The FMF debacle

The collapse of FMF Capital and its pending delisting from the Toronto Stock Exchange should be generating more interest, and public indignation, than it has so far. Canadian investors have lost almost $200 million in this debacle, yet no one seems to be doing anything to find out why. Where is the Ontario Securities Commission when we need it?

I have been watching the FMF situation for some time (we never recommended this company, just to keep the record straight), wondering when regulators were going to announce they would take a close look at what has happened here. So far, there has been nothing.

Last week, I received an e-mail from a member who was extremely upset about FMF and wanted to know about redress. I have edited his remarks for legal reasons but you’ll get a pretty good idea of his views from this abridged version:

“FMF.UN came to the TSX about two years age at $10. The way I understand it, a short time later the promoters (owners) of the company stopped distributions. Now the company is worthless and is being delisted from the TSX. Many honest people lost money.

“Do investors have any recourse here? Should not the TSX or the Ontario Securities Commission have some responsibility for allowing this company onto the TSX? Can they be sued? Who checks who is allowed to sell onto the market? Don’t they have insurance for such cases?” – Nachum L.

In fact, some investors in Quebec, Ontario, and Michigan launched class-action suits against FMF last year. The company announced in November that an out-of-court settlement had been reached with the plaintiffs, but no details were released and the company said in a statement that “There can be no assurance that the settlement will be approved by the courts. Neither FMF Capital Group Ltd. nor its directors will pay any part of the settlement amount.”

FMF Capital Group is a Delaware-incorporated company that is headquartered in Southfield, Michigan with branch offices in Nashville, Tennessee and Virginia Beach, Virginia. While the company was active, it operated in 39 U.S. states, using a network of 4,400 mortgage brokers.

FMF was sold under prospectus in Canada in early 2005 as an Income Participating Security (IPS) – not an income trust as has been incorrectly reported. The company was involved in residential mortgage lending in the U.S., primarily in the troubled “sub-prime” market. It would originate mortgage loans for people who could not qualify through the banking system because of poor credit and then resell the loans to institutional purchasers within an average of 39 days of funding. The U.S. sub-prime market has taken a severe beating in recent weeks, to the point where it threatened to drag down the major indexes with it. However, FMF’s troubles date back virtually to the time it went public in Canada.

When FMF was brought to market here, it was promoted by a Michigan firm, Michigan Fidelity Acceptance Corporation (MFAC). The final prospectus covering the terms of the offering contains the following legal references to the companies:

“…it may not be possible for investors to collect from MFAC judgments obtained in Canada predicated on the civil liability provisions of securities legislation of certain of the provinces and territories of Canada. There can be no assurance of recovery by an IPS holder from MFAC for judgments obtained in courts in Canada predicated on the civil liability provisions of securities legislation of certain of the provinces and territories of Canada, or (ii) the Issuer from MFAC for any breach of the representations and warranties provided by MFAC under the Acquisition Agreement, as there can be no assurance that the assets of MFAC will be sufficient to satisfy any such liability or contractual obligations set out in the Acquisition Agreement.”

In other words: buyer beware!

FMF’s IPO price was $10 a share and the company sought to raise almost $200 million. The shares began trading in spring 2005 and almost immediately fell below the offering price. FMF was trading at around $6 when the company announced the suspension of distributions in November 2005. Predictably the shares plunged, falling to about $1. They continued to drift lower after that. When the TSX announced on March 6 that trading in the stock was being suspended pending delisting, the shares were trading at 6c. Three days later, FMF announced it is winding down its business, saying in a statement: “This decision by the Company was made as a result of the continuing rapid and severe deterioration of the U.S. nonprime mortgage industry and other factors affecting its overall nonprime mortgage business.” The move came after FMF reported a third quarter (October-December) loss of US$23.6-million, which included a US$22.6-million write-off of intangible assets and goodwill.

Investors were warned of the possibility of trouble down the road at the time FMF went public. The offering prospectus contains about a dozen pages of risk warnings. However, they are buried deep within the document (starting at page 122) and many are the boiler-plate kind of stuff that you’ll read in any prospectus. Few investors would even look at them and would instead rely on guidance from their advisors and/or the reputation of the underwriters.

And who were the underwriters that brought this company to the Canadian market? The group was led by BMO Nesbitt Burns, which owns the trademark for the term “Income Participating Security”. Other participants, as listed in the prospectus, were National Bank Financial Inc., TD Securities Inc., Canaccord Capital Corporation, First Associates Investments Inc., and Sprott Securities Inc. As far as I can determine, none of them have had anything to say about this debacle, however if pressed to the wall I expect they will claim they did the appropriate due diligence and say that they cannot be held responsible for the subsequent collapse of the U.S. sub-prime market. Questions could also be leveled at the TSX for approving the listing, but we would undoubtedly get the same sort of response from them.

The most appropriate forum for finding out what really happened here is, I suggest, an inquiry by the Ontario Securities Commission, preferably held in public. Until now, I have not heard any suggestion that this is in the cards. I talked to a spokesperson at the OSC on Friday who simply said that the Commission doesn’t comment on companies that may or may not be under review. Big help that is!

FMF Capital is just one of a number of U.S. companies that have listed on the TSX, many as IPS or similar-type securities. As far as I know, none of the others are in deep trouble, however the FMF experience suggests we should take a closer look at this practice in general and, in particular, at exactly why this offering was ever approved for sale.

This article originally appeared in the Internet Wealth Builder, a weekly e-mail newsletter that provides timely financial advice from some of Canada’s top money experts. For more information about becoming an Internet Wealth Builder member, go to http://www.buildingwealth.ca/promotion/50plusproducts.htm