NIN 98/07 - Mortgages [NIN - Rescinded]

The Commission is publishing amendments to the Securities Rules that are intended to limit the availability of the mortgage exemption in the Securities Act.

The Commission has adopted and is publishing a rule that restricts the use of the mortgage exemption to trades that are regulated by the Registrar of Mortgage Brokers, that is, to trades in mortgages on land situated wholly in British Columbia (the "Interim Rule"). This rule comes into effect on February 23, 1998 and, because it has been adopted without prior publication for comment, will remain in effect for only 275 days.

The Commission is also publishing for comment a proposed rule that is intended to limit the availability of the mortgage exemption to non-syndicated mortgages on land situated wholly in British Columbia, to create a new exemption for certain qualified syndicated mortgages on land situated wholly in British Columbia, and to require disclosure to investors in all mortgages, both syndicated and non-syndicated (the "Proposed Rule").

Background

A mortgage is a security. Sections 46(e) and 75(a) of the Act exempt from the registration and prospectus requirements of the Act distributions of mortgages or other encumbrances on property that ar

(i) not contained in or secured by a bond, debenture or similar obligation or in a trust deed or other instrument to secure bonds or debentures or similar obligations, and

(ii) offered for sale by a person who is registered or exempted from registration under the Mortgage Brokers Act (the "MBA").

The MBA requires registration for every mortgage broker and submortgage broker. A person who is licensed under the Real Estate Act or is registered under the Securities Act is deemed to be registered under the MBA as a mortgage broker or submortgage broker.

A "mortgage" is not defined in the Securities Act, but is defined in the MBA to include "every instrument by which land in British Columbia is, in any manner, conveyed, assigned, pledged or charged as security for the payment of money or money’s worth to be reconveyed, reassigned or released on satisfaction of the debt, but does not include an agreement for sale of or a right to purchase land or an interest in land." [Emphasis added]

It is apparent that some mortgage brokers may be relying on the mortgage exemption for syndicated mortgages. A syndicated mortgage is an investment arrangement whereby a person is able, together with others, to participate as a lender in whole mortgages through the acquisition of a portion of the whole.

Any mortgage broker intending to rely on the mortgage exemption to offer a syndicated mortgage must ensure that the security offered is truly a mortgage and does not have the characteristics of an investment contract.

While the Commission has not had an opportunity to determine this question, Commission staff takes the position that a syndicated mortgage is likely to be an investment contract unless it has the following characteristics:

• the investor invests in one specific, identified mortgage - funds advanced by the investor may be applied only to that mortgage and no other mortgage or other security (i.e., no pooling of mortgages);

• the investor receives all the rights of a mortgagee and the investor’s interest in the mortgage is registered on the title to the property, either directly or through a bare trustee on behalf of the investor;

• there is no guarantee of return on the investment offered by any person other than the borrower or a principal of the borrower or an individual who is a principal of the borrower; and

• · the rate of interest and term offered to the investor is not different from that stated in the mortgage.

It is the Commission’s understanding that the rationale for the mortgage exemption in the Act was that all mortgages and other encumbrances on property offered by mortgage brokers in British Columbia were regulated by the Registrar of Mortgage Brokers. However, the Commission has identified three problems with the exemption:

• The scope of the exemption is broader than the scope of the MBA. The Commission has recently been advised that the Registrar of Mortgage Brokers regulates the activities of registered mortgage brokers and submortgage brokers only with respect to trades in mortgages on land in British Columbia and not with respect to any other activities they may carry on. Consequently, the sale by mortgage brokers of mortgages on property other than land in British Columbia and of other encumbrances on property is not regulated under the MBA but is exempt from the registration and prospectus requirements of the Securities Act.

• The MBA contains no requirements for disclosure to investors. The original objective of the MBA was to protect mortgage borrowers, by limiting participation in mortgage brokering activities to registered mortgage brokers and by requiring disclosure to borrowers of the terms of the mortgage transaction and financing costs. The Commission has been advised that the level of information provided to investors in mortgages, particularly syndicated mortgages, offered under the mortgage exemption is inadequate.

• Some mortgage brokers are using the exemption to offer complex and risky syndicated mortgages to unsophisticated investors. Many of the syndicated mortgages being offered under the exemption involve second or third mortgages. In some cases the value of the mortgage, together with all other existing mortgages on the property, exceeds the fair market value of the property on the date of the issue of the mortgage.

The Commission has adopted the Interim Rule and proposes to adopt the Proposed Rule to address these problems.

The Interim Rule

The Interim Rule restricts the use of the mortgage exemption in the Act to trades that are regulated by the Registrar of Mortgage Brokers, that is, to trades in mortgages on land situated wholly in British Columbia. As a result, the exemption will no longer be available for trades in other mortgages, including mortgages on land situated outside British Columbia, or for trades in other encumbrances on property, whether land or personal property.

The Interim Rule fills the gap in the regulation of mortgage brokers and distributions of mortgage securities and other encumbrances on property that are currently unregulated.

Persons wishing to trade in mortgages, other than those on land situated wholly in British Columbia, or in other encumbrances on property will be required to comply fully with the registration and prospectus requirements of the Act, or to rely on another exemption from these requirements. As many of these available exemptions require a disclosure document, prospective investors will generally obtain disclosure sufficient to allow them the opportunity to make an informed investment decision. Offerings of these securities will also be subject to the advertising restrictions currently imposed on other types of securities offerings (see discussion below).

In addition, persons relying on section 46(e) of the Act, which provides an exemption only from the requirement in the Act to register to trade, can currently rely on a blanket order issued by the Commission that permits them to advise with respect to mortgages and other encumbrances on property. As the mortgage exemption will now cover only mortgages on land situated wholly in British Columbia, persons wishing to trade in mortgages on land situated outside British Columbia and other encumbrances on property will no longer be able to rely on this blanket order and will be required to register to advise on these securities or to rely on another exemption from adviser registration.

Although rules must normally be published for comment before being enacted, there is a provision in the Act that permits the Commission to make a rule without first having to publish for comment where the Commission considers it necessary and in the public interest to do so and where the Minister consents to the making of the rule.

The Commission has determined that, in view of the regulatory gap caused by the scope of the mortgage exemption being broader than the scope of the MBA, it is necessary and in the public interest to adopt the Interim Rule without delay. The Minister has consented to the Commission’s adoption of the rule without following the normal publication and comment process.

An urgent rule, unless earlier repealed or revoked, is revoked on the 275th day after it is deposited with the Registrar of Regulations. However, the substance of the Interim Rule is incorporated in the Proposed Rule, which the Commission intends to adopt before the expiry of the Interim Rule.

The Proposed Rule

The Proposed Rule would limit the availability of the current mortgage exemption and create a new exemption for qualified syndicated mortgages. In addition, the Proposed Rule would require appropriate investor disclosure for investors, other than institutional investors, in all mortgages, both syndicated and non-syndicated.

The mortgage market has grown considerably in size and sophistication over the past few years. In particular, there have been a large number of mortgage offerings to unsophisticated investors and certain mortgage brokers have employed aggressive marketing methods, including the advertising of high returns. Exacerbating this problem is the fact that the MBA contains no investor disclosure requirements. As a result, the level of information currently provided to investors is generally inadequate.

The Proposed Rule, by providing for investor disclosure, would strengthen the regulation of mortgage offerings and provide more protection to investors in mortgages, both syndicated and non-syndicated.

In addition, the Proposed Rule would clarify the regulation of offerings of syndicated mortgages. The Proposed Rule would remove the mortgage exemption in the Act for syndicated mortgages and provide an exemption from the registration and prospectus requirements of the Act for qualified syndicated mortgages. As a result, relatively simple syndicated mortgages would continue to be exempt from the registration and prospectus requirements of the Act, provided certain disclosure requirements were met. More sophisticated syndicated mortgage offerings, however, would be required to comply fully with the registration and prospectus requirements of the Act, subject to the availability of another exemption from these requirements.

Form of Offering Memorandum and Information Statement Specific to Mortgages

Under NIN#98/8, the Executive Director has specified interim Form 43C as the required form of offering memorandum under section 133(1)(c) of the Rules for a distribution of mortgage securities. Under that Notice, the Executive Director has also published for comment a form of Information Statement for mortgages, draft Form 57, that will be required to be used by persons wishing to rely on the exemptions in the Act for mortgages or qualified syndicated mortgages.
Marketing of Mortgages

The Commission is concerned about the methods and materials used in the marketing and promotion of mortgages. The Commission has a number of requirements that apply to the marketing and promotion of securities generally. Rather than referring mortgage brokers to those requirements, the Commission is issuing guidelines, set out in this Notice, specific to the marketing and promotion of mortgages.

These guidelines, and the general prohibitions in the Act against fraud and misrepresentation, apply to any offering of mortgages, whether done under a prospectus or an exemption.

The Commission is aware that full disclosure can seldom be encompassed in an advertisement and, as a result, expects advertisements and other promotional materials to be worded so as to encourage the recipient to consult the relevant information statement, offering memorandum or prospectus. Advertisements, sales literature, other promotional materials and oral representations should be free of quotations, opinions, data and other information that may lead the recipient to make incorrect inferences. Above all, partial disclosure of a series of facts and figures should be avoided when full disclosure of such facts and figures is required for a proper comprehension of the offering. Promotional assertions should be substantiated by reference to disclosure of facts in the related information statement, offering memorandum or prospectus.

Due to the frequent misinterpretation by investors of words such as "guaranteed", "preferred", "liquid" and "indemnity", these words should not be used in any marketing or promotional materials or representations for mortgages. When other modifiers are used, their context should be made perfectly clear. The onus is on the mortgage broker to avoid using equivocal words and phrases and to ensure that all marketing and promotional materials are worded so that a recipient cannot reasonably be misled.

A reference to a benefit, or a comparison of outlay and benefits or returns from outlay, should be free of equivocation. For example, if a reference is made to a benefit that has specific conditions or contingencies riding on it, a reference should also be made to such conditional aspects. If matched columns of figures representing outlay and recovery, or outlay and tax benefits resulting from such outlay, are disclosed, the recipient is entitled to infer that no conditions attach to such figures unless such conditions are clearly disclosed. Where full disclosure on such points cannot be achieved in the materials and representations, partial disclosure should be avoided.

Reference to historical financial data should be based on the results for at least three consecutive years. When there has been less than three years’ history, any disclosure of financial data should be accompanied by a caveat to this effect.

Any financial forecasts or projections should be prepared in accordance with section 4250 of the CICA Handbook and should be audited in accordance with the Auditing and Related Services Guideline of the CICA Handbook entitled "Examination of a financial forecast or projection included in a prospectus or other offering document". A reference in marketing materials to the return on investment as stated in the mortgage document itself will not be considered to be a forecast or projection.

All advertisements and other marketing and promotional materials should contain a disclaimer stating that it must not be construed as an offering and that the offering is made only by information statement, offering memorandum or prospectus. In addition, these materials should disclose the name and address of at least one person from whom more information and a copy of the relevant information statement, offering memorandum or prospectus may be obtained.

Comments

Staff is interested in receiving comments on the Interim Rule and Proposed Rule, and on matters the Commission should consider in developing its long-term policy with respect to mortgage syndications. Interested persons are encouraged to direct written comments by April 15, 1998 to

Brenda J. Benham
Director
Policy and Legislation
British Columbia Securities Commission
200 - 865 Hornby Street
Vancouver, BC V6Z 2H4

Comment letters submitted in response to Requests for Comment are placed in the public file and form part of the public record, unless confidentiality is requested. Although comment letters requesting confidentiality will not be placed in the public file, freedom of information legislation may require the Commission to make comment letters available. Persons submitting comment letters should therefore be aware that the press and members of the public may be able to obtain access to any comment letter.

DATED at Vancouver, British Columbia, on February 4, 1998

Douglas M. Hyndman
Chair

Ref: NIN#98/8
Form 43C
Draft Form 57

1 The Securities Rules, R.B.C. Reg. 194/97, are amended by repealing section 92 and substituting the following section:

Restrictions on exemptions under section 46 of the Act

92 (1) The exemption under section 46(e) of the Act does not apply to a person making a trade of securities unless the securities are mortgages on land situated wholly in British Columbia.

(2) The exemption under section 46(g) of the Act does not apply to a person making a trade of securities unless

(a) the person making the trade is the issuer,
(b) the purchaser is the issuer or a security holder of the issuer, or
(c) the person making the trade is not the issuer and, before the trade is made, the person

(i) notifies the issuer of the proposed trade, and
(ii) provides the purchaser with a copy of any applicable information statement and financial and other information concerning the issuer's affairs that the issuer provided to the person during the 2 years immediately preceding the date of the proposed trade.

2 Section 131 is repealed and the following substituted:

Restrictions on exemption under section 75(a) of the Act

131 (1) The exemption under section 75(a) of the Act does not apply to a person making a distribution of securities described in section 46(e) of the Act unless the securities are mortgages on land situated wholly in British Columbia.

(2) The exemption under section 75(a) of the Act does not apply to a person making a distribution of securities described in section 46(g) of the Act unless

(a) the person making the distribution is the issuer,
(b) the purchaser is the issuer or a security holder of the issuer, or
(c) the person making the distribution is not the issuer and, before the distribution is made, the person

(i) notifies the issuer of the proposed distribution, and
(ii) provides the purchaser with a copy of any applicable information statement and financial and other information concerning the issuer's affairs that the issuer provided to the person during the 2 years immediately preceding the date of the proposed distribution.

1. Section 1 of the Securities Rules, R.B.C. Reg. 194/97, is amended by adding the following:

"qualified appraiser" means an appraiser who is a member of the Appraisal Institute of Canada or the Real Estate Institute of British Columbia.

"qualified syndicated mortgage" means a syndicated mortgage where

(a) the security is a mortgage that is

(i) not contained in or secured by a bond, debenture or similar obligation or in a trust deed or other instrument to secure bonds or debentures or similar obligations,

(ii) on land situated wholly in British Columbia, and

(iii) offered for sale by a person who is registered or deemed to be registered under the Mortgage Brokers Act¹,

¹ A person who holds a valid and subsisting licence under the Real Estate Act or registration under the Securities Act is deemed registered under the Mortgage Brokers Act as a mortgage broker or submortgage broker.

other than a person registered as a limited dealer under the Securities Act,

(b) if the purchaser is not an institutional purchaser as defined in section 134(1), the value of the mortgage, together with all other existing mortgages on the property, does not exceed

(i) 90 percent of the value of the land and existing improvements as determined on the most recent assessment roll by the British Columbia Assessment Authority, or

(ii) where there has been a substantial change in the condition of the property since the most recent assessment by the British Columbia Assessment Authority, the value of the land and existing improvements, as determined in an appraisal by a qualified appraiser, as of the date of the appraisal,

(c) the investment is limited to one specific, identified mortgage,

(g) there is no representation, undertaking or agreement that payments to the investor depend on the operation of the mortgage broker or on any other factors, other than

(i) the ability of the mortgagor to make the payments,

(ii) the personal covenant or guarantee of the mortgagor or of a director or officer of the mortgagor, if any, and

(iii) the value of the property

"syndicated mortgage" means an investment arrangement where a person participates, together with others, as a mortgagee in a mortgage through the acquisition of a portion of the mortgage.

2. Section 89 is amended by adding the following:

Qualified syndicated mortgages

(i) the trade is in a qualified syndicated mortgage and, if the purchaser is not an institutional purchaser as defined in section 134(1), an information statement in the required form is provided to the Registrar of Mortgage Brokers prior to any marketing of the mortgage and delivered to the purchaser before the agreement of purchase and sale is entered into.

3. Section 92 is repealed and replaced with the following²:

² Subsection (4) is a re-enactment of existing section 92.

Restrictions on exemptions under section 46 of the Act

92 (1) The exemption under section 46(e) of the Act does not apply to a person making a trade of securities unless the securities are mortgages on land situated wholly in British Columbia.

(2) The exemption under section 46(e) of the Act does not apply to a trade of a mortgage or other encumbrance on real property unless the mortgagee

(a) is an institutional purchaser as defined in section 134(1), or

(b) is provided with an information statement in the required form.

(3) The exemption under section 46(e) of the Act does not apply to a trade of a syndicated mortgage.

(4) The exemption under section 46(g) of the Act does not apply to a person making a trade of securities unless

(a) the person making the trade is the issuer,

(b) the purchaser is the issuer or a security holder of the issuer, or

(c) the person making the trade is not the issuer and, before the trade is made, the person

(i) notifies the issuer of the proposed trade, and

(ii) provides the purchaser with a copy of any applicable information statement and financial and other information concerning the issuer’s affairs that the issuer provided to the person during the 2 years immediately preceding the date of the proposed trade.

4. Section 128 is amended by adding the following:

Qualified syndicated mortgages

(j) the trade is in a qualified syndicated mortgage and, if the purchaser is not an institutional purchaser as defined in section 134(1), an information statement in the required form is provided to the Registrar of Mortgage Brokers prior to any marketing of the mortgage and delivered to the purchaser before the agreement of purchase and sale is entered into.

5. Section 131 is repealed and replaced with the following³:

³ Subsection (4) is a re-enactment of existing section 131.

(1) The exemption under section 75(a) of the Act does not apply to a person making a distribution of securities described in section 46(e) of the Act unless the securities are mortgages on land situated wholly in British Columbia.

(2) The exemption under section 75(a) of the Act does not apply to a person making a distribution of a security described in section 46(e) of the Act unless the mortgagee

(a) is an institutional purchaser as defined in section 134(1), or

(b) is provided with an information statement in the required form.

(3) The exemption under section 75(a) of the Act does not apply to a person making a distribution of a security described in section 46(e) of the Act if the security is a syndicated mortgage.

(4) The exemption under section 75(a) of the Act does not apply to a person making a distribution of securities described in section 46(g) of the Act unless

(a) the person making the distribution is the issuer,

(b) the purchaser is the issuer or a security holder of the issuer, or

(c) the person making the distribution is not the issuer and, before the distribution is made, the person

(i) notifies the issuer of the proposed distribution, and

(ii) provides the purchaser with a copy of any applicable information statement and financial and other information concerning the issuer’s affairs that the issuer provided to the person during the 2 years immediately preceding the date of the proposed distribution.

6. The Rules are amended by adding the following:

Deemed distribution - qualified syndicated mortgages

140.1 Despite section 140(2), a trade in a qualified syndicated mortgage acquired by the seller under section 128(j) is deemed to be a distribution, whether the issuer of the qualified syndicated mortgage is or is not a reporting issuer, unless the purchaser is

(i) another investor in the qualified syndicated mortgage, or

(ii) an institutional purchaser, as defined in section 134(1).