Investment programs involving the sale of undivided interests in land have caught the attention of provincial securities regulators and self-regulating organizations following a string of dealer queries regarding the nature of the investment vehicles and how they’re regulated.

Although investments in land are typically considered real estate transactions, experts warn they may trigger regulation under provincial securities acts, putting the onus on advisors to learn more about how the investment is structured before they refer clients to such a product.

But with limited information on exactly what the investment is and how it works, advisors are left with more questions than answers.

“The problem with undivided interests in land is they’re all different and the information on them is not, in all cases, completely transparent,” says Karen McGuinness, vice president of compliance at the Mutual Fund Dealers Association of Canada. “Clearly, it’s a real estate investment. But details like ownership and what the return is supposed to be are not entirely clear in all cases. I haven’t seen a lot of full and complete information out there.”

The MFDA caught wind of the investment program last summer when it was conducting its compliance examinations and learned that a number of members had been approached to enter into a referral arrangement with companies that distributed undivided interests in land; in some cases, advisors were being offered commissions of up to 13.5%.

“The primary concern from our perspective is the conflict of interest issue,” McGuinness says. “The questions is: can advisors really give unbiased advice that this product is better for the client than, say, a diversified mutual fund investment?”

The Ontario Securities Com-mission is tight-lipped about the potential risks involved in undivided interests in land and has declined to comment on whether the investment is becoming more prevalent.

In the meantime, the MFDA is treading carefully. The SRO issued a member regulation notice in July cautioning members that undivided interests in land may fall under the ambit of securities regulations. With referral arrangements under the microscope, advisors were warned that referring their clients to a specific security may be acting outside of the limits of their registration, and thus they should proceed with caution.

“What advisors need to ask themselves is: ‘What is it that the client is getting, and is it appropriate for the client to have this product?’” says McGuinness.

But answering those questions may prove difficult, given how complicated real estate investments can become, says David Ross, a partner at Toronto-based law firm McMillan Binch Mendelsohn LLP. “In a lot of cases, these investments are very sophisticated. And you really need to be looking at the value of the underlying investment.”

In some instances, a company promoting undivided interests in land may be raising money for a mortgage, which is presumably lent to a borrower that is going to develop the property. The promoter takes a service fee off the top, and distributes the interest generated by the mortgage to the investors, who continue to earn income over the course of the loan. The success of the investment ultimately depends on the borrower’s ability to repay the mortgage.

Although it’s difficult to estimate how many investment dealers are currently in business with a company that distributes undivided interests in land, McGuinness estimates that almost all independent MFDA dealers have been approached.

Partners in Planning Financial Services Ltd. was one of them. The Regina-based planning firm had a three-year referral arrangement with Walton International Group Inc. , a Calgary-based land banking operation that purchases and develops raw land.

PIP’s chief operating officer, Michael Wolfond, says about 20% of the firm’s 500-plus advisors referred their clients to Walton in what he calls a “very good” manufacturer/distributor relationship. Wolfond says the highest commission a PIP advisor ever received for a referral to Walton was 10%, and only accredited investors qualified. PIP ended the referral arrangement in 2005 when questions of how the product was regulated arose, although Wolfond maintains it was a solid arrangement while it lasted.

“Our compliance department cleared it and we’ve had a very successful relationship over a period of time,” Wolfond says.

Walton International would not comment.

The question now is when and how undivided interests in land trigger the securities acts, given the varying provincial regulations. McGuinness urges advisors to proceed as though the product is a security.

@page_break@“It’s a very high-risk position to take the view that it isn’t a security. One commission might say it is; the other might say it isn’t,” she says.

The issue was first brought to the attention of the Alberta Securities Commission in 2001, when it examined the case of Land Development Company Inc., a Calgary-based firm that purchased, developed and resold real estate. LDC had placed a series of ads in the Calgary Herald in 1999 offering undivided interests in undeveloped land in two development projects known as Bearspaw Ranche Estates and Bearspaw Ridge. Investors purchased one or two undivided interests in the projects for a price between $9,000 and $13,000, and agreed to grant LDC complete management control of the property. There was no prospectus or offering memorandum.

The question: was LDC making a simple sale of land, as it claimed, or was the transaction an investment contract, which is one of the defining characteristics of a security?

Up until that point, Canadian case law on such investment schemes was limited, so the ASC examined the handling of similar real estate deals in the U.S. for guidance. It found, among other things, that investment contracts were routinely described as those in which a person invests his money in a common enterprise and expects profits solely from the efforts of the promoter or third party. The ASC found that this condition was fulfilled in the LDC case, as investors were significantly dependent on a third party for the ultimate success of the projects.

In the end, the ASC concluded that LDC was indeed selling a security and subsequently shut LDC down. IE