Investors who lost millions in an alleged fraud involving mutual funds managed by Crystal Wealth Management System Ltd. will soon learn if they can proceed with a class-action lawsuit against the auditing firm that signed off on the funds’ books.
In December, Ontario’s Superior Court wrapped up hearings concerning a proposed class action against BDO Canada LLP, which audited a number of mutual funds offered by Crystal Wealth. Justice Paul Perell reserved his decision as to whether the lawsuit will be certified – the legal hurdle that determines whether the matter can proceed as a class action.
Crystal Wealth, which was based in Burlington, Ont., offered investments in 15 mutual funds and reported that it managed $193-million on behalf of 1,250 clients as of 2017. That same year, the Ontario Securities Commission froze the assets of Crystal Wealth, placed it into a court-ordered receivership and alleged fraud on the part of its founder, Clayton Smith.
Mr. Smith later agreed, as part of a 2018 settlement with the OSC, that he caused two of Crystal Wealth’s funds to make fraudulent transfers that were not in keeping with their investment objectives.
In particular, Crystal Wealth’s residential mortgage fund transferred nearly $895,000 to companies owned or linked to Mr. Smith – including a yoga studio owned by his former common-law wife. Mr. Smith also agreed that Crystal Wealth’s Media Fund, which was supposed to “generate a high-level of interest income” from loans to film and television production companies, made several investments with media firms, which in turn, made transfers back to Mr. Smith or companies linked to him totalling $2.9-million.
Although the receiver, Grant Thornton Ltd., has recovered about $62-million in proceeds, according to its last report to the court, the receiver has uncovered irregularities with other Crystal Wealth funds. In its fourth report to the court, Grant Thornton said it has “significant concerns over the quality and ultimate collectability of approximately $50.25-million” of Crystal Wealth’s total purported assets.
In the meantime, the receiver, investors and the OSC have set their sights on BDO and its alleged role in Crystal Wealth’s collapse. In addition to the proposed class action, the OSC has also initiated its own enforcement action against BDO, alleging the firm did not conduct its audits of Crystal Wealth in accordance with generally accepted auditing standards.
It is rare for the OSC to take action against accounting firms, though not without precedent. In 2014, Ernst & Young LLP agreed to an $8-million settlement with the OSC for failing to catch problems with two publicly listed companies with operations in China, one of which was Sino-Forest Corp.
A hearing into the OSC’s allegations against BDO is scheduled to take place in March. None of the allegations against BDO have been proved in court or before an OSC panel.
In an e-mailed statement, a spokesman for BDO said the company is contesting the allegations of the OSC and the claims made by the investors. “Given the matter is before the courts, BDO is not in a position to comment at this time beyond what is already on the public record.”
The claim launched by investors alleges they relied on Crystal Wealth’s audited financial statements when making their investment decisions. BDO owed investors “a continuing duty of care to diligently investigate, uncover, and disclose any misstatements or omissions in the funds’ financial statements and in any material filed with the OSC,” the claim alleges. “BDO breached this duty.”
Investors have also highlighted in their claim findings by Grant Thornton that “the documentation supporting the purported value of the funds is seriously deficient.”
In its defence, BDO has argued that the investors are “unjustifiably seeking to hold BDO responsible as an ‘insurer’ for the entirety of losses sustained by Crystal Wealth’s unitholders.” Investor losses are attributable to Mr. Smith, who “disguised the funds’ true finances, circumvented controls and skillfully and intentionally manipulated records,” BDO’s statement of defence alleges.
BDO also contends that it did not “owe a duty of care” to Crystal Wealth’s investors. In its statement of defence, it states the duty of care owed by an auditor is restricted under Canadian law. “The duty does not extend to individual investors making use of financial statements for their personal investment decisions.”
As part of its efforts to recover assets, Crystal Wealth’s receiver has also launched a lawsuit against BDO. The same law firm representing investors in the proposed class action, Adair Goldblatt Bieber LLP, is also representing the receiver.
BDO highlighted this fact in its statement of defence to the claim by investors, and argued that the competing actions are “duplicative and redundant.”
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