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Inside the downfall of a deal-making duo

Inside the downfall of a deal-making duo (Subscribers) by jembradshaw

Larry and Phillip Smith were a success story: They built PACE credit union into a $1-billion business and enjoyed a lavish lifestyle of island properties and sleek cars. But court documents reveal an apparent scheme to dodge the rules that is raising questions about oversight at Ontario’s credit unions

Last month, Ontario’s Superior Court froze assets belonging to Larry and Phillip Smith, their families and numbered companies the duo control. A list of those assets offers glimpses of a lavish lifestyle: It includes property on two islands in Georgian Bay, a 4,000-square-foot house in Florida, three boats and an Aston Martin DB9, the US$175,000 car made famous in James Bond movies.

According to the regulator, in the currency-exchange deal, Larry Smith also had an unlikely partner: a Toronto-based real estate agent named Joanna Whitfield with whom he had a close relationship, and who controls an obscure numbered company that had defaulted on loans from PACE before.

The allegations in the court filings raise questions about apparently lax oversight and regulation of credit unions. The conduct at issue dates back several years, and the regulator has not made public all of its “significant concerns involving various governance issues,” according to an affidavit DICO filed in court.

“These events are not impacting the current day-to-day operations of PACE. It is important to note that there is a strong foundation at PACE and all operations remain business as usual.”

Phillip Smith declined to comment and his lawyer did not respond.

Although the regulator has not filed a statement of claim against Larry or Phillip Smith,”the totality of the evidence … is such that the Administrator has concluded that there can be no reasonable explanation for their conduct,” DICO told an Ontario court.

PACE executives pitched the credit union’s board on the potential to sell services through CCE’s branches and kiosks, generating new profits. Originally, PACE planned to partner with The Mint Corp. Inc., a financial-technology company, to jointly acquire CCE through a special-purpose vehicle.

But in October, 2016, CCE founder and CEO Scott Penfound e-mailed Larry Smith, proposing that they “do a deal just between ourselves.” Mr. Penfound suggested PACE could acquire 75 per cent of CCE’s shares. (Mr. Penfound declined to comment.)

Yet, 2340 only had the funds to buy Trayco’s assets because, under Larry Smith’s direction, PACE provided 2340 with a separate loan of $2.2-million, as well as a $300,000 credit line, according to the regulator. Because 2340 used that new loan from PACE to purchase Trayco’s assets, those funds could then offset some of the credit union’s losses on its earlier loans to Trayco, which were in default.

After that, the business operated for a time as Premier Poultry Products, owned by 2340. But it was actually run by Larry Smith and Brian Hogan, PACE’s vice-president of commercial lending, according to DICO. They failed to make Trayco’s business successful, however, and 2340 ultimately defaulted on its loans. PACE wrote off $2.9-million in losses in 2016. “While the assets of the poultry business appear to have been disposed of, 2340′s loans to PACE were not repaid in full,” and it appears that PACE never undertook enforcement proceedings to recoup its losses, DICO alleges.

To finance 2340’s purchase of its stake, Larry Smith “caused PACE” to provide 2340 with a $14.5-million interest-only loan, and a $500,000 line of credit purportedly for “working capital purposes.” It’s also unclear whether PACE’s board knew of the loan, according to the regulator.

In an e-mail to The Globe, Ms. Whitfield said, “if this matter proceeds, I plan to vigorously defend myself. As always, there is another side to the story.”

In response, Phillip Smith asked that the language be “softened.” “The importance for us is PACE is not to be seen ‘cosmetically’ in control of CCE,” he wrote.

That same month, DICO first learned about the CCE deal “through a letter from an anonymous whistle-blower.” The regulator calls 2340′s role in the deal “a sham.”

“[Larry] Smith states that the CCE transaction, which is the subject of DICO’s legal proceeding, was a bona fide transaction that was unanimously approved by PACE’s board of directors. The transaction has been highly profitable for PACE and should continue to be, notwithstanding DICO’s intervention. DICO’s proceeding against Mr. Smith is purely tactical as PACE has suffered no damages.”

After the CCE deal closed in early 2017, significant payments began to flow from CCE to 2340 and, by extension, to the Smiths and Ms. Whitfield, according to the regulator.

E-mails from April, 2017, describe the potential for a recurring $525,000 payment from CCE to 2340, and Larry Smith asks Mr. Penfound to send the funds to PACE’s address, to the attention of him and his assistant. Mr. Penfound subsequently amended the amount to $450,000 – the quarterly dividends CCE agreed to pay to 2340.

In a Feb. 15, 2018, e-mail to Mr. Penfound, Larry Smith says: “At this point we’ve paid JW’s co … $1.35m … should it be classified as a dividend and/or management/consulting fee,” with DICO presuming JW is Ms. Whitfield.

“In fact, once all of the extra payments Larry and Phil received in relation to the Credit Union’s business are accounted for, Larry received (directly or indirectly) approximately $3.84-million and Phil received at least $225,000 more than the reported amount in 2017 alone.”

Most of the documents from this latest court proceeding are kept confidential under a sealing order issued by a judge. “The Administrator commenced legal proceedings to protect the best interest of the credit union members as part of its process to deal with the past governance issues,” Mr. Hubert said in a written statement.

Months after DICO was first contacted by the whistle-blower in October, 2017, the regulator sent PACE a letter of concern the following March. In April, 2018, the regulator met with several people at PACE, including with Larry and Phillip Smith. During that meeting, “DICO found much of the information to be incomplete or inaccurate,” the regulator alleges.

Last Dec. 5, DICO dismissed Larry and Phillip Smith with cause. The regulator alleges that it has found additional evidence confirming “that Larry and Phil were engaged in an improper scheme to evade the requirements of the [Credit Unions and Caisses Populaires] Act and the Regulations and, furthermore, to enrich themselves and others connected to them through the CCE Transaction.”

In an affidavit, DICO states that “the irregularities and the concerns regarding the CCE Transaction were only one of the issues that lead DICO to issue the Administration Order.”

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