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Home Capital shares plunge after OSC accuses executives of making misleading statements

Home Capital Group Inc. and three of its current or former executives are being accused of making false and misleading statements to the public about the reasons the alternative mortgage lender had begun to extend fewer loans. The stock plunged Thursday in reaction to the news, falling more than 18 per cent.

The Ontario Securities Commission is alleging disclosures Home Capital made in 2015 breached Ontario securities laws, have caused "significant investor harm" and eventually led to a nearly 19-per-cent drop in Home Capital's stock price once the information was released in July, 2015, wiping roughly $600-million in the company's market value the following day.

The company is one of Canada's largest alternative mortgage lenders through its subsidiary, Home Trust.

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Related: Home Capital terminates chief executive Martin Reid

The allegations come at a time when the booming housing market, and the role of lenders such as Home Capital in fuelling it, are coming under heavy scrutiny from policy makers. The federal government moved again last fall to tighten the rules for mortgages in a bid to cool rising house prices and debt levels. Meanwhile, the Ontario government unveiled new measures Thursday to reduce speculation in real estate.

In a statement late Wednesday, Home Capital said that it has carefully considered its disclosure obligations.

"The company believes that its disclosure satisfied applicable disclosure requirements, and the allegations are without merit," Home Capital said in a news release. "The allegations will be vigorously defended."

The OSC's allegations have not yet been proven. The executives, who are all named by the commission, couldn't be reached immediately for comment on Wednesday night.

In an 11-page statement of allegations, the commission said on Wednesday that former Home Capital chief executive Gerald Soloway, as well as its then-president Martin Reid, did not properly disclose material information they had learned after a six-month internal investigation, dubbed "Project Trillium," which found that certain mortgage brokers in its network were submitting fraudulent employment-income documentation.

The commission alleged that the executives began to make changes within the company, including firing some brokers in its network and revising its underwriting process that had a "significant detrimental effect" on mortgage originations.

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But it didn't disclose this information to investors until July, by publishing a news release announcing it had terminated 45 brokers, even though it knew these facts as early as Feb. 10, when it discovered fraud in its broker channel, the OSC said. In the interim period, the company filed its 2014 annual report and its first-quarter 2015 report, as well as held an earnings conference call in May.

In June, 2014, the commission says Home Capital became aware of "irregularities" associated with certain loan applications handled by "one or more of its underwriters." In August, the company began to investigate the scope and cause of the problem in a probe that lasted six months.

It discovered that one of its underwriting teams, including one of its best-producing underwriters by volume, was falsely documenting that they had completed income-verification steps when they had not actually done so. It turned out that information about these prospective borrowers' income and employment had been falsified.

By Feb. 10, Home Capital had terminated four underwriters, two brokerages and 30 brokers, and added a number of other brokers to management's watch list, the commission alleges.

The commission added that the terminated brokers referred a total of $881.4-million worth of loans for the company in 2014, or roughly 10 per cent of its originations that year. It also caused Home Capital's processing time for mortgage applications to increase significantly, resulting in brokers sending applications to other lenders.

But when the executives were asked about the drop in new loans in a conference call, the executives attributed the decline to cold winter weather, economic conditions and a careful approach to new loans, among other things.

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Also named by the commission is the company's chief financial officer, Robert Morton, who the commission alleges falsely certified the 2014 annual filing and first-quarter reporting by leaving out key details as to why mortgage originations fell.

"The 2014 annual filing did not disclose the broker terminations, the significant remediation or the effect of these changes on originations," OSC staff alleged. "These material facts, individually or collectively, would have been considered important by a reasonable investor in making a decision to buy, sell or hold HCG's securities."

On Feb. 9, 2015, two days before the company filed its 2014 annual report, Mr. Morton said in an e-mail that additional disclosure related to Project Trillium was "buried pretty deep within existing wording on cyberrisk. I would be impressed if someone even asked about it."

In May, 2016, Mr. Soloway retired after nearly 30 years in charge and handed the reins to Mr. Reid.

Last month, Mr. Reid was terminated from his role as CEO, making way for director Bonita Then to take over on an interim basis. At the time, equity analysts wondered why neither Mr. Soloway nor Robert Blowes, who served as CFO until 2014, were named interim CEO. Both former executives are still directors of the company.

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About the Author
Capital Markets Reporter

Christina Pellegrini is a reporter at The Globe and Mail and a regular contributor to Streetwise, covering capital markets, the exchange business and market structure.She writes about the capital markets divisions of BMO, CIBC and National Bank; independent brokerages such as Canaccord Genuity; and the Canadian operations of foreign dealers including JP Morgan, Goldman Sachs, Credit Suisse and Citigroup. More

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