An urgent question of trust

James Fleming January 17 1983

An urgent question of trust

James Fleming January 17 1983

An urgent question of trust


James Fleming

It was a move unprecedented in the annals of Canadian commerce.

First, there was the growing controversy over a bizarre series of transactions last November that resulted in the sale of nearly 11,000 Toronto apartment units for an estimated $500 million to unnamed Saudi investors. Then, last week the Ontario government stepped in to seize control of more than $2 billion in assets of Crown Trust Co., Greymac Trust Co., and Seaway Trust Co., three of the key companies involved in the “Great Apartment Sale.” The move was made, said Ontario Minister of Consumer and Commercial Relations Robert Elgie, because of a belief that in each case “there exists a practice of or state of affairs ... that is or may be prejudicial to the public interest or to the interests of the corporation’s depositors, creditors or shareholders.”

Approved in a special, secretive cabinet meeting last Friday afternoon, the takeover was carried out under emergency amendments to the trust act, hurried through the legislature in late December. For a period of weeks, although the firms will continue business, the senior management will be locked out of their offices as a specially appointed team of eminent businessmen sift through records and files. The aim of the investigation is to answer what Elgie termed “questions about the lending practices” of the trust companies. At the same time, an inquiry into the companies’ policy and management by a team of accountants, launched earlier by the government, will continue. Hanging in the balance is the fate of the companies—including that of Crown Trust, Canada’s 12th-largest and one of its most prestigious trust institutions—and the credibility of Leonard Rosenberg, the flashy, highflying Toronto entrepreneur who catapulted into the spotlight for his role in the apartment sale and his takeover of Crown. On a broader scale, the fiasco has already blemished the public image of Canada’s trust industry.

As the reverberations of the an-

nouncement shook the business community, opposition politicians declared it long overdue. Liberal Leader David Peterson said it was a “desperate” action that underlined the “woeful inadequacies” of Elgie’s ministry in monitoring the activities of trust companies. He called for Elgie’s resignation and the appointment of a royal commission to investigate both the companies’ activities and the conduct of -

the ministry.

But, despite the political rhetoric, the controversy remained focused on Rosenberg, who controls Greymac Trust’s $280 million in assets through his private holding company,

Greymac Credit Corp., and owns 99 per cent of the common stock of Crown, a company with assets of more than $1.7 billion. For his part, Rosenberg said he welcomed the investigation “since it

will finally clear everything up.” Indeed, his companies have been plagued by a burgeoning public outcry, spurred by the web of intrigue surrounding them and inquiries launched by the provincial department of insurance and the Ontario Securities Commission (OSC) into their dealings. Details of the apartment deal were only unearthed gradually, thanks largely to the efforts of competitive Toronto newspapers and, eventually, by a statement from 43-year-old Rosenberg himself. In a dazzling series of deals, Rosenberg first bought the real estate from Cadillac Fairview Corp. for $270 million in November. He quickly sold the buildings to William Player, a 35-year-old Elmvale, Ont., native who controls Kilderkin Investments and is known to his associates as a master of real estate flips. In a package deal, Player paid $312.5 million for the property and another $37.5 million for another Rosenberg company, Greymac Mortgage Corp. The profit

for Rosenberg on the Cadillac Fairview apartments alone: $42.5 million. Player sold the apartments to an estimated 50 numbered companies thought to be controlled by Saudi Arabian investors for a striking $500 million. The total appreciation on the buildings: $230 million.

Initially, the loudest cries of alarm arose from the tenants of the apartments, who feared the soaring price for _ the buildings would

lead to unconscionable rent increases. The uproar prompted the Ontario government to hurriedly pass legislation limiting rent hikes to five per cent of financing costs. But the investigators quickly shifted their attention to the controversial appraisal methods used to arrange mortgages totalling $375 million for ? the sale of property inio tially exchanged for o only $270 million. This 2 aspect of the sale is of

particular interest to Touche Ross accountant James Morrison, who was assigned to the case by the department of insurance last November. It is also a priority item for the blue-ribbon group of businessmen appointed last week. There has been no indication of concern about Cadillac Fairview’s role in the mortgaging arrangements. As part of its deal with Rosenberg, it was agreed that his holding company, Greymac Credit, would assume first mortgages totalling $110 million, with Cadillac taking back second mortgages totalling roughly $120 million. Rosenberg paid the remaining portion of the sale price, $40 million, in cash.

The next leg of the deal involving Player is highly complicated and, for some, controversial. Player intended to sell the units for $500 million as soon as he bought them. But to swing the deal he needed 75-per-cent financing. Thus, an additional $152 million in third mortgages was arranged. Of that,

Crown Trust provided $56 million, Greymac Trust $20 million and a third company, Seaway Trust, controlled by Player’s friend Andrew Markle, put up $76 million as part of an arrangement in which it also bought a 12^-percent ownership in the apartments. Player then promptly resold the units not owned by Seaway to the offshore investors, who put down a $125-million downpayment. The major question is whether or not the mortgages totalled 75 per cent of the true value of the real estate involved. Trust companies are prevented by law from providing mortgages that exceed this percentage of the appraised value of property—the purpose being to help protect the lender from default by the borrower. But the law does not clearly define how the value should be set. As a result, some companies are using a new method called discounted cash flow (DCF), by which value is based on a property’s projected income stream from rents. That alone is not unusual, but, while the new method allows owners to lose money on a property in the initial years of ownership, more traditional appraisals demand positive returns from the start. The DCF method was apparently used in arriving at the $500-million price tag for the apartment units. And this is a bone of contention for some critics. Says Liberal Leader Peterson:

“It [the DCF method] is certainly not standard commercial practice. Only high flyers use it.”

Many industry experts agree. Ira Gluskin, a respected Toronto real estate analyst, says appraisal “is an art, not a science.” But, he adds, “The current worth of the apartment units is $300 million, in my estimation.” For their part, officials at the firms believe they have nothing to hide and that they will be exonerated by the probes.

Stanley Stewart, newly appointed chief operating officer at Crown Trust, was not with the company when the

$56-million mortgage was approved. Having reviewed the process, however, he maintains that the method of appraisal is “hardly new at all and generally applicable to revenue-producing real estate.”

While government-appointed sleuths sort out the murky issue, however, there is another twist in the tangle of investigations into the affairs of Rosenberg and his firms. Some experts believe that the prestige of Crown Trust, a bastion of the business establishment—it was once part of the Argus empire of Bud McDougald—is at stake in the probes: the investigators are also empowered to determine the “fitness” of the management at the companies. Some businessmen see Rosenberg as a relative unknown who emerged suddenly on the scene to purchase control of Crown late last year from CanWest Capital. The view of the Old Establishment, says Gluskin, is that Rosenberg and his associates have “come out of the blue with no experience in business of this scale.” The reaction, he says, has been “hostile in principle.”

Crown officials hotly contest the view

that the company might change its course under the new management team appointed after Rosenberg’s takeover. David Cowper, a onetime fund raiser for the provincial Conservative party and now president of Greymac Trust, is the new president-designate of Crown Trust. The only change the “tremendous new team” will bring about, he says, is a speeding up of Crown’s former decision-making process. Stewart concurs and adds that, with Rosenberg as chairman of the board, the company will take advantage of his “exceptional ability to do deals.”

Still, one deal involving Crown Trust has become ensnared in rulings by the OSC. After acquiring a majority control of the company from CanWest Capital Corporation for $25 million last October, Rosenberg launched plans to merge Crown Trust with Greymac Trust. By mid-December he had acquired nearly 99 per cent of Crown’s common shares

through trading on the Toronto Stock Exchange. Greymac and Crown reached an agreement to merge, 2 but, when notice was •given of a shareholders’ meeting to approve the marriage, the OSC moved in. The major reason: the OSC concluded that the information circulars required to aid minority shareholders in deciding whether or not to approve the deal were sorely lacking in information. Trading in Crown Trust shares was halted at the end of December, and the meeting was called off. Last week the OSC extended its ruling until its staff is fully satisfied by the completeness of the information.

The merger may still take place if the senior management of Crown Trust and the other firms subject to the extraordinary inquest emerge with their reputations unscathed. Cowper, for one, is confident they will. “If we’re cleared and cleared soon,” he says, “then we can go back to business.” Whether Crown Trust’s time-steeped image will emerge intact is another matter. Wallis King, a financial consultant representing Crown Trust preferred shareholders who are distressed by the changes at the company, is not optimistic. Of last week’s events, he lamented, “It’s rather sad to see a company held in such high regard for so many years falling into disrepute to this extent.”