REGARDING the Mortgage Brokerages, Lenders and Administrators Act, 2006, S.O. 2006, c.29, in particular sections 38 and 39,

AND REGARDING Hi-Rise Capital Ltd.

AND REGARDING Jim Neilas

NOTICE OF PROPOSAL TO REVOKE LICENCES

NOTICE OF PROPOSAL TO IMPOSE ADMINISTRATIVE PENALTIES

TO:
Hi-Rise Capital Ltd.
130 King Street West, Suite 1800
Toronto, ON M5X 1E3

AND TO:
Dimitrios (“Jim”) Neilas
200 Adelaide Street West, Suite 401 Toronto,
ON M5H 1W7

NOTICE OF PROPOSAL TO REVOKE LICENCES

Section 19 of the Mortgage Brokerages, Lenders and Administrators Act, 2006 (“the “Act”) provides that the Superintendent of Financial Services may, by order, revoke a licence in certain specified circumstances.

Section 21 of the Act provides that if the Superintendent proposes to revoke a licence without the licencee’s consent, the Superintendent shall give written notice of the proposal to the licencee, including the reasons for the proposal.

TAKE NOTICE THAT pursuant to sections 19 and 21 of the Act, the Superintendent is proposing to revoke the mortgage brokerage licence of Hi-Rise Capital Ltd. The reasons for this proposal are described below.

TAKE NOTICE THAT pursuant to sections 19 and 21 of the Act, the Superintendent is proposing to revoke the mortgage administrator licence of Hi-Rise Capital Ltd. The reasons for this proposal are described below.

NOTICE OF PROPOSAL TO IMPOSE ADMINISTRATIVE PENALTIES

Section 39 of the Mortgage Brokerages, Lenders and Administrators Act, 2006 (“the “Act”) provides that the Superintendent of Financial Services may impose an administrative monetary penalty on a person or entity if the Superintendent is satisfied that the person or entity has contravened or failed to comply with a requirement established under the Act.

Section 39 of the Act also provides that if the Superintendent proposes to impose such a penalty, the Superintendent shall give written notice of the proposal to the person or entity including details of the contravention or failure to comply.

TAKE NOTICE THAT pursuant to section 39 of the Act, the Superintendent is proposing to impose administrative penalties in the amount of $3,175,000.00 on Hi- Rise Capital Ltd.. Details of this contravention or failure to comply are described below.

TAKE NOTICE THAT pursuant to section 39 of the Act, the Superintendent is proposing to impose administrative penalties in the amount of $1,320,000.00 on Jim Neilas. Details of this contravention or failure to comply are described below.

Si vous désirez recevoir cet avis en français, veuillez envoyer votre demande immédiatement à: Adjointe, audiences, Greffe, Commission des services financiers de l’Ontario, 5160 rue Yonge, boîte 85, Toronto ON M2N 6L9.

AND TAKE NOTICE THAT pursuant to subsections 21(3), 39(2) and 39(5) of the Act, a hearing before the Financial Services Tribunal about this proposal may be requested by completing the enclosed Request for Hearing (Form 1) and submitting it to the Tribunal within 15 days after this notice is received. A copy of that form is included with this notice. Additional copies can be obtained by visiting the Tribunal’s website at www.fstontario.ca.

If a written request for a hearing is made within 15 days, subsections 21(3), 21(4), 39(5) and 39(6) of the Act provide that the Tribunal shall hold a hearing and decide whether or not to direct the Superintendent to carry out the proposal to revoke licences and impose penalties, with or without changes, or substitute its opinion for that of the Superintendent, and the Tribunal may impose such conditions as it considers appropriate in the circumstances. If after a hearing, a penalty is ordered against a person, TAKE NOTICE of the payment requirements in subsection 4(2) of Ontario Regulation 192/08, which states that the person or entity shall pay the penalty no later than 30 days after the matter is finally determined or such longer time as may be specified in the order.

If no Request for Hearing (Form 1) is submitted to the Tribunal within 15 days after the Notice is received, TAKE NOTICE THAT the Superintendent will carry out the proposal to revoke the mortgage brokerage licence of Hi-Rise Capital Ltd., the mortgage administrator licence of Hi-Rise Capital Ltd., and the mortgage broker licence of Jim Neilas.

If no written request for a hearing is made within 15 days after this Notice is given, TAKE NOTICE THAT the Superintendent will carry out the proposal to impose the penalties described above pursuant to subsection 39(7) of the Act. TAKE FURTHER NOTICE of the payment requirements in subsection 4(1) of Ontario Regulation 192/08, which states that the penalized person or entity shall pay the penalty after the person or entity is given notice of the order imposing the penalty or such longer time as may be specified in the order.

Completed Request for Hearing Forms must be received by the Tribunal within 15 days after this notice is given. They may be mailed, faxed or delivered:

TO:
Financial Services Tribunal
5160 Yonge Street, 14^th Floor, Box 85
Toronto ON M2N 6L9

Attention: Registrar

Fax: 416-226-7750

AND TO:
Superintendent of Financial Services
Regulatory Discipline Officer Licensing and Market Conduct Division
5160 Yonge Street, 4^th Floor, Box 85
Toronto ON M2N 6L9

Fax: 416-590-7070

The hearing before the Tribunal will proceed in accordance with the Rules of Practice and Procedure for Proceedings before the Financial Services Tribunal, made under the authority of the Statutory Powers Procedure Act, R.S.O. 1990, c. S. 22. Those Rules are available at the website of the Tribunal: www.fstontario.ca. Alternatively, a copy can be obtained by telephoning the Registrar of the Tribunal at 416-590-7294, or toll free at 1-800-668-0128 ext. 7294.

At a hearing, your character, conduct and/or competence will be in issue. You may be furnished with further and or other particulars, including further or other grounds, to support this proposal.

REASONS FOR PROPOSAL TO REVOKE AND DETAILS OF CONTRAVENTION OR FAILURE TO COMPLY

I. INTRODUCTION

1. These are the reasons to support the Superintendent’s Notice of Proposal to revoke the mortgage brokerage licence and the mortgage administrator licence of Hi- Rise Capital Ltd. (“Hi-Rise”), and to impose Administrative Penalties in the amounts of $3,175,000.00 against Hi-Rise and $1,320,000.00 against Jim Neilas.


2. Hi-Rise acts as the mortgage brokerage and administrator for syndicated mortgage loans (“SMLs”) under which consumer investors are lenders (the “Investors”). Since 2011, the SMLs which Hi-Rise brokers and administers (“Hi-Rise SMLs”) are in respect of real estate development projects owned by development corporations in which Jim Neilas holds at least a controlling interest. Jim Neilas is also the sole owner of Hi-Rise and was, until the intervention of the Financial Services Commission of Ontario (“FSCO”), its sole director and principal broker. Prior to January 2017, Jim Neilas was also the CEO, President and Secretary of Hi-Rise.


3. FSCO has received approximately 40 complaints against Hi-Rise and Jim Neilas since 2015. FSCO Staff conducted an onsite examination of Hi-Rise in the fall of 2015 (the “2015 Examination”). More recently in 2017, FSCO Staff requested a large volume of additional material to assess Hi-Rise’s business practices and compliance with the Mortgage Brokerages Lenders and Administrators Act, 2006 (the“Act”). This material was reviewed by FSCO Staff. FSCO also retained Farber Financial Group and GlassRatner Advisory & Capital Group LLC (together “Farbers”) to assist with the review especially as it related to Hi-Rise’s mortgage administration activities and project performance and feasibility issues.


4. In 2018, FSCO Staff conducted a desk examination of Hi-Rise SMLs brokered after the 2015 Examination (the “2018 Examination”) to determine, in part, whether the findings of the 2015 Examination were adequately addressed by Hi-Rise. As part of the 2018 Examination, 11 Investor files brokered by Hi-Rise were reviewed.¹ The review of the materials gathered in 2017 and the 2018 Examination are referred to herein as the “Review”.


5. The findings from the Review reveal that the Hi-Rise SML transactions are defined by self-dealing and conflict of interest. In its capacity as mortgage brokerage, Hi-Rise’s point of sale business practices reveal serious and systemic failures to comply with the basic consumer protection measures set out in the Act. Further, in its capacity as mortgage administrator, Hi-Rise has failed to comply with a separate and further set of regulatory and fiduciary obligations to Investors to administer and enforce the Hi-Rise SMLs solely in the best interest of Investors.


6. These contraventions of regulatory and fiduciary requirements, whether by design or not, operate to the benefit of the ultimate beneficial owner of the development corporations, Jim Neilas. Specifically, various loan agreements between the entities owned by Jim Neilas (“Neilas Related Entities”) authorized fees greater than $55 million which were funded out of the SMLs. For some of these developments, little material progress has been made and the project economics suggest that the successful completion of the project is unlikely. For example, for the Oakville Project, the related party fees were estimated at almost $24 million or about 50% of total SML raise.


7. While Hi-Rise and Mr. Neilas have afforded some degree of disclosure regarding Jim Neilas’s conflicts, this disclosure fails to meet the high standard imposed on a fiduciary to obtain informed consent of beneficiaries to related party transactions.


8. The Review reveals that Hi-Rise and Jim Neilas have committed multiple breaches of the Act and have not conducted themselves in accordance with the law and with integrity and honesty and will not do so in the future.


9. Accordingly, there is sufficient basis to revoke of licences of Hi-Rise and Jim Neilas and to impose administrative penalties on Hi-Rise and Mr. Neilas as set out in more detail below.



II. THE PARTIES

(a) HI-RISE

10. Hi-Rise is a corporation incorporated in Ontario on June 11, 1999. Its head office is located at 200 Adelaide Street West. Jim Neilas currently owns 100% of the Hi-Rise although his shares are currently held in trust pursuant to certain arrangements entered into in late 2017 and described in more detail below. Prior to January 2017, Jim Neilas was the CEO, President and Secretary and sole director of Hi-Rise. Effective February 13, 2017, Michael Kraft was appointed CEO of Hi-Rise. Peter Neilas (Jim Neilas’s brother) has been the Chief Financial Officer of Hi-Rise since February 13, 2017. Peter Neilas holds a mortgage broker licence (licence number M12001884) which expired on March 31, 2018. The licence continues in force after the expiry date because Peter Neilas applied to renew it prior to its expiry. The renewal application is currently pending.


11. Hi-Rise holds both a mortgage brokerage licence (licence #10897) and a mortgage administrator licence (licence #11893).


12. Jim Neilas held a mortgage brokers licence until March 31, 2018 when his then existing licence expired and he did not apply to renew it. Until December 11, 2017, Jim Neilas was Principal Broker of Hi-Rise. As is described in more detail below, Jim Neilas resigned this position on December 11, 2017 at which time Noor Al-Awqati assumed the role of Principal Broker.


13. Hi-Rise was named Waterview Capital Corporation (“WCC”) from September 16, 2004 to August 18, 2011 when it changed its name to Hi-Rise Capital Limited. Prior to April 25, 2011, WCC was registered as an exempt market dealer under the Securities Act and Jim Neilas was WCC’s Ultimate Designated Person.


14. On April 25, 2011, the registration of WCC and Jim Neilas were both suspended on the basis of a number of identified contraventions of the Securities Act including the failure to maintain know your client forms for some investors, selling units to an investor who did not qualify as an accredited investor, and the failure to disclose the relationship between WCC and a related-party entity. In suspending the licences, the Ontario Securities Commission concluded that WCC and Neilas engaged in a pattern of non- compliance that is not appropriate for registrants.


15. As at September 20, 2017, Hi-Rise was the mortgage brokerage acting on behalf of the borrower/developer, the mortgage brokerage acting on behalf of Investors and the mortgage administrator for five syndicated mortgages relating to five real estate development projects (the “Hi-Rise Projects”) as follows:

    Municipal Address	Project Name	Development Corporation
    40-58 Widmer Street, Toronto	Widmer	40 Widmer Street Inc.
    263 Adelaide Street West, Toronto	Adelaide Street Lofts (“Adelaide”)	Adelaide Street Lofts Inc.
    1249 Queen Street East, Toronto	Stage East Lofts (“Queen”)	1249 Queen E. Inc.
    54 & 60 Shepherd Road, Oakville	OpArts Lofts (“Oakville”)	54 Shepherd Road Inc. (amalgamated with 60 Shepherd Road Inc. on October 20, 2016)
    799 College Street, Toronto	Cube Lofts (“College”)	799 College Street Inc.



16. On August 10, 2017, the property for the Queen project was sold by 1249 Queen E Inc. prior to the commencement of the construction of the project. The sale proceeds are being distributed to Queen Investors by Hi-Rise. The syndicate mortgages registered against the Queen property included both a first and second mortgage. For Investors under the first mortgage, total recoveries for Investors will be approximately 53% of the principal amount of the investment (approximately 81% if interest payments made to Investors during the term of mortgage are counted as payments against the principal amount of the loan). Subject to certain amounts payable pursuant to a cross- guarantee on the College property, recoveries for Investors under the second mortgage will be nil.


17. On December 19, 2017, the undeveloped Widmer property was sold. The sale proceeds were sufficient to pay Widmer Investors in full.


18. The Adelaide and Oakville properties have not yet been sold and losses that investors may experience have yet to crystalize. Investors will likely experience significant losses upon the final disposition of these properties, particularly for the Oakville Project.



(B) THE DEVELOPERS

19. As described by Hi-Rise, a corporation called Neilas Inc. plays the role of developer on all of the Hi-Rise Projects. As at March 31, 2017, Jim Neilas wholly owned Neilas Inc. Jim Neilas is the sole director and officer of Neilas Inc. Hi-Rise has advised that John Neilas (Jim Neilas’s brother) acquired a 40% interest in Neilas Inc. subsequent to March 31, 2017.


20. Neilas Inc. owns 100% of the shares of the five development corporations listed above at paragraph 15 (the “Development Corporations”) for each Hi-Rise Project which holds title to the actual parcel of land (in at least some cases, on behalf of and for the benefit of Neilas Inc. pursuant to a trust or nominee agreement). The Development Corporations are also the borrowers under the Hi-Rise SMLs.


21. Consequently, Jim Neilas and his brother John are the full beneficial owners of the Development Corporations through their interest in Neilas Inc. In addition, Jim Neilas is the sole director of Adelaide Street Lofts Inc., 1249 Queen E. Inc., and 54 Shepherd Road Inc. Jim is also the sole officer for Adelaide Street Lofts Inc. and 1249 Queen E. Inc.. 54 Shepherd Road Inc. has no officers. John Neilas is the sole director and officer of 799 College Street Inc. Jim and John Neilas are the directors and officers of 40 Widmer Street Inc.


22. Further, Jim Neilas is the sole owner, director and officer of AW General Contractors Inc. (“AW”). AW was retained to perform construction management services on a number of the Hi-Rise Projects, including Oakville, College, Queen and Widmer. AW was paid construction management fees out of SML funds raised from Investors. AW operated under the name Skypoint Hi-Rise Ltd. prior to November 2, 2015.



(C) RELATIONSHIPS BETWEEN THE PARTIES

23. In summary prior to late 2017, entities controlled and owned by Jim Neilas (either wholly or in conjunction with his brother John Neilas) performed a number of conflicting roles in respect of Hi-Rise SMLs as follows:
    
    
    1. Hi-Rise is the brokerage that brokers the Hi-Rise SMLs on behalf of the Development Corporations that are the borrowers under the SMLs. Hi- Rise also brokers the SMLs on behalf of Investors. Consequently, Hi- Rise brokers both sides of the Hi-Rise SML transactions.
    
    
    2. Hi-Rise holds the syndicate mortgages in trust for the Investors and is the mortgage administrator for the Hi-Rise SMLs. As such, Hi-Rise acts in a fiduciary capacity and is required to enforce the Hi-Rise SMLs against the borrowers, which are the Development Corporations. Consequently, one Jim Neilas owned and controlled entity, Hi-Rise, is required to enforce the Hi-Rise SMLs as against other Jim Neilas owned and controlled entities, the Development Corporations;
    
    
    3. The Development Corporations and Neilas Inc. together have title and beneficial ownership of the properties and act as the developer of the Hi- Rise Projects and are the borrowers under the Hi-Rise SMLs.
    
    
    4. AW acts as construction manager on Hi-Rise Projects and is paid fees in this capacity out of SML funds raised from Investors.
    
    


24. As described in more detail below, the Neilas Related Entities identified above were authorized under various loan agreements to collect separate fees and payments in respect of the roles played in the Hi-Rise Projects out of the funds raised from Investors in advance of monies being paid to the borrowers. The amounts of these fees are significant, estimated to be in excess of $55 million. In a number of notable instances, the fees paid to Neilas Related Entities by Hi-Rise are materially in excess of the amounts which Hi-Rise disclosed would be paid in the disclosure provided to Investors. For instance, for the Adelaide Project, the Development Fee disclosed to investor PT was 1% of total project cost; however, the Development Fee paid to Neilas Inc. was $3,432,667, approximately 5% of the total project cost as at December 31, 2017. In addition, in a number of cases, these fees exceed the amounts which are contractually authorized under the agreements entered into by the Investors. For example, a marketing fee of $68,820 was paid to Hi-Rise for the Queen Project. This marketing fee was not disclosed to investors and FSCO Staff determined there was not a contractual basis for its payment.



(D) CHANGES TO THE STRUCTURE OF HI-RISE BASED ON FSCO INTERVENTION

25. In September 2017, FSCO Staff approached Hi-Rise to provide submissions responding to a draft report prepared by Farbers (the “Draft Farbers Report”) outlining certain preliminary findings concerning Hi-Rise’s business activities, the structure of Hi-Rise SMLs and the financial viability of the Hi-Rise Projects.


26. In response, Hi-Rise advised, among other things, that it had ceased brokering SMLs to raise funds to support development activities as of June 2017. Hi-Rise has advised that its decision was based on its assessment of the SML market.


27. On October 20, 2017, Hi-Rise provided, at the request of the Superintendent, an Undertaking under the Act to cease dealing or trading in mortgages.


28. Based on the concerns raised in the Draft Farbers Report and otherwise by FSCO Staff, Hi-Rise and Jim Neilas implemented, in late 2017 and early 2018, certain corporate changes to Hi-Rise to mitigate the control which Jim Neilas exercised over Hi-Rise. Specifically, as of November 30, 2017, Jim Neilas resigned as director, President and Secretary of Hi-Rise and Michael Kraft was appointed President and Secretary of Hi-Rise and its sole director. In addition, Jim Neilas and Michael Kraft entered into a Blind Trust Agreement transferring the rights and entitlements of all issued and outstanding shares of Hi-Rise to Michael Kraft to be held in trust.


29. Further, Hi-Rise appointed two new independent directors (Myles Morin and Jordan Oxley) in early 2018. Consequent on the appointment of the new independent directors, Mr. Kraft resigned as a director of Hi-Rise on January 19, 2018.


30. While the Superintendent is of the view that changes to Hi-Rise’s corporate structure are insufficient to address the pervasive self-dealing inherent in Hi-Rise SML’s, the Superintendent relies primarily on events which occurred prior to September 2017 to support the sanctions proposed in this Notice of Proposal. The contraventions relied upon for the imposition of administrative monetary penalties in this Notice of Proposal were discovered by the Superintendent through a review of investor files provided by Hi-Rise on May 1, 2018, a review of the Hi-Rise policies and procedures provided by Hi-Rise on April 5, 2018, and from financial disclosures by Hi- Rise following the Draft Farbers Report.



III. HI-RISE SML DOCUMENTS

31. There are a number of documents which are entered into to execute the Hi-Rise SMLs.



(A) THE LOAN COMMITMENT

32. There are no detailed loan agreements documenting the terms of the Hi-Rise SMLs. Instead, a document referred to as a loan commitment (the “Loan Commitment”) is entered into as between Hi-Rise, identified as the “lender”, and the specific Development Corporation which is the borrower under the SML.


33. The various conflicting roles played by Jim Neilas in the Hi-Rise SMLs is aptly illustrated by the fact that Jim Neilas often signs the Loan Commitment on behalf of all parties (including both borrower and lender) although they are on opposite sides of the transaction.


34. The term of the SML under the Loan Commitment is typically 48 months. In some cases, the term of the SML may be extended at the request of the Development Corporation upon approval by Hi-Rise. There is no requirement to make payments against the principal prior to the end of the term of the loan.


35. The Loan Commitment provides for the payment of interest typically at a rate of 12 to 18 percent per annum. Often, the Loan Commitment allows the Development Corporation to defer interest payments, either in whole or in part, without such deferral constituting a default on the SML.


36. The Loan Commitments generally have terms which are heavily weighted in favour of the Borrower and lack the protection and remedies which are typical of the loan agreements in the real estate development context entered into between arm’s length commercial parties including provisions dealing with events of default and remedies available on default.


37. The Loan Commitments also provide for a number of fees to be paid to Hi-Rise by the Development Corporations. The fees payable vary in each Loan Commitment but the Loan Commitments generally require the Development Corporations to pay Hi- Rise a “Commission” or “Lender Fee” of 14 percent of the gross amount of the loan and a “Marketing Fee” of 2 percent of the gross amount advanced under the SML. In some Hi-Rise Projects, Hi-Rise charges additional fees. For instance, the Loan Commitment for Widmer provided for a $150,000 “non-refundable syndication fee” and a further $300,000 (also referred to as a “lender fee”) in addition to the fees previously noted. These fees are typically payable on or before the principal is advanced to the Development Corporation. As the Development Corporations do not have substantial liquid assets or income prior to the completion of the Hi-Rise Projects, these fees are paid from the money advanced through the SMLs.



(B) THE TRUST AGREEMENT, MORTGAGE ADMINISTRATION AGREEMENT AND LOAN PARTICIPATION AGREEMENT

38. 38. In order to invest in a Hi-Rise SML, each Investor enters into a Trust Agreement (the “TA”) or Mortgage Administration Agreement (the “MAA”). Although these documents have different titles, the substantive content of each is substantively similar. Hi-Rise is identified as the Trustee under the TA/MAA. The Beneficiary is identified as either the Investor directly (for cash investments) or, in some cases, the financial institution holding the registered account (for investments funded through a registered account). The TA/MAA indicates that Hi-Rise holds the investment “as trustee for the” Beneficiary.”


39. The TA/MAA also indicates that the “rights and obligations of the parties are more particularly set out” in a Loan Participation Agreement (“LPA”) which is attached to the TA/MAA. The LPA sets out the terms and conditions governing the relationship between Hi-Rise and the Investor. The LPA assigns to Hi-Rise mortgage administration functions including the remittance of payments made under the SML to Investors and the enforcement of the SML in the event of default.


40. The LPA is also heavily weighted against Investors. The LPA gives Hi-Rise complete discretion to take any action, including the renegotiation of the Loan Commitment in the event of default by the borrower. Further, the LPA provides: “The Participant expressly authorizes HRC to make all decisions and take any actions it may deem necessary to protect principal advanced under the Loan and enhance the value of the security including without limitation changing the nature and scope of the mortgage security.”


41. Furthermore, in the event of a default, the LPA provides Hi-Rise with the power to unilaterally renegotiate the terms of the loan without Investor consent. The LPA provides that, in the event of default on the Hi-Rise SML, Hi-Rise may “make such decisions, to take such action and exercise all such rights and remedies as HRC may, in its absolute discretion, deem advisable in the best interests of all Participants in the Loan, including the right to re-negotiate the Loan upon such terms as HRC shall deem advisable”. These provisions appear to grant broad powers for Hi-Rise to protect Investors, however, they have generally been used to authorize changes to the loan terms which operate to the benefit of the Development Corporations.


42. The LPA also establishes the rate of interest paid to the Investor. Typically, the interest rate for the investor is 10 percent per annum and there may be provision for 2 percent per annum as a bonus upon project completion.


43. The LPA is silent on the fact that Hi-Rise is entitled to collect 18 percent interest per annum under the Loan Commitment. In addition to not disclosing that Hi-Rise is receiving 8 percent more than investors per annum, the LPA does not provide any justification for these enhanced payments to Hi-Rise.


44. The LPA states the fees payable to Hi-Rise, Neilas Inc. or other related entities are as disclosed in the disclosure documentation provided to the Investor. However, as noted above, various fees, commissions and other payments are not disclosed to the investors.


45. Additionally, the LPA establishes substantial penalties for early redemption of the Hi-Rise SML of up to 25 percent of the amount redeemed and the forfeiture of any interest paid on the investment.



IV. CONTRAVENTIONS OF THE ACT

46. Hi-Rise has systemically contravened the Act in the brokering and administration of Hi-Rise SMLs. Hi-Rise has failed to observe the requirements of the Act designed to protect consumers and ensure that they have the appropriate information to make informed investment decisions. The contraventions alleged by the Superintendent against Hi-Rise are as follows.



(A) BROKERAGE FUNCTIONS

47. The following contraventions relate to Hi-Rise’s position as the mortgage brokerage in the Hi-Rise SML transactions.



Client Suitability and the Know Your Client Requirement

48. Hi-Rise failed to adequately assess client suitability for Hi-Rise SMLs.


49. Pursuant to subsection 24(1) of Ontario Regulation 188/08 (“Reg. 188”), a mortgage brokerage must take reasonable steps to ensure that any investment in a mortgage it presents to a lender or investor is suitable for the lender or investor having regard to the needs and circumstances of the investor.


50. The 2015 Examination revealed that Hi-Rise does not document steps taken by the agent/broker prior to completing the transaction to ensure investor suitability. Hi- Rise was not completing adequate Know Your Client (“KYC”) forms. The KYC forms that were completed did not include relevant information including: risk tolerance, investment objective, current portfolio and risk profile of current investments. There was no evidence of any analysis of the characteristics of the investment relative to the needs and circumstances of the Investors. The 2015 Examination is relevant for the purposes of revocation and to provide background for future contraventions.


51. Shortly after the 2015 Examination, Hi-Rise produced a more detailed KYC form. While the new KYC form addressed some concerns, the new KYC form (entitled “Investor Suitability Assessment Form”) was not used by Hi-Rise in the actual brokering of Hi-Rise SMLs until March 6, 2017, despite a commitment to do so in response to the 2015 Examination.


52. Further, even the new KYC form used after March 6, 2017 still does not collect information which would be required to determine that the SML was suitable for the Investor’s needs and circumstances. Furthermore, the new KYC form is based on a scoring system that is designed to generate the result that Hi-Rise SMLs are suitable investments for almost all Investors.


53. In all of the eleven files brokered by Hi-Rise sampled during the 2018 Examination,² the investor profile completed did not meet the KYC requirement to adequately assess the suitability of the investment. In seven files reviewed (TP, DR, NHM, DSD, RM, WP/GP, TP/RS), the new KYC form was not used. The KYC forms were the forms in use prior to the 2015 Examination. As a result, the KYC forms used in these seven files did not contain information reasonably required to assess investment suitability, including information such as the Investor’s total expenses, the Investor’s total assets, the Investor’s cash assets, the Investor’s liabilities, the Investor’s risk tolerance, the Investor’s time horizon, the Investor’s investment objective, the Investor’s short term financial requirements, whether the Investor intended to borrow to make the investment, whether the Investor is relying on the SML returns to fund immediate living expenses, the Investor’s financial situation, and the Investor’s preferred investment approach.


54. Hi-Rise could not have performed a reasonable suitability analysis without this information. Even in the remaining four files where the new KYC form was eventually used, the problems identified in paragraph 52 above prevent an adequate evaluation of the suitability of the investment.


55. The failure to take reasonable steps to ensure investment suitability resulted in situations where a Hi-Rise SML was brokered for Investors where the investment was demonstrably unsuitable in the case of ten of the eleven Hi-Rise brokered Investor files reviewed during the 2018 Examination.


56. Furthermore, the Hi-Rise SMLs were particularly unsuitable for Investors using registered funds. The LTV ratios for the Hi-Rise Projects typically exceeded 100 percent. In order for a debt obligation to be a qualified investment for a registered plan under the Income Tax Act, the debt obligation must be “fully secured”. Because the LTV ratios for Hi-Rise Projects exceeded 100 percent at the time the debt obligations were entered into, the Hi-Rise SMLs were not fully secured and were therefore non- qualified investments for registered plans under the Income Tax Act. Non-qualified investments held in registered plans are subject to significant negative tax consequences for the Investor and are clearly unsuitable.


57. The extent of risks associated with the use of registered funds for investment in Hi-Rise SMLs is significant. In the 2016-2017 period, approximately 70% of Investors were utilizing registered funds for the investment in the Hi-Rise SMLs.



Disclosure of Material Risks

58. Hi-Rise failed to adequately disclose material risks related to Hi-Rise SMLs.


59. Section 25 of Reg. 188 requires the brokerage disclose in writing to an investor, the material risks of each investment in a mortgage.


60. The Act creates a regime of advance disclosure. Disclosures are to be provided in advance of the Investors executing the documentation to enter into the transaction. The intent is that the Investor has an opportunity (2 days under section 36 of Reg. 188) to review and consider the characteristics and terms of the investment (including the material risks) before entering into the transaction. For this reason, the fact that certain aspects of the Hi-Rise SMLs which give rise to material risks are set out in the contractual documents the Investor executes to enter into the transaction does not constitute disclosure as required in the MBLAA.


61. In addition, Hi-Rise failed to disclose material risks of the Hi-Rise SMLs in all eleven files reviewed during the 2018 Examination. Specific risks of Hi-Rise SMLs include, but are not limited to, substantial default risk as the LTV ratio is above 100 percent of the current value of the property, risk of deregistration of registered funds due to holding noncompliant assets, subordination of Hi-Rise SMLs to subsequent financing and low likelihood of recovery if project was unsuccessful.


62. The 2018 Examination revealed that although some material risks are now disclosed in Declaration 12 in Section 2 of the Form 1, this disclosure is not sufficiently detailed or comprehensive to facilitate understanding by Investors. Material risks such as the taxation risk related to the use of registered funds, the risks posed by subordination of the Hi-Rise SML and the use of funds for start-up costs and soft costs, are not adequately disclosed to Investors by Hi-Rise. Nor are the risks associated with the challenging project economics which characterize Hi-Rise SMLs.


63. In addition, the risks arising out of the conflicts of interest and related-party transactions inherent in the structure of Hi-Rise SMLs were not disclosed. For example, the risks associated with the fact that Hi-Rise (a Neilas Related Entity) has exclusive legal authority to enforce the SMLs as against the Borrowers (other Neilas Related Entity) was not disclosed. Also, Hi-Rise did not disclose the fact that Hi-Rise was charged with the responsibility of ensuring that related-party payments of fees to other Neilas Related Entities were in accordance with the disclosure to Investors and the contractual terms governing such payments. Such risks were not merely speculative. A set out below, Hi-Rise permitted related party payments to Neilas Related Entities which exceeded the fee levels as disclosed and as permitted under the governing contractual documents.



Timing of the Delivery of Disclosure

64. Section 36 of Reg. 188 requires that disclosures be made at least two business days before the Investor enters into the SML transaction (subject to the completion of a waiver to reduce the waiting period to 1 day). In six (TP, PT, PD, PC, NHM, DR) of the eleven Investor files sampled during the 2018 Examination, HRC pre-filled the date of signature on behalf of the investor. As a result, FSCO was unable to confirm that Investor received the required waiting period.



Policies and Procedures

65. The Policies and Procedures of Hi-Rise are inadequate and non-compliant with the requirements under the Act. As can seen by the nature of the specific contraventions, the failure to ensure adequate policies and procedures led to many of the systemic compliance failures exhibited throughout the Hi-Rise SML process as evidenced in the specific Investor files reviewed by FSCO Staff.


66. Under section 40(1) of Reg. 188, the mortgage brokerage must establish and implement policies and procedures that are reasonably designed to ensure that the brokerage and every broker and agent comply with the requirements established under the Act. Pursuant to subsection 40(2) of Reg. 188, the mortgage brokerage must establish and implement policies and procedures that provide for the adequate supervision of mortgage brokers and agents.


67. Under section 2(1) of Ontario Regulation 410/07 (“Reg. 410”), the principal broker must take reasonable steps to ensure that the brokerage, and each broker and agent comply with every requirement established under the Act. Pursuant to subsection 3(1) of Reg. 410, the principal broker must review the policies and procedures of the brokerage to determine whether they are reasonably designed to ensure that the brokerage, and each broker and agent comply with every requirement established under the Act; and that each broker and agent is adequately supervised.


68. The Hi-Rise Policies and Procedures failed to ensure compliance with the requirements under the Act and adequate supervision of brokers and agents.


69. The Hi-Rise Policies and Procedures Manual does not provide adequate detailed information to ensure compliance with requirements under the Act when agents or brokers are dealing in syndicated mortgages. Under the heading “Syndicated Mortgages”, the December 8, 2017 Policies and Procedures Manual (“2017 Manual”) simply states: “HRC shall comply with all the duties and disclosures in this manual in respect to syndicated mortgages.”


70. The 2017 Manual does not provide sufficient detail and clarity with respect to the suitability determination. The 2017 Manual only provides the following guidance in performing the suitability analysis: “Except in the case where the lender is a financial institution, HRC shall take reasonable steps to ensure the investment is suitable for the prospective investor. This will include maintaining an understanding of the lending criteria of potential investors and a signed acknowledgement of those items which may be exceptions.” This passage does not provide adequate guidance to Hi-Rise employees assessing the suitability of Hi-Rise SMLs as investments for members of the public. For instance, it provides no guidance on how Hi-Rise agents should assess key aspects of a prospective investor such as their risk tolerance.


71. The 2017 Manual also fails to adequately detail the material risks involved in the Hi-Rise SMLs. For instance, the 2017 Manual does not list the potential general and specific risks of investing in Hi-Rise SMIs, nor does it provide information on how such risks are identified, analyzed and disclosed to Investors.


72. In addition, the December 2016 Policies and Procedures Manual and the 2017 Manual fail to reflect the new threshold for accepting advance payments or deposits in respect of services or fees in subsection 37 of Reg. 188 which came into force on January 1, 2016.


73. The numerous deficiencies identified indicate that Hi-Rise and Jim Neilas have failed to maintain Policies and Procedures that ensure compliance with the requirements of the Act and adequate supervision of agents and brokers.



Investor Disclosure of Conflicts of Interest and Related Party Payments

74. Hi-Rise did not adequately disclose the relationships and conflicts of interest between Hi-Rise and the other Neilas Related Entities.


75. Section 26(2) of Reg. 188 requires that a brokerage disclose in writing “the nature of the relationship between the brokerage and each borrower under a mortgage that it presents for the lender’s consideration”. Section 27(1) of Reg. 188 requires the mortgage brokerage to disclose to the Investor in writing “any conflict of interest or potential conflict of interest” that the brokerage or a broker may have in connection with a mortgage. Pursuant to section 33 of Reg. 188, this disclosure “must be expressed in plain language that is clear and concise and it must be presented in a manner that is logical and is likely to bring to the attention of the borrower, lender or investor, as the case may be, the information that is required to be conveyed.”


76. The Declarations in the mandated FSCO disclosure forms disclosed that Jim Neilas owned Hi-Rise, the Development Corporations and other Neilas Related Entities and that fees associated with the SML and profits if the project is successful were payable to these entities.


77. While these statements provide disclosure of Jim Neilas’ ownership of the borrower and Hi-Rise Capital Ltd., they failed to disclose Jim Neilas’ control over the Neilas Related Entities or the full range of fees payable out of the SMLs. Further, the disclosure did not address the substantive implications of Jim Neilas’ control over the parties. For instance, the disclosure did not advise Investors that the enforcement of the Hi-Rise SML against the Borrower (a Neilas Related Entity) was exclusively within the power of another Neilas Related Entity and that Hi-Rise would be responsible for monitoring related party fees payable to other Neilas Related Entities.



Form 1 and Form 1.1

78. Section 31(1) 1 of Reg. 188 requires that disclosure include “a completed disclosure form, in a form approved by the Superintendent, signed by a broker”. The relevant disclosure forms which were approved by the Superintendent during the period July 1, 2015 to June 30, 2018 are the Form 1 - Investor/Lender Disclosure Statement for Brokered Transactions (the “Form 1”) and the Form 1.1 - Investor/Lender Disclosure Statement For Brokered Transactions – Addendum for Construction and Development Loans (the “Form 1.1”). During the 2018 Examination, a number of contraventions were identified in the disclosure provided in Form 1 and Form 1.1 in Investor files examined by FSCO Staff, including inaccurate or incomplete related-party fee disclosure.



LTV Not Calculated on the Basis of the “as is” Value

79. In addition, in at least two Investor files (DR and NHM) reviewed during the 2018 Examination, the LTV presented is calculated on the basis of a “projected value” only rather than on the basis of the “as is” value of the property despite the clear requirements of the Form 1. Given importance of the current “as is” value of the property to mortgage lending decisions, these disclosure contraventions are significant.



Fee Disclosure

80. The Form 1 requires that the brokerage disclose the amount of fees and charges payable by the Investor and the fees and costs payable by the Borrower. Hi-Rise has failed to meet this requirement and is, therefore, in contravention of section 31(1) 1 of Reg. 188. In addition, such fees constitute information that an Investor of ordinary prudence would regard as material to the decision about whether to lend money. Consequently, the failure to disclosure such fees is also a contravention of section 31(1) 10 of Reg.188.


81. Specifically, in some cases, fees and costs were paid or payable to Neilas Related Entities out of SML proceeds where there was no disclosure of the fee whatsoever or the amount of the fee as disclosed was materially different than the fee paid or payable. The amount of the fee which was payable was set out in various agreements entered into between the relevant Neilas Related Entities including asset management agreements and construction management agreements. The cases of inaccurate fee disclosures are as follows:
    
    
    1. Interest Rate Spread/Mortgage Administration Fee: In eight of the eleven Investor files examined by FSCO Staff during the 2018 Examination, Hi-Rise failed to disclose the difference or “spread” in the interest rate applicable under the Loan Commitment and the rate payable under the LPA as discussed above. Further, there is no disclosure of whether Hi-Rise intended to collect the higher interest amounts. While (as discussed below), Hi-Rise, in its capacity as mortgage administrator, is required to disclose this fee, Hi-Rise, in its capacity as a brokerage is also required to disclose this fee because it is required to complete the Form 1 and it is information which is material to the decision to invest. FSCO Staff has determined that the disclosure of the interest spread amount did not meet the requirements of the Act for one Investor in Adelaide (PT), four in Oakville (DSD, PP, RM and WP/GP), one in Widmer (HL) and two in College (DR and NHM).
    
    
    2. Development Fees: In at least two projects, development fees were paid to Neilas Inc. These fees were significant. The development fee paid to Neilas Inc. was $3,432,667 for Adelaide and approximately $3,394,000 for Oakville. In two Investor files for Adelaide (PT and TP) and one Investor file for Oakville (WP/GP) examined by FSCO Staff the amount of the development fee as disclosed was materially less than the amounts paid.
    
    
    3. Project Management Fees: AW (the construction management corporation wholly owned and by controlled by Jim Neilas) was also paid project management fees in the amount of $280,652 in respect of Adelaide. These fee amounts were not disclosed to Investors in the two Investor files reviewed by FSCO Staff (TP and PT).
    
    
    4. Management Fees: Under the Loan Commitment, Hi-Rise was entitled to be paid amounts in respect of “management fees” out of SML funds raised from Investors. Specifically, Hi-Rise was entitled to estimated management fees of $2,099,375 for Adelaide, $2,356,800 for Oakville and $1,267,150 for Widmer, excluding tax. FSCO Staff were unable to calculate the precise dollar amount of the management fee payable for College. It is not clear if these amounts were paid; however, the fact that these substantial fees were payable under the Loan Commitment was not disclosed to Investors in the two Investor files for Adelaide (TP and PT), the four Investor files (DSD, PD, RM and WP/GP) for Oakville Project, the three Investor files for Widmer (HL, PC and TP/RS) and the two Investor files for College (DR and NHM) all reviewed by FSCO Staff during the 2018 Examination.
    
    
    5. Offering Marketing Fee: For Widmer, an offering marketing fee equal to 2% of the amount invested was payable to Neilas Inc. under the Loan Commitment. It is not clear to FSCO Staff if these fees were actually paid, however, the amount of the fee entitlement as disclosed in one of the Investor files (HL) reviewed by FSCO Staff during the 2018 Examination was materially less than the entitlement in the Loan Commitment.
    
    
    6. Marketing Fee: A marketing fee of $68,820 was paid to Hi-Rise for Queen. This fee was not disclosed in the two Investor files (DR and NHM) reviewed by FSCO Staff during the 2018 Examination and FSCO Staff could not find a contractual basis for the payment.
    
    
    7. Project Construction Fee: A project construction fee of $2,082,000 was paid to AW (the construction management corporation wholly owned and by controlled by Jim Neilas) for Oakville. The amount of fee entitlement as disclosed in one of the Investor files (DSD) reviewed by FSCO Staff during the 2018 Examination was materially greater than the entitlement in the Construction Management Agreement.
    
    
    8. Commission: For Adelaide, Widmer and Oakville, commissions totaled 14 percent of the amount invested. These fees were significant. The commission paid to Hi-Rise was $1,521,822 for Widmer. In one Investor file for Widmer (HL) examined by FSCO Staff the disclosure of the commission was materially less than the amounts paid.
    
    


82. As seen in the chart below, the quantum of the related party fees provided for under the terms of the various loan documents were significant individually and on an aggregate basis. In addition, the services provided or costs covered by these fees were not disclosed to Investors and it is difficult to discern what work or services were actually performed to warrant the payment of the fees and if such amounts served to materially advance the Hi-Rise Projects.
    
    

    Related Parties' Fees Schedule as of December 31, 2016

    Fees		Project
    		Adelaide	Oakville	Widmer	Queen	College
    1	Mortgage Administration Fee (0.5% of principal outstanding)	$551,276	$476,170	N/A1	N/A1	N/A1
    2	Mortgage Administration Fee (Interest Rate Spread)2	$9,853,408	$10,512,925	$1,699,087	N/A1	N/A1
    3	Offering Marketing Fee	$719,790	$1,225,123	N/A1	$ -	N/A1
    4	Commissions	$1,800,237	$2,025,531	$1,521,822	$225,636	N/A1
    5	Development Fee	$3,432,667	$3,394,000	$5,000,000	$250,000	N/A1
    6	Assignment Fee	$1,000,000	$ -	$ -	$ -	N/A1
    7	Acquisition Fee	$75,000	$500,000	$ -	$ -	N/A1
    8	Project Management fee	$280,652	$ -	N/A1	$ -	N/A1
    9	Step Up Fee	$140,000	$ -	$-	$	N/A1
    10	Lender Fee	$140,000	$300,000	$300,000	$ -	$36,000
    11	Management Fee3	$2,099,375	$2,356,800	$1,267,150	N/A1	N/A1
    12	Pre-Construction Consultation Fee	$ -	$578,000	$ -	$ -	N/A1
    13	Project Construction Fee	$ -	$2,082,000	$ -	$ -	N/A1
    14	Agent Fee	$ -	$186,500	$ -	$ -	N/A1
    15	Asset Management Fee	$ -	$ -	$1,309,677	$929,920	N/A1
    16	Syndication Fee	$ -	$ -	$150,000	$76,000	$76,000
    17	Construction Management Fee	$ -	$ -	$ -	$325,833	N/A1
    18	Marketing Fee	$ -	$ -	$ -	$68,820	N/A1
    		$20,092,405	$23,637,049	$11,247,736	$1,876,209	$112,000
    Total SML raised as of December 31, 2016		$41,987,500	$47,136,000	$25,343,000	$10,434,6444

    ¹ Fees could not be estimated by FSCO staff.
    ² Mortgage Administration Fee (Interest Rate Spread) totaled till October 31, 2017.
    ³ Management fee is estimated by FSCO staff based on total SML raised.
    ⁴ Total SML raised represent total mortgage investment for Queen and College projects as stated in investors Form 1 Appendix C .



83. While the failure to provide accurate disclosure of fees and costs is a violation of the disclosure requirements in section 31(1) of Reg. 188, Hi-Rise’s failure to prevent the payment of the Project Management Fees set out in paragraph 81(c) and its receipt of the Marketing Fee set out in paragraph 81(f) above give rise to even more serious contraventions of the Act.


84. Specifically, the terms of the LPA state as follows on the issue of fees payable to Neilas Related Entities:

    The Participant acknowledges that fees are payable to [Hi-Rise] and Neilas Inc. or other related entity for its role in the Participation Loan pursuant to and in accordance with the disclosure documentation provided to the Participant, as same may be amended from time to time.



85. Based on the terms of the LPA, the fees agreed to by the Investor are limited to the fees set out in the disclosure provided to the Investor. Under the terms of the LPA, if a fee has not been disclosed, an Investor has not agreed to the payment of the fee and there is no legal authorization to make the payment. Such payments are, consequently, contrary to law.


86. Section 14.2 of Reg. 188 (applicable to brokerages) and section 10.1 of Regulation 189/08 (“Reg. 189”) (applicable to administrators) state that a licensee “shall not act, or do anything or omit to do anything,” where the licensee “ought to know that by acting, doing the thing or omitting to do the thing,” the licensee is facilitating “dishonesty, fraud, crime or illegal conduct.”


87. Clearly, Hi-Rise would have known about the payments listed in paragraphs 81(c) and (f). In the case of the project management fee (paragraph 81(c)), these payments were made to another Neilas Related Entity such that the directing mind of Hi-Rise was also the directing mind of the recipient. At the very least, it is clear that Hi-Rise omitted to take appropriate steps to prevent the payments. In the case of the marketing fee (paragraph 81(f)), Hi-Rise was the actual recipient. Accordingly, Hi-Rise is in contravention of the duty to avoid dishonest, fraudulent, criminal or illegal transaction both in its capacity as brokerage and as administrator.


88. These contraventions are troubling because they not only involve the failure to accurately disclose fees and costs and the facilitation of unlawful payments they are fostered by the inter-relationships and conflicts of interest which infuse Hi-Rise SMLs.



(B) ADMINISTRATOR FUNCTIONS

89. The following contraventions relate to Hi-Rise’s position as the mortgage administrator in the Hi-Rise SML transactions.



Disclosure

90. Section 19(1) of Reg. 189 requires the mortgage administrator to “disclose in writing to each lender or investor in a mortgage the nature of the relationship, if any, between the mortgage administrator and each borrower under the mortgage.” Subsection 20(1) of Reg. 189 requires the mortgage administrator to “disclose in writing to each lender or investor in a mortgage any conflict of interest that the mortgage administrator or an employee engaged in administering the mortgage may have in connection with the mortgage.”


91. To the extent that any disclosures were provided by Hi-Rise concerning its conflicting roles and related entities that disclosure is limited to the disclosure provided by Hi-Rise in the Form 1s and 1.1s issued in its capacity as mortgage brokerage. There are no disclosures whatsoever by Hi-Rise in its capacity as mortgage administrator.


92. Even if Hi-Rise’s disclosure as to its relationships and conflicts of interest given in its brokerage capacity could be taken as disclosure by Hi-Rise in its administrator capacity (which the Superintendent denies), the brokerage disclosure was inadequate for the reason set out above and, therefore, Hi-Rise, in its administrator capacity, has not met its obligations under sections 19 and 20 of Reg. 189.


93. Further, Hi-Rise has not met its obligation to disclose fees it is entitled to receive as mortgage administrator. Pursuant to subsection 15(1) of Reg. 189, a mortgage administrator must disclose in writing whether the mortgage administrator has received, may receive or will receive a fee or other remuneration, directly or indirectly, from another person or entity in connection with the administration of the mortgage.


94. As discussed above, in eight of eleven Investor files reviewed by FSCO Staff during the 2018 Examination, the interest spread amount payable to Hi-Rise as a mortgage administration fee was not disclosed to Investors. Accordingly, the failure to disclose the spread amount is also a contravention of section 15 of Reg. 189.



Duty Regarding Administration Agreement

95. The LPA and the TA/MAA constitutes the Hi-Rise mortgage administration agreement. These agreements do not contain information required by Reg. 189.


96. Section 18(2)(6) of Reg. 189 requires that the administration agreement include the procedure to be followed in a foreclosure or in the exercise of a power of sale and the rights and duties of the Investor in either case.


97. The Hi-Rise mortgage administration documents do not address these requirements of Reg. 189. In fact, the Hi-Rise mortgage administration documents do not even mention the words “foreclosure” or “power of sale”.



Duty to Notify Investors

98. Section 18(3) also states that if the administration agreement does not contain the required notification provisions the “agreement is deemed to include them”. Accordingly, the failure of a mortgage administrator to ensure that the notification duties are set out in the administration agreement does not relieve the mortgage administrator of those duties. Those duties are imposed directly by Reg. 189. The failure to provide such notification, therefore, constitutes a separate contravention of Reg. 189.


99. Based on material received in May 2017, FSCO Staff determined that Hi-Rise has failed to notify Investors of significant changes in the circumstances affecting the mortgages and, therefore, has contravened section 18(3) of Reg. 189. Such failures to provide the required notification include but are not limited to:
    
    
    1. Amendments to the amount of the mortgage without any apparent change in the value of the collateral supporting the mortgage (Oakville – January 17, 2012 amendment to the Loan Commitment; Oakville – December 13, 2013 amendment to the Loan Commitment);
    
    
    2. Amendments to the term of the mortgage (Adelaide – December 4, 2013 replacement Loan Commitment; Oakville – December 6, 2016 amendment to the Loan Commitment);
    
    
    3. Amendments to permit the accrual of interest (Widmer – May 6, 2016 amendment to the Loan Commitment);
    
    
    4. Significant changes the scope and nature of the project (Oakville – decision to covert Oakville to rental units made in 2012 but not communicated to Investors until January 26, 2015; Oakville – in May 2016 target completion date was amended to late 2017).
    
    



Concurrent Business

100. As set out in detail in this Notice of Proposal, Hi-Rise has permitted its concurrent business activities—as a mortgage brokerage on behalf of the borrowers— to jeopardize its integrity, independence and competence as administrator in contravention of the requirements of section 40 of Reg. 189.



V. GROUNDS FOR REVOCATION

101. Under subsection 19(1) of the Act, the Superintendent may, by order, revoke a licence in any circumstances in which the Superintendent is authorized to suspend a licence. The circumstances under which the Superintendent may suspend a licence are listed in section 18(1). Subsections 18(1) (b) and (c) respectively provide that the Superintendent may order the suspension/revocation of a licence:
     
     
     1. if the Superintendent believes, on reasonable grounds, that the licensee is no longer suitable to be licenced having regard to the circumstances, if any, prescribed for the purposes of subsections 14(1) or 16(4) and such other matters as the Superintendent considers appropriate (section 18(1)(b)); or
     
     
     2. if the licensee contravenes or fails to comply with a requirement established under this Act (section 18(1)(c)).
     
     


102. In determining suitability to be licensed, the Superintendent is required by subsections 18(1) and 19(1) of the Act and subsection 1(2) of Ontario Regulation 408/07 (for brokerages) and subsection 1(2) of Ontario Regulation 411/07 (for administrators) to have regard to the following prescribed circumstances:
     
     
     1. Whether, having regard to its financial position, the corporation cannot reasonably be expected to be financially responsible in the conduct of its business;
     
     
     2. Whether the past conduct of a director or officer affords reasonable grounds for belief that the corporation will not deal or trade in mortgages or carry on business in accordance with the law and with integrity and honesty; and
     
     
     3. Whether the corporation is carrying on activities that contravene or will contravene the Act or the regulations if the corporation is licensed.
     
     



(A) CONTRAVENTIONS

103. The contraventions detailed above are serious, numerous and systemic. They reveal a way of doing business which is designed to further the interests of Jim Neilas and related entities at the expense of Investors. The contraventions on their own provide sufficient basis for the revocation of the licences under section 18(1)(c).



(B) SUITABILITY TO BE LICENSED

104. In addition to the contraventions above, the following affords reasonable grounds to believe that Hi-Rise will not carry on business in accordance with the law and with honesty and integrity.



Breach of Fiduciary Duties

105. Hi-Rise is the Trustee under the MAA/TAs entered into with Investors. Moreover, the Investors are dependent on Hi-Rise to administer and enforce the Hi- Rise SMLs. Investors have no independent right to enforce such mortgage obligations. As such, a fiduciary relationship arises.


106. In addition, the Investors are generally unsophisticated and are reliant on investment advice and expertise provided through Hi-Rise in its capacity as the brokerage acting on behalf of the Investor. This also gives rise to a second set of independent fiduciary duties given the relationship between the Investors and Hi-Rise.


107. As the directing mind of Hi-Rise at the material time, Jim Neilas’ failure to ensure that Hi-Rise complied with its fiduciary duties demonstrates his unsuitability to be licensed.


108. As a trustee and fiduciary, Hi-Rise and Jim Neilas are subject to 3 clear duties:
     
     
     1. Avoidance of Conflicts of Interest: Hi-Rise and Jim Neilas must not permit their interests to conflict with the interests of Investors and must not use their position to advance their own interest through related party transactions or self-dealing unless Investors provide informed consent.
     
     
     2. Standard of Care: Hi-Rise is subject to the standard of care defined by the common law standard applicable to fiduciaries (i.e.: the standard that a person of ordinary prudence would exercise in respect of his or her own affairs).
     
     
     3. Duty of Even Handedness: Hi-Rise had the duty to be even-handed as to its treatment of similarly situated investors.
     
     



Related Party Transactions and Conflict of Interest

109. Hi-Rise SMLs are defined by conflict and self-dealing. Jim Neilas is the owner and was the directing mind of Hi-Rise as well as the Development Corporations (the borrowers). What benefits the Development Corporations directly benefits Jim Neilas. Jim Neilas also owned and controlled other entities which profited from the Hi-Rise Projects such as the developer, and the construction management firm. Jim Neilas and Neilas Related Entities received substantial payments in respect of fees and commissions unrelated to the actual progress in the Hi-Rise Projects.


110. In addition to the statutory disclosure requirements, the SMLs themselves and the specific fee payments are prohibited at common law without the informed consent of Investors. As set out above, the disclosure of related party payments was either non-existent or inaccurate on the basis that the amount of fees paid or payable was materially in excess of the amounts as disclosed. Without accurate disclosure, there is no informed consent.


111. Further, although Jim Neilas’ interest in various Neilas Related Entities (including the Borrowers) is disclosed to Investors at the time of entering into the SML, this disclosure of the relationship is not sufficient to satisfy the informed consent requirements necessary to authorize related-party transactions involving a fiduciary. As set out above, the disclosure did not meet statutory requirements and were provided in the context of other serious and systemic breaches of the consumer protection provisions in the Act. Deficiencies in the disclosure include but are not limited to following:
     
     
     1. As set out above, the disclosure of related party payments was inaccurate with amount of fees paid materially in excess of the disclosed for some fees and costs and no disclosure in respect to other fees and costs paid to Neilas–related entities.
     
     
     2. There are material failures to disclose the true terms of the transactions. The significantly onerous terms of the loan commitment are not disclosed to Investors;
     
     
     3. Material risk disclosure is insufficient;
     
     
     4. As set out above, there is a failure to disclose other information which an investor of ordinary prudence would consider material to the decision to lend money on the security of real property;
     
     
     5. There is no provision made for investors to obtain independent legal and financial advice contrary to common law legal requirements. Independent advice is especially important in the context of Hi-Rise SMLs because of the lack of sophistication of the Investors;
     
     
     6. Hi-Rise failed to ensure the investment was suitable for the Investors given their needs and circumstances;
     
     
     7. The quantum of the payments made were excessive relative to the work performed and the degree of progress on the project; and
     
     
     8. While Jim Neilas’ ownership of the entities was disclosed, his legal control was not disclosed.
     
     



Preferential Payments

112. On at least two occasions, Hi-Rise authorized or acquiesced to the repayment of certain amounts invested or loaned by Neilas Inc. or Jim Neilas personally in preference to the repayment of Investors and contrary to legal requirements:
     
     
     1. In 2017, Adelaide paid $1.75 million to Neilas Inc. as a purported repayment of an unsecured loan provided by Neilas Inc. No documentation has been produced by Hi-Rise to date to support the characterization of the amount as a loan rather than as an equity investment. However, even assuming that its character as an unsecured loan can be established, it is clear that Neilas Inc. was not entitled to be repaid in priority to Investors who are secured creditors. Further, given Neilas’ control of Hi-Rise at the time and his status as its directing mind, it is clear the Hi-Rise had knowledge of and acquiesced to the payment.
     
     
     2. In November 2016, Neilas Inc. invested $275,000 in the Adelaide project pursuant to a LPA. In April 2017, Hi-Rise authorized the full repayment of the investment and the payment was made using proceeds from other investors. Other Adelaide Investors have not been offered the full repayment of their investment to date.
     
     



Breach of Duty of Care

113. Hi-Rise, in its capacity as mortgage administrator, regularly agreed to concessions or amendments to the syndicated mortgage loan terms to further the interest of the developers or other Neilas Related Entities. As stated above, Hi-Rise failed to provide notice of such agreements and concessions. Further, Hi-Rise failed to meet the standard of care applicable to a fiduciary in considering whether or not to grant such concessions. Specifically, Hi-Rise failed to perform basic due diligence including obtaining current appraisals, evaluating project viability, conducting appropriate legal analysis to determine if the requested amendments are permissible under the governing loan documents and can be agreed to by Hi-Rise on behalf of Investors and seeking appropriate consideration in return for granting such concessions. Such concessions operated in favor of the Development Corporations and other Neilas Related Entities, often to the detriment of Investors. The concessions include the items listed in paragraph 99 above.


114. Hi-Rise also failed to perform important gating functions prior to advancing SML funds to the Borrower to ensure the funds were only advanced when appropriate project milestones had been met and when other factors related to compliance with the loan documentation and the solvency of the Borrower have been confirmed. Instead, SMLs funds were advanced as they were raised without regard to these factors thereby exposing Investors to additional unnecessary risk.



Breach of Duty of Even-Handedness

115. Hi-Rise breached its duty of even-handedness by treating certain Investors more favourably than others.


116. Investors who complained were offered better settlements than were available under the LPA or were made available to other similarly situated Investors. To date, Hi-Rise has offered no legal basis to support the preferential treatment of such Investors.


117. In the case of Oakville, Investors who loaned to the Borrower under a third mortgage were paid back prior to Investors under a prior second mortgage contrary to basic debt priority rules. Disclosure to Investors who loaned under the second mortgage was insufficient to conclude that they would have agreed or even been aware of the fact that the lower priority mortgage would be paid in advance of their loan. Again, Hi-Rise has offered no legal basis to justify these payments.


118. Finally, certain Investors were offered the right to transfer their investments from College to Adelaide with no associated increase in loan proceeds made available to the Borrowers under those projects. This further increased the liabilities and diluted the security for existing Investors in the project without increasing the capital available to the project, thereby potentially harming existing Adelaide Investors. Again, no legal basis has been offered by Hi-Rise to justify these transfers.



(C) FINANCIAL POSITION OF HI-RISE

119. Under section 1(2) 1 of Reg. 408/07 (for brokerages) and of Reg. 411/07 (for administrators) the fact that “the corporation cannot reasonably be expected to be financially responsible in the conduct of its business” is a prescribed circumstance in determining whether a corporation is not suitable to be licensed.


120. Hi-Rise is not currently brokering mortgages as a result of its Undertaking given to the Superintendent and, consequently has no regular income. Nor does Hi-Rise have significant assets. All of Hi-Rise’s costs are being funded through loans from Neilas Inc. or other Neilas Related Entities.


121. Consequently, Hi-Rise cannot be expected to be financially responsible in the conduct of either its brokerage or its mortgage administration businesses giving rise to an additional ground to conclude that Hi-Rise is not suitable to hold brokerage or administrator licences.



VI. ADMINISTRATIVE MONETARY PENALTIES

122. Section 39 of the Act provides that if the Superintendent is satisfied that a person has contravened a requirement established under the Act, the Superintendent may, after giving written notice of his proposal, impose an administrative monetary penalty on that person.


123. Section 38 of the Act provides that administrative penalties may be imposed for either of the two following purposes:
     
     
     • to promote compliance with the requirements established under the Act,
     
     
     • to prevent a person from deriving an economic benefit as a result of contravening the Act.
     
     


124. The proposals for administrative penalties below are based on the review conducted of the individual investor files in 2018, reflects the pervasive and systemic non-compliance with the Act and also recognizes the very substantial economic benefits that have been derived, which amounts to tens of millions of dollars in fees, commissions and other remuneration. The Superintendent submits that the administrative penalties sought cannot be reduced without undermining the purposes of the Act in light of the deliberate conduct noted, the enormous financial gains realized by the individuals and Neilas Related Entities involved, and their failure to acknowledge, let alone address, these serious breaches.


125. Under section 41 of the Act, the maximum amount of an administrative monetary penalty that may be imposed for each contravention is $10,000 for an individual who is licensed as a mortgage Broker or Agent and $25,000 for a person or entity who is licensed as a mortgage Brokerage or Administrator. The Superintendent is seeking $3,175,000.00 as against Hi-Rise and $1,320,000.00 as against Jim Neilas. A summary of the breaches and quantum is attached as Appendix A.


126. The Superintendent is seeking administrative monetary penalties against Hi- Rise both in its capacity as a mortgage brokerage and a mortgage administrator.


127. The Superintendent is also seeking administrative monetary penalties against Jim Neilas as Principal Broker of Hi-Rise and as the sole and, therefore, controlling director and shareholder of Hi-Rise at the relevant times. The statutory basis for the imposition of administrative monetary penalties against Jim Neilas personally is as follows:
     
     
     1. Pursuant to subsection 2(1) of Reg. 410, the principal broker must take reasonable steps to ensure that the brokerage, and each broker and agent comply with every requirement established under the Act. The Superintendent alleges that Jim Neilas failed to take such steps and is, therefore, liable in respect of the contravention committed by Hi-Rise acting in its brokerage capacity;
     
     
     2. Further, section 3(1) of Reg. 410 states the principal broker must review the policies and procedures of the brokerage to determine whether they are reasonably designed to ensure that the brokerage, and each broker and agent comply with every requirement established under the Act; and that each broker and agent is adequately supervised. Jim Neilas is further specifically liable for the contraventions related to the policies and procedures pursuant to section 3(1) of Reg. 410; and
     
     
     3. Finally, section 48(5) of the Act states that it is an offence for a director or officer of a corporation to direct, authorize, assent to, acquiesce or participate in the commission of an offence by the corporation or to fail to take reasonable care to prevent the corporation from committing the offence. Section 52(2) states that the members of the “directing body of an entity” (other than a person or partnership) are jointly and severally liable to comply with any requirement established under the Act. Jim Neilas was the sole director and officer of Hi-Rise at all materials times and is, therefore, in contravention of section 48(5) of the Act in respect of Hi-Rise’s contraventions. As a member of Hi-Rise’s board of directors, he was a member of the directing body of Hi-Rise within the meaning of section 52(2) of the Act. Accordingly, he is liable for the Hi-Rise’s failure to comply with the requirements established under the Act imposed on both brokerages and administrators by virtue of section 52(2) of the Act.
     
     



(A) STATUTORY CRITERIA FOR ADMINISTRATIVE PENALTIES

128. In the Superintendent’s view, the administrative monetary penalties being proposed below for Hi-Rise and Jim Neilas will meet both of the purposes set out in section 38 of the Act.


129. First, the imposition of these administrative monetary penalties will promote compliance with the Act by deterring contraventions of the Act. The administrative monetary penalties will demonstrate to the individuals, the SML industry and the public, that violations of the Act will result in significant negative monetary consequences. A significant administrative monetary penalty will also emphasize the seriousness of the contraventions.


130. Second, the imposition of an administrative monetary penalty will offset some of the significant economic benefits that Hi-Rise and Jim Neilas received as a result of these contraventions. As of December 31, 2017, over $144 million had been raised in Hi-Rise SMLs on the five projects addressed in this Notice. The administrative penalties proposed take into account the fact that cumulatively Hi-Rise and Mr. Neilas earned tens of millions of dollars in remuneration on these projects through fees, commissions, and other means. Neilas Related Entities collected at least $39 million in fees.


131. As such, the proposed administrative penalties will negate, in small part, the economic benefit that the individuals and entities derived as a result of brokering and administering Hi-Rise SMLs in contravention of the Act and regulations.


132. In determining the amount of the proposed administrative penalties the Superintendent has taken into account the five criteria that are required to be considered pursuant to section 3 of Ontario Regulation 192/08. These criteria are:
     
     
     1. The degree to which the contravention or failure was intentional, reckless or negligent;
     
     
     2. The extent of the harm or potential harm to others resulting from the contravention or failure;
     
     
     3. The extent to which the person or entity tried to mitigate any loss or to take other remedial action;
     
     
     4. The extent to which the person or entity derived or reasonably might have expected to derive, directly or indirectly, any economic benefit from the contravention or failure; and
     
     
     5. Any other contraventions or failures to comply with a requirement established under the Act or with any other financial services legislation of Ontario or of any jurisdiction during the preceding five years by the person or entity
     
     


133. Under the first criterion (the degree to which the conduct was intentional, careless or negligent), the conduct of Hi-Rise and Jim Neilas suggests that the various contraventions were part of an overall scheme designed to promote the interests of Neilas even if this would undermine the consumer protection elements of the Act and Regulations. This conduct reflects a conscious intent to proceed in a way that benefited Hi-Rise (a regulated entity), other entities controlled by Jim Neilas and Jim Neilas, personally, without regard to the impact on Investors. The pervasive and systemic nature of these contraventions attract a higher administrative monetary penalty.


134. Under the second criterion, the extent of actual or potential harm to others is very significant in these cases. The persons harmed most directly were the Investors who were induced into investing in high risk SMLs which were not suitable for them. The Investors also face a significant risk that they will not be able to realize on some or all of their investment in the event a projects fails, especially in light of the initial misrepresentations as to the value of the security supporting the loans, lack of disclosure as to the subordination of the Hi-Rise SMLs to subsequent loans and the significant fees and commissions paid out of the funds raised rather than being used to support the projects.


135. Under the third criterion, with respect to the extent to which Hi-Rise and Jim Neilas tried to mitigate the loss or take remedial action, the Superintendent is not aware of any mitigating or remedial action taken by Hi-Rise or Jim Neilas that would warrant lowering an otherwise suitable administrative monetary penalty. While some limited action was taken by Hi-Rise and Jim Neilas after the Superintendent intervened in September 2017, it did not reflect any acknowledgement by the individuals or entities that there were serious problems with their conduct.


136. Under the fourth criterion, with respect to whether Hi-Rise and Jim Neilas derived an economic benefit from their contraventions, in each SML transaction in which they participated, Hi-Rise and other entities owned and controlled by Jim Neilas, earned various fees, commissions or other remuneration. As noted above, these SMLs involved hundreds of millions of dollars in investments and tens of millions of dollars in remuneration. The amount of the proposed administrative monetary penalty is designed to offset a small part of the economic benefit derived from the contraventions.


137. Finally, a relevant consideration is whether Hi-Rise or Jim Neilas committed other contraventions or failures to comply in the preceding 5 years. The Superintendent is not aware of any contraventions or failures to comply in the preceding 5 years beyond those identified in this Notice.


138. The Superintendent submits that cumulatively these are extremely serious breaches that undermine the consumer protection purposes of the Act and Regulations in a field where consumer protection is especially important given the high risks and unusual nature of the mortgage product. Accordingly, these breaches should attract significant administrative penalties for the Hi-Rise and Jim Neilas. The Superintendent submits that administrative penalties in the maximum amount of $25,000 per breach by the Brokerage and $10,000 per breach by the Principal Brokers are reasonable. As noted above, the specific contraventions alleged by the Superintendent with the specific AMP amounts sought is set out in Schedule A attached hereto.


139. In summary, the Superintendent is of the opinion that Hi-Rise and Jim Neilas undermined the consumer protection elements of the Act in a deliberate, pervasive, and systematic manner and therefore, the imposition of administrative penalties in the amounts set out above are appropriate, reasonable and would promote the purposes described in the Act.


140. Such further and other grounds as the Superintendent may advise.

DATED at Toronto, Ontario, April 1, 2019

Original signed by

Brian Mills
Superintendent of Financial Services

TO:
Financial Services Tribunal
5160 Yonge Street, 14th Floor, Box 85
Toronto ON M2N 6L9

Attention: Registrar

Tel: (416) 226-7752
Fax: (416) 226-7750
Email: contact@fstontario.ca

AND TO:
Ministry of the Attorney General, Civil Law Division
Financial Services Commission of Ontario Branch
5160 Yonge Street, 17th Floor
Toronto ON M2N 6L9

Attention: Troy Harrison and Michael Scott

Tel: (416) 590-7244
Fax: (416) 590-7556
Email: Troy.Harrison@fsco.gov.on.ca

Counsel for the Superintendent of Financial Services

SCHEDULE A

SCHEDULE B

Si vous desirez recevoir cet avis en français, veuillez nous envoyer votre demande par courriel immediatement a : contactcentre@fsrao.ca.

¹ A twelfth Investor file was requested and received, but it was not brokered by Hi-Rise. Contraventions related to mortgage brokering arose in the 11 files brokered by Hi-Rise.

²One of the Investor files reviewed was brokered by a brokerage other than Hi-Rise (GL). The eleven files brokered by Hi-Rise which were reviewed during the 2018 Examination were for the following Investors: PT and TP (Adelaide); DR and NHM (College); DSD, PD, RM, and WP/GP (Oakville); HL, PC, and TP/RS (Widmer).