Some Portus money to flow in the fall

Date: Friday, July 27, 2007
Author: Scot Blythe, Advisor.ca

The 26,000 investors who put $792 million into managed accounts with Portus Group will see some money starting early in the fall. So far, Portus's trustee in bankruptcy has traced roughly $150 million in cash.

But Robert Rusko, senior vice-president at KPMG, says the first allocation to Portus clients will be less than the amount of the cash so far collected.

Tracing that cash took two and a half years and involved a series of legal steps. One was to connect investor money to accounts at Portus Alternative Asset Management. Unlike client funds in the Portus-run Market-Neutral Preservation Fund, the investment structure for the Portus bancnotes was never implemented. Instead, KPMG's lawyer James Grout told Ontario Superior Court Justice Colin Campbell today that the money was misappropriated.

In the MNPF structure, Canadian stocks were bought, and trust units were established, such that Canadian investors would be able to accumulate the returns of an underlying, principal-protected hedge fund portfolio based on the trust units while deferring taxes to the degree the Canadian stocks did not distribute income.

For the managed accounts, that structure was never implemented. What the managed account agreement specified was an investment in Canadian stocks; what investors got was a commingled interest in a series of hedge fund notes as well as uninvested cash.

Grout says the trustee had to "marry the assets to the investors." The trustee in bankruptcy then moved to apply part 12 of the Bankruptcy and Insolvency Act. That section applies specifically to bankrupt securities firms. It allows for investments made through the securities firms to flow to investors before creditors and shareholders.

KPMG moved to create a customer pool that would have that priority in claims. However, since the funds were not invested but misappropriated, according to Grout, there was a chance the monies recovered could flow through to creditors and "the architects of the debacle" thanks to a "functional gap" in the Bankruptcy and Insolvency Act.

In a normal securities firm bankruptcy, whether because the firm ran out of working capital or suffered heavy losses in its own trading account, client securities would have been held at the Canadian Depository for Securities, Grout says, and clients would be able to claim their net equity: the market value of the securities on the day of the receivership less money owed to the firm.

Since Portus Alternative Asset Management did not purchase Canadian securities for its clients, a "black letter" interpretation of the state would mean the client market value was zero, Grout says, leaving the collected monies open to claims from creditors and shareholders.

Justice Campbell ruled, in view of this functional gap, that the assets belonged in the customer pool.

KPMG has not made a decision yet about the bulk of the client assets held in principal-protected notes. The earliest maturity, for $70 million in notes, is September 2008, with other maturities stretching out to 2011.

KPMG is also pursuing Portus principal Boaz Manor for $17.5 million in misappropriated funds, half of which were used to buy diamonds.

An Israeli district court has refused to rescind an order barring Manor from leaving Israel. Manor has sought permission to come to Canada to prepare for a January hearing by the Ontario Securities Commission. In a related case, the Israeli Supreme Court has denied the district court's request to jail Manor for contempt of court for not producing the diamonds.

Manor has claimed that a business associate, Yitzchak Toib, has the diamonds, while Toib has said he returned them to Manor. Using both a Mareva and an Anton Piller order, KPMG applied to search for and seize the diamonds at Toib's business and home.

Since it is not clear who has the diamonds, the high court handed the matter back to the district court, saying "in view of the heavy suspicion hanging over Boaz Manor that he still retains control of the diamonds, we return this file to the District Court," to take into account developments in other legal proceedings involving Manor and Toib.

Filed by Scot Blythe, Advisor.ca, scot.blythe@advisor.rogers.com.