Headnote National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – relief granted from the mutual fund self-dealing restrictions in the Securities Act (Ontario) to allow pooled funds to invest in securities of underlying funds under common management – relief subject to certain conditions.
Applicable Legislative Provisions
Securities Act (Ontario) R.S.O. 1990, c. S.5, as amended, sections 111(2)(b), 111(2)(c), 111(3) and 113.
March 1, 2013
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 K2 & ASSOCIATES INVESTMENT MANAGEMENT INC. (the Filer)
AND
THE K2 PRINCIPAL TRUST
(the First Top Fund)
DECISION
Background
The principal regulator in the Jurisdiction has received an application from the Filer on its behalf and on behalf of the First Top Fund and any other mutual fund which is not a reporting issuer and may be established and managed by the Filer in the future (together with the First Top Fund, the Top Funds), which invests its assets in The K2 Principal Fund L.P. (the First Underlying Fund) or any other investment fund which is not a reporting issuer under the Securities Act (Ontario) and may be established, advised or managed by the Filer in the future (together with the First Underlying Fund, the Underlying Funds), for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) exempting the Top Funds and the Filer from:
(a) the restriction in the Legislation which prohibits a mutual fund in Ontario from knowingly making an investment in a person or company in which the mutual fund, alone or together with one or more related mutual funds, is a substantial security holder;
(b) the restriction in the Legislation which prohibits a mutual fund in Ontario from knowingly making an investment in an issuer in which:
(i) any officer or director of the mutual fund, its management company or distribution company or an associate of any of them, or
(ii) any person or company who is a substantial securityholder of the mutual fund, its management company or its distribution company,
has a significant interest; and
(c) the restriction in the Legislation which prohibits a mutual fund in Ontario, its management company or its distribution company from knowingly holding an investment described in paragraph (a) or (b) above.
(collectively, the Requested Relief).
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 Alberta.
Interpretation
Terms defined in 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:
Manager
The Filer is a corporation established under the laws of Ontario with its head office located in Toronto, Ontario.
The Filer is registered as an investment fund manager, portfolio manager and exempt market dealer in Ontario and as an exempt market dealer in British Columbia, Alberta, Manitoba, Quebec and Nova Scotia.
The Filer is or will be the investment fund manager of the Top Funds. The Filer is or will be the investment fund manager of future Underlying Funds structured as limited partnerships and trusts. For future Underlying Funds structured as corporations under the laws of Ontario or another jurisdiction of Canada, the Filer will act as the investment fund manager. For future Underlying Funds structured as corporations under the laws of a foreign jurisdiction, either the Filer or the board of directors of the corporation will act as the investment fund manager.
The Filer is or will be the portfolio manager for the Top Funds and the Underlying Funds. The Filer acts or will act as a distributor of the securities of certain of the Top Funds and Underlying Funds not otherwise sold through another registered dealer.
The Filer is not a reporting issuer in any jurisdiction.
The Filer is not in default of securities legislation of any jurisdiction of Canada, except as noted in paragraph 8 below.
An officer and director of the Filer, who is also a substantial security holder of the Filer, currently has a significant interest in the First Underlying Fund. Through inadvertence, the First Top Fund invested in the First Underlying Fund, contrary to the Legislation. As soon as the requirement to seek the Requested Relief came to the Filer’s attention, the Filer initiated the process of seeking the Requested Relief and has strengthened its internal control systems to ensure future compliance with applicable laws and regulations.
Top Funds
The First Top Fund is an investment trust established under the laws of Ontario on October 1, 2009. The future Top Funds may be structured as limited partnerships, trusts or corporations under the laws of Ontario or another jurisdiction of Canada.
The securities of each Top Fund are, or will be, sold solely to investors pursuant to exemptions from the prospectus requirements in accordance with National Instrument 45-106 Prospectus and Registration Exemptions (“NI 45-106”).
Each of the Top Funds is, or will be, a “mutual fund” as defined in securities legislation of the jurisdictions in which the Top Funds are distributed.
The First Top Fund’s investment objective is to provide investors with long term capital growth, which will be achieved primarily by investing in securities of the First Underlying Fund.
None of the Top Funds is, or will be, a reporting issuer in any jurisdiction of Canada.
The First Top Fund is not in default of securities legislation of any jurisdiction of Canada, except as noted in paragraph 7 above.
Underlying Funds
The First Underlying Fund is a limited partnership established under the laws of Ontario by declaration dated November 29, 2000. The future Underlying Funds may be structured as limited partnerships, trusts or corporations under the laws of Ontario or another jurisdiction of Canada or foreign jurisdiction.
The general partner of the First Underlying Fund is K2 GenPar L.P., an affiliate of the Filer. The general partner of each future Underlying Fund that is structured as a limited partnership will be an affiliate of the Filer.
In Canada, securities of each Underlying Fund are, or will be, sold solely to investors pursuant to exemptions from the prospectus requirements in accordance with NI 45-106.
Each of the Underlying Funds is, or will be, an “investment fund” but may not be, a “mutual fund” as defined in securities legislation of the jurisdictions in Canada.
Each of the Underlying Funds has, or will have, separate investment objectives and investment strategies.
The First Underlying Fund’s investment objective is to generate extraordinary returns on its capital by using both non-directional and directional strategies. Non-directional strategies include taking market-neutral positions. Directional strategies include long or short equity strategies and global macro strategies. The First Underlying Fund does not invest in other investment entities managed by the Filer or its affiliates.
None of the Underlying Funds is, or will be, a reporting issuer in any jurisdiction of Canada.
The First Underlying Fund is not in default of securities legislation of any jurisdiction of Canada.
Fund-on-Fund Structure
The First Top Fund was, and other Top Funds may be, created by the Filer to allow investors in the Top Funds to obtain indirect exposure to the investment portfolio of the Underlying Funds and their investment strategies through, primarily, direct investments by the Top Funds in securities of the Underlying Funds (the Fund-on-Fund Structure). Rather than running the First Top Fund’s and each Underlying Fund’s investment portfolios as separate pools, the Filer makes use of economies of scale by managing investment pools in the Underlying Funds. Unlike the First Underlying Fund, which is a limited partnership, the First Top Fund was formed as a trust for the purpose of accessing a broader base of investors, including registered retirement savings plans and other investors that may not or wish not to invest directly in a limited partnership.
An investment by a Top Fund in an Underlying Fund is, or will be, compatible with the investment objectives of the Top Fund.
The Underlying Funds will invest primarily in equity securities and will also invest in fixed income securities, options on equities and currency, as well as illiquid assets including private equity and debt. Where an Underlying Fund holds illiquid assets, the remainder of the Underlying Fund’s portfolio will be managed to provide sufficient liquidity to fund redemptions in the ordinary course.
The Top Funds and the Underlying Funds have, or will have, matching valuation dates. The First Top Fund and the First Underlying Fund are valued monthly.
Securities of the Top Funds and the Underlying Funds have, or will have, matching redemption dates. The First Top Fund and the First Underlying Fund are redeemable monthly.
A Top Fund will not purchase or hold securities of an Underlying Fund unless:
(a) the Underlying Fund invests less than 10% of its net assets in other mutual funds other than mutual funds that are “money market funds” (as defined by NI 81-102) or that issue “index participation units” (as defined by NI 81-102);
(b) no management fees or incentive fees are payable by a Top Fund that, to a reasonable person, would duplicate a fee payable by an Underlying Fund for the same service;
(c) no sales fees or redemption fees are payable by a Top Fund in relation to its purchases or redemptions of securities of an Underlying Fund;
(d) the Filer does not cause the securities of an Underlying Fund held by a Top Fund to be voted at any meeting of the securityholders of the Underlying Fund except that the Top Fund may arrange for the securities it holds of the Underlying Fund to be voted by the beneficial holders of securities of the Top Fund; and
(e) the offering memorandum, where available, or other disclosure document of a Top Fund will be provided to all investors of the Top Fund and will disclose:
(i) that the Top Fund may purchase securities of the Underlying Funds;
(ii) that the Filer is the investment fund manager of both the Top Funds and the Underlying Funds, if applicable; and
(iii) the approximate or maximum percentage of net assets of the Top Fund that it is intended be invested in securities of the Underlying Funds; and
(iv) the process or criteria used to select the Underlying Funds.
Prior to the time of purchase of securities of a Top Fund, an investor will be provided with a copy of the Top Fund’s offering memorandum, where available, as well as disclosure about the relationships and potential conflicts of interest between the Top Fund and the Underlying Funds.
Securityholders of a Top Fund will receive, on request, a copy of the Top Fund’s audited annual and interim financial statements. The financial statements of each Top Fund will disclose its holdings of securities of Underlying Funds.
Securityholders of a Top Fund will receive, on request, a copy of the offering document, if available, and the annual and interim financial statements, of any Underlying Fund in which the Top Fund invests.
Generally
The amounts invested from time to time in an Underlying Fund by a Top Fund, either alone or together with the other Top Funds, may exceed 20% of the outstanding voting securities of the Underlying Fund. As a result, each Top Fund could, either alone or together with Top Funds, become a substantial security holder of an Underlying Fund. The Top Funds are, or will be, related mutual funds by virtue of common management by the Filer.
In addition, the Fund-on-Fund Structure may result in a Top Fund investing in an Underlying Fund in which an officer or director of the Filer has a significant interest and/or a Top Fund investing in an Underlying Fund in which a person or company who is a substantial securityholder of the Top Fund or the Filer has a significant interest.
Since the Top Funds and the Underlying Funds do not offer their securities under a simplified prospectus, they are not subject to NI 81-102 and therefore the Top Funds and the Underlying Funds are unable to rely upon the exemption codified under subsection 2.5(7) of NI 81-102.
In the absence of the Requested Relief, each Top Fund would be precluded from purchasing and holding securities of an Underlying Fund due to the investment restrictions contained in the Legislation.
Each investment by a Top Fund in an Underlying Fund represents the business judgment of responsible persons uninfluenced by considerations other than the best interests of the Top Fund.
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 Requested Relief is granted provided that:
(a) securities of the Top Funds are distributed in Canada solely pursuant to exemptions from the prospectus requirements in NI 45-106;
(b) the investment by a Top Fund in an Underlying Fund is compatible with the fundamental investment objectives of the Top Fund;
(c) no Top Fund will invest in an Underlying Fund unless the Underlying Fund invests less than 10% of its net assets in other mutual funds other than mutual funds that are “money market funds” (as defined by NI 81-102) or that issue “index participation units” (as defined by NI 81-102);
(d) no management fees or incentive fees are payable by a Top Fund that, to a reasonable person, would duplicate a fee payable by an Underlying Fund for the same service;
(e) no sales fees or redemption fees are payable by a Top Fund in relation to its purchases or redemptions of securities of an Underlying Fund;
(f) the Filer does not cause the securities of an Underlying Fund held by a Top Fund to be voted at any meeting of the securityholders of the Underlying Fund except that the Top Fund may arrange for the securities it holds of the Underlying Fund to be voted by the beneficial holders of securities of the Top Fund; and
(g) the offering memorandum, where available, or other disclosure document of a Top Fund will disclose:
(i) that the Top Fund may purchase securities of the Underlying Funds;
(ii) the fact that the Filer is the investment fund manager of both the Top Funds and the Underlying Funds, if applicable;
(iii) the approximate or maximum percentage of net assets of the Top Fund that it is intended be invested in securities of the Underlying Funds; and
(iv) the process or criteria used to select the Underlying Funds.
(h) prior to the time of investment, securityholders of a Top Fund will be provided with disclosure with respect to each person, if any, that has a significant interest in the Underlying Funds through investments made in securities of such Underlying Funds. Securityholders in a Top Fund will also be advised of the potential conflicts of interest which may arise from such relationships. The foregoing disclosure will be contained in any offering memorandum prepared in connection with a distribution of securities of the Top Fund, or if no offering memorandum is prepared, in another document provided to investors of the Top Fund.
“Edward Kerwin” “Judith N. Robertson” (Name)
Commissioner Commissioner (Title)
Ontario Securities Commission Ontario Securities Commission