Audit, Compliance and Risk Blog

BC Securities Commission Addresses Allegations of Fraud Against Real Estate Developer

Posted by Ron Davis on Thu, May 04, 2017

gavel 4.jpgIn Re Hornby Residences Ltd. (2017 BCSECCOM 17), the British Columbia Securities Commission had to determine whether a real estate development corporation and its principal had violated the BC Securities Act s. 57(b) prohibition against fraud in connection with the issuance of a security when the funds invested were used to pay the principal and other corporations controlled by the same principal, Brendan James Schouw. Schouw was a real estate developer and the sole director of Hornby, and of Grace Residences Ltd. and Homer Residences Ltd. Schouw was also connected with Drake Residences Ltd., although the Commission was not provided with information about its directors and officers.

Schouw met with a potential investor, only identified as HS, about using his inheritance to invest in Schouw’s developments. At that meeting, Schouw suggested HS invest in one of Schouw’s development projects, Artemisia, which HS was told was being developed through Hornby. When HS asked about the need to diversify his investments, Schouw suggested that part of the funds could be invested in Homer, which was developing another project. HS eventually invested $1 million in Hornby and $250,000 in Homer. In return, HS received an investment certificate setting out the annual interest rate and the four year term of the investment and a certificate permitting him to convert the debt into an interest in a unit in the development at a fixed rate. Although the Commission found that Schouw had told HS that his investment would be used to develop Artemisia, the investment certificate said the funds: “may be used, at the sole discretion of Hornby Residences Ltd., for purposes relating to the acquisition and improvement of land and premises located in the Downtown South neighbourhood of Vancouver, British Columbia.” The Commission noted that Downtown South was a term used to describe the downtown core of Vancouver that included, but was not limited to, the area of the Artemisia development.

The Commission found that Schouw told HS that his funds were to be used by Hornby in the development of the Artemisia project. After the funds were deposited into the Hornby account, the Commission found that: “Over the next six weeks, all of the funds from this Hornby account were paid out, either directly to third parties or into accounts in the name of Grace or Schouw (personally)” (para. 30). Schouw offered the explanation that the funds were paid to these parties for services in connection with the Artemisia development, but was unable to support this with any invoices, receipts or other documentation of the services he testified had been provided. In addition, the Commission found that some of the funds were used to partially pay a settlement of a legal action against Schouw and others; other funds were used to refund a security deposit on a penthouse apartment where Schouw was acting as rental manager for the apartment; others were used to pay Schouw’s mortgage or to repay certain investors in Grace and Artemisia (paras 39 – 42). Schouw relied on the wording of the investment certificate to say he was allowed to allocate the funds to other projects than Artemisia. However, the Commission pointed out that the decision to split HS’ investment into two different corporations in order to provide diversification, showed that the representation that the Hornby investment was for the Artemisia project alone had been made. The Commission ultimately held that the executive director of the Commission had not proved, on the balance of probabilities, that the money transferred to Grace did not represent services provided to the Artemisia project. However, the Commission did find that $74,612 transferred to Schouw was used for his personal mortgage debt and that of the property management business he was conducting, and thus was not used for the development of the Artemisia project. They found that because Schouw knew that these payments were made from his personal bank account and that he was depriving HS of the benefit of using these funds to develop Artemisia, they constituted fraud on HS.

The Commission went on to find Schouw personally liable for permitting or acquiescing in Hornby’s conduct because as the sole director and officer, he had made all the decisions required to conduct the fraudulent activity. Directors of closely held corporations should take steps to ensure any payments to them personally are correctly documented as to the purpose and services provided that justify such payments. As well, any representations to investors as to the use of the funds invested should be documented and the distribution of such funds accounted for, especially when funds are distributed to related entities.

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About the Author

Ronald Davis is an associate professor emeritus at the Peter A. Allard School of Law, University of British Columbia. He obtained his Bachelor of Laws degree from the Faculty of Law, University of Toronto in 1990, graduating as that year’s silver medalist. He was called to the Ontario Bar and practiced law in Toronto for 10 years before returning to graduate studies at the University of Toronto. See www.stpub.com for a full bio of Ronald Davis.

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Tags: Corporate Governance, Business & Legal, SEC, Canadian, directors & officers