A U.S. law firm is targeting BMO Nesbitt Burns Inc. in a class-action suit by investors in FMF Capital Group Ltd., a failed income trust that went public nine months ago.
The lawsuit, filed yesterday in a Michigan court, accuses Bank of Montreal's investment banking unit and a U.S. subsidiary, Harris Nesbitt Corp., of conspiring with FMF management to perpetrate a fraud during the marketing of the $197-million initial public offering.
FMF is a U.S. mortgage company that was spun into a trust and listed on the Toronto Stock Exchange in March. Investors were promised an initial yield of 11 per cent, but FMF shocked the market last month when it said it would suspend distributions. BMO Nesbitt was the lead underwriter.
The share price closed yesterday at a record low of 53 cents, down 94.7 per cent from the IPO.
Despite its TSX listing, FMF has no assets or offices in Canada, "which is why we're going after them in the U.S.," said Eli Karp, an associate in the Toronto office of Juroviesky and Ricci LLP, which filed the civil case. "The Michigan executives took their money out . . . they sold their business to the Canadian public and walked away."
Three FMF executives, who held just over 90 per cent of the company, sold the majority of their stake in the IPO. Chief executive officer Robert Pilcowitz, chief financial officer Howard Morof and chief operating officer Edan King are named as defendants.
Five other Bay Street firms -- National Bank Financial Inc., TD Securities Inc., Canaccord Capital Corp., Blackmont Capital Inc. and Sprott Securities Inc. -- are named as defendants. All were part of FMF's underwriting syndicate.
One of the key accusations is that FMF covered up key risks in its business, including the fact that the company could be stuck with mortgages it didn't want, and that BMO failed to properly investigate it before it agreed to handle the deal.
BMO Nesbitt spokeswoman Mirette Ghanem said the bank would not comment. None of the allegations has been proved in court.
FMF's business model was to lend money to borrowers with lower credit scores then turn around and sell the loans to investors at a profit, usually within about a month. But in November, FMF said several institutions had walked away from the mortgage market and the company was forced to buy back mortgages it had already sold because the borrowers had quickly defaulted on them.
The lawsuit charges that FMF buried those risks through its accounting, which failed to make an estimate for losses for bad loans the company was on the hook for.
"Executive management did not, and have never planned to have enough money in their reserve to cover their repurchase liability," it says. "In BMO's role as lead underwriter and in the course of its so-called 'due diligence,' it failed to identify the type of blatant misstatements and half-truths promulgated by executive management that perverted the financial statements and condition of the issuer."
Class-action lawsuits are still fairly rare for Canadian-listed companies. Investment dealers can be held liable for investors' losses, but it is rare. Even in one of the largest frauds in Canadian history -- the collapse of Bre-X Minerals Ltd. -- investors dropped a class-action after Nesbitt Burns agreed to cover their legal costs.
In that case, though, the suit was based on analysts' reports recommending Bre-X shares. In an IPO, the investment dealer who's leading an underwriting has to meet a higher standard of due diligence, said Adam Balinsky, a lawyer at Baker & McKenzie LLP in Toronto.
© The Globe and Mail
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