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Suit against ROI puts another labour fund in the hot seat

Alleges manager took control of investment in bid to thwart creditors, KEITH DAMSELL writes

MUTUAL FUNDS REPORTER

A $1.2-million lawsuit against Return on Innovation Fund Inc. is once again raising questions about the management practices of labour-sponsored funds.

Two investments in the construction business are at the heart of the complex dispute between ROI, manager of $64.6-million in assets, and Gould Leasing Ltd., both of Toronto. In a July 19 lawsuit, Gould claims ROI, through a series of complex transactions, acquired control of a troubled investment in order to protect its reputation and thwart creditors.

Launched in December, 2002, ROI invests in mature businesses and uses debt rather than equity to provide greater liquidity. The fund has returned about 0.48 per cent since its inception, a respectable gain for the tough asset class. Fund investors receive a hefty 30-per-cent tax break but must own the fund for eight years.

In December, 2003, ROI lent $1.5-million to 1347859 Ontario Inc., a numbered company operating as road paving firm Paveco. Then, in May, 2004, an additional $3.5-million was lent to landscaping firm Brooklin Concrete Properties Inc., the lawsuit claims.

The lawsuit alleges ROI's Brooklin loan was guaranteed, while its smaller loan to Paveco held no such ensure. Paveco and Brooklin were part of Sanan Group, a construction firm controlled by Toronto entrepreneur Michael Crupi.

Sanan also borrowed significant funds from other lenders. During the same period, Bank of Montreal, Sanan's No. 1 creditor, lent the group a total of $17-million. In May, 2004, Gould, the third creditor behind ROI, lent Mr. Crupi $1.5-million, the action claims.

Three months later, BMO hired Ernst & Young to audit Sanan Group. Accountants uncovered some serious discrepancies, including the company overstating its receivables by $12-million, the lawsuit alleges.

At BMO's urging, Ernst & Young was appointed receiver of Paveco. ROI "was certain of losing its entire investment" in Paveco and worried that the receivership of Brooklin was imminent, the lawsuit claims.

In December, 2004, BMO demanded Brooklin pay off its debt. Through a series of transactions, ROI acquired control of Brooklin and hired Mr. Crupi to manage operations part-time for an annual salary of $112,000. A liquidator then acquired BMO's debt and, early this year, a receiver began hunting for a Brooklin buyer, the lawsuit claims.

In March, a subsidiary of ROI agreed to buy Brooklin for $25.1-million, topping a rival $22.1-million bid. ROI directly invested $12.1-million, close to 25 per cent of its assets under administration at that time and contrary to the terms of the fund's prospectus that limit its exposure to 10 per cent of net assets, the lawsuit claims.

Gould alleges ROI and John Sterling, the company's co-founder and chief executive officer, bought Brooklin "for more than fair market value" in order to protect ROI's initial investment, to claim an additional $1.4-million in "improper" expenses, to protect the fund's investment profile and, finally, to secure the compensation of ROI's senior management. The take-home pay of Mr. Sterling and Fernando Cipriano, co-founder and chief operating officer, hinges on the fund's assets under administration.

"Once ROI Fund's actions, as directed by Sterling, are publicly disclosed, Sterling's compensation will stop growing," the Gould claim alleges. "ROI Fund and Sterling preferred Sterlings's personal financial interest over ROI Fund's interest as sole shareholder of Brooklin Concrete."

The allegations have not been proven in court. ROI and Mr. Sterling expect to file a statement of defence with the Ontario Superior Court in the next few weeks.

In an interview, Mr. Sterling described Gould's actions as "a total joke."

"There is no basis for it . . . this is a creditor that feels they are owed something when they are not," he said. "Our fund has the highest integrity and the best disclosure with respect to valuations and issues. We are a high-standard labour fund."

The allegations against ROI follow the meltdown of Winnipeg's Crocus Investment Fund. The labour-sponsored fund was put into receivership in June by the Manitoba Securities Commission amid a flurry of investigations, including a criminal probe by the RCMP.

Manager hot on tech

Bruised and battered technology funds are ready for a comeback.

That's the prognosis of a British fund manager who expects tech funds to rebound smartly in 2006.

"We do firmly believe we are reaching a turning point in the next 12 to 18 months . . . by the end of next year, people will want to be definitely overweight in technology," said Brian Ashford-Russell of Polar Capital Partners in London. Polar has about $800-million (U.S.) in technology assets under management, including Mackenzie Financial Corp.'s $138-million (Canadian) Mackenzie Universal World Science and Technology Capital Class Fund.

There's a mountain of evidence to support a recovery scenario, Mr. Ashford-Russell said. Since 2000, the tech market has been brutal for many firms, conditions that have forced weaker players out of the market, survivors to trim costs and management to get smart. Meanwhile, consumer spending for the latest gadgets continues to grow, especially within Asia's emerging middle class. Market trends, too, indicate the worst may be over; redemptions in tech funds have peaked over the past 12 months and there's some sentiment the sector has reached bottom at last.

Tech investors are long overdue for some relief. The tech-heavy Nasdaq Stock Market is down an annual average of 21.5 per cent over the past five years. The Mackenzie Universal World Science fund, meanwhile, is off 4.8 per cent since its inception in May, 2002.

kdamsell@globeandmail.ca

© 2007 The Globe and Mail. All rights reserved.

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