KHI bid at $5.30 per

share your cross guaranteed account are under margin by approximately [sic]

$13,000. If you keep everything else in the accounts constant, your excess margin

will increase (decrease) by 15,000 (-15000) for every $0.05 change in the bid

price of KHI.

[215] The Crown says that e-mails of this nature show just how price-sensitive Mr.

Potter’s accounts were, due to the concentration in KHI shares margined to the

limit of borrowing power. Since even small fluctuations in price could trigger a

margin call, maintaining the stock price was critical.

Bernard Schelew offers to option his shares at $0.64 per share

[216] On March 25, Bernard Schelew proposed to Dan Potter that he would sell

1.1 million options at $0.64 per share with a $1.36 strike price to any investor who

agreed to invest $700,000 in the private placement. He noted that this would free

up more than half a million dollars that the major shareholders had intended to

contribute to the private placement. He suggested those funds could be used “for

market support.” He proposed that, in exchange for optioning his shares, he be

given options on 200,000 shares from the other major shareholders at $5.00 per

share and he would agree to purchase $100,000 of KHI in market support on an

equal basis “with Managed Selling Group.” This transaction never took place.

Dan Potter tries a different approach with Charlie Keating

[217] Having failed to convince Charlie Keating to buy 1.4 million shares at $1.83,

Dan Potter e-mailed Mr. Keating on March 26, proposing that Mr. Keating loan his

one million KHI shares as security to a new investment company set up by Mr.

Potter, Mr. Wadden and others. The company would then apply for a loan for the

$700,000. Again, this transaction never took place.

Trading volumes and share price for March 2001

[218] Trading opened on March 1 at $5.45 and closed the day at $5.30. For the

rest of the month, the stock price remained quite stable, trading between $5.10 and

$5.55. When the stock hit the low of $5.10 on March 16, Bruce Clarke e-mailed

Dan Potter, writing, “Could you please give me a call. Knowledge House is $5.10

to $5.25.” The stock closed on March 30 at $5.40.

Page 64

[219] In March 2001, 106,830 KHI shares crossed the Exchange. Suspect

accounts¹⁷spent $356,191 and bought 62% of the total shares. Out of 21 trading

days, suspect accounts were involved in 10 alleged high closes (47.6%).

New plans for “market support”

[220] On April 4, Dan Potter sent an e-mail to Ken MacLeod, Bernard Schelew,

Calvin Wadden, and Ray Courtney, with copies to Bruce Clarke and Blois Colpitts,

with the subject, “Market support using Bernard’s shares”. Mr. Potter confirmed

that the $2 million private placement had closed. He explained that he’d met with

Ray and Calvin, and that they’d come up with a plan for Bernard Schelew to

provide a loan of 100,000 KHI shares. The first 60,000 would be divided equally

between Mr. Potter, Mr. Courtney, Mr. Wadden, and Mr. MacLeod. According to

the plan, once the shares were transferred into the recipients’ margin accounts, they

would each purchase 9,000 KHI shares in the market. The remaining 40,000

shares “will be available for future use.” Mr. Potter asked Mr. Colpitts to draft a

“loan of securities” agreement for each of the recipients.

[221] A few days later, when it became clear that Bernard Schelew was not keen

to loan his shares in pieces, a new plan was concocted, wherein Dr. Schelew would

transfer 100,000 shares to Jack Hill in exchange for $100,000 and a commitment

by Mr. Hill to purchase 30,000 more shares of KHI from treasury or on the market.

Although everyone was on board, Bruce Clarke and Blois Colpitts had difficulty

getting NBFL to accept the below market sale by Dr. Schelew’s RRSP, and the

transaction did not take place.

Blois Colpitts threatens Steve Wilsack with legal action

[222] At some point in early April 2001, Blois Colpitts became concerned that

Steve Wilsack was selling KHI shares on the market. On April 9, he e-mailed Mr.

Wilsack as follows:

We are the solicitors for Knowledge House Inc. Further to your agreement dated

December 13, 2000 which released your shares from escrow, among other things,

and based on your agreement not to sell shares of Knowledge House Inc.

otherwise than through Bruce Clarke, please provide us with evidence that you

have complied with the terms of your agreements.

¹⁷230 account, FutureEd.com, Clarke joint account, Calvin Wadden and Ray Courtney.

Page 65

I understand you have not contacted Mr. Clarke at all in this regard and therefore

would presume you have not sold any shares. Please acknowledge receipt of this

email by tomorrow and fax me your statements to prevent any further action.

[223] Mr. Wilsack replied on April 10:

Thank you for email. For clarification purposes, could you show me in the

December 13 agreement where it states that I cannot buy and sell shares of KHI

other than through Bruce Clarke and that I have to deal exclusively with National

Bank for my personal financial portfolio.

Also in your email you stated “to prevent any further action.” Could you please

clarify this statement.

[224] Mr. Colpitts responded the same day, with a copy to Andrew Burke:

Thank you for your email today.

Without getting into a legal argument with you, you have a copy of the agreement

and can read the last paragraphs.

You also are aware of the terms of the release of your shares from escrow. It is

very clear that you have not had any dealings with Bruce Clarke in respect of

selling any of your shares and therefore the presumption is that you have not sold

any shares or you have breached the agreement and will be held accountable for

any resulting damages caused by your breach(s), both in the past and the future.

You have told others you are not selling shares and we are merely verifying your

compliance with the agreement on behalf of our client. Please provide me with

copies of your statements to avoid any further action on this file.

[225] According to the Match Trade Report, between January 2 and April 10,

Steve Wilsack sold 37,400 shares of KHI. From March 30 to April 9, he sold

5,800 shares through Royal Bank Dominion Securities, all purchased by

FutureEd.com. From the date of Mr. Colpitts’ last e-mail until June 14, Steve

Wilsack sold only 300 shares.

Gerard McInnis warns that KHLP shares will soon be released

[226] On April 18, 2001, Gerard McInnis forwarded an e-mail to Dan Potter from

Chris Smith, Vice-President Finance and Administration,¹⁸containing a

¹⁸Chris Smith initially joined KHI in the role of Controller, reporting to Gerard McInnis. Mr. McInnis testified that

in late 2000 or early 2001, he transitioned out of Finance and into “more of an operations role”, while Mr. Smith

took over in Finance.

Page 66

spreadsheet breaking down how the 646,000 shares from the KHLP were issued,

and wrote:

fyi, just by way of reminder the hold restriction on these shares (although not

legended) was until June 27, 2001. This will be upon us sooner than not and

prework on some of these investors to ensure these shares stay off the market may

be necessary.

Trade volumes and share price for April 2001

[227] Trading opened on April 2 at $5.40, the only trade of the day. For the rest of

the month, KHI traded between $5.20 and $5.55, closing the month at $5.35.

During April 2001, 59,730 KHI shares crossed the Exchange. The only suspect

accounts purchasing were FutureEd.com and the Union account. Together, these

accounts spent $300,273, purchasing 71% of the total shares traded.¹⁹Out of 15

trading days, suspect accounts were involved in eight alleged high closings. (53%).

The warrant swap

[228] In late April, Calvin Wadden e-mailed Dan Potter with the subject “KHI

warrants and market support”. The e-mail set out a plan that the Crown calls “the

warrant swap”. The first step would be for the group members to offer options to

Donnie Snow in exchange for 124,733 warrants at $1.50.²⁰Next, the warrants

would be sold to Gerard McInnis, Jack Sullivan, and Jack Hill for one cent each.

Once the warrants were in their margin accounts, each of them would exercise the

warrants and use the resulting equity increase to “support the market” by

purchasing additional KHI shares on the TSX. The e-mail indicated that “Blois

feels that Bruce can do this transaction with our own accounts so if anyone would

like to take the lead it is fine with me.”

¹⁹Although Ian Black’s Summary of Daily Trading for April 2001 (Exhibit 62, Tab 30) showed the suspect buy

percentage as 58%, he testified that he forgot to exclude a prearranged trade of 11,200 shares which would result in

an increased suspect buy percentage.

²⁰Warrants are similar to options, but the two are not identical. Like options, warrants give the holder the right, but

not the obligation, to purchase a company’s stock at a specific price within a specific period of time. The key

difference is that warrants are issued directly by the company itself, not by another investor. When a warrant is

exercised, new shares are issued from the treasury of the company.

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[229] On April 30, 2001, Jack Hill’s margin account had a balance of $0.00. On

May 3, there was a deposit into the account of $10,000 cash, followed by the

reception of 15,000 shares of KHI.²¹The portfolio statement then shows a

purchase of 55,000 warrants of KHI at one cent each, for a cost of $550. Each

warrant allowed Mr. Hill to purchase one share at a price of $1.50. Those warrants

were exercised by Mr. Hill at a cost of $82,500 (55,000 x $1.50). With KHI shares

trading at between $5.30 and $5.40, the introduction of 55,000 shares significantly

increased the equity in the account. In other words, it cost $83,050 to bring

approximately $291,500 worth of equity into the account. With increased equity

comes the ability to purchase additional securities on margin, and, in accordance

with the agreement, that is exactly what Mr. Hill did. Between May 2 and May 16,

he purchased 20,000 shares on the Exchange.

[230] Jack Sullivan also participated in the warrant swap. On April 30, 2001, the

margin account for John (Jack) F. Sullivan and Linda Sullivan had a positive cash

balance of $423.24. The portfolio statement for May 2001 shows the purchase of

35,000 KHI warrants for one cent each, for a cost of $350, and the exercise of

those warrants for $52,500 (35,000 x $1.50). With a market price of $5.35 per

share on May 7, the purchase of 35,000 shares resulted in $187,250 worth of equity

entering the account. With KHI at a 50% margin rate, $93,625 could be used to

purchase additional shares on the market. Between May 22, 2001 and July 9,

2001, Mr. Sullivan purchased 8,100 shares of KHI on the market.

[231] Gerard McInnis was the third participant in the warrant swap. He acted

through his wife Janine’s account, over which he had trading authority. The

portfolio statement shows a purchase of 34,733 warrants for one cent each, for a

cost of $347.33, followed by the exercise of the warrants for $52,099.50 (34,733 x

$1.50). With the receipt of the shares, the equity in the account increased

substantially and Mr. McInnis used the excess margin to purchase 20,100 shares on

the market.

[232] The ingenious feature of this plan was that the shares purchased through the

exercise of the warrants effectively paid for themselves. When you purchase

securities, the shares immediately enter your account and increase the amount of

equity it contains. That said, you are not required to pay for them until the

“settlement date”. In this case, the settlement date was three business days after

²¹The source of the 15,000 shares is unclear.

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the purchase. Accordingly, Mr. Sullivan and Mr. McInnis²²were able to purchase

and exercise the warrants without depositing any additional funds into their

accounts. Once the warrants were exercised for a total cost of $1.51 per share, the

shares entered their accounts. With an actual market value of $5.35-$5.45 per

share, the reception of the shares into the accounts increased the equity levels

considerably. By the settlement date, the accounts contained enough equity to

cover the debt incurred through the purchase and exercise of the warrants.

Trading volumes and share price for May 2001

[233] On May 1, 2001, trading in KHI shares opened at $5.30 and closed at $5.35.

For the rest of the month, the stock traded between $5.25 and $5.80, before closing

the month at $5.40. During May 2001, 124,130 KHI shares crossed the Exchange.

The suspect accounts²³spent $386,335 and bought 74.7% of the total shares. For

the month of May, suspect accounts were involved in alleged high closes on nine

out of 21 trading days (42.8%).

Steve Wilsack wants to sell again, Calvin Wadden quits investor relations role

[234] On June 12, 2001, Steve Wilsack e-mailed Bruce Clarke:

Hi Bruce. I have held on as long as I could without selling a few KHI

shares…too many personal bills are mounting..8-)

Could you please sell 2000 shares between $5.15 and $5.25.

…

[235] Bruce Clarke forwarded the e-mail to Blois Colpitts who then prepared a

draft response which he e-mailed to Bruce Clarke, Calvin Wadden, and Dan Potter

on the same day:

Bruce:

The draft reply should be as follows:

²²Mr. Hill may have had sufficient equity in his account by virtue of the deposits of $10,000 and 15,000 KHI shares.

²³FutureEd.com, Calvin Wadden accounts, Jack Hill, Jack Sullivan, Janine McInnis and Clarke joint account.

Page 69

Steve:

Thank you for your email.

I have been put on notice by Blois Colpitts as counsel to KHI that you were under

an ongoing obligation pursuant to your letter agreement dated December 13, 2000

which released your shares from escrow, among other things, not to sell shares of

Knowledge House Inc. otherwise than through me.

Blois Colpitts has subsequently advised that you have an outstanding request to

provide him with evidence that you have complied with the terms of your

agreements.

As you are aware from your meeting the bids for KHI are currently support bids

and if others arise we will proceed with your request within the context of your

instructions.

Thank you.

Bruce

[236] Also on June 12, Steve Wilsack e-mailed Calvin Wadden, the daily market

support coordinator, to obtain permission to sell shares. Two days later, Mr.

Wadden e-mailed Dan Potter telling him he was confident that “if we can muster

1500 shares/mth for Steve he won’t be selling into the market.” Mr. Wilsack

followed up with Calvin Wadden on June 20:

Hi Cal.. just checking in to see about selling 2000 shares of KHI.

I am going to put a sell order into Bruce on Thursday. I have been holding off as

long as I could…but got too many bills and visa bills mounting…

[237] Calvin Wadden replied:

Steve,

I am working on your request every day but I have had no luck yet. Yesterday

there was more selling from BMO and Yorkton and we are out of support. I am

asking everyone to buy not to sell this week. I am hoping on Dan’s return on the

weekend we will have some progress and positive news.

I am going to keep doing what I can until I head for Russia the first week of July

(fingers crossed) then I am moving away from KHI and persuing [sic] another

career to see if I can rebuild. They say it is always easier the second time around.

I hope there is some truth to that.

I am asking everyone to send their statements to Dan by Saturday. I will forward

mine today to ensure the group I am part of the solution. It will be interesting

who will comply!? Blois mentioned he bought KHI (5,000 shares) last week for

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his mothers RRSP account. Things are really bad when that becomes our last bit

of support.

Going to be a rough few days..hope KHI can survive!

Cal

[238] Steve Wilsack agreed to “hold my breath for another few days to see what

the magician pulls out of the hat.”

[239] On June 21, Calvin Wadden e-mailed Dan Potter and resigned from his

investor relations role:

Dan,

I am hoping for the best for KHI and I will do my best to support Bruce but I have

no buying ability left to draw on. Yesterday there was selling (1500 shares from

Yorkton and more from BMO Investorline) .. I am printing of [sic] my statements

for both accounts for the last few months and will forward to you today to ensure

everyone I am not the problem. I am sending everyone a request to forward their

statements to you by Saturday so you and Blois can review them on the weekend.

I am not confident that everyone in our group is keeping their end of our non sell

agreement so I have decided to move away from the daily market responsibilities.

I am apparently no longer effective in that role and I am heading to Russia in a

few weeks anyway so I think we should look for a better candidate. The daily

debates with our merry band of investors is becoming too much for me to deal

with. I have my own financial issues and they never seem to be a topic of

conversation when I am dealing with our group.

I commend you and Blois for your perseverance and I will continue to support

your efforts. Blois mentioned last night that he had to buy 5,000 shares for his

mother account last week for support. I can't believe that our group continues to

sell and make demands when we are so close to having the stock crack. I can't

figure out if it is fear or selfish greed driving these guys!?!

I will do what I can until the end of the month and after that I will provide any

statements upon request to ensure the group I am not the problem. …

[240] According to the Match Trade Report, on June 22, Ray Courtney purchased

30,000 shares from his own company, 3019619 NS Ltd., at $5.20 per share. The

previous trade was at $5.35. With the Courtney transaction, the stock closed at

$5.20.

[241] On June 23, in an e-mail to Steve Wilsack, Calvin Wadden commented that

“Dan emailed me on my decision to move away from IR and he claims to have

good news just around the corner. Can’t wait to hear this one.” He also wrote:

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Bruce Clarke told me the idiot, AKA “Ray” did a 30,000 share cross below

market and screwed up the close for the weekend papers. He sure is the anchor

on our team of vagabonds. Gotta love the irony of the situation.

Trading volumes and share price for June 2001

[242] Trading opened on June 1 at $5.25 and closed at $5.40. During the rest of

the month, the stock traded between $5 and $5.50, with a brief drop to $4.55 on

June 8. The stock closed on June 28 at $5.30. During June 2001, 115,612 KHI

shares crossed the Exchange. Suspect accounts²⁴spent $102,473 purchasing

34.5% of the total shares. Although the Janine McInnis account purchased

$11,820 worth of shares, Gerard McInnis testified that Bruce Clarke made those

purchases without his authorization.

Dan Potter wants to keep LP certificate “lock up” expiration low-key

[243] On July 12, Chris Smith e-mailed Gerard McInnis and Dan Potter in relation

to the LP shares, confirming that the “lock up” had expired on June 27, 2001, and

that the 646,000 shares could hit the market. Dan Potter replied:

We are working to keep this low key- a number of the shares are still being held

and will only be released upon request, etc. etc. Please send any inquiries to me.

[244] George Unsworth and Kiki Kachafanas, LP unitholders, were anxiously

awaiting release of their share certificates. Mr. Unsworth and Ms. Kachafanas are

both accountants and, in 1999-2001, were partners at the same accounting firm in

Sydney, Nova Scotia. Mr. Unsworth testified that he started doing business with

Stewart McKelvey in 1971 and, several years later, was referred to Blois Colpitts.

Mr. Colpitts did a lot of work for Mr. Unsworth’s clients and the two men became

friends. It was through that friendship that Mr. Colpitts asked Mr. Unsworth to

invest in the KHLP. Mr. Unsworth spoke to Ms. Kachafanas about it, and they

agreed to each contribute to the purchase of an LP unit. Mr. Unsworth paid

$110,000 and Ms. Kachafanas paid $40,000. Mr. Unsworth financed his portion

with a loan, while Ms. Kachafanas used partner capital.

[245] George Unsworth testified that his expectation when he invested in

December 1999 was that the LP units would be converted one year later. In late

December 2000, when he signed the call option documents indicating that the

²⁴Clarke joint, Janine McInnis, Wadden accounts, Dan Potter, Union account, Colpitts joint account, and Clarke

RSP.

Page 72

shares would be held until June 27, 2001, he assumed that the share certificates

would automatically be sent to him on that date. When asked about his plans for

the shares, he testified that he intended to pay back the loan and then decide

whether to sell the other shares.

[246] Mr. Unsworth testified that when he did not receive his shares after June 27,

he called Blois Colpitts several times and asked where the shares were. When

asked what Mr. Colpitts told him, Mr. Unsworth testified:

Well basically put my – you got to remember we were friends, he basically just

said he would look into it or look in to try to find out where they were. To tell

you the truth I didn’t do enough research to realize he had the shares at the time. I

thought they were with a register or an agent other than him.

[247] Mr. Unsworth testified that he did not receive his share certificates until

2002, when they arrived in his mailbox. He did not know who sent them. By that

point, the shares were worthless.

[248] After George Unsworth finished testifying, Blois Colpitts approached him

outside the courtroom and made some relevant comments. The Crown learned of

the incident and recalled Mr. Unsworth. According to Mr. Unsworth’s testimony,

Mr. Colpitts had approached him while he waited for Ms. Kachafanas to return

from the washroom. He testified that Mr. Colpitts shook his hand, said he was

sorry for getting Mr. Unsworth “involved in this again”, and that his parting

comment was, “Well if I would have sent any of the certificates he would have had

me disbarred.” Mr. Colpitts then left on the elevator while Mr. Unsworth

continued to wait for Ms. Kachafanas. On cross-examination, Mr. Colpitts

suggested to Mr. Unsworth that he had actually said that “lawyers have to follow

client instructions or face disbarment” or words to that effect. Mr. Unsworth

disagreed, maintaining his version of the exchange.

NBFL cuts the KHI loan value

[249] Despite Dan Potter’s efforts to hold them off, NBFL cut the loan value on

KHI to 35%. Margin call letters were sent to Gerard McInnis, Craig Dunham,

Doug Rudolph and others. On July 23, 2001, Ken MacLeod e-mailed Dan Potter

saying he had just received a letter from National Bank telling him that he owed

them $280,000. He wrote, “Even if I can do something about this margin call, one

more of these and I’m definitely going to have to start selling KHI shares (no other

recourse??).” Dan Potter replied:

Page 73

I've been discussing the margin change with NBF and warned them not to be too

aggressive on timing with enforcing the change. I have received an undertaking

from the NBF senior management in Montreal that they will work with us -we

have set up a process whereby I have a telephone conference every two weeks

with one of their executives to report progress, etc.

You still need to work with Bruce to come up with your plan - but Aug 2 is not a

hard deadline for payment - hopefully, we can get some block sales of shares this

fall through the work we are doing with Michael Moe's firm (ThinkEquity

Partners) - no guarantee but it's part of the plan.

Bruce and Blois are working with me on the NBF file, so I'm copying them on

this to keep them in the loop.

Thomas Hickey invests

[250] At the end of July, Thomas Hickey invested in KHI on Dan Potter’s

suggestion. Mr. Hickey’s company at the time, Frontline Safety, had an online

training component. He had read about KHI and its online learning capability in

the media and approached Dan Potter and Calvin Wadden to see if there might be

an opportunity for a joint venture in the online safety learning space. During their

discussions, Mr. Potter told him that KHI was a growing e-learning company and

exciting things were happening. He thought Mr. Hickey’s idea to potentially

partner or enter a joint venture with KHI was a good one. When Mr. Hickey was

asked whether Mr. Potter had any discussions with him about the financial state of

the company prior to his investment, Mr. Hickey answered:

Everything was rosy in all of the discussions. There was no discussion that they

were in financial duress.

[251] On July 30, 2001, Mr. Hickey purchased 10,000 shares at $5.10 per share.

Within two to three weeks of his purchase, the share price dropped down to about

30 cents. He estimated his losses at between $40,000 and $50,000.

Trade volumes and share price for July 2001

[252] The stock opened on July 3 at $5.15 and closed the day at $5.15. For the

rest of the month, the stock price dipped below $5.00, trading down to $4.25,

before rebounding and closing the month at $5.34. In July 2001, 88,149 KHI

shares crossed the Exchange. Suspect accounts spent $146,432.50 and bought

32% of the shares. Although the Janine McInnis account spent $2,655 buying

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shares, Gerard McInnis testified that, again, Bruce Clarke made these purchases

without his authorization. There were no alleged high closes in July.

The demise of KHI

[253] On August 13, 2001, Leon Trakman, an LP unitholder, e-mailed Chris Smith

at KHI requesting his share certificates. Mr. Smith forwarded the e-mail to Dan

Potter, writing:

FYI – he called me directly today and wanted to know how/when to receive his

share certificates.

I asked him to send me an email with clear directions, which he has now done.

[254] On August 16, before Mr. Trakman received his share certificates, ITI, Mr.

Potter’s former company, announced that it had gone into receivership. This

caused the ITI share price to plummet, triggering margin calls for several ITI

shareholders who also held KHI. Making things worse, on August 17, KHI

announced it had entered an agreement with IBK Capital Corp of Toronto to raise

up to $5 million by way of private placement of common shares or other securities.

The news was not favourably received, and shareholders began aggressively

selling their shares. The result was a collapse from a closing price of $5.10 per

share on August 16 to $0.33 per share on August 31.

[255] On August 21, as KHI share prices fell, Lowell Weir e-mailed Bruce Clarke

in relation to his January 19, 2001 e-mail ordering him to sell KHI if the price

dropped below $5.00. He asked Mr. Clarke what action had been taken pursuant to

the order. Mr. Clarke replied, in part:

Lowell in refrence [sic] to your e-mail of Jan 19/01, 30 days is the norm to hold

an order interest, at the end of which time it has to be re-discussed – no such

discussion occurred. During the time frame of Jan 19/01 to Feb 20/01 the last sale

on the stock had a range of a low $5.05 and a high of $5.80.

Mr. Weir responded:

The email was direction given with regard to this investment which was

recommended by NBF and was not specific to a thirty day period. The order of

March 28 was I believe margin selling by you. The april 18 order was a specific

order.

For Enervision’s account can you provide me the loss on the Anitech and

Knowledgehouse shares which are under guarantee from you and Blois.

Page 75

[256] In late August, Leon Trakman and Dan Potter exchanged e-mails in relation

to KHI’s failure to deliver his share certificates in June 2001. On August 25, Mr.

Trakman responded to an e-mail from Dan Potter, writing in part:

I have received your e-mail. We agreed that this matter would be resolved today. I

am concerned that you are now requesting more time.

Nevertheless, I am willing to accept resolution of this matter by the receipt of

your certified cheque for $150,000 by noon Monday, to remediate your failure to

duly issue my shares.

The personal liability of the directors is in issue.

[257] On August 27, Dan Potter advised Mr. Trakman that the matter had been

turned over to the company’s lawyers and that Mr. Trakman’s lawyer should

contact them. On August 29, Dan Potter forwarded the chain of e-mails exchanged

with Mr. Trakman to Blois Colpitts and wrote:

We need to be careful about this [sic] guys - they could go to the TSE or

Securities Commission if we do not give them a lawyer to talk to!! Neither you or

I need that!

[258] Although the company tried to stay afloat with a loan from Fiona Imrie, on

September 13, 2001, KHI announced that it was unable to continue its operations

due to a lack of available financing. Unable to make payroll, the company closed

its doors.

Losses to investors

[259] When the KHI stock price collapsed, David Fountain lost $3 million. Jim

Wilson and Staffing Strategists lost $338,000. Derek Banks lost $1.1 million. Dr.

Lutz Ristow lost $1,625,000. Ben Barthe lost $3,325,000. The Union account lost

$849,000. Lowell Weir and his wife, Carol McLaughlin-Weir, estimated their

losses at $500,000. George Unsworth and Kiki Kachafanis lost a combined

$150,000. Thomas Hickey lost $50,000.

[260] The Court heard from numerous other investors who lost their investments

when the KHI stock price collapsed. I will review some of them below.

[261] John Atkinson is an electrical contractor who knew Ray Courtney and Jack

Hill. He described Mr. Hill as a “close personal friend”. Mr. Atkinson first met

Ray Courtney when he and Mr. Hill wired some schools for internet and LAN

Page 76

systems in 1999 and 2000. Mr. Courtney and Mr. Hill recommended that Mr.

Atkinson invest in KHI shares, telling him that KHI was “the next best thing

going”. He said he was “extremely nervous” about taking money out of his RRSP,

but he saw that KHI “went from the Montreal Exchange up to the Toronto Stock

Exchange” and the stock price “kept going up a little bit and up a little bit and it

seemed like it was going places.” He purchased 17,000 shares and estimated his

losses at close to $110,000.

[262] Michael MacIntyre heard about KHI through the media. He testified that the

company seemed to be doing well and had a government contract in the works, so

he called his broker in October 2000 and purchased 2,390 shares for himself and

for his children’s RESP. He lost $16,494.89.

[263] Darren Mitchell is a financial advisor. He purchased 3,000 KHI shares in

his wife’s name in October 2000 on the advice of his stock broker, Shirley Locke.

He estimated his losses at $20,000.

[264] Kathy Holman is a Judicial Assistant in Pictou, Nova Scotia. She purchased

shares on the recommendation of her best friend and stock broker, Shirley Locke.

She lost $21,700.

[265] Douglas Humphreys was Shirley Locke’s client. Ms. Locke had

discretionary trading authority over his account. He testified that he had no

investment knowledge and relied on her for advice and decisions. He invested at

least $63,000 in KHI and testified that he lost “probably” all of it.

[266] John Groves is a retired businessman who met Dan Potter shortly after

moving to Nova Scotia in 1998. Mr. Potter encouraged him to open an account

with Bruce Clarke and to invest in KHI, so he did. He bought 20,000 shares at

various points in 1999. He watched the stock rise and thought at times that he

should sell. Bruce Clarke always advised against it, telling him that the stock was

going to go much higher. Mr. Groves further testified that he also spoke to Dan

Potter about selling his shares several times, and Mr. Potter told him that “things

are going good” and “I think you should hang in there and go back and talk to

Bruce.” He did not sell any shares. His wife bought and sold shares and lost

around $16,000. Mr. Groves’ loss was not calculated.

[267] Michael Mahoney was a partner in J.R. Mahoney Ltd., a commercial

refrigeration and restaurant equipment business. He sold his share of the business

in 1999 for $300,000 and invested most of it. He bought KHI on the

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recommendation of his investment advisor, Bruce Clarke. Mr. Mahoney testified

that he had a lot of difficulty getting Mr. Clarke to sell KHI shares. When he

indicated that he wanted to reduce his position, Mr. Clarke would “stonewall” him,

telling him that a big announcement was coming and he should not sell his shares.

Other times, Mr. Clarke convinced him to sell other holdings instead. In June

2001, Mr. Mahoney told Mr. Clarke that he needed some cash to finance a three or

four-week motorcycle trip. Mr. Clarke recommended that instead of selling KHI,

he should sell some of his other stocks, like Harley Davidson. According to Mr.

Mahoney, Mr. Clarke eventually convinced him to borrow on his shares to pay for

his trip. When he returned, the stock price plummeted, and he lost approximately

$33,000.

[268] Michael Chambers works for a plumbing and heating wholesaler in

Bridgewater, Nova Scotia. In late July 2001, he received a call from his

accountant, Doug Rudolph, recommending that he invest his pension money (about

$60,000) in KHI. Mr. Chambers testified that he had thought his RRSP was locked

in, but Mr. Rudolph advised him to move it into Royal Bank Direct, which he did.

He gave Mr. Rudolph authorization to invest the money in KHI. On July 31, 2001,

Mr. Rudolph invested $56,000 in KHI shares on his behalf. Mr. Chambers lost it

all when the stock collapsed two weeks later.

[269] Every individual investor who testified at trial said that they would not have

invested in KHI stock if they had known that the stock price was being

manipulated.

[270] The Court also heard evidence from representatives of three major financial

institutions in relation to amounts either lost or put at risk by extending margin to

the alleged conspirators and others holding KHI stock. Jean-Francois Hamel, the

Associate Vice-President of Credit and Market Risk with Toronto Dominion

(“TD”) Financial Group, testified that TD loaned $800,000 against KHI stock to

three accounts (Calvin Wadden, Ray Courtney, and Jack Hill). After the stock

collapsed, TD managed to recover $105,000, resulting in a loss of $695,000.

[271] Bruno Falvo, a risk analyst at BMO NB, testified that BMO risked at least

$2,558,552.93 by loaning on margin secured by KHI stock. He did not testify as to

how much of that loss was recovered. Charyl Galpin, Chief Admin Officer and

Chair of the Risk Management Committee, testified that the bank would not have

loaned on margin had it known about a manipulation scheme.

Page 78

[272] The largest institutional losses were suffered by NBFL. The exact amount

of money NBFL put at risk through their margin loans to Mr. Potter, Mr. Colpitts,

Mr. Clarke, other alleged conspirators, and all other investors who margined KHI

stock, is not before the Court. However, on July 28, 2000, Mr. Clarke provided an

analysis of NBFL accounts holding KHI to Guy Roby and other managers at

NBFL. In it, he identified 26 margin accounts with a total outstanding debt of

$6,500,242. Anne Goudreault, senior auditor at National Bank of Canada, reported

that NBFL “recorded a bad debt provision of $6 million in its September 30, 2001

Financial statements” in relation to the bank’s KHI-related losses. Germaine

Carrière was shown several communications that he described as evidence of

manipulation, and said the information would have affected NBFL’s decision to

advance loans against KHI stock.

[273] The Crown calculates the “total calculable fraud” against individual

investors at $11,880,939.49. It submits that financial institutions were defrauded

of at least $9 million, resulting in a total fraud amount of over $20 million.

Effect of trading by suspect accounts on the KHI stock price during entire period

under review

[274] Langley Evans testified that, in preparing his report, he looked at the KHI

share price and observed that it seemed to significantly outperform market indices

over the period in question. He then reviewed KHI’s public disclosures to

determine whether the company’s operating results could explain the stock’s

comparatively superior performance. He found no explanation in the disclosure.

In his report, Mr. Evans noted that, “KHI’s operating results were poor and its

financial position deteriorated, especially in the latter half of 2000 and throughout

2001.”

[275] Having found nothing helpful in the disclosure, Mr. Evans reviewed the

documentary evidence provided by the RCMP and found what he considered to be

ample evidence to explain the stock’s superior performance. He cited numerous

manipulative indicators that he believed were used to affect the price for KHI

shares, including high closings, buy-side domination, use of nominees, parking

stock, providing undisclosed incentives, suppressing selling activity, and non-

disclosure of material changes. He found these indicators in the communications,

the trade data, account statements, and witness statements. At paras. 236-239 of

his report, Mr. Evans outlined his opinion as to the impact the suspect account

group’s actions had on the KHI stock price:

Page 79

The Group’s initial actions in the first few months of the period under review did

not have an immediate or dramatic effect on the KHI stock price. At the early

stages from December 1999 up [to] the end of March and into early April 2000,

the excitement of the new listing on the TSE, combined with the optimistic

market environment and the release of encouraging financial results by KHI, is

sufficient to provide reasonable explanations for the observed trading price of

KHI shares on the TSE.

However, beginning in mid-April 2000 and certainly by May 2000, the Group’s

actions began to affect the KHI stock price, and from that point forward, had a

cumulative and growing impact on the price of KHI shares as traded on the TSE.

From May 2000 onwards, there was a diminishing general market interest [in]

KHI. From November 2000 onwards, KHI was under increasing internal

financial pressure with losses from operations and an inability to raise sufficient

capital. The Group was able to stabilize the KHI market price and hold it at

artificially high levels while both the general tech market collapsed and KHI’s

operations also deteriorated. The actions of Group were successful in this regard

until the KHI price collapse in mid-August 2001.

Defence Evidence

[276] Blois Colpitts called 18 witnesses, including himself. The bulk of these

witnesses were individuals who worked at NBFL within the credit and compliance

departments, or who were otherwise in a position to oversee the performance of

Bruce Clarke. Mr. Colpitts’ apparent objective in calling these witnesses was to

establish: 1) that NBFL did not properly supervise Bruce Clarke; 2) that the

mechanisms in place to identify and address inappropriate or unlawful behaviour

were deficient; and 3) that NBFL caused or contributed to the demise of KHI by

advancing too much margin, allowing too much concentration, and loaning shares

for shorting purposes after cutting the margin rate. During closing submissions,

the defendants argued that NBFL came up with the market manipulation

allegations, after the stock price crashed, to deflect attention from its own failures.

[277] The position of the Crown, with which I agree, is that the evidence of these

witnesses is not responsive to the charges against the defendants. The Crown

advised the defendants before Mr. Colpitts opened his case that it was willing to

admit NBFL had failed to properly supervise Bruce Clarke. Further, the possibility

that NBFL’s actions caused or contributed to the demise of KHI is inconsequential.

Whether KHI collapsed or prospered is irrelevant to whether the defendants

artificially maintained the share price during the indictment period. The

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defendants’ attempt to shift blame onto NBFL is misguided and I see no benefit to

reviewing the evidence of these witnesses in any detail.

[278] In addition to the NBFL witnesses, Blois Colpitts called Dr. Bernard

Schelew, Shirley Locke, and Robert Peters. Much of Dr. Schelew’s time on direct

was spent recounting how and why he created Knowledge House Publishing

Limited and addressing the non-existent allegation that KHI was a “sham”

company. Again, the Crown was prepared to admit that KHI was a legitimate

company that developed real e-learning products and acquired real contracts. The

remainder of Dr. Schelew’s time on the stand was spent denying the Crown’s

allegation that he had been suppressed from selling his shares by Dan Potter and

Blois Colpitts. According to Dr. Schelew, he knew he could sell at any time he

wanted. He testified that there was no managed selling agreement and that he

never agreed to be part of any such agreement.

[279] Dr. Schelew testified that he decided to hold onto his shares because Dan

Potter reminded him of his moral and ethical obligations as the founder of a

developing company. He said Mr. Potter also informed him about the seller

overhang, and warned that even if he only wanted to sell 10,000 shares per week,

his selling would result in the other major shareholders dumping their shares onto

the market. According to Dr. Schelew, he realized that attempting to sell his

shares in that environment was not in his own best interests or the best interests of

the company.

[280] In relation to the alleged “KHI buying network”, Dr. Schelew explained that

he, Dan Potter and Blois Colpitts were doing nothing more than working to “take

the highs and lows out of the stock.”

[281] On cross-examination by the Crown, Dr. Schelew maintained his position

that he was not party to any managed selling agreement. When shown

communications from Dan Potter that suggested otherwise, he said they were

incorrect. He conceded, however, that he never responded to Mr. Potter in an

effort to disabuse him of this apparent misconception. When asked why his

October and November instructions to David Mack to sell 10,000 shares per week

were ignored, Dr. Schelew said that he never figured that out.

[282] Shirley Locke was an investment advisor and branch manager of BMO NB’s

Halifax office, and a close friend of Blois Colpitts. Ms. Locke denied ever

discouraging clients from selling KHI. She further denied entering an agreement

with Mr. Colpitts or anyone else to maintain the share price of KHI. She denied

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entering orders late in the day for the purpose of high closing the stock. Ms. Locke

testified that she never worked with the defendants to have her clients buy KHI

shares that the defendants could not keep from coming to market. When asked

about her clients purchasing almost all of the shares sold by Anthony Phelips and

3027748 Nova Scotia Ltd. on January 6, 2000, she testified that it was entirely

coincidental. She explained that she was merely accumulating a position through a

block trade and had no idea who was on the sell side. When shown examples of

her clients entering the market soon after she received an e-mail from Eric

Richards looking for buyers, Ms. Locke denied encouraging her clients to buy in

order to help absorb sell-side pressure on the stock.

[283] Ms. Locke testified that in mid-July of 2000, Blois Colpitts informed her

that Calvin Wadden had threatened to dump all of his shares onto the market in

order to destroy the stock price and the company. She said Mr. Colpitts told her

that if BMO NB executed any order from Mr. Wadden to that effect, KHI would

file suit against it. She said she instructed Eric Richards that because they were

privy to inside information, neither of them could solicit orders on KHI or trade the

stock in their own accounts until the situation was resolved. Ms. Locke testified

that she did not personally buy or sell KHI, or solicit clients to do so, until late

September 2000. According to her evidence, during July and August, she was

working with KHI to resolve the issues with Mr. Wadden. It was for this reason,

she said, that whenever Eric Richards informed her that he was selling KHI for a

client, she wanted Blois Colpitts and Bruce Clarke to know that BMO NB was not

selling for Mr. Wadden.

[284] Shirley Locke rejected the evidence of several investor witnesses. She

denied that she called David Banks and requested loans for two KHI employee

investors who were having financial problems. She said it was “absolutely not

true” that she frequently encouraged Mr. Banks to purchase shares from Mr.

Wadden and Mr. Courtney. Ms. Locke also denied the evidence of both Derek

Banks and Dr. Ronald Haines that she made unauthorized purchases of KHI in

their accounts in August 2001, after the stock price began falling. Mr. Colpitts'

failure to put Ms. Locke’s versions of these events to the investor witnesses

resulted in objections under the rule in Browne v. Dunn. Mr. Colpitts’ decision

not to recall the witnesses makes it a matter of the weight to be given to Ms.

Locke’s testimony on these points.

[285] Robert Peters was an investment advisor and branch manager of the Halifax

branch of NBFL from January 1985 until September 1998, when he was replaced

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by Eric Hicks. Mr. Peters remained with the firm as an investment advisor

reporting to Mr. Hicks. Mr. Peters testified that in 1995, he sought and received

permission from NBFL for Bruce Clarke to maintain an orderly market in the

shares of ITI on the Montreal Stock Exchange. He referred to a memo Bruce

Clarke sent to him on October 6, 1995, that stated:

Over the next two or three months I intend to be a relatively active trader in the

stock listed on the Montreal Board called ITI Education Corp.

[286] Mr. Peters forwarded the memo to Guy Roby, then Vice-President of

Internal Audit and Compliance at NBFL, with a note that said:

Guy –

Here is Bruce Clarke’s memo on his “market-making” activities in ITI Education

Corp (Symbol: ITK on the ME). Hope this is satisfactory.

- Rob

[287] Mr. Peters testified that Bruce Clarke asked for two to three months because

this was a period of reorganization of Novatron into ITI. He stated that the market

for the stock “would have been extremely thin and subject to the possibility of

intense volatility without that activity of Bruce.” Mr. Peters said that this type of

“market making” by an investment advisor was rare, but did occur. Although the

memo referred to “the next two or three months”, Mr. Peters testified that Mr.

Clarke continued his market making in ITI beyond that time period.

[288] Mr. Peters testified that Bruce Clarke later asked for permission to carry on

the same “market-making” activities for KHI. He said the request was made orally

and that NBFL gave its permission in the same manner. In other words, there is no

documentary evidence of the arrangement. As with ITI, Mr. Peters understood that

Mr. Clarke would be providing the funds for the KHI market-making activities.

[289] Mr. Peters testified that he regularly monitored the 540 account, paying it

particular attention due to Mr. Clarke’s past disciplinary history. He testified that

he had a specific recollection that the 540 account contained a concentration in

KHI.

[290] Blois Colpitts was the last witness. He testified for 14 days. In 1999 to

2001, he was a partner at Stewart McKelvey Stirling Scales practicing securities

law with a team of six or seven lawyers working for him. He said he was doing

about 85% of the securities filings for out-of-province law firms that needed to file

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prospectuses with the Nova Scotia Securities Commission. In addition to his

practice, Mr. Colpitts sat on a number of boards of client-related companies. He

said his client base was “too big” and he “couldn’t keep up.” He estimated that he

received between 300 to 500 e-mails daily, and often only paid attention to those e-

mails that assigned him a task. According to Mr. Colpitts, he billed and collected

close to 3,000 hours per year. He often worked at night and slept very little.

Although these habits allowed him to earn a great deal of money, they had a

detrimental impact on his personal life.

[291] Mr. Colpitts testified that in 1999 and 2000, corporate finance firms wanting

to capitalize on the extreme market interest in technology stocks called his firm

almost daily looking for companies to take public. He said banks were falling over

themselves to lend and hundreds of prospectuses were getting clearances in Nova

Scotia. The dot-com crash brought all of that to a halt. He testified that KHI was

not the only victim of the market correction. To the best of his recollection, only

two companies that were elevated from the Montreal Stock Exchange to the

Toronto Stock Exchange managed to survive.

[292] Mr. Colpitts said that lawyers at Stewart McKelvey were encouraged to own

shares in their client companies and to assume directorships as a means of bonding

with clients. To that end, he joined the KHI Board of Directors. In 1999 to 2001,

in addition to his role as corporate counsel, Mr. Colpitts was Lead Director and

Chair of the Audit Committee of KHI. He also held shares in the company. He

testified that he was a client of NBFL and BMO NB and he provided legal services

to each of those firms on financings of various public companies. He explained

that he gave business to those who did business with him, as a way to build his

practice.

[293] Blois Colpitts described KHI as a Nova Scotia success story from

approximately 1997 until its collapse in September 2001. He believed in the

company’s potential to revolutionize the public school system in Nova Scotia. Mr.

Colpitts attributed the company’s collapse to an “unforeseen confluence of internal

and external factors” including the general market environment where financing

dried up, the actions of NBFL, and the actions of insiders who treated their shares

in the small-cap company like cash to purchase houses, cars, boats, and so on.

Even after the collapse, Mr. Colpitts tried to revive the company, moving it to the

CDNX in February 2002.

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[294] Mr. Colpitts reviewed KHI’s acquisitions of Silicon Island, CD-Ed,

Micronet and Innovative Systems. Each transaction was structured in the same

way, with a Letter of Intent, a share purchase agreement, a five-year escrow

agreement and an employment agreement for each of the principals. Under the

escrow agreements, the principals were entitled to possession of their shares in

accordance with the following schedule:

It is agreed that the Escrowed Securities will be released from escrow on a pro

rata basis according to the following schedule:

(a) as to 10% thereof, two months from the date of this Agreement;

(b) as to 10% thereof, four months from the date referred to in (a) above; and

(c) as to 20% thereof on each of the first, second, third and fourth anniversaries of

the date referred to in (b) above.

[295] Calvin Wadden and Ray Courtney signed their escrow agreements on June

30, 1999. They would each acquire 1.1 million KHI shares in exchange for their

shares in Micronet. Using the Micronet acquisition as an example, Mr. Colpitts

explained that, according to the escrow agreement, Mr. Wadden and Mr. Courtney

would each receive 110,000 shares on August 31, 1999, followed by a further

110,000 shares on December 31, 1999. This meant that by the end of 1999, they

each had 220,000 shares free to sell. They would each then receive a further

220,000 shares on December 31, 2000, and every year thereafter until 2003.

Accordingly, after 4.5 years, Calvin Wadden and Ray Courtney would have each

received 1.1 million in freely tradeable shares.

[296] After completion of the acquisitions, Ken MacLeod, Donnie Snow, Calvin

Wadden, Ray Courtney, Steve Wilsack, and Craig Dunham were all employees of

KHI and subject to escrow agreements in respect of their shares. Messrs. Snow,

McLeod, Wadden, and Courtney were added to the Board of Directors. Messrs.

Wilsack and Dunham did not become directors because their purchase was

relatively small compared to the others.

[297] Mr. Colpitts testified that Mr. Wadden and Mr. Courtney were subsequently

provided with early releases from their contractual escrow agreements so that they

could deposit their shares into margin accounts. According to Mr. Colpitts, these

early releases were subject to a written undertaking that they would deal with the

shares “as if such shares remained subject to the terms of the Escrow Agreement.”

Mr. Colpitts exhibited an agreement entitled “Undertaking” that was signed by

Calvin Wadden on November 5, 1999. He said there would have been a copy

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signed by Mr. Courtney, but he was unable to find it. Mr. Colpitts testified that

Craig Dunham and Steve Wilsack also had their shares released early, subject to

similar agreements to work with the company to sell in an orderly fashion. He

denied suppressing sales by any of these individuals, emphasizing that the

company had done them a favour by releasing the shares early.

[298] Mr. Colpitts testified that in early 2000, he learned that Charlie Keating was

interested in investing in KHI. When Mr. Keating called him, Mr. Colpitts put him

in touch with Dan Potter. At some point thereafter, it was decided that Mr.

Keating’s $6 million investment would be used to take Donnie Snow out of the

company. Mr. Keating then joined the KHI Board of Directors.

[299] Blois Colpitts testified that for the first half of 2000, he did not pay much

attention to the stock market. His primary focus was on his practice which was

“spiralling upward out of control.” He said that it was not until mid-2000 that he

focused on KHI-related issues. On June 1, he attended the annual general meeting

where he met Ben Barthe, who was contemplating an investment in KHI. Later,

one day in July, Mr. Colpitts received a phone call from the receptionist at his firm

advising that he had visitors. He said Dan Potter, Calvin Wadden, and Eric

Richards were waiting for him in reception. They moved to a more private area

where Calvin Wadden threatened to crash the stock if Mr. Potter did not purchase

all of his shares. According to Mr. Colpitts, Mr. Wadden complained that he and

Ray Courtney were not being treated equally, and said that he had “tipped” his

friends to sell their stock before he crashed the company. (Mr. Colpitts alleged in

his testimony that “tipping” would be an offence under securities legislation.)

[300] Mr. Colpitts said it was during this meeting that he learned about the transfer

of the Wadden and Courtney margin loans to BMO NB when Eric Richards joined

the firm. He understood from the meeting that the shares had been heavily

margined because Mr. Wadden was building a house and a cottage and otherwise

spending like a “real millionaire”. Mr. Courtney had also borrowed heavily

against his shares.

[301] Mr. Colpitts testified that he was upset with Mr. Wadden’s behaviour and, as

Lead Director, he found himself in a difficult position. He called Shirley Locke

and explained that KHI would hold BMO NB accountable if it facilitated the

dumping of Mr. Wadden’s shares. He had lawyers at his firm prepare an

injunction application against Mr. Wadden, which ultimately proved unnecessary.

Mr. Colpitts began negotiating with Brian MacLellan, Mr. Wadden’s counsel, and

Page 86

reminded him of his client’s fiduciary duties as a director of KHI. Mr. Colpitts

testified that during these negotiations he first learned of the existence of the 540

account and the 100,000 shares Mr. Wadden had loaned to Bruce Clarke “for his

market-making activities.”

[302] Mr. Colpitts testified that while he was negotiating with Mr. MacLellan, he

was also working with Derek Banks and Ben Barthe to facilitate their investments.

He explained that, although Mr. Banks had initially understood he would be

purchasing shares directly from Calvin Wadden and Ray Courtney, the deal was

restructured because Mr. Banks wanted it to include options offered at a discount.

According to Mr. Colpitts, options could only be granted on unencumbered shares.

Since Mr. Wadden and Mr. Courtney had margined their shares, it was agreed that

Mr. Banks would purchase his shares from Dan Potter’s RRSP instead.

[303] According to Mr. Colpitts, Ben Barthe was also interested in some form of

discount. For this reason, he said, the Barthe deal changed from treasury to a

purchase on the Exchange. Mr. Colpitts testified, however, that the transaction

with Mr. Barthe was supposed to be executed in the same manner as that with Mr.

Banks – a purchase of shares from Dan Potter’s RRSP at a specific price per share.

He testified that Bruce Clarke instead went rogue, ignoring the term sheet, and

used Mr. Barthe’s investment to purchase shares at various prices from various

people. Mr. Colpitts testified he did not know that the transaction had been carried

out in this manner until he saw the Match Trade Report. He described the trades

listed in the MTR as “a surprise to me” because there should have only been one

trade – a single purchase by Mr. Barthe of 250,000 shares at $6.80 per share from

Mr. Potter’s RRSP. Mr. Colpitts testified that by carrying out the trades the way

he did, Bruce Clarke deprived Mr. Potter of $1.7 million in proceeds.

[304] Mr. Colpitts stated that his evidence in relation to the Barthe transactions is

particularly important because he is alleged to have sold 73,300 shares into the

Barthe deal. He referred to a fax dated August 29, 2000, from Bruce Clarke to

Wayne Mitchell, the head of the trading desk at NBFL, that stated:

Wayne, for my client: Blois Colpitts A/C 81-CDAE-7 I, first, will sell 73300 KHI

@ 6.55 to my buyer, A/C/ 81-D75A-7 – M. Barthe. Secondly, I will sell from my

personal A/C 00-8ANX-0, 43300 KHI @ 6.50 to Blois Colpitts A/C 81-CDAE-7

as per attached email. Please call me with your approval.

The fax attached an e-mail of the same date from Blois Colpitts to Bruce Clarke:

Page 87

I understand that you have pro status in National Bank Financial Inc. with respect

to KHI.

Nevertheless I hereby authorize you to buy for me 43,300 from your personal

account at $6.50.

[305] Mr. Colpitts testified that as of August 29, he believed that he would be

selling shares to Dan Potter, who was supposed to be in possession of the Barthe

proceeds. However, he received a call from Mr. Clarke, who requested that he

send the above e-mail consenting to the trade because Mr. Clarke could not reach

Mr. Potter. Mr. Colpitts testified that the whole transaction was a “complete

misrepresentation” to him by Bruce Clarke.

[306] Returning to the negotiations with Brian MacLellan, Mr. Colpitts testified

that the term sheets being passed back and forth contemplated the purchase of

1,473,000 shares from Calvin Wadden, Andrea Wadden, and Mr. Wadden’s

company 3019620 NS. Ltd., along with an additional 100,000 shares “owned by

certain other shareholders of KHI”. Mr. Colpitts testified that the additional

100,000 shares were intended to include the shares of Steve Tsimiklis, one of the

shareholders that he said was “tipped” by Calvin Wadden. In relation to Mr.

Wadden’s shares held by the 540 account, Mr. Colpitts testified that he met with

Eric Hicks and Bruce Clarke to get the story behind that transaction. He admitted

that he later prepared the letter for Mr. Clarke but denied that he was representing

the 540 account.

[307] Mr. Colpitts testified that on August 25, he received word that Calvin

Wadden wanted to “bury the hatchet” and the negotiation of term sheets ended.

Mr. Colpitts said that despite Mr. Wadden’s reconciliation with Mr. Potter, his

apology to the Board of Directors and his retention by KHI as a consultant, Mr.

Colpitts always remained suspicious that Mr. Wadden was selling shares through

accounts at other brokerages. He testified that it was for this reason that he sent e-

mails to people like Shirley Locke requesting help in identifying sellers on the

market. He denied that Ms. Locke ever worked with him or anyone else to

artificially support KHI stock.

[308] According to Mr. Colpitts, there was never a managed selling agreement.

He described Mr. Potter’s comments to the contrary as “wishful thinking”. Mr.

Colpitts testified that no agreement was disclosed because no agreement was ever

executed. In his view, however, a managed selling agreement would demonstrate

that the major shareholders were committed to the future of the company and

would be favourably received by the investing public.

Page 88

[309] In response to the allegation that the suspect account group was propping up

the share price in advance of the Barthe/Ristow private placement closing in

November 2000, Mr. Colpitts testified that “price protection” or “price

stabilization” in advance of a public offering, including a private placement, is

normal.

[310] Mr. Colpitts moved on to address the option agreement he prepared in

February 2001 between Dan Potter and Steve Tsimiklis. He testified that there was

nothing improper about the agreement because Steve Tsimiklis was one of the

individuals that Calvin Wadden told to sell their shares before he torpedoed the

stock. In other words, sales by someone who had been “tipped” would not reflect

genuine supply and demand.

[311] On the issue of the contractual hold period on the KHLP shares, Mr. Colpitts

emphasized that LP unitholders were only entitled to shares if KHI decided to

acquire the LP. There was never any guarantee that the company would elect to

exercise the call option. He claimed that in recommending a hold period, he was

simply trying to ensure that nothing harmed the public market of the company.

[312] In relation to the “warrant swap” in April 2001, Mr. Colpitts testified that

warrants expire, and once that happens, they are useless. He pointed out that the

warrant swap transactions put money into the treasury of KHI.

[313] Mr. Colpitts denied that he intentionally withheld share certificates from LP

unitholders following expiration of the hold period on June 27, 2001. He exhibited

an “FYI” e-mail he received from Dan Potter on July 18, 2001. Attached was an e-

mail from Chris Smith advising Mr. Potter that he was receiving requests from LP

unit holders for delivery of their share certificates. Mr. Smith wrote, “I know that

you would like to maintain some level of control over these shares, so please

advise how you would like me to handle these questions and requests.” In

response to Dan Potter’s “FYI”, Mr. Colpitts wrote, “What should we be doing.”

Mr. Potter replied:

I’d say that I send out a letter advising that the shares are now out of escrow and

will be forwarded to each holder as per their individual instructions – to be sent to

Chris Smith (who will compile them [sic] these instructions and forward them to

SMSS for action).

In my letter I will state that the [sic] in the current market conditions, they cannot

achieve liquidity, etc and that if [sic] wish to sell at some point it is advisable to

contact us to engage us so that we can help facilitate liquidity.

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What do you think of this?

[314] Mr. Colpitts testified that the matter slipped through the cracks and Mr.

Potter never sent the letter. Mr. Colpitts explained that the company’s failure to

issue the certificates reflected poorly on him, so he purchased Leon Trakman’s

claim against KHI for $110,000. Mr. Colpitts testified that he also bought the

claim of his law partner, Thomas MacQuarrie, for $38,000.

[315] Finally, in relation to allegations of high closing by Bruce Clarke, Mr.

Colpitts testified that he trusted that Mr. Clarke and NBFL were operating within

the rules at all times. He testified that when he saw an e-mail chain that suggested

Mr. Clarke and others were attempting to move the stock price up to $5.50, he

asked Mr. Clarke if he was following all the rules; Mr. Clarke told him that NBFL

had five levels of compliance and that he should stick to practising law.

Defence submissions on the reliability of the Crown’s evidence

[316] Although the defendants did not present a joint defence, Blois Colpitts

adopted Daniel Potter’s submissions in relation to alleged deficiencies in the

Crown’s case. According to the defendants, these shortcomings mean that the

Crown’s evidence against them is completely unreliable.

The Evidence of Ian Black

[317] Ian Black is an RCMP investigator who, at the time of the investigation, had

23 years of investigative experience, nine of those exclusively in commercial crime

investigations. He was also a licensed investment advisor and worked in the

industry for three years. Mr. Black was tasked by the RCMP with preparing a buy

and sell analysis for KHI shares for the relevant period. Mr. Black relied on the

Match Trade Report, trading information from the TSX, monthly portfolio

statements, e-mails from KHI servers, and witness interviews. The end result of

his efforts is Exhibit 62 – a binder with 31 tabs containing spreadsheets and charts

analyzing the trading in KHI from January 2000 to August 2001.

[318] Daniel Potter challenged the reliability of Mr. Black’s evidence at paras. 61-

63 of his post-trial brief:

It is clear that Mr. Black, almost from the moment he was hired on contract in

2004, determined that there was a conspiracy to illegally affect the price of KHI

shares by creating an artificial price. He then spent several years attempting to

confirm that theory without considering any purpose other than to create an

Page 90

artificial price for the trading in KHI shares. Mr. Black’s lack of understanding of

and experience in the capital markets was evidence [sic] throughout.

Even more problematic is the “analysis” conducted by Mr. Black which includes:

1) deciding which accounts to label as “suspect” or “control group” accounts; and

2) determining which trades should be considered by the Court to be illegal high

closings and therefore evidence of a conspiracy to unlawfully affect the public

share price of KHI shares.

The composition of the group of controlled accounts is not a decision that Mr.

Black can make. It is only after hearing all of the evidence that the Court must

then determine which accounts, if any, to include for the purposes of looking at

trading patterns. …

[319] Mr. Potter proceeded to argue at length that it is not even clear from the

evidence which accounts have been included in Mr. Black’s calculations or why

they have been included.

[320] I agree with Mr. Potter that it is for the Court to decide which accounts, if

any, to include for the purpose of looking at trading patterns. I further agree that

the mere fact that Mr. Black referred to a trade as a “high close” does not, without

more, establish that a late-day uptick involving a suspect account amounted to a

high close.

[321] I disagree, however, that there is any confusion about which accounts have

been included in Mr. Black’s calculations or why they have been included. As the

Crown explained in its post-trial brief, Mr. Black established a group of individuals

that he suspected were involved in the manipulation of KHI stock (the “control

group”). Next, he compiled a list of brokerage accounts that were either controlled

by these individuals or could be influenced by them. Using that list and the trading

data, he established a list of “suspect accounts” that were used to buy KHI shares

at various times. Some of these accounts were directly controlled by members of

the conspiracy (e.g., Calvin Wadden controlled accounts at NBFL, BMO, TD and

Yorkton Securities). Other accounts were used by members of the conspiracy

when needed (e.g., Clarke’s use of the Union and Enervision accounts). Finally,

others were included in the “suspect Account” group because the objective

evidence demonstrated that some trading by these accounts was done at the request

of, or in conjunction with, a member of the alleged conspiracy (e.g., Meg

Research).

Page 91

[322] Ian Black was a credible witness who gave his evidence in an honest and

forthright manner. I find that, on the whole, Mr. Black took a conservative

approach to his investigation. When he was in doubt as to whether to include

certain trades in his calculations, he erred on the side of the defendants by

excluding those trades from his analysis. A decision by this Court to adopt or

reject any of his conclusions does not undermine the usefulness of the materials he

prepared. Several of his charts and spreadsheets –particularly the colour-coded

“MTR Reduced”, the “Summary of Daily Trading on the TSX”, and “Suspect

Account Buying of KHI Shares on the TSX” (Exhibit 66) – were of assistance to

the Court in drawing its own inferences from the evidence.

The Evidence of Langley Evans

[323] I will now address the defendants’ criticisms of Langley Evans. Mr. Evans

is currently the manager of the Special Investigations Unit at the British Columbia

Securities Commission. He is a chartered accountant who has been employed as a

regulator in the investment industry since 1984, primarily with the Vancouver

Stock Exchange and then with the British Columbia Securities Commission. He

has held positions in investigations, enforcement and regulation, both in the field

and in management. Daniel Potter criticized Mr. Evans’ evidence at paras. 26-28

of his post-trial reply brief:

The Crown argues at paragraph 664 of its brief that “[i]t is hard to imagine a more

qualified expert in matters related to Canada’s capital markets.” From Mr. Evans’

evidence and his superficial report, it is hard to imagine anyone less helpful than

Mr. Evans to provide the Court with assistance in this case. The Crown’s theory

is entirely dependent on Mr. Evans. The Crown has referred to him almost 300

times in its brief.

The Crown attempts to downplay the significant deficiencies in Mr. Evans’ report

by stating that all he did was make “two mistakes”. He did not conduct the

analysis he said he did and he did not understand how margin is calculated. In

Mr. Potter’s submission, these are more than just mistakes and Mr. Evans’

opinion cannot be used to convict someone of a crime.

The Court cannot trust Mr. Evans’ work. Not only is it riddled with errors, it

deliberately omits any analysis of information that may not support the Crown’s

theory and presents conclusions that are deliberately misleading. …

[324] The first of the two errors referred to by Mr. Potter was acknowledged by

Mr. Evans on his first day of testimony. In preparing his report, Mr. Evans

consulted investigation reports prepared by Dean Holley, his former colleague at

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the British Columbia Securities Commission, and adopted portions for his own

report. Mr. Evans’ reliance on these reports was clearly disclosed at page 2 of his

own:

I have consulted reports on manipulative trading by other experts and have relied

heavily on some of their materials for the contents of paragraphs 19 through 49 of

my report. Where opinions are expressed in those sections, I agree with them and

adopt them as my own.

[325] Paragraphs 19-49 consist of an overview of the Toronto Stock Exchange and

an explanation of various manipulative trading techniques. Mr. Evans testified that

his analytical approach, as set out on page 3, was also largely derived from one of

Mr. Holley’s reports:

In the analysis that follows, I have examined a variety of factors including:

(a) the timing, price and volume of the orders entered by the related accounts;

(b) the circumstances that existed in the market at the time of the relevant orders

and transactions, such as:

 the current quotation for the security

 the volume of securities bid or offered

 the previous trade price

 the trading volume prior to the trade

 the market price in relation to the previous day’s closing price

 general market conditions

 market conditions in the same industry segment as KHI

 corporate announcements by KHI

(c) the impact the orders had on published quotations (bid and offering prices)

and market prices (prices of actual trades);

(d) the impact the orders and transactions had on the holdings of the related

accounts, including the status of any margin loans held among the Group; and

(e) the impact other non-trading actions by the Group had on the market for KHI

shares.

[326] After arriving in Halifax to testify, Mr. Evans realized that he had forgotten

to remove the references to order information, which he did not consider in his

own report, from Mr. Holley’s list. Order information would establish, for

example, the precise time an order was entered into the system, the type of order

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placed (market vs. limit, for example), the volume of shares ordered at any given

time and whether the order was filled or cancelled. The defendants argue that

order information is essential to proving manipulative intent and that Mr. Evans’

failure to consider it means the Court cannot rely on his report.

[327] Market manipulation takes many forms. Order information is clearly vital to

market manipulation cases based largely or entirely on allegations of high closing,

particularly where the timing of the trades is the only evidence of an intention to

high close the stock. The Holley reports that Mr. Evans relied on were admitted at

trial. Both were prepared at the request of the Alberta Securities Commission for

use in cases where the only manipulative technique alleged was high closing.

While high closing is alleged in this case, the defendants also stand accused of

using other techniques, including market domination, sales suppression, parking

stock, incentives, and non-disclosure of material information. Order information

would not be helpful to prove most of these techniques. Furthermore, Mr. Evans

pointed out in his report that the evidentiary record in this case was quite unique

and “rich with manipulative indicators.” When asked what he meant by this, Mr.

Evans testified:

The investigation record that I was presented with, the trading material, the

communications amongst the parties, their account statements, etc., was quite

unique in my experience. I haven’t seen or considered a manipulation that had

this many types of techniques at play and quite a spectrum, some of them are

quite subtle, some of them I think are quite blatant, and they also evolve over

time, depending on resources available, but the agenda seems to be quite

consistent throughout.

[328] With respect to high closing, order information could confirm whether

Bruce Clarke was the active participant in a late-day trade that upticked the stock.

Said differently, the order information would show whether Bruce Clarke entered a

late-day bid to hit an existing offer and high close the stock, or the seller entered

the market at the end of the day to hit Mr. Clarke’s pre-existing bid. Only the first

scenario could amount to a high close by Mr. Clarke. Mr. Evans testified that he

did not need order information in this case due to the “very strong pattern” of high

closing, and the sheer number of incidents:

… [t]he Match Trade report without consulting the orders seems to me to present

a very strong pattern of high closing. And there’s a hundred and twenty events

that are potential high closing of which I think at least 90 are quite significant and

formulate a pattern and where they didn’t formulate a pattern I tended not to give

them any weight in the report.

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[329] Furthermore, the Crown is not relying entirely on Mr. Evans or Mr. Black to

prove high closing by the defendants. It also relies on e-mails that it says disclose

a clear intention to high close the stock.

[330] Finally, the defence suggests that order information is relevant to the

allegation of market domination. Order information would show the volume of

shares ordered by an individual suspect account at any given time. The defendants

point out that where the Match Trade Report shows an account trading several

times in a single trading day, it is impossible to know whether those purchases

represent individual orders or a single large order being filled over several days,

weeks or months. Said differently, instead of trading in response to reports of sell-

side pressure, a suspect account that appears in the MTR may have placed a large

order for legitimate investment purposes weeks or months earlier. For reasons that

I will explain when I address the MTR, I do not find that order information is

necessary to prove market domination due to the uncontroverted evidence that KHI

was a highly-illiquid stock.

[331] The second error by Mr. Evans concerns his margin calculations. Mr. Evans

acknowledged on cross-examination that he had incorrectly calculated the margin

positions of individual accounts because he failed to consider the different rates of

margin that applied to different securities held in those accounts. That said, in

most cases, this error led to an overestimation of the excess margin available to the

suspect group. Mr. Evans also used a 50% margin rate for KHI throughout the

entire period, despite evidence that National Bank changed the loan value in

December 2000 from 50% to 70%.

[332] Although the defence made much of this error, I find it insignificant for two

reasons. First, Mr. Evans’ margin analysis was intended to show that margin

availability was one of several motives for maintaining the stock price at an

artificially high level. The Court has plenty of other evidence on margin

availability, including e-mails where the alleged conspirators are concerned or

complain about the lack of available margin, and e-mails from financial institutions

and Steven Clarke advising that accounts had fallen under margin. In other words,

Mr. Evans’ evidence that conspirators were motivated to keep the KHI share price

artificially high to avoid margin calls and increase buying power is corroborated by

numerous contemporaneous communications.

[333] Much time was spent at trial on the issue of the 50% vs. 70% loan value.

The evidence before the Court is clear – if NBFL increased the loan value to 70%

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in December 2000, the suspect group was not aware of it. Until June 2001, Steven

Clarke regularly prepared portfolio overviews for Dan Potter using a 50% margin

rate that he testified came directly from the NBFL computer system. Furthermore,

numerous e-mails exchanged by suspect group members reference a 50% margin

rate.

[334] Was Mr. Evans the perfect expert witness? Certainly not. The references to

order information should have been noticed long before trial, by both Mr. Evans

and the Crown. His report contained numerous typographical and mathematical

errors which reflected poorly on his attention to detail. After enduring cross-

examination in this trial, however, I suspect that Mr. Evans will be significantly

more careful in the future. That said, I am satisfied that his conclusions are

supported by other evidence – including statements by the defendants themselves –

and the Court can safely rely on his report.

The Match Trade Report

[335] A match trade report is a tool used by regulators and criminal investigators

to track the trading in a given security over time. The Match Trade Report for the

KHI investigation was prepared by Mehran Shahviri, a senior investigator for the

Ontario Securities Commission who has worked in the securities field for over 25

years.

[336] Both Mr. Shahviri and Langley Evans testified and were cross-examined on

the creation of the report, its uses, its strengths, and its limitations. Mr. Shahviri

explained that the MTR is the product of a match trading software program that

combined stock exchange data with broker data to generate a historical record of

the trading in KHI. Once the software generated its initial report, Mr. Shahviri did

an independent analysis of the broker data to verify the results, making

amendments where the software failed to make associations that it ought to have

made. Several years after completing the report, Mr. Shahviri did a “final check”

that involved reviewing the monthly statements of suspect account holders – where

available – to confirm the trading volumes reported in the MTR and on the TSX.

[337] The finished product admitted at trial is a 417-page trade-by-trade listing of

every transaction of KHI stock that took place on the TSX between December 6,

1999 and August 21, 2001. For each trading day, columns on the left side – the

“Buy Side” – identify the brokerage firm, the client who bought the stock and the

quantity of the stock. The centre columns identify the total number of shares

traded according to the TSX data, the time of the trade and the share price.

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Columns on the right – the “Sell Side” – identify the quantity of shares sold, the

name of the client who sold the stock, and the selling brokerage firm. Daily

trading totals are provided under the Buy quantity, TSX quantity, and Sell quantity

columns.

[338] In addition to the columns described above, there is a column on both the

Buy Side and the Sell Side with the heading “Unq.” This column attributes a

“uniqueness indicator” to each side of every trade. The uniqueness indicator

conveys to the reader how certain the software program is that the client it has

associated with a trade did in fact make that trade at that time. In other words, the

uniqueness indicator signifies to the reader the degree to which he or she can rely

on the report’s conclusion that a specific client purchased or sold a specific volume

of shares at a specific time on that trading day. Mr. Shahviri explained that where

two accounts at the same brokerage both purchased (or both sold) the same stock at

the same price on the same day, it is not possible to state with certainty which

account was involved in which trade. For example, assume that there were two

trades of 1,000 KHI shares at $5.75 in a single trading day by BMO NB accounts.

The TSX data shows one trade at 9:40:17 and one trade as the last trade of the day

at 15:59:00. The broker data identifies two clients who each purchased 1,000

shares on that day. In this situation, there is no doubt that each client did in fact

purchase 1,000 shares of KHI on that day, but it is impossible for the program to

say with certainty which account traded at 9:40:17 and which traded at 15:59:00.

[339] There are four possible uniqueness indicators – “T”, “=”, “S”, and a blank

(or no indicator). The “T” and the “=” are used where there is the highest degree

of certainty that the details of the trade as depicted in the MTR are accurate. For

example, assume the TSX data showed that on October 24, 2000, the brokerage

firm First Marathon had a client that bought 400 shares at 12:25:40 at a price of

$6.50. Turning to the brokerage data, the records at First Marathon showed that

there was only one client, Mr. Smith, who bought 400 shares at a price of $6.50 on

October 24, 2000. On that basis, it is safe to conclude that Mr. Smith was the

purchaser that should appear on the Buy Side of that particular trade on the TSX.

Accordingly, a “T” would appear beside Mr. Smith’s name on the Buy Side of the

MTR. It is important to understand that the “T” would apply only to the Buy Side.

The Sell Side has its own indicator. The MTR may be certain that Mr. Smith was

the purchaser at 12:25:40, but it may be less certain of the identity of the seller.

[340] The “=” indicator is used where there are multiple trades by the same

brokerage at the same price, but they were all done by the same client. For

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example, assume the TSX data shows three trades reported as sales by BMO NB.

All of them occurred at a price of $6.30 per share. If the brokerage data showed

that three different clients sold KHI at $6.30 on that trading day, it would be

impossible, without more information, to know who did which trade and when.

But assume instead that all three sales were done by Ms. Jones. In that case, it is

safe to conclude that Ms. Jones was the seller in all three transactions, and an “=”

would appear beside her name on the Sell Side of the MTR for each trade.

[341] The next uniqueness indicator is the “S”. An “S” is used where two suspect

accounts bought (or sold) KHI at the same price on the same trading day, but the

program cannot conclusively determine which trade came first in time. Since the

suspect accounts are alleged to have been working together to achieve the same

objective – maintaining the KHI stock price at an artificially high price – these

accounts can be treated as one for the purposes of the investigation. In other

words, it does not matter which of the accounts bought KHI stock at 10:15:06 for

$6.50 per share on a particular trading day and which bought at 11:30:13 for $6.50

per share. In these situations, an “S” would appear in the uniqueness column on

the Buy Side for each of the two trades.

[342] The final uniqueness indicator is the blank. Perhaps more accurately

described as “no uniqueness indicator”, a blank will appear in the uniqueness

column where more than one account from the same brokerage has purchased (or

sold) KHI stock at the same price on the same trading day. The blank signifies to

the reader that the account holder shown as the buyer (or seller) on a line of the

MTR cannot definitively be matched to the Exchange data on that line. A further

complication where a blank indicator appears is that the software may split the

trade. For example, the TSX data may show a single transaction involving 1,300

shares, while the MTR may show two trades – one for 1,100 shares and one for

200 shares. That said, no matter how the MTR splits the trades, the trade volumes

for each client will always be correct. If the broker data shows that Calvin

Wadden purchased 5,000 shares at $6.50 on a particular trading day, then Mr.

Wadden did indeed purchase those shares in that volume and at that price. The

only caveat is that the reader cannot be certain of the exact time, and the number of

separate transactions. It is important to note that split trades are only possible

where the uniqueness indicator is a blank. The MTR does not split trades with a

“T” or “=”.

[343] To summarize, where the MTR shows that a suspect account bought or sold

KHI shares on a given trading day, the reader can be certain that those accounts did

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in fact buy or sell KHI shares on that day. The uniqueness indicators relate only to

the degree of certainty between the client name ascribed by the report to a given

trade and the timing of that trade. It is only where a “T” or an “=” appear on both

sides of a trade that the reader can be certain that the client identified on the Buy

Side traded at the time listed in the MTR to the client identified on the Sell Side.

Any other combination of uniqueness indicators means that there is potentially

room for error.

[344] When using the MTR as evidence in a criminal trial, it is critical to

understand its purpose and its limitations. The MTR represents Mr. Shahviri’s

attempt to create a historical record of the accounts buying and selling KHI stock

on the TSX and the timing of the transactions, using only the Exchange data and

the broker data (verified later with suspect account statements). One limitation is

that data was not obtained from a small number of brokerages. However, the

missing data affected only about 1% of the volume of the 6.8 million shares traded.

[345] Next, as highlighted on cross-examination, there was additional brokerage

information like order tickets, cancelled/unfilled order tickets, fill tickets and trade

blotter (some of which were in the RCMP’s possession) that Mr. Shahviri could

have used to confirm the identity of the buyer and seller for trades that the software

assigned an “S” or a blank indicator. Mr. Shahviri conceded that if he had

reviewed these additional documents, it would have been theoretically possible for

him to create an MTR with all “T” indicators.

[346] A related limitation is the lack of market depth information. As just

discussed, if Mr. Shahviri had obtained and reviewed every order ticket generated

by every brokerage for every day of trading included in the MTR, he would have

been able to confirm the buyer and seller for every trade. In addition, however, he

could theoretically have used unfilled order tickets and other order information to

reconstruct how the market looked at any given time. In other words, the MTR

does not show the open orders (if any) stacked in the TSX electronic trading

system at any given time. This information is available to brokers on their screens

throughout the trading day, if they have paid for the market depth information

service. Whether such an undertaking would have been realistic, or even

particularly helpful, is another issue.

[347] The MTR does not speak to intention. It does not indicate whether a trade

was solicited or unsolicited. Where a trade is solicited, it occurred on the advice of

the client’s investment advisor. Where a trade is unsolicited, the client contacted

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the investment advisor and gave instructions to place the order. Furthermore, the

MTR does not account for the fact that a single client order for a specific volume

of shares might have been filled in a series of transactions over several days, weeks

or even months (as long as the broker had discretionary trading authority). To put

it differently, the reader cannot assume that every trade shown on the MTR

represents a unique order placed by the client on that trading day. The MTR also

does not account for priority rules that dictate whose order is filled first on the

TSX. For example, orders placed with a “pro” account, like the one held by Bruce

Clarke, are filled after any client orders. This is a relevant consideration where the

MTR is being used to support allegations of high closing.

[348] In Mr. Potter’s closing brief, he lists a series of shortcomings of the MTR

that he says make it unreliable. First, he argues that the MTR cannot be said to be

accurate in matching a buyer to a seller in 26% of the entries on the buy side and

26% of the entries on the sell side because the program “guesses” the buyer and the

seller and the sequence of trades. This is a reference to those entries on the Buy

Side and the Sell Side that have a blank indicator rather than a “T” or an “=”. Only

26% of the trades in the MTR have a blank indicator. This means that for 74% of

the trades listed, there is a high degree of certainty that the trade occurred exactly

as depicted. For the remaining 26%, the MTR may have swapped the names of

clients from the same brokerage who purchased or sold shares on the same day for

the same price. It may also have split the trades into more than one transaction.

Again, however, this would not affect the accuracy of the total number of shares

purchased or sold that day and the price paid for those shares.

[349] During the voir dire on qualification, Langley Evans and Mr. Potter’s

counsel discussed the relevance of the 26% of trades with the blank indicator to the

kind of market manipulation alleged in this case. Mr. Evans explained that for the

purposes of identifying market domination, it is not necessary to know the precise

timing of every trade or the specific clients on each side of every transaction. The

timing of trades and the identity of the clients would be important in cases

involving allegations of false volume or wash trades, or to prove high closes. Even

then, however, this information will be less important where, as in this case, there

are obvious patterns of high closing.

[350] Next, Mr. Potter says the software that generates the report may produce a

different version each time it is run. While this is technically true, any

inconsistencies would be limited to those trades with a blank indicator. If the

broker and TSX data was fed into the software a second time, the resulting MTR

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may swap client names or split the trades where two clients from the same

brokerage purchased shares at the same price in a different manner than it did in

the previous iteration. The degree of certainty that the Court can apply to the

trades with a blank indicator remains the same, from iteration to iteration. This

would not affect the accuracy of the total number of shares a suspect account

purchased or sold on that trading day, or the share prices applicable to each

transaction.

[351] Mr. Potter says the MTR does not provide information about the time an

order was entered, which broker entered the order, the type of order or the price at

which it was entered, the “depth” of the market or the current quotation for the

stock. Some of these limitations have been discussed in relation to the Evans

report. The defendants have repeatedly asserted that the lack of evidence as to the

timing of individual orders, the types of orders placed, the volume of shares

ordered at any given time and the volume of open orders in the TSX system at any

given time raises a reasonable doubt as to the intentions of the suspect group

members trading in the stock.

[352] The defendants’ position ignores the evidence that the stock had little to no

liquidity. The evidence at trial was clear -- there was no retail demand for the

stock and there was an abundance of shareholders eager to sell their holdings.

Gerard McInnis testified that from the day he joined KHI in January 2000 until the

company ceased operations, there was always an abundance of sellers over buyers.

On this point, the Court heard from David Watson, the Registered Trader (a.k.a.

the “market maker”) for KHI appointed by the TSX. He testified as follows:

Q. And how would you describe the market for KHI when you were working as

a market maker?

A. It was very – it was a very quiet… it was one of my low priority stocks. It

wasn’t a big trader. It was pretty illiquid stock.

[353] According to Mr. Watson – whose job it was to constantly watch the market

for KHI – there were very few “orders in the book behind”, meaning that there was

very little market depth:

Q. Now you said “an orderly market.” What does that mean?

A. With a stock like Knowledge House that was very illiquid, there wasn’t many

orders in the book behind. Bids and offers behind the initial bid and offering. So

if somebody came in with a large order it was hard for them to buy or sell because

there was nothing in the system.

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[354] Mr. Watson further testified that when no one was buying, a broker at NBFL

would always step in and buy:

Q. Now did you make any observation sir as to who was trading in the stock

during this timeframe?

A. I did notice that number 80 was always around on the stock. He was -- he

always seemed to come back in and buy the stock.

A. Now you say he, you’re not – are you referring to a specific individual or ---

Q. I’m just referring to a firm, No. 80.

A. Okay. And what firm was that?

Q. I believe it was National Bank or Levesque. I’m not sure when Levesque

changed to National Bank or ---

A. So what do you mean he was always around? What does that mean?

Q. It just meant that No. 80 would always seem to come back in and buy the

stock when there was nobody else around, nobody else bidding except for myself,

No. 80 always seemed to come back as a buyer.

[355] To similar effect, Mr. Evans made the following comments on cross-

examination during the voir dire:

Q. But you didn’t do any analysis of the orders right?

A. The orders? You’re right.

Q. So you have no idea whether there was anybody out there who was prepared

to buy [Steve Tsimiklis’ shares]?

A. It – the group by – the group seemed to be the only significant and consistent

source of buying.

[356] Mr. Potter and others sent e-mails complaining about the lack of buyers and

the overall lack of liquidity for KHI shares. Mr. Potter and Mr. Clarke pleaded for

support bids and commented on the lack of buying power within the group. The

only reasonable conclusion is that the TSX system was not stacked with bids

waiting to be filled. There were no large orders from suspect group members

slowly being filled over weeks and months. In other words, order information is

unlikely to have been of much assistance to the defendants.

[357] Before moving on, it is worth noting that order information, including the

complete order information for NBFL, was included in the Crown disclosure. This

information was available to the defendants to put to the Crown’s expert and Ian

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Black on cross-examination in an attempt to raise a reasonable doubt. Not a single

order ticket was put to these witnesses. Finally, while the defendants are under no

obligation to call evidence, it was open to them to retain an expert to review the

order information and respond to the Crown’s evidence.

[358] In sum, I am not satisfied that the MTR is unreliable because it was prepared

without reference to order information. Order information would not help to prove

sales suppression, parking stock, incentives or non-disclosure of material

information. Order information is not necessary to prove market domination

because (1) the MTR accurately reflects the total daily volumes of stock purchased

by the suspect accounts, and (2) there was no depth to the stock. Finally, while

order information would assist in proving high closes, other evidence is available

to supplement the MTR on this issue.

Credibility

[359] In R. v. R.E.M., 2008 SCC 51, McLachlin C.J., for the Court, discussed the

assessment of credibility at paras. 48-52:

The sufficiency of reasons on findings of credibility -- the issue in this case --

merits specific comment. The Court tackled this issue in Gagnon, [2006] 1 S.C.R.

621 setting aside an appellate decision that had ruled that the trial judge's reasons

on credibility were deficient. Bastarache and Abella JJ., at para. 20, observed that

"[a]ssessing credibility is not a science." They went on to state that it may be

difficult for a trial judge "to articulate with precision the complex intermingling of

impressions that emerge after watching and listening to witnesses and attempting

to reconcile the various versions of events", and warned against appellate courts

ignoring the trial judge's unique position to see and hear the witnesses and instead

substituting their own assessment of credibility for the trial judge's.

While it is useful for a judge to attempt to articulate the reasons for believing a

witness and disbelieving another in general or on a particular point, the fact

remains that the exercise may not be purely intellectual and may involve factors

that are difficult to verbalize. Furthermore, embellishing why a particular

witness's evidence is rejected may involve the judge saying unflattering things

about the witness; judges may wish to spare the accused who takes the stand to

deny the crime, for example, the indignity of not only rejecting his evidence and

convicting him, but adding negative comments about his demeanor. In short,

assessing credibility is a difficult and delicate matter that does not always lend

itself to precise and complete verbalization.

What constitutes sufficient reasons on issues of credibility may be deduced from

Dinardo, where Charron J. held that findings on credibility must be made with

regard to the other evidence in the case (para. 23). This may require at least some

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reference to the contradictory evidence. However, as Dinardo makes clear, what

is required is that the reasons show that the judge has seized the substance of the

issue. "In a case that turns on credibility . . . the trial judge must direct his or her

mind to the decisive question of whether the accused's evidence, considered in the

context of the evidence as a whole, raises a reasonable doubt as to his guilt" (para.

23). Charron J. went on to dispel the suggestion that the trial judge is required to

enter into a detailed account of the conflicting evidence: Dinardo, at para. 30.

The degree of detail required in explaining findings on credibility may also, as

discussed above, vary with the evidentiary record and the dynamic of the trial.

The factors supporting or detracting from credibility may be clear from the

record. In such cases, the trial judge's reasons will not be found deficient simply

because the trial judge failed to recite these factors.

[360] The Supreme Court of Canada in R. v. W.(D.), [1991] 1 S.C.R. 742, [1991]

S.C.J. No. 26, provided important guidance on the issue of credibility when an

accused testifies in his own defence and how it relates to the principle of

reasonable doubt. The Court directed the following three-step procedure:

First, if you believe the evidence of the accused, obviously you must acquit.

Second, if you do not believe the testimony of the accused but you are left in

reasonable doubt by it, you must acquit.

Third, even if you are not left in doubt by the evidence of the accused, you must

ask yourself whether, on the basis of the evidence which you do accept, you are

convinced beyond a reasonable doubt by that evidence of the guilt of the accused.

Although formulated in the context of a jury charge, the W.(D.) instruction also

applies to judge-alone trials.

[361] In R. v. J.H.S., 2008 SCC 30, [2008] S.C.J. No. 30, the Supreme Court

confirmed that the main point of the W.(D.) instruction is that “a lack of credibility

on the part of the accused does not equate to proof of his or her guilt beyond a

reasonable doubt”: para. 13. Even where an accused’s credibility is suspect, the

burden of proof remains with the Crown and the trial judge must consider the

whole of the evidence in deciding whether the prosecution has proven guilt beyond

a reasonable doubt.

[362] These are the principles that will inform my assessments of credibility in this

case.

Blois Colpitts

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[363] While there are elements of Mr. Colpitts’ testimony that I find credible, the

bulk of his evidence was unconvincing. I accept that he ran a very busy securities

practice during the relevant period and spent most of his time working, to the

detriment of other parts of his life. I accept that Mr. Colpitts’ belief in KHI’s

potential to “disrupt” public education and its prospects for growth was sincerely

held. I find that in July 2000, Mr. Colpitts had concerns about Calvin Wadden

liquidating his stock. I accept that Derek Banks ended up purchasing shares from

Dan Potter’s RRSP rather than directly from Calvin Wadden and Ray Courtney

because Mr. Banks wanted options at a discount. I find it possible that the trades

between Mr. Colpitts and his mother were intended to assist her with the purchase

of a vehicle.

[364] Mr. Colpitts’ evidence that Bruce Clarke went rogue and ignored the Barthe

term sheet – depriving Mr. Potter of $1.7 million in proceeds in the process –

defies common sense. Dan Potter knew exactly what Bruce Clarke was doing in

relation to Mr. Barthe’s investment. On September 8, 2000, Mr. Clarke e-mailed

Mr. Potter with the subject “Re: Michael Barthe”:

Hello Dan,

We have completed the purchase of KHI for “Ben” and the final numbers are

259,000 shares with an average cost of $6.564 per share. I will officially confirm

this on Monday with Ben, once our processing has been completed.

[365] Further, on November 26, 2000, in the “best of times, worst of times” e-

mail, Dan Potter mentioned, in relation to Steve Tsimiklis’ need for liquidity, that

“we placed 50,000 of his [shares] with Barthe in Aug.” Similarly, in an e-mail

dated January 14, 2001, Mr. Potter noted that he “arranged for Ray to sell 37,500

into the Banks purchase and for Calvin to sell 50,000 shares into the Barthe

purchase.” Furthermore, Jack Sullivan, whose account was cross-guaranteed by

Dan Potter, borrowed $60,000 from KHI in order to exercise options to purchase

15,000 shares which he then sold into the Barthe deal on August 30, 2000, for

$6.55 per share. In KHI’s subsequent annual report, however, the company

reported that Mr. Sullivan’s $60,000 shareholder loan was for moving expenses.

Dan Potter was not only aware of how Mr. Barthe’s investment was being used, he

was the one “arranging” the transactions.

[366] I reject Mr. Colpitts’ evidence that he was unaware that he, too, would be

selling into the Barthe purchase. His explanation that he authorized the purchase

of 43,300 shares from Mr. Clarke’s account because Mr. Clarke said he could not

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reach Mr. Potter made no sense. What does make sense, however, is that Mr.

Colpitts knew he would be selling 73,300 shares into the Barthe transaction,

43,300 of which he would have purchased from Mr. Clarke. By so doing, Mr.

Clarke, a “pro trader”, could benefit from the Barthe transaction without having to

worry about priority rules or having to obtain consent from Mr. Barthe to sell to

him directly.

[367] Not only is Mr. Colpitts’ version of these events inconsistent with common

sense, it is contradicted by his own e-mail. On November 26, 2000, Mr. Colpitts e-

mailed Mr. Potter to ensure that Dr. Schelew was aware of the extent of his market

support activities. After outlining his contributions, Mr. Colpitts responded to Dr.

Schelew’s complaint that “Even Blois has netted out $50,000!”:

He should also understand that sales were made in conjunction with Barthe,

Banks (not Fountain) that I spent the whole summer working on – to the exclusion

of any vacation with the kids.

[368] This e-mail reflects that Mr. Colpitts sold into the Barthe deal knowingly,

contrary to his assertion that he was deceived by Bruce Clarke to sell because Mr.

Clarke could not reach Mr. Potter.

[369] Mr. Colpitts gave evidence that although Calvin Wadden and Ray Courtney

had all their escrowed shares (1.1 million each) released early, they had signed

undertakings in November 1999 that they would deal with the shares “as if such

shares remained subject to the terms of the Escrow Agreement.” Mr. Colpitts

referred to this undertaking numerous times in his evidence, describing certain

sales by Messrs. Wadden and Courtney as breaches of that undertaking. Mr.

Colpitts entered a copy of the undertaking into evidence. It states, in part:

AND WHEREAS, at the request of Wadden and Courtney and with the consent of

Knowledge House, the Trustee has released from the escrow of the Escrow

Agreement for each of Wadden and Courtney 220,000 common shares of

Knowledge House which were to be released on the final release date, together

with 30,000 common shares of Knowledge House which were to be released on

the release date next preceding the final release date, all for the purpose of

Wadden and Courtney depositing the released common shares into a margin

account.

NOW THEREFORE, each of Wadden and Courtney hereby undertake to

Knowledge House that, subject to the requirements of the margin account, they

will deal with the common shares released from the Escrow agreement as if such

shares remained subject to the terms of the Escrow Agreement.

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[370] Mr. Colpitts is an experienced lawyer and this document is not difficult to

interpret. It applies to 250,000 shares – 220,000 that were to be released on Dec.

31, 2003 (the final release date under the escrow agreement), along with 30,000 of

the 220,000 that were to be released on Dec. 31, 2002 (the year immediately

preceding the final release date). It has no application to the balance of the 1.1

million shares that were released from escrow in January 2000. I find that Mr.

Colpitts’ reliance on this document was part of a larger strategy to obfuscate the

evidence before the Court. The same is true of his evidence on the issue of

“market support” or “price stabilization”. Mr. Colpitts testified that there is

nothing wrong with supporting or protecting the stock price, particularly in

advance of a public offering like a private placement. On cross-examination by the

Crown, Mr. Colpitts testified as follows:

Q. Let me just back up Mr. Colpitts you agree with me that there was a price

support effort going on in 2000 and 2001 though. And you knew it at the time?

A. There were circumstances in the concept of financing where people provided

market support.

Q. Well not just ---

A. Yes.

Q. --- during financing, at all times during 2000 and 2001.

A. The company was seeking financing at all times in 2000 and 2001.

Q. And sir there was a price support effort underway in 2000 and 2001 correct?

A. There were support levels yes.

[371] Mr. Colpitts intimated that these market support efforts were similar to those

undertaken in “bought deals”, which are an entirely different kind of transaction.

Mr. Colpitts’ evidence on price support is contradicted by the evidence of the

Crown’s expert who testified that, regardless of what you call it, it is inappropriate

to engage in “market support” in order to prevent a stock from moving in a

direction that it is expected to move. Mr. Colpitts never challenged him on this

point during cross-examination.

[372] On the issue of high closing, Mr. Colpitts testified that he approached Bruce

Clarke to ensure that he was following all the rules and was told to mind his own

business. According to Mr. Colpitts, that was sufficient to end his inquiry. I do

not accept this evidence. The evidence shows that Mr. Clarke regularly sought

direction from the defendants and relied on them for advice, even allowing Mr.

Colpitts to draft letters for him. I do not accept that Mr. Clarke told Mr. Colpitts,

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the self-described premier securities lawyer in Atlantic Canada, to stick to

lawyering, or that Mr. Colpitts would have accepted such a response from him.

[373] Mr. Colpitts repeatedly denied the existence of a managed selling agreement

among the major shareholders. He conceded on cross-examination that if there had

been a non-sell agreement in place, whether written or verbal, the company would

have been obligated to disclose it. His denial of such an agreement is completely

inconsistent with the evidence as a whole. While there is no written agreement

signed by the parties in evidence, the communications indicate that the major

shareholders believed there was a non-sell agreement and acted in conformity with

it. For example, on February 9, 2001, Mr. Potter told Mr. Colpitts that they needed

to get the agreement “written up ASAP because we promised it to the new equity

investors…” On February 21, Mr. Potter prepared a memorandum for the Board of

Directors and advised that the managed selling agreement had been reached. Mr.

Colpitts was a member of the Board and received the memo. At the Board of

Directors’ meeting on February 28, Mr. Potter told the Board that an agreement

had been reached. Mr. Colpitts was present and apparently said nothing to the

contrary. Meeting minutes were prepared and circulated, stating that a formal

agreement had been reached.

[374] On March 6, 2001, Mr. Colpitts e-mailed Mr. Potter, with copies to the other

major shareholders, indicating that Bernard Schelew was prepared to offer to sell

100,000 KHI shares for $1.83, and to provide $100,000 of market support

“conditional on the managed selling agreement previously discussed.” On March

15, Mr. Potter e-mailed Mr. Colpitts to confirm that a non-sell agreement was in

place:

I believe that we have a managed selling arrangement – it has not yet been

reduced to writing yet – I hate to bring this up but you said you were going to

draft it. I understand what you are saying about the lack of “perfection” in the

way the arrangement is working but it is certainly a far cry from what we had and

well within what was promised to Directors and new investors including David F.

[375] Mr. Colpitts agreed that there was an agreement, but he was not confident

that everyone was adhering to it:

We may have a “more managed selling arrangement” but it is certainly not a

managed selling agreement from what I have seen lately. Maybe I’m just

suffering from extended attention to this – Andrew is preparing the agreement for

closing but I won’t bank on it being signed by Ray – Bernie until after it is signed

from past experience. …

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[376] On March 20, Blois Colpitts forwarded a draft version of the agreement to

Dan Potter in advance of a group meeting at the KHI offices. After the meeting,

Ken MacLeod e-mailed Dan Potter that “[i]t seems everyone is in agreement with

the managed selling agreement so that didn’t seem to be a big issue.”

[377] On June 21, 2001, Calvin Wadden confirmed his view that an agreement

was reached:

I am hoping for the best for KHI and I will do my best to support Bruce but I have

no buying ability left to draw on. Yesterday there was selling (1500 shares from

Yorkton and more from BMO Investorline). I am printing of [sic] my statements

for both accounts for the last few months and will forward to you today to ensure

everyone I am not the problem. I am sending everyone a request to forward their

statements to you by Saturday so you and Blois can review them on the weekend.

I am not confident that everyone in our group is keeping their end of our non sell

agreement. …

I commend you and Blois for your perseverance and I will continue to support

your efforts.

[378] Finally, on the issue of withholding share certificates from LP unitholders, I

prefer the evidence of Mr. Unsworth to that of Mr. Colpitts, both in general and in

relation to the exchange that took place outside the courtroom.

[379] On the whole, then, I did not find Mr. Colpitts to be a credible witness.

Where his evidence diverged from the contemporaneous written communications –

and the only rational inferences that can be drawn from them – I do not accept it.

Credibility of Bernard Schelew, Shirley Locke and Robert Peters

[380] The Crown challenges the credibility of Mr. Schelew, Ms. Locke, and Mr.

Peters. I will comment on each in turn.

[381] I was not impressed with Bernard Schelew as a witness. He was often

evasive and defensive. His evidence that the defendants did not suppress his sales

is completely at odds with the contemporaneous e-mails exchanged by the parties,

which I find far more reliable. The same is true of his testimony in relation to his

“support buying”. In an e-mail dated February 13, 2001, from Calvin Wadden to

Steve Wilsack, Mr. Wadden wrote:

Market is getting stronger every day. I had a meeting with Ken, Dan, Ray,

Bernard at breakfast. …

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I made it a point to tell the whole table you are not selling into them … you were

actually buying! Big impact and helped me convince Ray and Bernard to support

and help put the stock in the $6+ range. …

[382] Dr. Schelew steadfastly denied that he agreed to help put the stock in the

$6.00+ range, despite the evidence that he purchased $84,500 worth of stock from

February 13 to February 23, often at increasing prices. According to Dr. Schelew,

in January, he had authorized David Mack to purchase 20,000 shares at Mack’s

discretion. He testified that, at that time, he did not know whether Mack would

execute those trades in February, March or April. The fact that the purchases

began on the same day as the Wadden e-mail was merely a coincidence. Dr.

Schelew’s evidence on these transactions was completely unbelievable. In that

respect, it was a good representation of his testimony in general. When Dr.

Schelew’s testimony is considered against the e-mail chains and his objective

trading data, the credibility assessment results in only one conclusion: his

testimony relating to the actions of the defendants cannot be believed if it is at odds

with the objective evidence.

[383] Shirley Locke was similarly unimpressive. She denied entering into an

agreement with Blois Colpitts, Dan Potter, or anyone else to bring clients into the

market to soak up sell-side pressure. According to Ms. Locke, it was a complete

coincidence that on January 6, 2000, when Anthony Phelips finally made the move

to sell 45,800 shares, Ms. Locke’s clients were in the market buying 45,500 shares.

On the same day, her clients bought 32,200 shares from 3027748 Nova Scotia

Limited, a company associated with Donnie Snow and Ken MacLeod. In fact, of

the 80,000 shares purchased by Shirley Locke’s clients on January 6, only 2,000

were from a seller with no connection to KHI insiders. I do not accept Ms.

Locke’s evidence that this was pure coincidence. Nor was it coincidence that

when Ben Kennedy, a former officer of KHI, sold 25,000 shares on February 28,

2000, Shirley Locke and her clients bought them all. Finally, it was no

coincidence that whenever Eric Richards could not avoid selling KHI shares for

clients, Ms. Locke found clients to buy them.

[384] During June, July and August 2000, the message from BMO NB’s head

office could not have been clearer – bring down the loan balances of the Wadden

and Courtney accounts. The accounts were accepted by the firm on the condition

that both Mr. Wadden and Mr. Courtney intended to diversify their holdings. On

May 16, 2000, Carole Cushing e-mailed the BMO NB Risk Management

Committee and stated, in relation to Wadden and Courtney:

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Their intention is to sell 200,000 shares of Knowledge House each by the end of

June and by fall to have liquidated a total 500,000 shares of Knowledge House,

each.

[385] And yet, no shares were sold during the summer of 2000. Ms. Locke

attributed this to the alleged threat by Mr. Wadden to crash the stock. According

to Ms. Locke, this was also the reason she insisted that Blois Colpitts and Bruce

Clarke be informed whenever her branch was selling KHI for other clients. She

testified that she wanted them to know that BMO NB was not putting orders on the

market for Mr. Wadden “while they were out there trying to solve a problem.” She

conceded, however, that BMO NB’s right to demand the sale of KHI from these

accounts was separate from any legal obligation Mr. Wadden might have had to

KHI as a director. Similarly, it was separate from any obligation BMO NB might

owe to KHI to keep Mr. Wadden from dumping shares onto the market. The threat

from Mr. Wadden also does not explain why Ms. Locke helped Mr. Colpitts track

down the identity of sellers at other brokerages. If Mr. Wadden was indeed selling

out of an account with another brokerage, it would have nothing to do with BMO

NB.

[386] Furthermore, whenever Mr. Potter and Mr. Colpitts needed information

about potential sellers or needed to suppress sales, they reached out to Ms. Locke

for help. On January 11, 2001, for example, Ken MacLeod e-mailed Dan Potter to

tell him that Eric Richards was “the culprit” selling KHI shares. He suggested that

Mr. Potter, “Send one of da boys to make him an offer he can't refuse :-).” Mr.

Potter forwarded the e-mail to Blois Colpitts, with the message, “FYI How can

Shirley help with this?” Mr. Colpitts then forwarded the e-mail chain to Ms.

Locke. Ms. Locke was unable to satisfactorily explain why Mr. Colpitts would

have sent her the message or what he expected her to do about it. In addition, on

July 11, 2001, Mr. Colpitts e-mailed Ms. Locke, “It would be good to find some

support for KHI.” The same day, Ms. Locke entered orders for two clients,

accounting for 8,500 of the day’s 11,900 shares – another coincidence, according

to Ms. Locke.

[387] When shown an e-mail in which Mr. Potter stated that he had “arranged” for

BMO NB clients like Steve Tsimiklis to sell into the Barthe transaction, Ms. Locke

said she knew nothing about that. She was similarly unable to explain why, in

March 2001, she permitted Calvin Wadden to increase his margin debt by $50,000

in return for 20,000 additional KHI shares being deposited to his account. She

allowed this notwithstanding the fact that Mr. Wadden received margin calls on his

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accounts in January and February, and BMO NB’s credit department remained

concerned about the Halifax branch’s concentration in KHI.

[388] Ms. Locke’s behaviour in relation to KHI even managed to attract the

attention of the BMO NB compliance department during the fall of 2000. By

March 2001, Tammy Carpenter, a compliance officer, concluded that the Halifax

branch was “supporting/creating the market on this stock to avoid the deterioration

of the price.”

[389] I did not find Ms. Locke to be a credible witness. For that reason, where her

evidence conflicts with the evidence of the investor witnesses, and common sense,

I decline to accept it.

[390] Blois Colpitts called the evidence of Robert Peters to establish that Bruce

Clarke’s “market making” activities in relation to KHI stock had been authorized

by NBFL. Mr. Peters testified that he regularly monitored Mr. Clarke’s 540

account. He specifically recalled that the account contained concentration of KHI.

On cross-examination, however, Mr. Peters was shown portfolio statements for the

540 account that proved it had done no trading in KHI when Mr. Peters was

Branch Manager. In the face of that evidence, Mr. Peters was forced to concede

that his recollection was inaccurate.

[391] Mr. Peters was clearly an advocate for the defendants. On November 15,

2015, the literal eve of trial, Mr. Peters sent a letter to Sergeant Murdock of the

RCMP. In it, he described the charges against Blois Colpitts and Dan Potter as a

“gross miscarriage of justice”. According to Mr. Peters, the only wrongdoer in

relation to KHI was NBFL. Mr. Peters maintained this position at trial despite

admitting that he never reviewed (or even had access to) any information in

relation to Bruce Clarke’s accounts or his trading activities after September 1998.

Nor did he ever see any internal NBFL documentation relating to KHI, or any of

the KHI e-mails or other internal company documents in evidence. When asked

whether there was anything he could be shown that would change his mind, Mr.

Peters said, “I don’t know if it exists.” Mr. Peters was not a credible witness, and

this Court cannot rely on his evidence.

Bruce Clarke as market maker?

[392] The defendants take the position that the Crown cannot prove conspiracy

because they are missing a critical element – a criminal objective. They argue that

they were buying KHI stock because they valued the company or because they

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were smoothing out the peaks and valleys in KHI trading. They describe their

actions as “market support” – a legitimate practice. Mr. Potter and Mr. Colpitts

say that they filed all necessary insider reports disclosing their respective trades.

They say that Mr. Clarke, as a representative of NBFL, offered “market-making

services” to Mr. Potter, which he accepted. They say that if Mr. Clarke did

anything outside the scope of the role of a marker maker, like high closing the

stock, then NBFL should have reeled him in. I will now address the claim that

Bruce Clarke was a market maker.

[393] Investors assume that the price of a stock on an exchange is the product of

the unimpeded interaction of real supply and demand. They are entitled to assume

that no individual or group is intervening to intentionally influence the market,

subject to one exception – the market maker.

[394] For every stock that trades on the Toronto Stock Exchange, the TSX

appoints a designated market-maker firm (e.g., NBFL, BMO NB, etc.) and a

Registered Trader (an employee of the designated market-maker firm). The

Registered Trader represents the market-maker firm and carries out the market

making duties for the stock. The Registered Trader for KHI was David Watson at

BMO NB. Mr. Watson was a witness for the Crown.

[395] The Registered Trader is responsible for supporting an orderly market for

the stock. He must maintain a continuous two-sided market within the spread goal

for the security.²⁵This means he must ensure that there is always a bid and an ask

available to retail investors. If a shareholder wants to sell, the Registered Trader is

there to buy, and vice versa. The Registered Trader’s job is to enhance market

liquidity and depth, and to moderate price volatility.

[396] Although the Registered Trader is appointed by the Exchange, he is not paid

by the TSX for his services. As noted above, the Registered Trader is employed by

the market maker firm. It is the firm’s capital that the Registered Trader uses for

his trading. Any profits are split between him and the firm. Losses are different;

the Registered Trader is personally responsible for any losses he incurs.

[397] It is important to point out that the Registered Trader is not an investment

advisor. He does not act as a broker for clients and has no association with the

²⁵David Watson testified that the spread goal for KHI was 50 cents. This meant that if someone was bidding at

$6.00, there had to be an offer to sell at no higher than $6.50.

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insiders of the company whose stock he has been assigned. This independence is

critical to his ability to fulfill his obligations to the Exchange and to earn his living.

It would be a conflict of interest if a Registered Trader for a security was in a

position to advise his clients on whether they should trade in that security. In

addition, if the Registered Trader had clients who also traded in the stock, his

trading would be subject to priority rules that place client orders ahead of his own.

[398] The Registered Trader’s trading activity is regulated by both the TSX and

the Securities Commission. These bodies set strict parameters on what he can and

cannot do. As Mr. Watson testified, if someone wanted to sell a large volume of

stock at market and there were no buyers, Mr. Watson would not be allowed to buy

some of the shares at $6.50, and then buy at $1.00. He explained:

The Exchange set limits where I would have to step in and buy so much at this

level, so much at this level, all the way down until the value got to a point where

the Exchange said “That’s enough.” They halt trading on the stock to see if

there’s something – some news or a reason why the value has changed so much.

[399] Said differently, the Exchange limits the percentage by which the Registered

Trader can uptick or downtick the stock.²⁶So if someone was offering to sell

5,000 shares of KHI and there was a single bid for 500 shares at $7.00, that would

leave the seller with 4,500 shares. Mr. Watson would then come to market and

buy a portion of the stock for an amount less than $7.00 (downticking the stock).

How much less was dictated by the Exchange. As Mr. Watson said, “Then the

next bid, I was only allowed to downtick so much, step in and buy some there, and

then downtick again, buy so much there.” The same rules applied to upticking:

Q. Okay. And you said you had to be on both – earlier you said you have to be

on both sides of the market.

A. Yes.

Q. What does that mean?

A. It’s the same thing, if somebody came in to buy and there was only five

hundred shares offered at one level, I would have to come in and sell stock higher

up. The same thing, like uptick, downtick, the same thing on both sides.

²⁶An uptick occurs when a stock is traded at a higher price than the last trade. A downtick occurs when a stock’s

price has decreased in relation to the last trade.

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[400] Langley Evans described the role of a Registered Trader as having “an

obligation to support the market, so buy on the way down and sell on the way up.

… So you’ll see him buy on downticks and sell on upticks. So he’s supposed to

act somewhat as a drag on the market. If the market’s falling, he’s supposed to

pick some up, and then…” At that point, I had the following exchange with Mr.

Evans:

Q. Affecting – thereby affecting the price of the stock, right?

A. Yeah. Yeah. Well…

Q. It’s okay for him to do that?

A. Yeah, and he’s authorized to do that, but it’s important in how he does it. You

will rarely see him buy on an uptick or sell on a downtick. He’s not supposed to

be leading the market, he’s supposed to be acting as a bit of a

counterbalance.

[Emphasis added]

[401] This last point by Mr. Evans is a critical one. The Registered Trader is not

working to bring the price up or to push it down. Mr. Evans continued:

[The market maker would] get in, he’d get out, temporary fluctuations in the stock

price he takes advantage of, and he’s there to moderate the declines, the speed of

the declines and the speed of the increases, and so he does that by acting contrary

to the direction of the last trade. So he acts as a kind of a counterweight a bit.

[402] The Registered Trader reacts to the direction of the market, he does not

direct it. Mr. Evans testified that although the Registered Trader impacts on the

natural forces of the market, his actions are not considered manipulative:

First, he is regulated and he’s expected to do that. So in certain limited

circumstances he is allowed to do that. The second thing, it’s important, is the

manner of it. You won’t see him, or you shouldn’t or he’d be subject to

discipline, high closing a stock. So that you wouldn’t see him buying at the end

of the day to move the price up. [ … ] he can sell into that. He’s expected to

moderate on the upside and moderate on the downside. So any time there’s a

price movement down, you’d expect him to be a buyer, and if it’s up, to be a

seller, and he’s supposed to do that – he’s supposed to act contrary to the market,

I think there’s a percentage, like 70 percent of the time.. and more so if he can.

[ …. ] It’s – he’s kind of a market follower or, sorry for the Maritime analogy, a

bit of a sea anchor. [ … ] If the wind’s blow you this way, the anchor slows you

down.

Page 115

[403] A good example of the kind of activity you would expect from a Registered

Trader can be found in the Match Trade Report for January 25, 2001. At 11:43:15,

Thomas E. Mack purchased 600 shares of KHI at $5.10. At 15:20:17, Mr. Mack

purchased 100 more shares at $5.00. The price was dropping. At 15:29:33, thirty

minutes before the trading day ended, two purchases took place – L.B. Stevens

Construction Ltd. bought 100 shares at $4.85, and David Watson, the Registered

Trader, purchased 1,000 shares at $4.75. A mere three minutes later, David

Watson sold 1,000 shares at $5.00, making 25 cents per share. So Mr. Watson

bought on a downtick and sold on an uptick. He took advantage of a brief

fluctuation in the market and earned $250, to be split between him and his firm.

[404] Another important point illustrated by the activity on January 25, 2001, is

that the goal of a Registered Trader is to hold very little inventory at the end of the

trading day. On January 25, David Watson purchased 1,100 shares. By the end of

the day, he had disposed of 1,000 of those shares. The Registered Trader is not

buying for investment purposes. His goal is to take advantage of temporary

fluctuations in the stock price, and to end the day with little or no stock in his

account. As Mr. Evans testified, if the Registered Trader does end the day with a

position, it is rarely more than 5,000 shares and usually less than 2,000.

[405] As part of the Registered Trader’s obligation to enhance market liquidity, he

is required to pick up odd lots. An odd lot on a share like KHI would be anything

less than 100 shares. David Watson offered the example of someone bidding at

$6.60 for 100 shares and a seller coming in to sell 190 shares. In that situation, Mr.

Watson would buy the 90 at the same price as the other buyer paid for the first 100.

[406] A Registered Trader must also observe Minimum Guaranteed Fill (“MGF”)

requirements. Investors who trade on the TSX are guaranteed a specific volume of

shares at the current best price, known as the Minimum Guaranteed Fill. Mr.

Watson believed that the MGF on KHI was 599. This meant that at least 500

shares had to be available. As an example, assume that someone has 5,000 shares

and wants to sell them at market. The spread goal on the stock is 50 cents. The

only bid is for 200 shares at $6.50. The seller would sell the 200 shares at $6.50, at

which point the Registered Trader would step in and buy 300 more at $6.50, giving

the seller the MGF. So the seller would be left with 4,500 shares. When asked

how he would proceed in that situation, once he had fulfilled the MGF, Mr.

Watson testified:

A. Then I’ll bid $6.25. If my spread goal was 50 cents, I would only have to bid

$6.00. Maybe I bid 500 at $6.25, 500 at $6.00 behind.

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That’s why this stock was very hard, because there wasn’t a lot of orders in

the book behind you know but I have to guarantee at least that 500 shares.

Q. And that would go on for how long? Say it’s going down.

A. Until the value hits a certain point where the Exchange halts the stock, and

that’s governed by the Exchange.

[407] Since there is only one Registered Trader for every stock on the TSX, Bruce

Clarke was obviously not the official market maker for KHI. The defendants do

not suggest otherwise. They say, instead, that KHI hired NBFL to act as an

“informal” market maker which, they argue, is not expressly forbidden by the rules

of the TSX. The defendants point to the October 6, 1995 memo from Robert

Peters to Guy Roby in relation to Mr. Clarke’s request to perform “market-

making” activities in ITI, as well as Mr. Peters’ testimony. They also rely on the

evidence of Germain Carrière, former President of Individual Investor Services at

NBFL. When it was put to him by Mr. Potter’s counsel that Mr. Peters was

expected to testify that he obtained permission from NBFL for Mr. Clarke to

provide liquidity for KHI, Mr. Carrière responded:

Could have happened. I don’t know what he will say but base – it could have

happened. But I don’t recall specifically.

[408] Based on the memo, the testimony of Mr. Peters and the above response

from Mr. Carrière, the defendants ask the Court to extrapolate that Bruce Clarke

received approval to act as a market maker for KHI.

[409] There are many reasons why the defendants’ assertion has no air of reality.

Before I review them, it is important to point out that Daniel Potter chose not to

testify. That was his prerogative and no inferences arise from his decision.

Having made that choice, however, he cannot use his post-trial brief to supplement

the evidentiary record with submissions like this:

NBFL offered a market making service and Mr. Potter agreed to accept it. There

is nothing illegal about this agreement. Mr. Potter, on instructions from NBFL

provided shares and cash to operate the account. This was under the direction of

NBFL and it was all done above board.

[410] Although Mr. Peters testified that Bruce Clarke obtained authorization from

NBFL to act as a market maker for KHI, there is no evidence before the Court

concerning any discussions between Mr. Clarke or anyone else at NBFL and Mr.

Potter as to how this service would operate. There is no evidence that Bruce

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Clarke or anyone else at NBFL told Mr. Potter to provide shares and cash to

operate the account. Attempts like this to supplement the record after the fact will

not be accepted.

[411] Although Guy Roby had no recollection of the memo from Mr. Peters, there

was some evidence at trial that, during the period when the Montreal Stock

Exchange traded in equities, brokerages occasionally offered to facilitate liquidity

for small-cap stocks held by their clients. Germaine Carrière testified that the

trading would be done by an investment advisor using his own capital, not the

capital of the firm. He explained that these arrangements were not ideal, and are

no longer permitted. He testified, however, that if an investment advisor like Mr.

Clarke were to offer such a service, he would be expected to follow the rules. Like

the Registered Trader on the TSX, he would be expected to follow the market, not

to lead it. He would be expected to try to balance his portfolio through trades on

both sides of the market, to pick up odd lots, and so on. He would not be allowed

to manipulate the market.

[412] There was no clear evidence on whether this type of informal market making

has ever been permitted by the Toronto Stock Exchange. The Crown put it to

several witnesses that the rules of the Montreal Stock Exchange, unlike those of

the TSX, allowed for both formal market makers, known as specialists, and

informal market makers. No one could confirm or deny that suggestion. The

Crown submits that since the TSX rules refer only to the highly-regulated position

of Registered Trader, the only reasonable inference is that informal market making

is not allowed. The defendants, however, assert that anything not expressly

prohibited by the rules is allowed. I would obviously have preferred better

evidence on this point. In my view, it is extremely unlikely that the TSX has ever

permitted market making other than by the Registered Trader due to the risk of

manipulation. Fortunately, however, I need not determine whether the TSX

allowed informal market making during the relevant period because I am satisfied

of the following: (1) Mr. Clarke’s activities could not be classified as market

making; and, (2) the defendants never believed that Bruce Clarke, on behalf of

NBFL, was acting as market maker for KHI.

[413] The evidence from David Watson, Langley Evans and Germain Carrière

confirmed that market makers are expected to maintain a two-sided market. If

someone wants to buy, the market maker is there to sell. If someone wants to sell,

the market maker is there to buy. The goal of a market maker is to provide

liquidity to shareholders while making money from small fluctuations in the

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market. Ideally, a market maker ends the day with little or no inventory. Having a

position when the market closes is risky; if bad news about a company is released,

the market maker may be unable to unload the stock the next morning.

[414] By intervening to buy when a stock price is dropping, and to sell when it is

rising, the market maker follows the market, helping to smooth out the stock

without impacting the direction of the price. If market forces cause the stock price

to begin to fall, or to rise, the market maker does not prevent that from happening.

He simply moderates the speed at which the stock moves, preventing dramatic

fluctuations in price. This is what separates the activities of a market maker from

those of a market manipulator.

[415] Bruce Clarke, on the other hand, used the 540 account primarily to purchase.

Unlike a market maker, he did not buy on downticks and sell on upticks to earn a

profit. On the few occasions where the 540 account did sell stock, it was done to

create additional buying room. Unlike a market maker, Mr. Clarke accumulated a

huge position in the stock. For example, the August 2000 portfolio statement for

the 540 account shows the account holding 435,970 KHI shares, worth about $2.9

million. Moreover, there are numerous examples of Mr. Clarke leading the market

(buying on an uptick, for example). Unlike a market maker, Mr. Clarke received

his capital from KHI insiders like Dan Potter and Calvin Wadden, and kept Dan

Potter informed on all of the 540 account’s activities.

[416] Even the testimony of Robert Peters, the witness Mr. Colpitts called to prove

that Mr. Clarke was authorized to act as a market maker for KHI, does not support

the defendants’ story. Mr. Peters testified that when he obtained permission for

Mr. Clarke to act as market maker for KHI, he understood that Mr. Clarke would

be using his own funds to trade in the stock. He said it would be a significant

conflict of interest for a broker to accept money from a company to trade in their

stock. In other words, Mr. Clarke would not have been permitted to contract with

KHI to provide liquidity for the company’s shares. According to Mr. Peters, when

an investment advisor provided liquidity, he did so for the benefit of his client

base, not the company itself. Mr. Peters testified that he expected that any trading

by Mr. Clarke in KHI would accord with the rules of the TSX. None of this

evidence supports what the defendants say took place in this case.

[417] Furthermore, in January 2001, the 540 account simply stopped buying. If

NBFL, through Mr. Clarke, had been retained by KHI to provide liquidity for the

stock, why did the account suddenly stop trading? Why were there no e-mails

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from Mr. Potter asking why NBFL was no longer holding up its end of the

agreement? Why, when the 540 account stopped buying, did Dan Potter, Calvin

Wadden and others discuss contributing stock to a new investment account that

could be used to buy more KHI shares on margin? And why, when Dan Potter was

exchanging frantic letters with NBFL trying to convince them not to slash the loan

value on the stock, did he not mention the market-making arrangement he had with

the firm and the impact a reduced loan value would have on the 540 account?

These questions lead to only one conclusion: there was no market-making

arrangement between NBFL and KHI.

[418] Dan Potter’s own words support the conclusion that he never believed Mr.

Clarke was a legitimate market maker. On November 25, 2000, Dan Potter wrote

in an e-mail to Bernard Schelew:

As I mentioned to you before by telephone, it is most unfortunate that you have seen fit to

include Bruce Clarke [sic] your communications re liquidity. It only serves to put more

pressure of [sic] him - a person who has undertaken huge personal risks to invest in

the company.

[Emphasis added]

[419] While it is true that Bruce Clarke had invested heavily in KHI in his

personal capacity, he was no different in that regard from any other major

shareholder. So what were the “huge personal risks” mentioned by Dan Potter?

The only rational inference is that Mr. Clarke had undertaken “huge personal risks”

by using his position as an investment advisor to help the defendants control the

market for KHI. He had accepted funds and shares from his clients into his

corporate account, something that even Robert Peters testified would be a conflict

of interest, then leveraged the account to the hilt buying millions of dollars worth

of KHI shares. If Dan Potter had actually believed that Mr. Clarke was only doing

what market makers do, why would he describe him as having taken huge personal

risks?

[420] Furthermore, Dan Potter and Bruce Clarke did not have a typical broker-

client relationship. On several occasions, Mr. Clarke either provided Mr. Potter

with confidential information or was a party to conversations where Mr. Potter

received such information from David Mack. For example, on December 1, 1999,

in an e-mail to Bernard Schelew in relation to the “Share the Future Program”, Dan

Potter wrote:

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In discussing this program with Bruce and David, they advised that Anthony P.

wanted to sell 200,000 shares.

[421] Anthony Phelips was a client of David Mack. The Court heard evidence that

investment advisors like Mr. Mack and Mr. Clarke should never disclose

confidential client information, including whether a client wants to buy or sell a

particular security. This was not the only time that Mr. Potter received confidential

client information. On April 21, in response to an earlier e-mail from Donnie

Snow, Dan Potter wrote:

Bruce Clark [sic] tells me that Danny M. has told him to sell his 7,000 KHI

into the market next week, in part, so he can invest in your company. Of

course this puts pressure on the stock in the absence of a rally in the stock. It

would be good if you could be sure that people in your network don't do this -

remember the concept of not killing the goose that lays the golden eggs. Having

said this, I recognize that it's completely within Danny's rights to do whatever he

wants with his shares.

[Emphasis added]

[422] Mr. Snow responded the same day:

I will call Bruce on Monday and buy Danny's fathers [sic] shares. I did talk to him

last week and told him not to do it but he is 76 years old and I guess it did not

work. I told him to leave the shares there and margin them but I guess he did not

understand what I meant.

[423] Dan Potter immediately e-mailed Bruce Clarke with the subject line “Danny

MacDonald’s shares”:

Donnie told me (by email today) that he is going to call you next week and buy

Danny’s (father’s!) shares. So, just hold tight and don’t sell (or buy!) them until

you see if Donnie comes through on his promise. We’ll see if he’s better than

Terry O’Leary!!

[424] This e-mail demonstrates that although Mr. Clarke was executing the

orders on the market, Dan Potter was the one calling the shots.

[425] For all of these reasons, I find that Bruce Clarke was not hired by Dan Potter

or anyone else at KHI to act as a market maker for the company’s shares. It

follows that I reject Mr. Potter's argument that, as a customer of NBFL, he was

entitled to assume that Mr. Clarke was following all of the rules applicable to a

market maker.

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Not enough information?

[426] Another argument raised by the defendants is that the Crown has failed to

provide the Court with sufficient evidence to determine whether their actions were

criminal. In his post-trial brief, Mr. Potter states:

148. After the Crown closed its case, it was clear that it had not called evidence

to provide the proper context to support its allegations. This resulted in

frustration, confusion and frankly was a disservice to the Court throughout this

trial.

149. The Crown approached this case as though rules and practices in the capital

markets, the rules and practices of brokerages and the legalities of the securities

industry are irrelevant. Repeatedly, the Crown has said that this is a simple fraud

case and it took the position that anything done that may affect the share price of a

public company is suspicious and potentially fraudulent. The Crown suggests that

the following activity is not permitted and in fact, is evidence of illegal activity:

 Pre-arranging transactions by bringing buyers and sellers together;

 Arranging to have large investors buy another large investors’ holdings

through the market at an agreed upon price;

 Taking steps to ensure that founders and insiders do not “dump” their

shares in the market and collapse the company;

 Encouraging people to invest in the company;

 Offering options or warrants to encourage investment;

 Offering options or warrants (“options in the money”) at prices that are

below the price at which the security is publicly traded;

 Putting contractual hold periods on common shares issued as a result of

having called in the units of a Limited Partnership;

 Insiders agreeing that, in the interests of the company, they will not dump

their shares onto the market but rather, will manage any selling through a

Managed Selling Agreement;

 Talking to investors about the potential impact selling shares or liquidating

their position will have on the share price, and ultimately, the return they

may receive on their shares;

 Insiders acting as buyers of last resort;

 Engaging brokers to provide liquidity or informal market making services

for a thinly traded security;

 Requiring that insiders get permission from the CEO before entering the

market to ensure that they do not unduly impact the market and to ensure

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that there is no material undisclosed information that may restrict them for

trading.

150. The Crown, however, has not provided the evidence to prove this this type

of activity is not permitted or illegal in any way. The Court simply has not been

given the tools to make these findings.

[427] Mr. Potter misstates the Crown’s position. The Crown does not say that the

activities listed are always suspicious or necessarily evidence of illegal activity.

For example, the Crown does not argue that a managed selling agreement that is

publicly disclosed and entered into by the major shareholders as a sign of their

confidence in the company is suspicious or evidence of illegal activity. Instead,

the Crown says that a non-sell agreement between major shareholders that is kept

from public view and entered into primarily to keep the stock price from falling

may be evidence of a manipulative agenda. Similarly, the Crown acknowledges

that pre-arranged trades, like the one that took place between Derek Banks and Mr.

Potter, are permitted.²⁷What matters, according to the Crown, is the intention

behind the pre-arranged trade. Pre-arranging a trade between two individuals for

$1 million worth of shares is not the same as pre-arranging buyers and sellers to

the extent that the market becomes a stage-managed performance where only those

shareholders who “bring their own buyer” are permitted to sell. In relation to the

Banks trade specifically, the relevance for the Crown was not its pre-arranged

nature, but the fact that Mr. Potter immediately used the proceeds to buy more

shares on the market from specific individuals, often at a higher price per share.

[428] The defendants rely on various authorities to support their argument that

many of the things the Crown alleges that they did can be done lawfully. They say

the evidence is not sufficient to establish that their actions crossed the line into

criminal territory. For example, the defendants rely on Québec (Autorité des

marches financiers) c. Forget, 2016 QCCS 6522, 2016 CarswellQue 12604, leave

to appeal allowed, 2017 QCCA 337, to argue that the Crown failed to provide the

Court with the information necessary to determine the effects, if any, of the trading

by the suspect accounts leading up to the Barthe/Ristow private placement. During

closing arguments, Mr. Potter’s counsel said the following about Forget:

Now in that case the Court made that very point. The allegation in that case, one

of the allegations … was that an individual had made a large purchase of shares

²⁷In Re Chapters Inc., 2001 CarswellOnt 902, 24 O.S.C.B. 1663, the Ontario Securities Commission confirmed that,

“for the purpose of the TSE Rules, a trade matched between a buyer and seller directly and then completed on the

facilities of the exchange is considered to be a trade through the facilities of the exchange”: para. 30.

Page 123

that were trading around that time at about $0.17, for the purpose of bringing it up

to $0.20 because that is what the private placement had been agreed to at. They

would go at $0.20. What the Court said is, “Well that may be so.” But there

hadn’t been any evidence called about how a private placement and its price could

be affected by the market price a few days before. The evidence just wasn’t

called.

So, My Lord, you can’t conclude that that is somehow manipulative, artificial or

the reason that Mr. Potter and others, as alleged by the Crown, are buying at that

time because you just don’t know what the effects legally may be.

We know from Mr. Colpitts and from the other evidence that TSE – the TSE had

given price protection at 6.50 at that time for this private placement to occur.

Could it be that once that price protection is given that it doesn’t matter what the

market price is? I say it’s so, but I don’t have to call evidence that it’s so.

[429] In Forget, Clément Forget was charged under the Securities Act, RSQ, c. V-

1.1, with influencing or attempting to influence the market price or value of a

security through unfair, abusive or fraudulent practices. Mr. Forget was the

founder and largest shareholder of Clemex Technologies Inc., a company that

traded on the TSX Venture Exchange. According to the evidence, in the spring of

2008, Clemex anticipated the closing of a private placement. On June 12, 2008,

the Exchange accepted the proposed private placement at the price of $0.20 per

share. The acceptance was renewed on July 3, 2008, and the Exchange required

the placement to be completed by August 4. On July 29, Mr. Forget asked his

broker to purchase 20,000 Clemex shares using his wife’s account. Mr. Forget did

not have trading authority over the account. The evidence showed that the shares

were purchased at prices ranging from $0.22 to $0.24. As a result of the trading

that day, the value of Clemex shares increased from $0.17 per share to $0.24 per

share. Three days later, on August 1, 2008, Clemex announced the closing of the

private placement.

[430] The Autorité des marchés financiers alleged that Mr. Forget bought shares

on July 29 to artificially inflate the value of the stock in order to secure the closing

of the private placement at $0.20. The Quebec Superior Court held that the

prosecution had not provided the Court with sufficient evidence to determine the

impact, if any, of Mr. Forget’s trading on the private placement price:

[152] The appellant contends that Clément Forget’s motive for influencing the

price of the security on July 29, 2008 is to ensure the completion of the private

placement. It must therefore be understood that the transaction of July 29, 2008 is

likely to influence the completion of the private placement. At least that is what

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the appellant purports to say, but without putting into evidence anything other

than the existence of the private placement.

[153] However, while the appellant has adduced evidence that Clemex had set up

a private placement in the preceding weeks, it must be held that it did not put into

evidence all the factors relevant to the proper assessment of this evidence by the

trial judge, inter alia as to the operation of such an investment, as to its

negotiation, as to the expectations of the participants, as to the financial and

commercial situation of the company, as to the context of this private placement.²⁸

[431] On the issue of the trading leading up to the Barthe/Ristow private

placement, Mr. Colpitts testified that “price stabilization” or “price protection” in

advance of a public offering, including a private placement, is accepted practice.

In other words, according to Mr. Colpitts, there was nothing wrong with the major

shareholders buying stock in order to keep the price at $6.50 until the deal closed.

Mr. Potter, through counsel, argued that once the TSX agreed to protect the price at

$6.50 per share, it no longer mattered what happened in the market. At the same

time, he suggested that, as in Forget, the Court does not have sufficient evidence to

know whether his assertion is correct. I disagree. This Court, unlike the Court in

Forget, has sufficient evidence to conclude that the trading by the suspect group

was not some form of legitimate price stabilization or price protection. This Court

also has evidence that the stock price in the days and weeks leading up to the

private placement would indeed have influenced whether or not the deal closed.

[432] Langley Evans gave evidence on private placements. He testified that they

are used to provide funds to a company through the issuance of treasury shares.

No prospectus is required because the transaction falls under an exemption in the

Securities Act. He agreed with Mr. Colpitts that an issuer negotiating a private

placement at $5.00 per share (for example) must obtain price protection from the

TSX. Without price protection, if the market price for the stock increases to

$10.00 per share following negotiation but prior to issuance of the shares, the TSX

will not permit the issuer to issue the shares at $5.00 per share. Mr. Evans further

agreed that obtaining price protection in relation to the Barthe/Ristow private

placement was complicated by the fact that the purchase price was to be made in

four equal installments, with the share price to be preserved over the course of

those installments. This is consistent with the e-mails that were exchanged while

²⁸There is no official English translation of the Forget decision. The parties relied on an unofficial translation

prepared by -- 2016 QCCS 6522 ().

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the terms of the deal were being put together. On October 23, 2000, Blois Colpitts

e-mailed Dan Potter, Gerard McInnis, Andrew Burke and others as follows:

The NS hold period would be 12 months. There may also be difficulty in protecting the

price if they are not going to pay for the extended period. We may have to sell them a

warrant to protect the price if it goes ahead.

[433] Mr. Potter replied on the same day:

Whoops - I don't think the extra six months hold period will be a problem – their stated

investment intent is clearly 3 to 5 years.

Repayment in installments, wouldn't in [sic] simply be a matter of the shares being

subscribed for and issued but only "paid-up" in installments. After the first closing, the

375,000 shares not yet paid for would be held against payment at the prescribed payment

dates? The problem with a warrant structure is that they would not be obliged to exercise.

As per the memo below, Gerard is drafting the business terms to fax to Ben – he can

include the 12 months hold (and explain that I was mistaken) .

If my approach re installments will not work, Blois/Andrew will have to give Gerard an

alternate structure (wording) to do the job.

[434] On October 26, 2000, Gerard McInnis e-mailed Dan Potter, writing in part:

Re the installment plan .. Andrew does not believe this poses problems re "price

protection" if in fact the consideration is not conditional on any future event. ie we have

sold securities and have a bona fide note receivable as consideration.

[435] Gerard McInnis gave evidence consistent with the definition of price

protection outlined above:

Q. All right. And there's a reference here to: "There may be difficulty in protecting the price if

they're not going to pay for an extended period." What did you understand that to refer to?

A. Well there was an agreement being made that the placement would be at a specified price, but

the payment was going to be in the four installments. I think the legal issue was whether or not

they could sell all the shares at that price or if the -- or if the price had to be variable depending

on the timing of when they made their payments.

Q. Variable attached to what?

A. Well, the -- the change in stock price based on the time -- time differences, because they were

going to make payments in installments. So that was the legal issue.

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[436] The TSX subsequently granted price protection for the private placement at

$6.50, subject (as always) to any intervening material change from the time of

price protection to the time of issuance of the securities. As a result, if the market

price went up after the price protection was in place but before the shares were

issued, the German investors would still pay only $6.50 per share. The price they

negotiated was protected. But what if the market price went down? Dan Potter

answered that question in an e-mail to Calvin Wadden in response to news that

Steve Tsimiklis “would like to have some type of proposal for liquidity.” On

November 19, Mr. Potter wrote to Mr. Wadden:

As you know, we are closing on a $3,250,000 treasury issue to our German friends- we

are hoping to get this completed (closed) on Mon. or Tues. (Nov. 20 or 21). The price of

this issue is $6.50 per share. If the market is driven down in advance of this issue it is

quite likely that the investors will not close. This would be most harmful for the

company and all of its shareholders, including Steve. Hopefully, he can be convinced to

proceed with care, prudence and caution.

…

I'm copying Blois just to keep him in the loop.

[Emphasis added]

[437] Finally, the Court has the evidence of Dr. Lutz Ristow who testified as to

how the private placement was initiated, negotiated and concluded. On the issue of

the price, Dr. Ristow testified as follows:

Q. Dr. Ristow, how was the price determined?

A. The purchase price was mentioned by Mr. Potter at six dollar fifty per share which --

and this was his argument -- the then going market price. I recall mentioning to him that

newly issued shares are normally offered at a discount. But he rejected that. As a result

of which we found a different way for an indirect discount mainly by paying the price in

four instalments, four equal instalments by the way spreading from November, 2000 until

August 2001 which of course at the then going interest rates meant an indirect discount

for us.

[438] He further testified:

Q. Dr. Ristow did you -- prior to making your investment did you look at the

performance of the stock on the Toronto Stock Exchange?

Page 127

A. Yes, of course. As I mentioned there was a disagreement between Mr. Potter and

myself with regard to the purchase price. As a result of which I checked the running stock

exchange price after my return to Germany.

And with the limitations to access of daily trading of shares of so small companies I

found that six fifty was repeatedly paid. Yeah.

[439] In cross-examination, the defendants never suggested to Dr. Ristow that the

price he negotiated with Mr. Potter was fixed or “stabilized” in advance of the deal

closing.

[440] Based on the foregoing, I find that this Court has the evidence necessary to

determine that the suspect purchases leading up to the private placement were not a

lawful form of price stabilization and that a decline in the market price could result

in the German investors pulling out of the deal.

[441] On the issue of the legality of insiders acting as buyers of last resort, the

defendants rely on Re Sheito and Woods, a decision of the Nova Scotia Securities

Commission dated May 7, 2013. According to Mr. Potter’s brief, the Commission

found that “insiders who enter bids in an effort to support the price are not acting

manipulatively nor are they doing so with the intention of creating an artificial

price.” In my view, that statement does not accurately reflect the content of the

decision.

[442] The question before the Securities Commission was not whether “support

bids” by an insider are, in general, lawful and proper, but “whether the conduct of

the Respondents in making a total of 22 bids, including 13 below market bids, of

which 10 of the total bids resulted in purchases with an aggregate purchase price of

$9,060.00 resulted in or contributed to a misleading appearance of trading

activity”: para. 47.

[443] Allan Sheito and Gary Woods were both geologists and insiders of Mountain

Lake Resources Inc., a gold and base metal exploration and development company.

Mountain Lake’s 26,521,938 outstanding shares were publicly traded on the TSX

Venture Exchange with the symbol MOA. Mr. Sheito and Mr. Woods were

alleged, inter alia, to have entered bids for MOA shares without any bona fide

investment intent and for the purpose of supporting the share price or keeping the

share price from falling due to selling pressure.

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[444] Dean Holley, a former colleague of Langley Evans, was called as an expert

on behalf of Mr. Sheito and Mr. Woods in that case. He prepared an expert report

that contained a number of relevant passages:

63. Bids posted by directors (or by others with a significant interest in the company) that

are near current market prices are commonly referred to as ‘support bids.’ In my opinion,

providing that these ‘support bids’ are real ones (that are not cancelled at the first sign

that they might be filled), are not designed to mislead investors about the state of the

market, do not result in fictitious trading volume (e.g., trades that do not involve a change

of beneficial ownership) and do not establish prices that are inconsistent with market

conditions at the time, they would not violate accepted principles of fair trading.

64. Based on the available trading data and on the content of the videotaped interview of

Mr. Woods and Mr. Sheito it would be my opinion that the respondents entered their

support bids as reluctant buyers of last resort, rather than buyers whose goal was to

establish or maintain an artificial price or artificial trading volume for Mountain Lake.

They may well have hoped that their support bids would not be filled, particularly if they

believed that the shares were already undervalued by the market, but that does not mean

that the bids were not bona fide buy orders or that they were entered to maintain prices at

artificial levels or mislead other investors about the liquidity of Mountain Lake shares.

…

68. The buy orders placed by the respondents in this case were modest in size and each

represented an investment of less than $2,000. I am aware of no evidence to suggest that

Mr. Sheito or Mr. Woods took any steps to prevent the buy orders they had entered from

being filled. Indeed, some of the buy orders for the Sheito account were repeatedly re-

entered after they had expired. The results of these orders was that Mr. Sheito purchased

and paid for 71,000 shares and Mr. Woods purchased and paid for 12,000 shares. Neither

sold any shares during the Relevant Period or in the months that followed…

69. Mr. Sheito and Mr. Woods may well not have wanted to buy more shares of

Mountain Lake, even at the historically low prices evident during the Relevant Period. In

my experience, that is often the lot of directors and officers of junior companies who are

expected, perhaps unfairly, to use their own money to provide liquidity when few other

investors are paying any attention to the company’s securities. That does not mean that

the orders the respondents entered were not bona fide orders that they intended to honour.

70. Small companies with thinly traded securities, like MOA, can be subject to extreme

short-term share price volatility due to the limited following among dealers and investors

and the resulting lack of depth of bids or offers at various prices in the marketplace. …

…

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73. I have already set out my opinion that Mr. Sheito’s participation in the MOA

markets, albeit as a reluctant buyer, does not mean that his bids were not bona fide bids

that he intended to honour. The fact that Mr. Sheito entered orders that led to immediate

fills provides further evidence that he intended to be a buyer, as does the fact that the

shares he purchased were not sold despite increased trading prices. The Sheito purchases

were made at the best offering prices available at the time and I am aware of no evidence

that the shares were acquired from anyone other than an arms’ length seller. In my view

one cannot conclude that the purchases were improper absent evidence that the trades

were made to establish artificial prices or were otherwise intended to deceive other

market participants.

[445] The Securities Commission adopted Mr. Holley’s view that determining

whether purchasing by insiders runs afoul of fair trading practices requires a

contextual analysis:

[43] Mr. Holley did not categorically approve of support bids. He said “the trading

analysis must try to determine if and when activity becomes misleading or deceptive or

when prices become artificial. This is not a formulaic exercise. Any indicia of trading

misconduct must always be considered in the context of the market in which it occurred,

and with appropriate consideration of the circumstances, consequences and purpose of

the activity.” He said, and we agree, “In each case, the nature of an order or trade must

be viewed within the context of the market at the time, the way the activity was

undertaken, the effect it had on the markets and on other market participants, and the

purpose that the order or trade was intended to achieve.”²⁹

[446] The Commission held that “[i]mproper intent exists where trading activity is

not reflective of true market supply and demand and done in violation of fair

trading practices”: para. 48. Relevant factors considered by the Commission

included whether the bids are “near current market prices, are not cancelled at the

first sign that they might be filled, are not designed to mislead investors about the

state of the market, do not result in fictitious trading volume … and do not

establish prices that are inconsistent with market conditions at the time”: para. 49.

In dismissing the allegations against the Respondents, the Securities Commission

held that “the small number of bids and small aggregate of purchase prices paid

($9,060) in the circumstances of this case did not constitute sufficient activity that

²⁹The Commission also made the following observation:

[46] Some argument was presented as to whether the Respondents’ conduct could be legitimized as market

making, but this argument was not pressed and we do not consider it applicable as there was no recognized

rules for market makers on the TSX Venture Exchange and there was no evidence that the Respondents

bought and sold shares as a market maker would do; the Respondents only bought shares.

Page 130

a person would know or ought to know would result in or contribute to a

misleading appearance of trading activity.”

[447] The allegations in this case are vastly different than those in Sheito and

Woods. That case involved a small number of bids made at market prices over a

short period of time that resulted in purchases totalling $9,060. The allegations

against these defendants are that, over a period of 18 months, together with the

unindicted co-conspirators, they made purchases exceeding $10 million in order to

establish a price that was inconsistent with market conditions and to mislead

investors. Sheito and Woods offers helpful guidance as to the analysis required to

determine whether support bids violate fair trading principles, but, contrary to Mr.

Potter’s submissions, the decision does not stand for the proposition that “insiders

who enter bids in an effort to support the price are not acting manipulatively nor

are they doing so with the intention of creating an artificial price.”

[448] The defendants also rely on R. v. Campbell, [1993] O.J. No. 3094, 1993

CarswellOnt 913 (Ont. CJ (Gen. Div.)) – a penny stock manipulation case that the

defendants say “is almost on all fours” with the present case – to say that the

Crown has not provided the evidence and analysis sufficient to allow the Court to

find deceitful trading practices conducted for the purpose of creating an artificial

price.³⁰The three accused were stock promoters for a junior mining company that

traded on the Alberta Exchange. The company’s shares fell within the

“speculative” category. The accused were charged, together with an unindicted co-

conspirator (Salter), with conspiring to commit the indictable offence of

fraudulently affecting the public market price of shares in Penway Explorers Ltd.

The Court described the issue before it as whether the conduct of the accused “fell

within the parameters of legitimate ‘stock promotion’, or whether it exceeded those

limits and constituted ‘stock manipulation’, in the generic sense contrary to the

Criminal Code”: para. 8. The Crown alleged that the accused agreed to create a

false or misleading appearance of active public trading in Penway with the

intention of causing the price of the shares to escalate by using manipulative

trading techniques, with the shares ultimately to be sold at an inflated price to

unsuspecting members of the public. The Court particularized the Crown’s

allegations at para. 16:

More particularly, as set out in para.44 of their thorough written submissions,

Crown counsel assert that the accused agreed, by means of the following

³⁰Whether that assertion is accurate will be considered later in this decision.

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dishonest conduct, with fraudulent intention, to affect the public market price of

Penway Explorers:

— by rigging the bids in the market by paying off investors and brokers to

place bids at particular prices;

— by selling stock off the market to clients of Mercore Securities at prices

above current market price to facilitate the means to place bids on the

market at ever increasing prices;

— by pre-arranging match trades among themselves and others paid off to

place bids in order to create volume and/or uptick the price of the stock

(while keeping the stock in what the Crown refers to as “friendly hands”);

— by “cleaning” the market of “loose paper” with a view to orchestrating

a deliberate mark-up in the price of Penway shares including deliberately

dropping of the price of Penway;

— by ensuring that bids were entered from more than one brokerage house

to create the appearance of wide interest in the stock;

— by marking-up the stock to a pre-determined price at which price “all

[their] people” would be taken out by means of placing the paper with a

mutual fund; and,

— by guaranteeing the price to which the stock will rise as an inducement

for people to buy stock.

[449] The Court considered s. 380(2) and set out the elements of the offence:

24 There is not a great deal of Canadian jurisprudence on the scope and

application of s.380(2). Looked at analytically, however, the offence involves

someone a) doing something; b) doing it “by deceit, falsehood or other fraudulent

means” i.e., dishonestly, in general terms; and, c) doing it with intent to defraud.

The “something” in question is “[affecting] the public market price of ... anything

that is offered for sale to the public”, including stocks or shares.

25 Clearly, it is not everything which is done that affects the public market

price of stocks or shares that is proscribed by the provisions of s.380(2).

Promoters and others who are involved in the market may take steps that affect

price. One example of such conduct is the role played by those who engaged in

“maintaining the market”, sometimes referred to as “market makers”, a role often

referred to in the evidence in these proceedings. Maintaining a market with

respect to a particular stock involves taking steps to dampen the impact of wide

and sudden swings in the market — upwards or downwards. While the formal

“market maker” occupies an authorized position in the market structure, and while

that position cannot be said to fit any of the accused here, the evidence is that

other people, including promoters, act to maintain the market. As Mr. Cleland

said,

Page 132

Q. And does this have an[y] relationship to what might be described as

maintaining a market?

A. People use maintaining a market loosely. Maintaining a market means

keeping; to me, maintaining a market means keeping an active quotation

available, and designated market makers, they do that, they do that, other

people may do that as well. (emphasis added)

26

It was Mr. Hamouth’s evidence that part of a promoter’s job is to make sure

that there are bids available in the market to meet offers and offers available to

meet bids. I accept this evidence. It is perfectly consistent with what Mr. Cleland

said. Such conduct, I conclude, does not in itself contravene s. 380(2).

27 Thus, affecting the public market price of a stock is not per se an offence,

nor is agreeing to do such a thing. The actus reus of the offence is to take the steps

in question dishonestly (using that word in its broad sense) and with intent to

defraud the public. I have no doubt that the section is expansive in its scope, and

is intended to capture all kinds of dishonest conduct that affects the public market

price of shares.

[Emphasis in original]

[450] The Crown’s theory was that the conspiracy failed when Mr. Salter, the

unindicted co-conspirator, reneged on the agreement and began to sell his shares

into the market. The Court drew an adverse inference against the Crown for its

failure to call Mr. Salter as a witness:

63 Mr. Salter’s role is central to the Crown’s theory of the case. The

conspiracy failed, the Crown contends, because Mr. Salter backed out and began

to sell into the market, thus frustrating the plan. The acts and conversations of the

accused, as reflected particularly in wiretap interceptions 6-31 are put forward as

evidence of this and, accordingly, as evidence of the conspiracy itself. These acts

and conversations are also consistent, however, with the defence position that

they were simply trying to get Mr. Salter out of the market because he was a “bad

guy”, and this could be the case even (a) if Mr. Salter had been part of the

promotion at the outset, or (b) if, as Mr. Hamouth contends, Mr. Salter bought the

stock and came into the market because he was upset that he had not been

included in the promotion in the first place by reason of his earlier partnership

arrangement with Mr. Vohra.

64 Thus, in my view, Mr. Salter’s evidence was “essential to the unfolding

narrative” of the case. The failure of the Crown to call him as a witness may lead

to an adverse inference that his evidence would not have been helpful to the

Crown’s case …

[451] After reviewing the evidence, including wiretap recordings, the Court

concluded that it could support the Crown’s theory, but that it was also consistent

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with the position of the accused that they were simply promoting the stock and

providing liquidity:

96

The accused are promoters. They are penny stock salesmen. Their

stock and trade is hyperbole. Mr. Hamouth is perhaps the most afflicted with

these propensities. He was described by one counsel as “a voluble, incorrigible

talker”, a description with which I doubt even he would disagree. What the

accused say must be assessed — and excused, or rejected — with those

propensities in mind. I do not accept everything the accused have told me. There

are numerous internal inconsistencies in their testimony, as Crown counsel have

so ably pointed out in their written submissions. … At the end of the day,

however, I do accept the thrust of the accuseds’ testimony, namely, that what they

were engaged in was an attempt to promote the Penway stock, causing its prices

to rise in the process, to their own profit and advantage but also to the profit and

advantage of those who followed them into the market to buy the stock.

97 At least, I am satisfied that their evidence raises a reasonable doubt in this

respect, and that is all that is required, on all of the evidence, from the accuseds’

perspective. The Crown is required to prove that they committed the offence

charged beyond a reasonable doubt and the accused are entitled to the benefit of

the presumption of innocence unless and until the Crown meets that burden.

98 As I have said, the evidence in this case is capable of bearing the

interpretation which the Crown seeks to put on it. That, in itself, is not enough,

however. I must be satisfied beyond a reasonable doubt that the accused are guilty

of the offence charged. I am not. There is evidence which I accept that also points

towards the accuseds’ version of the events and which raises a reasonable doubt

as to their guilt.

[Emphasis added]

[452] The decision in Campbell is distinguishable. As the trial judge said in that

case, “the accused are promoters. They are penny stock salesmen. Their stock and

trade is hyperbole.” At the end, the trial judge found that the evidence had to be

assessed in light of the roles of the accused in promoting this speculative penny

stock. Nearly all of their conduct could be traced back to their salesmanship. Mr.

Potter and Mr. Colpitts were not stock promoters or penny stock salesmen. They

were the CEO, Chair of the Board of Directors, Legal Counsel, Lead Director and

Chair of the Audit Committee of KHI.

[453] The Court in Campbell held that the accuseds’ conversations concerning

Salter, obtained through wiretap interceptions, could support the existence of a

conspiracy. They were, however, also consistent with an innocent explanation,

rendering Salter’s evidence “essential to the unfolding narrative.” In this case, on

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the other hand, there is an abundance of evidence from the alleged unindicted co-

conspirators in the form of contemporaneous e-mails that support only one

interpretation. Providing the other unindicted co-conspirators with the opportunity

to deny the plain meaning of those communications would be as helpful to the

defendants (and to the Court) as the evidence of Dr. Schelew and Ms. Locke.

[454] Of equal importance in Campbell is that the Court was not satisfied that the

accused had the means to control the Penway stock:

55 Much of the foregoing, then, is inconsistent with the accused having the

kind of “control” over the Penway stock which the Crown seeks to attribute to

them. On balance I am not persuaded that the accused had control, either in the

normal sense or in the expanded sense of being able to influence the shareholders

not to sell which would enable them to carry out the accumulation side of a

manipulation strategy. Nor am I persuaded that they believed that they had the

means of “control” to do so. …

[455] Control over buying and selling is critical to an accused’s ability to

fraudulently affect the public market price. As will become clear later in this

decision, I am satisfied that the defendants, unlike the accused in Campbell, were

remarkably effective at controlling the market for KHI shares. As will also

become clear, I find that there is far more evidence in this case to establish

fraudulent intent than in Campbell.

[456] Before moving on, a comment is called for on the manner in which the

Crown led evidence in this trial. I refer, in particular, to the decision to call a

single expert, and to call him as the Crown’s final witness. While I am satisfied

that I have the evidence I need to determine whether the Crown has proven the

charges against the defendants, the Crown did a disservice to the Court by failing

at the outset of trial to set out the necessary context of the workings of the capital

markets and the investment industry. Instead, this information was scattered

through the trial like bread crumbs, dropped by witnesses who had no reason to

provide the Court with fulsome explanations of fundamental terms and concepts.

To be clear, I do not blame the witnesses for this deficiency. The Crown should

have anticipated this issue and, as I suggested during closing argument, called a

separate expert at the start of trial to properly orient the Court. Mr. Evans’

evidence was very helpful, but the Crown’s decision not to call him until the end of

its case, while not impacting on trial fairness, placed a burden on the Court that

was both unreasonable and unnecessary. I would encourage Crown counsel in

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future prosecutions to keep these observations in mind when dealing with evidence

in technical fields.

The Law of Conspiracy

[457] The Crown alleges that during the period from January 2000 to the collapse

of the KHI share price in August 2001, the defendants conspired to commit fraud,

and committed fraud, by unlawfully affecting the price of the stock using a variety

of techniques, including:

 buy-side domination: this conduct supported the market price through

purchasing shares offered for sale by retail shareholders, when there was

little or no retail demand for the shares;

 sell-side suppression: suppressing the selling side of the market by

pressuring or preventing existing shareholders from selling their shares in

the market, which would have put downward pressure on the share price;

and

 intentionally moving the share price higher through uneconomic trading

such as high closing the stock, upticking the bid price and buying at

increasing prices.

[458] The offence of criminal conspiracy is set out at s. 465(1)(c) of the Criminal

Code:

465(1) Except where otherwise expressly provided by law, the following provisions

apply in respect of conspiracy:

…

(c) every one who conspires with any one to commit an indictable offence not provided

for in paragraph (a) or (b) is guilty of an indictable offence and liable to the same

punishment as that to which an accused who is guilty of that offence would, on

conviction, be liable;

The gist of the offence is the agreement by two or more persons to perform an

illegal act or to achieve a result by illegal means: R. v. O’Brien, [1954] S.C.R. 666

at pp. 668-669.

Page 136

[459] The essential elements of conspiracy are: 1) an intention to agree, 2) the

completion of an agreement, and 3) a common unlawful design: United States v.

Dynar, [1997] 2 S.C.R. 462, [1997] S.C.J. No. 64, at para. 86. Further, there must

exist an intention to put the common design into effect: O’Brien, at p. 668; Dynar

at para. 86. The offence of conspiracy is entirely complete upon the formation of

the agreement.

[460] In conspiracy cases, the focus of the inquiry is not on acts done in

furtherance of the agreement (if any), but on whether there was an agreement and,

if so, on what was agreed: R. v. Root, 2008 ONCA 869, [2008] O.J. No. 5214,

leave to appeal denied [2009] S.C.C.A. No. 282, at para. 67. Acts done in

furtherance, however, “may help to establish the core element of conspiracy – the

agreement”: para. 67. As Rinfret J. wrote for the Supreme Court in R. v. Paradis,

[1934] S.C.R. 165 at p. 168:

Conspiracy, like all other crimes, may be established by inference from the

conduct of the parties. No doubt the agreement between them is the gist of the

offence, but only in very rare cases will it be possible to prove it by direct

evidence. Ordinarily the evidence must proceed by steps. The actual agreement

must be gathered from "several isolated doings", … having possibly little or no

value taken by themselves, but the bearing of which one upon the other must be

interpreted; and their cumulative effect, properly estimated in the light of all

surrounding circumstances, may raise a presumption of concerted purpose

entitling the jury to find the existence of the unlawful agreement.

[461] Similarly, in R. v. J.F, 2013 SCC 12, 1 S.C.R. 565, at para. 44, the Supreme

Court of Canada noted:

[A]greement is a central element to the offence of conspiracy. Conversely, an act

done in furtherance of the unlawful object is not an element of the offence of

conspiracy. Although such acts can serve as circumstantial evidence to support

the existence of a conspiracy, they are not themselves a component of the actus

reus of conspiracy. Indeed, a conspiracy can be established in the absence of any

overt acts done in furtherance of its unlawful object.

[462] The individual participants in a conspiracy need not know each other, nor

communicate directly with one another: Root, at para. 68. Their respective roles

may vary in nature, importance and duration: R. v. Bernard, 2009 CarswellOnt

7828, [2009] O.J. No. 5366 (Ont. Sup. Ct. J.), aff’d 2013 ONCA 371, at para. 41.

Each member need not know every detail of the common scheme, but each must be

aware of the general nature of the common design and intend to adhere to it: Root,

at para. 68.

Page 137

[463] Accordingly, in order for this Court to find the defendants guilty of

conspiracy to commit fraud in relation to the market price for KHI shares, the

Crown must prove the following essential elements beyond a reasonable doubt:

(a) That there was an agreement among two or more persons to commit the

indictable offence of fraud in relation to the market price for KHI shares;

and

(b)That the defendants were parties to that agreement.

The co-conspirators’ exception to the hearsay rule

[464] The co-conspirators’ exception to the hearsay rule is used when the Crown

seeks in its case against the accused to rely on statements of unindicted co-

conspirators for the truth of their contents. The Crown submits that there is

overwhelming evidence supporting the allegations against the defendants without

resort to the exception, but says the Court may apply the exception in any event if

it concludes that the probative value of any of the statements hinges on their truth.

[465] The Nova Scotia Court of Appeal recently reviewed the law in relation to the

co-conspirators’ exception to the hearsay rule in R. v. Kelsie, 2017 NSCA 89,

[2017] N.S.J. No. 467:

140 In R. v. Carter, [1982] 1 S.C.R. 938, the Court set out a 3-step process for

the admissibility of hearsay evidence and the use of that evidence by the trier of

fact, when deliberating on a conspiracy charge. Carter was summarized by the

Ontario Court of Appeal in R. v. Gagnon, 2000 O.J. No. 3410 as follows:

50 In R. v. Carter (1982), 67 C.C.C. (2d) 568, the Supreme Court of

Canada set out the following three-tiered approach to apply in conspiracy

cases:

Considering all the evidence, the trier of fact must conclude

beyond a reasonable doubt that the conspiracy charged in the

indictment existed. This determination is independent of any

consideration as to whether an indicted or unindicted conspirator is

actually a member of the conspiracy charged.

Once the trier of fact is satisfied beyond a reasonable doubt that the

conspiracy charged existed, the trier of fact must determine,

exclusively on the basis of "evidence directly receivable against

the accused", whether the accused was probably a member of the

conspiracy. The trier of fact is not to consider co-conspirator

hearsay evidence at this stage of deliberations.

Page 138

If the trier of fact concludes that an accused was probably a

member of the conspiracy, the trier of fact must determine whether

the Crown has proven that accused's membership in the conspiracy

beyond a reasonable doubt. At this stage of deliberations, the trier

of fact is entitled to consider hearsay acts and declarations of co-

conspirators made in furtherance of the objects of the conspiracy.

The trier of fact must be cautioned that the mere fact that the

conclusion has been reached that an accused is probably a member

of a conspiracy does not make a conviction automatic.

[Emphasis added]

141 In R. v. Mapara, 2005 SCC 23, the Supreme Court of Canada affirmed the

3-step process set out in Carter and defined the co-conspirators' exception to the

hearsay rule as follows:

8 The co-conspirators' exception to the hearsay rule may be stated as

follows: "Statements made by a person engaged in an unlawful conspiracy

are receivable as admissions as against all those acting in concert if the

declarations were made while the conspiracy was ongoing and were made

towards the accomplishment of the common object" (J. Sopinka, S.N.

Lederman and A.W. Bryant, The Law of Evidence in Canada (2nd ed.

1999), at p. 303). Following Carter, co-conspirators' statements will be

admissible against the accused only if the trier of fact is satisfied beyond a

reasonable doubt that a conspiracy existed and if independent evidence,

directly admissible against the accused, establishes on a balance of

probabilities that the accused was a member of the conspiracy.

[Emphasis added]

142 Step 1 in R. v. Carter is concerned with whether the Crown has proven the

existence of the conspiracy. At this stage, it is not concerned with who the

members of the conspiracy were. McIntyre, J. explained in R. v. Barrow, [1987] 2

S.C.R. 694:

74 ... It may often be true, that in determining beyond a reasonable doubt

the existence of a conspiracy one may also determine the identity of some

of the members. On some occasions and in respect of some conspirators it

may not be necessary to have resort to the hearsay exception, but this is

not always so. It is entirely possible, and not uncommon, to be satisfied

beyond a reasonable doubt on all the evidence that a conspiracy for the

purposes alleged in the indictment existed while still being uncertain as to

the identity of all the conspirators. Once this is understood it becomes

evident that there is no substance to the appellant's argument. On this first

step what is considered is the existence of the conspiracy, not individual

membership. At this point the hearsay exception is inapplicable. This is in

accordance with the view expressed by Martin J.A. in R. v. Baron and

Page 139

Wertman (1976), 31 C.C.C. (2d) 525, in reference to the conspirator's

exception to the hearsay rule, where he said, at p. 544:

It only comes into play, however, where there is evidence fit to be

considered by the jury that the conspiracy alleged between A and

B exists. It is clear that where the fact in issue to be proved is

whether a conspiracy exists between A and B, A's acts, or

declarations implicating B cannot be used to prove that B was a

party to the conspiracy, in the absence of some other evidence

admissible against B to bring him within the conspiracy: see

Savard and Lizotte v. The King (1945), 85 C.C.C. 254 at p. 262,

[1946] 3 D.L.R. 468, [1946] S.C.R. 20 at p. 29.

[Emphasis added]

143 Of similar effect is the decision of R. v. Jamieson, [1989] N.S.J. No. 158

(N.S.S.C.A.D.) where Macdonald, J.A. held:

The co-conspirator's exception to the hearsay rule can only be applied

when it is first established beyond a reasonable doubt that a conspiracy

existed and, on a balance of probabilities on evidence directly admissible

against the accused, that he was a member of the conspiracy. It is therefore

obligatory that a trial judge instruct the jury that the hearsay evidence

which was introduced pursuant to the co-conspirator's exception to the

hearsay rule can be considered by them only after:

1. They are satisfied beyond reasonable doubt that the

alleged conspiracy existed;

2. That, on a balance of probabilities based on evidence

directly admissible against the accused, he was a member

of the conspiracy.

144 It is important to recognize that at Step 1 of the Carter analysis, the acts

and declarations of what others may have said are not introduced for the truth of

their contents but rather as circumstantial evidence of the existence of the

conspiracy. This was explained by Cromwell, J.A. (as he then was) in R. v. Smith;

R. v. James, 2007 NSCA 19:

189 The distinction between hearsay and non-hearsay is both critical and

difficult in conspiracy cases. The gist of the offence is the agreement to

perform an illegal act or to achieve a result by illegal means: R. v.

Douglas, [1991] 1 S.C.R. 301 at p. 316. The agreement can rarely be

proved by direct evidence. As Rinfret, J. said for the Supreme Court in R.

v. Paradis, [1934] S.C.R. 165 at p. 168:

The actual agreement must be gathered from "several isolated

doings", ... having possibly little or no value taken by themselves,

but the bearing of which one upon the other must be interpreted;

and their cumulative effect, properly estimated in the light of all

Page 140

surrounding circumstances, may raise a presumption of concerted

purpose entitling the jury to find the existence of the unlawful

agreement.

190 It follows from this that in many instances, acts and declarations of

alleged co-conspirators may not be hearsay but original circumstantial

evidence of the existence of the conspiracy, but these same acts and

declarations may be hearsay for the purpose of showing who were

members of the conspiracy: [Authorities omitted].

145 It is only at the third step of Carter that out-of-court statements by persons

who have been proven to have been members of the conspiracy and which are

made in furtherance of it are admissible against other probable members (R. v.

Smith, para 195).

[Emphasis in original]

[466] This disposes of the general law of conspiracy; the other pillar of the present

case is, of course, fraud.

The Law of Fraud

[467] The defendants are charged with two types of fraud: the general fraud

offence related to the market for KHI shares (s. 380(1)(a)), and the specific fraud

offence of affecting the public market price of KHI shares with intent to defraud (s.

380(2)). The applicable offence sections in force during the relevant period³¹are:

Fraud

380 (1) Every one who, by deceit, falsehood or other fraudulent means, whether

or not it is a false pretence within the meaning of this Act, defrauds the public or

any person, whether ascertained or not, of any property, money or valuable

security or any service,

(a) is guilty of an indictable offence and liable to a term of imprisonment

not exceeding ten years, where the subject-matter of the offence is a

testamentary instrument or the value of the subject-matter of the offence

exceeds five thousand dollars; …

…

Affecting public market

³¹Section 380 was amended by S.C., 2004, ch. 3, s. 2 to increase the maximum punishment to 14 years and amended

again by S.C., 2011, ch. 6, s .2 to provide for a minimum punishment in particular circumstances.

Page 141

(2) Every one who, by deceit, falsehood or other fraudulent means, whether or not

it is a false pretence within the meaning of this Act, with intent to defraud, affects

the public market price of stocks, shares, merchandise or anything that is offered

for sale to the public is guilty of an indictable offence and liable to imprisonment

for a term not exceeding ten years.

Proving the offence of fraud: s. 380(1)(a)

[468] From the statutory definition, it is clear that the actus reus for fraud under s.

380(1) consists of a conduct element (an act of deceit, falsehood, or other

fraudulent means) and a consequence element (defrauds).

[469] The Supreme Court of Canada in R. v. Olan, [1978] 2 S.C.R. 1175, 1978

CarswellOnt 49, considered the definition of “defraud” at para. 11:

Courts, for good reason, have been loath to attempt anything in the nature of an

exhaustive definition of “defraud”, but one may safely say, upon the authorities,

that two elements are essential, “dishonesty” and “deprivation”. To succeed, the

Crown must establish dishonest deprivation.

[470] The Court addressed the element of deprivation at para. 13:

The element of deprivation is satisfied on proof of detriment, prejudice or risk of

prejudice to the economic interests of the victim. It is not essential that there be

actual economic loss as the outcome of the fraud. The following passages from

the English Court of Appeal judgment in R. v. Allsop (1976), 64 Cr. App. R. 29,

in my view correctly state the law on the role of economic loss in fraud, pp. 31-

32:

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. If the deceit which is employed

imperils the economic interest of the person deceived, this is sufficient to

constitute fraud even though in the event no actual loss is suffered and

notwithstanding that the deceiver did not desire to bring about an actual

loss.

We see nothing in Lord Diplock’s speech [in Scott, supra] to suggest a

different view. ‘Economic loss’ may be ephemeral and not lasting, or

potential and not actual; but even a threat of financial prejudice while it

exists it may be measured in terms of money ...

Interests which are imperilled are less valuable in terms of money than

those same interests when they are secure and protected. Where a person

Page 142

intends by deceit to induce a course of conduct in another which puts that

other’s economic interests in jeopardy he is guilty of fraud even though he

does not intend or desire that actual loss should ultimately be suffered by

that other in this context.

[471] In R. v. Théroux, [1993] 2 S.C.R. 5, 1993 CarswellQue 5, the Court

confirmed that the following principles, first set out in Olan, will govern the

definition of the actus reus of fraud:

(i) The offence has two elements: dishonest act and deprivation;

(ii) The dishonest act is established by proof of deceit, falsehood or “other

fraudulent means”;

(iii) The element of deprivation is established by proof of detriment, prejudice, or

risk of prejudice to the economic interests of the victim, caused by the dishonest

act.

[para. 13]

[472] Théroux indicates that where the actus reus of a particular fraud is an

alleged act of deceit or falsehood, “all that need be determined is whether the

accused, as a matter of fact, represented that a situation was of a certain character,

when, in reality, it was not”; on the other hand, where “other fraudulent means” is

alleged, “the existence of such means will be determined by what reasonable

people consider to be dishonest dealing”: para. 15.

[473] In R. v. Zlatic, [1993] 2 S.C.R. 29, [1993] S.C.J. No. 43, McLachlin J. (as

she then was), writing for the majority, explained “other fraudulent means” at para.

32:

The fundamental question in determining the actus reus of fraud within the third

head of the offence of fraud is whether the means to the alleged fraud can

properly be stigmatized as dishonest: Olan, supra. In determining this, one applies

a standard of the reasonable person. Would the reasonable person stigmatize what

was done as dishonest? Dishonesty is, of course, difficult to define with precision.

It does, however, connote an underhanded design which has the effect, or which

engenders the risk, of depriving others of what is theirs. J. D. Ewart, in his

Criminal Fraud (1986), defines dishonest conduct as that "which ordinary, decent

people would feel was discreditable as being clearly at variance with

straightforward or honourable dealings" (p. 99).

[474] The mens rea of fraud was addressed by the Court in Théroux at paras. 21-

23:

Page 143

[T]he proper focus in determining the mens rea of fraud is to ask whether the

accused intentionally committed the prohibited acts (deceit, falsehood, or other

dishonest act) knowing or desiring the consequences proscribed by the offence

(deprivation, including the risk of deprivation). The personal feeling of the

accused about the morality or honesty of the act or its consequences is no more

relevant to the analysis than is the accused’s awareness that the particular acts

undertaken constitute a criminal offence.

This applies as much to the third head of fraud, “other fraudulent means”, as to

lies and acts of deceit. Although “other fraudulent means” have been broadly

defined as means which are “dishonest”, it is not necessary that an accused

personally consider these means to be dishonest in order that he or she be

convicted of fraud for having undertaken them. The “dishonesty” of the means is

relevant to the determination whether the conduct falls within the type of conduct

caught by the offence of fraud; what reasonable people consider dishonest assists

in the determination whether the actus reus of the offence can be made out of

particular facts. That established, it need only be determined that an accused

knowingly undertook the acts in question, aware that deprivation, or risk of

deprivation, could follow as a likely consequence.

I have spoken of knowledge of the consequences of the fraudulent act. There

appears to be no reason, however, why recklessness as to consequences might not

also attract criminal responsibility. Recklessness presupposes knowledge of the

likelihood of the prohibited consequences. It is established when it is shown that

the accused, with such knowledge, commits acts which may bring about these

prohibited consequences, while being reckless as to whether or not they ensue.

[475] In Zlatic, the Court framed the mens rea requirement of fraud as follows at

para. 40:

… The accused must knowingly, i.e. subjectively, undertake the conduct which

constitutes the dishonest act, and must subjectively appreciate that the consequences of

such conduct could be deprivation, in the sense of causing another to lose his or her

pecuniary interest in certain property or in placing that interest at risk.

[476] Irrelevant to a fraud charge is any claim by an accused that their motives

were pure and that they did nothing wrong. This is made clear in Théroux at para.

33:

Pragmatic considerations support the view of mens rea proposed above. 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

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believe that their act of placing other people’s property at risk will not ultimately

result in actual loss to those persons. If the offence of fraud is to catch those who

actually practise fraud, its mens rea cannot be cast so narrowly as this.

[Emphasis added]

[477] Nor is it a defence that one’s actions were done for the purpose of keeping a

company afloat, or out of a belief that one is protecting value for public

shareholders. In R. v. McCarthy, [2008] O.J. No. 3843 (Ont. Sup. Ct. J.),

McCarthy was convicted of fraud in relation to his public company, Betacom. The

Court noted that he neither sought nor received any personal benefit from his

fraud. The Court wrote at paras. 114-115:

Mr. McCarthy testified that he never intended to deceive or defraud anyone. He

explained that he acted to help the company, not to hurt investors. This evidence

does not negate the intention to commit fraud. The law of fraud does not permit

Mr. McCarthy to mislead investors in the course of salvaging a company,

even if he believed that the business would become profitable and the

investors would recover their investment.

It was not open to Mr. McCarthy to mislead investors into investing their money

in Betacom, even though he may have sincerely believed that the company would

ultimately survive and their investments would be safe. By misleading investors,

Mr. McCarthy effectively removed their ability to make fully informed business

decisions and induced them to place their money at risk on the basis of false

information. I therefore conclude that Mr. McCarthy knowingly participated in a

scheme to inflate the accounts receivable and was aware that he was putting the

property of others at financial risk.

[Emphasis added]

[478] In R. v. Gaetz, [1992] N.S.J. No. 444, 1992 CarswellNS 245 (N.S. C.A.) the

accused argued on appeal that the trial judge erred in failing to instruct the jury that

the accused was acting in the best interests of the company and without personal

gain. The trial judge recognized in his charge that the accused was trying to buy

more time to meet the company’s financial obligations, and that he had been acting

diligently in attempting to find other sources of funds. Chipman J.A. rejected this

argument, finding that it did not vitiate intent:

Indirect personal gain or absence of loss to the appellant was clearly at the heart

of his efforts to keep [his business] afloat. Other motives, such as the welfare of

his employees and perhaps in the long run even that of the bank, undoubtedly

played their part, but these generally good intentions of the appellant are of no

help in determining whether he intended in fact to deprive the bank by

fraudulent means. It is the deception and deprivation that is the evil aimed at

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by the legislation, any benefit or lack of it to the accused being of no

consequence. It is clear too that fraud is not negated merely because the

accused does not intend or desire that actual loss be suffered by the victim.

[para. 13. Emphasis added]

[479] So long as the accused’s conduct is dishonest and the accused subjectively

knew that they were acting to the prejudice of another’s economic interests, even

the best intentions or the belief that there is only a remote likelihood of creating a

risk of economic loss will not save an accused from a conviction on fraud charges.

[480] The defendants are charged with two counts of fraud under s. 380(1)(a).

Count 3 of the indictment alleges that the defendants defrauded the public in

respect of the market for KHI shares. In R. v. Riesberry, 2014 ONCA 7455,

[2014] O.J. No. 5094, aff’d 2015 SCC 65, [2015] S.C.J. No. 103, the accused was

charged with, among other things, defrauding the public in connection with his

attempt to fix a horse race by injecting performance-enhancing drugs into a horse.

The horse finished sixth, and the accused was arrested while attempting to inject a

second horse in a subsequent race. The accused argued that he could not be

convicted of defrauding the betting public because the public was not put at risk of

deprivation by his actions and, in the alternative, that the risk of deprivation was

too remote. At the trial level, the Court was satisfied that the accused had acted

deceitfully, but found that the Crown had not proven deprivation beyond a

reasonable doubt. The Ontario Court of Appeal held at paras. 20-22:

Concerning the risk of deprivation issue, it was established at trial that horse

racing is a highly regulated industry and that the regulatory scheme includes a ban

on the presence of the performance-enhancing drugs utilized by the respondent in

the body of a horse on race day. Given this regulatory scheme, bettors were

entitled to bet on each race assuming that no horse in the race was affected

by such drugs.

In this regard, we agree with the Crown that the horseracing bettors are in a

similar position to the investors in R. v. Drabinsky, 2011 ONCA 582. Just as

investors were entitled to rely on the accuracy of the financial statements, bettors

were entitled to assume compliance with the regulatory scheme. What occurred in

this case was not a minor breach or minor non-compliance with the regulatory

scheme. Where there is an attempt (successful or not) to affect the outcome of a

race through the use of banned performance-enhancing substances, such a

significant breach of the regulatory scheme necessarily places bettors at risk of

being deprived of their bets. Indeed, as the trial judge found, the very purpose of

the injection was to create "an unfair advantage" for the respondent's horse. …

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Further, as in Drabinsky, where there is a failure to disclose material non-

compliance with the regulatory scheme, it is no answer to say bettors may have

relied on other factors in making their bets. Bettors were entitled to assume

compliance with the regulatory scheme when weighing those others factors and

coming to a final decision. Non-compliance with the regulatory scheme in a

manner so as to affect the outcome of a race necessarily puts the bettors'

economic interests at risk. Bettors were deprived of information about the

race that they were entitled to know; they were also deprived of an honest

race run in accordance with the rules. In these circumstances, the trial judge

erred in law because he failed to take account of the regulatory scheme in

considering the risk of deprivation issue.

[Emphasis added]

[481] The Supreme Court of Canada agreed with the Ontario Court of Appeal,

holding at paras. 23-27:

We should first be clear about what Mr. Riesberry's fraudulent conduct was

before turning to the question of whether it caused a risk of deprivation.

Fraudulent conduct for the purposes of a fraud prosecution is not limited to

deception, such as deception by misrepresentations of fact. Rather, fraud requires

proof of "deceit, falsehood or other fraudulent means": s. 380(1). The term "other

fraudulent means" encompasses "all other means which can properly be

stigmatized as dishonest:" R. v. Olan, [1978] 2 S.C.R. 1175 (S.C.C.), at p. 1180.

The House of Lords made the same point in Scott v. Metropolitan Police

Commissioner (1974), [1975] A.C. 819 (U.K. H.L.), a case approved by the Court

in Olan (p. 1181). Fraud, according to Viscount Dilhorne in Scott, may consist of

depriving "a person dishonestly of something which is his or of something to

which he is or would or might but for the perpetration of the fraud be entitled": p.

839. And as Lord Diplock said, the fraudulent means "need not involve fraudulent

misrepresentation such as is needed to constitute the civil tort of deceit": ibid., at

p. 841.

It follows that where the alleged fraudulent act is not in the nature of deceit or

falsehood, such as a misrepresentation of fact, the causal link between the

dishonest conduct and the deprivation may not depend on showing that the victim

relied on or was induced to act by the fraudulent act. This is such a case.

Mr. Riesberry injected and attempted to inject the racehorses with performance

enhancing substances. The use of such drugs is prohibited and trainers such as

Mr. Riesberry are prohibited even from possessing loaded syringes at a racetrack.

This conduct constituted "other fraudulent means" because in the highly regulated

setting in which he acted, that conduct can "properly be stigmatized as dishonest":

Olan, at p. 1180. He carried out these dishonest acts for the purpose of affecting

the outcome of two horse races on which members of the public placed bets. His

dishonest acts, therefore, were intended to and in one case actually did result in

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the possibility that a horse that might otherwise have won would not. The conduct

therefore caused a risk of deprivation to the betting public: it created the risk of

betting on a horse that, but for Mr. Riesberry's dishonest acts, might have won and

led to a payout to the persons betting on that horse. To return to Viscount

Dilhorne's words in Scott, Mr. Riesberry's dishonest conduct created a risk that

bettors would be deprived dishonestly of something which, but for the dishonest

act, they might have obtained.

There is a direct causal relationship between Mr. Riesberry's dishonest acts

and the risk of financial deprivation to the betting public. Simply put, a

rigged race creates a risk of prejudice to the economic interests of bettors.

Provided that a causal link exists, the absence of inducement or reliance is

irrelevant. I agree with the Court of Appeal that Mr. Riesberry's reliance on R. c.

Côté, [1986] 1 S.C.R. 2 (S.C.C.), is misplaced. That case made it clear that

[f]raud consists of being dishonest for the purpose of obtaining an

advantage and which results in prejudice or a risk of prejudice to

someone's 'property, money or valuable security'. There is no need to

target a victim ... and the victim may not be ascertained. [p. 19]

This statement covers what Mr. Riesberry did.

[Emphasis added]

Fraudulently affecting the public market: s. 380(2)

[482] Although securities markets in Canada are primarily regulated under the

various provincial Securities Acts, Part X of the Criminal Code also contains

specific provisions related to frauds in relation to the stock market and securities.

These provisions include s. 380(2), which is reproduced again below for

convenience:

380 (2) Every one who, by deceit, falsehood or other fraudulent means, whether

or not it is a false pretence within the meaning of this Act, with intent to defraud,

affects the public market price of stocks, shares, merchandise or anything that is

offered for sale to the public is guilty of an indictable offence and liable to

imprisonment for a term not exceeding ten years.

[483] The actus reus under s. 380(2) is similar to that of fraud simpliciter under s.

380(1). Both sections refer to the conduct elements as being “deceit, falsehood or

other fraudulent means.” Subsection 380(2), however, has a different consequence

element -- affecting the market price of stocks, shares, merchandise or anything

offered for sale to the public.

Page 148

[484] The British Columbia Supreme Court’s decision in United States of

America v. Shull, 2009 BCSC 238, [2009] B.C.J. No. 334, confirmed that that the

same “fraudulent means” can be used to establish proof of the actus reus for

offences under both s. 380(1) and s. 380(2). In that case, the U.S. sought the

extradition of the respondents to face charges in Massachusetts on various counts

of conspiracy to commit securities fraud, securities fraud and wire fraud. The

charges arose from the trading of shares in Fairmount Resources, a company listed

on the Alberta Stock Exchange.

[485] The evidence in Shull indicated that the respondents entered agreements

with several stockbrokers to promote the sale of shares in Fairmont to their clients

in exchange for compensation from the respondents that would not be disclosed to

the clients. The evidence also showed that the respondents and unindicted co-

conspirators engaged in buy-side domination, wash trades and upticking the stock.

An expert retained by the applicant concluded that the manipulative techniques

used by the suspect group artificially created the appearance of an active market

for Fairmont stock and artificially increased the price of the shares in order to

facilitate the sale of shares by the company’s major shareholders.

[486] The respondents did not challenge the facts as framed by the applicant, but

argued that they had a benign interpretation, in that their actions were not dishonest

or illegal, and were at all times permissible. The respondents further argued that

there was insufficient evidence to justify a committal for trial in Canada because

there was no evidence that the brokers would not have recommended the sale of

the stock in the absence of compensation paid by the respondents, nor was there

any evidence that the purchasers of the shares would not have purchased them had

they known of the additional compensation paid to the brokers. Finally, they

submitted that the increase in the Fairmont share price was attributable to the

company’s acquisition of potentially lucrative oil and gas assets and its aggressive

oil and gas exploration.

[487] The question for the Court in Shull was whether the evidence was sufficient

for a properly instructed Canadian jury to convict. The court held at paras. 78-79:

I find that there exists a body of direct and circumstantial evidence which is

presumptively reliable and certified as available for trial and which constitutes some

evidence upon which a reasonable jury properly instructed could conclude that the

Respondents and others were involved in a fraudulent scheme to manipulate trading

and artificially inflate the value of the Fairmont shares. The conduct alleged, if

replicated in Canada, would amount to fraud or, in the alternative, attempted fraud, and

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conspiracy to commit fraud contrary to Sections 380(1), 380(2), 463 and 465(1)(c) of

the Criminal Code.

Specifically, the Committal Evidence infers that the Respondents were engaged in a

fraudulent ongoing scheme to manipulate market trading in Fairmont shares, a scheme in

which they employed manipulative trading practices and paid kickbacks to various

stockbrokers to promote the sale of Fairmont shares. Moreover, there is sufficient

evidence to establish that the respondents conspired between themselves and others to

effect this unlawful object.

[488] The mens rea for fraud under s. 380(2) was discussed by Brenda L.

Nightingale and Mina D. Sennek in The Law of Fraud and Related Offences

(Carswell, Looseleaf, updated to 2014) at 12-10:

Unlike the general offence of fraud, described in s. 380(1) of the Criminal Code,

the offence described in s. 380(2) is not simply an offence of general intent. …

[I]n addition to proof of knowledge of the conduct elements of the actus reus

(proof of knowledge of the facts found to constitute “deceit, falsehood and other

fraudulent means”) and proof of foresight in relation to the consequence element

of the offence (proof of foresight that the public market price of the subject-matter

of the offence will be affected), the Crown must also prove that the accused

committed the conduct elements of the offence with “an intent to defraud.”

[489] In R. v. Tatton, 2015 SCC 33, [2015] S.C.J. No. 33, the Court held that the

distinction between crimes of specific and general intent “lies in the complexity of

the thought and reasoning processes that make up the mental element of a

particular offence, and the social policy underlying the offence”: para. 21. The

Court went on to explain that specific intent offences contain a “heightened mental

element” that may take different forms in different circumstances:

37 In contrast, specific intent offences involve a heightened mental element. In

Daviault, Sopinka J. limited his discussion of specific intent offences to crimes

involving an ulterior purpose. For such crimes, the accused must not only intend

to do the act that constitutes the actus reus, he must also act with an ulterior

purpose in mind....

38 Although Sopinka J. restricted his discussion of specific intent offences to

crimes involving an ulterior purpose, it would be a mistake to assume that an

ulterior purpose is always required. To the contrary, a heightened mental element

could take the form of a requirement that the accused intend and bring about

certain consequences, if the formation of that intent involves more complex

thought and reasoning processes. Murder provides a classic example. Equally, a

heightened mental element could take the form of a requirement that the accused

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have actual knowledge of certain circumstances or consequences, where the

knowledge is the product of more complex thought and reasoning processes...

[490] Other than Campbell, discussed earlier, there are few decisions considering

s. 380(2). In R. v. Allman, [1984] B.C.J. No. 1406 (B.C. C.A.) Allman was

convicted of conspiracy to affect the public market price of shares of a company,

with intent to defraud, and unlawfully matching sale and purchase orders with

intent to create a false or misleading appearance as prohibited by s. 340 (now s.

382). At trial, Allman and his co-accused argued that they had believed that the

future of the company was bright and that the market price for its shares was more

than justified by the company’s prospects. They attempted to establish that their

conduct was an everyday occurrence in the promotion of a junior resource

company. The court disagreed. Allman appealed both convictions. In relation to

the conspiracy conviction, Seaton J.A., for the court, commented at para. 25:

Several grounds of appeal turned on the allegation that these people honestly believed

that the market price to which the shares were driven was a fair and legitimate price. It is

said that if that is the case there is no mens rea. It is also said that there was no actus

reus if there was no deprivation. I do not think these contentions to be sound. By deceit,

the appellant and Kohn affected the market price of shares. Their intention was to cause

people to part with their money in exchange for shares or not acquire money by disposing

of their shares. In short, they were deceiving people into having shares instead of money.

There was a risk of prejudice to them. It is not necessary for the Crown to prove in

addition that there was actual economic loss, or indeed that the accused persons intended

that they suffer economic loss. …

And further, at paras. 27-28:

The trial judge found that Allman and Kohn, with others, conspired and offered to pay

secret commissions are part of a scheme to control the market price for shares. He found

that they used accounts in the names of others to mislead the public. He found that orders

for the sale of Grand Prix shares were based on information obtained respecting purchase

orders and the actions were to the detriment of the public. And he found that they

conspired to and did pay secret commissions or bribes to persons in the securities

industry for the purpose of inducing those persons to cause members of the public to buy

Grand Prix shares. To all of this, the answer that there was no deprivation, no intention

to defraud, that everything that they were doing was in the best interests of the public, I

find quite unrealistic.

An argument that is common to a number of grounds is that the words in the indictment,

“with intent to defraud of money or other valuable securities”, focuses the Crown’s onus.

It is my impression that the allegation was made out if what I just said is accepted; that is,

that a person is defrauded of money if he is induced dishonestly to buy shares, regardless

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of the values of those shares. That seems to me was the intention, and in a conspiracy

count it is the intention that is vital.

[491] In R. v. McNaughton, (1976), 43 C.C.C. (2d) 293, [1976] Q.J. No. 187

(Que. C.A.), the accused was convicted on a charge of conspiracy to affect the

public market price of shares by fraudulent means. The evidence at trial indicated

that the accused had agreed, with two others, to manipulate the public market price

of certain shares through the use of a “box account”. The Court in McNaughton

recognized that, at the time of these events in 1971, box accounts were permitted

for the purpose of price stabilization.³²The trial judge found that the use of the box

account by the accused was not done for the legitimate purpose of stabilizing the

price of the stock in question, but instead was used to drive up the value of the

stock to a level disproportionate to its intrinsic value. The Court dismissed

McNaughton’s appeal in three separate concurring judgments. Montgomery J.A.

wrote at para. 3:

McNaughton’s defence is that, although he was a party to the organization of the box, it

was his understanding that this was to be used in a legitimate manner to stabilize the price

of the stock. As the trial Judge has pointed out, while McNaughton’s direct and personal

participation in the operation of the box may have been limited, there is no reason to

doubt that he was at all stages fully informed as to what was going on, and there is no

evidence that he protested until after the event. There is, therefore, every reason to

presume that what was done was done in accordance with the understanding between the

parties and not in violation of it. …

[492] In separate judgments, Turgeon J.A. and Mayrand J.A. rejected

McNaughton’s claim that he was not aware that the box account was being used

for manipulation. They did accept, however, that McNaughton was not aware that

manipulation of the market in this manner was prohibited by the Criminal Code.

Mayrand J.A. held that it was not necessary for the accused to appreciate that his

conduct was illegal so long as he knew that by using the box account in such a way

as to cause a fictitious and disorderly rise in prices, he was distorting the ordinary

operation of the market rather than stabilizing it.

³²As Nightingale and Sennek note at p. 12-10.1 of The Law of Fraud and Related Offences, “The use of this

mechanism to stabilize the market had by this time fallen into disuse in other Exchanges which utilized instead

‘specialists’ who operated on the floor of the Exchange and whose activities were controlled by the Exchange

itself.”

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[493] In The Law of Fraud and Related Offences at p. 12-10, the authors suggest

that the Quebec Court of Appeal in McNaughton neglected to consider the specific

intent required for conviction under s. 380(2):

While s. 380(2) provides that an accused must engage in the prohibited conduct “with

intent to defraud,” it is clear that the Court in McNaughton considered this to be an

offence of general intent, as it found mens rea upon the proof that the accused had

knowledge of the prohibited conduct and had foresight of the prohibited consequences.

[494] In other words, according to Nightingale and Sennek, the Court in

McNaughton found mens rea upon the proof that: (1) the accused had knowledge

of the facts found to constitute “deceit, falsehood and others fraudulent means”

(the manipulative use of the box account) and that (2) the accused had foresight

that the public market price of the stock would be affected. I note, however, that

Montgomery J.A. was satisfied that the accused was not only aware of the

illegitimate use of the box account but that he had agreed to it, and Mayrand J.A.

acknowledged that the resultant false appearance of an increase in share value was

intended to deceive the public for the benefit of a small group of speculators.

Nevertheless, I agree that the analyses in McNaughton are unclear on the issue of

the necessary intent and are not of much assistance on that point.

[495] In addition to s. 380(2), the phrase “with intent to defraud” appears in other

offence provisions of the Criminal Code including cheating at play (s. 209),

criminal breach of trust (s. 336) and arson for a fraudulent purpose (s. 435). In R.

v. Bird, 2013 SKQB 343, [2013] S.J. No. 586, the accused was charged with fraud

and criminal breach of trust. In determining whether the accused’s actions were

committed with intent to defraud, the trial judge relied on the following helpful

principles:

1) The specific intent of "with intent to defraud" is to be assessed by the use of a

subjective test;

2) The specific intent of "with intent to defraud" can be established upon proof of:

a) knowledge or recklessness as to the facts which constitute a "deceit", a

"falsehood" or "other fraudulent means"; and

b) foresight or recklessness as to the facts which are found in law to constitute

"deprivation";

3) A belief held by the accused that his conduct is not dishonest will not negate a

finding of specific intent; and

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4) A belief by an accused that his conduct will not cause deprivation will not negate a

finding of specific intent.³³

[496] Turning to the consequence element of s. 380(2), what does it mean to

“affect the public market price” of a stock? The Toronto Stock Exchange is a

“public market” for “stocks, shares, merchandise or anything that is offered for

sale to the public” within the meaning of s. 380(2) of the Criminal Code. The

“public market price” for a security is the trading price on an exchange like the

TSX. The Code seeks to protect the integrity of Canada’s capital markets and

prevent fraudulent conduct that “affects” the public market price.

[497] The “public market price” at which a security trades must be the product of

the natural and unimpeded forces of supply and demand within that market place.

Investors are entitled to assume that the price they see is a real price, determined

by the unimpeded forces of supply and demand. The Crown’s expert testified that

price discovery through the unimpeded forces of supply and demand is

fundamental to the integrity of Canada’s capital markets. Public confidence in the

integrity of those markets is essential to their continued successful operation. In R.

v. MacMillan, [1968] 1 O.R. 475, 1968 CarswellOnt 241 (Ont. C.A.), the Ontario

Court of Appeal wrote at para. 14:

… To the extent that the economy of the country is based upon enterprises requiring

capital and therefore the free trading in securities it is of the utmost importance that

public confidence be maintained in the integrity of trading on the stock exchanges which

are in one sense public utilities and also that a similar confidence be maintained in the

financial community serving that phase of economic life. …

[498] Any attempt to interfere with the normal forces of supply and demand in the

marketplace, or any attempt to create a misleading appearance with respect to the

price of a security or its trading volume, is contrary to these fundamental principles

and undermines public confidence in the market:

When investors and prospective investors see activity, they are entitled to assume that it

is real activity. They are also entitled to assume that prices that they pay and receive are

determined by the unimpeded interaction of real supply and real demand so that those

prices are the collective marketplace judgements that they purport to be. Manipulations

³³These principles appear in Nightingale and Sennek’s The Law of Fraud and Related Offences at p. 22-69.

Page 154

frustrate these expectations. They substitute fiction for fact … the vice is that the market

has been distorted and made into a ‘stage-managed performance.’³⁴

[499] To similar effect, in United States v. Brown, 5 F. Supp. 81 (S.D.N.Y. 1933);

aff’d 79 F.2d 321 (2d Cir. 1935), the Court wrote:

When an outsider, a member of the public, reads the price quotations of a stock listed on

an exchange, he is justified in supposing that the quoted price is an appraisal of the value

of that stock due to a series of actual sales between various persons dealing at arm's

length in a free and open market on the Exchange, and so represents a true chancering of

the market value of that stock thereon under the process of attrition due to supply

operating against demand.

If, however, the market for the stock listed on an exchange is a manipulated or controlled

market, in which a group of insiders, in order to enable themselves profitably to dispose

of their holdings, are artificially raising the quoted price of the stock on the only market

to which any man who wishes to purchase that stock would inevitably resort, and an

outsider buys in that market, he obviously pays more--how much more perhaps cannot be

estimated and, in any event, in a criminal case of this kind, it is not material--than he

would have paid in a free and open market, and hence is a victim of unfair dealing by the

insiders.³⁵

[500] The regulatory framework of Canada’s capital markets provides context for

the Court’s interpretation of the Criminal Code phrase “affects the public market

price.” Canada’s stock exchanges, and the people who use them, are heavily

regulated by a combination of provincial legislation (e.g., the Nova Scotia

Securities Act) provincial regulators (e.g., the Nova Scotia Securities

Commission), self-regulatory organizations (e.g., the Investment Industry

Regulatory Organization of Canada), the exchanges themselves, (e.g., the TSX)

and Canadian criminal law. Among other things, these various laws, rules, and

regulations seek to protect the integrity of Canada’s capital markets.

[501] In Workum and Hennig, Re, 2008 ABASC 363, the Alberta Securities

Commission set out several principles in relation to Alberta’s securities law that

apply to all of Canada’s provinces and territories:

…Securities laws are designed to protect investors and to foster a fair and

efficient capital market, and confidence in that market. These objectives require

³⁴Re Edward Mawod & Co., 46 SEC 865, (1977), aff’d, 591 F. (2d) 588 (10^thCir. 1979) at 871-872. See also

Hogan v. British Columbia (Securities Commission), 2005 BCCA 53, [2005] B.C.J. No. 131, at para. 14.

³⁵This passage was cited in R. v. Allman, [1983] B.C.W.L.D. 1615, 1983 CarswellBC 1258, at para. 43.

Page 155

that those engaged in securities trading act with integrity, and that market

participants have access to adequate, reasonably reliable information on which to

base trading and investment decisions. Essential to this is that trading activity

involve real transactions reflecting genuine supply and demand and genuine

assessments of value. Trading that creates a false impression about the price or

value of, or level of interest in, a security is fundamentally incompatible with fair

and efficient market operation. Alberta securities laws prohibit such deceptive

practices. …

[para. 1141]

[502] The Commission went on to describe an “artificial price”:

This Commission discussed "artificial price" in this context in Re Podorieszach,

[2004] A.S.C.D. No. 360 at paras. 84-90:

... In our view, the meaning can best be determined by considering it in the

context of the Act and the framework of securities regulation established

by the Act. ... that framework is designed to protect investors and to foster

fair, efficient capital markets and confidence in those markets, all of which

turn on the integrity with which the market and market participants

operate. Key to that market integrity is that the market be able to operate

on real information.

... in this context, an artificial price can be described as a price that

differs from the price that would result from the market operating freely

and fairly on the basis of information concerning true market supply and

demand.

The capital market is the venue in which buyers and sellers come together

and trade on the basis of their own investment decisions, assessments and

preferences. The accumulation of their interactions makes up market

supply and demand and establishes market prices. Any transactions

between buyer and seller can affect market price. Normal-course

transactions between buyers and sellers, operating at arm's length, reflect

real demand and supply; whatever the effect on price, it can be said to be a

genuine market effect. If, however, demand or supply is distorted, then

price will likely also be distorted - no longer reflective of real market

demand and supply, it will be artificial.

[para. 1142]

[503] The Commission noted that investor confidence is a key component and goal

of market integrity:

Investors must have confidence that they can trade in a marketplace in which the

available information properly reflects genuine trading activity. Investors in the

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capital market base their behaviour and their investment decisions on posted

trading prices. They are entitled to assume that the posted prices reflect bona fide

transactions in a market operating free of improper influence. Their own

transactions are then reflected in subsequent prices. If any investor makes an

investment decision in reliance on a posted price that does not reflect genuine

trading activity, that investor may be harmed. Subsequent transactions could also

be materially affected by that single instance of a misleading posted price. The

result could be harm to investors generally and the undermining of investor

confidence in the marketplace.

An individual's trading activity may have the intended effect of raising or

lowering the price of a security to a level different than it would be under normal

market conditions. Alternatively, the trading activity may maintain a price when it

would otherwise have risen or fallen. In our view, both situations create an

artificial price because the price is not reflective of the market's unimpeded

judgment of the value of the security being traded. Such conduct that is designed

to affect artificially the prices on the market is contrary to the public interest

because it misleads other buyers and sellers .

[para. 1142. Emphasis in original]

[504] Finally, the Commission distinguished between bona fide transactions which

have unintended impacts upon the market and transactions that have, as their

purpose, an impact upon the market:

Our conclusion is that in assessing whether a price is artificial, it is relevant to

consider whether one party or another to a transaction is or is not acting in

response to real demand for or supply of a security. For this purpose, the

circumstances surrounding a transaction, including any special attributes of the

parties and the manner in which it is carried out, can indicate whether or not the

transaction reflects or does not reflect real demand and supply.

Others have reached a similar conclusion. For example, the TSE in its TSE Policy

4-202 said ... essentially that an artificial price is one not justified by supply or

demand having regard to the particular circumstances involved in the trade.

Thus, the fact that trading changes a price does not by itself mean that the price is

artificial. The test is whether the trading itself was an expression of bona fide

investment decisions by both parties to the trade - that is, genuine market demand

and supply. If so (and absent some other factor), then the resulting price is not

artificial. Artificiality is, rather, essentially the product of intentional

misrepresentation of genuine demand or supply.

[paras. 1142-1143]

[505] The regulatory framework of Canada’s capital markets can also inform the

Court’s analysis of “other fraudulent means” under s. 380. As discussed above, the

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Supreme Court of Canada in Riesberry held that the accused’s “conduct

constituted ‘other fraudulent means’ because in the highly regulated setting in

which he acted, that conduct can ‘properly be stigmatized as dishonest’”: para. 25.

Conspiracy analysis

[506] For this Court to find the defendants guilty of conspiracy to commit fraud in

relation to the market price for KHI shares, the Crown must prove each of the

following essential elements beyond a reasonable doubt:

(a) That there was an agreement among two or more persons to commit the

indictable offence of fraud in relation to the market price of KHI shares; and

(b)That the defendants were parties to that agreement.

[507] While I agree with the Crown that the allegations against the defendants can

be proven without resorting to the co-conspirators’ hearsay exception, I will follow

the three-tiered approach set out in Carter to eliminate all doubt.

Stage 1 - Proof of the conspiracy

[508] The first step of the Carter analysis is concerned with whether the Crown

has proven the existence of the conspiracy. It is not concerned with the identity of

the members of the conspiracy. At this stage, the acts and declarations of others

are not introduced for the truth of their contents but only as circumstantial evidence

of the existence of the conspiracy.

[509] In most conspiracy cases, the existence of an agreement and its scope must

be inferred from the conduct of the parties. This is one of the rare cases where

proof of the conspiracy exists in writing

[510] On November 25, 2000, Dan Potter e-mailed Bernard Schelew and told him

that he was going to send an e-mail the following day to each of the major

shareholders “with a recommended joint plan for cooperative action.” The goal?

“[T]o support and protect the KHI stock over the coming weeks while we are

bringing in more new investors.”

[511] The next day, Mr. Potter revealed the depth and scope of the conspiracy

when he put forth the “Recommended Plan of Joint Action” to Calvin Wadden,

Ray Courtney, Ken MacLeod, Bernard Schelew, Bruce Clarke, and Blois Colpitts.

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The e-mail, sent with the subject line “Major Shareholder Co-operation and Help

needed to Support KHI”, set out a plan that included sales suppression, buy-side

support, the use of incentives to bring buyers to the market, and other techniques.

In the e-mail, Mr. Potter explained that “the current retail market for KHI shares

(like most other small caps) is almost non-existent”, “our sources of buying are

currently exhausted”, and “[w]e need some more new investment.” He continued:

In the meantime, however, there is significant pressure on the market. As you

have seen there has been increasing retail selling over the last couple of weeks.

This is [sic] driven the price down and has exhausted buying support.

[512] He described the sell-side pressure, and noted that Calvin Wadden had

managed to convince Steve Tsimiklis to stop selling and work with the group:

As of Friday afternoon, there was up to 30,000 shares on the ask side on the

market. Further, Steve Tsmikilis, who still owns over 150,000 shares (we placed

50,000 of his with Barthe in Aug.) has advised that he needs to sell 50,000 more

by Dec. 1 to finance a real estate project. He has been good about communicating

his situation, but I have now [sic] doubt that he will start putting shares in the

market soon. In fact, he started several days ago until Calvin personally bought

10,000 shares from him and convinced him to stop and work with us.

[513] Mr. Potter acknowledged that group members had already borrowed heavily

to buy shares on the market:

We all know that each of us is highly leveraged. Ken has bought over 135,000 on

margin since Aug. I have a $1.3 million margin loan with virtually no buying

room left, Calvin needs to have funds to pay down high margin loans and do

projects, Ray needs to pay down his margin and other loans. …

[514] He warned the major shareholders that without a cooperative effort to

support the stock, the bottom could quickly fall out of the market:

These are all valid needs for liquidity, but in the current conditions, we really

need to be more concerned about protecting the value of our KHI shares -without

support from us, it is clear that there will be further price erosion and, in

fact, the market could fall significantly and rapidly in the next few days.

Unless we all put our liquidity requirements aside for the short term and turn our

attention to finding ways of supporting the shares in the market, there will be no

liquidity opportunities for any of us worth having.

[Emphasis added]

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[515] Mr. Potter informed the group that Doug Rudolph, an accountant, would try

to place 200,000 to 300,000 shares of KHI in exchange for stock options. Mr.

Potter then set out a four-part plan going forward. First, buy 50,000 shares from

Steve Tsimiklis to keep him from putting more downward pressure on the stock:

RECOMMENDED PLAN OF JOINT ACTION

In the short term, I propose that:

We each agree to buy 10,000 of Steve T's shares this coming week.

[516] Second, add more equity to the 540 account, enabling it to buy more shares

on margin:

Bernard lend 100,000 shares to Bruce Clarke's company for an interim period. I'd

ask that Ray agree to put 100,000 shares with Bruce to replace Bernard's as soon

as he (with our help) can get BMO Nesbitt Burns to release 100,000 from his

margin arrangements at that brokerage. For information, I have already provided

Bruce with 120,000 shares months ago plus $100,000 in cash, which he still has

and Ken has provided 100,000 shares which he still has. Calvin had provided

100,000 shares before Ken for several months.³⁶

[517] Third, each agree to contribute to an options package that would incent

Doug Rudolph to find buyers for shares: