Decisions

Rainforest Mushrooms Ltd., et. al. [Decision]

BCSECCOM #:
Document Type:
Decision
Published Date:
1992-05-01
Effective Date:
1992-04-29
Details:

COR #92/091
IN THE MATTER OF The Securities Act, S.B.C. 1985, c. 83
AND IN THE MATTER OF Rainforest Mushrooms Ltd.
AND IN THE MATTER OF G. Gerry Hargitai and John Czinege
Hearing Decision
D.M. Hyndman, H.D. Browne, D. Devine
Heard:  February 18, 19, 1991
Reasons:  April 29, 1992

COUNSEL:

   Robert J. Climie, for Commission Staff.

   A. David Long, for Rainforest Mushrooms Ltd.

   Patricia Connor, for G. Gerry Hargitai.

   Malcolm Maclean and Keith Mitchell, for John Czinege.

DECISION OF THE COMMISSION:--


CONTENTS
1.
INTRODUCTION
2.
BACKGROUND
3.
FINDINGS
4.
DECISION
* * * * *
1.
INTRODUCTION
      This is a hearing under section 144(1) of the Securities Act, S.B.C. 1985, c. 83.  A notice of hearing was issued on April 10, 1990.  The notice accompanied a temporary order made by the Superintendent of Brokers under section 144(2) of the Act that all trading cease in the shares of Rainforest Mushrooms Ltd.  On April 18, 1990, the hearing was adjourned and the temporary order was extended pending the hearing being held and this decision being rendered.  Following a series of adjournments and two amendments to the notice, dated September 17, 1990, and January 15, 1991, the hearing was set down for February 18, 1991.  The notice sets out allegations concerning the conduct of Rainforest, G. Gerry Hargitai and John Czinege.

      On August 14, 1990, eight orders (the "Freeze Orders") were issued under section 135 of the Act by a member of the Commission, Jeremy P.H. McCall.  One of the Freeze Orders directed Rainforest to refrain from withdrawing any of its funds, securities or other property from any person having them on deposit, under control or for safekeeping.  The other Freeze Orders directed four current or former directors of Rainforest and three branches of financial institutions to hold any funds, securities or other property of Rainforest that they have on deposit, under control or for safekeeping. On November 15 and 16, 1990, the Vice Chairman of the Commission, Joyce C. Maykut, Q.C., issued orders under section 153 varying the Freeze Orders to permit Rainforest to make certain payments.

      On February 8, 1991, a further order (the "Hargitai Freeze Order") was issued under section 135 by Vice Chairman Maykut. The Hargitai Freeze Order directed Hargitai to refrain from withdrawing, and directed The Toronto Dominion Bank to hold, the contents of a safety deposit box.

      The Commission has been asked to determine whether it is in the public interest

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to make orders under section 144(1)(c) of the Act that any or all of the exemptions described in sections 30 to 32, 55, 58, 80 and 81 do not apply to Hargitai and Czinege;
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to make orders under section 144(l)(d) of the Act that Hargitai and Czinege are prohibited from becoming or acting as directors or officers of any reporting issuer;
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to make orders under section 135 of the Act extending the Freeze Orders until Rainforest and its directors and senior officers have fulfilled conditions prescribed by the Commission;
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to make orders under section 144(1)(b) of the Act further extending the temporary cease trade order until Rainforest has complied with such disclosure provisions considered to be in the public interest as are ordered by the Commission;
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to make orders under section 154.2 of the Act that Rainforest, Hargitai and Czinege pay prescribed fees or charges for the costs of or related to the hearing that are incurred by or on behalf of the Commission or the Superintendent;
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to make any other orders as may be appropriate in the circumstances.
2.   BACKGROUND

      Rainforest is a reporting issuer and an exchange issuer under the Act.  It was incorporated under the Company Act, R.S.B.C. 1979, c. 59, on July 9, 1985.  Its shares were listed on the Vancouver Stock Exchange on September 21, 1989. Within seven months, on April 10, 1990, Rainforest's shares were cease traded.

      Hargitai was president and a director of Rainforest from February 5, 1987, until June 18, 1990.  He was born in Hungary in 1960.  He is now 32 years old.  He said that he had business connections in Europe, where he travelled frequently, and that he had been in business in Vancouver since 1981.

      Czinege is Hargitai's uncle.  He is in his fifties.  He is a contractor by trade and has been a director of Rainforest since February 5, 1987.  He has not been a director of any other public company.

      Rainforest filed a prospectus dated February 27, 1989, and obtained a receipt for it on March 13, 1989.  The prospectus qualified the distribution, through an initial public offering, of 765,000 shares at a price of $0.50 per share.  The agents for the distribution were Pacific International Securities Inc., as to 665,000 shares, and Georgia Pacific Securities Corporation, as to 100,000 shares  The prospectus provided that the minimum subscription for the offering was 765,000 shares and stated that, if the minimum subscription was not obtained, all subscription funds would be returned to the subscribers. The distribution was completed on September 21, 1989.

      The prospectus indicated that:

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Rainforest was in the business of growing and marketing mushrooms and had achieved commercial production in Britannia Beach, British Columbia, from August 1, 1985, to July 31, 1987, with revenues of $51,366 during this period;
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commercial production had ceased subsequent to July 31, 1987, due to production problems and lack of working capital;
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Rainforest was to resume production at the Britannia Beach facility upon completion of the public offering;
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Rainforest's primary market for mushrooms was to be local, although it had a letter of intent with Madame Mushrooms Natural Foods to sell oyster mushrooms in export markets;
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Rainforest's business operations in Britannia Beach were the subject of a technical report prepared by Carob Management Ltd.
      The prospectus stated that the net proceeds of $351,900 from the public offering, together with cash on hand at February 27, 1987, were to be expended as follows:

Estimated costs of the offering
$  20,000
Accounts payable and other liabilities
71,814
Facility start-up costs
12,500
Direct production costs for four months
16,800
Production facility overhead for 12 months
17,580
Marketing expenses
53,600
General and administrative overhead
30,000
Unallocated working capital reserve
130,116
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Total
$ 352,410
      The prospectus disclosed that the directors and senior officers held 336,750 Rainforest shares.  It stated that this holding represented 23.8 per cent of the shares outstanding before the public offering and would represent 15.5 per cent of the shares outstanding after the public offering.  The prospectus indicated that the directors and senior officers would not be purchasing any shares from the public offering.

      On September 15, 1989, Pacific International paid $285,511 to Rainforest from the proceeds of the public offering. These funds were deposited to Rainforest's account at the Bank of Montreal.  On the same day, Hargitai withdrew $150,000 from this account and purchased a bank draft, which he deposited to an account under his control.  He used $149,000 of this to purchase shares of Rainforest from the public offering, through five accounts at three brokerage firms, prior to September 21, 1989.  As at September 21, a total of 321,500 Rainforest shares purchased from the public offering were held in these accounts, including 85,000 shares in Hargitai's account and 236,500 shares in accounts in the names of two other persons.

      On September 21, 1989, Hargitai and Czinege swore affidavits that there had been no material changes that would make untrue or misleading any statement of material fact contained in the prospectus.

      On September 26, 1989, Georgia Pacific paid $44,185 to Rainforest from the proceeds of the public offering.  These funds were deposited to Rainforest's account at The Toronto Dominion Bank.  On the same day, Hargitai transferred $24,000 from this account by debit memo to his account at the same bank for his personal use.  On October 6, 1989, Hargitai and Czinege withdrew $35,000 by cheque from Rainforest's account at the Bank of Montreal.  The cheque was payable to the Bank of Montreal and was used to purchase a bank draft, which Hargitai deposited in his account at The Toronto Dominion Bank for his personal use.

      More than $35,000 of the $59,000 transferred from Rainforest to Hargitai's account at The Toronto Dominion Bank was used on October 10 to cover debit balances outstanding in accounts at Pacific International in the names of Hargitai and his relative Zoli Hargitai.  These accounts held 392,000 Rainforest shares.  Hargitai's account had a debit balance of $19,634.38 and held 243,000 Rainforest shares.  It held no other securities.  Zoli Hargitai's account had a debit balance of $15,746.96 and held 149,000 Rainforest shares (of which 2,000 shares were transferred on October 10 by journal entry to an account in the name of S. Hargitai).  The only other securities held in this account were 3,000 shares of another exchange issuer.

      On November 3, 1989, Hargitai withdrew $12,500 from Rainforest's account at The Toronto Dominion Bank, by cheque payable to cash, and purchased a bank draft, which he deposited with the law firm Alexander Holburn in trust.

      Between September 15 and November 3, 1989, Hargitai made four withdrawals for a total of $221,500 from Rainforest's accounts at the Bank of Montreal and The Toronto Dominion Bank. The four withdrawals were made by means of a cheque payable to the bank, a cheque payable to cash and two internal bank debit memos.  Neither the bank statements nor any of these documents showed to whom the funds were transferred.

      Three of the four withdrawals, aggregating $186,000, were authorized by the signature of Hargitai alone. Rainforest's listing agreement with the Exchange, signed by Hargitai on February 28, 1989, requires a minimum of two signatures on all cheques issued by Rainforest.

      Between September 1, 1989, and January 2, 1990, Rainforest filed no press releases, material change reports or amendments to the prospectus, and did not obtain approval from the Exchange for any material changes.  Rainforest also failed to file its required quarterly report during this period.

      On January 3, 1990, Rainforest issued a news release, which read, in its entirety, as follows:

Mr.  Gerry Hargitai, President, reports that Rainforest Mushrooms Ltd. (the "Company") is involved in negotiations with a European group regarding a partnership to jointly set up and operate a mushroom production and distribution facility in Europe.  Negotiations are also ongoing with a financial group with respect to financing this transaction.
Further information will be released in a timely manner.
      Rainforest's audited financial statements for the two months ended August 31, 1989, dated January 16, 1990, and signed by Hargitai and another director, were mailed to shareholders on January 19, 1990, and filed with the Commission on January 22, 1990.  They disclosed the following as a subsequent event:

The Company is to enter into a partnership with a European group in order to set up and operate a mushroom production and distribution facility in Europe.  The Company has advanced $221,500 towards the project.
      On January 29, 1990, Rainforest filed its quarterly report for the three months ended September 30, 1989.  The report was signed by Hargitai and Czinege.  This disclosure covered the period during which the initial public offering was completed. It was filed two months after the required filing date of November 29, 1989.  The interim financial statements in the quarterly report and the management discussion section of the report both referred to negotiations by Rainforest to set up and operate a mushroom production and distribution facility in Europe and stated that Rainforest had advanced $174,000 toward the project at September 30, 1989.  Rainforest's total assets at September 30, 1989, as disclosed in the quarterly report, were $249,058.

      On March 1, 1990, Rainforest filed its quarterly report for the six months ended December 31, 1989, signed by Hargitai and another director.  This report stated that $221,510 had been advanced toward the project in Europe. Rainforest's total assets at December 31, 1989, as disclosed in the quarterly report, were $239,376.

      On April 10, 1990, after reviewing the quarterly reports, the Superintendent issued the temporary cease trade order against the shares of Rainforest.  On April 12, 1990, staff of the Commission wrote to Rainforest's solicitors requesting information on the negotiations in Hungary and setting, as a condition for the removal of the temporary order, a requirement that Rainforest's funds be returned from Hungary.

      On April 16 and 18, 1990, Czinege advanced $170,000 to Rainforest.  On April 20, 1990, Hargitai and Czinege purchased on behalf of Rainforest two Guaranteed Investment Certificates (the "GICs") from The Toronto Dominion Bank in the amounts of $150,000 and $20,000.  The GICs were hypothecated as security for a $170,000 personal loan from The Toronto Dominion Bank to Hargitai on April 20, 1990.  The hypothecation was dated April 18, 1990, and was signed by Hargitai and Czinege on behalf of Rainforest.  On April 20, 1990, Kerfoot, Cameron & Company, Barristers & Solicitors, provided an opinion to the bank that Rainforest had the power and authority to hypothecate the GICs and that the hypothecation was a legal, valid and binding obligation of Rainforest.  The hypothecation was attached to Kerfoot, Cameron's letter.  Hargitai used the proceeds of the loan to repay Czinege on April 20, 1990, for his advance to Rainforest.

      On April 23, 1990, Rainforest represented through its solicitors to the staff of the Commission that the funds required to be returned from Hungary were now in the form of GICs held by the solicitors.

      At Hargitai's request, a law firm in Hungary sent a letter to Rainforest's solicitors on April 24, 1990, describing the purported arrangements in Hungary as follows:

Mr. Gerry Hargitai, who introduced himself as President of Rainforest Mushrooms Ltd. Vancouver, B.C. a Canadian company visited our office on several occasions in the fall of 1989.  Mr. Hargitai informed us about his business negotiations in Hungary concerning the establishment of joint-venture company for the production of oyster mushrooms.  Mr. Hargitai sought legal advice and eventually retained our firm.
He requested our firm to maintain regular contact with the proposed joint-venture partners, conduct negotiations in his absence, initiate work on a related feasibility study and coordinate market research activities.  In October and November 1989 our firm received four bank drafts from Mr. Hargitai totalling Canadian dollars 221,500 to be held in lawyer's trust. This good faith money corresponded to the proposed initial capital (Forints 10.000.000) and contained provisions for some legal fees.  Mr. Hargitai and our firm agreed that our firm will return the above amount less legal fees incurred at his first demand.  Mr. Hargitai and our firm also agreed that 1% per annum interest will be credited to Rainforest Mushrooms on the above amount.
We have been instructed by Mr. Hargitai not to pay any sum towards the proposed joint-venture company until the relative agreement is signed and the necessary regulatory approvals are obtained.
Our firm has spent a lot of time on this project since last fall.
We shall submit a detailed invoice for our fees and disbursements made by us regarding the feasibility study and market research when we finish our work.  We estimate that the above amounts so far to Canadian Dollars 40.000.
The negotiations are proceeding well.  However, we have been advised by Mr. Hargitai not to enter into any agreement on his behalf until the necessary regulatory approvals are obtained by Rainforest Mushrooms Ltd.
      Subsequently, in April or May 1990, a second letter was sent from the law firm in Hungary to Rainforest' s solicitors. The letter states: "At the request of our client, Rainforest Mushrooms Ltd. we are submitting hereby our preliminary invoice for our services rendered so far.  It is our understanding that our client, Rainforest Mushrooms Ltd, is still pursuing the business opportunity presented in Hungary last year and our client is currently waiting for the necessary regulatory approvals. Consequently we shall submit our detailed and final invoice when the deal is closed or the parties terminate their negotiations and our client asks for the Bill." The letter identifies legal fees and disbursements of $40,000, comprised of $20,000 for legal advice, calculated at $2,500 per month for 8 months, a retainer of $10,000 paid to a team of specialists doing a feasibility study, and an advance of $10,000 paid to a team of marketing specialists.

      Although the two letters referred to regulatory approvals, Rainforest never sought regulatory approval for the purported transaction.

      On June 18, 1990, Hargitai ceased to be a director and officer of Rainforest.  In a letter dated June 25, 1990, Hargitai advised Rainforest's solicitors as follows:

You have asked me, on behalf of Rainforest Mushrooms Ltd., to provide you with the paper trail relating to the transfer of funds back into the local account of Rainforest Mushrooms Ltd. from Hungary.
I have requested the parties concerned to give me all the supporting documentation.
I regret to inform you that my European counterparts are the most uncooperative in this matter and have declined my request referring to the confidentiality of banking transactions and their business interests.
      On June 28, 1990, Hargitai wrote to the Commission affirming that he would not act in any management capacity for Rainforest until the resolution of the staff's investigation by way of a Settlement or hearing.  Hargitai continued to be a signing officer for Rainforest's bank accounts.

      On June 30, 1990, The Toronto Dominion Bank completed a bank confirmation form for Rainforest's auditors.  It showed the two GICs for a total of $170,000.  There was no reference to the hypothecation of the GICs.

      On August 1, 1990, Czinege executed a statutory declaration stating that The Toronto Dominion Bank was holding GICs in the amount of $170,000 for Rainforest and that he had no reason to believe that the money did not belong to Rainforest or that any third parties could advance claims to the money.  At this time, the GICs were still hypothecated as security for Hargitai's loan.

      On August 3, 1990, Hargitai and Czinege signed a cheque on Rainforest's account at The Toronto Dominion Bank paying $12,000 to Hargitai.  On the same day, Hargitai deposited four cheques totalling $21,000 (including one cheque for $12,000) to his account at The Toronto Dominion Bank.  He then drew a $20,000 cheque on his account, payable to The Toronto Dominion Bank for a loan payment.  The bank then released the hypothecation on the $20,000 GIC and Hargitai deposited the GIC proceeds into a Rainforest account.

      On August 14, 1990, the Commission imposed the Freeze Orders with respect to any funds, securities or other property of Rainforest.

      Rainforest's audited financial statements for the year ended June 30, 1990, were dated August 16, 1990, and signed by Czinege and another director.  The statements included an expense item of $41,500 for "Joint venture expenses writtenoff". A note to the statements, headed "Joint Venture Expenditures", contained the following disclosure:

During the year the company negotiated with a European group to set up a joint venture to operate a mushroom production and distribution facility in Europe.  The company incurred various costs during the course of the negotiations including feasibility and marketing studies. Subsequent to June 30, 1990 the project was suspended pending regulatory approval.  Since the outcome of such approval is not certain, all costs have been written-off to operations.
The statements made no reference to the hypothecation of the GICs.

      On August 20, 1990, Czinege paid $150,000 to Hargitai. Hargitai used this money to retire the remaining $150,000 loan to him from The Toronto Dominion Bank, releasing the hypothecation on Rainforest's $150,000 GIC.  The proceeds of the GIC were rolled over into another GIC and remain in Rainforest's account for its use and benefit.

      In November 1991, Commission staff first reviewed a synoptic journal of Rainforest's accounts, which led to the evidence that funds from the public offering were paid to Hargitai rather than advanced to a lawyer's trust in Hungary. On February 8, 1991, the Commission imposed the Hargitai Freeze Order on Hargitai's safe deposit box.

      In February 1991, Rainforest's new solicitors wrote to the law firm in Hungary requesting details of funds received from Rainforest in 1989, copies of cheques or drafts by which the money was received, a statement of any remaining funds in trust, details of payments other than the $40,000 previously detailed, any evidence in the firm's possession indicating that the funds were the property of Rainforest and, if possible, an opinion that under Hungarian law Rainforest was the legal and beneficial owner of the funds while they were held by the firm. The response from Hungary was brief:

The sum of $221,500.00, received from Mr. Hargitai between September 11, 1989 and November 3, 1989, under Hungarian law always belonged to Rainforest Mushrooms and there was no claim against it.  The Company s money was always fully accessable (sic) to the Company's officers and representatives.
As to the other details, we have already informed the Company's lawyers, Mr. Harder at Alexander Holburn in our letters in April and May, 1990.
By the end of August 1990, through private arrangements, Mr. Hargitai effectively transferred the Company's funds to Vancouver.  Because Rainforest abandoned its Hungarian project, we no longer act as legal advisors for the Company.
3.   FINDINGS

      Rainforest, Hargitai and Czinege entered into an agreed statement of facts with Commission staff.  That statement, together with documentary evidence, was produced at the hearing.  Hargitai also gave oral evidence at the hearing providing his explanation of events in the affairs of Rainforest.  We have considered all of the evidence and have determined that no weight should be given to Hargitai's evidence.  The following are our reasons and our findings based on the evidence we have accepted.

      We begin with the events of September and October 1989, when Rainforest completed its initial public offering, Hargitai withdrew most of the proceeds and transferred them to his personal bank accounts, and a large portion of the shares distributed under the public offering ended up under Hargitai's control.  These events were followed by a series of disclosure documents issued by Rainforest and representations made by Rainforest, Hargitai and Czinege concerning Rainforest's affairs.

      The prospectus disclosed that Rainforest was in the business of growing and marketing mushrooms in British Columbia.  It laid out the expected use of the proceeds of the offering, amounting to about $350,000, which was to cover the expenses of the offering, pay off some liabilities, cover business expenses and establish a working capital reserve. On September 21, 1989, Hargitai and Czinege signed affidavits declaring that there had been no material changes that would make untrue or misleading any statement of material fact contained in the prospectus.

      The bank records and the agreed statement of facts show that Hargitai transferred $221,500 of the proceeds of the public offering into accounts controlled by him.  The money was withdrawn, mostly on the authority of Hargitai's signature alone, by means of cheques or debit memos that did not show to whom the money was transferred.

      Hargitai claims that this money was owing to him as repayment of amounts that he advanced on Rainforest's behalf to a lawyer's trust account in Hungary in connection with a proposed acquisition by Rainforest of a Hungarian mushroom business.

      Hargitai explains the circumstances of the advances as follows.  He travelled to Europe, partly on behalf of Rainforest, in August and October 1989, visiting a number of countries, including Hungary.  A lawyer in Hungary named Dr. Paroczai introduced him to a state-owned company that was the largest mushroom producer in Hungary and, perhaps, in Europe. The new Hungarian government that had taken office in May 1989 was committed to privatizing this company.  The company had annual sales of $20 million (U.S.) and annual profits of $12 million (U.S.), and would cost between $100 million and $150 million (U.S.) to acquire.  However, the management of the company wished to negotiate an arrangement whereby they would leave the company and join Rainforest in setting up a new operation, which would require an initial investment of $600,000.  The negotiations were sensitive, because the Hungarian government would not have liked to see the management selling out the core of the business on such favourable terms, and the management asked Hargitai not to divulge their names or any information about the negotiations.  On Dr. Paroczai's advice, Hargitai advanced funds, initially $150,000 on September 11, 1989, and ultimately $221,500, to a lawyer's trust with Dr. Paroczai's firm in Hungary as a condition of entering negotiations.  The funds in trust belonged to Rainforest.  The funds for the advances were borrowed by Hargitai from a Mr. Akos Varga in Hungary, on the security of assets in Hungary belonging to Hargitai's family, and paid into the lawyer's trust. Hargitai treated these advances as shareholder's loans to Rainforest and was then repaid in Canada by Rainforest.

      Hargitai says that he has no details of the loan agreement with Varga and that there was no agreement as to an interest rate on the loan.

      Hargitai says he did not give Rainforest's other directors any details about the negotiations in Hungary because of their sensitivity.  His testimony under cross-examination was vague and evasive as to when the other directors learned of the advances.  He ultimately said that it could have been any time between September 21 and December, 1989, that is, any time between the completion of the public offering and the issuance of Rainforest's press release.

      Hargitai's evidence about the purported negotiations and about the money he claims was held in Hungary for Rainforest was supported by three letters purporting to be from a law firm in Hungary and by statements in Rainforest's press release, quarterly reports and audited financial statements.

      The letters from the law firm are vague and are inconsistent with other evidence, including Hargitai's current story.

      The April 24, 1990, letter says that Hargitai "informed us about his business negotiations".  However, Hargitai's oral evidence was that it was Dr. Paroczai of the law firm who had first introduced him to the mushroom company in Hungary.

      The April 24, 1990, letter refers to the receipt by the law firm of "four bank drafts from Mr. Hargitai totalling Canadian dollars 221,500" which "corresponded to the proposed initial capital (Forints 10.000.000)". This leaves the clear impression that the money was received from Canada in Canadian dollars.  Hargitai now says that no money was transferred from Canada to Hungary, but that money was borrowed from Varga in Hungary and put into the lawyer's trust.

      The April 24, 1990, letter refers to the funds having been received by the law firm in October and November 1989. Hargitai's evidence now is that he first had money put in the lawyer's trust on September 11, 1989.  In response to further inquiries just before the hearing, the law firm said, in its letter of February 1991, that the money had been received between September 11 and November 3, 1989.

      The April 24, 1990, letter refers to the need to obtain regulatory approvals.  The second letter states that Rainforest was "currently waiting for the necessary regulatory approvals." No regulatory approvals were ever sought.

      Hargitai produced no documents relating to his purported negotiations in Hungary, to the $221,500 he claims was held in the lawyer's trust in Hungary or to the return of that money to his family by the law firm.

      The February 1991 letter from the law firm states that details concerning the money were previously sent to Rainforest's solicitors.  That is simply not so.  The questions asked by Rainforest's new solicitors have never been answered and the evidence they requested has never been produced.

      We do not accept the letters from the law firm in Hungary as evidence that Rainforest was involved in negotiations to acquire a mushroom business in Hungary or that there was money belonging to Rainforest held in Hungary.

      Nor do we accept that the references in Rainforest's press release, quarterly reports and audited financial statements provide support for Hargitai's story.  The statements in these documents concerning the purported negotiations in Hungary and the money purportedly advanced to Hungary are brief and vague and, in any case, are merely representations of Rainforest's management. No records exist to document the negotiations or the loan arrangement by which Hargitai now says the funds were transferred to Hungary.  No disclosure was made of the purported negotiations or advances in the prospectus, whose contents Hargitai and Czinege swore on September 21, 1989, were, in effect, true.

      With respect to the audited financial statements, we have no evidence as to what steps, if any, the auditors took to verify the representations concerning the purported negotiations and advances.  The audited financial statements for the period ended August 31, 1989, were dated January 16, 1990.  A note to the statements represented that Rainforest "is to enter a partnership with a European group" and that Rainforest had advanced $221,500 toward the project.  This amount represented virtually all of Rainforest's assets.  At that time there was no documentation related to the purported partnership nor was there documentation to show that any money had been advanced to or was being held in Hungary. Rainforest's banking documents showed the withdrawals totalling $221,500 but did not show to whom the money had been paid.  There was no independent evidence on which the auditors could have relied to support representations by Hargitai regarding the purported negotiations and advances.

      The audited financial statements for the year ended June 30, 1990, were dated August 16, 1990, and included an expense item of $41,500 for "Joint venture expenses written-off" as well as a note describing the purported negotiations.  The note stated that the project had been suspended pending regulatory approval and that the approval was not certain. By this time, Rainforest's shares were subject to a cease trading order, $20,000 had been returned to Rainforest's bank account, $150,000 was held in the form of a GIC that was still hypothecated to the bank as security for Hargitai's loan, and two letters had been received from the law firm in Hungary.  No other documentation existed to support the representations in the financial statements concerning the purported negotiations. No documentation existed to support the statements concerning regulatory approval and, in fact, regulatory approval was never sought.

      Hargitai's oral evidence was even more problematical. He was evasive and inconsistent in his answers, became very vague when asked for details, and gave explanations that were highly improbable.

      His description of the financial arrangements in Hungary was murky.  When he was pressed for details on the money that was supposedly held in the lawyer's trust, he made vague references to family arrangements.  He claimed that he borrowed the equivalent of $221,500 from a Mr. Varga on the security of family assets, but that no rate of interest had been established on the loan.  He said the loan was later paid back by his family and that he had an obligation to his family but could not tell us anything about it.  He provided no documentation related to the purported loan.

      The investment proposal in Hungary was equally mysterious. Hargitai claimed that the state mushroom company was worth between $100 million and $150 million, but that Rainforest could effectively acquire it by setting up a new enterprise with the management of the state firm at a cost of only $600,000.  He provided no documentary evidence of the investment proposal and did not provide the names of the state enterprise or any of the individuals with whom he claimed to have been negotiating.

      We do not accept Hargitai's claim that he was negotiating on behalf of Rainforest to acquire a Hungarian mushroom business or that the transfer of $221,500 to him from Rainforest represented the repayment of shareholder's loans.

      We find that Hargitai had no claim to the $221,500 withdrawn from Rainforest's accounts.  These funds were raised through a public offering under a prospectus for the purpose of developing a mushroom business in British Columbia.  After he had already withdrawn $150,000 from Rainforest's accounts, Hargitai swore a false affidavit stating that the disclosure in the prospectus was true.  Hargitai made withdrawals using bank documents that concealed the fact that the money was being transferred to him.  He withdrew most of the money on his signature alone, in contravention of Rainforest's listing agreement.

      We find that the withdrawal of $221,500 from Rainforest's accounts was a fraudulent misappropriation of Rainforest's funds by Hargitai.

      Rainforest's public offering was for 765,000 shares and was subject to a provision that subscription funds would be refunded if subscriptions were not obtained for all of the shares.  The public was left with the impression that Rainforest completed a public offering of 765,000 shares and raised net proceeds of about $350,000.  The reality was very different.

      Hargitai used at least $184,000 of the proceeds of the public offering to purchase shares under the public offering. He made these purchases through five accounts in the names of three individuals at three different brokerage firms.  On September 21, 1989, the day the public offering was completed, 321,500 Rainforest shares, accounting for 42 per cent of the public offering, were held in these accounts, including 85,000 in Hargitai's account and 236,500 in the other accounts.  There was no disclosure in the prospectus to suggest that Hargitai, the president of Rainforest, would be purchasing 42 per cent of the offering.  In fact, the prospectus clearly implied that directors and officers would not be purchasing any of the offering.

      Investors purchased Rainforest shares in the belief that Rainforest was doing a public offering to raise funds for the purposes set out in the prospectus.  In fact, the investors' money was taken by Hargitai and used to purchase 42 per cent of the offering.  Since more than half of the $350,000 purportedly raised under the public offering was actually used to purchase shares under the public offering, Rainforest did not, on an objective analysis, obtain the minimum subscription required under the prospectus.  The offering therefore ought to have been terminated and the funds raised ought to have been returned to the subscribers.  Instead, the offering was represented to have been completed and Rainforest became listed on the Exchange.

      Hargitai purchased shares from the public offering in a manner that concealed his involvement in most of the purchases. He paid for the shares using money that he fraudulently misappropriated from Rainforest.  His purchases created the appearance that Rainforest had successfully completed its public offering when in fact it had not.  We find that Hargitai's purchases of Rainforest shares were transactions that he must have known created a misleading appearance of trading activity in Rainforest shares and perpetrated a fraud on other investors in Rainforest shares. In other words, we find that Hargitai manipulated the trading in Rainforest shares.

      Most of the $221,500 transferred from the accounts of Rainforest in September and October 1989 was authorized by the signature of Hargitai alone.  Rainforest's listing agreement with the Exchange, signed by Hargitai on February 28, 1989, requires a minimum of two signatures on all cheques issued by Rainforest.

      We find that, Rainforest contravened its listing agreement with the Exchange.  Hargitai was directly responsible for the contravention.

      Rainforest was asked by Commission staff on April 12, 1990 to retrieve the money reported to have been advanced to Hungary.  Hargitai says that he could have brought Rainforest's funds back from Hungary as requested by Commission staff, but that it would not have been in Rainforest's interests to lose the opportunity in Hungary. He says that he had a choice of abandoning the opportunity or making other arrangements and that he chose the latter. He chose to create the appearance that funds had been transferred from Hungary.

      By April 18, 1990, Hargitai had borrowed $170,000 from Czinege to put into Rainforest's account, which was used to purchase two GICs.  Hargitai and Czinege then hypothecated Rainforest's GICs to secure a personal loan from the bank to Hargitai, with which Hargitai repaid Czinege on April 20. On April 23, Rainforest represented through its solicitors to Commission staff that the funds required to be returned from Hungary were now in the form of GICs held by the solicitors.

      Hargitai was later asked by Rainforest's solicitors to provide the paper trail for the return of the money from Hungary.  He responded, in his letter of June 24, 1990, that he had been unable to obtain records of the paper trail with respect to the return of Rainforest's money from Hungary. Despite the fact that he now admits that no money was ever transferred, he refuses to acknowledge that his letter was false. He was unable under cross-examination to explain what the letter means and, in the end, simply insisted that what he had said in the letter was true.  The following exchange is illustrative:

Q  In fact, there wasn't any paper trail, or any documents to support the transfer of funds back, were there, on your evidence?
A  Well, you see, because, as you know, that the final, or the effective transfer of those, this is something that I am not legally -- what is the actual date of that.  The company has had, or the company had been deposited the corresponding amount of money in its bank account for its use, and it's been earning interest for almost a year in that bank account since it's been there for the company.
Q  We've heard all that evidence, sir.  Pardon me for interrupting.
A  Okay, so --
Q  What I'm interested in is a response to my question that there weren't any documents to support that, because they were never generated because of the arrangement that you had structured?
A  Well, I mean, partly, yes.  I mean, obviously, because of the way, because the funds were then placed into the company's account from the proceeds of a loan that I have taken from Mr. John Czinege.
Q  Right.  But why didn't you simply come out and say that at the time? -
A  Why didn't I simply come out and say that?  I mean, they have requested - - my understanding was that they have requested various other documents, bank drafts, and so on, how that might have happened, and I simply did not have that.  And I have answered exactly what -- I have answered the request, that's what I have done.
Q  What I want to know is why didn't you tell them why you couldn't?  It's not because you've requested and they couldn't give them to you, it's because they didn't exist, because that's not, what this letter refers to is not the nature of the deal, is it?  That's why you couldn't.  It's not because they wouldn't give them to you, it's because they didn't exist, because the deal wasn't structured the way you represented it in the letter.
A  Well, I don't see where there's anything represented in that letter.  There was a response to a request, and I believe that this is correct.
      The conduct of Hargitai and Czinege, where Czinege made a loan to Rainforest, the GICs were purchased with the money, a loan was made from the bank to Hargitai on the hypothecation of the GICs, and Hargitai repaid Czinege's loan to Rainforest, made no commercial sense.  In our view, the only purpose of this arrangement was to create the illusion that Rainforest had $170,000 in the bank.  We find that the representation to Commission staff that funds had been returned from Hungary was false and misleading and that it was intended to deceive Commission staff as to Rainforest's financial affairs.  We find that both Hargitai and Czinege participated in this deception.

      On August 1, 1990, Czinege executed a statutory declaration stating that The Toronto Dominion Bank was holding GICs in the amount of $170,000 for Rainforest and that he had no reason to believe that the money did not belong to Rainforest or that any third parties could advance claims to the money.  At this time, the GICs were pledged as security for Hargitai's loan.

      The hypothecation agreement between Rainforest and the bank is signed by Hargitai and Czinege for Rainforest. Hargitai claims that it was his understanding that the GICs were not pledged but that there was merely an understanding with the bank that Rainforest would not withdraw the $170,000 until Hargitai's loan was repaid.  He claims that he told Czinege that it was not necessary to pledge the GICs.

      We have no evidence as to what inquiries, if any, Czinege made before signing the statutory declaration.  He points to bank audit confirmation of Rainforest's deposits and to Rainforest's audited financial statements for the year ended June 30, 1990, neither of which made reference to the hypothecation, to support his argument that any inquiries would not have revealed the hypothecation.

      We reject this argument.  Czinege was in a different position from that of the auditors.  He was a director of Rainforest.  He had actually signed the hypothecation agreement for the purpose of securing a loan to Hargitai, with which Hargitai repaid Czinege $170,000.  If Czinege had been exercising any of the care, diligence and skill of a reasonably prudent person, the deception would not have occurred and Hargitai would have been found out.  It borders on the absurd for Czinege to explain his false declaration by pointing to the bank confirmation slip and the financial statements.

      We find that Czinege falsely declared the statutory declaration of August 1, 1990.

      In early 1990, Rainforest issued four disclosure documents.  A press release dated January 3, 1990, stated that Rainforest was involved in the purported negotiations. Rainforest's audited financial statements for the period ended August 31, 1989, dated January 16, 1990, stated that Rainforest "is to enter a partnership with a European group" and that $221,000 had been advanced toward the project. Rainforest's quarterly reports for the period ended September 30, 1989, filed on January 29, 1990, and for the period ended December 31, 1989, filed on March 1, 1990, both referred to the purported negotiations and advances.

      In addition, Rainforest issued audited financial statements for the year ended June 30, 1990, dated August 16, 1990.  These statements included an expense item of $41,500 for "joint venture expenses written off" as well as a note describing the purported negotiations and stating that the project had been suspended pending regulatory approval.

      We find that these statements in the press release, quarterly reports and audited financial statements were false and misleading.

      Hargitai and Czinege were directors of Rainforest. Section 142 of the Company Act sets out the duties of directors as follows:

142.
(1) Every director of a company, in exercising his powers and performing his functions, shall
(a)  act honestly and in good faith and in the best
interests of the company; and
(b)  exercise the care, diligence and skill of (i) a reasonably prudent person ...
      We find that Hargitai acted dishonestly and in bad faith and not in the best interests of Rainforest in fraudulently misappropriating Rainforest's funds to his personal use, in creating a misleading appearance of trading activity in Rainforest shares and in misrepresenting Rainforest's financial affairs and attempting to deceive Commission staff in an effort to conceal the misappropriation of funds.

      Czinege's conduct also failed to meet the standard required of a director.

      On October 6, 1989, Czinege signed a cheque on Rainforest's account for $35,000 payable to the Bank of Montreal, which was used by Hargitai to purchase a draft and transfer the funds to his own account.  The cheque itself gave no indication of the purpose of the payment or the identity of the ultimate payee.  On the evidence, there was no documentation on which Czinege could have relied to satisfy himself that this payment was appropriate.

      At some point before the press release, Czinege learned that a total of $221,500 had been withdrawn from Rainforest's accounts, purportedly for a transaction being negotiated in Hungary.  He ought to have realized, when Hargitai told him that funds had been advanced to the lawyer's trust in Hungary, that there might have been a contravention of the listing agreement, which requires two signatures on every cheque.  At that point, Czinege ought to have made inquiries to determine what had happened to the proceeds of the public offering.  If he had, he would have found no documentation to support the purported negotiations and advances.  Action by Czinege at that point would have caused Rainforest's shares to have been cease traded.  Instead, Rainforest issued a series of false and misleading disclosure documents and the public traded on that information.

      Czinege signed Rainforest's quarterly report for the period ended September 30, 1989, which contained representations concerning the purported negotiations and advances.  He also signed the audited financial statements for the year ended June 30, 1990, which included a statement about the purported negotiations and a write-off of $41,500 purportedly for expenses related to the negotiations.  These representations in the disclosure documents were false and misleading.  There was no documentation on which Czinege could have relied to satisfy himself that the representations were true.

      In April 1990, when Commission staff requested Rainforest to return the funds represented to be in Hungary, Czinege advanced $170,000 to Rainforest for a few days and participated with Hargitai in purchasing two GICs of $150,000 and $20,000. Czinege signed a document hypothecating the GICs to secure a personal loan to Hargitai, from which he was then repaid by Hargitai.  In our view, this conduct made no commercial sense and any reasonably prudent person would have questioned the conduct.  Czinege did not. We have found that he and Hargitai acted deceitfully.  Czinege subsequently executed a false statutory declaration stating that he had no reason to believe the GICs were subject to any third party claims.

      We find that, in exercising his powers and performing his duties as a director of Rainforest, Czinege acted in bad faith and not in the best interests of Rainforest and did not exercise the care, diligence and skill of a reasonably prudent person.  In fact, it appears to us that Czinege exercised no care, diligence or skill in acting as a director of Rainforest.

4.   DECISION

      The conduct of Hargitai and Czinege as directors of Rainforest is the type of conduct that damages public confidence in the capital markets.  For the public capital market to work efficiently and fairly, investors and others interested in the market must be able to rely on the directors of issuers to act honestly, to comply with regulatory requirements and to perform their duties to the required standards.

      Hargitai was the president of Rainforest and, in effect its chief executive officer.  Almost coincidentally with Rainforest's initial public offering, Hargitai fraudulently misappropriated most of the proceeds of the offering to his personal use.  He used most of this money to create a misleading appearance of trading activity in Rainforest's shares.  He orchestrated the attempts to cover up his fraudulent misappropriation of funds through a series of false and misleading disclosure documents and conduct intended to deceive Commission staff.  Hargitai acted with a complete disregard for regulatory requirements.  He acted dishonestly and in bad faith and not in the best interests of Rainforest.

      We consider it in the public interest to remove Hargitai from participation in the capital market and in reporting issuers for a lengthy period.

      There is no evidence that Czinege was aware of Hargitai's fraudulent misappropriation and stock manipulation at the time. However, in failing to meet the standards required of a director, Czinege assisted Hargitai to perpetrate his fraudulent misappropriation, stock manipulation and the publication by Rainforest of a series of false and misleading disclosure documents.  Czinege and Hargitai acted deceitfully in connection with the hypothecation.  Czinege declared a false declaration.  We have found that he acted in bad faith and not in the best interests of Rainforest and he appeared to exercise none of the care, diligence or skill required of a director.

      We consider it in the public interest to remove Czinege from participation in reporting issuers for a substantial period.

      Rainforest is currently subject to a temporary cease trading order and the Freeze Orders.  In addition, the Hargitai Freeze Order has frozen the contents of Hargitai's safe deposit box, which is alleged to contain a large number of Rainforest share certificates in street form.

      In light of our finding that funds were fraudulently misappropriated from Rainforest and used to purchase Rainforest shares, we consider it in the public interest that the cease trading order, the Freeze Orders and the Hargitai Freeze Order remain in effect.  At the appropriate time, the Commission will consider applications to revoke or vary these orders.

      We order:

1.
under section 144(1)(c) of the Act, that the exemptions described in sections 30 to 32, 55, 58, 80 and 81 do not apply to Hargitai for 25 years from the date of this decision;
2.
under section 144(1)(d) of the Act, that Hargitai is prohibited from becoming or acting as a director or officer of any reporting issuer, or of any issuer that provides management, administrative, promotional or consulting services to a reporting issuer, for 25 years from the date of this decision;
3.
under section 144(1)(d) of the Act, that Czinege is prohibited from becoming or acting as a director or officer of any reporting issuer, or of any issuer that provides management, administrative, promotional or consulting services to a reporting issuer, for 15 years from the date of this decision;
4.
under section 144(1)(b) of the Act, that all persons cease trading in the shares of Rainforest;
5.
under section 135(1) of the Act, that the Freeze Orders and the Hargitai Freeze Order remain in effect;
6.
under section 154.2 of the Act, that Hargitai and Czinege pay prescribed fees or charges for the costs of or related to the hearing incurred by the Commission and the Superintendent, the amounts to be determined following further submissions from the parties.
D.M. HYNDMAN
Chairman
D. DEVINE
Member
H.D. BROWNE
Member