The timing was curious, or perhaps poor, depending on whom you talk to, when the Ontario Securities Commission filed allegations against Home Capital Group and some of its current and former executives just a day after federal, provincial and city officials publicly remarked on the irrational exuberance of buyers in the Toronto housing market.
Was the OSC talking to or even aware of these pronouncements as it prepared to reveal its case against Home Capital? Did it not think the enforcement action against one of Canada's main non-bank mortgage providers could prompt a crisis that, as one of our writers suggested, could be "the pin that pops a housing bubble?"
Certainly, I'm hearing from those who believe the alleged misdeeds at Home Capital are tiny compared with the fallout that's occurring – an apparent run on the company's deposits that has brought into question its prospects for survival. It has hired two investment banks to help with a strategic review that could lead to a sale or breakup of the firm.
Read more: The rise and fall of Home Capital
"If this all leads to a pricing burst and large financial losses to banks and taxpayers, how culpable are our political leaders?" one reader wrote. "Home Capital is a minnow, but confidence is a funny thing that easily transfers across institutions."
Another reader who works in the financial sector said that, "while management was very sloppy in its disclosure, this was not a question of fraud or other serious breach of fiduciary duty to the shareholders." The reader added: "The OSC actions, combined with the press reports, caused a run on Home Capital which destroyed the company and cost shareholders hundreds of millions of dollars of losses. My guess is that the OSC had no idea that their actions would have this result."
Certainly, the Canadian financial industry's quick loss of confidence in Home Capital – as seen by various banks' and brokerages' limits or prohibitions at sending client deposits to it – was startling in its speed. And once the markets realized Home Capital's reputational problems were real, the investor-confidence problems manifested themselves even more rapidly.
But, even if the OSC foresaw that its actions could result in a run on the bank, the regulators were right to pursue Home Capital. Because the flip side of the above arguments is this: If the leaders of banks or other major financial-market participants believe that securities regulators will look past violations of the law in order to maintain stability in the markets, they'll continue to try to get away with poor disclosure and other similar wrongdoing against their shareholders. In truth, to have true confidence in the markets, we need to see companies and their executives punished if they run afoul of the law – even if it means we suffer through episodes like this one.
It bears repeating that the OSC's allegations have not been tested in court, the company says the case is "without merit" and it believes it "satisfied applicable disclosure requirements."
And now I will review the timeline again, as outlined in the OSC complaint.
In June, 2014, Home Capital became aware some of its brokers were submitting documents with phony details about the applicant's income. In August, it launched an internal investigation. From about November, 2014, to January, 2015, it terminated brokers and brokerages that had generated $881.4-million in mortgage originations in 2014, about 10 per cent of the company's total.
All this was known to the company by Feb. 10, 2015 – the day before it filed its 2014 annual financial statements, the OSC believes. But in the management discussion and analysis that accompanied them, Home Capital blamed its decline in mortgage originations on things such as macroeconomics, seasonality and competition, not on problems with bad brokers. The first-quarter report, filed on May 6, was no better, with weather taking a share of the blame as well.
Instead, it took until July 10, 2015, for Home Capital to tell its investors of the investigation and the broker firings. But, it should be noted, it initially failed to give the timeline I just provided or the amount of mortgages initiated by the brokers. The company filed a material change report with the OSC about the situation on July 17, 2015 that said this was a "full description" of the matter and that "no significant facts remain confidential in, and no information has been omitted from, this report."
And then 19 days after the first news release, on July 29, 2015, it amended that report, adding quite a few significant facts. The firm noted that "the Ontario Securities Commission has requested that Home Capital provide further disclosure" on the matter, in particular "disclosure of the nature of issues identified with certain mortgage brokers, the remedial actions taken by the Company and the financial and operational impacts of these actions."
This was absolutely clear evidence the OSC was unhappy with Home Capital's disclosure, for investors who were watching. (This includes short-seller Marc Cohodes, now taking a well-deserved victory lap for being the strongest anti-Home Capital voice during this time.) The only question remaining was whether the regulators cared enough to kick it up a notch.
And in February of this year, Home Capital disclosed the OSC had indeed served notice it intended to take an enforcement action, and the firm had an opportunity to offer its defence. The Globe and Mail has reported Home Capital's settlement offer was based on only former CEO Gerald Soloway taking responsibility; the OSC believed other executives – former president Martin Reid and chief financial officer Robert Morton, who are named in the action – needed to be called to account.
Perhaps you can say this all took too long. Perhaps the OSC ought to have swooped in and whacked Home Capital by Christmas of 2015, because the inadequacy of its disclosure was clear well before the snow first fell that year. But these things take time, even if home prices continued to inflate as the OSC prepared its case.
Ultimately, securities regulators need to bring their cases when ready, not timed to the latest report on Toronto home sales, or to the legitimate questions of how much longer the game of musical chairs in the Canadian housing market will continue.
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