Alternative Investment Opportunity”. While my index finger was
twitching to strike the delete button, I decided to open the message.
Here is what I read:
“Given the challenges of identifying investments in this
marketplace that produce rates of return that can make a
substantial difference in helping you reach your retirement goals,
I would like to bring an investment opportunity that may be of
interest to you. I’ve been able to structure a syndicated second
construction mortgage investment that is offering a 14% per
annum rate of return. The total investment amount for the project
is $810,000, structured through a syndicated mortgage, with the
minimum investment being $25,000.”
Ontario Regulation 188/08 under the MBLAA sets out
the disclosure requirements with respect to a mortgage that a
brokerage presents for the consideration of an investor. The most
significant of these requirements is a completed disclosure form,
in a form approved by the Superintendent, signed by a broker.
The disclosure requirements do not apply if the lender or investor
is a member of a designated class of lenders and investors. The
“designated class” term essentially describes a set of criteria that
mimic those of an “accredited investor”.
FSCO has also produced a presentation entitled “Duty to Ensure
Product Suitability and Duty to Disclose Risks” which provides that
the mortgage brokerage must “take reasonable steps to present
a suitable mortgage product, having regard to the needs and
circumstances of the borrower, lender or investor and to disclose
material risks in writing, using plain language that is brief and clear”.
These concepts are also embedded in a series of compliance
checklists that FSCO has created to assist mortgage brokerages in
achieving the mandated standards of practice under the MBLAA.
This would seem to be a reasonable approach as it gives
the brokerage the latitude to make a judgement as to whether
a syndicated mortgage investment meets the needs and
circumstances of the investor:
• There is no requirement for the investor to be accredited or
part of a designated class.
• There is no minimum investment amount.
• And there are no rules or guideline pertaining to concentration risk.
Is FSCO’s approach to regulating syndicated mortgage
investments far too lax?
Let’s refer back to the example above of the 14% second
mortgage investment opportunity on the construction project. An
interesting twist on this transaction is that the first mortgage on this
project was not in favour of a bank, but rather a private mortgage
investment corporation (MIC) which is a form of MIE that raises
money pursuant to an Offering Memorandum through an EMD.
What is wrong with this scenario? Even though the syndicated
second mortgage is objectively a riskier investment than the 1st
priority charge held by the MIC, the EMD that sells units in the MIC
is held to a much higher standard by the OSC than the mortgage
brokerage that raises money for the subordinated position debt
under FSCO’s regulations. The EMD cannot offer a $25,000
investment in the MIC to an investor who is not accredited. The
mortgage brokerage; however, can offer a $25,000 syndicated
share of a mortgage to an investor who is not accredited.
Mortgage investment products are unfortunately not subject
to a uniform regulatory regime
Let’s explore this further. Let’s say that a 55 year-old investor
with a net financial worth of $850,000 and net income before
taxes in each of the last 2 years of $175,000 has invested in
syndicated mortgages for many years, but has recently suffered a
loss of capital on a syndicated loan and would now like to invest
in a fund. He has been referred by a friend to a local MIC that
manages $75 million that is invested in first mortgages. The return
to investors has been at least 7.5% in each of the last 3 years. He
meets with the EMD to discuss a $100,000 subscription in the
MIC. He is comforted by the fact that he will be investing in a pool
of mortgages. But, there is a problem. The EMD will not accept
a subscription from the investor as he is not accredited based
on income thresholds and he is not ready to commit $150,000
to qualify under the minimum amount exemption. The investor
leaves the EMD’s office but later the same day he coincidentally
hears about a syndicated mortgage investment opportunity on a
local construction project that a mortgage brokerage is arranging.
The interest rate is 14%. He gathers some information on the
transaction and based on some limited due diligence he decides
to invest $100,000 in this deal, notwithstanding his recent loss
with a syndicated product. While the EMD adhered to securities
law by turning away the non-accredited investor, the mortgage