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Inquiry into the 1 Parliament Street Car-Park Limited Contributory Mortgage

GLOSSARY OF ABBREVIATIONS

"BBJ" - Barratt-Boyes Jefferies Limited, registered valuers

"Contributory Mortgage Regulations" and "the regulations" - The Securities Act (Contributory Mortgage) Regulations 1988

"MGC" - Mahoney Gardner Churton Limited, registered valuers

"MFL" - The Mortgage Financier Limited

"MM" - Money Managers Limited

"Parliament Street mortgage" - the 1 Parliament Street Car-Park Limited contributory mortgage over a property at 1 Parliament Street, central Auckland, in respect of which The Mortgage Financier Limited was the registered contributory mortgage broker. A company called 1 Parliament Street Carpark Limited was to be the borrower of the funds raised under the contributory mortgage. "Securities Act" - The Securities Act 1978

"section 38B order" - an order made by the Commission prohibiting the distribution of advertising for an offer of securities to the public, on the grounds that advertising for the offer is likely to deceive, mislead or confuse investors, or otherwise breaches the legal requirements of such advertisements.

"section 44B order" - an order made by the Commission on the grounds that a broker has contravened the securities laws and that it is in the public interest to make the order. Under section 44B the Commission may do one or more of the following things:

prohibit the broker from offering interests in contributory mortgages to the public for a certain time period;
remove the broker as manager of any of its contributory mortgages and appoint another person to act as broker in its place;
remove the directors of the broker's nominee company and appoint new directors in their place.

"SRL" - Securities Registry Limited

BACKGROUND TO THIS REPORT

On 18 February 2002 the Commission began an inquiry into the circumstances of the offering and management of interests in a contributory mortgage that had been offered to the public for subscription by a registered contributory mortgage broker called The Mortgage Financier Limited. The interests were secured by a first mortgage over a property at 1 Parliament Street in central Auckland.
As a result of its inquiry, on 21 March 2002 the Commission made an order under section 44B(2)(c) of the Securities Act 1978 removing MFL as contributory mortgage broker for the Parliament Street mortgage. The Commission appointed Crichton Horne & Associates Mortgage Brokers Limited to act as contributory mortgage broker in its place. Crichton Horne & Associates Mortgage Brokers Limited is a registered contributory mortgage broker managed by Crichton Horne & Associates, Chartered Accountants in Christchurch. The Commission understands that MFL has co-operated fully with Crichton Horne.
The Commission had also previously made orders under section 38B of the Securities Act prohibiting all advertising for the Parliament Street mortgage. The section 38B orders were made on 14 February 2002.
It is one of the Commission's functions under section 10(c) of the Securities Act to "keep under review practices relating to securities, and to comment thereon to any appropriate body". In the Commission's view, the circumstances of the offering and management of the Parliament Street mortgage raise issues of securities law and practice upon which it is appropriate for it to comment. It has decided to do so by way of this report.
The Commission has prepared this report, and made the orders referred to above, after carefully considering a large volume of documentary and verbal evidence, and written submissions made by the parties. MFL, MM, SRL, Douglas Somers-Edgar (director of MM), Brent Clode (the owner of the company that was to borrow the funds under the mortgage) and the valuer of the property have had the opportunity to comment on sections of the report relevant to them. Their comments have been taken into account in finalising the report.
The report has been prepared by a quorum of Members of the Commission comprising Jane Diplock (Chairman), Elizabeth Hickey and Cathy Quinn. The quorum was assisted by counsel.
When referring to persons in our report we have generally not used the customary honorifics. We have used a person's full name the first time it is mentioned. Subsequently we may use the surname only. No disrespect is intended by this practice.

SUMMARY OF THE COMMISSION'S CONCLUSIONS

The Commission has considered two broad questions in the course of its inquiry:
1. whether securities law provisions have been breached; and
2. if they have, who might be responsible at law for those breaches.
The Commission has formed the view that provisions in the Securities Act 1978, the Securities Regulations 1983, and the Securities Act (Contributory Mortgage) Regulations 1988 have been breached in the offering and management of the Parliament Street mortgage. The breaches relate principally to investors being given misleading information about the value of the property in which they were investing, and their money being placed at risk by being paid to the borrower before fundraising was complete.
The Commission has formed the view that MFL as contributory mortgage broker was responsible for the breaches under the Contributory Mortgage Regulations and, as issuer of the mortgage, may be criminally and civilly liable for the breaches under the Securities Act.
The Commission considers that MM has acted as a contributory mortgage broker by offering interests in the Parliament Street mortgage to the public for subscription. As such, it has breached the regulations by not being properly registered. It might also be criminally and civilly liable under the Securities Act as an issuer in the same way as MFL.
The Commission has formed the view that SRL and MM were promoters of this offer in terms of the securities laws. As promoters, SRL and its directors might be subject to criminal and civil liability under the Securities Act. MM might also be subject to criminal and civil liability under the Securities Act as promoters. If the Commission is correct in concluding that MM was a contributory mortgage broker and therefore an issuer of the mortgage, the directors of MM were not promoters because the definition of "promoter" excludes the directors of the issuer.

BACKGROUND TO THE INQUIRY

In February 2002 the Commission received a report from the auditors of MFL. MFL had initiated a review by its auditor, prior to the usual year end audit, to ensure that its year end audit went smoothly. The report identified breaches of the Contributory Mortgage Regulations with regard to a contributory mortgage that had been offered to the public by MFL over a property at Parliament Street in Auckland.
After reviewing the offer documents for the Parliament Street mortgage, the Commission made orders under section 38B of the Securities Act 1978 on 14 February 2002 prohibiting the distribution of all advertisements for the offer. The prohibition included all offer documents for the Parliament Street mortgage, which are advertisements for the purposes of the Securities Act 1978 and regulations made under that Act.
The Commission made the orders because, in its opinion, the offer documents were likely to mislead or confuse with regard to a particular material to the offer, namely the value of the property in question. It was also of the opinion that the documents failed to comply with the Contributory Mortgage Regulations, particularly the requirements for the valuation report.
The Commission formed the opinion that the auditor's report indicated that MFL had breached the Contributory Mortgage Regulations in other respects relating to the management of the mortgage. These are discussed further below. The Commission informed MFL that it wished to hear from it about the breaches identified.
When the Commission makes orders under section 38B, the issuer of the securities is entitled to appear and be represented before the Commission. MFL requested that the Commission hear it as soon as possible. The Commission convened a meeting for that purpose on 18 February 2002. The three directors of MFL appeared at that meeting. They confirmed that they were aware of their right to be represented, but chose not to be on that occasion.
After that meeting, the Commission carefully considered the submissions of the directors and their answers to the Commission's questions. The Commission decided to undertake an inquiry under section 10 of the Securities Act 1978 into the circumstances of the offer and management of interests in the Parliament Street mortgage. The Commission also decided to request the Registrar of Companies to exercise his powers of inspection under section 67 of the Securities Act in relation to the parties involved with the mortgage.
The Commission conducted hearings involving representatives of the key parties over two days on 28 February and 8 March 2002, and received submissions from them on the issues raised by the inquiry. Somers-Edgar, MM, SRL and MFL were legally represented at the hearings. Evidence was taken at the hearings under oath. Brent Clode and his companies were not invited to take part in the hearings. As previously noted, Clode has had an opportunity to consider and comment on a draft of this report. The Commission has carefully considered the submissions and the evidence obtained during the hearings and from the Registrar's inspection in making this report.

BACKGROUND TO THE OFFER

Development mortgage

MFL sought to raise $27 million from the public in respect of a development at 1 Parliament Street in Auckland. According to the offer documents, the money would be lent to the developer for two years and be secured by a first mortgage over the property. Investors would receive 9.5% interest, and would be repaid in full at the end of the two years.
This is a development mortgage under the Securities Act and the Contributory Mortgage Regulations, and must be offered and managed in accordance with securities law.

Persons involved in the offer and management of the Parliament Street mortgage

MFL is a company incorporated in 1998. It is registered as a contributory mortgage broker under the Contributory Mortgage Regulations. Its three directors are Beau Davidson, Dyanne Kokich, and Warwick Edgar. Its shareholders are the three directors and two other individuals, Iain Duffy and Craig Gunson. As required by the Contributory Mortgage Regulations it has a wholly owned subsidiary nominee company, Mortgage Financier Nominees Limited, which holds mortgage investments on behalf of contributors. All payments to and from contributors and borrowers must pass through the nominee company's trust account.
The borrower is a company called 1 Parliament Street Carpark Limited. It is owned by Brent Clode, an Auckland property developer. Clode has told the Commission that 1 Parliament Street Carpark Limited "is a declared corporate trustee for an investment trust called 1 Parliament Street Carpark Trust". Another Clode company was to undertake the development work. The borrower planned to build a multi-storey apartment and car park building on the bare site it owned at 1 Parliament Street using money raised under the contributory mortgage brokered by MFL. The borrower planned to keep the building once it was finished, rent out the apartments and car parks, and refinance with a bank to repay the contributory mortgage. According to the offer documents for the Parliament Street mortgage, the trustees to the 1 Parliament Street Carpark Trust, Clode and Clode Consulting Limited guaranteed that 1 Parliament Street Carpark Limited would meet its obligations under the mortgage.
MM is a company that operates a nationwide network of financial advisers. It is ultimately owned by Somers-Edgar and his wife Anne Somers-Edgar. Doug Somers-Edgar is the sole director and manages the company from its head office in Auckland. By agreement with MFL, MM had exclusive rights to market the Parliament Street mortgage. (MFL says that it could have introduced contributors, but chose not to. Any contributors introduced by MFL would still have had to sign up through MM.) This means that all of the money invested in the mortgage was contributed by clients of MM, either directly or through MM's First Step investment product (as explained further in the next paragraph). The role played by MM, and its legal status under the securities laws, are discussed further below.
SRL is a company associated with MM. Its principal role is to invest funds on behalf of the "First Step" investment products promoted by MM. Its directors are Somers-Edgar, Anne Somers-Edgar, Gerald Siddall and Russell Tills. Siddall and Tills are the directors of New Zealand Funds Management Limited, a funds management company also involved with the First Step products. Phil Epps is the Chief Executive of SRL. SRL contributed $3 million of First Step funds to the Parliament Street mortgage. The role played by SRL, and its legal status under the securities laws, are discussed further below.
The property at 1 Parliament Street was valued by Phillip Amesbury, a registered valuer with BBJ.

How the Parliament Street mortgage came to be offered to the public

At some time in or before March 2001 Clode approached SRL to borrow the finance necessary to build a multi-storey apartment and car park building on the Parliament Street site. Clode had previously borrowed from SRL to fund other projects.
SRL has a policy of limiting its lending exposure to any one borrower to a percentage of its total assets under management. Because the amount of the Parliament Street loan, together with other outstanding loans made to Clode, would exceed those limits, SRL declined to make the loan directly. Instead, in conjunction with Clode, it decided to raise the funds by way of a contributory mortgage. A registered contributory mortgage broker would be found, in SRL's words, to "administer" the mortgage and MM would have the exclusive rights to market the offer to its clients in return for a fee of 2.00% of the total loan. SRL would receive a "finders fee" of 0.25%. The contributory mortgage broker would also receive a fee for its services in "administering" the mortgage.
As far as the Commission is aware, SRL approached two registered contributory mortgage brokers about the loan, including MFL. The other broker had previously offered contributory mortgages through the MM network. It charged a higher fee than MFL and offered a form of capital insurance underwritten by Lloyds of London. MFL quoted a lower fee of 0.35% and offered no assurance of return of capital. MFL has told the Commission that it did not know what the other broker would have charged.
MFL was chosen by SRL as the broker to "administer" the Parliament Street mortgage. The precise reasons for choosing MFL are not entirely clear from the evidence. There is evidence that MM consulted its network of advisers as to whether investors would prefer the higher interest rate that MFL was able to offer by taking lower fees, without any capital insurance, or the other broker's lower interest rate with the capital insurance.
In early August 2001 MFL made a loan offer to 1 Parliament Street Carpark Limited. After some negotiation, the terms and conditions of the loan were agreed. MFL referred aspects of the negotiation to SRL. In particular, at one point in the negotiations Clode wished to delete from the loan offer the condition that his development company, Clode Consulting Limited, would guarantee the loan. Clode also proposed certain other amendments to the terms of the loan offer. MFL referred these proposed changes to Epps of SRL, noting that it was "your call" (ie, SRL's call) whether or not Clode Consulting Limited would be a guarantor. SRL replied that the term requiring Clode Consulting Limited's guarantee was to remain in the loan offer. That term did remain, and was accepted by Clode. In its submissions to the Commission MFL has said that:
"The reason for MFL referring aspects of the terms of the loan to SRL was simply because SRL was intended to be a major contributor to the mortgage. In the specific example [referred to above] MFL was indifferent to whether Clode Consulting would be a guarantor. MFL took this view because in its opinion it had sufficient security in all other respects. Accordingly, the example used [above] was the exception, rather than the rule."
The evidence indicates that by mid August 2001 MM was ready to begin marketing the offer. However, it seems that the borrower had not yet satisfied all of the conditions of the loan agreement. In particular, it had not yet provided a registered valuer's report on the property as required by the loan offer and by the Contributory Mortgage Regulations. The several valuations of this property that have been produced at various times are discussed more fully later in the report. A valuation that complied with the conditions of the loan offer or with the Contributory Mortgage Regulations was not given to contributors before the Commission's section 38B order on 14 February 2002 prohibited further advertising. What potential contributors to the mortgage were given was a copy of a valuation prepared by BBJ dated 24 August 2001, which did not comply with the law.
MM began marketing the contributory mortgage before the borrower had met all of the conditions of the loan offer. Also, while marketing was in progress, the borrower reconfigured the plans for the building to provide for more apartments. A new valuation dated 27 September 2001 which took into account the reconfiguration was obtained, but not provided to those who had already contributed to the mortgage.
A "check valuation" dated 8 October 2001 by another valuer, MGC, was obtained at the request of MFL. The "check valuation" did not value the property, but it did query the BBJ valuation dated 27 September 2001 and identified areas of non-compliance with the Contributory Mortgage Regulations. MGC's comments on the 27 September valuation also apply to the 27 August valuation that was sent to contributors, which differs only in the number of apartments to be built. MFL asked Clode to obtain a compliant valuation from BBJ, but contributors were not sent a compliant valuation nor were they informed of any deficiencies.
A few days before the offer was due to close, less than half the amount of the loan had been raised. On 25 September 2001 Somers-Edgar, on behalf of MM, signed a document entitled "Promissory Note" which MFL understood to constitute a promise to raise or pay the full amount of the loan on or before 29 March 2002. The closing date of the offer was extended, and the offer had not yet closed when the Commission made section 38B orders on 14 February 2002.
On 8 October 2001 the loan agreement and security documentation were signed. Also on 8 October the first payment of approximately $8 million was paid to the borrower or applied on its behalf. Of that amount, approximately $3.3 million was retained by MFL as prepaid interest and fees (MFL has told us that of this amount $189,000 was prepaid fees, which were to be paid proportionately in arrears for each month of the duration of the loan. Fees actually received by MFL totalled $39,375). MM and SRL were paid the full amount of their commission, $540,000 and $67,000 respectively. They were paid the full commission even though fundraising was not yet complete. Another $6,000 was paid to the Whangarei lawyers who had acted on the transaction for MFL. The balance was used by the borrower to pay for costs of the property and the project.

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