R. v. De Zen et al., 2010 ONCJ 630

COURT FILE No.: Oshawa 2811-998-10-00690-01; -02; -03; -04; -05; -06 DATE: 2010·12·24 Citation: R. v.

De Zen et al. , 2010 ONCJ 630 ONTARIO COURT OF JUSTICE BETWEEN: HER MAJESTY THE QUEEN — AND — VITTORIO (VIC) DE ZEN DOUGLAS DUNSMUIR GARY BROWN RONALD GOEGAN LUCIANO (LU) GALASSO GORDON BROCKLEHURST Before Justice Richard Blouin Heard over 52 days throughout April, May, June, September, October and November 2010 Oral Judgment given December 10, 2010 Written Judgment released on December 24, 2010 Damien Frost and Wendy Levant.................................................................................. for the Crown Mark Sandler, Jonathan Shime and Scott Bergman ................... for the accused Vittorio (Vic) De Zen Brian Greenspan and Robin McKechney......................................... for the accused Douglas Dunsmuir Alan Gold, Vanessa Arsenault and Danielle Douek................................... for the accused Gary Brown David Porter and Christopher Wayland ............................................... for the accused Ronald Goegan David Harris............................................................................... for the accused Luciano (Lu) Galasso Gregory Lafontaine and Vincenzo Rondinelli ............................. for the accused Gordon Brocklehurst BLOUIN J.: Introduction [ 1 ] The defendants were charged with two counts of Fraud Over $5,000 upon Royal Group Technologies Ltd. (“Royal” or “RGTL”).

All six defendants were members of executive management. Count one involves the purchase of land (Vaughan West) by three of the defendants personally (among others), which was sold to RGTL soon thereafter for a profit of approximately $6.5 million.

Count two involves receipt by five defendants of approximately $2 million resulting from a disposition of a financial instrument (a Premdor warrant) that belonged to the company. [ 2 ] The allegations reduce to the proposition that the defendants benefitted personally from opportunities or assets that belonged to the shareholders of RGTL, and then made efforts to ensure their actions were not scrutinized by the Board of Directors, the auditors, and the investing public. [ 3 ] RGTL was a private company started in 1970 by Vic De Zen and two partners (known before 1997 as Royal Plastics).

Immediately before the company went public in 1994, Royal held 49 wholly owned or joint-ventured manufacturing businesses in

Canada, the U.S. and Mexico. Even after the Initial Public Offering (IPO), which allowed investors to share the business, RGTL was structured to recognize Mr. De Zen’s role as the driving force and operating mind behind the company. Through the periods relevant to this prosecution, Mr. De Zen was the President, Chief Executive Officer (CEO) and Chairman of the Board of Directors (the Board). Mr. De Zen owned all of the multiple voting shares, which allowed him to possess 80 to 90 percent of the votes available to shareholders. Mr.

De Zen is named in both counts. [ 4 ] Douglas Dunsmuir was General Counsel and Executive Vice President during the period from 1994 to 2002. Thereafter, he was President and eventually CEO until his dismissal in November 2004. Mr. Dunsmuir is named in both counts. [ 5 ] Gary Brown was Chief Financial Officer (CFO) and Executive Vice President until he retired in December 2001. He is named in count one only. [ 6 ] Ronald Goegan was Vice President Corporate Finance from 1994 to 2001. He succeeded Mr. Brown as the CFO until dismissed in November 2004.

He is named in both counts. [ 7 ] Luciano Galasso was a Vice President and Director of Taxation until September of 2004, when he left Royal to work in Mr. De Zen’s private business. He is named in count two only. [ 8 ] Gordon Brocklehurst was Director of Accounting and Vice President of Business Development until being asked to resign in March of 2005. He is named in count two only. [ 9 ] The Crown called 21 witnesses.

In an attempt to catalogue them into cohesive groupings, I will refer to the witnesses together in the following categories: Background Witnesses: Regarding the Vaughan West transaction – David Hofstedter, Trevor Blakely; Regarding the Premdor transaction – John Ambruz, Harley Ulster, Mitchell Finkelstein and Dietmar Neuhaus Independent Directors: Greg Sorbara, Ronald Slaght, Ralph Brehn, Irvine Hollis and James Sardo KPMG Auditors: Enzo Francescutti, Robert Nobes, Todd Buchanan and Rosa Chiefari Internal Employees: Scott Bates, Donna Costa and Rosemary Cecatini Investigative and Forensic Accountants: Ross Hamilton, Alan Stewart, Stephen Hill and Jeffrey Good (report admitted on consent) In addition to the viva voce evidence, counsel spent countless hours constructing a comprehensive Agreed Statement of Facts spanning 55 pages which was filed as Exhibit 1 on this trial.

This court remains indebted to counsel for their herculean efforts. [ 10 ] The defence called no evidence, save and except filing one document. [ 11 ] I must say, at the outset, that the witnesses that testified in this case, often attempting to recall events that occurred 10 to 12 years earlier, were most impressive. Even though all were called by the Crown, and three were investigators, I seldom felt the evidence was coloured by bias or allegiance.

The only exception to this characterization was James Sardo, who was not present when the alleged events occurred, and was RGTL Board Chair when a number of the defendants were dismissed. His bias was obvious, and he took every opportunity to voice it. I was impressed with the independent Board members who admitted shortcomings when confronted with them. KPMG employees were straightforward regarding the mistakes made in their work. [ 12 ] The cross-examination in this case was largely focused on eliciting further evidence to complete the story as opposed to attacking witness credibility and reliability.

Generally, I came to view the evidence presented as the Crown eliciting testimony which supported the absence of proper accounting and direct reporting, and the defence finding evidence from those same witnesses, which tended to show transparency and openness. [ 13 ] One other general finding I should make clear, before I proceed, is that I am convinced by the evidence that the decisions made regarding the purchase of Vaughan West privately and the sale to RGTL, and the disposition of the warrant through bonuses, were decisions made by Mr. De Zen. I have no doubt Mr.

De Zen received advice and assistance on how to effect these transactions from others, including some of the defendants. If Mr. De Zen was fraudulent, there is little doubt other defendants would have been found to have been parties to that fraud to the extent they assisted, encouraged, or formed a common intention. However, the evidence satisfies me that there was no fraud. [ 14 ] What I concluded after hearing the entirety of the evidence was that prior to 2003, the corporate governance, management structure, and disclosure practices of RGTL were fundamentally deficient.

Specifically, the management structure provided one person with virtually unfettered power to transact significant contracts on behalf of the corporation. The Board was not engaged in providing sufficient oversight of management’s decisions. Management had no procedures in place to identify important transactions which involved related parties and potential conflicts of interest. This last deficiency was particularly problematic in a vast company with a complex web of connections between subsidiaries and the public company, and between private companies and the public company.

It was abundantly clear that most of the defendants apportioned time working for the private and public entities. RGTL, during the late 90’s, was evolving from a private company to a public entity, still intertwined with the private interests of senior management and significant shareholders.

[ 15 ] Almost every witness who was asked about the issue of corporate governance supported the view that a “sea change” occurred in North America around 2002 with the passage of the Sarbanes-Oxley Act in the United States. Structures, like those at RGTL, such as the Chief Financial Officer sitting on the Audit Committee; multiple voting shares; the same individual holding the positions of President, Chief Executive Officer, and Chairman of the Board; $60 million threshold before Board oversight; and majority of inside directors were all viewed after 2002 as antiquated.

Therefore, to view events in RGTL’s life in 1996, for example, through a corporate governance lens 10 years later, distorts the historical record. [ 16 ] After hearing oral submissions on December 10, 2010, I found myself in a position to render judgment that day. Although I mentioned briefly the reasons that allowed me to acquit the defendants directly after submissions, I would like to expand upon those reasons. Fortuitously, counsel had arranged with the court services to structure the reporting to allow transcripts of the proceedings to be released the next day.

As a result, I was able to review the evidence as the trial progressed. After the introduction of witnesses concluded on November 2, 2010, I was able to access those transcripts and summarize the evidence while awaiting written submissions delivered on November 30, 2010. In the 10 days before oral submissions I fully reviewed the written submissions of both parties (each exceeding 100 pages).

I did not think it fair to the defendants to delay my verdict any longer when the result was clear to me after reviewing the evidence and considering the oral and written submissions. [ 17 ] The sheer volume of evidence called by the Crown caused me to review the viva voce evidence, and the applicable passages from the Agreed Statement of Facts, for each of the two counts separately. Because many witnesses were taken to the same documents, and areas of concern, there is, by necessity, some repetition in my attempt to summarize the important evidence in each category of witness.

I also make note that the same exhibit might be identified with different numbers, depending on the witness, since each witness had his/her own dedicated binder with multiple tabs. Also, to avoid any more confusion than a complex case like this inherently possesses, I should point out that RGTL only became that after 1997. It was Royal Plastics Group before that date. Similarly, a reference to the Premdor warrant also includes options, as the warrant was first classified as options. Similarly, Premdor became Masonite in 2001, hence the reference to the Masonite warrant.

Count 1 – Vaughan West Vaughan West Background [ 18 ] David Hofstedter’s family business (Vaughan West Corporate Centre Inc.) owned a parcel of undeveloped land (185 acres) located on the southwest corner of Highways 7 and 27 in Vaughan, opposite the headquarters of RGTL (the “Vaughan West” lands). In the autumn of 1997, Mr. Hofstedter asked Trevor Blakely of Royal Lepage to value the land and to seek potential purchasers. Hofstedter did not want to list the property for sale publicly as he was concerned people would get the wrong impression about his company’s cash flow stability. Mr.

Blakely thought that RGTL was a logical potential purchaser. Mr. Blakely did pursue RGTL on November 20, 1997 when a discussion with Mr. Goegan left Blakely to understand that Royal or one of its partners might have an interest in Vaughan West. Goegan indicated that Vic De Zen may be interested in the property on a personal investment basis. That interest appeared to fizzle and soon thereafter Hofstedter was approached by another real estate agent, Ernie Racco, who indicated he had a buyer for the property – that being Fortunato Bordin, in trust. [ 19 ] Negotiations ensued and Vaughan West was acquired by Mr.

Bordin for $20.5 million (or $113,889 per acre) in an Agreement for Purchase and Sale dated January 22, 1998 with a closing date of March 31, 1998. The Agreement for Purchase and Sale was conditional, in that the purchaser had until March 8, 1998 to complete a soil analysis. Mr. Hofstedter agreed it was possible that the purchaser received a “very favourable” price because of a greater understanding of the industrial real estate market in the surrounding area, a greater understanding of the municipal development process, and Hofstedter’s decision to restrict the marketing of the land. In addition, Mr.

Hofstedter did not want to invest the capital and the time required to develop the land into high-end commercial property. No appraisal was done by Royal Lepage regarding the fair market value. Ultimately, Mr. Hofstedter felt the $113,889 per acre price was a “fair deal”. [ 20 ] Scott Bates, a lawyer who worked in the legal department of RGTL, but also for private interests related to senior management of the company, requisitioned a search of the property on January 22, 1998 and asked Sam Sperenza of Jovien (RGTL subsidiary) to arrange for an environmental inspection. Mr.

Bates agreed that there was a co-mingling of Jovien’s work between both public and private companies. [ 21 ] On March 6, 1998, Mr. Bordin assigned his interest in the property to 1260392 Ontario Ltd. That company originated on October 10, 1997, later allocating shares to six private companies as follows: Recipients of Shares Amount Percentage (%) De Zen Investments Canada Limited 4,450 44.50 Fortunato Bordin Investments Canada Limited 2,225 22.25 Domenic D’Amico Investments Canada Limited 2,225 22.25 1251744 Ontario Limited (Tony DiGiorgio) 500 5.00 Gary Brown Investments Canada Limited 300 3.00 D.

Dunsmuir Investments Canada Limited 300 3.00 Total 10,000 100.00 [ 22 ] On closing date, March 31, 1998, a deposit consisting of four cheques totalling approximately $20.5 million was made to the account of 1260392 Ontario Ltd. Those contributors were the first four listed above as shareholders of the company. Then Mr. De Zen signed a cheque on behalf of 1260392 Ontario Ltd. to the benefit of Vaughan West Corporate Centre Inc. that same day for $20,213,198.17, needed to close the deal. The transaction was accomplished through a deposit to, and cheque from, Mr. Dunsmuir’s

trust account, although Mr. Dunsmuir was in Asia the week prior to April 1, 1998. [ 23 ] Importantly to these allegations, on that same day, March 31, 1998, 1260392 Ontario Ltd. transferred all of its shares to Roybridge Investments Ltd. (RIL), the real estate division of RGTL. This was done by resolution of the sole director, Mr. De Zen, and share transfer forms were executed by all six shareholders. However, it was not until April 7, 1998, when Mr.

Goegan prepared an internal RGTL document that reflected $27,390,500 was to be transferred by cheque from RIL to the shareholders of 1260392 Ontario Ltd., that payment was made by the public company to the private shareholders. Independent Directors Gregory Sorbara [ 24 ] Gregory Sorbara acted as an independent member of the Board of Directors from the inception of the public company in 1994 until his resignation in October 2003. Throughout that period he was the chair of the Audit Committee. Mr. Sorbara was emphatic in agreeing that Mr.

De Zen was the driving force behind the company that had, by 2002, close to $2 billion of revenue. He worked “outrageously slavish” hours and lived and breathed his company. He was also capable of making impulsive decisions based upon epiphanies that came to him. [ 25 ] Mr. Sorbara was referred to documents that articulated relevant provisions of RGTL’s corporate constitution or governing by-laws that were instituted in 1994. By-law No. 1 of the corporation contained an important term dealing with conflict of interest.

Section 4.18 provided that a director or officer shall disclose any personal interest in a material contract or proposed material contract with the corporation. The by-law was signed by Mr. Dunsmuir and Mr. De Zen on November 25, 1994. It reads as follows: 4.18 CONFLICT OF INTEREST – A director or officer who is a party to, or who is a director or officer of, or has a material interest in any person who is a party to, a material contract or proposed material contract with the Corporation shall disclose the nature and extent of his or her interest at the time and in the manner provided by the Act.

Any such contract or proposed contract shall be referred to the board or shareholders for approval even if such contract is one that in the ordinary course of the Corporation’s business would not require approval by the board or shareholders. Such a director shall not vote on any resolution to approve the same except as provided by the Act. [ 26 ] In addition, the corporate constitution dealt with decisions requiring Board approval which included transactions, investments, or dispositions with an aggregate value of $60 million or more. As a result, Mr.

Sorbara agreed that management did not require Board approval for transactions under $60 million. That relatively high threshold was consistent, Mr. Sorbara testified, with the primary theme of the IPO which was that the company was, and would remain, under the complete direction and management of Mr. De Zen. The share structure, most particularly the shares held by Mr. De Zen, confirmed that, giving Mr. De Zen approximately 80 to 90 percent of the votes allocated to shareholders. Mr. Sorbara also agreed that the multiple voting shares held by Mr.

De Zen were reflective of his role as the driving force behind the company when it went public. The corporate management structure was weighted in favour of inside (meaning executive management) directors on the Board. [ 27 ] During Mr. Sorbara’s Board tenure there was no discussion regarding Clause 4.18 of RGTL By-law No. 1 – about what conflict of interest means and how it is to be applied.

There was no discussion at the Audit Committee regarding the by-law, or its relationship to the $60 million threshold and how those two provisions would work within the content of an intense concentration of power vested in Mr. De Zen. Even so, Mr.

Sorbara was of the view that the contract for the purchase of the Vaughan West lands was a material contract in which three of the defendants had a personal interest, and, as a result, should have been disclosed to the Board, but wasn’t. [ 28 ] All of these factors: multiple voting shares amounting to 80 percent to 90 percent of the votes of shareholders; inside directors; $60 million threshold for Board approval, “vested in Mr. De Zen virtually total control of this company.” Mr. Sorbara’s view was that if this company had been taken public 10 years later, it would not have made it to the market. [ 29 ] Mr.

De Zen also relied heavily on others to assist in regulatory and legal compliance issues. Mr. Sorbara does not remember ever having a conversation with Mr. De Zen on those topics. [ 30 ] Exhibit 35-9 evidenced the minutes of a meeting of the Board on April 29, 1998. This was the first meeting after the Vaughan West lands had been purchased by RGTL. The first item discussed was that RGTL had purchased a 155(sic) acre site on Highway 27, across from head office, and would construct a 500,000 square foot warehouse as soon as possible. Mr.

Sorbara testified that he had not been informed as to the price RGTL had paid, from whom the property was purchased, nor when the deal had closed. Discussion centred around building a campus for RGTL on the acquired property and not the acquisition details. Apparently, Mr. Sorbara, nor any other board member, asked for details. [ 31 ] On November 28, 1998, KPMG (RGTL auditors) issued an audit report to the Audit Committee. The report warranted the auditors were not aware of any illegal or questionable acts, or unusual or high risk transactions which should be brought to the attention of the Audit Committee.

One of the key areas of the audit report dealt with acquisitions in that financial year. Although other acquisitions were noted, there was no mention of the Vaughan West acquisition. [ 32 ] Mr. Sorbara was shown a Management Representation Letter (Exhibit 35-10) signed by Mr. De Zen and Mr. Brown, dated November 20, 1998, that confirms, to the best of their knowledge and belief, the company had not entered into transactions with related parties other than disclosed in the financial statements. Mr.

Sorbara agreed no such transactions were disclosed in the financial statement and that no related party transactions were brought to his attention. He, as a member of the Board, would have pursued the details of the transaction if they were “material”, and he considered the $27 million purchase of Vaughan West as material. The company had no established internal system for identifying and disclosing related party transactions in 1998.

Related Party Transactions [ 33 ] Mr. Sorbara testified that during his tenure on the Board there was no discussion about any exception to the $60 million threshold, and there was no formal process to bring related party transactions to the Board’s attention (as became the case in 2004 – related party transactions of $100,000 or more were to be approved by the Audit Committee). [ 34 ] At fiscal year end, or shortly after, KPMG submitted an audit plan to the Audit Committee. Mr. Sorbara, as chair of the Audit Committee, confirmed that neither his committee nor management dictated the level of audit review.

The depth of investigation into the financial documents of the company rested exclusively with KPMG, who would report to the committee upon completion of its audit work. [ 35 ] Regarding the issue of the reporting of related party transactions, Mr. Sorbara agreed that KPMG identified other related party transactions which never were submitted to the Board for approval.

In fact, he agreed that related party transactions that were done in the ordinary course of business, fell below the $60 million material threshold, and were done at fair market value, need not be the subject of separate disclosure in the financial statement or subject of Board approval.

At least that was the case, until 2002, when a different perspective regarding corporate governance was reflected by including a separate note in the financial statement, even if a related party transaction was done at fair market value. [ 36 ] However, prior to 2002, there were many related party transactions that were dealt with at the audit level and not disclosed in the financial statements and not dealt with by the Board. These pre-2002 related party transactions that came to the attention of KPMG were not even presented to the Audit Committee.

By way of example, in 1996, RGTL purchased four companies: Jovien, Royal King Electric, La Pineta and Freeze Company, which KPMG reflected as related party transactions in the audit report. Mr. Sorbara agreed that those four related party transactions were not included as separate notes in the 1996 financial statements and that they were never submitted to the Board for approval. Also, at the Board meeting of April 28, 1997 there was discussion regarding the purchase of Baron Metals but nothing about its related party nature (Mr. De Zen, among others, had an interest in the company before purchase). Mr.

Sorbara agreed the above accounting was consistent with an assessment being made by the auditors regarding related party transactions, done at fair market value in the ordinary course of business and, as such, need not be subject of Board approval or be disclosed in a note to the financial statements. [ 37 ] Every year KPMG, as part of the RGTL audit, would construct a document called a Management Representation Letter that would be presented to executive management. In the letter, management would represent that no material related party transactions occurred.

With respect to the issue of Management Representation Letters, Mr. Sorbara confirmed that the same representation was made by management regarding related party transactions in 1997, when it is clear from the above that there were some. He agreed that the management representation contained in those letters dealt with “material” related party transactions. That concept was also captured in a Management Proxy Circular disclosed to the public which used the language of “material” interests of insiders that would “materially” affect RGTL. Expansion Plans [ 38 ] Mr.

Sorbara reviewed documents that spoke of RGTL’s planned business expansion in late 1997 and early 1998. This was a period of rapid expansion of RGTL business. At a December 3, 1997 Board of Directors’ meeting (Exhibit 35-8), the company indicated that it had built two million square feet of manufacturing plant and expected to build two million square feet more in 1998.

At a RGTL meeting on January 8, 1998 (Exhibit 35-56), it was clear that those proposed plants involved future manufacturing by various subsidiaries often in other countries. [ 39 ] Finally, at a Board of Directors’ meeting on February 11, 1998 (Exhibit 35-57), expansion related to the above was discussed. [ 40 ] At none of these meetings was it contemplated the Vaughan West lands be considered for this expansion. In fact, as Mr.

Sorbara concluded, the proposed expansion couldn’t be done at Vaughan West given the process of re-zoning and servicing takes eight to 12 months, so that construction would be a year away. Irvine Hollis [ 41 ] Irvine Hollis was shown a Management Proxy Circular dated December 31, 1998 (Exhibit 63-6) prepared for the Annual Shareholders Meeting of February 18, 1999. Under the signature of Mr.

De Zen, it reads at page 14: INTEREST OF MANAGEMENT AND OTHERS IN MATERIAL TRANSACTIONS During the year ended September 30, 1998, no Director, senior officer, principal shareholder or other insider of Royal Group, nor any associate or affiliate thereof, has or has had any material interest, direct or indirect, in any transaction or in any proposed transaction which has materially affected or would materially affect Royal Group, its affiliates or any of their collective subsidiaries. [ 42 ] There was never any discussion regarding the meaning of this clause.

He was never told by anyone about the Vaughan West land transactions’ related party nature until 2004, when Kroll investigated. [ 43 ] However, Mr. Hollis was also of the view that this transaction would not have been subject to Board approval since it was below the $60 million material threshold. As a result, there would not have been any discussion about whom the property was purchased from. [ 44 ] Mr. Hollis testified that the Board never discussed the concept of materiality. If the transaction was less than $60 million there was never a discussion regarding the parties to it.

With the benefit of notes made by investigators in 2004, Mr. Hollis was able to

come to a “logical conclusion” that someone at the Board meeting of April 29, 1998 indicated the acquisition of the Vaughan West property took place at fair market value, although Hollis had no present memory of that discussion. Ralph Brehn [ 45 ] Ralph Brehn, an Independent Director for RGTL, recalls that sometime in late 1997 (probably December 3, 1997), during a break in the meeting, Ron Goegan came into the boardroom and sat down next to him and Vic De Zen.

Goegan had a folder and indicated to De Zen, “We’ve got to make a final decision on this land across the street…the real estate people want an answer.” Mr. Brehn heard Mr. De Zen respond with, “No, no, we don’t need more land right now.” He heard Mr. Goegan reply by saying, “It may not be available when you want it.” As Ron folded up his folder and started to leave, Mr. De Zen turned to Brehn and stated, “Maybe I’ll buy it myself and that way it would be available if the company wanted it later.” Mr. De Zen also stated that if the company did not need it, he could put it into his business and sell it. [ 46 ] Mr.

Brehn testified that he found it “commendable” that Mr. De Zen was prepared to put up his money to ensure the company had access to the land when needed. This was also consistent with his knowledge that Mr. De Zen had a private land development business in the Vaughan area. [ 47 ] At the Board meeting of April 29, 1998, Mr. Brehn, after noticing bulldozers moving soil on the property as he travelled to the meeting, asked Mr. Dunsmuir if Royal had bought the land across the street. When asked about the purchaser, Mr.

Dunsmuir replied, “It was just one of those numbered companies we bought it from.” No further questions were asked, and Mr. Brehn assumed that Mr. De Zen did not buy it. When later he was asked by investigators about the transaction and Board approval necessity, Mr. Brehn assumed that it was within Mr. De Zen’s $60 million threshold. He also admitted that the first time he told anyone about this conversation with Mr. Dunsmuir was eight years after the event and the details surrounding the event were, not surprisingly, somewhat fuzzy (e.g. he could not remember other persons sitting beside Mr.

Dunsmuir in the boardroom). Ronald Slaght [ 48 ] Ron Slaght joined the Board of Directors upon the inception of the public company in 1994 and became a member of the Audit Committee that same year. He was present by telephone at the April 29, 1998 Board meeting, where the minutes reflect the purchase of the Vaughan West lands. Although Mr. Slaght had acted for RGTL and Mr.

Goegan, who had been sued by Royal Lepage for lost commissions when the Vaughan West purchase was conducted through another firm (Rentex), he was not aware of the connection between the two events until 2004 when the Kroll investigations took place. He did believe that information contained in an affidavit that he constructed for Mr. Goegan to sign, that indicated RGTL had no interest in the property, came from Mr. Bates during a telephone conversation and not Mr. Goegan. He agreed as well that the affidavit contained many references to Mr.

De Zen and it is clear that RGTL was not trying to hide his personal interest in Vaughan West or the fact that he, Mr. De Zen, was ultimately one of the purchasers of the land that was sold to RGTL. [ 49 ] Mr. Slaght was asked about a report that was released in 2001 by Anthony Scilipoti, an analyst with Veritas Investment, wherein Mr. Scilipoti reported that he had a discussion with management regarding the RGTL purchase of the Vaughan West property.

Scilipoti was advised that Vaughan West was acquired by RGTL from Vic De Zen and his private interests at fair market value and that the company was fortunate to do so. Mr. Slaght was not aware of this report until after November 2004. That report was publicly circulated and available and Mr. Slaght agreed that no one could expect its contents be excluded from the Board’s attention. [ 50 ] Along the same lines, Mr. Slaght was not aware earlier of another analyst’s report (Steve Laciak) which indicated a discussion with management in July 1998 that Vaughan West had been sold to RGTL by Mr.

De Zen privately for $150,000 per acre, whereupon Mr. Laciak engaged his own real estate people to confirm that price as a fair price for the property. As with the Veritas report, Mr. Slaght testified that he would have liked to have been made aware of the Laciak report before November of 2004. KPMG Auditors Rosa Chiefari [ 51 ] Rosa Chiefari started as junior staff accountant in 1995 and was the field auditor (meaning she did the work to implement the audit plan) for the year of the Vaughan West transaction. The audit plan contained the scope or level of audit.

Scope 1 and 2 generally required “testing” or “vouching”, which means looking at underlying documents to substantiate the numbers presented in the financial documents of the company. Scope 3, 4 and 5 do not involve looking at underlying documents. Regarding Roybridge, the audit level was a scope 3 in 1998, which means no vouching, just discussion with management. Importantly, Roybridge drew a scope 2 in 1996 and 1997. [ 52 ] Ms. Chiefari’s main client contact at Roybridge was Frank Montesanti.

She looked at the balance sheet and income statement prepared by Roybridge and discussed any significant changes with him. One of the items in what is called a balance sheet analytical (part of Exhibit 36-2) was a discussion with Mr. Montesanti regarding information provided by Roybridge in the “Land Held for Development” heading.

Montesanti provided information regarding “land purchased across from Royal Head Office (addition of $30 M).” This land is also mentioned later on in Exhibit 36-2 as “the most significant piece of vacant land located across from RGTL head office ($30 M).” Because the Roybridge audit did not require vouching, Ms. Chiefari did not look into the general ledger or any other supporting documentation. Importantly, she did not ask Mr. Montesanti any questions regarding the acquisition.

The discussion centred around amounts capitalized in relation to anticipated revenue from the property when developed. [ 53 ] As indicated, the audits on Roybridge in years previous to 1998 were done at a scope 2 level, which would include some examination of underlying documents. For example, in 1996, KPMG examined supporting documents for a $990,000 land purchase because the audit was a scope 2. Ms. Chiefari agreed that RGTL could expect to be required to produce supporting documents if the 1998 audit was performed at the same level as 1997 and 1996. In theory, if one were trying to hide a transaction, Ms.

Chiefari agreed

that it would be foolish to leave information about that transaction in the general ledger. Also, a trail of cheques, cheque requisitions, a statement of adjustments, and the Agreement for Purchase and Sale of the property would be discovered and the transaction clearly identified if the same scope of audit was performed in 1998 as was in the previous years. The scope level for 1998 would not have been known in March and April 1998, and management would not have been privy to that information until October 1998.

In fact, if Roybridge had been audited as it was in 1996 or 1997, the general ledger and the other documents would have been scrutinized by KPMG.

It would be clear from the names that this was a related party transaction. [ 54 ] She also agreed that confusion may have resulted when KPMG referred to intercompany transactions which they categorized as related party transactions, some of which did not appear in the consolidated financial statements because they were not material. [ 55 ] Not only that, but KPMG issued a directive placing an onus on its auditors to “investigate circumstances that may indicate the existence of undisclosed related party transactions.” No questions were asked by KPGM of Mr.

Montesanti or anyone else at RGTL even though Vaughan West was one of the most significant transactions in RGTL history. The land held for development had also increased from $14 million in 1997 to $34 million in 1998, which would be a significant change in position. [ 56 ] Again, if the object of the exercise was to hide the related party nature of the Vaughan West transaction, Ms.

Chiefari agreed that an asset purchase, as opposed to the share purchase (RGTL purchased Vaughan West by purchasing the shares of the numbered company), would better suit the purpose since the individual shareholders would not show up in the general ledger. [ 57 ] Another issue that arose in the examination of the audit procedure was how KPMG treated related party transactions that they determined not to be material. An auditor could find a related party transaction and not require its disclosure as a separate note in the consolidated financial statements if it were not material.

This is in accordance with s. 3840 of the CICA Handbook (Exhibit 43-B). Ms. Chiefari was taken to the acquisition by RGTL in 1996 of four related companies (Jovien, Royal King Electric, La Pineta and Freeze Company) identified as such in the September 30, 1996 audit plan (Exhibit 45). The audit report that was presented to the RGTL Audit Committee after the audit did not reflect any related party transactions in 1996. She agreed, had there been an assessment, that they were not significant.

Appendix II to the Report reads, RPGL has been involved in certain transactions with related parties in the ordinary course of its business.

None of the transactions are significant in relation to RPGL’s consolidated financial statements and thus this revision is not expected to have a significant impact on RPGL. (Note: RGTL was then known as RPGL) Enzo Francescutti [ 58 ] As the engagement partner for KPMG, Enzo Francescutti had overall responsibility to ensure the audit work was properly planned and executed and was mainly responsible for conducting and signing the audit opinions for the financial years 1997 to 2000. [ 59 ] The first step in that process would be the preparation of an audit plan to be presented to the Audit Committee, which is a committee of the Board.

A timetable was constructed that outlines the key steps and milestones, including meetings with management, that would be followed until completion of the audit report and an opinion given on the consolidated financial statements of the company. [ 60 ] Francescutti further testified that the company presents the financial statements and related notes and the auditor signs an opinion as to the reliability of these statements. If the auditor felt the statements were not accurate or reasonable, they would provide either a qualified opinion or no opinion at all.

The auditor does not test every single transaction given the volume and complexity of a large company like RGTL, but instead identifies areas of risk upon which to focus. [ 61 ] In order that the field auditor would recognize the breadth of the investigation into various subsidiaries of RGTL, a level of review (or scope) would be determined by the engagement partner. The field auditor review would be determined by that scope number. Scope 1 and 2 involved looking at underlying documents.

Scope 3 and above would involve looking at unusual trends or significant changes and not at underlying documents. [ 62 ] Significant to this case, the level of review applicable to Roybridge Investment Ltd. (the real estate division of RGTL) changed in 1998 to a level 3 from a level 2 in 1997. Whereas, Roybridge’s underlying documents were subject to examination in 1997, they were not in the following year, although if any auditor requested to look at documents there was nothing prohibiting the auditor from doing so. [ 63 ] In that vein, the Vaughan West development showed up in Ms.

Chiefari’s (the field auditor) balance sheet analysis as “land held for development” in the amount of $30 million. Even though it was the largest real estate transaction of the year, no further analysis of the transaction was necessary. Mr. Francescutti remembers a discussion during the 1998 audit with Gary Brown wherein they discussed the business rationale for the purchase, and the estimated cost and time frame for the development of the land. There was no discussion regarding the identity of the purchaser. Mr. Francescutti did not ask if the purchaser was a related party.

If aware of that fact, KPMG would then need to look at the related party transaction to find support that it was conducted at fair market value. [ 64 ] A KPMG internal document (Exhibit 36-5) regarding audit procedures suggests that the auditor should “obtain from management a list of all related parties and the transactions with these parties…” Mr. Francescutti believes he directed his staff to obtain such a list. Ms.

Chiefari did not obtain one. [ 65 ] KPMG also drafted a document called the “Management Representation Letter”, which required senior management to indicate that the information provided to the auditors was accurate and complete.

[ 66 ] One of the key representations found in this letter was that management had not been involved in any related party transactions. The recommended wording was provided by KPMG. Defence reviewed with Mr. Francescutti a number of examples where RGTL engaged in related party transactions with members of senior management that were not disclosed in the consolidated financial statements. That was so because those related party transactions were not “material”.

In determining if a related party transaction was material or significant and needed to be disclosed in the financial statements, the auditor used his professional judgment looking at, among other things, whether the transaction was in the ordinary course of business, and was conducted at fair market value. KPMG Knowledge of Related Party Transactions [ 67 ] Found in possession of KPMG were flow charts for the relevant years, Exhibits 37, 40, and 41.

Those charts were provided to KPMG by RGTL to show the relationship of the subsidiary companies to the parent, and the relationship of RGTL to the private interests of some members of senior management. For example, a company called Baron Metal was held privately by members of management in 1996, and the 1997 chart showed that this company was now part of RGTL.

In addition, in the 1996 report to the Audit Committee, it was obvious that four companies, Royal King Electric, Joven, La Pineta, and Freeze Company, were acquired by RGTL in related party transactions totalling just over $3 million, but were not included in the consolidated financial statements because they were not “significant”. KPMG agreed with this assessment, attaching a positive opinion to the financial statements. [ 68 ] Mr. Francescutti made it clear that he personally was not apprised of any related party transaction during his term as engagement partner.

However, it was also clear that two KPMG corporate financial partners were aware of the related party nature of the relationship between Baron Metals and RGTL. They both operated in the downtown Toronto KPMG office. As well, Ed Bartucci, who was a tax partner at KPMG’s Vaughan office in 1997, was aware of the purchase agreement regarding Baron Metals and RGTL, and accordingly, its related party nature. Mr. Francescutti would have expected his tax people to relay the information regarding this related party transaction, but they did not.

Add to that, the Baron Metals audit team, including the engagement partner, Mr. Francescutti and Bob Novakowski, were aware of the related party transaction makeup of that deal. Mr. Francescutti was not told by Mr. Novakowski.

Although Baron Metals was an $11 million deal, and was known to a number of employees of KPMG as a related party transaction, its exclusion from the RGTL financial statements was not disputed by the auditors. [ 69 ] Public documents regarding the amalgamation of Byron Bay – Royal Eco Products (i.e. the amalgamation circular) and other documents that were in KPMG’s possession, made it clear that certain individuals at KPMG were aware that there was a related party transaction. The related party nature of this amalgamation was never communicated to the Audit Committee.

And again, there is no reference in the RGTL consolidated financial statements where KPMG provided a positive opinion that this was a related party transaction. When that amalgamated company was then taken in by the public company, a $6.4 million deal was recorded in documents provided by RGTL to KPMG as a related party transaction, but not disclosed in the financial statements as such.

Management Representation Letters [ 70 ] Before KPMG could offer an opinion on the financial statements to the Audit Committee, and ultimately the shareholders, a Management Representation Letter would be prepared by the auditor and delivered to the company. The company would review it and make any changes necessary.

Among other representations, the important one indicated, “...the company has not entered in transactions with related parties...other than disclosed in the consolidated financial statements.” [ 71 ] Certain people within KPMG were aware that the company had entered into four related party transactions in 1996 that were not disclosed in the consolidated financial statements, yet provided draft wording suggesting otherwise. KPMG employees again in 1997 were aware of the acquisition of Baron Metal as a related party transaction not disclosed, but provided the same draft wording suggesting otherwise.

There are other examples noted above. Mr. Francescutti was of the view that the responsibility to modify the wording of that representation rested with management since they signed the letter. [ 72 ] On the issue of what was known by KPMG regarding related parties at the outset of the 1998 auditing process, the organizational chart, Exhibit 40, provided by RGTL to KPMG, discloses crucial information. [ 73 ] The real estate division includes a box which shows a numbered company as a subsidiary of Roybridge (itself, the subsidiary of RGTL that held land for development).

Along with 1260392 Ontario Ltd., “Vaughan West” is included in brackets. The same disclosure is provided in the 1999 organizational chart. Mr. Francescutti, as engagement partner, was aware that 1260392 Ontario Ltd. had only one asset, which was the Vaughan West land. Robert Nobes [ 74 ] Mr. Nobes was a senior accountant and the RGTL client contact. He was questioned by the Crown as to how related party transactions would typically come to the attention of the auditors. Mr. Nobes indicated that, mostly, the auditors would be told about them.

However, when asked if any part of the audit involved searching for related party transactions, he replied, “We ask questions of management.” Exhibit 36-5 was an internal document employed by KPMG which requires the auditors to obtain a list of related party transactions from management. Internal Employees Scott Bates [ 75 ] Scott Bates joined RGTL as a corporate lawyer in 1996 to work in the legal department for Mr. Dunsmuir. The legal department of RGTL worked on private legal matters in addition to legal matters of the public company.

This is consistent with a general interconnection of RGTL executive management’s efforts between public and private endeavours. He was aware Mr. De Zen and others had private commercial real estate interests.

[ 76 ] Mr. Bates performed legal work on Vaughan West commencing in January 1998, after the Agreement for Purchase and Sale was signed. As indicated earlier, he requested an environmental assessment and soil probe. He worked closely with Mr. Goegan as the closing date approached on the financial aspects and commission litigation response. He does not recall if he became aware before or after March 31, 1998 that RGTL (through Roybridge) was buying the property. As corporate counsel, he took no steps to inform the Board of Directors or anyone else.

He had no concern, at that time, regarding possible conflicts of interest. There was no prohibition from anyone at RGTL to prevent discussion about the transaction, including the profit, with anyone. It was well known at RGTL, Jovien, and other entities from whom Vaughan West was acquired, and it “was not a significant issue.” He agreed the usual and ordinary business of Roybridge was to acquire and maintain real estate for RGTL. [ 77 ] Mr. Bates was also asked about his involvement in the preparation of the Management Proxy Circular for the year end 1998.

The paragraph that warranted that no member of senior management had a material interest in any transaction with RGTL was a form paragraph used each year. De Zen, Dunsmuir and Brown received a draft for comment, but no one, including Mr. Bates, raised a concern regarding the Vaughan West transaction. When asked why he did not, Mr. Bates indicated his judgment at the time allowed an assumption that senior management made an assessment of materiality of the transaction, which explained its omission.

If he had been asked about the transaction by the auditors or the Board, he would have disclosed the transaction, including the profit. He confirmed that some of the land (40 acres) was sold for $450,000 per acre in 2004. [ 78 ] Throughout the last week of March 1998, Mr. Bates was acting as a liaison between Mr. Slaght and Mr. Goegan regarding the preparation of Mr. Goegan’s affidavit supporting the defence of Royal Lepage’s claim for commission. In Mr. Goegan’s memorandum given to Mr. Bates, it was reflected that Mr. De Zen (through De Zen Holdings) had an interest in Vaughan West and that RGTL had no interest.

This was consistent with Mr. Bates’ understanding at the time. This information was conveyed to Mr. Slaght, who was counsel, but also a Board member. Investigative and Forensic Accountants Stephen Hill [ 79 ] Stephen Hill was qualified, on consent, as an expert in the area of accounting, auditing, and forensic accounting. He was employed by an accounting firm but was seconded to IMET (the Integrated Market and Enforcement Team of the RCMP) from January 2004 until he authored reports in 2007 regarding RGTL. [ 80 ] Mr. Hill was able to identify Mr.

Goegan’s handwriting on a document that was prepared to assist in negotiating the price for Vaughan West with Mr. Hofstedter during the period December 18, 1997 to January 22, 1998. Interestingly, the parties that Mr. Goegan appears to put on either side of the negotiation were “Royal” and “H&R”. The Agreement of Purchase and Sale of course has the parties as Vaughan West Corporate Centre Inc. (Mr. Hofstedter), and Fortunato Bordin, in trust. [ 81 ] Hill also testified that the disbursements regarding the environmental assessment done by Briggs for Jovien were paid by Roybridge (public company) in May of 1998.

This work was performed between January 22, 1998 and the invoice date of March 12, 1998. Ross Hamilton [ 82 ] Ross Hamilton, the Kroll investigator, who was the lead on the Vaughan West transaction, was asked why Integris was not asked to assist in relation to a valuation of Vaughan West at March 31, 1998, as they had done with respect to other related party transactions looked at in the RGTL investigation. The simple answer was that the purchase and sale on January 22, 1998 had been an arm’s length transaction two months earlier, as was the Arbor Jane deal a few months later.

Summary and Findings [ 83 ] In late 2003, the Ontario Securities Commission was investigating the relationship between RGTL and Mr. De Zen’s development of a resort and casino in St. Kitts. A Special Committee of the Board of Directors comprised of independent directors was established to assist the investigation. That Committee, through counsel, retained the forensic accounting firm Kroll to investigate. On April 21, 2004, Kroll reported that it did not find any evidence of conduct calculated to improperly shift costs from the resort development to RGTL and that further investigation was not warranted.

Six months later, the Special Committee instructed Kroll to broaden its forensic work to include investigation into related party transactions from January 1, 1996 to the present, in order to fully cooperate with the OSC and RCMP investigations of RGTL. [ 84 ] About one month later, November 24, 2004, Kroll had discovered certain facts by reviewing RGTL documents and interviewing employees, including some of the defendants. Mr.

Hamilton, Kroll’s lead investigator on Vaughan West, testified on October 7, 2010 outlining the problem: Because we had a transaction on January the 22 nd , you know, where the land was bought for $20.5 million, and then two months later that land was then sold from a private interest to the public company for 27 million dollars.

And so there was relating profit of six and a half million dollars where we had sort of, if you will, senior management of the company acting for the company, but also having a financial interest in the sale of the transaction, and sharing in the profit so we were looking for any indication that this transaction had been reviewed and approved by – reviewed, approved, disclosed to other independent people within the organization. [ 85 ] Although the Crown characterizes the transaction as a “flip”, wherein the Vaughan West property was bought and sold the same day, Mr.

Hamilton’s assessment comes closer to describing its true character. Despite the closing of the purchase by 1260392 Ontario Ltd. and its sale to RGTL transacting on the same day (March 31, 1998), the numbered company negotiated and contracted to purchase the property about two and a half months earlier (January 22, 1998). Even so, an increase in price from $114,000 per acre to $150,000 in two and a half months is extraordinary. In addition, the fact that Mr. De Zen sold the property to a public company he

controlled at a substantial profit, raised red flags. In fact, it raised bright red flags. [ 86 ] The Crown identified other factors that contributed to a concern regarding the propriety of senior management’s conduct: 1. The corporate constitution contained a conflict of interest by-law requiring disclosure of material contracts to the Board of Directors when a director or officer has a material interest in the contract. The related party nature of the transaction was not disclosed to the Board at the meeting where the purchase of Vaughan West was discussed (April 29, 1998), or, any other Board meeting. 2.

A Management Representation Letter to KPMG that warranted the company had not entered into transactions with related parties. The related party nature of the transaction was not disclosed to KPMG (RGTL auditors). 3. A Management Proxy Circular which warranted that no director, senior officer, preferred shareholder or other insider of RGTL (all of which Mr. De Zen and others were) had any material interest in any transaction which would materially affect RGTL. The related party nature of the transaction was not disclosed to the shareholders or the investing public.

Fair Market Value of Vaughan West [ 87 ] The Crown submitted that senior management caused Vaughan West to be purchased at an inflated value by RGTL, but also submitted that the defence position that RGTL paid fair market value was a red herring. The defence relied on the Polo Realty appraisal letter found by Kroll in Mr. Dunsmuir’s legal file dated March 27, 1998, which contained an opinion the land was worth $31.5 million, or $170,000 per acre, and was addressed to Fortunato Bordin.

The Crown contends that opinion was “produced” to justify the inflated price paid by RGTL. [ 88 ] There are real concerns surrounding the bona fides of that appraisal. I find the inclusion of a single comparable property, an MLS listing of a 39 acre site in Brampton at $175,000 per acre, to be unconvincing, especially in the context of Mr. Sorbara’s evidence that a valid real estate appraisal to determine fair market value is an expensive, time consuming process involving indentifying values in and around the area. Mr.

Blakely, an experienced commercial real estate agent in Vaughan, had never heard of Polo Realty, nor did he note any accreditation attached to Polo’s letter which would indicate expertise in the field. Although the appraisal letter dated March 27, 1998 was in Doug Dunsmuir’s file, the same letter with a different date (July 20, 1997) was produced to the Kroll investigators by Mr. Dunsmuir. The latter letter was obviously incorrect as it purported to give an opinion regarding value in the future. Kroll was unable to contact Mr.

Buttiglieri, who signed the appraisal letter. [ 89 ] I conclude that although this letter does not inspire confidence regarding its reliability, it is the only purported valuation of Vaughan West at the relevant time. The Kroll investigators did not request a valuation by Integris (property valuators) as they did for 12 other related party transactions included in their investigation.

I note that Integris found the other investigated related party transactions to be done at fair market value. [ 90 ] No expert evidence was tendered by the Crown to establish the value of Vaughan West during the relevant period of January 22, 1998 to March 31, 1998. The Crown position advanced was that fair market value of the property as at January 22, 1998 was $114,000 an acre for the following reasons: • That price was arrived at by two independent arm’s length parties after negotiations. • Mr.

Bates suggested and received $114,000 per acre when a remaining encumbrance (five acres to Arbor Jane) was removed on June 18, 1998 after negotiations with Arbor Jane commencing May 15, 1998. • In October of 2000, Mr. Bates was tasked with preparing documentation to obtain a land transfer tax exemption. He communicated with Mr.

Goegan by email, who told Bates to “see Ernie Racco – he told Vic it was fair at the time.” A letter from Racco, dated August 16, 2000, provided an opinion that the raw land at Vaughan West was worth $28,231,000 to $31,368,00 after three years of unprecedented growth . [ 91 ] The argument that fair market value was established on January 22, 1998, since it was arrived at after negotiations by two independent arm’s length parties, has some initial attraction. I accept prices are often set in a market economy through negotiation and agreement by distinct parties.

However, this transaction was not available to the full market of purchasers, since it was not listed for sale publicly, and only one potential purchaser, RGTL, was contacted. [ 92 ] Mr. Hofstedter explained that he did not list the property to avoid negative industry impressions regarding his company’s financial position. He realized that decision might compromise the price he received. He also indicated that he was amazed at how quickly the property was developed and, at that time, was not anxious to commit long term capital to what would likely be a “high-end” development. He conceded it was possible that Mr.

Bordin had purchased Vaughan West at a very favourable price due to the purchaser’s greater understanding of the industrial real estate market in the area, a greater understanding of the time needed to connect municipal services, and the restricted marketing of the property. No appraisal was done by Royal Lepage regarding the fair market value. [ 93 ] Between January 22 and March 31, 1998, work was performed by Briggs Environmental Canada Limited (see Exhibit 70-194) which allayed any concern that the environmental and clean-up costs would be prohibitive.

That analysis, obviously not available when the property was purchased by Bordin, would be instrumental in determining a fair market value for the land as at March 31, 1998. [ 94 ] Mr. Sorbara testified early in the trial regarding the rapid increase in property value during the relevant period: ...if Mr. De Zen and his private partners had kept this land for their own account over the course of two or three years they would’ve made a heck of a lot of money because land was increasing in value dramatically in that area.

If you review the economic performance of York Region and Vaughan, within York Region, industrial land was becoming increasingly scarce and month-by-month, quarter-by-

quarter, year-by-year prices were going up and so much so that it would be very hard to predict what a piece of land might be worth six months or a year down-the-road. [ 95 ] The Crown also relied upon the price negotiated by Mr. Bates with Arbor Jane in May and June, 1998 as proof of the fair market value of $114,000 per acre as at March 31, 1998. However, Mr. Bates knew of the higher price paid by RGTL ($150,000), but was negotiating on behalf of the company to pay Arbor Jane the lowest possible price for the five acres.

Since Arbor Jane would only have access by way of title search to the publicly available price of $114,000 per acre, it was a representation made to secure RGTL the best price, not to establish what would be fair market value. [ 96 ] Regarding the land transfer tax exemption evidence, the Crown relies on an opinion from Ernest Racco (the same agent who acted for 1260392 Ontario Ltd. in the purchase) that the Vaughan West lands were worth between $28,231,000 and $31,368,000 as of August 16, 2000 after three years of unprecedented growth. [ 97 ] Mr.

Racco was not called as a witness and there is no evidence to establish when throughout that period the growth occurred. To have some value in assessing market value as at March 31, 1998, one would need some evidence providing the rate of growth between approximately August 16, 1997 and March 31, 1998, and the growth thereafter to August 16, 2000. In addition, this opinion was attached to more property than the original 185 acres, including some additional (hydro) lands purchased at $50,000 per acre. [ 98 ] In my view, the Crown has not established Vaughan West was purchased by RGTL at an inflated value.

In fact, the majority of evidence on the value issue points toward 1260392 Ontario Ltd. purchasing the property at a discount. There is no doubt that Mr. Hofstedter, who was already motivated to sell (see reasons above), became more motivated when his only target purchaser (RGTL) appeared not to be interested. [ 99 ] Finally, I agree with the defence submission that although 40 vacant acres of Vaughan West was eventually sold in 2004 for about $450,000 per acre, the court cannot extrapolate in reverse. But I do again agree that this supports Mr.

Sorbara’s evidence surrounding the dramatically increasing property values in the area during that period, and the argument that could be made that Mr. De Zen’s private partners had every reason to conclude that he sold the property to RGTL at a deflated value and thereby benefitted the company at their expense. RGTL Fingerprints [ 100 ] The Crown produced evidence which suggested that RGTL, the public company, was involved throughout the process of negotiating and acquiring Vaughan West well before March 31, 1998.

RGTL “fingerprints were all over every aspect of the purchase of the Vaughan West property” up to and including their acquisition of the property on March 31, 1998. Among the connections made were: • The property was exclusively offered to RGTL in November 1997 but rejected by Mr. De Zen on behalf of the company in early December. • Very soon thereafter (December 18, 1997), Mr. De Zen’s brother-in-law and an RGTL employee, Fortunato Bordin, made an offer for the property. • Mr.

Goegan was directly involved in the negotiations to find a price that the private interest represented by Bordin would pay. • RGTL’s legal department, headed by Mr.

Dunsmuir, acted for the purchaser, arranged for an environmental and soil analysis, paid disbursements for closing, incorporated the private company 1260392 Ontario Ltd. and kept its minute books, and represented both sides on the transfer of the land (by share purchase) from the private interests to the public company. [ 101 ] The Crown also elicited documentary evidence of a Board meeting on December 3, 1997 (Exhibit 35-8) wherein it was discussed that RGTL “built two million square feet of manufacturing plant this year and will do two million more next year.” The obvious inference sought was that since RGTL was expanding, Vaughan West was needed by the company in January. [ 102 ] However, a document found in RGTL’s files and independently produced by Mr.

Dunsmuir, dated January 8, 1998, entitled “Royal Group Technologies Limited, Expansion Program – Draft #1” (Exhibit 35-56) tells a very different story. The expansion plan alluded to at the Board meeting involved a number of individual plants at various locations, often in other countries, rather than a strategy that would involve the construction of a 500,000 square foot warehouse at Vaughan West. Mr.

Sorbara confirmed that the expansion plan at that point could not have included the Vaughan West property since the process of rezoning and servicing wouldn’t allow one to build on the property for eight to twelve months. [ 103 ] At some point during a break at the December 3 Board meeting, a very important exchange occurred between Mr. Goegan and Mr. De Zen, which involved Mr. Brehn, one of the independent directors. Mr. Goegan approached Mr. De Zen about the necessity for an answer on RGTL acquiring the Vaughan West property wherein Mr. De Zen indicated that RGTL did not need the land at that time. When Mr.

Goegan indicated the land might not be available when needed by the company, Mr. De Zen turned to Mr. Brehn and said, “Maybe I’ll buy it myself and that way it would be available if the company wanted it later.” [ 104 ] Other evidence points toward Mr. De Zen changing his mind late in March 1998 and deciding Vaughan West would fit within RGTL: • Mr. Bates advised Mr. Slaght that RGTL had no interest in the Vaughan West property and Mr.

Slaght incorporated that into an affidavit in late March 1998. • The payments to the shareholders of the numbered company happened one week later on April 7, 1998 supporting the inference that the decision to transfer the land to the company was made late in March and documents were not ready on March 31, 1998.

[ 105 ] I am satisfied that Mr. De Zen honestly believed the land was not needed by RGTL when, on January 22, 1998, it was acquired. The private acquisition would be consistent with De Zen’s private business affairs, as he had significant land holdings in the area. It would be consistent with his stated intentions on December 3, 1997 to Mr. Brehn. And his change of mind in late March would be entirely consistent with his particular approach to conducting business affairs wherein he made quick decisions and sometimes experienced epiphanies, as described by Mr. Sorbara, Mr. Slaght and Ms.

Costa. [ 106 ] I conclude that the evidence suggests that De Zen did not dishonestly deprive RGTL of the opportunity to acquire the land less expensively, and that he honestly believed RGTL paid a fair price for the land. This alone requires an acquittal. Disclosure to the Board of Directors [ 107 ] The Board was advised of the Vaughan West acquisition and discussed the building of a 500,000 square foot warehouse on April 29, 1998, the first Board meeting after March 31, 1998.

However, the related party aspect of the transaction was clearly not disclosed in any formal way to the Board as would be required if it was characterized as a material contract. There is no doubt Mr. Sorbara believed that the largest purchase of real estate by the real estate division of RGTL was, in fact, a material contract.

It should be noted at this time neither he, nor any other Board member, asked for any details regarding this important transaction. [ 108 ] Also, it appears that a “partners’ meeting” was held on April 2, 1998 which dealt with the “roll in of the Highway 27 property from personal to group.” The Crown submits that since the partners meeting was attended by senior management and key shareholders, and no independent Board members, this was akin to keeping two sets of books. [ 109 ] Materiality is a concept that flows through all sections of the accountant’s handbook ( CICA Handbook ).

One of the KPMG auditors, Todd Buchanan, testified that he was aware that RGTL management believed prior to 2003 that a related party transaction done at fair market value, in the ordinary course of business, need not be disclosed in the financial statement because it wasn’t material. [ 110 ] The corporate structure at RGTL was reflective of Mr. De Zen’s entrepreneurial origins. It allowed him approximately 80 percent of the voting shares, a majority of the inside directors, and most importantly a $60 million threshold on transactions below which he was not required to submit for Board approval.

Three independent directors testified that Mr. De Zen could reasonably expect that his decisions would prevail. There was no system to identify and report related party transactions. [ 111 ] Because there existed an extensive intermingling of RGTL and senior management’s private business interests throughout its public history, the company was investigated by Kroll regarding other related party transactions, including St. Kitts.

Those investigations revealed nothing improper, or revealed they had taken place at fair market value, despite the absence of Board approval or Audit Committee oversight. [ 112 ] Add to that, the size of the transaction ($27 million) relative to a company with close to $2 billion in revenue and a $4 billion market capitalization. RGTL senior management viewed Vaughan West as occurring at fair market value. The transaction was in the ordinary and usual course of business from the real estate holding subsidiary, Roybridge, and it did not exceed the $60 million threshold.

All of the above is consistent with management taking the position that the Vaughan West transaction was not material. [ 113 ] Mr. Sorbara did not remember a discussion at the Board about the meaning of materiality, conflict of interest, or how the $60 million threshold interrelated with the above concepts. When the climate for corporate governance changed after 2002, a requirement to have all related party transactions of $100,000 or more approved by the Audit Committee was instituted (in 2004). According to Mr.

Sorbara, the whole area of materiality was a “grey area”. [ 114 ] It is also clear from the KPMG witnesses that this was not a situation where management failed to respond honestly to inquiries by the auditors regarding related party transactions. Even though KMPG had a policy to ask for a list of related party transactions, and Mr. Nobes, the senior accountant, said the normal search would involve asking questions about them, and Mr.

Francescutti testified that directions to the field auditor would include those inquiries, the simple fact is nobody asked. [ 115 ] Again, although there was no formal disclosure to the Board of the related party aspect of the Vaughan West transaction, there were many examples of informal disclosure which, in my view, are inconsistent with a desire to hide the nature of the transaction. • The December 3, 1997 discussion with Mr. Goegan and Mr. Brehn ( an independent member of the Board) about Mr. De Zen’s intention to possibly purchase Vaughan West privately and to hold it for the company if needed. • Mr.

Dunsmuir hired Mr. Slaght (another independent Board member) to defend the Royal Lepage commission litigation. If Mr. Dunsmuir was attempting to conceal the related party nature of the transaction from the Board and others, the one lawyer he would avoid retaining would be Mr. Slaght. • Mr. Goegan told Mr. Slaght that Mr. De Zen had an interest in the private acquisition through a memorandum prepared for defending the commission litigation. • Mr. Bates was aware of the related party nature of the sale to RGTL and the profits made by the vendor.

It was not suggested to him (or anyone else who testified in this case) that the matter should be kept secret. He did not feel it to be a significant issue. • Mr. De Zen told Mr. Scilipoti (an analyst with Veritas Investment Research) that RGTL acquired Vaughan West from Mr. De Zen and his personal partners. This disclosure appeared in a Veritas report dated May 9, 2001 (Exhibit 35-49). An email trail (Exhibits 35-60 and 35-61) makes it clear that Mr.

De Zen was not trying to hide the related party nature of the acquisition from the public, including any members of the Board who might read that report. • Although not admissible for the truth of its contents, there was information relayed by another analyst named Steve Laciak (to James Sardo) during a conference call on November 29, 2004 (Exhibit 35-52). Mr. Laciak indicated to Mr. Sardo that he was told by

management in 1998 that RGTL bought Vaughan West from Mr. De Zen and that fact was generally known. The Crown asked Mr. Sardo if the disclosure was known to him in November 2004 and, if it was, would it have made any difference in the decision to fire senior management the previous week. Mr. Sardo answered no to both questions. [ 116 ] It is important to note that Mr. Brehn gave evidence regarding a discussion he claimed to have had with Mr. Dunsmuir at the April 1998 Board meeting. Mr.

Brehn observed activity on what he assumed was the Vaughan West property on his trip from the airport to headquarters that morning. Remembering what Mr. De Zen had indicated in December, Brehn asked Dunsmuir from whom the property was purchased. Dunsmuir’s reply was, “It was just one of those Ontario numbered companies.” There was no discussion after that, but Mr. Brehn assumed that the purchaser was not Mr. De Zen. [ 117 ] This was one of the few examples where defence (Mr. Greenspan in this case) cross-examined on the reliability of the remembered utterance. Mr.

Brehn was certain that he observed construction activity on the subject property which could not have been the case. It was proven that no construction could have been taking place at Vaughan West in April 1998. Mr. Brehn could not remember other important details regarding who else was present. [ 118 ] Given the above, it would be dangerous to accept Mr. Brehn’s recall verbatim, especially when there were eight years between when he says he heard the comment, and when he told police about it.

Disclosure to KPMG [ 119 ] The accounting records for Roybridge Investments Limited (RGTL subsidiary purchaser) and 1260392 Ontario Ltd. (private interests vendor) are full of documents that made the nature of this transaction readily apparent to any viewer. Ms. Costa made the bookkeeping entries on the Vaughan West transaction (overseen by Mr.

Goegan) and believed the ability to track the identities of all parties to the transaction to be “completely transparent”. [ 120 ] Examples of this transparency are outlined in the defence written submissions at paragraph 24: This evidence includes the following: • The Roybridge Investments general ledger that itemizes, by name, the recipients of the cheques from Roybridge as payment for the transfer of the Vaughan West land (Ex 39, tab 8). • The six cheques paid to the shareholders of 1260392 Ontario Limited .

The cheques, (which correspond with the ledger entries) also identify, by name, the recipients of the monies for the transfer of the land to Roybridge Investments Limited (Ex 39, Tab 8A). • The six cheque requisitions , all payable from Roybridge Investments Limited to the individual shareholders. They all show the purpose of the cheques as, “Purchase of Vaughan Industrial West” (Ex 39, Tab 8B). Ms.

Chiefari testified that even if one had no other documentation and only the cheque requisitions, this transaction would be readily identifiable as a related party transaction. • The corporate charts for 1997, 1998 and 1999 that were provided by Royal management to KPMG to assist in preparing the audit. Specifically, the 1997 chart does not have 1260392 Ontario Limited listed as a subsidiary of Roybridge Investments Limited, while it does appear as such on the 1998 and 1999 charts. The 1998 chart indicates, on its face, that 1260392 Ontario Limited is related to Vaughan West. (Exhibits 40, 41 and 42) Ms.

Chiefari, upon reviewing the charts, testified that one could easily see that 1260392 Ontario Limited was clearly related to the Vaughan West land purchase and that it would have been relatively easy to link the charts to the entries on the general ledger and the cheques. She further testified that if an audit had been done of the numbered company (as might be expected by RGTL senior management, since KPMG looked at all subsidiaries), the auditor would have quickly found out the details about the Vaughan West transaction. Mr.

Francescutti testified that providing the chart to KPMG reflected that there was no attempt to hide or conceal the existence of the numbered company from KPMG in 1998 or 1999. • The 1260392 Ontario Limited minute book (Exhibit 39-8C). Once the numbered company became a Royal subsidiary, the company’s minute book became available to KPMG.

Within it, there were a series of documents that clearly demonstrated the related party nature of the transaction, including, but not limited to: ➢ The Share Transfer Forms signed by each of the individual investors, each one stating that their respective shares had been sold, assigned and transferred unto Roybridge Investments Limited. ➢ The Shareholders’ Ledger, which also explicitly set out the transfer of each of the individuals’ respective shares to Roybridge Investments Limited.

Ms. Chiefari testified that had KPMG looked through the minute book, the identity of the shareholders and the fact that they were selling their shares to Roybridge would have been readily apparent. • Ms. Chiefari, Mr. Nobes and Mr. Francescutti all confirmed that a review of the available documents would have made it clear that this was a related party transaction. Indeed, as Mr.

Francescutti agreed, “from a documentary perspective, nothing was hidden”. [ 121 ] Add to the above, if one were trying to conceal the transaction, it would be more easily accomplished if the numbered company transferred the real estate (or assets) to RGTL as opposed to the shares. A share transfer contains the names of shareholders which can be identified. [ 122 ] Of course, we know none of the documents above were ever reviewed by KPMG in the 1998 audit. Ms. Chiefari testified they would have been if RGTL was audited that year at the same scope as existed in 1996 and 1997.

The decision to change the scope of the audit, made by KPMG, would not have occurred until the fall of 1998. It is obvious to me that RGTL had every reason to expect that KPMG would be reviewing those documents as they had done in previous years, and as a result were not attempting to hide the transaction from the auditor. [ 123 ] Additionally, Ms. Chiefari did not ask Mr.

Montesanti, the RGTL controller with whom she dealt, about the Vaughan West land, or from whom it was bought, even though KPMG had a policy to make inquiries about any related party transactions. [ 124 ] No issue was taken by the defendants with the omission of Vaughan West in the Management Representation Letter provided to KPMG. The letter (Exhibit 36-4) was part of the auditing process and was necessary for KPMG to offer an opinion.

In 1998, as in other years, it contained the following term: The Company has not entered into transactions with related parties, including no-charge transactions, sales, purchase, loans, transfers, leasing arrangements and guarantees, nor are there any related amounts receivable or payable other than disclosed in the consolidated financial statements. Mr. De Zen and Mr.

Brown signed the letter with no mention of Vaughan West. [ 125 ] The defence submitted that RGTL management treated the Management Representation Letter as pro forma and that it was reasonably regarded as compelling disclosure of material related party transactions, not all related party transactions. This submission finds support in the evidence: • Although there were many related party transactions throughout the relevant years, KPMG seemed content to provide an opinion.

For example, in 1996, there were at least four related party transactions (La Pineta, Royal King Electric, Jovien, Freeze Co.) that KPMG knew about, but did not object to their omission in the Management Representation Letter that year. • In 1997, there were two related party transactions (Baron Metals, Royal Eco Products) which were not disclosed as such, but were known to at least three employees of KPMG. [ 126 ] Although I accept that individual KPMG auditors

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