Six years ago, many Canadians learned of the massive real estate fraud being perpetrated by a Toronto-based development company, Fortress.
When the public learned of the scale of the Fortress Development scandal – not to mention the shamelessness, greed, and outright boneheadedness of the principal parties, namely founders Jawad Rathore and Vince Petrozza – the response was outrage and disgust.
In April 2018, the RCMP raided Fortress and its affiliate brokerages revealing to investors that 50 per cent of their principal was deducted towards commissions, fees and their own interest. Property values were grossly inflated, resulting in thousands of Canadians losing their investments.
The news trumpeted that the complaints against Fortress had been piling up for years before any regulator bothered to look into them. The coverage also provided detailed, emotional portraits of retirees who had lost hundreds of thousands of dollars from investments in syndicated mortgage investments, or SMIs.
For most of the public, this was their first time hearing of SMIs, which are an arrangement in which more than one investor (i.e. lender) is involved in a loan or debt obligation secured by a mortgage. These are not the ideal instruments for funding a development project, but due to the exorbitant costs of construction and associated fees, they became essential for getting construction projects off the ground for many Canadian companies in the 2000s and 2010s.
For the man who essentially invented these instruments, Toronto native Jim Neilas, they became the lifeblood of his company.
“There’s no way we could have survived without SMIs,” says Neilas.
Unfortunately for Neilas, the many craven abuses of the SMI system by Fortress were attached to the industry in general – including the Neilas Group, which had a two-decade track record of delivering outstanding returns.
“It was an industry-wide meltdown.”
Syndicated mortgages allow small investors to pool their resources to gain access to the commercial real estate market. They were developed as a response to an inability to access the market through traditional means.
“SMI’s have always had baked-in risk involved,” says Neilas. “But because of that, as we developed the model, we had to bake in extra due diligence and accountability. We had to be way ahead of any compliance issues.”
From 2004 to 2017, Neilas originated 24 investments involving over 3,000 investors, primarily using the SMI model. He was able to provide successful exits and returns of over 10 per cent on 21 of those 24 investments.
“We earned trust through results. And we made sure the model stood up to scrutiny. But, much like junk bonds in the late 80’s, the new model was open to abuses by nefarious actors. Fortress certainly qualifies.”
In the case of junk bonds, the inventor of the model, Michael Milken, became the face of the abuses, receiving a broadly public rebuke with a fine of $600 million in 1990.
Milken, however, has since been somewhat vindicated, meriting a pardon from President Trump that was many years in the making from his defenders. The Milken Institute Global Conference has now become one of the year’s most prestigious industry events, attracting a who’s who of the financial services sector.
Neilas feels that he, too, became a target of overzealous regulators who had a grudge against the model itself, beyond the particular abuses of some actors.
In 2019, in the wake of the Fortress scandal, the Financial Services Commission of Ontario (FSCO) transformed into the Financial Services Regulatory Authority of Ontario (FSRA), specifically to focus more on SMI abuses in the wake of all the news coverage and publicity.
Who better to offer up first than the model’s inventor?
That same year, the new FSRA brought a Notice of Proposal against Neilas, seeking a $1.32 million fine with the claim that his syndicated mortgage transactions were “defined by self-dealing and conflict of interest.”
But after investigating, these claims bore out to be more of a general complaint about the model itself than about anything specific with Neilas’ operations.
FSRA backed down from this fine amount, withdrawing 97 per cent of it and agreeing to a smaller fine of $38,000. Quite the change of position for a regulator.
The agency also conducted a thorough review of his books searching for improprieties. But after poring over six years of records, they found no contraventions of the law, and more importantly, no financial discrepancies.
Even though they missed their target on Neilas, the FSRA may be having overall success at striking a death blow to the SMI model. Neilas, like many other developers who have relied on the model to build a viable business, has decided to move his operations to more lucrative markets.
“It’s impossible to eliminate risk from financial markets, much as regulators want to be able to do so,” says Neilas. “We’re in an era of hyper-inflation, geopolitical turmoil everywhere – we can’t just ignore risk as a general principle. Our economy will collapse.”
Neilas doesn’t have much hope for the industry ever staging a comeback in Canada. “Everything in Canada always moves to monopolies. As soon as an industry gains traction, there is a failure and it collapses with the full blessing of the industry.
Neilas believes that the best example of this industry-sanctioned collapse is the Equitable Bank debacle.
“For me it’s simple, they got too big, and industry moved against it. Where are we now? Back to the Five Bank model. I call Canada the country of FIVE. Five is enough, after that, there just isn’t a place for you. I feel sorry that Canadian developers all end up going to the same source of capital time and time again. And they wonder why there is a housing crisis. What’s the government solution over smooth and efficient capital markets? The federal government has become a developer of multi-family apartments. It’s embarrassing.
“I don’t think that small to medium-sized development developers will be able to survive in Canada without SMIs. It’s a bit of self-sabotage, to throw the baby out with the bathwater. You’re stifling growth at a time when we desperately need it.”
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