Two former senior executives of Norshield Financial Group are the targets of a $159-million lawsuit that alleges they were “the principal architects of the wrongful conduct” at the collapsed hedge fund operator.

Former Norshield CEO John Xanthoudakis and former president Dale Smith are named as defendants in the Ontario Superior Court action brought by RSM Richter Inc. , the court-appointed receiver of Norshield and its associated companies.

The lawsuit states that inves-tors are owed a total of $472 million in the wake of the 2005 collapse of Norshield and its complex offshore investment structure. A total of $159 million of the money belongs to some 1,900 Canadian retail investors living mostly in Ontario, with the rest owed to institutions and international investors.

Xanthoudakis and Smith are alleged to have improperly diverted assets, engineered sham transactions to inflate asset values and to have used new investor money entirely to fund redemptions.

Lawyers for the two men deny they had been involved in any wrongdoing.

The lawsuit alleges Xanthoudakis and Smith hid from investors a deteriorating situation at Norshield caused by “the diversion and loss of corporate assets in undisclosed and speculative investments.

“Xanthoudakis and Smith intentionally turned to elaborate schemes to overstate the financial condition and performance of the plaintiff companies [Norshield and associated companies] to stem the tide of redemptions and attract new investors,” the action alleges. “Ultimately, the business of the plaintiff companies and the Norshield Financial Group as a whole ceased to have any legitimate business purpose and existed only to attract new investors to meet growing redemption requests.

“Xanthoudakis and Smith breached their fiduciary duties and other duties of care,” the action also alleges, “by concealing the diversion of corporate assets, hiding failed investments and presenting false financial information to attract additional investment in the plaintiff companies.”

Furthermore, the action states that since Richter was appointed receiver in June 2005, just $31 million in assets have been identified or recovered in Canada or offshore; and even this money may be subject to competing claims.

“Accordingly, approximately $441 million of investor funds entrusted to the Norshield Financial Group have not been recovered and/or identified,” the action says.

Regarding the associated retail funds: “Olympus Funds did not direct the investor funds into hedge funds as represented in the offering memoranda; rather, the funds were negligently, recklessly and improperly used by Xanthoudakis and Smith as officers, directors and the controlling minds of the plaintiff companies and the Norshield Financial Group as a whole for unexplained purposes through a complex web of individuals and companies,” the lawsuit alleges.

However, Alistair Crawley, a lawyer with Crawley Meredith Brush LLP in Toronto who represents Xan-thoudakis, says the allegations in the lawsuit are essentially the same as those in Richter’s sixth receiver’s report, released in March 2007, and have not been proven in court.

In denying the allegations against his client, Crawley notes the receiver’s report stated that no evidence had been found that $215 million in unexplained payments to third parties had personally benefited either Xanthoudakis or Smith.

“In large part, the theory behind this claim is based on an erroneous assumption that there was a so-called Norshield Financial Group that included entities such as Mosaic or Olympus Univest,” Crawley says. “These entities were third-party, arm’s-length entities and they weren’t controlled or directed by Xanthoudakis.”

Xanthoudakis and Norshield relied on independent accounting and legal professionals to prepare offering documents, net asset value calculations, financial statements and audits, Crawley adds.

Smith’s lawyer, Steven Sofer, a partner with Gowling Lafleur Henderson LLP in Toronto, says he believes his client shouldn’t have been named as a defendant, given the receiver’s previous findings.

“We don’t know why he’s been included as a defendant,” Sofer says, adding that although Smith wasn’t exonerated in the receiver’s reports, “there didn’t appear to be any evidence of wrongdoing, either.”

Xanthoudakis, Smith and a third Norshield executive, Peter Kefalas, were accused in October 2006 by the Ontario Securities Commission of violating that province’s Securities Act by misleading investors and OSC investigators.

An OSC hearing on the allegations is scheduled to start May 5.

In March 2007, Richter received court permission to turn over evidence of possible fraud at Norshield to police and securities regulators in Canada and abroad.

According to the March 2007 receiver’s report, Norshield’s investment structure saw money invested in Olympus United retail hedge funds in Canada flow offshore first to the Olympus United Bank and Trust in Barbados and then mostly into investment vehicles in the Bahamas known as Olympus Univest Ltd. and Mosaic Composite Ltd.

@page_break@A key group of assets in the investment structure were held in a series of companies known as the Channel Entities. The value of the mostly illiquid holdings in these companies was overstated by at least US$300 million, the receiver’s report states.

In May 2005, Norshield suspended client redemptions after inves-tors pulled $375 million out of the company’s funds in less than a year. Norshield was placed in receivership in June 2005.

Xanthoudakis, who lives in Montreal, has maintained in media interviews that he has done nothing wrong and claims his personal net worth has been depleted by the Norshield collapse. In an attempt to prove his innocence, he has gone so far as to pay for lie detector tests.

He lays much of the blame for his firm’s downfall on an aggressive and, he claims, unfair legal campaign by Montreal animation firm Cinar Corp. to recover money still owed to it from transfers of Cinar money to Bahamian companies linked to Norshield in the 1990s.

This past December, an alleged Montreal mafia figure was charged with two counts of extortion in connection with incidents involving Xanthoudakis, including a November 2005 attack. Xanthoudakis was punched while in a lawyer’s office by a man who police believe was trying to collect money on behalf of Norshield investors.

Richter partner Raymond Massi told Montreal’s The Gazette in December that because of the complexity of the file, the liquidation of the Norshield companies is continuing and it will take at least another year before investors receive a payout.

The March 2007 receiver’s report stated that retail investors will recover just 6¢-9¢ on the dollar. IE