PELLETIER ON GOOD, BAD & FRAUDULENT.
One of the biggest risks investors can face is investment fraud and it isn’t a coincidence that it often happens in those areas of the market that are unregulated or too large for regulators to keep a close eye on. Recently, we’re starting to see more and more of these kinds of issues in the real estate market and in particular, private syndicated mortgages.
Unfortunately, a lot of these don’t get flushed out until it’s too late for many investors, with the catalyst being a change in market dynamics such as rising interest rates and/or falling real estate prices — both of which are now beginning to happen.
This certainly doesn’t mean that one should avoid making private investments such as real estate — when done in moderation, they can be a good way to diversify an investment portfolio. However, a bit of due diligence can quickly separate the good from the bad and certainly the potentially fraudulent.
For those considering investing in such markets, or who already have, here is an easy checklist to run through.
Do they promise high returns with little risk?
This is where common sense plays a huge role. Think about it logically: Why would someone with a low loan-to-value ratio mortgage (i.e., a less risky mortgage) pay a large spread to what they could get at a Canadian bank? Risk goes hand in hand with return, so an investment with a high single-digit yield has a much higher risk associated with it than one with a low single-digit yield. It’s that simple.
Are aggressive, high-pressure sales tactics involved?
There is a great saying in our business: “Often, the best trade is the one you don’t do.” So if there is a high-pressure sales tactic not allowing you enough time to complete a proper due diligence, then don’t be afraid to pass on the deal. Trust me, you won’t be missing out as there are plenty of other opportunities out there.
Is the entity offering the security registered?
Provincial Securities regulators have this great search function called “Check First” allowing you to type the name of the person and corporation to see if they are registered. If the group selling the investment product and the product managers themselves are not registered at least as an Exempt Market Dealer, then take a pass.
Those registered will have to provide an Offering Memorandum (OM) which is a legal document outlining all of the terms of the investment. This is a very important document, so be sure to take the time to read through it and check to see if it matches what is being promised either verbally or in any of marketing materials that were provided.
Who are the administrator and auditor?
The OM will also list the fund administrator and auditor. Both roles are important, with the administrator providing an ongoing independent valuation of the funds’ assets while the accounting firm will be auditing the fund’s financial statements.
Who has custody over the investor’s capital?
It is imperative that the investor’s capital is not held in the same account as that of the fund company, a situation known as “self-custodied.” Having an independent firm provide custody of the investor’s capital is an essential layer of protection against misappropriation of funds.
Additionally, in the niceto-have category, investors should look at how much capital the fund managers are contributing out of their own pockets, as well as their backgrounds and track record.
Understanding some of the specific investments that are going to be made is a good idea too.
Also ask for a disclosure of the total fees being paid to the fund company and those selling the fund and take notice if it is anywhere near the annual return or yield being touted.
Take an immediate pass if it isn’t provided or doesn’t match what is being outlined in the Offering Memorandum.
Finally, if you are still unsure, bring it to your adviser for an independent review.