Ontario has seen a lot of mortgage regulation changes in recent years. In 2018, the Canadian Securities Administrators (CSA) released a series of proposed changes that would see the OSC assume responsibility for the oversight of mortgage syndication in the Province of Ontario. Mortgage syndicators are waiting with bated breath to see what finally comes from the recent interventions of two competing regulatory bodies into their market. We’ll walk you through the latest developments.

Key Points

• Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.
• The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

Who are the mortgage syndicators and what do they do?

Mortgage syndicators are syndicated mortgage brokers who are regulated by FSCO. In Ontario, only syndicated mortgage brokers (and their agents) are allowed to deal in or advise upon mortgages. Given the proximity to the market, syndicated mortgage brokers are the natural syndicators. The job of the mortgage syndicator is to initiate, promote and organise the syndicate.

A syndicate, by definition, is a self-organised group of people. A syndicated mortgage is a mortgage where there are two or more persons acting as lenders. The lenders have a direct beneficial interest in the underlying mortgage.

It’s attractive to be part of a syndicate as the investor (who now becomes a lender) is sharing the risk of being repaid by the borrower with other investors/lenders of like mind.

What are the new mortgage syndication rules?

Previously, the regulatory environment was relatively light. Now, the first major proposed change is that mortgage syndications are no longer exempt from the Securities Act (Ontario). The mortgage syndicator will now only be able to choose between distributing the syndicated product in the (i) public markets pursuant to a prospectus filed and reviewed by the regulatory authorities (highly unlikely given costs) or (ii) private markets under the rules governing private placements.

Mortgage syndicators will likely do the latter, yet it won’t be without its challenges. It is expected that the OSC will impose a registration requirement that will require mortgage brokers to successfully complete some series of courses that will eventually evidence their competence to solicit and sell in the exempt market.

Why did the mortgage syndication rules change?

First, it was to harmonize the rules of mortgage syndication across the country. In Ontario mortgages are currently exempt from securities law and the oversight of the OSC. Once the changes are adopted, there will no longer be exemptions from securities law anywhere across Canada and the placement of mortgage security would have to comply with the rules governing the private and public investment markets.

Second, at the time the amendments were announced, the mortgage syndication market was in turmoil, leaving many inexperienced investors exposed to questionable deal offerings made into the market by overly aggressive promoters.

The new rules are thought not to come into force until late in the Spring of 2019, if not early summer. It is further anticipated that the mortgage brokerage community will be given an extra year to comply.

CSA changes vs FSCO changes

Within a month of the CSA announcing its changes, FSCO released its intent to overhaul the rules governing mortgage syndication. Rather haphazardly, FSCO unleashed a web of policies and procedures. Where the OSC thinks it may take a year or two to bring the mortgage brokerage community into line, FSCO thought a few months adequate.

Instead of adopting the seasoned approach of the CSA, FSCO created a one-size-fits-all solution from which no market participant is exempt. The ensuing confusion and the abrupt cessation of market activity was not surprising. The new rules were described at the time of their introduction as transitional, yet as at the date mentioned above, no one knows how long transition is going to be or to what degree the regulators are cooperating.

The new mortgage syndication rules became effective July 1, 2018 — the same day many syndicators governed by FSCO gave up business.

Mortgage syndicators have a choice: embrace the changes imposed by FSCO now, or wait and see what the OSC will require?

Mortgage syndicators are stuck between a rock and a hard place. Embracing the FSCO regulatory regime today will involve significant cost and client interruption. (Further, there’s no guarantee that once the OSC publishes its rules, the syndicator will not have to go back and revisit all of the work they just put in place.) However, if the syndicator chooses to wait it out, he or she will likely lose business. What’s the answer?

What should mortgage syndicators do now?

There’s a way to circumvent FSCO’S transitional rules: Retain a private market intermediary to carry out mortgage participation transactions that comply with the Securities Act (Ontario) instead of the Mortgages, Brokerages, Lenders and Administrators Act (Ontario).

In Ontario, private market intermediaries are referred to as exempt market dealers (EMDs). EMDs are fully registered securities dealers who engage in the business of trading in prospectus exempt securities (which soon will include syndicated mortgages), or any securities to qualified exempt market clients.

Whereas a syndicate is a self-organized group, an EMD will represent a group organized by a third party. In the area of mortgages, it is common to organize groups under mortgage investment corporations (MICs), mortgage trusts (Trusts), or limited partnerships (LPs) whose sole business is investing in mortgages. In any of these examples, the EMD is not selling syndicated interests of mortgages, but rather shares in a MIC, units in a trust or limited partnership interests in a limited partnership.

The mortgage syndicator can continue advising on mortgages, but the EMD is responsible for qualifying the investors and providing the independent investment advice that marks best practice for the OSC.

How Fundscraper can help

Fundscraper is registered with FSCO as a mortgage brokerage and with the OSC as an EMD in the Province of Ontario as well as British Columbia, Alberta, Quebec and Prince Edward Island. We have spent the last two and a half years perfecting our online compliance procedures with the full expectation of the changes happening today in the mortgage syndication market. We discovered that by creating an interactive online environment we can greatly reduce the costs of compliance while delivering best-in-practice solutions. Once we qualify investors, we apply computer-generated algorithms to their investment decisions to assess suitability of investment and flag common investment risks. A qualified investor can begin our process and complete a subscription within twenty minutes from the comfort of their own home.

At Fundscraper, we also enhance distribution by making available, if a client so chooses, a product offering to a much larger educated audience than the client would have access to alone. Fundscraper is able to show syndicators how they can continue profitably in business and give them the comfort that between them and the regulator stands a seasoned platform that will shield them and provide protection for their investors. Having Fundscraper as a trusted partner puts the mortgage syndicator back in business.

Asset managers of private mortgage investment entities often pose the following question: “Do I need to be registered with the securities regulatory authorities to openly discuss my product offering?” It depends: Are you advertising, or are you advising? An issuer can certainly tell the world what it has to offer; advertising by itself is okay. But it’s important to exercise caution.

Key Points

• The regulator’s primary concern is advertising or promotion that is (i) unbalanced and misleading, (ii) selective and/or (iii) misuses of future oriented information. Any advertising that misrepresents and manipulates information
• An “adviser” is defined by the Securities Act (Ontario) to mean a person or company engaging in or holding himself, herself or itself out as engaging in the business of advising others as to the investing in or the buying or selling of securities.
• The issuer who elects to be a dealer, either through registration or by way of an ICDR, increases its regulatory liability. Retaining an independent securities dealer will always be the better practice and, in many instances, likely cheaper.

Advertising and advising are not the same thing.

Why are regulators concerned about advertising?

The regulator’s primary concern is advertising or promotion that is (i) unbalanced and misleading, (ii) selective and/or (iii) misuses of future oriented information. Any advertising that misrepresents and manipulates information — such as exaggerated and unsubstantiated performance claims or unrealistic hypothetical performance scenarios — raises red flags.

Regulators are also concerned if the issuer is acting in the capacity of an “advisor” to persons to whom they are advertising their wares. Depending on what exemptions are relied upon, only certain people can participate in certain transactions. For this reason, private issuers have to be very careful to whom they sell their security. Complicating the matter more, simply because someone is able to purchase the exempt security, does not mean it is suitable for that person. Thus, advisors must first determine if a proposed purchaser is qualified, then whether the investment is suitable for them.

What is advising?

An “adviser” is defined by the Securities Act (Ontario) to mean a person or company engaging in or holding himself, herself or itself out as engaging in the business of advising others as to the investing in or the buying or selling of securities.

Whether or not a firm or individual ought to register, the regulator will look for certain “triggers” for registration. The list is non-exhaustive, but includes the following:

1. The firm or individual holding itself out as being in the business of buying and selling or advising on the buy and sell of securities
2. The firm or individual acting as an intermediary – a broker – between the issuer and the buyer/seller
3. The firm or individual regularly trading or advising in any way that produces profits to be for a business purpose
4. The firm or individual receiving any form of compensation for carrying on the activity
5. The firm or individual contacting anyone to solicit securities transactions or to offer advice may reflect a business purpose

Anyone found to be in the business of advising must be registered with the regulatory authorities. In Ontario, that’s the Ontario Securities Commission.

What is solicitation?

The word “solicitation” is used in two ways. In the most general usage, “solicitation” means making potential purchasers aware of a given product. There is no law prohibiting an asset manager from boasting about their product (provided the boast is truthful) or contrasting their investment product to others in the marketplace (provided it’s not misleading).

Solicitation becomes a trigger when it evolves from product promotion to subscriber conversion. When the promoter engages a person with the goal of having that person subscribe for units, then the promoter is dealing in securities.

There is a clear distinction between advertising and advising or product promotion and subscriber conversion.

How can I ethically convert subscribers?

These considerations aren’t meant to deter you from converting subscribers! We want to make sure you understand how to go about it ethically. When it comes to subscriber conversion, asset managers have three options: (i) hire a registered dealer, (ii) apply to become a registered dealer themselves, and (iii) have a “connected” dealing representative (generally an employee of the asset manager who is qualified to be a dealing representative) sit on the desk of a securities dealer and process only those trades of the asset manager.

Hiring a registered dealer vs becoming a registered dealer

The purpose of hiring a registered dealer is to offload the regulatory burden (and the concurrent liability) that attaches to solicitation for trading. The scope of the retainer will be determined by the services required . Many managers simply require a dealer to process subscribers. The retainer may be broader, including soliciting new clients, providing services, and curing prior deficiencies.

The dealer has two jobs: confirm the proposed subscriber is actually qualified to participate in the exempt market and assess whether the investment is suitable for the proposed subscriber. It is with respect to suitability assessment that most issuers fail in the eyes of the regulator. As conflict is so apparent, the presumption is that it cannot be done in a properly disinterested fashion.

Issuers may also seek to become registered with the regulatory authority to advise on security. It requires a terrific amount of work, time, and money. There are a lot of hoops to jump through, and once everything is in hand and the requisite documents are filed, it may take anywhere from four to eight months to be issued a license.

Advertising crosses the line into advising when the focus shifts from general product promotion to individual subscriber conversion.

Working with a connected dealer representative

In the last couple of years, the regulatory authorities have begun to permit issuer-connected dealer representatives (ICDRs). An ICDR is a dealing representative who is connected with one issuer only and registered with a registrant. Generally, an ICDR is an employee of the issuer who has taken and passed the courses necessary to be a dealing representative.

At the end of day, the issuer ends up with the worst of both worlds: it is now paying a dealer a “desk fee” (in the place of commissions, etc.) and still risks the possibility of being shut down if their own ICDR makes a mistake.

The issuer who elects to be a dealer, either through registration or by way of an ICDR, increases its regulatory liability. Retaining an independent securities dealer will always be the better practice and, in many instances, likely cheaper.

It’s perfectly legal for a private issuer to advertise its wares. The ordinary rules governing advertising also apply in the securities industry: be truthful, do not mislead. There’s a fine line between product promotion and subscriber conversion, and there’s nothing wrong with seeking advice from the pros. An independent exempt market securities dealer like Fundscraper can help you develop and deploy effective marketing campaigns to attract qualified subscribers.