Home Capital Group says it will vigorously defend itself against allegations by the Ontario Securities Commission that are, it says, "without merit." This is a standard response, particularly for a company that may not have quite figured out how much trouble it's in and what the best course of action is.
I have a suggestion for the company and its leadership: Defend yourself with a little less vigour, because a read of the OSC's narrative suggests there may be merit in this case. Then find a way to thank director Gerald Soloway and chief financial officer Robert Morton — two of the three defendants in the OSC matter – for their years of service and show them where the door is. Companies can't be fully contrite for their alleged misdeeds when the accused are still running the show.
Now, to be clear, the OSC's allegations have not been tested in court. But it seems there are two main lines of defence for Home Capital here: Either the commission is making up facts out of whole cloth, or the company disputes that the facts it failed to disclose were of importance to the average investor. I am wholly unpersuaded by either potential argument.
In short, here is what the OSC says: In June, 2014, Home Capital, one of Canada's biggest alternative mortgage lenders, became aware of irregularities in the applications it was receiving. Some brokers were putting through mortgages in which the documents verifying the borrower's employment income were bogus.
In August of that year, it launched an internal investigation that lasted several months. The probe revealed some ugly stuff, and from about November, 2014, to January, 2015, Home Capital terminated brokers and brokerages with which it had done a lot of business – $881.4-million worth of mortgage originations in 2014, about 10 per cent of the company's total. The investigation concluded the company needed to make major changes in its internal controls to prevent a similar problem from occurring in the future.
According to the OSC, all this was known to the company by Feb. 10, 2015 – the day before it filed its 2014 annual financial statements. But in the management discussion and analysis that accompanied them, Home Capital blamed its decline in mortgage originations not on the fact that it ditched those brokers, but on things like macroeconomics, seasonality and competition. The first-quarter report, filed May 6, was no better, with weather taking a share of the blame as well.
Instead, the company sat on the facts for months. It took until July 10 for Home Capital to breathe a word to its investors of the investigation and the broker firings.
The essence of the OSC's case is that that was way too late.
"These facts known to HCG would have been considered important by a reasonable investor in making a decision to buy, sell or hold HCG securities," the OSC writes in its complaint. As such, company statements about the cause for the decline in originations were "misleading or untrue or did not state a fact required to be stated or that was necessary to make the statement not misleading."
Will Home Capital and the former and current executives named – which include ex-CEO Martin Reid, excused from further work by the company last month – claim that these facts should not have been considered important by investors? Will they be able to avoid mentioning the 18.9-per-cent drop in the stock price on July 11, after the announcement of the broker problems? The 20.6-per-cent drop Thursday, after the OSC's allegations were revealed?
If OSC investigators got their facts right, the continued presence of Mr. Morton in the CFO's role is particularly egregious. Here is the man who is directly responsible for Home Capital's financial disclosure to investors.
And what was he doing two days before the firm filed its year-end financials for 2014? According to the OSC statement, he was boasting in an e-mail about how cleverly the company had buried even the vaguest mention of the broker-fraud investigation. It was, he said, "pretty deep within existing wording on cyber risk. I would be impressed if someone even asked about it."
He's still at the financial controls of Home Capital. Really?
I look forward to the forthcoming formal response from the company and the former executives, should there be no settlement. On Wednesday, Home Capital said in a statement that it "has always carefully considered its disclosure obligations" and it "believes that its disclosure satisfied applicable disclosure requirements."
For the sake of investors in all Canadian stocks, we shouldn't want to invest in a market where Home Capital's disclosure is deemed satisfactory.
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David Milstead