The Canadian Securities Administrators (the "CSA") have unveiled new rules addressing syndicated mortgages with the dual objectives of establishing a more consistent framework across the country and enhancing investor protecting through greater transparency. The new rules are outlined in amendments to National Instrument 45 -106 - Prospectus Exemptions and National Instrument 31 - 103 - Registration Requirements, Exemptions and Ongoing Registrant Obligations (collectively, the "Proposed Amendments").
A syndicated mortgage is a mortgage in which two or more private persons participate, directly or indirectly, as lenders in a debt obligation that is secured by a mortgage registered against title to real property. The mortgage typically funds the initial stages of a development project - consulting fees, zoning permits, architecture costs, marketing and sales expenses - rather than the actual construction of the project, which is what makes it a risky investment. Ordinary retail investors often lack the requisite level of sophistication to appreciate the risk of the investment and are subject to being misled about where their money is being allocated, who has priority on returns and what recourse they have if their investment goes belly up.
As the CSA became aware of an uptick in the syndicated mortgage market, it introduced the Proposed Amendments, which would:
- remove the prospectus and registration exemptions for the distribution of syndicated mortgages in the CSA jurisdictions where the exemptions are available;
- introduce additional requirements to the offering memorandum exemption that apply when the exemption is used to distribute syndicated mortgages; and
- amend the Private Issuer prospectus exemption so that it is not available for the distribution of syndicated mortgages.
Removal of Prospectus and Registration Exemptions
Currently, CSA jurisdictions have prospectus and registration exemptions for securities that are mortgages if they are sold by a mortgage broker licensed in the Canadian jurisdiction where the property is located. As these exemptions do not exist in Alberta, British Columbia, Manitoba, New Brunswick, Quebec and Saskatchewan, the CSA is proposing to apply this approach across the country. If the Proposed Amendments pass, it is expected that syndicated mortgages will be offered under the Accredited Investor Exemption, the Offering Memorandum Exemption or the Family, Friends and Business Associates Exemption. Sellers of syndicated mortgages would also need to be registered as licensed dealers or rely upon an exemption.
Changes to the Offering Memorandum Exemption
As it is expected that the Offering Memorandum Exemption will be one of the primary exemptions relied upon for the distribution of syndicated mortgages, the Proposed Amendments require issuers to deliver to prospective investors an independent third-party appraisal of the current fair market value of the property. Under the current regime, this is not required, which has allowed issuers of syndicated mortgages to inflate the value of a property by using an appraisal prepared by a related entity. In addition to the independent appraisal requirement, any other valuation of the property disclosed by the issuer would be required to have a reasonable basis and the issuer would be required to disclose the material factors and assumptions underlying that value and whether it was prepared by a qualified appraiser who is independent of the issuer.
The Proposed Amendments also require the disclosure of development risks, prior obligations secured against the property, the price paid by the developer to acquire the property, and information regarding the business and financial position of the borrower (who is typically the issuer) under the syndicated mortgage.
Mortgage brokers involved in the distribution of a syndicated mortgage under the offering memorandum exemption would also be required to provide a certificate that the offering memorandum does not contain a misrepresentation with respect to matters within its knowledge and that the mortgage broker has made best efforts to ensure that matters that are not within its knowledge do not contain a misrepresentation.
Changes to Private Issuer Exemption
The Proposed Amendments eliminate the Private Issuer Exemption as a viable prospectus exemption for the distribution of syndicated mortgages, as the exemption does not mandate the filing of reports of exempt distribution following the closing of an offering. Reports of exempt distribution are viewed by the CSA as a key mechanism to monitor developments related to syndicated mortgage distributions.
Expected Impact of the Proposed Amendments
The requirements of providing more robust disclosure, obtaining an independent property appraisal and filing reports of exempt distribution will likely increase distribution costs for issuers. Additionally, registering as an exempt market dealer will be more costly for dealers of syndicated mortgages. However, in the CSA's view, the expected benefits of enhanced disclosure, informed investment decisions and a harmonized regime across the country will outweigh the resulting marginal costs.
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