On August 9, 2017 a panel of the Ontario Securities Commission approved a settlement agreement [PDF] with Home Capital Group Inc. and three of its former executives. The settlement agreement requires the respondents to pay a total of $12.5 million. The settlement is in relation to Home Capital’s failure to adequately and promptly disclose information related to fraudulent activity it uncovered in its residential mortgage business subsequent to an internal investigation commenced August 2014 and completed February 2015. The approved settlement agreement calls for $11 million of the settlement funds to be used as part of a proposed $29.5 million settlement in a related class proceeding in Ontario.

As widely reported, the background and lead up to the settlement had been closely watched. It raised a number of interesting issues and questions about the challenges for market players who are subject to multiple regulators with potentially differing mandates and objectives, and the challenges those players face in addressing their obligations to their stakeholders.

Background

Home Capital is in the residential and commercial lending business. The residential lending business makes up roughly 90% of Home Capital’s business. Part of the residential lending business involves lower margin, prime mortgages (known as the “Accelerator” line of mortgage products), which are insured by Canada Mortgage and Housing Corporation (CMHC). Home Capital’s growth and performance is measured in part by originations (the number of mortgage loans generated), including those related to its Accelerator business.

Home Capital became aware of irregularities related to Accelerator applications handled by one of its underwriters and undertook an internal investigation in August 2014 to determine the scope, extent and cause of the issue. The internal investigation uncovered that members of Home Capital’s Accelerator underwriting team were falsifying employment/income information and falsely documenting that they had completed verification steps related to mortgage applications. Subsequent to the investigation, which concluded in February 2015, Home Capital terminated several underwriters, ended its relationships with several brokers and brokerages, and put in internal controls to address the issues it had uncovered.

As set out in the settlement agreement, Home Capital knew that the issues uncovered by its investigation and the subsequent termination of employees and broker/brokerage relationships would have a material impact on its business. After all, the terminated brokers and brokerages had generated a cumulative total of $881.4 million in originations in 2014, representing approximately 10% of Home Capital’s total 2014 originations. However, as outlined in the settlement agreement, despite what the company’s executives knew by February 2015, Home Capital blamed its poor first quarter results on seasonality, a harsh winter, macroeconomics and a review of business partners. It did not mention the results of its investigations or its subsequent steps. These explanations were echoed by the individual respondents on a May 7, 2015 earnings call.

Home Capital ultimately disclosed the termination of brokers and brokerages and the changes to its controls and procedures in a news release on July, 10 2015. It filed a material change report a week later.

OSC proceeding against Home Capital, its CEO, CFO and president

As a result of Home Capital’s conduct in relation to the disclosure of the problems within its Accelerator business and the actions it took following its investigation, OSC Staff commenced proceedings against Home Capital, its CEO, its CFO, and its President, in April 2017. Staff alleged that Ontario securities laws had been breached and the respondents had acted against the public interest because Home Capital failed to satisfy its continuous disclosure obligations and because its executives made misleading statements and authorized, permitted, or acquiesced to Home Capital’s conduct.

Home Capital is not only a reporting issuer, being subject to capital market regulatory requirements, but is also a financial institution subject to the regulatory oversight of the Office of the Superintendent of Financial Institutions (OFSI), CMHC and the Canadian Deposit Insurance Corporation.

The Panel’s August 9, 2017 approval of the settlement agreement took into account several factors, including: Home Capital’s disclosure of its investigation to CMHC, OSFI and its auditors; the steps Home Capital has taken to remedy the falsification problems it uncovered; the respondents’ reliance on external professional advisors on decisions related to disclosure and materiality; the respondents’ cooperation with Staff; and Home Capital’s leadership changes in recent months at the executive and board levels.

Ultimately, the Panel approved the settlement which requires Home Capital to pay $10,000,000 plus an additional $500,000 in costs, among other monetary penalties and bans for the individual respondents.

Notably, of the $12.5 million the respondents were ordered to pay as part of the settlement, $11 million is to be used as part of a proposed $29.5-million settlement in a related class proceeding in the Ontario Superior Court of Justice [PDF] brought against Home Capital and certain of the individual respondents.

Dealing with concurrent civil and regulatory proceedings arising from an investigation

As discussed previously on this blog, it is not uncommon for companies to find themselves facing overlapping regulatory and civil proceedings (including class actions). Companies who take part in investigations, either commenced internally or by a regulator, should have a well-developed plan with respect to the investigation, the outcome and likely challenging decisions facing management and directors in addressing potentially conflicting regulator priorities, and the possible proceedings that may follow. This advanced planning will help to ensure, among other things, that steps taken in response to one proceeding do not adversely affect the company’s position with other regulators or in other proceedings, and that privilege is protected. This plan should be developed in combination and consultation with legal counsel, accountants, auditors and other necessary professionals to minimize liability and reputational risks to the company.