Scandal really with OSC, allegations

On April 19, OSC staff released a “statement of allegations” against the company and its three top executives. According to the OSC, Home Capital — including the highly respected Gerald Soloway — allegedly failed to adequately disclose certain “material” developments in its mortgage lending operations. They had also issued “materially misleading” information and “falsely certified” an annual report.

In the wake of the OSC allegations, Soloway and the other executives have resigned. The scandal, however, is not with Soloway or Home Capital. It’s with the OSC staff and their unprecedented and damaging allegations that are at best contentious and are irrelevant to Home’s corporate condition.

By also playing into the hands of some U.S. shortsellers, the OSC has turned a minor and legally debatable issue of corporate disclosure into the potentially catastrophic destruction of a 30-year Canadian corporate success.

Because Home Capital is dependent on depositors to provide funds for mortgage investments, the financial institution is dependent on market confidence. The OSC should have known — and maybe did know — what would happen next.

That confidence began to evaporate immediately after the OSC’s allegations were filed. Depositors started to flee, leaving Home in a battle to keep the company in cash. In the end, late last week, it was forced to line up $2-billion in emergency borrowings at killer interest rates of up to 22.5 per cent.

If the company does not survive, the OSC must carry the blame.

Most of the following information is from the OSC statement of April 19.

The allegations against Home date back to 2014 and early 2015 and have long since been resolved to the apparent satisfaction of shareholders and investors.

The central issue, now three years old, involved a small number of the 4,000 brokers who provided Home Capital with individual mortgage clients. In 2014, the company discovered that some of those brokers — about 45 were involved — had been providing “fraudulent employment income documentation” on some of the home buyers.

An internal investigation, overseen by James Baillie, a former OSC chair and Home board member, had been completed. As a result, Home terminated 4 underwriters, two brokerages and 30 brokers for exaggerating the income levels of borrowers.

Home acted promptly to change its internal verification systems to ensure the future accuracy of information supplied by brokers.

The OSC claims that the termination of the brokers should have been reported in public statements on the grounds that it was “material information” that could have an impact on new mortgage business and shareholder value.

Whether the broker issues amounted to a material change is open to legal debate, to say the least. The definition of material change in corporate affairs is roughly on a par with defining the public interest. It can become whatever one wants to make of it.

Home Capital, presumably advised by the top accounting and legal firms in the country, did not disclose the broker issue until July 2015. The OSC alleges, among other things, that the 2015 disclosures “were not sufficient for a reader to understand the actual nature of the material change, nor the significance of their impact on immediate and future quarters.”

All very interesting — in 2015. But this is 2017. Home Capital has publicly dealt with the broker issue on numerous occasions, apparently to the satisfaction of shareholders and investors.

The broker fraud scandal passed with little obvious impact on Home’s business. It’s financial statements say the mortgages held by the small number of borrowers whose brokers falsified income levels have been performing well.

In late 2016, two years after the broker events, Home reported that after a review of “all of the customer files and the income documentation” there “have been no unusual credit issues on these mortgages.” And since the mortgages covered by the broker issue were CMHC insured, the profit margins on the mortgages were low to start with, amounting to a fraction of Home’s income being put at risk.

So the alleged material mortgage change turned out to be not particularly material. Earlier this year, Home reported 2016 net income of $247-million on gross assets of $29-billion. It expected more growth.

Then along came the OSC to inject an unforeseen material change into the company’s affairs. For what are now clearly insignificant developments in the company’s affairs three years ago, the OSC has thrown the whole company and 30 years of success over a cliff.

In the history of Home Capital, the greatest failure to give notice of a material development detrimental to shareholders and investors is that perpetrated by the staff of the OSC.

Why? If it was trying to set a precedent or teach the market a lesson, it picked the wrong company. Did it really need to risk the destruction of a successful financial player to score a dubious regulatory point?