Post-mortem of principles

January 18 1988

Post-mortem of principles

January 18 1988

Post-mortem of principles



Seventy-one-year-old Ralph Candler of Calgary had worked hard all his life, first as an 80-cents-an-hour carpenter in 1949 and eventually, before his retirement in 1985, as a manager of a realty office. Last year, he says, he felt that his financial position was secure. After all, he had invested his life savings of $80,000 with a subsidiary of Principal Group Ltd., an Edmontonbased financial conglomerate. But within months Candler and some 34,000 other investors in Western Canada and the Atlantic region had fallen victim to the collapse of the giant Principal Group. Last week a special inquiry into the affair resumed in Edmonton with two pointed tasks: to discover why the once-rich empire toppled and whether or not its failure involved fraud.

Like thousands of other Principal clients, Candler had been living on a modest pension and the interest he earned on his holdings. As a result, he was able to comfortably support his wife, Elsie, 72, and their daughter, who is a single mother of two children. Candler said that he thought he had invested his money cautiously. Four years ago he started switching his money from Edmonton-based NorthWest Trust, which he had heard was in financial trouble, to Principal Group. Recalled Candler: “I did some checking here and there. I talked to people, and they seemed to think that Principal was top of the line.”

Candler was right. Principal Group Ltd., the parent company of some 80 companies offering everything from insured deposit certificates to riskier mutual funds and investment contracts, was a premier Albertan company with $1.2 billion in assets. It was headed by multimillionaire Donald M. Cormie—a flamboyant man but, nonetheless, a member in good standing in the western business establishment and the founding partner of a prestigious Edmonton law firm. But last June Candler received the shock of his life when he heard on television that two investment contract companies owned by Principal Group, in which his investments were apparently held, had collapsed. “It took a day to sink in,” said Candler. “I was under the impression that they were above board. I just couldn’t believe it.” Candler and the more than 34,000

other investors had about $467 million invested when Alberta Treasurer Dick Johnston pulled the operating licenses of First Investors Corp. and Associated Investors of Canada Ltd. on June 30. And dozens of creditors, including 22 Alberta Hutterite colonies, who held the promissory notes of parent Principal Group, lost $60 million when the rest of the financial empire declared bankruptcy on Aug. 10.

Now, those investors and creditors are treated to almost daily dissections of what went wrong with the companies, as the court inquiry—which is expected to cost the Alberta government $10 million—wends through what will likely be six months of testimony before Calgary lawyer William Code, 55. Resuming hearings following a threeweek Christmas break, Code’s mandate is to discover whether there is evidence of fraud leading to the failures. The scope of his post-mortem also allows him to call Alberta cabinet ministers and senior civil servants to testify.

Since the opening session on Oct. 14, Code has heard testimony that paints a picture of lax regulating by provincial authorities and a corporate owner single-mindedly bent on preserving his empire. The investigation, taking place in a sterile hearing room in a downtown Edmonton office tower, has already heard 1.5 million words of testimony from more than 100 witnesses and tabled more than 12,000 pages of documents. During January and February Cormie and senior government officials are scheduled as witnesses, and they are expected to explain some of the sensational evidence.

Twenty lawyers and an even larger number of accountants are attached to the inquiry, which normally runs from Monday to Thursday. Court-appointed receivers estimate that contract holders may eventually receive 60 to 65 cents for every dollar invested. But since the collapse, many elderly investors have complained of worsened health problems as they despair of ever

regaining their financial security. Annette McCullough, a social worker at the Kerby Centre, a drop-in centre for seniors in downtown Calgary, said that following the collapse of the companies, 300 elderly Calgarians who lost their savings have gone to the centre specifically to register their concerns with the centre’s social work department. Social workers flagged about 50 of them as sounding so depressed that they needed

to be watched closely—and two were hospitalized.

Meanwhile, the man who owned and ran Principal Group was able to settle out of court with the trustee in bankruptcy assigned to Principal Group. Under an agreement reached following the failure in August of the entire group of companies of „, „ ,, which he was president,

Donald Cormie relinquished control of about $40 million in assets.

But he was able to preserve some of his personal fortune and continues to run two mutual funds in the United States worth about $16 million. He retained his 18,000-acre cattle breeding ranch located in Tomahawk, Alta., 75 km west of Edmonton, a sprawling ranch-style house with a spectacular

view of the city of Edmonton, and a 41foot yacht moored at Victoria. Cormie also kept two Vancouver Island mansions set on 40 acres of prime waterfront property. And in Arizona, Cormie retains a house in one of the most exclusive areas in Scottsdale, a wealthy suburb of Phoenix.

What stings many of Principal’s ruined investors is a clause in the bankruptcy agreement guaranteeing that

Cormie’s personal assets are free and clear of any claims by the trustee in bankruptcy of Principal Group Ltd. The agreement also forgave Cormie a $10million debt to Principal Group and let him keep $1.5 million to cover tax liabilities and housing loans to two of his sons. Asked Elsie Candler: “Why didn’t he go bankrupt with the rest of us?”

By financial industry standards, Principal had an extraordinarily high proportion of clients 55 years and older—the result of a company objective to attract customers with a lifetime of savings to invest. They became the innocent victims in a tragedy whose roots were planted more g than 30 years ago when S Cormie founded his fi-

; nancial empire. 1 Equipped with a Har-

vard education and a knack for the money markets, Cormie began promoting a concept of systematic savings by contractual arrangement. He established First Investors in 1954 by offering investors four-per-cent interest and later a share of the profits from investments that the company made on their behalf. But the federal government introduced deposit insurance for banks and trust companies in 1967, making it harder for investment contract companies like Cormie’s to attract new clients and continue to grow unless they offered an interest-rate premium above that offered by insured institutions.

In the 1960s Cormie incorporated a trust company, creating a parent holding company, Principal Group, and established a number of mutual funds. Principal continued to be privately held, with Cormie and his family owning 89.5 per cent. The remaining 10.5 per cent was held by Kenneth Marlin, a longtime friend of Cormie’s and president of the investment contract companies, as well as senior vice-president of Principal. By the 1980s ï Principal was a well-es= tablished company based * in Edmonton, with $ branches and salesmen I in nearly every hamlet of Western and Atlantic Canada. Cormie’s sons, John and James, had been brought in as shareholders and company officers. Principal Group had also expanded into investment companies in Arizona and owned a graphics and computer company in Toronto.

But according to the testimony of Principal employees at the Code hearing, Cormie’s empire began to crumble in the early 1980s, when the bottom dropped out of the real estate market in the West. He was by no means alone. Eight other western institutions, including banks and trust and mortgage companies, collapsed between 1981 and 1985, when the 1981-1982 recession wiped hundreds of millions of dollars of value from their real estate and mortgage portfolios. Westerners have repeatedly blamed the financial scandals on federal government policies in the early 1980s that precipitated the recession. Indeed, in September, in his first major speech on the subject of the Principal collapse, Alberta Premier Don Getty called it “the final legacy of the National Energy Program by that

remarkable coalition of Liberals and New Democrats.” Getty added at that time that he felt sympathy for Cormie.

But in most cases—in the failure of Edmonton-based Fidelity Trust, Regina-based Pioneer Trust and Calgarybased Northland Bank—investigators also discovered improper business practices that were at the root of the collapses. And the Code inquiry seems to be uncovering the same thing at Principal.

Much of the testimony from senior Principal officials has portrayed Cormie as an impatient autocrat who would stop at nothing to keep the companies operating.

Confidential company memos filed with the inquiry show that Cormie planned to use his influence with several B.C. cabinet ministers to solve a regulatory problem in that province.

Cormie was also unable to delegate, personally making almost all the decisions in the billiondollar organization.

According to employees who have testified, problems in the real estate and mortgage portfolios of the companies were camouflaged on the orders of Cormie. In one instance, they testified that Cormie dictated that 30 problem loans— many of them originally approved by Cormie’s sons—be removed from the control of a mortgage manager who insisted on lower, more realistic valuations. One former Principal vice-president testified that Cormie also insisted that the parent company should not issue an audited financial statement for 1985 because he did not want to reveal the financial hemorrhaging.

Cormie also skirted a number of attempts by government regulators to enforce rules governing the companies. In 1986 provincial regulators insisted that advertisements for Associated and First Investors include a statement in bold print that said investments with those companies were not covered by deposit insurance. However, Cormie instead diverted ad funds for the two companies and spent the money advertising Principal Trust, which did qualify for insurance. The Code inquiry has heard from numerous investors who say that they

were the victims of so-called bait-andswitch tactics. They say that they were attracted by the trust company’s ads, but then Principal representatives talked them into making investments with the riskier contract companies.

But that was by no means the most

startling allegation. A former Principal computer analyst testified that Cormie ordered him to keep two sets of books: one, presenting a positive, profitable picture of the company, was shown to customers and government regulators, while the accurate account, prepared by auditors, was shown to only a handful of top company executives.

As well, a moral vacuum appeared to have developed in Principal as the need to soak up more and more investor funds grew. Last fall the inquiry heard a tape recording of Principal salesman Douglas Haydock impersonating a tax adviser on the telephone and using confidential tax information in an effort to win business from an elderly person. And during other testimony, salesmen employed by Principal

admitted that they had forged the signatures of clients on investment contracts. One Feb. 17, 1987, memo to area managers and vice-presidents listed forgery and unethical conduct among “the more frequently occurring situations.”

In other testimony, a salesman admitted to switching a client’s investment from Principal Trust, where it qualified for federal government deposit insurance in the event of a failure, to an investment with First Investors, which was not insured, without the client’s knowledge.

One of the hardesthit groups of investors in Principal was the Hutterite community of Alberta. Plain-living and deeply religious, the Hutterites live apart from mainstream society. The Code investigation has heard that, for 30 years, Principal salesmen have targetted the Hutterites as particularly desirable investors because of their large pools of savings. And when Principal Group collapsed in August, Hutterite savings accounted for roughly a third of the $87 million in unsecured promissory notes issued by Principal. But in 1986, when Jacob Kleinsasser, the manager of one Hutterite colony, had asked a Principal salesman about the health of the company after it had failed to release audited statements, the salesman told him it was “as sound as the Rock of Gibraltar.”

The Code investigation is also, in effect, a trial of Alberta’s lenient handsoff regulatory policy for financial institutions. On a much-publicized openline radio show last fall, Getty vowed that if the inquiry found that government regulators were negligent, the province would fully reimburse investors. Evidence submitted to the investigation so far shows that on Mar. 31, 1986, Alberta’s superintendent of insurance refused to renew the licences of First and Associated Investors because they had not filed audited financial statements. However, on May 16 the superintendent issued the licences, even though financial information re-

vealed a capital deficiency of $15 million.

In remarkable testimony last week, Principal’s vice-president of finance, William Johnson, revealed that provincial regulators had commissioned an examination of Principal by the accounting firm Price, Waterhouse. He said that the regulators and company officials then attempted to conceal from Principal’s outside auditors the appointment and the damning report that resulted from Price, Waterhouse’s examination. The accountants recommended in the February, 1987, report that the government suspend the operating licences of the two investment contract companies and appoint receivers. The report was originally commissioned by the government in November, 1986, because of officials’ concerns about losses in the companies that had accumulated since mid-1984.

Other witnesses have testified that the two Principal subsidiaries operated without licences in Alberta and British Columbia for part of 1986. And the Code inquiry has also heard that Alberta regulators wrangled with Principal executives for eight months in 1984 over real es-

tate assets that they said were overvalued by as much as 69 per cent.

Despite that mounting crisis, Cormie refused government aid because it would have meant giving up some of his control. In a downtown Edmonton office building, Cormie, his sons

John and James, and former Principal vice-president of corporate development Christa Petracca, a close friend of the senior Cormie’s, continue to operate the company that manages the U.S. mutual funds. And in an interview, Petracca gave some in-

dication of their testimony: “The government has tried to make us out to be terrible people and fraud artists, and no one has said that real estate collapsed in 1982.”

Running concurrently with Code’s investigation is an inquiry by Alberta’s ombudsman, Aleck Trawick, who also will examine the government’s regulatory performance. In October an inquiry in British Columbia— where many retirement-age investors in Principal lost their savings —concluded that the business practices of Principal Group were deceptive and misleading. And further investigation may come after RCMP officers, who regularly attend sessions of the Code inquiry, review testimony.

Investigator Code will likely hear even more startling evidence as the central figures in the Principal drama come forward. A former Alberta regulator who disagreed with government practices told Maclean's that he hopes to be called to testify. But those who are counting on a tidy ending by the time the investigation winds up may be disappointed. Predicted Petracca: “It’s

going to get more complex and messier.” □