Middlefield Fund Management Limited (Re), 2008 CanLII 25070

May 23, 2008

IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO (the Jurisdiction)

AND

(collectively, the “Existing Funds”), AND

(collectively, the “New Funds”)

AND

MIDDLEFIELD FUND MANAGEMENT LIMITED (the Filer)

Background

The principal regulator (the “Decision Maker”) in the Jurisdiction has received an application from the Filer, on behalf of the New Funds and each mutual fund hereafter created and managed by the Filer or any of the affiliates of the Filer (together with the New Funds, the “Funds”), for a decision under the securities legislation of the Jurisdiction (the “Legislation”) pursuant to section 19.1 of National Instrument 81-102 – Mutual Funds (“NI 81-102”) to revoke and replace the Prior Decision (defined herein) with this Decision exempting the Funds from the following requirements of the Legislation, subject to certain terms and conditions:

i) the requirements of sections 2.6 (a) and 2.6(c) of Part 2 of National Instrument 81-102 relating to the ability of the Funds to sell portfolio securities short; and

ii) the requirements of section 6.1 (1) of Part 6 of National Instrument 81-102 relating to the deposit of a portion of a Fund’s assets with an entity other than such Fund’s custodian (collectively, the “Requested Relief”.)

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):

the Ontario Securities Commission is the principal regulator for this application; and
the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (“MI 11-102”) is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Prince Edward Island, Nova Scotia, Newfoundland and Labrador, Northwest Territories, Yukon and Nunavut.

Interpretation

Defined terms contained in National Instrument 14-101 Definitions and MI 11-102 have the same meaning in this decision unless they are otherwise defined in this decision.

Representations

This decision is based on the following facts represented by the Filer:

Each Existing Fund is a class of shares of Middlefield Mutual Funds Limited or an affiliate of the Manager, a corporation established under the Business Corporations Act (Ontario).
Each Fund is or will become a reporting issuer in each of the Jurisdictions. A preliminary simplified prospectus and annual information form dated April 16, 2008 for the New Funds has been filed.
On June 8, 2005, a MRRS decision was granted to the Existing Funds allowing the Existing Funds to sell securities short up to 10% of their net asset value subject to certain conditions (the Prior Decision).
The Manager proposes that each Fund be authorized to engage in a limited, prudent and disciplined amount of short selling. The Manager is of the view that the Funds could benefit from the implementation and execution of a controlled and limited short selling strategy. This strategy would operate as a complement to the Funds’ primary discipline of buying securities with the expectation that they will appreciate in market value.
In order to effect a short sale, a Fund will borrow securities from either its custodian or a dealer (in either case, the “Borrowing Agent”), which Borrowing Agent may be acting either as principal for its own account or as agent for other lenders of securities.
Each Fund will implement the following controls when conducting a short sale:

(a) securities will be sold short for cash, with the Fund assuming the obligation to return to the Borrowing Agent the securities borrowed to effect the short sale;

(b) the short sale will be effected through market facilities through which the securities sold short are normally bought and sold;

(c) the Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sale is effected;

(d) the securities sold short will be “liquid securities” in that:

(i) the securities will be listed and posted for trading on a stock exchange, and

A. the issuer of the security will have a market capitalization of not less than CDN$100 million, or the equivalent thereof, at the time the short sale is effected; or

B. the investment advisor will have pre-arranged to borrow for the purposes of such short sale; or

(ii) the securities will be bonds, debentures or other evidences of indebtedness of or guaranteed by:

A. the Government of Canada or any province or territory of Canada; or

B. the Government of the United States of America;

(e) at the time securities of a particular issuer are sold short:

(i) the aggregate market value of all securities of that issuer sold short by the Fund will not exceed 5% of the net assets of the Fund; and

(ii) the Fund will place a “stop-loss” order with a dealer to immediately purchase for the Fund an equal number of the same securities if the trading price of the securities exceeds 120% (or such lesser percentage as the Manager may determine) of the price at which the securities were sold short;

(f) the Fund will deposit Fund assets with the Borrowing Agent as security in connection with the short sale transaction;

(g) the Fund will keep proper books and records of all short sales and Fund assets deposited with Borrowing Agents as security;

(h) the Fund will develop written policies and procedures for the conduct of short sales prior to conducting any short sales; and

(i) the Fund will provide disclosure in its prospectus of the short selling strategies and the details of this exemptive relief prior to implementing the short selling strategy.

Decision

Each of the Decision Makers is satisfied that the test contained in the Legislation that provides the Decision Maker with the jurisdiction to make the decision has been met.

The decision of the Decision Makers under the Legislation is that the Requested Relief is granted provided that:

the aggregate market value of all securities sold short by the Fund does not exceed 20% of the net assets of the Fund on a daily marked-to-market basis;
the Fund holds “cash cover” (as defined in NI 81-102) in an amount, including the Fund assets deposited with Borrowing Agents as security in connection with short sale transactions, that is at least 150% of the aggregate market value of all securities sold short by the Fund on a daily marked-to-market basis;
no proceeds from short sales by the Fund are used by the Fund to purchase long positions in securities other than cash cover;
the Fund maintains appropriate internal controls regarding its short sales including written policies and procedures, risk management controls and proper books and records;
for short sale transactions in Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall be a registered dealer in Canada and a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund;
any short sale made by the Fund is subject to compliance with the investment objective of the Fund;
for short sale transactions outside of Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall:

(a) be a member of a stock exchange and, as a result, be subject to a regulatory audit; and

(b) have a net worth in excess of the equivalent of CDN$100 million determined from its most recent audited financial statements that have been made public;

except where the Borrowing Agent is the Fund’s custodian, when the Fund deposits Fund assets with a Borrowing Agent as security in connection with a short sale transaction, the amount of Fund assets deposited with the Borrowing Agent does not, when aggregated with the amount of Fund assets already held by the Borrowing Agent as security for outstanding short sale transactions of the Fund, exceed 10% of the total assets of the Fund, taken at market value as at the time of the deposit;
the security interest provided by a Fund over any of its assets that is required to enable the Fund to effect short sale transactions is made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;
prior to conducting any short sales, the Fund discloses in its simplified prospectus a description of: (a) short selling, (b) how the Fund intends to engage in short selling, (c) the risks associated with short selling, and (d) in the Investment Strategy section of the simplified prospectus, the Fund’s strategy and this exemptive relief;
prior to conducting any short sales, the Fund discloses in its annual information form the following information:

(a) whether there are written policies and procedures in place that set out the objectives and goals for short selling and the risk management procedures applicable to short selling;

(b) who is responsible for setting and reviewing the policies and procedures referred to in the preceding paragraph, how often the policies and procedures are reviewed, and the extent and nature of the involvement of the board of directors in the risk management process;

(c) the trading limits or other controls on short selling in place and who is responsible for authorizing the trading and placing limits or other controls on the trading;

(d) whether there are individuals or groups that monitor the risks independent of those who trade; and

(e) whether risk measurement procedures or simulations are used to test the portfolio under stress conditions;

the Requested Relief will not apply to a Fund that is classified as a money market fund or a short-term income fund;
prior to conducting any short sales, the Fund has provided to its securityholders not less than 60 days’ written notice that discloses the Fund’s intent to begin short selling transactions and the disclosure required in the Fund’s simplified prospectus and annual information form as outlined in paragraphs 10 and 11 above, or the Fund’s initial simplified prospectus and annual information form and each renewal thereof has included such disclosure; and
the Requested Relief shall terminate upon the coming into force of any legislation or rule of the Decision Makers dealing with matters referred to in subsections 2.6(a), 2.6(c) and 6.1(1) of NI 81-102.

“Rhonda Goldberg”

Rhonda Goldberg

Manager, Investment Funds

Ontario Securities Commission