NIN 99/30 - Republication for Comment of Proposed Rule on Syndicated Mortgages [NIN - Rescinded]

Published Date:	1999-08-20
Effective Date:	1999-08-18

The Commission is republishing for comment proposed amendments to the Securities Rules relating to syndicated mortgages (the "New Proposal").

In February 1998, the Commission published for comment, under NIN#98/7, proposed amendments to the Securities Rules (the "Previous Proposal") that were intended to 

• limit the availability of the registration and prospectus exemptions in sections 46 (e) and 75 (a) of the Securities Act to non-syndicated mortgages on land situated only in British Columbia,
  
• create a new exemption for certain qualified syndicated mortgages on land situated only in British Columbia, and
  
• require disclosure to investors in all mortgages, both syndicated and non-syndicated, sold under either exemption.

At that time, the Commission also adopted and published an urgent rule that restricted the use of the mortgage exemptions to trades that are regulated by the Registrar of Mortgage Brokers, that is, to trades in mortgages on land situated only in British Columbia. This rule came into effect on February 23, 1998 and, because it was adopted without prior publication for comment, remained in effect for only 275 days. Consequently, in order to make the urgent rule a permanent one, the Commission published the proposed permanent rule for comment concurrently with publication of the urgent rule and the Previous Proposal. The permanent rule came into effect when it was deposited with the Registrar of Regulations on October 19, 1998 (the "Permanent Rule") (published under NIN#98/66). The New Proposal would replace the Permanent Rule.

The legislature has adopted amendments to theMortgage Brokers Act (the "MBA") in Bill 9, the Finance and Corporate Relations Statutes Amendment Act, 1998, and Bill 97, the Miscellaneous Statutes Amendment Act (No. 3), 1999, but these have not yet been brought into force. The amendments to the MBA will result in the Registrar of Mortgage Brokers regulating the actions of registered mortgage brokers with respect to mortgages arranged on land situated outside British Columbia and will require investor disclosure for all mortgages. The MBA will then require disclosure regardless of the location of the property and whether or not the mortgage is syndicated (other than those mortgages for which disclosure has been provided under the Securities Act). These amendments to the MBA are expected to come into force within the next few months, upon the finalization of the new MBA Regulations and investor disclosure form, concurrently with the New Proposal.

The Previous Proposal

The Previous Proposal, by providing for disclosure to investors, other than institutional investors, was intended to strengthen the regulation of mortgage offerings and to provide more protection to investors in mortgages, both syndicated and non-syndicated.

In addition to imposing a form of disclosure for offerings under the mortgage exemption, the Previous Proposal would have removed the mortgage exemption for syndicated mortgages and provided a new exemption from the registration and prospectus requirements of the Act for certain types of syndicated mortgages, called "qualified syndicated mortgages". As a result, qualified syndicated mortgages would have continued to be exempt from the registration and prospectus requirements of the Act, provided certain disclosure requirements were met, as well as being governed by the MBA. More sophisticated syndicated mortgage offerings (including development or construction loans) would have been required to comply fully with the registration and prospectus requirements of the Act, subject to the availability of another exemption from these requirements.

The New Proposal

After considering the comments received and further considering the risks to investors in offerings of syndicated mortgages, the Commission is publishing a revised proposal.

The requirements of the exemption for qualified syndicated mortgages in the New Proposal differ from those in the Previous Proposal in a number of ways. The New Proposal narrows the scope of the proposed exemption for qualified syndicated mortgages by restricting that exemption to mortgages on property that, at the time of the trade, contains no more than four residential dwelling units.

As a result of the reduced scope of the exemption, the Commission has removed other requirements that were included in the Previous Proposal, including requirements for the interest of the investor to be registered on the title to the property either directly or through a trust company registered under the Financial Institutions Act and for the value of the property to be based on the most recent assessment roll prepared by the British Columbia Assessment Authority.

As a result of the amendments to the MBA, the New Proposal no longer contains any restrictions on the location of the mortgaged property (although it continues to restrict the exemption to mortgages on land) and does not require an investor information statement under the Securities Act (Draft Form 57). The New Proposal does require a qualified syndicated mortgage to be offered for sale by a registered mortgage broker.

Syndicated mortgages that do not meet the requirements of the proposed new exemption will have to comply fully with the registration and prospectus requirements of the Securities Act, subject to the availability of another exemption from these requirements (discussed below).

Exemptions from the Mortgage Brokers Act

Any person wishing to sell mortgages in British Columbia is required to be registered under the MBA as a mortgage broker or submortgage broker. However, any person registered under the Securities Act, other than a limited dealer, will be exempt from the provisions of the MBA when selling syndicated mortgages, provided that the person delivers to purchasers a prospectus or offering memorandum, in the form required under the Securities Act, in respect of that sale. If the registrant wishes to rely on an exemption from the Securities Act that does not require delivery of either a prospectus or an offering memorandum, the registrant would be required to comply with the requirements under the MBA.

In this way, an investor in a syndicated mortgage will be assured of obtaining either a prospectus or offering memorandum under the Securities Act or the Investor/Lender Information Statement required under the MBA.

Available Exemptions Under the Securities Act

The registration and prospectus exemptions that are likely to be of most interest to mortgage brokers are the exemption for trades in excess of $97,000, the 50 purchaser exemption and the $25,000 exemption for sales to sophisticated purchasers. There is also a prospectus (but not registration) exemption for sales of at least $25,000 where sales are made through a person registered under the Securities Act.

$97,000 Exemption

This exemption is found in sections 45 (2) (5) and 74 (2) (4) of the Securities Act. It requires that the purchaser purchase as principal and that the securities have an aggregate acquisition cost of no less than $97,000. The exemption is therefore not available if the purchaser gathers 10 individuals who each put up $9,700. In that case, the purchaser would not be purchasing as principal.

As long as the issuer does not advertise to find investors, the issuer does not have to provide purchasers with a prescribed form of disclosure under theSecurities Act. However, as noted above, in that case the issuer would have to be registered, and have to provide the disclosure required, under the MBA. If the issuer does advertise, it must deliver an offering memorandum to the purchasers before an agreement of purchase and sale is entered into. The offering memorandum must provide contractual rights of action to the purchaser if there is a misrepresentation and must be in the required form (Form 43C for offerings of mortgages).

If the issuer relies on this exemption, it must obtain an acknowledgement from any individual purchaser of their limited rights (Form 20A) and must file a report of the distribution with the Commission (Form 20).

50 Purchaser Exemption

This exemption, which is found in sections 89 (a) and 128 (a) of the Rules, allows an issuer to sell securities to no more than 49 purchasers in any 12-month period. Each purchaser must be a spouse, parent, brother, sister or child of a director or senior officer of the issuer or a sophisticated purchaser (described below) and must purchase as principal. The issuer must not advertise and must not pay any selling or promotional expenses, other than for fees for professional services or services performed by a registered dealer. The issuer must also deliver an offering memorandum to each purchaser.

Each purchaser must sign a Form 20A acknowledging their limited rights and also certifying that the purchaser is a spouse, parent, brother, sister or child of a director or senior officer of the issuer or is a sophisticated purchaser. The issuer must retain those forms for six years and make them available to the Commission upon request. The issuer must also file a Form 20 to advise of the distribution.

$25,000 Exemption for Sales to Sophisticated Purchasers

This exemption, which is found in sections 89 (b) and 128 (b) of the Rules, allows an issuer to sell securities to sophisticated purchasers in minimum amounts of at least $25,000.

The term sophisticated purchaser is defined in section 1 of the Rules and means a purchaser that gives an acknowledgement to the issuer (Form 20A) that the purchaser has a net worth of at least $400,000 or an annual net income for each of the previous two years of at least $75,000 (or $125,000 if including annual net income of one’s spouse) and reasonably expects that level of income in the current year. In addition, the purchaser must be able to evaluate the risks and merits of the investment on the basis of financial, business or investment experience or on the basis of advice from someone registered under the Act, or exempted from the requirement to be registered, to provide advice.

Again, the issuer must deliver an offering memorandum to the purchaser, must file a Form 20 with the Commission and must obtain an acknowledgement in Form 20A from each purchaser.

$25,000 Exemption Where Sales Through a Registrant

This prospectus exemption, which is found in section 128 (c) of the Rules, is available for an issuer that uses a person registered under the Act to sell securities in amounts of at least $25,000. The registrant must be qualified to sell the securities that are being offered. Unlike the other exemptions discussed, a corresponding registration exemption is not provided.

Once again, the issuer must file a Form 20 with the Commission, deliver an offering memorandum to the purchaser and obtain a Form 20A from each purchaser. In the Form 20A, the purchaser must identify the registrant who acted for him or her in the purchase of the securities.

Discussion of Significant Comments Received

During the comment period on the Previous Proposal, which expired on April 15, 1998, the Commission received five written submissions. In addition, Commission staff subsequently met with a group of real estate lawyers and mortgage brokers, as well as representatives of the Mortgage Brokers Association of British Columbia, the Commercial Mortgage Brokers Association and the Mortgage Investors Association, to solicit further comments. Below is a summary of the significant comments received.
Development or Construction Loans

The Previous Proposal excluded development or construction loans from the definition of a qualified syndicated mortgage. As a result, syndicated offerings of these loans would have been required to comply fully with the registration and prospectus requirements of the Act, subject to the availability of another exemption from these requirements.

This requirement met with strong opposition from the mortgage brokerage industry, which represented that much of its business is derived from offerings of syndicated mortgages for development or construction financing. As a result, these mortgage brokers would like to be able to continue offering such investments to retail investors and to investors who choose to diversify their mortgage portfolio over a number of different mortgages. They submitted, further, that having to rely on the sophisticated purchaser and $97,000 exemptions for these kinds of mortgage offerings would have significant adverse effects on their business.

Members of the mortgage brokerage industry submitted that, with prudent controls and procedures, such offerings pose no greater risk to investors than non-development mortgages. One of the suggested controls to maximize investor protection in development and construction mortgages was the imposition of a requirement for development funds to be advanced on a "cost to complete" basis. In this way, interim advances would be permitted up to a percentage of the value of improvements in place as certified by an arm’s length engineer, architect or quantity surveyor.

The Commission, after careful consideration of the submissions by members of the mortgage brokerage industry and after extensive consultations with the office of the Registrar of Mortgage Brokers, remains unconvinced that syndicated development and construction mortgages should be exempt from the registration and prospectus requirements of the Act.

Moreover, the Commission is now proposing to restrict the exemption further, so as to exclude also syndicated mortgages on commercial real estate projects from the definition of a qualified syndicated mortgage, except where the purchaser is an institutional purchaser. As a result, syndicated offerings of these loans would also be required to comply fully with the registration and prospectus requirements of the Act, again subject to the availability of another exemption from these requirements (discussed above).

The New Proposal reflects the Commission’s view that it is proper to draw a distinction between (i) investments where the value of the land exists at the time the mortgage is granted and the risk associated with the mortgage is limited almost exclusively to fluctuations in real estate values, and (ii) investments where the mortgage is either not fully secured by the value of the land and existing improvements alone or is dependent to a large extent on other factors, including rental revenues.

In development or construction projects, for instance, the investor will need to rely on the ability of the mortgage broker to assess the various construction stages, to recognize the warning signs of a project in trouble and to advance funds appropriately.

The Commission is of the opinion that an unsophisticated investor who does not receive advice from a person required to determine the suitability of the investment for that investor typically does not understand the risks involved and the true value of the property in these projects. The Commission therefore considers that these kinds of offerings should be regulated under the Securities Act.

Requirement to Use Trust Companies

In order for a mortgage to fit within the exemption for qualified syndicated mortgages under the Previous Proposal, an investor’s interest in the mortgage would have been required to be registered on title, either directly or through a trust company registered under the Financial Institutions Act that is unrelated to the mortgage broker or any other person connected with the offering.

Members of the mortgage brokerage industry expressed the view that this requirement would be an enormous problem from a practical standpoint. In addition to the opinion that the use of registered trust companies would be prohibitively costly, the commenters were concerned that there would be no practical benefit to investors as the trustee would have little or no understanding of the mortgage transaction. In addition, they were concerned that the requirement for a third party trustee would result in an unnecessary slowing in the flow of certain documents.

The Commission remains concerned about poorly drafted trust agreements, the inability by investors in large syndications to obtain the name of their co-lenders under the mortgage (which effectively prevents them from being able to hold an extraordinary meeting in situations where they would like to remove a trustee) and the conflicts of interest that arise when the mortgage broker acts also as trustee, particularly in foreclosure situations. As a result, Commission staff proposes to amend the requirements of the form of offering memorandum for mortgages (Form 43C) so as to require detailed disclosure of the material terms of any trust agreement.

However, in light of the practical difficulties in using a registered trust company, and in view of the proposed narrowing of the proposed exemption for qualified syndicated mortgages, the Commission has removed from the New Proposal the requirement for an investor’s interest in the mortgage to be registered on title either directly or through a trust company registered under the Financial Institutions Act.

Determination of Property Values

The exemption for qualified syndicated mortgages under the Previous Proposal stipulated that the value of the mortgage, together with all other existing mortgages on the property, could not exceed 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. Where there had 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 would have to be determined by an appraiser that is a member of the Appraisal Institute of Canada or the Real Estate Institute of British Columbia.

Members of the mortgage brokerage industry expressed the view that the use of the assessment in isolation to determine value could be erroneous and misleading for a number of reasons. They argue that the assessment roll values are frequently out of date and might not reflect actual value in a fluctuating market. For instance, assessments do not reflect factors such as zoning, current use, highest and best use, current and proposed density and declining rental revenues.

In view of the proposed new restrictions on the use of the exemption for qualified syndicated mortgages, the Commission has removed the requirement relating to how the value of the property is determined.

Institutional Purchasers

The proposed restrictions on the exemption under sections 46 (e) and 75 (a) of the Act do not apply if the purchaser of the mortgage is an institutional purchaser as defined in section 134 (1) of the Securities Rules. Credit Union Central of British Columbia submits that while most of the financial institutions to which British Columbia credit unions sell mortgage loans are entities that would be institutional purchasers, primarily savings institutions and other entities listed in sections 45 (2) (2) and 74 (2) (1) of the Act, there are situations when credit unions may sell assets, including mortgages, to entities not included in the definition of institutional purchasers. These could include credit unions incorporated outside British Columbia (which are not covered by the definition of savings institution in section 29 of the Interpretation Act) and special purpose trusts or other vehicles established for the purpose of a securitization of credit union assets. Credit Union Central of British Columbia submits that these institutions should also be exempt from the registration and prospectus requirements of the Act.

Although the application of the New Proposal is affected by the current definition of an institutional purchaser, any amendments to section 134 (1) of the Rules would have much broader implications. As a result, the Commission is of the view that any amendments to that definition should be dealt with separately from the New Proposal and be published for comment as a stand-alone amendment to the Rules.

Amendments Required Due to MBA Amendments

As noted above, the amendments to the MBA contained in Bill 9 and Bill 97 will result in the Registrar of Mortgage Brokers regulating the actions of registered mortgage brokers with respect to mortgages arranged on land situated outside British Columbia and will require investor disclosure for all mortgages, wherever the property may be located and whether syndicated or non-syndicated (other than those for which disclosure has been provided under the Securities Act). As a result, the Commission proposes to eliminate the restriction on the location of the mortgaged property for mortgages sold under the mortgage exemption. In addition, the need for an information statement under the Securities Act for qualified syndicated mortgages and non-syndicated mortgages will be eliminated and, consequently, all references to that information statement have been removed from the New Proposal.

The amendments to the MBA also deleted the provision of that act that deems a person who holds a valid and subsisting licence under the Real Estate Act or registration under theSecurities Act to be registered under the MBA as a mortgage broker or submortgage broker. As a result, the New Proposal requires a qualified syndicated mortgage to be offered for sale by a mortgage broker.

Forms

Many of the comments received from the mortgage brokerage industry related to the disclosure requirements of the offering memorandum for mortgages (Form 43C) and the draft information statement for qualified syndicated mortgages and non-syndicated mortgages (Draft Form 57). While the need for an information statement will be eliminated, as a result of the new investor disclosure requirements of the MBA, Form 43C will be retained as the form of offering memorandum for mortgages. In light of the comments received, however, staff proposes to amend the requirements of Form 43C and will shortly adopt a revised form.

Alternatives Considered

The Commission considered both a more liberal and a more restrictive approach. On the one hand, thought was given to retaining the exemption for qualified syndicated mortgages as proposed in the Previous Proposal, which would allow issuers of syndicated mortgages on commercial real estate projects to rely on the exemption. On the other hand, consideration was given to removing the proposed exemption for qualified syndicated mortgages altogether, which would effectively require full compliance with the registration and prospectus requirements of the Act for offerings of all syndicated mortgages, subject to the availability of another exemption from these requirements.

Consideration was also given to creating a new exemption for syndicated construction and commercial real estate mortgages - one that would parallel the existing exemption for sales of $25,000 worth of securities through a registrant, and under which sales could be made as long as the aggregate acquisition cost is at least $25,000, the purchaser receives an offering memorandum and the mortgages are sold through a licensed mortgage broker. However, the Commission is reluctant to grant a new exemption for offerings of construction mortgages and mortgages on commercial real estate projects that wouldn’t require a determination of the suitability of the investment for the purchaser to be made by a person registered under the Securities Act.

In light of the practical difficulties in using a registered trust company, the Commission also considered prescribing the contents of a trust agreement for offerings of qualified syndicated mortgages where the interests of the investors were registered on title through a trustee. With the more restrictive exemption, however, the Commission decided not to impose these requirements.

Anticipated Costs and Benefits

The proposed new exemption for qualified syndicated mortgages does not apply to offerings of development or construction mortgages or to offerings of mortgages on commercial real estate projects. As a result, mortgage brokers that wish to offer syndicated mortgages on these types of projects will have to comply fully with the registration and prospectus requirements of the Securities Act, subject to the availability of another exemption from these requirements (discussed above).

The Commission is aware that these requirements will require certain mortgage brokers to change the manner in which they conduct their business and will impose burdens of time, cost and personnel.

The Commission believes that the incremental costs of compliance with the registration and prospectus requirements of the Act on the mortgage brokerage industry will be outweighed by the very significant benefits provided to investors, namely more reliable investor disclosure. A further benefit should be greater confidence in the integrity of the mortgage market, itself a significant benefit to issuers.

Comments

Staff is interested in receiving comments on the New Proposal. Interested persons are encouraged to direct written comments by October 20, 1999 to:

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.

Questions on the New Proposal may be referred to:

Questions on the amendments to the Mortgage Brokers Act may be referred to:

DATED at Vancouver, British Columbia, on August 18, 1999.

Douglas M. Hyndman
Chair

Ref: NIN#98/7
NIN#98/66
Form 20
Form 20A
Form 43C
Draft Form 57

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

"mortgage broker" means a person who is registered under the Mortgage Brokers Act;

"qualified syndicated mortgage" means a syndicated mortgage if

(a) the syndicated mortgage 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, and

(ii) offered for sale by a mortgage broker,

(b) at the time of the trade, the property contains no more than 4 residential dwelling units,

(c) at the time of issue, the amount of the debt secured by the syndicated mortgage, together with all other debt secured by mortgages on the property that have priority over, or the same priority as, the syndicated mortgage, does not exceed 90 percent of the fair market value of the property, excluding any value that may be attributed to proposed or pending development on the property,

(d) the syndicated mortgage is limited to one identified debt obligation,

(e) the rate of interest payable under the syndicated mortgage is equal to the rate of interest payable under the identified debt obligation less an amount required for the administration of the syndicated mortgage, if any, and

(f) the term of the syndicated mortgage is not different from the term of the identified debt obligation;

"syndicated mortgage" means a security that provides an investment arrangement in which a person participates, together with others, as a mortgagee through the acquisition of a portion of an identified debt obligation that is secured by a mortgage.

2. Section 89 is amended by adding the following paragraph:

Qualified syndicated mortgages

(i) the trade is made

(i) by an issuer in a qualified syndicated mortgage of its own issue, or

(ii) by a person other than the issuer if

(A) the security is a qualified syndicated mortgage, and

(B) the purchaser is an existing investor in the same qualified syndicated mortgage.

3. Section 92 (1) is repealed and the following substituted:

(1) Unless the purchaser of the securities is an institutional purchaser as defined in section 134 (1), the exemption under section 46 (e) of the Act does not apply to a person making a trade of securities if

(a) the securities are mortgages, or other encumbrances, on property other than land, or

(b) the securities are syndicated mortgages.

4. Section 128 is amended by adding the following paragraph:

Qualified syndicated mortgages

(j) the trade is made

(i) by an issuer in a qualified syndicated mortgage of its own issue, or

(ii) by a person other than the issuer if

(A) the security is a qualified syndicated mortgage, and

(B) the purchaser is an existing investor in the same qualified syndicated mortgage.

5. Section 131 (1) is repealed and the following substituted:

(1) Unless the purchaser of the securities is an institutional purchaser as defined in section 134 (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 if

(a) the securities are mortgages, or other encumbrances, on property other than land, or

(b) the securities are syndicated mortgages.