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

THE MORTGAGE FINANCIER LIMITED REMOVED AS BROKER

On 21 March 2002 the Commission made orders removing MFL as broker of the Parliament Street mortgage and appointing another broker to act in its place. MFL complied with the order. On 28 March, the replacement broker, Crichton Horne, made a written demand that MM pay the $3.65 million shortfall in the full amount of the loan. (It made this demand on 28 March because the due date of the promissory note, 29 March, was Good Friday). MM replied through its solicitors that it would be "inappropriate" for MM to pay while the matter was still before the Commission. The Commission advised on 3 April that it could see no impediment to MM making the payment. MM's solicitor indicated that MM would be happy to do so, and had funds available. After further correspondence and meetings between Crichton Horne and MM, MM paid the $3.65 million on 11 April 2002.

PRINCIPAL AREAS OF INQUIRY

The Commission has considered two broad questions in the course of its inquiry:
1. whether any provisions of the securities laws have been breached; and
2. if they have, who might be responsible at law for those breaches.

FINDINGS AS TO BREACHES OF THE SECURITIES LAWS

After reviewing the offer documents for the Parliament Street mortgage, and carefully considering the evidence obtained in the course of the inquiry and the submissions of the parties, the Commission has formed the opinion that the securities laws have been breached in the offering and management of the Parliament Street contributory mortgage, as described below.
Section 44B(2) of the Securities Act empowers the Commission to make certain orders in relation to the activities of a contributory mortgage broker. The Commission was satisfied that MFL contravened regulations made under the Securities Act, and that it was desirable in the public interest to make orders under section 44B(2). In particular:
1. the valuation information disclosed in the offer documents for the Parliament Street mortgage (which constitute an advertisement for securities law purposes) was likely to deceive, mislead or confuse with regard to a material particular, namely the value of the subject property, in contravention of Regulation 8 of the Securities Regulations 1983;
2. contributions were paid to the borrower or for its benefit before there were contributions in the trust account or investments referred to in Regulation 27 of the Contributory Mortgage Regulations equal to the amount of the principal sum of the mortgage, in contravention of Regulation 21(d) of the Contributory Mortgage Regulations;
3. contributions were paid to the borrower or for its benefit when there were insufficient funds available in the form of contributions retained in the trust account, or investments referred to in Regulation 27, to complete the development, in contravention of Regulation 21(f) of the Contributory Mortgage Regulations;
4. contributions were paid to the borrower or for its benefit when MFL knew, or ought to have known, that a document relating to the mortgage (namely, the valuation report) sent or given to contributors was false or misleading in a material particular, in contravention of Regulation 20(1) of the Contributory Mortgage Regulations;
5. contributions were paid to the borrower or for its benefit when the documents given to contributors did not contain all of the information and other matters specified in the Eleventh Schedule to the Contributory Mortgage Regulations, in contravention of Regulation 19 of the Contributory Mortgage Regulations;
6. the valuation report sent to contributors did not comply with the Third Schedule to the Contributory Mortgage Regulations. In particular it did not contain the information required by clauses 7, 9, 10(a) and 13 of the Third Schedule.
The Commission was satisfied that it is desirable in the public interest to make the orders because:
1. MFL's failure to ensure compliance with the Regulations, and its continuing failure to comply after becoming aware of breaches, indicated that contributors' funds were not properly managed and may be at risk if MFL continued to manage the 1 Parliament Street mortgage;
2. the directors of MFL have, in relation to this mortgage, failed to meet the standards of care and good governance expected of those who raise funds from the public.
Furthermore it is in the public interest that people who raise funds from the public comply with relevant laws and that those laws are enforced.

LIABILITY FOR BREACHING THE SECURITIES LAWS

The Securities Act contains various provisions imposing criminal or civil liability for breaches of the Act or regulations made under the Act. It follows from the Commission's findings about breaches of the securities laws that the liability provisions listed below might apply. Please note that this is a brief summary and not an analysis of the law. It is not for the Commission to determine liability under these provisions - that is the role of the Courts.
Under section 56, every director of the issuer and every promoter may be liable to compensate anyone who subscribes for securities on the faith of an advertisement which contains any untrue statement for any loss or damage sustained by reason of the untrue statement.
Under section 57A, the contributory mortgage broker and its directors may be liable to compensate anyone who subscribes for or holds an interest in a contributory mortgage, for any loss or damage sustained by reason of any breach of regulations relating to the offer, sale, or management of interests in the contributory mortgage.
The directors of the issuer may be fined or imprisoned if convicted under section 58 of distributing an advertisement containing an untrue statement.
Under section 59, the issuer, every principal officer of the issuer, and every promoter may be fined for offering or allotting an interest in a contributory mortgage in contravention of the regulations.
Under section 57, an expert may be liable to compensate anyone who subscribed for securities on the faith of an advertisement containing an untrue statement made by the expert, for any loss or damage sustained by reason of the untrue statement.
For the purposes of these provisions, an "untrue statement" includes a statement that is misleading:
1. in the form and context in which it is included;
2. by reason of the omission of a particular that is material to the statement in the form and context in which it is included.
For the purposes of the securities laws:
1. an "advertisement" includes offer documents for a contributory mortgage;
2. an "expert" includes a valuer;
3. the "issuer" of a contributory mortgage is defined in section 2 of the Act, as discussed further below; and
4. "promoter" is defined in section 2 of the Act, as discussed further below.
The liability provisions described above all apply to the issuer and/or its directors or principal officers (except section 57 which applies to experts). As well, a promoter might be civilly and criminally liable under sections 56 and 59 respectively. As part of its inquiry the Commission has considered which of the parties involved with the Parliament Street mortgage is an issuer, and whether any might be a promoter.

WHO IS AN ISSUER OF THE PARLIAMENT STREET MORTGAGE?

Section 2 of the Act provides as follows:
"Issuer" means -
...
1. In relation to an interest in a contributory mortgage offered by a contributory mortgage broker, or to an advertisement that relates to such an interest, the contributory mortgage broker.
"Contributory mortgage broker" means a person (not being a mortgagor under the mortgage or any other person to whom or for whose benefit any money is lent in consideration for the mortgage given by the mortgagor) who -
1. Offers an interest in a contributory mortgage to the public for subscription; or
2. Manages interests in a contributory mortgage, being interests that have been offered to the public for subscription, whether or not that person holds beneficially any interest in that mortgage.
The effect of these definitions is that the issuer of a contributory mortgage is the contributory mortgage broker, and the contributory mortgage broker is the person who either offers the contributory mortgage to the public, or manages the contributory mortgage once it has been offered to the public.

Was MFL a contributory mortgage broker / issuer under the Securities Act?

MFL falls within paragraph (a) of the definition of "contributory mortgage broker". The offer documents for the mortgage were in the name of MFL and on its letterhead. Contributions were ultimately deposited in its trust account pending distribution.
MFL also falls within paragraph (b) of the definition. MFL undertook the management of the Parliament Street mortgage - it was responsible for dealing with contributors' funds once MM deposited them in its trust account, it kept the accounting records, and it paid contributions out of the trust account to the borrower (albeit in contravention of the regulations).
For these reasons, in the Commission's view, MFL was a contributory mortgage broker and therefore an issuer of the Parliament Street mortgage.

Was MM a contributory mortgage broker / issuer under the Securities Act?

MM was the only party to deal directly with contributors and potential contributors about their decision to invest in the Parliament Street mortgage. By agreement with MFL, MM had sole rights to market the mortgage. Contributors were unable to invest in the mortgage other than by dealing with MM. Advertisements for the offer (other than the offer documents themselves) were heavily branded with the MM name and logo. Some of the print advertisements stated that the mortgage was "issued in association with The Mortgage Financier Limited", while radio advertising did not refer to MFL at all. MFL handled the paperwork and administration only after an investment decision was made.
The Commission considers that much of the advertising material for the Parliament Street mortgage was likely to give contributors the impression that MM was offering and issuing the mortgage investment, whether or not "in association with" another party. This raises the question of whether MM falls within paragraph (a) of the definition of "contributory mortgage broker" by offering interests in the Parliament Street mortgage to the public for subscription.
Section 2 of the Securities Act sets out an inclusive definition of the term "offer" as follows:
"Offer" includes an invitation, and any proposal or invitation to make an offer; and "to offer" has a corresponding meaning.
MM, together with SRL and Somers-Edgar, have made submissions to the Commission that none of those three parties fall within paragraph (a) of the definition of contributory mortgage broker for three reasons:
The Commission does not consider it necessary to comment on the parties' interpretation of the authorities referred to in their first submission set out above. On the evidence, the Commission does not accept that MM had no part in "creating" the security. The role of MM in formulating the Parliament Street mortgage is discussed in the next section of the report.
With regard to the second submission above, the Commission agrees that it is arguable that the scheme of the legislation anticipates only one broker per mortgage, insofar as it generally refers to "the broker" rather than "a broker". However, "contributory mortgage broker" is defined in section 2 of the Securities Act as a person who offers a contributory mortgage or who manages it, which appears to contemplate the involvement of more than one person.
The Commission is not sure what "impractical consequences" are referred to in the third submission above. If MM performed the role of a contributory mortgage broker in this case, then we see no public policy reasons why it should not be held liable as a contributory mortgage broker and, by definition, an issuer.
The Commission considers that the extent and nature of MM's involvement in the marketing of the Parliament Street mortgage, particularly its exclusive rights to deal with potential contributors and the heavy use of its own brand in the advertising material, indicates that MM "offered" the mortgage for the purposes of paragraph (a) of the definition of contributory mortgage broker.
This means that in the Commission's view both MM and MFL were contributory mortgage brokers, and therefore issuers, of the Parliament Street mortgage.
We note that the Contributory Mortgage Regulations prohibit a person acting as a contributory mortgage broker unless it has registered as a broker with the Registrar of Companies and completed certain other prescribed formalities. MM is not a registered contributory mortgage broker.

WHO IS A PROMOTER OF THE OFFER?

The term "promoter" is defined in section 2 of the Securities Act as follows:
"Promoter", in relation to securities offered to the public for subscription, -
1. Means a person who is instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public; and
2. Where a body corporate is a promoter, includes every person who is a director thereof; but
3. Does not include a director or officer of the issuer of the securities or a person acting solely in his or her professional capacity.
There is no question in this case that securities (i.e. interests in the Parliament Street contributory mortgage) were offered to the public for subscription. In determining whether any party was a promoter of the securities, the key issue is whether any person was instrumental in the formulation of the plan or programme pursuant to which the securities were offered.
MM, SRL and Somers-Edgar have made joint submissions that none of them is a promoter of the Parliament Street contributory mortgage. They propose a test for determining whether or not a person is a promoter under the securities laws, as follows:
"In the securities legislation, we submit that the test is whether a person (of whom the enquiry is made) has the power to mandate or control in a definitive way the formulation of the proposal. Put another way, does this person have the power to veto terms of the proposal.
This is a very stringent and narrow test. It requires a direct involvement in the proposal and, it is submitted that merely taking an interest in the formulation of a proposal is not sufficient for that person to be regarded as a promoter.
Nor is it sufficient for a person to have the ability to exert control indirectly e.g. a competitor, another broker or even as [sic] associate of an investor. If it were, the meaning of instrumental would be expanded to an unreasonable degree.
On a proper application of the statutory test it is clear that DSE/MM/SRL are not promoters, as the facts establish, they simply did not have the ability to control directly or indirectly, the proposal or the way it was formulated and offered to the public.
It is important to apply the statutory test rigorously and faithfully as the Act has already extended the definition of promoter. Any further extension of the definition is not contemplated by the Act and would be inappropriate and invalid."
The Commission does not consider that the narrow test proposed in the submissions is supported by the wording of the statutory definition, nor by the authorities.
Statutory interpretation involves ascertaining the meaning of the text in light of the purpose of the statute (Interpretation Act 1999, section 5). In the Securities Act, the concept of "promoter" is used to attribute certain statutory responsibilities to those whom the law assumes should, because of the nature and extent of their involvement, accept certain responsibilities in respect of the issue of securities to the public.
It is well settled that it is a question of fact in any particular case as to whether or not a person is a promoter (see for example Morison's Company & Securities Law, Chapter 6.2). We are not aware of any authority for the proposition that a promoter must have the power to control or veto the terms of the offer. In company law, where the concept of promoter originates, a wide variety of activity has been held by the courts to constitute promotion. For example, in Jubilee Cotton Mills v Lewis [1924] AC 958, a person who agreed to provide cash to assist in forming a new company, but otherwise left the organisational details to others, was held, on the facts, to be a promoter of the company. Also, one might consider that, if a power of control or veto was contemplated by the legislature, the definition of "promoter" might include a term such as "controls" rather than "is instrumental".
MM has submitted that its involvement was only "a sort of quality control - to allow the marketer [i.e. MM] to be confident its customers would accept the product on offer. This is different altogether from the marketer (or its agent) being able to control or veto specific terms contained in the proposal. If the marketer doesn't like the final form of the proposal its only remedy is to refuse the offer from the CMB [contributory mortgage broker] to market the offer. It does not have any other remedy."
SRL has submitted that its involvement in the Parliament Street mortgage was primarily because of its overall exposure to Clode (SRL has made other loans to Clode), and secondarily because it was itself investing in the Parliament Street mortgage. It has submitted that:
"SRL undoubtedly had more information about Clode than other investors. However, this was simply because of SRL's existing relationship with Clode.
Furthermore even if MFL and/or Clode did accept suggestions made by SRL, it does not automatically follow that SRL therefore became instrumental in the formulation of the proposal. As explained above, MFL is not bound by suggestions made by SRL and SRL cannot insist that its suggestions will be followed. If they are, well and good and everyone will benefit. If they are not, then SRL is left to reassess its position accordingly."
The Commission has formed the opinion that, on all the evidence, both MM and SRL were instrumental in the formulation of the contributory mortgage scheme pursuant to which interests in the Parliament Street contributory mortgage were offered to the public. In forming that opinion, the Commission has taken particular account of the following matters:
1. SRL initiated the idea of a contributory mortgage scheme, after being approached by Clode seeking a loan that was beyond SRL's prudential limits;
2. SRL actively sought out a registered contributory mortgage broker to "administer" the scheme. The evidence shows that two registered brokers were approached. The plan was formulated in its early stages without the involvement of any specific registered broker;
3. SRL remained closely involved with many aspects of the scheme throughout its formulation and the ensuing offer process. It corresponded with the borrower about its development plans, about the need to provide a valuation report, and about progress of the fundraising. It was involved in settling the terms of the loan offer. MFL treated SRL as having the power to decide on critical terms of the loan, particularly the Clode Consulting Limited guarantee. The MGC valuation review and the quantity surveyor's reports were sent to SRL. It attended, and initiated, meetings with the borrower and MFL, both before and after the public offer commenced;
4. as well as acting in its own right in relation to the scheme, SRL says that it also acted as MM's agent. By virtue of this agency relationship, as well as the other matters referred to below, MM was involved in the formulation of the scheme;
5. MM had exclusive rights to market the offer. This was an integral feature of the scheme. Contributors could not invest in the mortgage other than through MM. The Commission is satisfied that MFL's appointment as broker was effectively conditional upon MM having those exclusive rights;
6. when less than half of the funds had been raised a few days before the offer was due to close, it was MM that decided to extend the offer rather than withdraw it and return contributions already received;
7. MM provided a promissory note which, the parties believed, had the effect of allowing the project to commence. MM internal correspondence indicates that it also had the effect of allowing the fundraising to continue.
The Commission considers that, on all the evidence, SRL and MM were not only instrumental in, but integral to, the formulation of the plan. The Commission considers that the nature and extent of the involvement of SRL and MM was such that it is unlikely that the particular scheme would have proceeded if either of them had withdrawn their support.
As stated above, the Commission rejects the "power of control or veto" test proposed by SRL and MM. However, if that test did apply, the Commission would consider that it would be satisfied in this case, in that the evidence indicates that both SRL and MM did have the power to control and to veto the scheme.
The definition of "promoter" excludes a person acting solely in their professional capacity. This exclusion would apply, for example, to a lawyer who advised on legal structuring and compliance, or an accountant who prepared any financial statements. It is likely also to apply to an introducing broker and to an investment adviser or broker who agreed to market the securities to its clients.
However, in this case the Commission has formed the view that the extent and nature of the involvement of MM and SRL in the formulation of the plan including the offering process, meant that they were not acting solely in their professional capacity in relation to the Parliament Street mortgage.
For these reasons, the Commission has formed the opinion that SRL and MM were promoters of the Parliament Street contributory mortgage. By definition, the directors of SRL were also promoters of the offer. If the Commission's conclusion that MM was an issuer are correct, the directors of MM were not promoters because the definition of "promoter" in section 2 of the Securities Act excludes the directors of the issuer.

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