The Cheque That Bounced
On a sunny mid-summer day in June, 1965, a cheque for $5 million made out in favor of Royal Securities Corporation Ltd., a well-established old-line investment house, bounced back like a rubber ball to the company’s usually imperturbable offices in the heart of Toronto’s financial district. The returned NSF cheque was issued by Atlantic Acceptance Corporation Ltd., then Canada’s fourth biggest finance company, and drawn on the Toronto-Dominion Bank, one of the country’s Big Five chartered banks.
Understandably, the dud cheque caused immediate consternation and embarrassment at Atlantic’s modern, single-storied head office in Oakville, a pleasant lakeside dormitory town near Toronto. And alarm, if not panic, reigned supreme at Royal Securities. But far worse was yet to come—for the decision of the Toronto-Dominion Bank not to honor this cheque was, probably unwittingly, the first step in a long, drawn-out and traumatic expose of the biggest and probably the most complex commercial fraud in Canada’s financial history.
Like an individual who issues a dud cheque, a company is in for some embarrassing explanations to a doubtless irate creditor who has accepted the cheque in good faith. The company caught in such straits will usually call their friendly banker for an explanation. And, of course, the friendly and hitherto accommodating banker will reply that there simply was not enough cash in the account to cover the cheque in question.
What can the company do? Maybe a line of credit is possible. “Things are tight right now, but we have receivables and other assets that we can pledge for a loan in the form of a running overdraft.” The friendly but cautious banker deals with each such plea on its own merit.
This slightly oblique discourse is by way of explaining why the T-D decided to say “thus far and no further” when they did. For some months they had been warning Atlantic Acceptance to do something about its ballooning overdraft. T-D had arranged with the company a more or less permanent line of credit of $3.7 million. At one stage, in 1963, a year in which Atlantic’s business appeared to be growing at a phenomenal rate, the bank decided to become even more generous—increasing the line of credit to $5 million. A year later, however, with a banker’s sixth sense, T-D’s head office cut Atlantic’s overdraft back to $3.7 million. But if the bankers, and Canadian bankers are noted the world over for their hyper-caution and conservatism, had a sixth sense, they also apparently had oodles of patience. From time to time Atlantic could draw on its account with almost reckless disregard for the $3.7 million limit. When the bank complained, the monies would come in to bring the overdraft down to the agreed level.
In the summer of ’65, Atlantic’s money needs appeared to be soaring as never before. When the line of credit swelled suddenly to $8.8 million in May, a phone call from the bank put the matter right for a few days. But, again, by June 14, despite repeated pleas from its bankers, Atlantic’s overdraft had climbed to a new peak of $9.5 million. Enough was enough, hence the NSF cheque of June 15.
Before the full significance of that decision by Atlantic’s major bankers can be readily understood, one more analogy is called for. An ordinary type of company, say a firm that makes nuts and bolts, can have a cheque bounce but it ends there. Certainly it still owes the hapless creditor money but provided the company is not insolvent, he knows he’ll eventually get paid—maybe in 30, 60 or 90 days, or whenever the company gets more cash in the kitty.
But with a finance company things are not quite so simple. A finance company deals with one commodity—money. It lends money to people to buy cars and make home improvements , or it lends money to companies to buy machinery and equipment. In order to get the funds to lend, the finance company must itself borrow cash. And most of it comes from investors of one sort or another—shareholders, preference shareholders, debenture holders and, most commonly, from companies who put up cash for short-term paper (a loan for 30, 90 or 180 days) at a certain rate of interest for which the company lending the money gets in return a promissory note—the paper—from the borrowing company.) And that’s how a finance company makes its profits. What the company charges the man who buys a new Volkswagen for his money, say 18 or 24 per cent, is a lot more than it pays its investors. A 30-day note, for example, would earn something like 6 to 8 per cent, depending on prevailing rates of interest in the money market. The difference between the 18 to 25 per cent and the 6 or 8 per cent is called the “spread”; that represents the finance company’s income.
Because finance companies borrow so much money from other people (the shareholders, noteholders and their bankers, too) their creditors must have some kind of protection. The more risk they take, the higher interest rates they get on their money. Thus a “senior” noteholder might earn 6 per cent on a 30-day loan. A “junior” noteholder, who if the company has to pay off all its debts in one shot, ranks behind the senior noteholder in the line-up for cash, would expect to earn at least 8 per cent for his 30-day loan to compensate him for the higher risk he is taking.
A finance company’s stock in trade, then, is money. And because it is built on a pyramid-like structure of various debts to all types of creditors, it falls under special protective company law. It has, in short, to operate under special “deeds of trust”, which lay down who gets what if the balloon goes up. One specific point about such trust deeds is that, once the finance company defaults on one loan, then all the other loans become immediately and simultaneously payable. All prudently managed finance companies are ready for just such contingencies, and they make sure that at all times they are sufficiently liquid; that is, they have enough ready cash to meet all debts whose payment is demanded under the trust deed. Here, a banker’s line of credit can, of course, be invaluable.
For Atlantic Acceptance, the refusal of T-D to accommodate the company any further proved lethal. The dud cheque set the wheels in motion. The company’s trustees, the Montreal Trust Co. Ltd., duly appointed a receiver and manager to look after the interests of Atlantic’s creditors and manage the day-to-day affairs of the company, at least until the situation could be clarified.
It wasn’t long before the trustees found to their and everyone else’s dismay that, despite a plethora of recent financial statements to the contrary, there was simply not enough money in Atlantic’s coffers to pay off all existing debts. The difference between the realizable value of loans made out to individuals and companies and the figures carried in the company’s books was a colossal $52 million. Total assets (the loans made by the company) of $155 million therefore shrank, after diligent scrutiny, to $103 million, or by roughly one-third. And that was some $3 million short of the total amount of money the company owed its creditors. The company was clearly insolvent.
The news of Atlantic’s collapse exploded on Bay Street like a megatonic bombshell. That such a company, whose rapid growth and aggressive management in the early ’sixties had made it a darling of the investment community and a “must” for every growth portfolio, should, apparently overnight, disintegrate was well-nigh inconceivable. It was especially shattering to those backroom boys on Bay Street, the investment analysts, who until Atlantic went under hadn’t heard so much as a whisper or a hint about anything being wrong. Those T-D people certainly lived up to the bankers’ tradition of tight-lipped discretion.
Where had the money gone? As the shareholders and creditors demanded the answer to that question, Atlantic’s president and founder C.Powell Morgan, a bespectacled, portly, avuncular one-time chartered accountant, explained away the company’s difficulties as rationally as he could. He was telling people that the reason for Atlantic’s problems was basically that the source of the short-term money it needed to finance its continuing expansion and growth had simply “dried up”. He was referring to U.S. President Johnson’s recently announced foreign investment guidelines, which discouraged U.S. investors from placing U.S. dollars abroad. It was a temporary stratagem to help bolster the value of the U.S. dollar and help solve the country’s balance of payments problems, which were worsening as the Viet Nam war escalated.
Morgan, in fact, was in New York the infamous day the cheque bounced. He was trying desperately to raise a short-term loan of $10 million through Atlantic’s fiscal agents, the prestigious investment banking firm of Kuhn, Loeb & Co.
A secondary excuse for the company’s current difficulties was the backlash of a crude but abortive attempt to push up the price of the shares of two companies which were known to be associated with Atlantic—Commodore Business Machines Ltd. and Racan Photo-Copy Corporation Ltd. The attempted stock manipulation, claimed Morgan, also hindered his attempts at raising short-term money in the U.S., Wall Street having been the target of the would-be swindlers. Although the Racan Photo-Copy caper was not part of the Atlantic Acceptance fraud, Elias Yassin Rabbiah, architect and founder of the Racan outfit, had been a heavy borrower from the Atlantic complex.
Morgan was hoping against hope that his verbal exchanges with the financial press would buy time once again. After all, it could hardly have been the first occasion that the fate of the company hung on a few hours of negotiations—negotiations through which the astute, agile and persuasive Morgan raised enough money to meet maturing debts. Up to now his ability to raise large sums of money, plus the accepted practice of big lenders of short-term funds simply to “roll over” their loans (renew them after withdrawing the interest earned), had saved the day. But now time had run out….
Atlantic Acceptance was to be found hopelessly insolvent and what had become in just a few years, the fourth biggest and fastest growing finance company in Canada was to develop into “the most damaging commercial failure in Canadian history”. * A colossal swindle, involving a myriad of companies and a motley group of unscrupulous individuals was to be unraveled. Bankruptcies, personal and corporate, were to follow, conspirators were to be thrown in jail, others would become fugitives from justice. And, as fate would have it, Morgan the grand perpetrator of this corporate cataclysm, would die within 18 months.
* The Hon. S.H.S. Hughes, Royal Commission Report.