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It is a convoluted web of suspect dealings and payments that stretches back more than two decades.

For years, Larry Smith, the man at the top of a sizable Ontario credit union, arranged loans and business deals, as was his job. But Mr. Smith and a number of his family members and associates – including one former provincial cabinet minister – also pocketed millions in “consulting fees” and other benefits in connection with those deals, according to an extraordinary set of allegations levied by a financial regulator.

The alleged misconduct appears to have been so pervasive that the regulator, the Financial Services Regulator Authority of Ontario (FSRA), is now investigating itself. It has retained an external law firm to conduct a formal review of its own actions to learn why it wasn’t discovered sooner.

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The financial institution in question, PACE Savings & Credit Union Ltd., was seized last year by the Deposit Insurance Corporation of Ontario (DICO), which invoked a rarely used power reserved for stabilizing firms in serious distress. Two months later, regulators fired Mr. Smith, who had been PACE’s chief executive for 28 years and was still its president, and his son Phillip, who succeeded him as CEO in 2015, without severance.

In its early court filings, the regulator focused on PACE’s questionable purchase of a currency-exchange business in 2017. But the credit union’s 40,000 members have had little access to the real story of what happened behind the scenes. Until now.

Confidential regulatory documents and newly unsealed court filings obtained by The Globe and Mail show that investigators allege that they uncovered a broader pattern of secret commissions and self-dealing by the father-son duo that was facilitated by a complicit board of directors at PACE.

Officials at FSRA, which absorbed DICO this past June as part of a restructuring of financial regulation in the province, allege that Larry and Phillip Smith both committed “civil fraud” against the credit union.

None of the allegations have been proven in court and Larry and Phillip Smith deny the allegations against them.

The amounts at stake are meaningful for PACE, which is based in Vaughan, Ont., north of Toronto, and has $1-billion in assets. An early estimate by the regulator put the potential damages suffered by the credit union at approximately $58-million. That included nearly $3.4-million in alleged secret payments to numbered companies owned by Larry Smith, and another $49-million relating to allegedly questionable loans that PACE may have to write down.

Earlier this year, Ontario’s Superior Court froze assets belonging to Larry and Phillip Smith, their families and numbered companies they control, although the restrictions were later relaxed. A list of those assets offered glimpses of a lavish lifestyle: It includes property on two islands in Georgian Bay, a 4,000-square-foot house in Florida, three boats and an Aston Martin DB9, the car made famous in James Bond films.

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The defendants to DICO’s legal action also include another of Larry Smith’s sons, his common-law spouse, former Ontario politician Frank Klees, a consultant named Ron Williamson, and several companies those defendants own, all of which received payments from transactions Larry Smith helped arrange through PACE.

After receiving a complaint from a whistle-blower in October, 2017, DICO began a months-long investigation into PACE. “That investigation revealed an entrenched campaign by former senior executives to commit fraud at the expense of the Credit Union and its depositors, members and shareholders,” FSRA spokesperson Judy Pfeifer said in a statement.

As the investigation progressed, the regulator became so alarmed by the scope of the alleged wrongdoing that it concluded PACE’s board could not be trusted to help remedy the problem. "The culture of systematic self-dealing and secret commissions found by DICO was facilitated by Board negligence, poor judgment and complicity,” the regulator alleges in a report it provided to directors when it took control.

But in sworn statements, Larry Smith claims he was entitled to receive commissions and other fees through consulting contracts he signed with PACE and its predecessor credit unions, dating back decades. Phillip Smith denies knowledge of many of the payments made to his father’s numbered companies. Both of them claim all transactions and payments were approved by PACE directors.

“[Larry] Smith will be fully defending all of the allegations made by FSRA/DICO through the court process," said his lawyer, Alistair Crawley, in a statement. “Mr. Smith’s consulting arrangements were long-standing, and had been approved by PACE’s board of directors, reviewed by its internal and external auditors, and by DICO.”

The Globe previously reported on early court filings, in which DICO alleged that Larry and Phillip Smith hid the extent of an investment PACE made in Continental Currency Exchange (CCE) from regulators through a tangled structure. But both men say they were trying to comply with regulations, not evade them.

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But documents detail much more extensive dealings, and FSRA has added more defendants, although their names are still under a judge’s seal.

The rest will be unsealed on Nov. 25, and FSRA plans to hold a town hall to address PACE members that evening.

The regulator is also probing its own conduct. Earlier this week, FSRA chief executive officer Mark White launched a review led by an external law firm into the conduct of some DICO staff after receiving “what appears to be credible allegations that certain DICO employees may not have acted on relevant information provided to them” about PACE before 2017, the regulator said in statement.

What started out as a headache at a mid-sized credit union has ballooned into a legal battle that could shape the way all Ontario credit unions, which serve 1.7 million members, are regulated.

The consultant CEO

The history of PACE and its predecessor credit unions goes back more than 60 years, but it was shaped into its current form by the Smith family.

Larry Smith was CEO for 28 years. In 2012, when Phillip Smith was promoted to be PACE’s chief financial officer, a clause in his new contract said he would be further promoted to CEO when his father left the job. In 2015, when that happened, no further board approval was required.

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Although father and son worked side by side, and the two men and their families still occasionally live under the same roof in Aurora, Ont., Phillip Smith now tries to distance himself from his father’s business ventures and consulting fees.

In a statement through his lawyers, Phillip Smith says the regulator’s allegations against him “are inflammatory, unsubstantiated and unwarranted.” He adds: “I believe the allegations of misconduct stem from a fundamental misunderstanding of the credit union’s commercial lending business and arise out of a poorly conducted investigation.”

In an affidavit, Phillip Smith describes himself as an “operational” CEO who didn’t source loans for PACE, “had no experience with commercial loans,” and did not receive referral fees or commissions, “nor did he aspire to do so.”

Phillip Smith also claims his father reported directly to PACE’s board, to avoid conflicts of interest. And he says he was not aware of the commissions and fees paid to Larry Smith and others in connection with several loans, despite the fact that Phillip sat on the credit committee charged with approving the loans.

“At all material times, PACE, the Board, and the individual defendants, approved, implicitly or explicitly, [Phillip Smith’s] conduct, practices, and performance,” his lawyers allege in court filings. He has also filed a lawsuit against PACE and two former board members, alleging breach of contract and wrongful dismissal, and asking for more than $12-million in damages.

As president, Larry Smith devoted the bulk of his time to finding loans and other business opportunities for PACE. That had always been a big part of his job – and he had been paid handsomely for it for years through side agreements.

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As of January, 2014, Larry Smith put his personal net worth at more than $30-million, according to a list of assets filed in court, including the properties, boats and the Aston Martin.

Some of that wealth was concentrated in two numbered companies he owned. One of them provided so-called “business development services” for PACE on a contract basis. The other was geared toward property development projects.

Starting in 1988, Larry Smith was general manger or CEO of a series of credit unions that were predecessors to PACE. But he was also hired as a contractor through one of the numbered companies.

In 2000, when he was CEO of Greater Toronto Area (GTA) Savings and Credit Union, Larry Smith signed a more typical employment contract. On the first day of 2001, however, he made a separate consulting deal for his company to provide “electronic data processing” and “management services." That deal was worth $55,000 a year to start, escalating to $75,000 a year two years later.

The following year, GTA Credit Union merged with PACE, which made Larry Smith CEO, and he struck a similar consulting contract in addition to his employment agreement. The services he agreed to provide expanded to include public relations, marketing, and advising on mergers and acquisitions. By 2005, fees had climbed to $320,000. In 2007, they were set at a minimum of $20,000 a month, plus invoices and bonuses “approved from time to time by the Board of Directors of PACE."

That consulting contract, in revised form, was still in force when DICO took control of PACE, and the regulator is challenging its validity. Larry Smith was collecting regular fees of more than $450,000 annually through his consulting deal, plus additional commissions on business done by the credit union.

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The chance to earn those extra commissions gave him added incentive to drum up new business for PACE and to pursue mergers. But they are also the genesis of DICO’s allegations about “secret commissions.”

The board’s role in sanctioning Larry and Phillip Smith’s conduct is at the heart of the legal and regulatory actions hanging over PACE. Larry Smith says in a sworn affidavit that all employment and consulting agreements, “and the payments made pursuant to them, have been fully disclosed to and approved by the Board and the Audit Committee throughout."

But regulators also question the way board chair Ian Goodfellow and its audit committee chair, Deborah Baker, signed off on myriad payments to Larry Smith and his family.

Larry Smith insists the board was fully informed. “The [regulator’s] suggestion that I forged or concealed the existence of these arrangements from the Board is preposterous,” he says in a filing.

Fees for deals

By early 2017, Larry Smith was juggling multiple deals at once.

In January, when PACE closed the acquisition of its disputed stake in CCE, the credit union also granted a $1.6-million, interest-only loan to SusGlobal Energy Corp., a Toronto-based company working to develop ways to turn organic waste into energy. That September, PACE added another $3.9-million, for a total of $5.5-million.

To the regulator, the loans appeared to be highly risky. When the first loan was made, SusGlobal had minimal assets and no income, as its only contracts had been cancelled. But Larry Smith says in court filings that the loans were secured by a personal guarantee from SusGlobal founder and CEO Marc Hazout, as well as a claim against the company’s Toronto office and shares pledged to PACE.

Neither Mr. Hazout nor SusGlobal have been accused of wrongdoing.

To borrow the original $1.6-million, SusGlobal paid a finder’s fee of US$300,000 to Texas-based Ron Williamson Quarter Horses Inc. Mr. Williamson, its owner, is a mortgage and real estate consultant and lender, and he acted as a broker to bring three deals to PACE. He is also a defendant in the regulator’s legal action. He has known Larry Smith for 25 years and the two men became golf partners in Florida, where both own homes.

A letter that SusGlobal – a U.S. listed company – filed with the U.S. Securities and Exchange Commission shows the finder’s fee was two payments of US$150,000 each: one to Mr. Williamson’s company, and the other to Larry Smith’s business-development services company. Larry Smith and Mr. Williamson also received 810,000 shares each in SusGlobal, according to the regulator, although Larry Smith’s shares were later signed over to PACE.

In its confidential report to PACE directors, DICO alleged that “This payment to Larry’s holding company appears to have not been disclosed to or authorized by the Board."

In an affidavit, Larry Smith admitted that when regulators asked him about the deal in 2018, he “did not recall receipt of this payment," but says that was “unintentional.” Both men say Mr. Williamson offered to split the fees.

In later court filings, Mr. Smith produced a copy of an e-mail from Mr. Hazout to Mr. Williamson outlining the payments, which bears the stamp of the audit committee of PACE’s board, initialled by directors.

Mr. Williamson said in an interview that Larry Smith “did a lot of work” on deals Mr. Williamson brought to PACE. “I’m a consultant. I do land development, I do mortgages, I do packaging. I take a good deal to PACE. How would I know that the regulator is not happy that Larry gets a fee when it’s disclosed?"

Mr. Hazout, who has arranged mortgages through Mr. Williamson before, said in an interview that it is “not unusual” to pay finder’s fees for transactions, and that SusGlobal’s payments to Mr. Williamson and Larry Smith, via PACE, were “in the normal course of business.”

“It’s all disclosed publicly” in SEC filings, Mr. Hazout said, “so I don’t understand how we’re involved in this at all.”

Other transactions bear similar hallmarks, according to the regulator, among dozens of transactions and payments it has alleged were improper.

In January, 2017, the credit union invested $6-million to acquire a 15-per-cent stake in The Lora Bay Corporation, a real estate development company based near Collingwood, Ont. As part of the deal, the credit union paid $180,000 in “consulting and referral fees” to a numbered company owned by Malek Smith, Larry Smith’s son. (Lora Bay has not been accused of wrongdoing.)

The credit union’s files “do not document any rationale as to why Malek’s holding company was paid this amount," the regulator says, and the payment raises concerns “that this represents self-dealing for the benefit of Malek and perhaps Larry.”

But Larry Smith contends in his affidavit that the regulator “falsely” characterizes the payments as “secret commissions.” He says he disclosed the fees to Mr. Goodfellow and Ms. Baker, and the two directors signed off on them.

A lawyer for Malek Smith declined to comment.

Some of the largest fees paid to Larry Smith and his associates came through half a dozen joint ventures PACE struck with Geranium Corp., a developer of housing north of Toronto.

PACE made roughly $50-million in investments and loans to Geranium projects, and bought 30-per-cent stakes in several joint ventures – the maximum allowed for credit unions without special permission from the regulator. But PACE allegedly received at least half of the profits and contributed most of the capital that funded some of those projects. Geranium is not accused of wrongdoing.

“Through his numbered companies, Larry receives payments related to these projects from both the Credit Union and from companies related to Geranium,” the regulator alleges. The payments, which add up to millions of dollars, came mostly from PACE and from JLG Management Consulting Ltd., a company registered to Geranium partner Mario Giampietri and his wife.

Some fees were paid to a numbered company registered to Alison Golanski, Larry Smith’s common-law partner, who had her own consulting contract with PACE.

The credit union also paid nearly $1.7-million to JLG consulting late in 2016, while JLG also received large sums from Larry Smith’s companies, including $565,000 in February, 2017.

"Both the nature and quantum of these payments seems highly irregular,” the regulator alleged, adding that “there would be no reasonable explanation” for Mr. Giampietri to be paying large sums directly to Larry Smith. "The Credit Union’s capital is being put to undue risk for transactions that are benefiting Larry personally.”

Mr. Giampietri and Geranium Corp. did not respond to requests for comment.

Larry Smith disputes the regulator’s allegations, saying in court filings that all joint-venture agreements “were signed by members of the board or other officers of PACE,” and that any fees he received were also approved.

Larry Smith’s lawyer, Mr. Crawley, said in a statement that, “To the best of [Larry] Smith’s recollection,” he diverted fees to his family’s companies for practical reasons, “such as tax planning."

A lawyer for Ms. Golanski, Jonah Arnold, declined to comment as materials he has filed in court on her behalf are still sealed by a judge.

In an affidavit, Phillip Smith says he was aware of the Geranium ventures as CEO, but “never received any payments” from them, “nor did I negotiate or approve the specific payments."

In total, Larry Smith’s “direct and indirect” compensation for 2017, as calculated by the regulator, "was $1.17-million more than the amount reported on PACE’s financial statement,” which was $691,549, the regulator says.

Political connections

Some of the disputed transactions also proved lucrative to former Ontario politicians who are close to Larry Smith.

Frank Klees, who was a minister in the Progressive Conservative government led by former premier Ernie Eves in 2002 and 2003, is a long-time friend of the Smith family. In 2013, before Mr. Klees left politics, he signed a consulting contract with PACE, approved by Larry Smith. It paid Mr. Klees a $5,000 monthly retainer in its first year, and promised him a percentage commission on loans or joint ventures that he helped arrange for the credit union.

Between 2015 and 2018, Mr. Klees collected nearly $2.8-million in payments for consulting work on two joint ventures between PACE and Geranium, according to court filings. Some of the payments were made by PACE, as shown in invoices he submitted, for amounts ranging from $169,500 to $678,000. Mr. Klees also invoiced JLG Consulting, Mr. Giampietri’s company, for $339,000 for consulting services.

Mr. Klees, who is a defendant in the regulator’s legal action, said he is “limited” in what he can say, but the documents outlining his work for PACE “speak for themselves.”

“As a consultant, my role was to source and facilitate real estate development projects between Pace, land owners and developers/builders,” Mr. Klees said in an e-mail. “For those services, the parties with whom I had agreements were invoiced by my company for fees commensurate with the services delivered.”

In May, 2018, Mr. Klees joined PACE’s board of directors. Based on the regulator’s analysis, the total monthly compensation he was earning from PACE increased to $12,500, and the regulator “believes this arrangement put Klees at a conflict and potentially impairs his ability to perform his fiduciary duty,” as set out in provincial legislation.

“I can confirm that the issues under investigation pre-dated the [four] months during which I was on the Pace Board,” Mr. Klees said. “I was never in a conflict and it was understood that if a matter on which I had an interest were to come to the board, I would have recused myself.”

Another one of Larry Smith’s contacts was Mr. Eves, who presented him with the chance for PACE to buy a stake in CCE. Mr. Eves is not accused of any wrongdoing.

As PACE was negotiating a deal to buy 30-per-cent ownership, Mr. Eves gave Mr. Smith “both strategic and advisory services,” said the former premier’s lawyer, Peter Proszanski, in a statement.

Larry Smith agreed that Mr. Eves would be paid a consulting fee of $10,000 a month for his services on the deal. The regulator alleges that those payments came from a numbered company controlled by real estate agent Joanna Whitfield, who had a close relationship with Larry Smith.

Using a loan from PACE, her company bought a 45-per-cent stake in CCE. Larry and Phillip Smith both say in court filings that they hoped PACE could acquire that stake later – an arrangement the regulator alleges was designed to circumvent the 30-per-cent limit for credit unions when they invest in other companies.

“Mr. Eves was at the time not privy” to Ms. Whitfield’s company, “let alone how their purchase was purportedly funded,” Mr. Proszanski said.

Untangling the web

The regulator’s concerns about some of these disputed deals and payments first surfaced in June, 2017, when DICO conducted a routine on-site visit and flagged several commercial loans as potentially problematic.

The scrutiny intensified that October, when an anonymous whistle-blower began writing to top DICO officials, urging them to look into allegedly improper transactions. After two PACE directors raised similar concerns the following spring, the regulator hired KSV Advisory Inc. to perform a special audit of PACE in May, 2018.

While that investigation was still underway, the whistle-blower threatened to make allegations public. The regulator responded by taking control of PACE using an administration order on Sept. 28, 2018, “to protect Pace members and other stakeholders,” according to the regulator.

“Premature disclosure of the allegations raised risked causing a crisis of confidence in the solvency or liquidity of the Credit Union and a consequent run of the institution that could cause its collapse,” DICO told the credit union’s board at the time.

But the new allegations raise troubling questions about why misconduct apparently went undetected for so long.

In court filings, Larry and Phillip Smith both refer to a multilayered approval process at PACE. Loans were vetted by PACE’s credit department and employees made recommendations to a credit committee of senior officers. That committee which was overseen by PACE’s board, and subject to both internal and external audits.

But the regulator’s June, 2017, evalution found deficiencies in PACE’s credit risk management and internal audit processes, bolstered by more detailed allegation made by the whistle-blower four months later.

In its own defence, FSRA claims that it “diligently investigated those allegations while taking steps to ensure procedural fairness and rigor," said Ms. Pfeifer, the regulator’s spokesperson.

The manner in which members of PACE’s board approved payments to Larry Smith and his numbered companies has also drawn the regulator’s scrutiny. A lynchpin of Larry and Phillip Smith’s defences is that the payments were stamped as approved by the board’s audit committee, and many were initialed by particular directors, as shown in court filings.

In cross-examination, Larry Smith said he would often provide copies of the invoices issued by his numbered companies to his personal assistant or PACE’s corporate secretary to put in a folder for board approval. He would then meet with Mr. Goodfellow, the board chair, and Ms. Baker, the audit committee chair, to explain the documents and get their signatures. But the invoices were not typically shown to PACE’s full board.

Mr. Goodfellow and Ms. Baker “are both chartered accountants and were perfectly capable of independently assessing [Larry] Smith’s requests for approvals of payments of fees and expenses," said his lawyer, Mr. Crawley. “It is fanciful to suggest that they or the other members of the board would be bamboozled by the placement of materials in a folder."

Ms. Baker declined to comment and Mr. Goodfellow did not respond to requests for comment.

In a statement to The Globe, FSRA also put responsibility on PACE’s long-time external auditor, Deloitte LLP, which signed off on PACE’s financial reporting during the years under scrutiny.

A spokesperson for Deloitte said it would be inappropriate to comment while PACE is under the regulator’s control, “except to confirm that Deloitte co-operated with DICO and that at all times. Deloitte fulfilled its mandate to PACE with the utmost professionalism and in accordance with its professional standards.”

After DICO took control in September, 2018, PriceWaterhouseCoopers was named the credit union’s new external auditor. In its report to the board, the regulator said it was concerned that PACE was holding properties for sale to avoid recognizing losses on loans. After further audits, which uncovered other discrepancies, the credit union restated its 2017 financial results, wiping out a $4.5-million profit and reporting a $77,000 loss.

Regulators have now turned their attention to trying to recover some of the money that they allege PACE lost through fraud and improper loans and payments. That includes seeking damages from defendants and trying to collect insurance payments.

FSRA has run into hurdles. One asset it wants to sell is PACE’s multimillion dollar stake in CCE. But the company’s founder and former CEO, Scott Penfound, still owns 25 per cent.

In a separate lawsuit, FSRA is suing Mr. Penfound and his family. The regulator alleges that when it audited CCE, it found more than $2-million in allegedly improper expenses charged to the business while Mr. Penfound CEO, and that he allegedly drafted and backdated more lucrative employment contracts for his adult children, who work for CCE.

Mr. Penfound decined to comment.

As for PACE itself, the regulator is aiming to return control to its members “as early as practicable in Spring 2020," Ms. Pfeifer said. For the time being, FSRA is conducting the internal review it announced this week. Some of the employees implicated in the allegations about DICO’s conduct have been removed from PACE’s administration and placed on paid leave, to avoid any perception that they “could impede” the process.

“This review will help ensure that FSRA, as DICO’s successor, learns whether its processes can be improved for the benefit of the Ontario credit union system,” Ms. Pfeifer said.

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