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Inquiry into the 1 Parliament Street Car-park Limited Contributory Mortgage involving The Mortgage Financier Limited, Money Managers Limited and Securities Registry Limited [2002] NZSecCom 5 (2 May 2002)

Last Updated: 7 November 2014

Inquiry into the 1 Parliament Street Car–Park Limited Contributory Mortgage
- involving The Mortgage Financier Limited, Money Managers Limited, and Securities Registry Limited

An inquiry under section 10 of the Securities Act 1978 into the circumstances of the offering and management of interests in the 1 Parliament Street Car-Park Limited contributory mortgage.

2 MAY 2002

Table of Contents

• Glossary of Abbreviations
• Background to this Report
• Summary of the Commission's Conclusions
• Background to the Inquiry
• Background to the Offer
• The Valuation Information
• The Promissory Note
• The Mortgage Financier Limited Removed as Broker
• Principal Areas of Inquiry
• Findings as to Breaches of the Securities Law
• Liability for Breaching the Securities Law
• Who is an Issuer of the Parliament Street Mortgage
• Who is a Promoter of the Offer?
• Update
• Actions
• Recommendations
• Appendix A
• Appendix B

Securities Commission
12th Floor, Reserve Bank Building
2 The Terrace
PO Box 1179
WELLINGTON

GLOSSARY OF ABBREVIATIONS

"BBJ" - Barratt-Boyes Jefferies Limited, registered valuers

"Contributory Mortgage Regulations" and "the regulations" - The Securities Act (Contributory Mortgage) Regulations 1988

"MGC" - Mahoney Gardner Churton Limited, registered valuers

"MFL" - The Mortgage Financier Limited

"MM" - Money Managers Limited

"Parliament Street mortgage" - the 1 Parliament Street Car-Park Limited contributory mortgage over a property at 1 Parliament Street, central Auckland, in respect of which The Mortgage Financier Limited was the registered contributory mortgage broker. A company called 1 Parliament Street Carpark Limited was to be the borrower of the funds raised under the contributory mortgage. "Securities Act" - The Securities Act 1978

"section 38B order" - an order made by the Commission prohibiting the distribution of advertising for an offer of securities to the public, on the grounds that advertising for the offer is likely to deceive, mislead or confuse investors, or otherwise breaches the legal requirements of such advertisements.

"section 44B order" - an order made by the Commission on the grounds that a broker has contravened the securities laws and that it is in the public interest to make the order. Under section 44B the Commission may do one or more of the following things:

1. prohibit the broker from offering interests in contributory mortgages to the public for a certain time period;
2. remove the broker as manager of any of its contributory mortgages and appoint another person to act as broker in its place;

100. remove the directors of the broker's nominee company and appoint new directors in their place.

"SRL" - Securities Registry Limited

BACKGROUND TO THIS REPORT

1. On 18 February 2002 the Commission began an inquiry into the circumstances of the offering and management of interests in a contributory mortgage that had been offered to the public for subscription by a registered contributory mortgage broker called The Mortgage Financier Limited. The interests were secured by a first mortgage over a property at 1 Parliament Street in central Auckland.
2. As a result of its inquiry, on 21 March 2002 the Commission made an order under section 44B(2)(c) of the Securities Act 1978 removing MFL as contributory mortgage broker for the Parliament Street mortgage. The Commission appointed Crichton Horne & Associates Mortgage Brokers Limited to act as contributory mortgage broker in its place. Crichton Horne & Associates Mortgage Brokers Limited is a registered contributory mortgage broker managed by Crichton Horne & Associates, Chartered Accountants in Christchurch. The Commission understands that MFL has co-operated fully with Crichton Horne.
3. The Commission had also previously made orders under section 38B of the Securities Act prohibiting all advertising for the Parliament Street mortgage. The section 38B orders were made on 14 February 2002.
4. It is one of the Commission's functions under section 10(c) of the Securities Act to "keep under review practices relating to securities, and to comment thereon to any appropriate body". In the Commission's view, the circumstances of the offering and management of the Parliament Street mortgage raise issues of securities law and practice upon which it is appropriate for it to comment. It has decided to do so by way of this report.
5. The Commission has prepared this report, and made the orders referred to above, after carefully considering a large volume of documentary and verbal evidence, and written submissions made by the parties. MFL, MM, SRL, Douglas Somers-Edgar (director of MM), Brent Clode (the owner of the company that was to borrow the funds under the mortgage) and the valuer of the property have had the opportunity to comment on sections of the report relevant to them. Their comments have been taken into account in finalising the report.
6. The report has been prepared by a quorum of Members of the Commission comprising Jane Diplock (Chairman), Elizabeth Hickey and Cathy Quinn. The quorum was assisted by counsel.
7. When referring to persons in our report we have generally not used the customary honorifics. We have used a person's full name the first time it is mentioned. Subsequently we may use the surname only. No disrespect is intended by this practice.

SUMMARY OF THE COMMISSION'S CONCLUSIONS

8. The Commission has considered two broad questions in the course of its inquiry:
   1. whether securities law provisions have been breached; and
   2. if they have, who might be responsible at law for those breaches.
9. The Commission has formed the view that provisions in the Securities Act 1978, the Securities Regulations 1983, and the Securities Act (Contributory Mortgage) Regulations 1988 have been breached in the offering and management of the Parliament Street mortgage. The breaches relate principally to investors being given misleading information about the value of the property in which they were investing, and their money being placed at risk by being paid to the borrower before fundraising was complete.
10. The Commission has formed the view that MFL as contributory mortgage broker was responsible for the breaches under the Contributory Mortgage Regulations and, as issuer of the mortgage, may be criminally and civilly liable for the breaches under the Securities Act.
11. The Commission considers that MM has acted as a contributory mortgage broker by offering interests in the Parliament Street mortgage to the public for subscription. As such, it has breached the regulations by not being properly registered. It might also be criminally and civilly liable under the Securities Act as an issuer in the same way as MFL.
12. The Commission has formed the view that SRL and MM were promoters of this offer in terms of the securities laws. As promoters, SRL and its directors might be subject to criminal and civil liability under the Securities Act. MM might also be subject to criminal and civil liability under the Securities Act as promoters. If the Commission is correct in concluding that MM was a contributory mortgage broker and therefore an issuer of the mortgage, the directors of MM were not promoters because the definition of "promoter" excludes the directors of the issuer.

BACKGROUND TO THE INQUIRY

13. In February 2002 the Commission received a report from the auditors of MFL. MFL had initiated a review by its auditor, prior to the usual year end audit, to ensure that its year end audit went smoothly. The report identified breaches of the Contributory Mortgage Regulations with regard to a contributory mortgage that had been offered to the public by MFL over a property at Parliament Street in Auckland.
14. After reviewing the offer documents for the Parliament Street mortgage, the Commission made orders under section 38B of the Securities Act 1978 on 14 February 2002 prohibiting the distribution of all advertisements for the offer. The prohibition included all offer documents for the Parliament Street mortgage, which are advertisements for the purposes of the Securities Act 1978 and regulations made under that Act.
15. The Commission made the orders because, in its opinion, the offer documents were likely to mislead or confuse with regard to a particular material to the offer, namely the value of the property in question. It was also of the opinion that the documents failed to comply with the Contributory Mortgage Regulations, particularly the requirements for the valuation report.
16. The Commission formed the opinion that the auditor's report indicated that MFL had breached the Contributory Mortgage Regulations in other respects relating to the management of the mortgage. These are discussed further below. The Commission informed MFL that it wished to hear from it about the breaches identified.
17. When the Commission makes orders under section 38B, the issuer of the securities is entitled to appear and be represented before the Commission. MFL requested that the Commission hear it as soon as possible. The Commission convened a meeting for that purpose on 18 February 2002. The three directors of MFL appeared at that meeting. They confirmed that they were aware of their right to be represented, but chose not to be on that occasion.
18. After that meeting, the Commission carefully considered the submissions of the directors and their answers to the Commission's questions. The Commission decided to undertake an inquiry under section 10 of the Securities Act 1978 into the circumstances of the offer and management of interests in the Parliament Street mortgage. The Commission also decided to request the Registrar of Companies to exercise his powers of inspection under section 67 of the Securities Act in relation to the parties involved with the mortgage.
19. The Commission conducted hearings involving representatives of the key parties over two days on 28 February and 8 March 2002, and received submissions from them on the issues raised by the inquiry. Somers-Edgar, MM, SRL and MFL were legally represented at the hearings. Evidence was taken at the hearings under oath. Brent Clode and his companies were not invited to take part in the hearings. As previously noted, Clode has had an opportunity to consider and comment on a draft of this report. The Commission has carefully considered the submissions and the evidence obtained during the hearings and from the Registrar's inspection in making this report.

BACKGROUND TO THE OFFER

Development mortgage

20. MFL sought to raise $27 million from the public in respect of a development at 1 Parliament Street in Auckland. According to the offer documents, the money would be lent to the developer for two years and be secured by a first mortgage over the property. Investors would receive 9.5% interest, and would be repaid in full at the end of the two years.
21. This is a development mortgage under the Securities Act and the Contributory Mortgage Regulations, and must be offered and managed in accordance with securities law.

Persons involved in the offer and management of the Parliament Street mortgage

22. MFL is a company incorporated in 1998. It is registered as a contributory mortgage broker under the Contributory Mortgage Regulations. Its three directors are Beau Davidson, Dyanne Kokich, and Warwick Edgar. Its shareholders are the three directors and two other individuals, Iain Duffy and Craig Gunson. As required by the Contributory Mortgage Regulations it has a wholly owned subsidiary nominee company, Mortgage Financier Nominees Limited, which holds mortgage investments on behalf of contributors. All payments to and from contributors and borrowers must pass through the nominee company's trust account.
23. The borrower is a company called 1 Parliament Street Carpark Limited. It is owned by Brent Clode, an Auckland property developer. Clode has told the Commission that 1 Parliament Street Carpark Limited "is a declared corporate trustee for an investment trust called 1 Parliament Street Carpark Trust". Another Clode company was to undertake the development work. The borrower planned to build a multi-storey apartment and car park building on the bare site it owned at 1 Parliament Street using money raised under the contributory mortgage brokered by MFL. The borrower planned to keep the building once it was finished, rent out the apartments and car parks, and refinance with a bank to repay the contributory mortgage. According to the offer documents for the Parliament Street mortgage, the trustees to the 1 Parliament Street Carpark Trust, Clode and Clode Consulting Limited guaranteed that 1 Parliament Street Carpark Limited would meet its obligations under the mortgage.
24. MM is a company that operates a nationwide network of financial advisers. It is ultimately owned by Somers-Edgar and his wife Anne Somers-Edgar. Doug Somers-Edgar is the sole director and manages the company from its head office in Auckland. By agreement with MFL, MM had exclusive rights to market the Parliament Street mortgage. (MFL says that it could have introduced contributors, but chose not to. Any contributors introduced by MFL would still have had to sign up through MM.) This means that all of the money invested in the mortgage was contributed by clients of MM, either directly or through MM's First Step investment product (as explained further in the next paragraph). The role played by MM, and its legal status under the securities laws, are discussed further below.
25. SRL is a company associated with MM. Its principal role is to invest funds on behalf of the "First Step" investment products promoted by MM. Its directors are Somers-Edgar, Anne Somers-Edgar, Gerald Siddall and Russell Tills. Siddall and Tills are the directors of New Zealand Funds Management Limited, a funds management company also involved with the First Step products. Phil Epps is the Chief Executive of SRL. SRL contributed $3 million of First Step funds to the Parliament Street mortgage. The role played by SRL, and its legal status under the securities laws, are discussed further below.
26. The property at 1 Parliament Street was valued by Phillip Amesbury, a registered valuer with BBJ.

How the Parliament Street mortgage came to be offered to the public

27. At some time in or before March 2001 Clode approached SRL to borrow the finance necessary to build a multi-storey apartment and car park building on the Parliament Street site. Clode had previously borrowed from SRL to fund other projects.
28. SRL has a policy of limiting its lending exposure to any one borrower to a percentage of its total assets under management. Because the amount of the Parliament Street loan, together with other outstanding loans made to Clode, would exceed those limits, SRL declined to make the loan directly. Instead, in conjunction with Clode, it decided to raise the funds by way of a contributory mortgage. A registered contributory mortgage broker would be found, in SRL's words, to "administer" the mortgage and MM would have the exclusive rights to market the offer to its clients in return for a fee of 2.00% of the total loan. SRL would receive a "finders fee" of 0.25%. The contributory mortgage broker would also receive a fee for its services in "administering" the mortgage.
29. As far as the Commission is aware, SRL approached two registered contributory mortgage brokers about the loan, including MFL. The other broker had previously offered contributory mortgages through the MM network. It charged a higher fee than MFL and offered a form of capital insurance underwritten by Lloyds of London. MFL quoted a lower fee of 0.35% and offered no assurance of return of capital. MFL has told the Commission that it did not know what the other broker would have charged.
30. MFL was chosen by SRL as the broker to "administer" the Parliament Street mortgage. The precise reasons for choosing MFL are not entirely clear from the evidence. There is evidence that MM consulted its network of advisers as to whether investors would prefer the higher interest rate that MFL was able to offer by taking lower fees, without any capital insurance, or the other broker's lower interest rate with the capital insurance.
31. In early August 2001 MFL made a loan offer to 1 Parliament Street Carpark Limited. After some negotiation, the terms and conditions of the loan were agreed. MFL referred aspects of the negotiation to SRL. In particular, at one point in the negotiations Clode wished to delete from the loan offer the condition that his development company, Clode Consulting Limited, would guarantee the loan. Clode also proposed certain other amendments to the terms of the loan offer. MFL referred these proposed changes to Epps of SRL, noting that it was "your call" (ie, SRL's call) whether or not Clode Consulting Limited would be a guarantor. SRL replied that the term requiring Clode Consulting Limited's guarantee was to remain in the loan offer. That term did remain, and was accepted by Clode. In its submissions to the Commission MFL has said that:

"The reason for MFL referring aspects of the terms of the loan to SRL was simply because SRL was intended to be a major contributor to the mortgage. In the specific example [referred to above] MFL was indifferent to whether Clode Consulting would be a guarantor. MFL took this view because in its opinion it had sufficient security in all other respects. Accordingly, the example used [above] was the exception, rather than the rule."

32. The evidence indicates that by mid August 2001 MM was ready to begin marketing the offer. However, it seems that the borrower had not yet satisfied all of the conditions of the loan agreement. In particular, it had not yet provided a registered valuer's report on the property as required by the loan offer and by the Contributory Mortgage Regulations. The several valuations of this property that have been produced at various times are discussed more fully later in the report. A valuation that complied with the conditions of the loan offer or with the Contributory Mortgage Regulations was not given to contributors before the Commission's section 38B order on 14 February 2002 prohibited further advertising. What potential contributors to the mortgage were given was a copy of a valuation prepared by BBJ dated 24 August 2001, which did not comply with the law.
33. MM began marketing the contributory mortgage before the borrower had met all of the conditions of the loan offer. Also, while marketing was in progress, the borrower reconfigured the plans for the building to provide for more apartments. A new valuation dated 27 September 2001 which took into account the reconfiguration was obtained, but not provided to those who had already contributed to the mortgage.
34. A "check valuation" dated 8 October 2001 by another valuer, MGC, was obtained at the request of MFL. The "check valuation" did not value the property, but it did query the BBJ valuation dated 27 September 2001 and identified areas of non-compliance with the Contributory Mortgage Regulations. MGC's comments on the 27 September valuation also apply to the 27 August valuation that was sent to contributors, which differs only in the number of apartments to be built. MFL asked Clode to obtain a compliant valuation from BBJ, but contributors were not sent a compliant valuation nor were they informed of any deficiencies.
35. A few days before the offer was due to close, less than half the amount of the loan had been raised. On 25 September 2001 Somers-Edgar, on behalf of MM, signed a document entitled "Promissory Note" which MFL understood to constitute a promise to raise or pay the full amount of the loan on or before 29 March 2002. The closing date of the offer was extended, and the offer had not yet closed when the Commission made section 38B orders on 14 February 2002.
36. On 8 October 2001 the loan agreement and security documentation were signed. Also on 8 October the first payment of approximately $8 million was paid to the borrower or applied on its behalf. Of that amount, approximately $3.3 million was retained by MFL as prepaid interest and fees (MFL has told us that of this amount $189,000 was prepaid fees, which were to be paid proportionately in arrears for each month of the duration of the loan. Fees actually received by MFL totalled $39,375). MM and SRL were paid the full amount of their commission, $540,000 and $67,000 respectively. They were paid the full commission even though fundraising was not yet complete. Another $6,000 was paid to the Whangarei lawyers who had acted on the transaction for MFL. The balance was used by the borrower to pay for costs of the property and the project.

THE VALUATION INFORMATION

37. The Contributory Mortgage Regulations require that contributors are given a written valuation report on the subject property that is prepared and signed by an independent registered valuer, containing the information set out in the Third Schedule to the Regulations.
38. The Commission considers that the valuation report dated 27 August 2001 given to contributors was likely to deceive, mislead or confuse with regard to a material particular, namely the value of the subject property. The Commission formed the opinion that the valuation report was likely to deceive, mislead or confuse in two main ways:
    1. it did not contain all of the information required by the regulations; and
    2. the dollar figure of the value itself was misleading because of the basis upon which it had been calculated.

Required valuation information

39. The regulations require a valuation report to set out a range of defined values for the subject property. These include (in simplified terms) the latest government valuation, the value of the bare land (the "land value"), the value of any improvements on the land, and the value of the land including any improvements (the "capital value"). For a development mortgage, it is also required to set out the land value minus the cost of removal of any improvements to the land (the "modified land value"), and the capital value of the property after completion of the development.
40. Obviously it is material for investors to know what the property is worth at the time they invest in it, as well as what it might be worth after the development is completed (which in some cases is some time after their money is due to be repaid). For example, the modified land value is relevant because, if the borrower defaults and the property has to be sold in a mortgagee sale, it may be that the most a buyer will pay is the value of the bare land minus the cost of demolishing a partially completed development.
41. The regulations also require that the valuer makes a recommendation as to the amount for which the land provides adequate security for a loan on first mortgage. This is material because investors will be taking a proportionately higher risk if the amount of the loan is higher than the recommended amount. In the Commission's view, for many small investors with some experience in mortgage investments, the valuer's mortgage recommendation may be the single most important factor in deciding whether to invest.
42. The regulations also require a statement by the valuer that the valuation has been prepared for use by intending lenders, and that the valuer has consented to the distribution of the report to intending lenders and has not withdrawn that consent. This is so that investors know that the report has not been prepared for some other purpose that could make it unsuitable for investors to rely on. It also triggers certain liability provisions if the report contains an untrue or misleading statement.

Missing valuation information

43. The valuation report dated 27 August 2001 given to contributors to the Parliament Street mortgage did not comply with the regulations in that it did not contain the land value, the capital value, the modified land value, or a mortgage recommendation.
44. The valuer has told the Commission that "the initial valuation" was prepared for Clode in accordance with Clode's instructions, was not intended for contributory mortgage purposes and for that reason did not contain the information required by the Contributory Mortgage Regulations.
45. The Commission notes however that the valuation report given to contributors, dated 27 August 2001, contains the statements about independence and consent required by the Contributory Mortgage Regulations. The valuer states in the 27 August valuation that he has "acted in an independent manner as provided for under Regulation 5 of the Securities Act (Contributory Mortgage) Regulations 1988". He also states that "the valuation has been prepared for use by intending lenders, we consent to the distribution of the report to the intending lenders and that, as at the date of the valuation report, we have not withdrawn that consent". The Commission considers that these statements indicate that a contributory mortgage was anticipated in the preparation of the 27 August 2001 valuation report.

Misleading valuation

46. Under section 5(4) of the Securities Act, contributory mortgages are exempt from certain provisions of the Securities Act, including the requirements to have an investment statement and a registered prospectus. However, they are not exempt from the provisions relating to advertisements.
47. Contributory mortgage offer documents, including the valuation report, are by definition advertisements for the purposes of the Securities Act and the Securities Regulations 1983, which set out requirements for the content of advertisements for offers of securities.
48. One of the principal requirements is set out in Regulation 8 of the Securities Regulations 1983, which provides that:

"No advertisement shall contain any information, sound, image, or other matter that is likely to deceive, mislead, or confuse with regard to any particular that is material to the offer of securities contained or referred to in the advertisement".

49. The Commission has formed the opinion that the valuation report given to contributors, dated 27 August 2001, breached Regulation 8 of the Securities Regulations 1983. As well as failing to contain all the required information, the report was also misleading, in the Commission's view, because of the basis upon which the property value was calculated.
50. The 27 August valuation report stated that the "total market valuation upon completion" was $49,215,500 "including GST if applicable". This figure was set out in an "Executive Summary" at the front of the report, immediately followed by the following statement:

"Please note; the above valuation is a summation of the individual unit values, including goods and services tax, upon completion. No allowance has been made for selling costs, profit and risk or holding costs."

51. That statement is repeated later in the report, under the heading "Special Conditions".
52. This means that the valuation is based on what might be termed the "gross realisation" of the property. The valuer has estimated what each of the apartments and car parks might sell for when completed, and added those figures together. He has not deducted any of the costs associated with selling the apartments.
53. In the Commission's opinion the use of such a valuation in the present context is misleading because a seller will never actually receive the gross value of a property. There are always costs of sale that will be offset against the gross sale price.
54. The Commission considers that valuation on this basis is misleading even though the basis is clearly disclosed in the report. This is because an investor is unable to determine from the report what the nett value of the property might be. Reports for this property prepared at a later date (as discussed further below) indicate that the nett value of the property is 20% - 25% lower than the gross value. The Commission considers this to be a material difference that should have been disclosed to contributors.
55. Further, even though the basis on which the valuation was prepared is spelt out, the expectation of prudent but non-expert investors that the valuation would reflect what they could expect if the property had to be sold creates a very real risk that some would not appreciate the significance, let alone the extent, of the difference.
56. Also, it appears that the borrower did not intend to repay the contributory mortgage by selling the apartments and car parks separately. It intended to rent them out and refinance the mortgage with a mainstream lender. The Commission considers that the report given to contributors should have contained a valuation that reflected the borrower's actual intentions, showing a projection of its value measured by its income earning capacity, which is a common mode of valuing investment properties.
57. MFL has submitted that a broker should not be responsible for a misleading method of valuation. Submissions on behalf of MFL state:

"While our client has been prepared to accept responsibility, subject to materiality, where the valuation does not comply to the letter with the statutory requirements, we believe it is placing an unreasonable onus on the broker to make an assessment of a valuation that it is not at law required to do, nor is it qualified to do so. That role must be fulfilled by the valuer. In our submission, the current form of the Commission's report would suggest that the potential liability of a broker is much wider than the industry would expect."

58. In the Commission's view it is clear under the law, particularly Regulation 8 of the Securities Regulations 1983, that the broker is obliged to ensure that nothing in an advertisement, including valuation information, is likely to deceive, mislead or confuse investors about any matter that is material to the offer. This obligation is fundamental to the operation of the securities laws and applies to issuers of all types of securities, including contributory mortgage brokers. It applies regardless of whether the information is provided by a third party "expert". It will require the broker to do more than simply "tick the boxes" to check that the prescribed information is included. Accordingly, the Commission is unable to accept MFL's submissions that a broker should not be responsible for a misleading valuation report.

History of the valuation reports

59. Several valuation reports have been prepared by BBJ for this property. As noted above, it seems that all contributors were given a copy of the report dated 27 August 2001 that valued the property at $49,215,500. Those who received offer documents after 5 October 2001 or thereabouts were also informed that the property had been revalued upwards to $52,036,500 because the borrower had reconfigured the floor space to fit in more apartments. Those investors were not given a copy of the amended valuation, which we understand was dated 27 September 2001. Earlier investors were not informed of the change.
60. It is clear from the evidence that MFL was aware all along that the valuation report did not comply with the regulations.
61. It was a condition of the loan offer made by MFL to the borrower that it obtain a valuation from MGC that complied with the regulations. MFL attached a copy of the Third Schedule to the regulations to the loan offer. The evidence indicates that the borrower did not satisfy that condition before MM began marketing the offer. Instead, SRL agreed that the borrower could provide a BBJ valuation that Clode already had "on file". It is not clear whether the valuation report on Clode's file was the same report given to investors, dated 27 August 2001. However, it is clear that the report given to investors did not satisfy the conditions of the loan offer, and did not comply with the Contributory Mortgage Regulations.
62. Davidson told the Commission that he agreed to use the 27 August valuation report, even though he knew it did not comply in certain respects, because he did not believe that the deficiencies would lower the value of the property. MFL appeared to be under the impression that it could rectify the breach of the regulations by sending contributors a copy of a compliant valuation at a later date. MFL continued to press the borrower on the matter. There is evidence that Clode did instruct BBJ in writing to produce a further report that did comply with the regulations. There is also evidence from the valuer that Clode subsequently qualified this instruction verbally.
63. In the meantime a review of the BBJ valuation was undertaken by MGC. The review, called a "check valuation" by the parties, is dated 8 October 2001 and addressed to Mortgage Financier Nominees Ltd C/- SRL. This review noted that several items of information required by the regulations were missing from the BBJ report, and also queried the basis of the valuation, as follows:

"It is evident that on completion, if the units are to be sold, then allowance would need to be made for costs to be incurred including selling and legal costs, interest during the sale period, holding costs and an allowance for profit and risk. Alternatively, if the building was to be retained for rental purposes i.e. 221 rental units, then its value as a single holding would more likely be calculated adopting the investment approach, allowing for vacancies, holding costs, management costs, etc (as well as maintenance) and an appropriate capitalisation rate adopted based on comparable development.

The instructions to Barratt Boyes Jefferies Ltd, apparently required neither of these calculations to be undertaken, the request apparently being solely for a total, including GST, of the individual values of the units, and was subject to separate titles being issued. Presumably the mortgages would be registered against each title. However the potential gross income of the 221 apartments was also provided.

It is apparent however, even though Barratt Boyes Jefferies Ltd were not requested to value on such a basis, that the value would be significantly less than the combined value of apartments of $52,036,500 including parking if considered as a single entity.

We draw this to your attention for consideration when making any mortgage advance to the development. This could impact on the gross realisation by a factor of 20% - 25%."

64. On 8 February 2002, MFL received a copy of what it considered to be a compliant valuation (except for a minor typographical error which meant that the value expressed in words differed from the value expressed in figures). In this report, BBJ allowed for costs of sale. It also included a separate calculation of the value based on the building being retained as a rental property. Both methods of valuation produced a value of approximately $40 million, some $12 million or 23% less than the value previously advised to contributors. This report also included a mortgage recommendation of $26,600,000, slightly less than the amount of the loan the borrower was seeking to raise.
65. Davidson has told the Commission that MFL intended to have the typographical error amended, send the 8 February valuation to all contributors, reduce the amount of the loan to $26,600,000, and offer existing contributors the chance to withdraw their investment. Essentially, this would have amounted to making a new offer.
66. As the first step in this process, Davidson says that he asked Clode to ask BBJ to amend the typographical error. Davidson has told the Commission that Clode did not do so, but instead instructed BBJ to revert to the "gross realisation" method of valuation which would show a value of $52 million rather than $40 million. The valuer, Amesbury, has also told the Commission that Clode verbally countermanded his previous written instructions to produce a compliant valuation and instructed him to revert to the gross realisation method. We note that Clode has subsequently told the Commission verbally that he instructed BBJ to comply with the regulations. The statements of Amesbury and Clode are in conflict on this point. It is not necessary for the Commission to resolve that conflict.

Investors not informed

67. While MFL was apparently waiting for a compliant valuation report, the Commission made orders banning all advertising of the Parliament Street mortgage, and commenced this inquiry shortly thereafter.
68. Despite MFL's apparent attempts to obtain a compliant valuation, investors were never fully or properly informed about the value of the property. MFL was aware from the outset that the 27 August valuation report given to investors did not comply with the regulations. It ought to have also been aware, after receiving the MGC review, that the valuation given to investors was prepared on a basis that was likely to mislead investors. The borrower and its owner, Clode, were also aware the report did not comply. The MGC review was sent to SRL for the attention of an SRL employee. SRL was therefore on notice from 8 October 2001 that the valuation information given to investors was non-compliant and misleading. As SRL refers to itself as the "agent" of MM in this matter, the Commission also concludes that MM knew or ought to have known about the deficiencies in the valuation information.
69. Despite their knowledge of these breaches of the law, there is no evidence to indicate that any of these parties took any steps to stop the offer or to inform contributors about the non-compliant valuation. MFL may have intended to do so, but did not do so. MM continued to market the offer and to receive contributions, SRL made no attempt to withdraw the First Step money it had contributed, and MFL continued to take in contributions and to pay out funds to the borrower in accordance with six drawdown requests.

THE PROMISSORY NOTE

70. One of the key documents in the Commission's inquiry is a document referred to by the parties as "the promissory note". A copy of the promissory note is at Appendix A. It is headed "Promissory Note" and expressed to be from MM to Mortgage Financier Nominees Limited. It is signed by Somers-Edgar and dated 28 September 2001. The text of the note reads as follows:

"We the undersign [sic] promise to raise funds to the quantum amount of $27,000,000.00. Such funds represent the full subscription to the loan of $27,000,000.00 to be incrementally advanced to 1 Parliament Street Limited [sic].

We undertake to make good our promise incrementally by or before Friday 29 March 2002."

71. It seems clear that the promissory note came into existence because the full amount of the loan had not been raised in time for the first instalment to be paid out to the borrower.
72. The parties agree that Davidson of MFL asked that Somers-Edgar sign the promissory note. Davidson has told the Commission that he requested the promissory note because he understood that the law required the full amount of the loan to be raised before the building project could commence. He said that he regarded the promissory note as being "as good as cash", and that on faith of the promissory note MFL was able to begin advancing funds to the borrower.
73. MM, SRL and Somers-Edgar agree that Somers-Edgar signed the promissory note to enable the project to commence. They have made the following submissions concerning the circumstances in which the promissory note was provided :

"DSE [Doug Somers-Edgar] was asked to sign the PN [promissory note] by Al Scott [of Money Managers]. There was no pressure on DSE to sign the PN, it was signed simply so that the development could get underway.

This point is important. It is not correct to draw any inference that because the PN was signed, MM anticipated difficulties in being able to raise the full amount of the funds for PSM [the Parliament Street mortgage]. Quite the opposite is the case.

DSE had no concerns at all about signing the PN because he knew at the time of signing it that MM would have no difficulty whatsoever in raising the funds. DSE knew that MM could raise the funds, - in particular from maturing contributory mortgages. When Al Scott gave DSE the PN to sign, he also provided DSE with statistics about the level of funds MM would be receiving from maturing mortgages...

In these terms, the PN is equivalent to cash in the hands of MFL and should be regarded as such by the Commission."

74. Whatever Somers-Edgar's views, the documentary evidence received by the Commission indicates that MM was having difficulty raising the funds and that at least part of the purpose of the promissory note was to avoid canceling the offer and returning funds already subscribed. For example, the following message was sent by e-mail to MM branches on 25 September, 3 days before the promissory note was signed:

"Parliament Street mortgage
With just 10 days to go before Parliament Street mortgage is due to be completed, we note there is $11 million booked and $6.1 million banked. This leaves us with the following options:

1. Cancel the mortgage and return all funds invested to investors
2. Extend the mortgage for a period of time

Before we make the final decision, we need to get some feedback from advisers. Given previous calls for CMs and the purported demand that existed for them at the Fiji RO conference, is the problem just with Parliament Street? Has the debacle in the US been a factor in the slow bookings? Is there a perception this is another Metropolis? Are CMs finally getting a reputation for not repaying on time? Is the lack of a Lloyds of London insurance been a factor? How much damage has the non-repayment of Downtown Medical etc been a factor?
Once we receive your feedback, we will re-evaluate the situation and make a decision.
Regards, Alasdair Scott."

75. The following e-mail was sent to MM branches two days later, on 27 September:

"Thanks for your feedback over the Parliament St mortgage. To summarise, the consensus was to extend the mortgage. While it was not mentioned in my first email, an extension would require a Promissory Note provided by Money Managers effectively underwriting the remainder of the mortgage. We have agreed to the extension until 1 March 2002, but realistically expect the full amount to be raised by early December...
Obviously a Promissory Note of this magnitude is a significant commitment. We appreciate the same commitment by many ROs and advisers that they will continue to market this investment to clients and prospects.
Alasdair Scott"

76. Whatever the reasons for the promissory note or the parties' intentions in making it, the parties appear to agree on its legal effect. Davidson and MFL believed that it constituted an unconditional promise to raise $27 million dollars for the loan and to pay any shortfall that had not been raised on or before 29 March 2002.
77. The submissions of MM, SRL and Somers-Edgar support that interpretation. They say:

"By the PN, MM has undertaken '...to make good the promise' by 27 [sic] March 2002. The only way MM can meet this undertaking is to pay any shortfall (from not having raised the full $27m) to Mortgage Financier Nominees Limited on or before 27 March 2002.

It is accordingly an unconditional promise to pay this shortfall....

To interpret the PN otherwise is to violate the clear meaning of the words in the PN".

Effect of the promissory note

78. It is neither appropriate nor necessary for the Commission to comment on the contractual effect or legal enforceability of the promissory note.
79. For the purposes of the securities laws however, the Commission does not consider that the promissory note is "equivalent to cash in the hands of MFL" as submitted by MM. The Contributory Mortgage Regulations prohibit funds being paid to a borrower unless contributions have been made by contributors to the particular mortgage that equal the amount of the principal sum of the mortgage. Those contributions must be held in the broker's trust account or invested on behalf of contributors. Those contributions must also be sufficient to complete the development (Regulation 21). The Commission considers that Regulation 21 requires that all the money must be in the broker's trust account before any can be paid out to the borrower. The reason for this is fairly clear - if the broker is unable to raise the total amount of the loan, it will be unable to return contributions in full if it has allowed the borrower to spend some of the money.
80. In this case, contributions equaling $27 million had not at any time been held in MFL's trust account, or invested by MFL on behalf of contributors, before the Commission made its orders. Sufficient funds to complete the development had never been held. Despite this, MFL paid out some $8 million to the borrower, or for its benefit, on 8 October 2001. The Commission has formed the opinion that in doing so MFL breached the regulations and thereby placed contributors' funds at risk. For the purposes of the Contributory Mortgage Regulations, the Commission does not consider that a promise to top up any shortfall at a later date is equivalent to "money in the bank" at the time of payment to the borrower.
81. We have referred above to the submissions of MM, SRL and Somers-Edgar that the promissory note was an unconditional promise to pay any shortfall on or before 29 March 2002. Those parties also submitted that this matter should be resolved by MFL reverting to contributors with compliant offer documents and an explanatory letter, and offering them the option to withdraw their contribution.
82. In light of those submissions, the Commission wrote to MM's solicitors on 22 March 2002 as follows:

"Would you please confirm that the effect of these submissions is that Money Managers will make good any shortfall in the $27 million remaining after contributors have decided whether or not to withdraw their investment. In other words, please confirm that Money Managers agrees that its obligations under the promissory note will extend beyond 29 March until such time as contributors have decided whether or not to withdraw."

83. On 26 March we received the following reply:

"...in order to assist the Commission and a speedy resolution of this matter, MM is prepared to confirm that it will '...make good any shortfall in the $27 million remaining after contributors have decided whether or not to withdraw their investment' on the following terms:

1. MM is agreeing to assist the Commission resolve this matter expeditiously;
2. This represents an additional obligation on MM, and one that was not in place when DSE signed the PN;
3. This assistance will resolve the matter and there will be no outstanding issues between the Commission and DSE, MM or Securities Registry Limited. We are sure you will understand that noting this condition is not to influence the Commission's regulatory role in any way, but is simply to clarify what MM has taken from your letter of 22 March 2002 that in the light of the above indications, this may well resolve the matter. This is the basis on which MM has proceeded to provide the commitment to make good any shortfall set out in this letter; and
4. That there be no indication to investors that if they require the return of their investment, that any shortfall will be met by MM."
84. We replied that "the Commission will not enter into any discussion, or consider any proposals, which would imply a constraint on the Commission's powers to properly address the issues raised in its inquiry". MM solicitors assured us in reply that it was not MM's intention to imply any such constraints. A copy of this exchange of correspondence is at Appendix B.

THE MORTGAGE FINANCIER LIMITED REMOVED AS BROKER

85. On 21 March 2002 the Commission made orders removing MFL as broker of the Parliament Street mortgage and appointing another broker to act in its place. MFL complied with the order. On 28 March, the replacement broker, Crichton Horne, made a written demand that MM pay the $3.65 million shortfall in the full amount of the loan. (It made this demand on 28 March because the due date of the promissory note, 29 March, was Good Friday). MM replied through its solicitors that it would be "inappropriate" for MM to pay while the matter was still before the Commission. The Commission advised on 3 April that it could see no impediment to MM making the payment. MM's solicitor indicated that MM would be happy to do so, and had funds available. After further correspondence and meetings between Crichton Horne and MM, MM paid the $3.65 million on 11 April 2002.

PRINCIPAL AREAS OF INQUIRY

86. The Commission has considered two broad questions in the course of its inquiry:
    1. whether any provisions of the securities laws have been breached; and
    2. if they have, who might be responsible at law for those breaches.

FINDINGS AS TO BREACHES OF THE SECURITIES LAWS

87. After reviewing the offer documents for the Parliament Street mortgage, and carefully considering the evidence obtained in the course of the inquiry and the submissions of the parties, the Commission has formed the opinion that the securities laws have been breached in the offering and management of the Parliament Street contributory mortgage, as described below.
88. Section 44B(2) of the Securities Act empowers the Commission to make certain orders in relation to the activities of a contributory mortgage broker. The Commission was satisfied that MFL contravened regulations made under the Securities Act, and that it was desirable in the public interest to make orders under section 44B(2). In particular:
    1. the valuation information disclosed in the offer documents for the Parliament Street mortgage (which constitute an advertisement for securities law purposes) was likely to deceive, mislead or confuse with regard to a material particular, namely the value of the subject property, in contravention of Regulation 8 of the Securities Regulations 1983;
    2. contributions were paid to the borrower or for its benefit before there were contributions in the trust account or investments referred to in Regulation 27 of the Contributory Mortgage Regulations equal to the amount of the principal sum of the mortgage, in contravention of Regulation 21(d) of the Contributory Mortgage Regulations;
    100. contributions were paid to the borrower or for its benefit when there were insufficient funds available in the form of contributions retained in the trust account, or investments referred to in Regulation 27, to complete the development, in contravention of Regulation 21(f) of the Contributory Mortgage Regulations;
    4. contributions were paid to the borrower or for its benefit when MFL knew, or ought to have known, that a document relating to the mortgage (namely, the valuation report) sent or given to contributors was false or misleading in a material particular, in contravention of Regulation 20(1) of the Contributory Mortgage Regulations;
    5. contributions were paid to the borrower or for its benefit when the documents given to contributors did not contain all of the information and other matters specified in the Eleventh Schedule to the Contributory Mortgage Regulations, in contravention of Regulation 19 of the Contributory Mortgage Regulations;
    6. the valuation report sent to contributors did not comply with the Third Schedule to the Contributory Mortgage Regulations. In particular it did not contain the information required by clauses 7, 9, 10(a) and 13 of the Third Schedule.
89. The Commission was satisfied that it is desirable in the public interest to make the orders because:
    1. MFL's failure to ensure compliance with the Regulations, and its continuing failure to comply after becoming aware of breaches, indicated that contributors' funds were not properly managed and may be at risk if MFL continued to manage the 1 Parliament Street mortgage;
    2. the directors of MFL have, in relation to this mortgage, failed to meet the standards of care and good governance expected of those who raise funds from the public.
90. Furthermore it is in the public interest that people who raise funds from the public comply with relevant laws and that those laws are enforced.

LIABILITY FOR BREACHING THE SECURITIES LAWS

91. The Securities Act contains various provisions imposing criminal or civil liability for breaches of the Act or regulations made under the Act. It follows from the Commission's findings about breaches of the securities laws that the liability provisions listed below might apply. Please note that this is a brief summary and not an analysis of the law. It is not for the Commission to determine liability under these provisions - that is the role of the Courts.
92. Under section 56, every director of the issuer and every promoter may be liable to compensate anyone who subscribes for securities on the faith of an advertisement which contains any untrue statement for any loss or damage sustained by reason of the untrue statement.
93. Under section 57A, the contributory mortgage broker and its directors may be liable to compensate anyone who subscribes for or holds an interest in a contributory mortgage, for any loss or damage sustained by reason of any breach of regulations relating to the offer, sale, or management of interests in the contributory mortgage.
94. The directors of the issuer may be fined or imprisoned if convicted under section 58 of distributing an advertisement containing an untrue statement.
95. Under section 59, the issuer, every principal officer of the issuer, and every promoter may be fined for offering or allotting an interest in a contributory mortgage in contravention of the regulations.
96. Under section 57, an expert may be liable to compensate anyone who subscribed for securities on the faith of an advertisement containing an untrue statement made by the expert, for any loss or damage sustained by reason of the untrue statement.
97. For the purposes of these provisions, an "untrue statement" includes a statement that is misleading:
    1. in the form and context in which it is included;
    2. by reason of the omission of a particular that is material to the statement in the form and context in which it is included.
98. For the purposes of the securities laws:
    1. an "advertisement" includes offer documents for a contributory mortgage;
    2. an "expert" includes a valuer;
    100. the "issuer" of a contributory mortgage is defined in section 2 of the Act, as discussed further below; and
    4. "promoter" is defined in section 2 of the Act, as discussed further below.
99. The liability provisions described above all apply to the issuer and/or its directors or principal officers (except section 57 which applies to experts). As well, a promoter might be civilly and criminally liable under sections 56 and 59 respectively. As part of its inquiry the Commission has considered which of the parties involved with the Parliament Street mortgage is an issuer, and whether any might be a promoter.

WHO IS AN ISSUER OF THE PARLIAMENT STREET MORTGAGE?

100. Section 2 of the Act provides as follows:

"Issuer" means -
...

100. In relation to an interest in a contributory mortgage offered by a contributory mortgage broker, or to an advertisement that relates to such an interest, the contributory mortgage broker.

"Contributory mortgage broker" means a person (not being a mortgagor under the mortgage or any other person to whom or for whose benefit any money is lent in consideration for the mortgage given by the mortgagor) who -

4. Offers an interest in a contributory mortgage to the public for subscription; or
5. Manages interests in a contributory mortgage, being interests that have been offered to the public for subscription, whether or not that person holds beneficially any interest in that mortgage.

101. The effect of these definitions is that the issuer of a contributory mortgage is the contributory mortgage broker, and the contributory mortgage broker is the person who either offers the contributory mortgage to the public, or manages the contributory mortgage once it has been offered to the public.

Was MFL a contributory mortgage broker / issuer under the Securities Act?

102. MFL falls within paragraph (a) of the definition of "contributory mortgage broker". The offer documents for the mortgage were in the name of MFL and on its letterhead. Contributions were ultimately deposited in its trust account pending distribution.
103. MFL also falls within paragraph (b) of the definition. MFL undertook the management of the Parliament Street mortgage - it was responsible for dealing with contributors' funds once MM deposited them in its trust account, it kept the accounting records, and it paid contributions out of the trust account to the borrower (albeit in contravention of the regulations).
104. For these reasons, in the Commission's view, MFL was a contributory mortgage broker and therefore an issuer of the Parliament Street mortgage.

Was MM a contributory mortgage broker / issuer under the Securities Act?

105. MM was the only party to deal directly with contributors and potential contributors about their decision to invest in the Parliament Street mortgage. By agreement with MFL, MM had sole rights to market the mortgage. Contributors were unable to invest in the mortgage other than by dealing with MM. Advertisements for the offer (other than the offer documents themselves) were heavily branded with the MM name and logo. Some of the print advertisements stated that the mortgage was "issued in association with The Mortgage Financier Limited", while radio advertising did not refer to MFL at all. MFL handled the paperwork and administration only after an investment decision was made.
106. The Commission considers that much of the advertising material for the Parliament Street mortgage was likely to give contributors the impression that MM was offering and issuing the mortgage investment, whether or not "in association with" another party. This raises the question of whether MM falls within paragraph (a) of the definition of "contributory mortgage broker" by offering interests in the Parliament Street mortgage to the public for subscription.
107. Section 2 of the Securities Act sets out an inclusive definition of the term "offer" as follows:

"Offer" includes an invitation, and any proposal or invitation to make an offer; and "to offer" has a corresponding meaning.

108. MM, together with SRL and Somers-Edgar, have made submissions to the Commission that none of those three parties fall within paragraph (a) of the definition of contributory mortgage broker for three reasons:
     1. "The authorities ... all show that for a person to have offered a security to the public there must exist a close causal nexus between that person's ability to control the form of the security interest and the advertisement of the security interest to the public on that person's behalf...The evidence in this case quite clearly shows that no such causal link exists between DSE/MM/SRL and the creation of the security. In other words DSE/MM/SRL did not create the security and then afterwards make it known to the public that it was available. All MM did was to make its clients aware [the mortgage] existed after it had been created by MFL. On any analysis contained in the cases referred to above, MM has not offered [the mortgage] to the public."
     2. "The scheme of the legislation clearly anticipates that there would only be one broker for any given contributory mortgage."
     100. "[These reasons are] supported by public policy to avoid the impractical consequences of extending the definition of offer to include a person who fulfils a role similar to that of MM in the present case."
109. The Commission does not consider it necessary to comment on the parties' interpretation of the authorities referred to in their first submission set out above. On the evidence, the Commission does not accept that MM had no part in "creating" the security. The role of MM in formulating the Parliament Street mortgage is discussed in the next section of the report.
110. With regard to the second submission above, the Commission agrees that it is arguable that the scheme of the legislation anticipates only one broker per mortgage, insofar as it generally refers to "the broker" rather than "a broker". However, "contributory mortgage broker" is defined in section 2 of the Securities Act as a person who offers a contributory mortgage or who manages it, which appears to contemplate the involvement of more than one person.
111. The Commission is not sure what "impractical consequences" are referred to in the third submission above. If MM performed the role of a contributory mortgage broker in this case, then we see no public policy reasons why it should not be held liable as a contributory mortgage broker and, by definition, an issuer.
112. The Commission considers that the extent and nature of MM's involvement in the marketing of the Parliament Street mortgage, particularly its exclusive rights to deal with potential contributors and the heavy use of its own brand in the advertising material, indicates that MM "offered" the mortgage for the purposes of paragraph (a) of the definition of contributory mortgage broker.
113. This means that in the Commission's view both MM and MFL were contributory mortgage brokers, and therefore issuers, of the Parliament Street mortgage.
114. We note that the Contributory Mortgage Regulations prohibit a person acting as a contributory mortgage broker unless it has registered as a broker with the Registrar of Companies and completed certain other prescribed formalities. MM is not a registered contributory mortgage broker.

WHO IS A PROMOTER OF THE OFFER?

115. The term "promoter" is defined in section 2 of the Securities Act as follows:

"Promoter", in relation to securities offered to the public for subscription, -

1. Means a person who is instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public; and
2. Where a body corporate is a promoter, includes every person who is a director thereof; but

100. Does not include a director or officer of the issuer of the securities or a person acting solely in his or her professional capacity.

116. There is no question in this case that securities (i.e. interests in the Parliament Street contributory mortgage) were offered to the public for subscription. In determining whether any party was a promoter of the securities, the key issue is whether any person was instrumental in the formulation of the plan or programme pursuant to which the securities were offered.
117. MM, SRL and Somers-Edgar have made joint submissions that none of them is a promoter of the Parliament Street contributory mortgage. They propose a test for determining whether or not a person is a promoter under the securities laws, as follows:

"In the securities legislation, we submit that the test is whether a person (of whom the enquiry is made) has the power to mandate or control in a definitive way the formulation of the proposal. Put another way, does this person have the power to veto terms of the proposal.

This is a very stringent and narrow test. It requires a direct involvement in the proposal and, it is submitted that merely taking an interest in the formulation of a proposal is not sufficient for that person to be regarded as a promoter.

Nor is it sufficient for a person to have the ability to exert control indirectly e.g. a competitor, another broker or even as [sic] associate of an investor. If it were, the meaning of instrumental would be expanded to an unreasonable degree.

On a proper application of the statutory test it is clear that DSE/MM/SRL are not promoters, as the facts establish, they simply did not have the ability to control directly or indirectly, the proposal or the way it was formulated and offered to the public.

It is important to apply the statutory test rigorously and faithfully as the Act has already extended the definition of promoter. Any further extension of the definition is not contemplated by the Act and would be inappropriate and invalid."

118. The Commission does not consider that the narrow test proposed in the submissions is supported by the wording of the statutory definition, nor by the authorities.
119. Statutory interpretation involves ascertaining the meaning of the text in light of the purpose of the statute (Interpretation Act 1999, section 5). In the Securities Act, the concept of "promoter" is used to attribute certain statutory responsibilities to those whom the law assumes should, because of the nature and extent of their involvement, accept certain responsibilities in respect of the issue of securities to the public.
120. It is well settled that it is a question of fact in any particular case as to whether or not a person is a promoter (see for example Morison's Company & Securities Law, Chapter 6.2). We are not aware of any authority for the proposition that a promoter must have the power to control or veto the terms of the offer. In company law, where the concept of promoter originates, a wide variety of activity has been held by the courts to constitute promotion. For example, in Jubilee Cotton Mills v Lewis [1924] AC 958, a person who agreed to provide cash to assist in forming a new company, but otherwise left the organisational details to others, was held, on the facts, to be a promoter of the company. Also, one might consider that, if a power of control or veto was contemplated by the legislature, the definition of "promoter" might include a term such as "controls" rather than "is instrumental".
121. MM has submitted that its involvement was only "a sort of quality control - to allow the marketer [i.e. MM] to be confident its customers would accept the product on offer. This is different altogether from the marketer (or its agent) being able to control or veto specific terms contained in the proposal. If the marketer doesn't like the final form of the proposal its only remedy is to refuse the offer from the CMB [contributory mortgage broker] to market the offer. It does not have any other remedy."
122. SRL has submitted that its involvement in the Parliament Street mortgage was primarily because of its overall exposure to Clode (SRL has made other loans to Clode), and secondarily because it was itself investing in the Parliament Street mortgage. It has submitted that:

"SRL undoubtedly had more information about Clode than other investors. However, this was simply because of SRL's existing relationship with Clode.

Furthermore even if MFL and/or Clode did accept suggestions made by SRL, it does not automatically follow that SRL therefore became instrumental in the formulation of the proposal. As explained above, MFL is not bound by suggestions made by SRL and SRL cannot insist that its suggestions will be followed. If they are, well and good and everyone will benefit. If they are not, then SRL is left to reassess its position accordingly."

123. The Commission has formed the opinion that, on all the evidence, both MM and SRL were instrumental in the formulation of the contributory mortgage scheme pursuant to which interests in the Parliament Street contributory mortgage were offered to the public. In forming that opinion, the Commission has taken particular account of the following matters:
     1. SRL initiated the idea of a contributory mortgage scheme, after being approached by Clode seeking a loan that was beyond SRL's prudential limits;
     2. SRL actively sought out a registered contributory mortgage broker to "administer" the scheme. The evidence shows that two registered brokers were approached. The plan was formulated in its early stages without the involvement of any specific registered broker;
     100. SRL remained closely involved with many aspects of the scheme throughout its formulation and the ensuing offer process. It corresponded with the borrower about its development plans, about the need to provide a valuation report, and about progress of the fundraising. It was involved in settling the terms of the loan offer. MFL treated SRL as having the power to decide on critical terms of the loan, particularly the Clode Consulting Limited guarantee. The MGC valuation review and the quantity surveyor's reports were sent to SRL. It attended, and initiated, meetings with the borrower and MFL, both before and after the public offer commenced;
     4. as well as acting in its own right in relation to the scheme, SRL says that it also acted as MM's agent. By virtue of this agency relationship, as well as the other matters referred to below, MM was involved in the formulation of the scheme;
     5. MM had exclusive rights to market the offer. This was an integral feature of the scheme. Contributors could not invest in the mortgage other than through MM. The Commission is satisfied that MFL's appointment as broker was effectively conditional upon MM having those exclusive rights;
     6. when less than half of the funds had been raised a few days before the offer was due to close, it was MM that decided to extend the offer rather than withdraw it and return contributions already received;
     7. MM provided a promissory note which, the parties believed, had the effect of allowing the project to commence. MM internal correspondence indicates that it also had the effect of allowing the fundraising to continue.
124. The Commission considers that, on all the evidence, SRL and MM were not only instrumental in, but integral to, the formulation of the plan. The Commission considers that the nature and extent of the involvement of SRL and MM was such that it is unlikely that the particular scheme would have proceeded if either of them had withdrawn their support.
125. As stated above, the Commission rejects the "power of control or veto" test proposed by SRL and MM. However, if that test did apply, the Commission would consider that it would be satisfied in this case, in that the evidence indicates that both SRL and MM did have the power to control and to veto the scheme.
126. The definition of "promoter" excludes a person acting solely in their professional capacity. This exclusion would apply, for example, to a lawyer who advised on legal structuring and compliance, or an accountant who prepared any financial statements. It is likely also to apply to an introducing broker and to an investment adviser or broker who agreed to market the securities to its clients.
127. However, in this case the Commission has formed the view that the extent and nature of the involvement of MM and SRL in the formulation of the plan including the offering process, meant that they were not acting solely in their professional capacity in relation to the Parliament Street mortgage.
128. For these reasons, the Commission has formed the opinion that SRL and MM were promoters of the Parliament Street contributory mortgage. By definition, the directors of SRL were also promoters of the offer. If the Commission's conclusion that MM was an issuer are correct, the directors of MM were not promoters because the definition of "promoter" in section 2 of the Securities Act excludes the directors of the issuer.

UPDATE

129. The Commission understands that the borrower has arranged an alternative source of finance for the Parliament Street development. Crichton Horne & Associates has informed the Commission that it will contact contributors as soon as it can with regard to repayment of their capital and any interest.

ACTIONS

130. The Companies Office, headed by the Registrar of Companies, is the primary enforcement agency in respect of the securities laws. The Commission will refer its report in this matter to the National Enforcement Unit of the Companies Office for it to consider whether to lay any criminal charges in respect of the breaches of the law identified in this report.
131. As noted earlier in this report, the Commission is of the view that MM falls within the definition in the Securities Act of "contributory mortgage broker". We have also noted that the Commission has made orders under section 44B of the Securities Act removing MFL as contributory mortgage broker for the Parliament Street mortgage. The Commission has notified MM of a meeting at which it will consider whether or not to exercise any of its powers under section 44B in respect of MM. MM may choose to appear and to be legally represented at that meeting. The Commission may make section 44B orders where it is satisfied that a broker has contravened the Securities Act or regulations and that it is desirable in the public interest to make the orders. The Commission will be considering those matters at the meeting.

RECOMMENDATIONS

132. The Commission understands that there is a practice that a valuer is instructed by the borrower rather than the lender. Contributory mortgage brokers may wish to consider whether they should take a more active role in dealing with valuers. It is the broker and its directors who are responsible under the law for ensuring that their offer documents comply with all applicable laws. It is they who may be liable to compensate anyone who suffers loss as a result of any failure to comply.
133. The BBJ valuer in this case has said that "a clear and direct line of responsibility between the broker and the valuer is essential in order to establish clear instructions and terms of valuation requirements, and to prevent an inappropriate use of valuations compiled for other purposes".
134. As a result of this inquiry, and Commission reviews of other contributory mortgages, the Commission will write to the New Zealand Property Institute asking that they remind all their members of the need to comply with the Contributory Mortgage Regulations, and note that valuers risk civil liability under section 57 of the Act if they fail to so comply.

APPENDIX A

The Promissory Note

(This is a reproduction of the promissory note signed by D. Somers-Edgar and dated 28th September 2001)

PROMISSORY NOTE

From: Money Managers Limited

To: Mortgage Financier Nominees Limited

We the undersign promise to raise funds to the quantum amount of $27,000,000.00. Such funds represent the full subscription to the loan of $27,000,000.00 to be incrementally advanced to 1 Parliament Street Limited.

We undertake to make good our promise incrementally by or before Friday 29 March 2002.

Authorised signatures

Name

Date 28 September 2001

APPENDIX B

Exchange of correspondence between the Commission and Money Managers Limited

22 - 26 March 2002

(These letters are reproductions of this correspondence)

Ref: 340-320 / #36768

22 March 2002

Lowndes Jordan
Barristers & Solicitors
Facsimile : (09) 309 1445
AUCKLAND

Attention: Alan Webb

1 PARLIAMENT STREET CONTRIBUTORY MORTGAGE

We refer to paragraphs 8.18 to 8.34 of the submissions of Mr Somers-Edgar, Money Managers Limited and Securities Registry Limited. The unequivocal commitment of Money Managers to pay any shortfall in the full amount of the loan on or before 29 March 2002 is important to the Commission's consideration of this matter.

In paragraph 10.3 of the submissions your clients propose that "MFL should be required to obtain a further valuation and post it to investors with an explanatory letter and the option to withdraw their investment".

Would you please confirm that the effect of these submissions is that Money Managers will make good any shortfall in the $27 million remaining after contributors have decided whether or not to withdraw their investment. In other words, please confirm that Money Managers agrees that its obligations under the promissory note will extend beyond 29 March until such time as contributors have decided whether or not to withdraw.

Please confirm your clients' position by 5pm Monday 25 March 2002.

We note that the Confidentiality Orders in this matter remain in force.

Yours faithfully
Kathryn Rogers
Senior Solicitor

26 March 2002

Securities Commission
PO Box 1179
WELLINGTON

Attention: Kathryn Rogers

Facsimile: 04 472 8076

1 PARLIAMENT STREET CAR-PARK LIMITED - CONTRIBUTORY MORTGAGE

Thank you for your facsimile dated 22 March 2002.

When Mr Somers-Edgar (DSE) signed the promissory note (PN) on behalf of Money Managers Limited (MM), he was confident that MM would have no difficulty in raising the funds for the Parliament Street contributory mortgage (PSM) - see clauses 8.30 and 8.31 of our submissions.

Therefore, whilst an objective assessment shows that the PN imposed an unconditional promise by MM to pay any shortfall of funds, DSE's subjective assessment at the time he signed the PN was that he did not believe that MM would have any obligation to pay any shortfall (as the funds would easily have been raised by MM).

This assessment demarcation is important as neither DSE nor MM resile from the position adopted in our submissions and do not believe that they have any obligation to meet any shortfall.

However, in order to assist the Commission and a speedy resolution of this matter, MM is prepared to confirm that it will... make good any shortfall in the $27 million remaining after contributors have decided whether or not to withdraw their investment on the following terms:

1. MM is agreeing to assist the Commission resolve this matter expeditiously;
2. This represents an additional obligation on MM, and one that was not in place when DSE signed the PN;
3. This assistance will resolve the matter and there will be no outstanding issues between the Commission and DSE, MM or Securities Registry Limited. We are sure you will understand that noting this condition is not to influence the Commission's regulatory role in any way, but is simply to clarify what MM has taken from your letter of 22 March 2002 that in the light of the above indications, this may well resolve the matter. This is the basis on which MM has proceeded to provide the commitment to make good any shortfall set out in this letter; and
4. That there be no indication to investors that if they require the return of their investment, that any shortfall will be met by MM.

We look forward to hearing from you.

Yours faithfully
LOWNDES JORDAN

Alan Webb
Solicitor

Ref: 340-320 / #36836

26 March 2002

Lowndes Jordan
Barristers & Solicitors
PO Box 5966
AUCKLAND

Attention: Alan Webb

By facsimile: 09 309 1445

1 PARLIAMENT STREET CAR-PARK LIMITED CONTRIBUTORY MORTGAGE

We refer to your facsimile of today's date.

We note your statement that "This demarcation assessment is important as neither DSE nor MM resile from the position adopted in our submissions and do not believe that they have any obligation to meet any shortfall".

It is not clear to us how your clients can both stand by their submissions, and also believe that they have no obligation to meet any shortfall. Your clients' submissions stated that "It is accordingly an unconditional promise to pay this shortfall" (para 8.24), and "MM must make good its promise by the payment of money" (para 8.27). They also stated that "the parties' intentions when signing the PN are immaterial"(para 8.22).

With regard to your numbered paragraphs, the Commission will not enter into any discussion, or consider any proposals, which would imply a constraint on the Commission's powers to properly address the issues raised in its inquiry.

Yours faithfully
Kathryn Rogers
Senior Solicitor