An Underwriter (the “Underwriter”) has agreed to pay $3.3 million in a settlement with the Ontario Securities Commission in connection with the initial public offering of subprime mortgage company FMF Capital Group Inc. (FMF). As part of the settlement, the Underwriter admitted that it engaged in conduct contrary to the public interest in that it “conducted due diligence in a manner that did not comply with reasonable underwriting practices.” The Underwriter did not admit liability or misconduct, but will be reprimanded.
The Underwriter acted as the lead underwriter in a $197.5 million financing done by FMF, a Michigan-based subprime mortgage firm, in March 2005. As part of its underwriting, the Underwriter signed a certificate stating that to the best of its knowledge the FMF prospectus constituted full, true and plain disclosure of all material facts relating to FMF’s income participating units. FMF soon folded after its revenue from pooling and selling subprime mortgages fell sharply.
The settlement agreement lays out guidelines that explain what the Underwriter could have done better to act with reasonable due diligence in the public’s best interest. These include: analyzing FMF’s declining subprime revenue to properly assess the materiality of that information; engaging in further testing of a final and complete version of FMF’s cash flow model; discussing with participating underwriters the compliance weaknesses set out in a due diligence memorandum by U.S. regulatory counsel retained by the Underwriter; and talking to institutional loan purchasers prior to the IPO.
The agreement sets out the OSC’s expectations that “especially thorough due diligence” by an underwriter will occur when: (i) the issuer is undertaking an initial public offering; (ii) the issuer has undergone recent significant growth or a significant change in business in the recent past (eg. 24 months); (iii) the issuer is a new client for the underwriter and no previous due diligence has been performed on the issuer; or (iv) the issuer has not previously raised capital in Canada.
The Underwriter earned $4.41 million in fees related to the underwriting, plus another $659,895.03 on the sale of subordinated notes. The Underwriter has agreed to pay $3 million to be allocated under the Securities Act or for the benefit of third parties, and another $300,000 toward the OSC’s costs of the investigation.