Headnote
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – Relief granted to allow mutual funds to short sell up to 20% of net assets, subject to certain conditions – National Instrument 81-102 Mutual Funds.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, subsections 2.6(a) and (c), 6.1(1) and section 19.1.
June 23, 2008
IN THE MATTER OF THE SECURITIES LEGISLATION OF ONTARIO
(the “Jurisdiction”)
and
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS
IN MULTIPLE JURISDICTIONS
and
IN THE MATTER OF JOVFUNDS MANAGEMENT INC.
(the “Filer”)
and
IN THE MATTER OF JOV CANADIAN EQUITY CLASS
(“Jov Class”)
Decision
Background
The principal regulator in the Jurisdiction has received an application from the Filer, on behalf of Jov Class and each mutual fund hereafter established and managed by the Filer or any of the affiliates of the Filer (the “Future Funds”, and together with Jov Class, the “Funds”) for a decision under the securities legislation of the Jurisdiction of the principal regulator (the “Legislation”) for an exemption from the requirements in subsections 2.6(a), 2.6(c) and 6.1(1) of National Instrument 81-102 Mutual Funds (“NI 81-102”) to permit each Fund to sell securities short, provide a security interest over Fund assets in connection with the short sales and deposit Fund assets with dealers as security in connection with such transactions (the “Exemption Sought”).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) 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 each of the provinces and territories of Canada (the “Jurisdictions”).
Interpretation
Terms defined in NI 81-102, National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
Representations
This decision is based on the following facts represented by the Filer:
The Filer or an affiliate of the Filer is or will be the manager of each Fund. JovInvestment Management Inc. (“JovInvestment”), which is registered under the Securities Act (Ontario) as an advisor in the categories of investment counsel and portfolio manager, is the portfolio advisor of Jov Class. T.I.P. Wealth Manager Inc., which is registered under the Securities Act (Ontario) as an advisor in the categories of investment counsel and portfolio manager, is the sub-advisor of Jov Class and is responsible for providing portfolio management and advisory services for Jov Class.
The head office of the Filer is located in Toronto, Ontario.
Each Fund is or will be a reporting issuer in each of the provinces and territories of Canada and distributes or will distribute securities under a simplified prospectus and annual information form.
The investment practices of each of the Funds will comply in all respects with the requirements of Part 2 of NI 81-102, except to the extent that the Funds have received permission from the applicable securities regulatory authorities or regulators of the Jurisdictions to deviate therefrom.
The Filer proposes that each Fund be authorized to engage in a limited, prudent and disciplined amount of short selling. The Filer and JovInvestment are 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.
Any short sales will be consistent with each Fund’s investment objectives.
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.
The simplified prospectus and annual information form of a Fund will disclose the proposed use of short selling by a Fund and the specific risks related to short selling.
Each Fund will implement the following requirements and 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, and “liquid securities” are securities that satisfy either (i) or (ii) below:
(i) the securities are listed and posted for trading on a stock exchange; and
(A) the issuer of the securities has a market capitalization of not less than CDN $300 million, or the equivalent thereof, at the time the short sale is effected; or
(B) the Fund’s portfolio advisor has pre-arranged to borrow the securities for the purpose of such short sale, or
(ii) the securities are bonds, debentures or other evidences of indebtedness of, or guaranteed by, the Government of Canada or any province or territory of Canada or 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 Filer 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 maintain appropriate internal controls regarding short sales prior to conducting any short sales, including written policies and procedures and risk management controls; and
(h) the Fund will keep proper books and records of all short sales and Fund assets deposited with Borrowing Agents as security.
Decision
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that in respect of each Fund:
(a) 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;
(b) any short sale made by the Fund is subject to compliance with the investment objectives of the Fund;
(c) the Exemption Sought does not apply to a Fund that is classified as a money market fund or a short term income fund;
(d) the Fund maintains appropriate internal controls regarding its short sales, including written policies and procedures, risk management controls and proper books and records;
(e) 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;
(f) no proceeds from short sales by the Fund are used by the Fund to purchase long positions in securities other than cash cover;
(g) for short sale transactions in Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund is a registered dealer in Canada and a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund;
(h) for short sale transactions outside of Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund is:
(i) a member of a stock exchange, and, as a result, subject to a regulatory audit; and
(ii) has a net worth in excess of the equivalent of CDN $50 million determined from its most recent audited financial statements that have been made public;
(i) 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 net assets of the Fund, taken at market value as at the time of the deposit;
(j) the security interest provided by the Fund over any of its assets 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;
(k) prior to conducting any short sales, the Fund discloses in its simplified prospectus a description of: (i) short selling, (ii) how the Fund intends to engage in short selling, (iii) the risks associated with short selling, and (iv) in the Investment Strategy section of the simplified prospectus, the Fund’s strategy and this exemptive relief;
(l) prior to conducting any short sales, the Fund discloses in its annual information form the following information:
(i) that there are written policies and procedures in place that set out the objectives and goals for short selling and risk management procedures applicable to short selling;
(ii) who is responsible for setting and reviewing the policies and procedures referred to in the preceding item (i), how often the policies and procedures are reviewed, and the extent and nature of the involvement of the board of directors or trustees of the Fund or the board of directors of the Filer (as applicable) in the risk management process;
(iii) 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;
(iv) whether there are individuals or groups that monitor the risks independent of those who trade; and
(v) whether risk measurement procedures or simulations are used to test the portfolio under stress conditions; and
(m) 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 made the disclosure required in the Fund’s simplified prospectus and annual information form as outlined in paragraphs (k) and (l) of this decision, or the Fund’s initial simplified prospectus and annual information form and each renewal thereof has included such disclosure.
The Exemption Sought shall terminate upon the coming into force of any legislation or rule of the principal regulator dealing with the 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 Branch
Ontario Securities Commission
SEDAR Project No. 1269430