Securities Law & Instruments

March 23, 2012

Fasken Martineau DuMoulin LLP
333 Bay Street, Suite 2400
Bay Adelaide Centre, Box 20
Toronto, ON M5H 2T6
 
Attention: David A. Hausman
Attention: Tracy L. Hooey
 

Re:

ONE Financial Corporation and ONE Financial All-Weather Profit Family Corp.

Preliminary Prospectus dated October 5, 2011 (the Prospectus) -- SEDAR Project No. 1845211

This letter sets out my decision as Director on an Opportunity to be Heard (OTBH) held on February 28, 2012 and February 29, 2012 in respect of staff's recommendation to refuse to issue a receipt for the Prospectus. I have received extensive written materials from both ONE Financial Corporation (ONE Financial) and staff (Staff) of the Ontario Securities Commission (the Commission), and I have reviewed and considered both the written materials and oral submissions made to me.

Based on the materials and submissions made by the parties, I accept Staff's recommendation that a receipt not be issued for the Prospectus for the reasons set out below.

This Decision follows closely the completion of the OTBH and subsequent written submissions provided on March 2, 2012 and March 13, 2012. This is at the request of ONE Financial. Accordingly, the Decision highlights the key policy considerations that form the basis of my determination.

Finally, I note that Staff in their written materials identified several issues still to be addressed prior to the issuance of the receipt for the Prospectus, outside of the scope of the OTBH.{1} I have made no determination with respect to these issues.

I. Background

On October 5, 2011, ONE Financial filed a draft prospectus on a confidential pre-filing basis with the Commission on behalf of the All-Weather Profit Family Corp. (the individual share classes of which are referred to as a Fund). Each Fund is a commodity pool whose investment objectives include potentially gaining exposure to a reference fund (each, an Investment Pool) by way of a forward agreement.

Staff provided comments on the draft prospectus on October 28, 2011 and ONE Financial responded to the comments on November 11, 2011. On December 2, 2011, Staff provided a further comment letter that advised ONE Financial that Staff would be hesitant to recommend a receipt for the draft prospectus on the basis that it would not be in the public interest to do so.

On December 29, 2011, ONE Financial filed the Prospectus. Staff issued a comment letter in connection with the Prospectus on January 13, 2012 and ONE Financial responded to the comment letter on January 31, 2012. In its response letter, ONE Financial indicated that it wished to exercise its opportunity to be heard by the Director under subsection 61(3) of the Securities Act (Ontario) (the Act).

In connection with the OTBH, ONE Financial filed a Memorandum of Argument and supporting materials on February 13, 2012. On that same date, ONE Financial also filed a revised draft of the Prospectus. This revised draft of the Prospectus is the only one submitted by either of the parties at the OTBH and is therefore the version of the Prospectus that I refer to and rely on throughout this decision.

Staff filed their written submissions and supporting materials on February 23, 2012. The OTBH was held on February 28 and 29, 2012 at the offices of the Commission. Additional written submissions were received from Staff on March 2, 2012 and from ONE Financial on March 13, 2012.

II. Issues

In their February 23, 2012 and March 2, 2012 written submissions and at the OTBH, Staff argued that a receipt for the Prospectus should not be issued on the basis of the following elements:

(A) the payment of the Collateral Investment Compensation (defined below) to ONE Financial;

(B) the Advisor Performance Bonus (defined below);

(C) the following disclosure issues in the Prospectus:

(i) the disclosure of the fee payable to the counterparty in respect of the forward agreements;

(ii) the inclusion of the Indices (defined below) in the Prospectus; and

(iii) the disclosure of the Funds' use of leverage;

(D) issues related to the following forward agreement structures that may be used by the Funds:

(i) the forward purchase agreement and forward sale agreement; and

(ii) the prepaid forward agreement;

(E) the failure of ONE Financial to file a prospectus for the Investment Pools; and

(F) the payment of the Advisory Fee (defined below) to ONE Financial.

Staff submit that, as a result of the above elements, issuing a receipt for the Prospectus would be contrary to the public interest. Furthermore, Staff submit that the Prospectus "appears to not comply with the requirements of the Act or the regulations; and contains statements, promises, estimates or forward-looking information that are misleading".{2}

For the reasons set out below, with respect to each of the elements above (except items (D)(i) and (E), where I have made no determination for reasons discussed below, and item (C)(iii)) I accept Staff's recommendation that a receipt not be issued for the Prospectus. That is, issuing a receipt for the Prospectus in light of each of these items, taken alone or cumulatively, would be contrary to the public interest. Moreover, in respect of items (C)(i) and (C)(ii) above, these elements comprise or contain misleading statements, promises or estimates, and in respect of (C)(ii), the inclusion of the Indices does not comply with the requirements of the regulations under the Act.

III. Legislative Framework for Commodity Pools

Each Fund is a commodity pool, which is a specialized type of mutual fund that uses certain alternative investment strategies involving specified derivatives and physical commodities beyond what is permitted by National Instrument 81-102 Mutual Funds (NI 81-102). Like conventional mutual funds, commodity pools are in continuous distribution and permit daily redemptions of their securities at net asset value (NAV), and the securities of commodity pools are generally not listed on a stock exchange.

National Instrument 81-104 Commodity Pools (NI 81-104) exempts commodity pools from the application of several of the investment restrictions in NI 81-102 to allow commodity pools liberalized use of derivatives, leverage strategies and physical commodities. NI 81-104 also provides commodity pools with an exemption from the concentration restrictions in NI 81-102 in connection with a commodity pool's exposure to a counterparty in a specified derivatives transaction.

Section 1.4 of Companion Policy 81-104CP (81-104CP) states that the Canadian Securities Administrators (the CSA) considered the following regulatory principles in developing and implementing NI 81-104:

(a)Commodity pools should be regulated in the same manner as conventional mutual funds, except in respect of their use of specified derivatives and leverage strategies. Therefore, commodity pools are defined in NI 81-104 as a type of mutual fund, so that the rules of NI 81-102, and other applicable securities legislation apply except as provided otherwise in NI 81-104. [emphasis added]

(b)Commodity pools should be granted greater freedom in their use of specified derivatives and leverage strategies than conventional mutual funds, in exchange for requirements which, among other things, are aimed at increasing the information available to investors about the investment strategies, risks and on-going performance of commodity pools. Therefore, NI 81-104 generally exempts commodity pools from the specified derivative rules of NI 81-102. [emphasis added]

With this in mind, NI 81-104 imposes higher proficiency and supervisory requirements on dealers who trade in securities of a commodity pool than on those who trade in securities of conventional mutual funds.

Finally, unlike conventional mutual funds, commodity pools file a long form prospectus in accordance with the requirements of Form 41-101F2Information Required in an Investment Fund Prospectus (Form 41-101F2). Moreover, commodity pools are required to include certain prescribed warning language on the cover page of their prospectuses that is not required of other types of investment funds.

IV. Applicable Provisions and the Extent of the Director's Discretion

The OTBH engages the Director's jurisdiction under subsection 61(1) and clauses 61(2)(a)(i) and 61(2)(a)(ii) of the Act.

Subsection 61(1) of the Act states that, subject to specified exceptions, the Director shall issue a receipt for a prospectus "unless it appears to the Director that it is not the public interest to do so".

Subsection 61(2) of the Act states in part that the Director

"shall not issue a receipt for a prospectus or an amendment to a prospectus if it appears to the Director that,

(a) the prospectus or any document required to be filed with it,

(i) does not comply in any substantial respect with any of the requirements of this Act or the regulations,

(ii) contains any statement, promise, estimate or forward-looking information that is misleading, false or deceptive..."

Meaning of Public Interest in the Context of Subsection 61(1) of the Act

Both ONE Financial and Staff refer to Committee for Equal Treatment of Asbestos Minority Shareholders v. Ontario (Securities Commission) (Asbestos) as informing the scope of the public interest jurisdiction in the context of subsection 61(1) of the Act. In that case, the Supreme Court of Canada, in considering the public interest jurisdiction under section 127 of the Act, declared that the Commission has broad discretion to intervene in Ontario capital markets if it is in the public interest to do so. However, the court held that such discretion is not unlimited; it must be exercised with reference to the purposes of the Act as set out in section 1.1 of the Act.{3} Staff and ONE Financial both submit that the Director must also have regard to the principles outlined in section 2.1 of the Act.{4}

The purposes of the Act as detailed in section 1.1 of the Act are,

(a) to provide protection to investors from unfair, improper or fraudulent practices; and

(b) to foster fair and efficient capital markets and confidence in capital markets.

Staff submit that, even though the purposes of the Act as detailed in section 1.1 are to a large degree complementary, the purposes do not have to be treated equally in a given case, so long as they are both considered.{5} I agree with Staff's submission that in a retail-focused context, such as the mutual fund industry, confidence in capital markets and investor protection gain more prominence.{6}

In considering the public interest jurisdiction under subsection 61(1) of the Act, Staff argue that the Commission has stated that there is no requirement that the Director find a breach of the Act or related instruments, or that, in the absence of a breach, the transaction be "abusive". In support of this proposition, Staff cite the Commission decisions in Biovail Corp. (Re) and Guard Inc., Re.{7} Staff also argue that the discretion granted to the Director under subsection 61(1) is broader than the public interest jurisdiction that the Commission has typically exercised under subsection 127(1) of the Act, and gives the Director some degree of "blue sky" discretion.{8}

In its submissions, ONE Financial argues that "in the case of a commodity pool, the scope of the Director's public interest jurisdiction is tightly constrained by the specificity of applicable instruments, which provide a comprehensive code respecting the obligations of commodity pool issuers and leave little room for supplementary public interest consideration."{9} ONE Financial further submits that because a prospectus in the context of an initial public offering (IPO) is incapable of affecting the pre-existing rights of any member of the public, the animating principles of the Act must be premised fundamentally upon the quality of the disclosure, where the viability of the issuer is not in question.{10} I disagree.

The rapid pace of product and market innovation does not always make it possible for rule-making to keep pace with product and market developments. In this context, I agree with Staff's submission that National Instruments may inform the Director's discretion,{11} but, as Staff submitted at the OTBH, the Commission has stated that it should not be supposed that specific rules necessarily exhaust all of the policy concerns which led to the implementation of the rules in the first place.{12}

In my experience, an IPO prospectus for an investment fund can give rise to concerns about whether the product is consistent with the purposes and animating principles of the Act, beyond the quality of the disclosure in the prospectus. In a dynamic market environment, it is important for the Director to have broad discretion when it comes to determining whether it is in the public interest to issue a receipt for a prospectus. This is consistent with the Supreme Court of Canada's decision in Asbestos.{13}

In exercising a broad public interest discretion, I am mindful of the guidance provided in the Commission decisions referred to by both ONE Financial and Staff. Specifically, I recognize that the public interest jurisdiction must be exercised with some caution and restraint,{14} and that caution needs to be exercised where intervention in the public interest would amount to an amendment of the existing law or policies.{15} I note that I do not consider the public interest jurisdiction I have exercised in this decision to constitute intervention that would amount to any amendment of existing law or policies.

Onus and Standard of Proof for the OTBH

Both ONE Financial and Staff agree that Staff bear the onus of proving that (i) the issuance of a receipt for the Prospectus would be contrary to the public interest, (ii) the prospectus does not comply in any substantial respect with the requirements of the Act or the regulations, or (iii) the prospectus contains any statement, promise, estimate or forward-looking information that is misleading.

I accept the submissions of Staff that the standard applicable to Staff in establishing that a receipt should not be granted for the Prospectus is the balance of probabilities.{16} That is, "whether it is more likely than not" that the issuance of a receipt would be contrary to the public interest, that the Prospectus does not substantially comply with the requirements of the Act, or that the Prospectus contains misleading statements, promises, estimates or forward-looking information.

Precedent Prospectuses

ONE Financial submits that the Director, in exercising her public interest jurisdiction under subsection 61(1) of the Act, should take into consideration where other issuers have received receipts for prospectuses that have the same or similar disclosure, or attributes of, those that Staff are objecting to in the OTBH.{17} At the OTBH, counsel for ONE Financial argued that precedents must have value as they are one of the only ways counsel have for advising clients as to what kinds of structures and disclosure are appropriate. Moreover, previously receipted prospectuses create reasonable expectations among market participants.

While I would agree that receipted prospectuses have some value in demonstrating to market participants the level of disclosure, attributes of a product or investment strategies for which Staff have, in the past, been prepared to recommend a prospectus receipt, I accept Staff's submission that the precedential value of previously receipted prospectuses is limited and in no way confines the Director's public interest jurisdiction under subsection 61(1) of the Act. In their submissions, Staff referred to the Commission's statement in Guard Inc., Re,

"While it may be reasonable for counsel to consider past decisions of the Commission and the Director in advising clients, the fact that a receipt has issued in the past for a prospectus does not necessarily mean that the Director, in exercising her discretion under the Act, must issue a receipt for a similar prospectus in the future. Counsel should exercise some caution in relying on such precedents, particularly given the selective review system for prospectuses that is now in place."{18}

At the OTBH, Staff argued that at least since the Commission decision in Guard Inc., Re, the reasonable expectations of market participants should be informed by the statement quoted above regarding previously receipted prospectuses. I agree.

Finally, I note that no precedent prospectus has been provided to me by ONE Financial that contains all the elements of the Prospectus that Staff is objecting to in the OTBH.

V. Discussion of the Issues

As identified above, Staff have raised nine grounds for refusing to issue a receipt for the Prospectus. Other than with respect to (i) the use of forward sale agreements and forward purchase agreements and the failure to file a prospectus for the Investment Pools, for which I have made no determination, and (ii) the leverage disclosure in the Prospectus, I accept Staff's recommendation that each of these grounds is sufficient on its own for refusing a receipt, for the reasons set out below. Alternatively, even if any of the grounds would not be sufficient in itself to refuse a receipt, in my view their cumulative effect is sufficient to find it is not in the public interest to issue a receipt for the Prospectus. A discussion of each of the issues follows.

A. Collateral Investment Compensation

Submissions

The Prospectus discloses that the interest income generated from Collateral Investments (the Collateral Investment Compensation) held by the Funds or the Investment Pools from time to time will be payable to ONE Financial in its capacity as principal broker of the Funds.

The Prospectus defines "Collateral Investments" as,

"cash and cash investments in investment grade debt, money market instruments, or demand deposits of Canadian chartered banks, or similarly rated foreign denominated investments, held by a [Fund] or an Investment Pool including on account of initial and maintenance margin and reserves for the variation thereof."{19}

Staff submit that the Collateral Investment Compensation is contrary to the public interest on the basis that the Prospectus disclosure does not allow prospective investors to know the total compensation payable to ONE Financial, and that the payment of the Collateral Investment Compensation to ONE Financial is not consistent with the standard of care expected of an investment fund manager under the Act.

With respect to the disclosure, Staff argue that the Prospectus does not display the Collateral Investment Compensation as part of the management fee, but rather as an operating expense, which makes it difficult for an investor to identify and assess the impact this fee would have on an ongoing basis.{20} More significantly, Staff submit that, because the Collateral Investment Compensation is variable, it is difficult for prospective investors to know in advance what the total compensation earned by ONE Financial will be.{21}

In response, ONE Financial argues that there is comprehensive disclosure of the Collateral Investment Compensation in the Prospectus{22} that is consistent with the law of fiduciaries, which states that a fiduciary may enter into a fully agreed and disclosed compensation arrangement with the beneficiary of the fiduciary duty.{23}

ONE Financial further submits that while it is not possible to disclose this form of compensation as a component of the management fee, as it will vary depending on prevailing interest rates and the amount of cash held from time to time, the Collateral Investment Compensation will be fully disclosed to investors as a component of each Fund's management expense ratio (MER) in the Funds' subsequent continuous disclosure.{24} In this regard, ONE Financial argues that the variable nature of the Collateral Investment Compensation is similar to fees payable to third-party service providers, such as legal, audit or custodial fees. In addition, ONE Financial proposes to disclose in the Prospectus an estimate of the first year's Collateral Investment Compensation prior to publishing the first MERs and financial statements of the Funds, to provide investors with sufficient disclosure of their anticipated ownership costs.{25}

At the OTBH, counsel for ONE Financial also argued that the Collateral Investment Compensation cannot be found contrary to the public interest because of the legislative history surrounding the structure of these fees. Specifically, OSC Policy 11.4 Commodity Pool Programs (Policy 11.4), the predecessor to NI 81-104, required that any interest or other income earned by any portion of a commodity pool's assets accrue solely to the benefit of the commodity pool. Moreover, the manager of a commodity pool was prohibited from taking any action with respect to the assets or property of the commodity pool which does not benefit the commodity pool.{26} ONE Financial submitted that these requirements from Policy 11.4 were not carried over into NI 81-104 on the basis that the CSA believed that "generally the appropriate regulatory approach to fees is to mandate their disclosure, but not regulate the quantum".{27} Accordingly, ONE Financial argued at the OTBH that the appropriate approach to the Collateral Investment Compensation is disclosure.

In response, at the OTBH Staff focused on the CSA's use of the word "generally". Staff argued that the CSA recognized that there may be situations where regulating the quantum of fees would be appropriate, and that the legislative history of NI 81-104 should not be read as limiting the Director's public interest jurisdiction in connection with commodity pools. At the OTBH, Staff submitted that their primary concern was with the disclosure of the Collateral Investment Compensation in the Prospectus, and indicated that they would be prepared to accept a maximum placed on the Collateral Investment Compensation, as a way to mitigate Staff's concern that prospective investors cannot discern the total fee payable to ONE Financial.

In addition to disclosure, Staff also submit that the Collateral Investment Compensation is not consistent with the standard of care expected of investment fund managers under section 116 of the Act, as it is contrary to the presumption that assets of a mutual fund are invested for the benefit of securityholders. According to Staff, diverting revenue generated by an investment fund's portfolio assets to the investment fund manager impairs an investor's ability to benefit from the returns of the fund's portfolio and is not in the best interests of the fund.{28} In light of the conflict of interest inherent in the structure, Staff argue that the use of the Funds' assets for the benefit of ONE Financial is inconsistent with ONE Financial's statutory duties towards the Funds.{29}

In contrast, ONE Financial submits that the Collateral Investment Compensation payment structure is not uncommon in the managed futures industry generally.{30} Furthermore, ONE Financial is able to offer its services at a lower fixed fee as a consequence of the income generated from the Collateral Investment Compensation.{31}

Determination

In my view, a key aspect of a prospective investor's consideration when making an investment decision is the cost of ownership. ONE Financial submits that it is settled law that a fiduciary may receive remuneration for fully agreed and disclosed compensation arrangements.{32} On a balance of probabilities, however, I find the variable nature of the Collateral Investment Compensation makes it more likely than not that it will not be possible for prospective investors to fully agree to such a payment, as the total compensation payable to ONE Financial is not fully disclosed.

On this point I agree with Staff's submission that the inclusion of an estimate of the total Collateral Investment Compensation in the Prospectus is of little utility,{33} as is the subsequent disclosure of the MER. Neither disclosure, in my view, enables potential investors to determine the total compensation that will be payable to ONE Financial, since absent a maximum limit placed on the Collateral Investment Compensation, the amount payable could be unlimited.

The Commission has stated that disclosure by reporting issuers is a fundamental cornerstone of securities regulation.{34} Accurate and efficient disclosure is fundamental to protect investors from unfair or improper practices and to foster fair and efficient capital markets and confidence in those markets.{35} I consider this to be particularly relevant with respect to the fees and expenses that are payable by a mutual fund, since these costs reduce the fund's (and ultimately, the investors') return; and with respect to the fees payable by the mutual fund to the investment fund manager, given the fundamental role of the manager in the organization and ongoing oversight of the mutual fund. Accordingly, confidence in the capital markets is crucial in this area.

I further agree with Staff that the payment of the Collateral Investment Compensation to ONE Financial, in its capacity as principal broker, gives rise to a potential conflict of interest. That is, as investment fund manager and portfolio manager, ONE Financial is required to manage the Funds' portfolios in the best interests of the Funds, while as principal broker, ONE Financial has an interest in making the Funds invest in Collateral Investments, as any interest earned on these investments is paid to ONE Financial. In my view, this potential conflict of interest related to the Collateral Investment Compensation, in addition to the variable nature of the payment, heightens the need for prospective investors to have disclosure in the Prospectus that allows them to determine what the total compensation payable to ONE Financial will be.

While I accept the proposition that generally, the appropriate regulatory approach to fees is to mandate their disclosure, not regulate the quantum, I disagree with the submission made by counsel for ONE Financial at the OTBH that it is not necessary, in the public interest, for ONE Financial to impose a hard maximum on the Collateral Investment Compensation.

Based on the specific facts before me, namely, the potential conflict of interest and the variable nature of the payment, I agree with Staff's submission that absent the inclusion in the disclosure of the Prospectus of a maximum limit on the Collateral Investment Compensation, issuing a receipt for the Prospectus would be contrary to the public interest under section 61(1) of the Act.

On this point, I note that the only precedent to which ONE Financial directed me has a maximum limit on compensation substantially similar to the Collateral Investment Compensation.

With respect to section 116 of the Act, while I agree with Staff that the Collateral Investment Compensation creates a potential conflict of interest for ONE Financial, based on the facts before me I do not find the payment of the Collateral Investment Compensation to ONE Financial to be inconsistent with ONE Financial's duties under section 116 of the Act. The CSA have recognized that the structure of the fund industry creates the potential for the interests of fund investors to diverge from the pecuniary interests of the fund manager, and that this risk is exacerbated by the fact that, in many cases, related parties provide all of the requisite services to the fund.{36} However, in my view not all potential conflicts of interest will result in a breach of the fund manager's duties under the Act. I note that the CSA introduced National Instrument 81-107 Independent Review Committee for Investment Funds (NI 81-107) to provide "for the independent review and oversight of the conflicts faced by the fund manager in the operation of the investment fund."{37} The potential conflict of interest for ONE Financial raised by the Collateral Investment Compensation is, in my view, the type of "business" or "operational" conflict intended to be captured by NI 81-107.

Furthermore, in light of the evidence provided by ONE Financial with respect to the use of this payment structure in the managed futures industry generally, as well as its impact on fees, I am satisfied that the Collateral Investment Compensation is not inconsistent with the statutory duties of ONE Financial as an investment fund manager.

Finally, I note that Staff had queried whether ONE Financial has the appropriate registration status to act as principal broker with respect to the activities associated with the Collateral Investments.{38} In subsequent written submissions dated March 2, 2012, Staff stated that, based on the information contained in an e-mail provided by counsel for ONE Financial dated February 29, 2012, the concerns previously expressed by Staff regarding the requisite registration status of ONE Financial, in the context of the Collateral Investment Compensation, have been addressed.{39} Accordingly, in my view I do not have to make a determination on this issue.

B. Advisor Performance Bonus

Submissions

The Prospectus discloses that brokers, dealers and advisors of clients holding any series of shares of a Fund may also be paid a portion of the performance bonus earned by ONE Financial in its capacity as investment fund manager of the Funds in respect of that Fund (the Advisor Performance Bonus). The Advisor Performance Bonus is calculated as 15 per cent of the performance bonus earned by ONE Financial.

Staff argue that National Instrument 81-105 Mutual Fund Sales Practices (NI 81-105) prohibits payments to advisors other than in the form of sales commissions or trailing commissions that comply with Part 3 of NI 81-102. In their submissions, Staff disagree with the characterization of the Advisor Performance Bonus as a trailing commission contemplated by Part 3 of NI 81-105, as it is based solely on the performance of the Fund.{40} Accordingly, Staff submit that the Advisor Performance Bonus is prohibited by NI 81-105.

Additionally, Staff argue that the payment of the Advisor Performance Bonus in addition to a trailing commission already payable to the advisor at competitive industry rates{41} creates a potential conflict of interest where an advisor may recommend the Funds to an investor because of the potential for receiving the Advisor Performance Bonus, rather than because of the suitability of the Fund for the investor. Staff submit that this new type of fee arrangement is contrary to the spirit and intent of NI 81-105, as contemplated by sections 2.2 and 2.4(2) of Companion Policy 81-105CP (81-105CP) and is therefore contrary to the public interest.{42}

In contrast, ONE Financial argues that the Advisor Performance Bonus is consistent with the express requirements and the spirit and intent of NI 81-105. In its submissions, ONE Financial argues that Part 3 of NI 81-105 prohibits a variable trailing commission that is based on the level of sales by the advisor. This prohibition is intended to remove the conflict inherent in advisors seeking to achieve specific asset and sales thresholds in order to receive compensation in respect of mutual fund sales.{43} According to ONE Financial, as the rate payable pursuant to the Advisor Performance Bonus is always fixed, it does not contravene NI 81-105. In fact, ONE Financial submits that the Advisor Performance Bonus aligns the interests of advisors with those of their clients. Since an advisor will only receive the Advisor Performance Bonus if the Funds perform well, the advisor has an incentive to monitor the anticipated performance of the Funds at the point of sale and in subsequent periods, as his or her compensation is dependent on the Funds' performance.{44}

At the OTBH, counsel for ONE Financial argued that NI 81-105 contemplates that more than one trailing commission could be paid to advisors, so long as the commissions do not violate the express wording of the Instrument. Since NI 81-105 does not limit the quantum of the trailing commission payable to advisors, there are no grounds to find the Advisor Performance Bonus problematic on the basis that, when combined with the trailing commission, it results in too high a compensation being paid to advisors whose clients have securities of the Funds in their accounts.

Finally, ONE Financial submits that, as the Funds are commodity pools, the higher proficiency and supervisory requirements imposed by NI 81-104 on advisors who sell the Funds will help ensure that they will only recommend the Funds where the investment is suitable for the investor.{45} Moreover, given that non-investment fund issuers and issuers in the exempt market pay bonuses to advisors substantially similar to those described in the Prospectus, there is no basis for having different forms of compensation payable to advisors on products with similar attributes.

Determination

The question of whether the Advisor Performance Bonus complies with NI 81-105 is difficult. I note that the only precedents to which ONE Financial has directed me involve either corporate issuers or investment funds sold under a prospectus exemption, neither of which are subject to NI 81-105.

Even if I accept the submissions of ONE Financial that the Advisor Performance Bonus complies with the express requirements of Part 3 of NI 81-105, in keeping with the general purpose of the Instrument as set out in Part 2 of 81-105CP, I nonetheless have to consider whether the Advisor Performance Bonus undermines, compromises or conflicts with the fundamental obligations outlined in subsection 2.2(2) of 81-105CP. For the reasons stated below, I believe it more likely than not that it does. Accordingly, I find the issuance of a receipt for the Prospectus while it contemplates the Advisor Performance Bonus to be contrary to the public interest.

I agree that Part 3 of NI 81-105 is intended to ensure that the rate of sales commissions and trailing commissions payable to advisors is not dependent on the level of sales achieved, so as not to create an incentive on the part of advisors to recommend a mutual fund without adequate regard to the merits of the investment. However, I do not agree with the submissions made by ONE Financial that this objective is the animating concern underlying the Instrument.{46}

On this point, 81-105CP is helpful with respect to the background and general purpose of NI 81-105. From the discussion in Part 2 of 81-105CP, it is clear that NI 81-105 was adopted in response to sales practices and compensation arrangements that had developed at the time, which gave rise to questions as to whether advisors were being induced to sell mutual fund securities on the basis of the incentives they were receiving as opposed to what was suitable for and in the best interests of their clients.{47}

However, subsection 2.2(3) and section 2.4 of 81-105CP clearly state that the CSA also intended NI 81-105 to capture any future sales practices or compensation arrangements that "could arise" that may undermine, compromise or conflict with the fundamental obligations outlined in subsection 2.2(2) of 81-105CP. These obligations are:

(a) investment recommendations should be made by a representative of a participating dealer to an investor based on the investor's investment objectives and circumstances and must be suitable for that investor;

(b) a participating dealer and its representatives have a primary obligation to act in the best interests of clients;

(c) where an investor is relying on a participating dealer and a representative of a participating dealer to provide him or her with independent expertise and advice regarding options for mutual fund or other investments, the participating dealer and the representative of the participating dealer have a fiduciary obligation not to compromise the provision of this expertise and advice;

(d) a participating dealer, as a registrant under securities legislation, is required to exercise adequate and appropriate supervision of its representatives who are dealing with clients to ensure compliance with all statutory and other legal obligations;

(e) members of the organization of a mutual fund providing management services to a mutual fund have an obligation to act honestly, in good faith and in the best interests of the mutual fund and its securityholders; and

(f) full, true and plain disclosure of all material facts concerning a mutual fund, including the compensation paid to participating dealers and their representatives and other sales practices followed in connection with the distribution of mutual fund securities, is essential to ensure that investors understand the nature of the investments they are making and the impact of fees and charges on them.

I accept Staff's submission that it is more likely than not that the Advisor Performance Bonus will cause a misalignment of the interests of advisors and clients, by incenting advisors to sell securities of the Funds over mutual fund securities that do not offer a similar performance bonus, contrary to their obligations as outlined in subsection 2.2(2) of 81-105CP. I consider this potential conflict of interest to be inherent in the structure of the Advisor Performance Bonus. That is, while the benefit of the Advisor Performance Bonus goes to the advisor, the risk of negative performance by the Funds falls on the investor.

Maintenance of high standards of business conduct to ensure honest and responsible conduct by market participants is a fundamental principle for achieving the purposes of the Act.{48} In my view, this is especially relevant with respect to sales practices and compensation arrangements in the mutual fund industry, which the Commission has identified as attracting a high level of retail investor participation.{49} Accordingly, confidence in the capital markets is crucial in this area.

I am not persuaded by the submissions of ONE Financial that the higher proficiency and supervisory requirements imposed on advisors who sell commodity pools mitigates the potential conflict of interest raised by the Advisor Performance Bonus. While commodity pools are a specialized class of mutual funds, they are not exempt from, nor distinguished by, NI 81-105. Section 1.4 of 81-104CP specifies that commodity pools are a type of mutual fund and applicable securities legislation applies to them except as provided otherwise in NI 81-104.

I am also not persuaded by ONE Financial's argument that there is no basis for having different forms of compensation payable to advisors for corporate issuers and prospectus exempt investment funds with similar attributes to the Funds. As noted already, the Commission has recognized that the mutual fund industry is a vital and important component of our capital markets, attracting a high level of retail investor participation.{50} Publicly offered mutual funds are subject to a robust regulatory framework that includes NI 81-105, a rule dedicated to sales practices and compensation arrangements for the mutual fund industry. In my view, this demonstrates that the CSA have chosen to take a different approach with respect to these retail focused products.

C. Disclosure Issues

In my view, three of the grounds raised by Staff in recommending that a receipt not be granted for the Prospectus focus on the disclosure in the Prospectus. These elements of the Prospectus are: the disclosure of the fee payable to the counterparty in respect of the forward agreements; the inclusion of the Indices (defined below) in the Prospectus; and the disclosure of the Funds' use of leverage.

The Commission has stated that disclosure by reporting issuers is a fundamental cornerstone of securities regulation, and the public interest jurisdiction should not be interpreted or constrained in a manner that condones inaccurate, misleading or untrue public disclosure regardless of whether that disclosure contravenes Ontario securities law.{51}

Applying the balance of probabilities test discussed above, the question for me is whether it is more likely than not that the disclosure in question in the Prospectus is misleading or that it does not comply in a substantial respect with any of the requirements of the Act or the regulations.

(i) Disclosure of the fee payable to the counterparty in respect of the forward agreements

Submissions

In relation to the forward agreements proposed to be entered into by the Funds, the Prospectus states that each Fund will pay to the counterparty an expense amount (the Forward Fee) up to a maximum per cent of the applicable Investment Pool's net assets. There is also a minimum payment amount that is payable by all the Funds. Although the maximum percentage and minimum payment are not identified in the Prospectus, at the OTBH ONE Financial confirmed Staff's understanding (based on the draft prospectus reviewed during the pre-file) that the maximum rate per annum would be 0.30 per cent of the NAV of the applicable Investment Pool and the minimum payment amount would be $480,000.

Staff argue that the disclosure in the Prospectus with respect to the maximum Forward Fee payable is misleading. Given that the Funds expect to hold approximately 30 to 50 per cent of their assets in cash and cash equivalents, in Staff's estimation the average aggregate net asset value of the Investment Pools to which the Funds are exposed would have to reach at least between $228 to $320 million to keep the maximum Forward Fee at or below 0.30 per cent of the Investment Pools' NAV.{52} Accordingly, in certain circumstances the Forward Fee may exceed the "maximum" of 0.30 per cent of NAV disclosed in the Prospectus.

Staff submit that, at a minimum, the disclosure must be revised so that the maximum amount of the Forward Fee is clear to investors, including the fact that the range of Forward Fees payable by the Funds depends largely on the value of the underlying Investment Pool's NAV.{53}

In addition to the disclosure issue, Staff also submit that, given that the Funds cannot guarantee a certain level of the Funds' NAV (or the NAV of the underlying Investment Pools), the minimum Forward Fee may threaten the viability of the Funds, thus raising public interest concerns.{54}

Determination

Accurate and efficient disclosure is fundamental to protect investors from unfair or improper practices and to foster fair and efficient capital markets and confidence in those markets.{55} As noted above, in my view this is particularly true with respect to the fees and expenses that are payable by a mutual fund, since these costs reduce the mutual fund's (and ultimately, the investors') return.

On a balance of probabilities, I consider the disclosure in the Prospectus with respect to the Forward Fee to be misleading as it gives investors the impression that 0.30 per cent of the NAV of the applicable Investment Pool is the highest Forward Fee payable by each Fund. Accordingly, I find a receipt for the Prospectus may not be issued under clause 61(2)(a)(ii) of the Act. Furthermore, I agree with Staff's submission that absent disclosure that makes the maximum amount of the Forward Fee clear to investors, issuing a receipt for the Prospectus would be contrary to the public interest under subsection 61(1) of the Act.

With respect to Staff's argument that the minimum Forward Fee may threaten the viability of the Funds, in my view the Funds' fee structure must be viewed in the context of the regulatory framework governing commodity pools, which allows for considerable freedom in entering into derivative transactions and structuring agreements with counterparties. Commodity pools are permitted to take on types of risk (such as leverage) and amount of risk (e.g., more than 10 per cent exposure to one counterparty) not permitted to conventional mutual funds. With this perspective, I consider the minimum Forward Fee to be another type of risk of the commodity pool. I also accept the submissions of ONE Financial that the minimum fee was negotiated with an arm's length third party to effect the best commercially available terms, and will not materially affect the fees ultimately payable by each Fund. Therefore, within this context, I do not consider an accurately disclosed minimum Forward Fee to raise public interest concerns.

(ii) The inclusion of the Indices in the Prospectus

Submissions

Under the heading "Overview of the Sector that the Share Classes Invest In", the Prospectus discloses the historical performance of the Barclay CTA Index, the Newedge CTA Index, the Global/Long Short Index, the Barclay Global Marco Index and the Newedge Macro Trading Index (collectively, the Indices).

If an investment fund invests, or intends to invest, in a specific sector or sectors, Item 7.1(1) of Form 41-101F2 asks for a brief description of the sectors in which the investment fund has been or will be investing. Item 7.1(2) of Form 41-101F2 further elaborates on the content of such disclosure, which may include known material trends, events or uncertainties in the sector(s) that the investment fund invests or intends to invest in that might reasonably be expected to affect the investment fund. The Indices have been included in the Prospectus in response to these Items.

Staff submit that the Indices are confusing, misleading and should be removed from the Prospectus because they do not represent the sectors in which the Funds invest.{56} Further, the Indices do not comply with Form 41-101F2, but rather, represent "the performance history of an unknown collection of trading programs and investment funds that may or may not invest in the same sectors that the Funds may invest in".{57} That is, Staff submit the Indices illustrate the past performance of other funds that use a similar investment strategy as the Funds, which is not the disclosure contemplated by Item 7.1 of Form 41-101F2.

In contrast, ONE Financial argues that the Indices do in fact illustrate the nature of the sectors to which the Funds will have exposure, namely the long/short managed futures sector. According to ONE Financial, the "index information provided informs investors (and their Advisors) of the nature of the sectors to which the Funds will have exposure and illustrates the sector's average performance, risk/return profile and trends".{58} At the OTBH, counsel for ONE Financial argued that showing the performance of other similar funds is relevant information for investors and is not confusing, as it shows an objective or benchmark of the Funds, not a promise of certain returns.

In its submissions, ONE Financial further argues that there is no provision in securities law that prohibits the disclosure of the Indices. Moreover, submits ONE Financial, the statements cannot be characterized as misleading because of the cautionary language used.{59} ONE Financial goes on to argue that,

"the public interest is not engaged on this issue because the use of the indices does not pertain to any element of the securities being offered apart from the use of descriptors to illustrate past performance of similar investments. That is to say that the Director cannot invoke the public interest to justify the refusal of a receipt where it cannot be established that a statement or series of statements are misleading. To do so would amount to an amendment of the form requirements."{60}

Determination

In considering the use of the Indices to describe the "sectors" in which the Funds invest or intend to invest, I have considered the ordinary meaning of the term. In my view, in the context of the capital markets, a "sector" is generally understood to be an industry or market sharing common characteristics. The Canadian Investment Funds Standards Committee includes, as examples of sectors, precious metals, real estate, industrials, financial services and utilities.{61}

With this in mind, I agree with Staff that the Indices do not provide information that is specific to the actual equity, fixed income, currency, or commodity sectors in which the Funds will invest,{62} as intended by Form 41-101F2. Nor do the Indices provide information about the material trends, events or uncertainties in the actual sectors in which each Fund will invest and which may reasonably be expected to affect the Fund, which is the express intent of Item 7.1 of Form 41-101F2. Accordingly, I find that the inclusion of the Indices in the Prospectus does not comply in any substantial respect with the requirements of Item 7.1 of Form 41-101F2 and, therefore, a receipt for the Prospectus may not be issued under clause 61(2)(a)(i) of the Act.

In my view, General Instruction (11) to Form 41-101F2 contemplates that performance data may be included in a prospectus if such data is relevant. In this case, I accept Staff's submission that the Indices do not measure the actual performance of ONE Financial as manager, nor is there any indication that ONE Financial will approximate the performance of the Indices since the Funds do not have investment objectives that seek to track the Indices.{63} Rather, I consider it more likely than not that investors will mistakenly infer that the Indices are indicative of the performance of the Funds.

On this point, I am not persuaded by ONE Financial's argument that the inclusion of cautionary language in the Prospectus stating that the performance of the Indices is not in any way indicative of either the historical or future performance of the Funds, and that the Funds may even perform worse than the Indices, makes the inclusion of the Indices not misleading.{64} If this were correct, then reporting issuers would be able to include any information in a prospectus, no matter how extraneous or confusing, so long as cautionary language was included. In my view, the presence of cautionary language in the Prospectus does not outweigh, on a balance of probabilities, the concern that the Indices will be misconstrued by investors as indicative of how the Funds will perform. Therefore, I find a receipt for the Prospectus may not be issued under clause 61(2)(a)(ii) of the Act.

Accurate and efficient disclosure of information is a fundamental principle for achieving the purposes of the Act.{65} Consequently, I disagree with ONE Financial's argument that the public interest is not engaged in this instance because the Indices do not pertain to any element of the securities being offered, apart from the use of descriptors to illustrate past performance of similar investments. As noted, the Commission has stated that the public interest jurisdiction should not be interpreted or constrained in a manner that condones inaccurate, misleading or untrue public disclosure regardless of whether that disclosure contravenes Ontario securities law.{66} Having found the inclusion in the Prospectus of the Indices to be misleading and not in substantial compliance with the requirements of Item 7.1 of Form 41-101F2, in my view issuing a receipt for the Prospectus would be contrary to the public interest under subsection 61(1) of the Act.

Finally, I note that Staff raised concerns regarding the reliability of the data in the Indices, and that ONE Financial provided substantial submissions, both in writing and at the OTBH, in response. In my view, whether or not the data in the Indices is reliable is ancillary to the grounds raised by Staff in recommending that a receipt not be granted for the Prospectus. Accordingly, in my view I do not have to make a determination on this issue.

(iii) The disclosure of the Funds' use of leverage

Submissions

Items 3.3(1)(e) and 6.1(1)(b) of Form 41-101F2 require disclosure of an investment fund's use of leverage, including any restrictions and the maximum amount of leverage the fund could use, expressed as a ratio.{67}

The Prospectus does not provide disclosure of the potential leverage of the Funds in the form of a ratio, but states that the Investment Pools are not limited to any specific maximum amount of leverage. Moreover, the Prospectus states that the margin utilization ratio of the Investment Pools in normal market conditions is expected to be between one per cent and 25 per cent.

Staff submit that the disclosure of the Funds' use of leverage does not comply with the requirements of Form 41-101F2 to disclose the notional market exposure of the derivative positions of a fund divided by the fund's net assets.{68} Staff argue that the total notional exposure of the derivatives positions of a fund is important information for investors, as it illustrates the ultimate exposure of the fund in respect of its derivatives positions.

In response, ONE Financial submits that, with respect to leverage gained through the use of derivatives, the total notional exposure is not useful disclosure, as the Funds will never actually pay or receive that amount. Rather, a fund that wants to exit a derivatives position will simply take an offsetting position in the same derivative product. What is relevant, argues ONE Financial, is the margin utilization ratio which illustrates the aggregate amount of cash or securities on deposit with brokers as required for initial margin for all derivative contracts expressed as a percentage of a fund's total net assets.{69} At the OTBH, Staff responded to this argument by stating that if the market begins to quickly move away from the fund's position in a specified derivative, it could become very costly for the fund to offset that position. The larger the fund's total notional exposure under the specified derivative relative to net assets, the costlier the offsetting may be.

Additionally, at the OTBH counsel for ONE Financial submitted that, because there is no maximum amount of leverage applicable to the Funds or the Investment Pools, a statement to this effect satisfies the requirements of Form 41-101F2.

Determination

While I agree with Staff that disclosure of the notional exposure of the derivatives positions of a fund divided by the fund's net assets is useful disclosure for an investor, I accept the submissions made by ONE Financial that, because the Funds impose no limitations on the use of leverage, the requirements in Items 3.3(1)(e) and 6.1(1)(b) of Form 41-101F2 are satisfied by disclosing in the Prospectus that there is no maximum amount of leverage available to the Funds. Accordingly, I find the leverage disclosure in the Prospectus to comply with the requirements of Form 41-101F2 and to not be misleading.

D. Forward Agreement Structure

In addition to the disclosure of the fee payable to the counterparty in connection with the Forward Fee, Staff raise two additional issues with respect to the forward agreements: the use of forward purchase agreements and the use of prepaid forward agreements.

(i) Forward Purchase Agreement and Forward Sale Agreement

Submissions

The prospectus discloses two possible forward agreement structures that may be utilized by the Funds: a forward purchase agreement and a forward sale agreement (the Forward Agreements).{70}

Staff submit that they do not object to the use by the Funds of forward sale agreements, subject to the resolution of disclosure comments related to the All-Weather Profit SPC Notes in Staff's February 6, 2012 e-mail to ONE Financial (the Request for Clarification).{71}

With respect to the use of forward purchase agreements by the Funds, the initial concern raised by Staff during the comment process appears to have been addressed. Specifically, the potential for the majority of the Funds' portfolio assets to be exposed to the credit risk of a single financial institution where the Deposit Account is held. Staff had found it difficult to reconcile the degree of exposure to the financial institution with the rationale underlying the concentration restrictions applicable to mutual funds, including commodity pools.{72}

In light of this concern, ONE Financial appears to have agreed to amend the Prospectus and to enter into an irrevocable direction regarding the disposition of redemption proceeds in the event of counterparty insolvency. In a letter to Staff dated November 11, 2011, ONE Financial responded to Staff's comments as follows:

"... the proposed counterparty to the Funds has agreed to enter into an irrevocable direction with respect to the units of the Investment Pools whereby upon certain insolvency events of the counterparty, the proceeds of the redemption of any units of the Investment Pools held by a counterparty will be paid directly to the Funds."{73}

While the Prospectus does not disclose an intention to enter into the irrevocable direction mentioned above, Staff submit that, subject to the inclusion of appropriate disclosure in the Prospectus and confirmation of the nature of the collateralization created by the irrevocable direction referred to above, Staff would no longer have a concern with the degree of exposure to the financial institution and therefore would no longer object to the potential use of forward purchase agreements by the Funds.{74}

Determination

ONE Financial did not make any submissions with respect to these issues in its written submissions or at the OTBH that were contrary to its November 11, 2011 response to Staff. Accordingly, I assume Staff and ONE Financial are in agreement regarding the disclosure proposed by Staff in the Request for Clarification with respect to the forward sale agreement, and with the disclosure proposed by ONE Financial in its November 11, 2011 response letter to Staff with respect to the Forward Agreements. As the parties appear to have reached agreement, in my view I do not have to make a determination on this issue.

(ii) Prepaid Forward Agreement

Submissions

On March 15, 2011 ONE Financial made an application for exemptive relief from the investment restrictions regarding illiquid assets set out in section 2.4 of NI 81-102, in connection with the Funds' proposed use of prepaid forward agreements (the Requested Relief). A comment letter was issued by Staff on May 4, 2011, which ONE Financial responded to on June 27, 2011.

By comment letter dated September 7, 2011 Staff advised ONE Financial that they were not prepared to recommend approval of the Requested Relief.{75} The primary concern identified was the potential magnitude of a Fund's exposure to a single counterparty through an over-the-counter derivative, which Staff submitted could not be reconciled with the rationale underlying the concentration restrictions applicable to mutual funds, including commodity pools. Staff further stated that even with effective collateralization, they were concerned that the prepaid forward agreement would add complexity to the Funds, such that they would not be readily understood by investors or advisors. Finally, Staff stated they were not comfortable allowing a commodity pool to be potentially 100 per cent exposed to a single counterparty through an over-the-counter derivative in an illiquid asset.

Staff and ONE Financial agree that the onus of proving that the Requested Relief should be granted rests with ONE Financial, and not Staff.{76} Therefore, ONE Financial must establish on a balance of probabilities that the granting of the Requested Relief would not be prejudicial to the public interest.{77}

In its written submissions and at the OTBH, ONE Financial submitted that the counterparty to the forward agreements will be a Canadian chartered bank and, as such, the risk of counterparty default is remote. Additionally, the forward agreement would be fully collateralized and, in the event that a Fund detects a potential default or insolvency of the counterparty, it may pre-settle the forward agreement at any time.{78}

ONE Financial further argues that the unique structure of the Funds, specifically their exposure to a portfolio of managed futures, will allow for a significant amount of their assets to be held in cash, with approximately 30 to 50 per cent in cash and cash equivalents. Therefore, there will be sufficient liquid assets to satisfy redemption requests and pay operating expenses. This structure, argues ONE Financial, further insulates investors against the risks associated with illiquidity or default.{79}

Finally, ONE Financial submits that notwithstanding the complexity of the prepaid forward structure, there is no basis to conclude that advisors will not be able to comprehend the rationale for the forward structures or to assess counterparty risks, particularly given the higher proficiency and compliance requirements to which advisors of commodity pools are subject.{80} In addition, 81-104CP recognizes that commodity pools are granted greater freedom in their use of specified derivatives and leverage strategies than conventional mutual funds, in exchange for requirements which, among other things, are aimed at increasing the information available to investors.{81}

In their submissions, Staff note that the Prospectus does not indicate that the Funds will utilize a prepaid forward agreement to gain exposure to the Investment Pools. Staff argue that if it is intended that the Funds will use prepaid forward agreements, the disclosure in the Prospectus is misleading.{82}

At the OTBH and in additional written submissions provided on March 2, 2012, Staff elaborated on their concerns regarding the Requested Relief.

Specifically, Staff submit that while NI 81-104 exempts commodity pools from several of the investment restrictions in NI 81-102 concerning derivatives, it does not exempt them from the illiquid asset restrictions in section 2.4 of NI 81-102. These restrictions, Staff argue, are fundamental. Unlike several other similar investment restrictions in NI 81-102, the illiquid asset restrictions apply not only at the time a portfolio asset is purchased, but also contain an ongoing restriction that prohibits a mutual fund, including a commodity pool, from holding illiquid assets in excess of 15 per cent of its net assets for a period of more than 90 days.{83}

Staff argue that even though not all of the Funds' assets will be exposed to the prepaid forward, the amounts that will be exposed will be several times larger than the illiquid asset thresholds specified in section 2.4 of NI 81-102.{84} Staff further argue that the opportunity to pre-settle in advance of specified settlement dates is not the same as the ability to dispose of an asset through market facilities. That is, the ability to pre-settle "is dependent on the counterparty and may be impaired or unavailable during periods where the counterparty is in default of its obligations or during an insolvency event".{85} Therefore, Staff recommend that the Requested Relief not be granted to permit the Funds to enter into a concentrated over-the-counter derivative transaction.{86}

In addition to liquidity risk, Staff submit that while effective collateralization may reduce the potential effect of counterparty credit risk, it does not remove the risk altogether. Moreover, in Staff's view, the risk would be exacerbated by the concentrated nature of the prepaid forward.{87}

In its reply to Staff's additional written submissions, ONE Financial argues that the terms imposed on the prepaid forward agreement will "virtually eliminate any counterparty risk" and also address any concerns about the ability of a Fund to satisfy redemption requests.{88} These terms are (i) 30 to 50 per cent of each Fund's assets will be held in cash or cash equivalents; (ii) the Funds may pre-settle a forward agreement in whole or in part for any reason on any day; (iii) the Funds are required by NI 81-102 to terminate a forward agreement if the rating of the counterparty or the guarantor falls below the prescribed level; and (iv) the obligations of the counterparty to fully collateralize the prepaid forward agreement.

ONE Financial further submits that given the full collateralization of the prepaid forward agreement, there is no policy reason why commodity pools should be treated differently from closed-end investment funds with respect to their use of prepaid forward agreements or open-ended mutual funds with respect to their use of forward purchase agreements.{89}

Finally, in its September 7, 2011 comment letter, Staff stated that over the last six months it had reviewed several applications and pre-files seeking similar relief, and had discussed the Requested Relief with the CSA Investment Funds Committee. At the OTBH and in additional written submissions provided on March 2, 2012, Staff submitted that none of these applicants, which included a conventional mutual fund, a commodity pool and a closed end fund that would become subject to NI 81-102 on its pre-planned conversion into a conventional mutual fund, received relief to enter into prepaid forwards.{90} In response, ONE Financial stated that the Funds are distinguishable from other applicants in that the Funds are commodity pools that seek to maintain 30 to 50 per cent of their net assets in cash and cash equivalents, and therefore, the Director should entirely discount the value of such previous applications.{91}

Determination

On the basis of the facts and submissions before me, I accept Staff's recommendation that the Requested Relief not be granted, as it would be prejudicial to the public interest. Accordingly, the Funds may not utilize prepaid forward agreements to gain exposure to the Investment Pools.

Issuer regulation is fundamental to protecting investors and fostering fair and efficient capital markets, especially in relation to the mutual fund industry, which the Commission has noted attracts a high level of retail investor participation in particular.{92} Accordingly, confidence in the capital markets is crucial in this area.

I agree with Staff's submissions that the restriction on a mutual fund investing in illiquid assets is a fundamental investment restriction in NI 81-102. In the June 27, 1997 Notice of Proposed National Instrument 81-102 and Companion Policy 81-102CP, the CSA, citing a previously published commentary on a proposed federal mutual fund statute, stated that:

"Constraints inherent in the mutual fund form of organization result largely from the availability ofthe right to redeem which is the key attribute of a mutual fund. This right dictates constraints to avoid investments that would result in portfolios which could not be precisely valued or would be so illiquid as to make the redemption right unrealistic."{93}

Therefore, it is fundamental to investor protection that a mutual fund should hold sufficient assets that can be quickly liquidated to allow the fund to meet the redemption requests of investors on an on-going basis. In my view, this attribute is equally applicable to commodity pools, and provides the basis for why granting relief from section 2.4 of NI 81-102 to allow retail commodity pools to utilize prepaid forward agreements would be prejudicial to the public interest. On this issue, I am not persuaded by the submission by ONE Financial that holding 30 to 50 per cent of each Fund's assets in cash or cash equivalents effectively mitigates the risks associated with illiquidity, as it is not evident to me from the submissions that this amount would permit the Funds to avoid liquidity risk. Further, I note that the 30 to 50 per cent in cash or cash equivalents proposed by ONE Financial is substantially lower than the threshold on holdings of non-illiquid assets in subsection 2.4(2) of NI 81-102.

With respect to the issue of counterparty risk, I believe that the exposure of the Funds to counterparty credit risk must be viewed in the context of the regulatory framework governing commodity pools, which allows up to 100 per cent exposure to a single counterparty. I accept the submissions made by ONE Financial that NI 81-104 was established to allow retail investors to participate in commodity pools through retail products, which carry added complexity and risks (including credit risk), in exchange for additional disclosure.{94} Accordingly, in my view, where the applicant is a commodity pool, the concern with the prepaid forward structure is the large investment in an illiquid asset, not counterparty credit risk.

In light of Staff's submissions regarding recent applications for similar relief, in my view, granting the Requested Relief would represent a substantive policy shift, and that it would therefore be more appropriate to consider the use of prepaid forwards by mutual funds generally as part of a policy initiative that would allow for public comment.

Further to this point, I disagree with ONE Financial's submission that the previous applications cited by Staff should be discounted because the applicants in those cases were not commodity pools with a large portion of their net assets held in cash or cash equivalents. As 81-104CP clearly states, all rules applicable to mutual funds apply to commodity pools unless commodity pools are explicitly exempted by NI 81-104. Accordingly, the illiquid asset restriction in section 2.4 of NI 81-102 is as applicable to the Funds as it is to conventional mutual funds, and no reason has been presented to me for distinguishing commodity pools from conventional mutual funds on this point.

E. Failure to File a Prospectus for the Investment Pools

Staff submit that the Director should not issue a receipt for the Prospectus until Staff have been able to review the prospectus for the Investment Pools, as "the Funds' exposure to the Investment Pools will be the primary means through which the Funds seek to achieve their investment objectives".{95}

In its January 31, 2012 response letter to Staff, ONE Financial stated that a prospectus for the Investment Pools would be filed as soon as possible after ONE Financial had settled on a forward structure.

In my view, a prospectus for the Investment Pools, in a form acceptable to Staff, must be filed before a receipt for the Prospectus may be issued. Given that ONE Financial appears prepared to file a prospectus for the Investment Pools, in my view I do not have to make any further determination on this issue.

F. Advisory Fee

Submissions

On February 29, 2012, counsel for ONE Financial sent Staff an e-mail (the E-mail) responding to questions previously posed by Staff regarding whether ONE Financial had the requisite registration status to act as principal broker for the Funds, as described in the Prospectus. In the E-mail, ONE Financial specifies it will provide "value-added advisory services to the Funds beyond its typical role as portfolio manager" in respect of the Funds' acquisition of commodity futures contracts and commodity futures options. In exchange for these services, ONE Financial will be paid an advisory fee (the Advisory Fee) equal to a percentage of the fees paid to the registered dealer.

In their written submissions dated March 2, 2012, Staff submit that while the E-mail addresses the concerns previously expressed by Staff in relation to the Collateral Investments, it raises additional issues that cannot be considered separately from the determination of whether the Prospectus should be receipted.{96} Specifically, Staff argue that the Advisory Fee is prohibited by Ontario commodity futures law and gives rise to conflicts of interest under Ontario securities law. Accordingly, it would be contrary to the public interest to receipt the Prospectus.{97}

The Prospectus discloses that brokerage commissions will be paid to dealers on a "roundturn commission" basis.{98} Staff argue that this means that ONE Financial will be paid compensation based on the volume of trades executed by futures commission merchants.{99} Since the Advisory Fee to ONE Financial constitutes a charge based on the volume of transactions, Staff submit that it is expressly prohibited by subsection 29(3) of Regulation 90 (the CFA Regulation) made under the Commodity Futures Act (Ontario) (the CFA).{100} Subsection 29(3) of the CFA Regulation states:

"Every commodity trading counsel shall charge clients directly for services and such charge may be based upon the dollar value of the client's portfolio, but not on the value or volume of the transactions initiated for the client and, except with the written agreement of the client, shall not be contingent upon profits or performance."{101}

In its subsequent written submissions dated March 12, 2012, ONE Financial does not respond to Staff's argument regarding the non-compliance of the Advisory Fee with the CFA Regulation. Instead, it states that it "recognizes and agrees" that the Advisory Fee and the activities of ONE Financial must comply with applicable law and that the disclosure in the Prospectus must reflect the final compensation structure in accordance with applicable law.{102} Moreover, ONE Financial argues in its subsequent written submissions, as it did at the OTBH, that the payment of the Advisory Fee to ONE Financial is not a matter before the Director, as it is fundamentally a registration and compliance issue that can be resolved with Staff independently of the OTBH.{103}

In addition to compliance with the CFA Regulation, Staff also submit that if the Advisory Fee is received by ONE Financial on transactions in respect of "securities", as defined in the Act, the Advisory Fee payable to ONE Financial in its capacity as principal broker creates a potential conflict of interest because ONE Financial will receive the fee in respect of the number of trades executed, which it is responsible for initiating.{104} Staff submit this type of compensation fee may encourage ONE Financial to initiate trades that may or may not have any benefit to the Funds in order to maximize its own compensation.{105}

On this point, Staff argue the Advisory Fee represents a material conflict of interest that requires ONE Financial to take reasonable steps to identify and respond to the conflict as portfolio manager for the Funds in accordance with section 13.4 of National Instrument 31-103 Registrant Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103).{106} Staff note the Prospectus does not disclose what steps ONE Financial will take to meet its obligations under NI 31-103.{107} This, in turn, makes it also difficult for Staff to ascertain whether the Prospectus complies with Item 19.3(3) of Form 41-101F2, which requires that the particulars of existing or potential material conflicts of interest between an investment fund and its portfolio advisor be disclosed.{108}

Staff seem to suggest in their submissions that an appropriate response to the conflict of interest associated with the Advisory Fee would be for ONE Financial to avoid the fee altogether, consistent with the guidance provided in Companion Policy 31-103CP. Staff argue the prohibition of the Advisory Fee in the CFA Regulation should inform ONE Financial's assessment of how to respond to the conflict of interest.{109} Furthermore, Staff submit they do not have sufficient information to assess whether ONE Financial, as an investment fund manager, has complied with its obligations under NI 81-107 with respect to the Advisory Fee.{110}

In response, ONE Financial submits that any conflict of interest associated with the Advisory Fee is not material,{111} and that a prohibition of a fee similar to the Advisory Fee in the CFA should not inform the assessment of whether or not it is a conflict of interest that can be managed in accordance with NI 31-103.{112} In fact, ONE Financial argues that any conflict created by the Advisory Fee is more than offset by the fact that ONE Financial has a greater incentive to ensure that the Funds perform well to ensure its reputation and to receive the performance fee contemplated in the Prospectus, than it would be to be incented to initiate trades which will not add value to the overall performance of the Funds.{113} Additionally, as the investment fund manager and portfolio manager of the Funds, ONE Financial is required to comply with the applicable standards of care and good faith in the Act and in OSC Rule 31-505 Conditions of Registration.

ONE Financial submits that the Prospectus will be clarified to include the particulars of any existing or potential conflict of interest with respect to the Advisory Fee,{114} and the Advisory Fee will be compliant with ONE Financial's policies and procedures regarding conflicts of interest.{115} Furthermore, ONE Financial submits that it will comply with its obligations under NI 81-107 with respect to the Advisory Fee. The Funds' independent review committee will be presented with a conflict of interest policy and related standing instruction regarding best execution.{116}

Finally, Staff submit that an increase in the portfolio management fee to reflect the additional services associated with the Advisory Fee, rather than the addition of the Advisory Fee "would remove the conflict of interest of having a portion of the fee based on the volume of trades in the portfolio, as well as address Staff's general submissions regarding an investor's ability to assess the overall costs of investing in the Funds."{117} ONE Financial disagrees. It submits that if it was not providing the enhanced advisory services (and paid the Advisory Fee) with respect to trades of commodity futures contracts and commodity futures options, the Funds would have to pay a higher commission to a registered dealer to provide these services and the Funds could not obtain these services from a dealer that provides direct market access only, which is the circumstance here.{118} Furthermore, ONE Financial submits that an investor has sufficient information to assess the overall costs of investing in the Funds, as the Prospectus discloses the compensation per trade applicable to each trade in a commodity futures contract or commodity futures option, a level of information investors do not normally receive with respect to potential trading and brokerage commissions.{119}

Determination

As noted above, the Commission has stated that disclosure by reporting issuers is a fundamental cornerstone of securities regulation.{120} Accurate and efficient disclosure is fundamental to protect investors from unfair or improper practices and to foster fair and efficient capital markets and confidence in those markets.{121} As I have indicated, I consider this to be particularly relevant with respect to the fees and expenses that are payable by a mutual fund, since these costs reduce the mutual fund's (and ultimately, the investors') return. Therefore, while I accept the submission of ONE Financial that the question of whether the Advisory Fee is in compliance with the CFA Regulation will be resolved with Staff independent of the OTBH, in my view absent a resolution of the legality of the Advisory Fee and disclosure in the Prospectus that reflects the final compensation structure, issuing a receipt for the Prospectus would be contrary to the public interest under subsection 61(1) of the Act.

Having found that the issuance of a receipt for the Prospectus absent a resolution of the legality of the Advisory Fee would be contrary to the public interest, and given that the discussion of the potential conflict of interest of the Advisory Fee is premised on its current structure, I consider it premature to assess the conflict of interest that may be created by the Advisory Fee given that it is not yet finalized. Accordingly, in my view I do not have to make a determination whether the Advisory Fee gives rise to a material conflict of interest for ONE Financial that cannot be effectively managed.

VI. Closing Comments

In summary, having considered the extensive written material before me and the oral submissions made by Staff and ONE Financial, I find that a receipt for the Prospectus should not be issued.

I note that this decision does not preclude ONE Financial from amending the Prospectus to address the issues noted in this decision and seeking a new recommendation from Staff on the revised Prospectus.

Yours truly,

"Rhonda Goldberg"
Director, Investment Funds Branch
 
cc:
Cullen Price, Senior Litigation Counsel, Enforcement
Sonny Randhawa, Manager, Investment Funds
Stephen Paglia, Senior Legal Counsel, Investment Funds
Ian Kearsey, Legal Counsel, Investment Funds
Carina Kwan, Legal Counsel, Investment Funds

{1} Written Submissions of Staff of the Commission (23 February 2012) at para 113.

{2} Ibid at para 1.

{3} Committee for the Equal Treatment of Asbestos Minority Shareholders v. Ontario (Securities Commission), 2001 SCC 37, [2001] 2 SCR 132 at paras 39-41.

{4} Supra note 1 at para 15; Memorandum of Argument of ONE Financial Corporation and ONE Financial All-Weather Profit Family Corp. (13 February 2012) at para 13.

{5} Supra note 1 at paras 14-16.

{6} Ibid at para 20.

{7} Biovail Corp. (Re), (2010), 33 OSCB 8914 at paras 382, 388-389 [Biovail]; Guard Inc., Re, (1996), 19 OSCB 3737 at 3743 [Guard].

{8} Ibid.

{9} Memorandum of Argument of ONE Financial Corporation and ONE Financial All-Weather Profit Family Corp. (13 February 2012) at para 20.III.

{10} Ibid at para 18.

{11} Supra note 1 at para 34.

{12} H.E.R.O. Industries Ltd. (Re), (1990), 13 OSCB 3775 at 3788.

{13} Supra note 3.

{14} Biovail, supra note 7 at para 374.

{15} Supra note 9 at para 20.IV; Financial Models Co. (Re), (2005), 28 OSCB 2184 at para 54.

{16} Maple Leaf Investment Fund Corp. (Re), (2011), 34 OSCB 11551 at paras 42-43.

{17} Supra note 9 at para 20.V.

{18} Guard, supra note 7 at 3744 [emphasis added].

{19} Draft Prospectus of All-Weather Profit Family dated February 13, 2012 at 15, submitted as evidence in the Book of Authorities of Staff of the Commission (23 February 2012) at Tab 9.

{20} Supra note 1 at para 38.

{21} Ibid at paras 40-45.

{22} Supra note 9 at para 42.

{23} Ibid at paras 44-45.

{24} Ibid at para 46.

{25} Ibid at para 47.

{26} OSC Policy 11.4 Commodity Pool Programs, s E.II.4, as replaced by NI 81-104.

{27} Notice of Proposed National Instrument 81-104 and Companion Policy 81-104CP Commodity Pools, Mutual Fund Rules Supplement to the OSC Bulletin, 20 OSC(Supp2) 109 (27 June 1997) at 113.

{28} Supra note 1 at para 47.

{29} Ibid at paras 46-50.

{30} Supra note 9 at para 39.

{31} Ibid at para 41.

{32} Ibid at paras 44-45.

{33} Supra note 1 at para 39.

{34} Biovail, supra note 7 at para 376.

{35} Securities Act, RSO 1990, c. S. 5, s 2.1(2).

{36} Notice of National Instrument 81-107 Independent Review Committee for Investment Funds, National Instrument 81-107 Independent Review Committee for Investment Funds Supplement to the OSC Bulletin, 29 OSCB (28 July 2006) at 3-4.

{37} Ibid at 5.

{38} Supra note 1 at paras 54-55.

{39} Additional Written Submissions of Staff of the Commission (2 March 2012) at para 3.

{40} Supra note 1 at paras 57-59.

{41} Ibid at para 61. The trailing commissions payable in connection with the Funds vary between zero to 2.00 per cent per annum depending factors such as the Fund, the series of securities purchased and the sales charge option selected. See supra note 19 at 51.

{42} Ibid at paras 60-63.

{43} Supra note 9 at paras 23-24.

{44} Ibid at paras 27-28.

{45} Ibid at para 31.

{46} Ibid at para 23.

{47} Companion Policy 81-105CP -- To National Instrument 81-105 Mutual Fund Sales Practices, ss 2.1-2.2.

{48} Supra note 35.

{49} AGF Funds Inc. (Re) (2005), 28 OSCB 73 at para 47 [AGF].

{50} Ibid.

{51} Biovail, supra note 7 at paras 376, 382.

{52} Supra note 1 at para 80.

{53} Ibid at para 83.

{54} Ibid at para 82.

{55} Supra note 35.

{56} Supra note 1 at para 91.

{57} Ibid at para 94.

{58} Supra note 9 at para 70.

{59} Ibid at para 75.

{60} Ibid at para 76.

{61} Canadian Investment Funds Standards Committee, Retail Investment Fund Category Definitions (31 August 2011) at 4.

{62} Supra note 1 at para 99.

{63} Ibid at para 101.

{64} Supra note 9 at para 73.

{65} Supra note 35.

{66} Biovail, supra note 7 at paras 376, 382.

{67} The ratio must be expressed as follows: (total long positions including leveraged positions plus total short positions) divided by the net assets of the investment fund.

{68} Supra note 1 at paras 86-88.

{69} Supra note 9 at para 56.

{70} Pursuant to each forward sale agreement, each Fund may use a portion of its proceeds to purchase a basket of common shares of Canadian public companies (a Canadian Share Portfolio) which will be pledged to the counterparty to secure the Fund's obligation to exchange it for cash on the date the Forward Agreement matures in accordance with its terms (the Forward Date).

Pursuant to each forward purchase agreement, each Fund may use a portion of its proceeds to make an investment in an interest-bearing account (the Deposit Account) collaterally pledged to the counterparty to secure the Fund's obligation to exchange it for a Canadian Share Portfolio on the Forward Date.

See supra note 19 at 27.

{71} Supra note 1 at paras 71 and 77.

{72} Ibid at para 73.

{73} Ibid at para 75. The November 11, 2011 letter of ONE Financial was submitted as evidence at the OTBH in the Book of Documents of ONE Financial Corporation and ONE Financial All-Weather Profit Family Corp., Volume 1 of 2 (13 February 2012) at Tab 6.

{74} Supra note 1 at para 76.

{75} Book of Documents of ONE Financial Corporation and ONE Financial All-Weather Profit Family Corp., Volume 1 of 2 (13 February 2012) at Tab 4.

{76} Supra note 39 at para 29.

{77} Supra note 35, s 147; National Instrument 81-102 Mutual Funds, s 19.1 [NI 81-102].

{78} Supra note 9 at para 84.

{79} Ibid at para 85.

{80} Ibid at para 87.

{81} Ibid at para 88.

{82} Supra note 1 at para 69.

{83} Supra note 39 at para 25; NI 81-102, supra note 77, s 2.4(2).

{84} Supra note 39 at para 26.

{85} Ibid at para 27.

{86} Ibid at para 26.

{87} Ibid at para 28.

{88} Reply of ONE Financial and ONE Financial All-Weather Profit Family Corp. to the Additional Written Submissions of Staff of the Commission (12 March 2012) at para 15.

{89} Ibid at para 16.

{90} Supra note 39 at paras 30-31.

{91} Supra note 88 at para 21-22.

{92} AGF, supra note 49.

{93} Notice of Proposed National Instrument 81-102 and Companion Policy 81-102CP Mutual Funds, Mutual Fund Rules Supplement to the OSC Bulletin, 20 OSC(Supp2) 109 (27 June 1997) at 4 [emphasis added].

{94} Supra note 9 at para 88.

{95} Supra note 1 at para 109.

{96} Supra note 39 at para 3.

{97} Ibid at para 4.

{98} Supra note 19 at 47.

{99} Supra note 39 at para 6.

{100} Ibid at para 10.

{101} RRO 1990, Reg 90, s 29(3) [emphasis added].

{102} Supra note 88 at para 5.

{103} Ibid at para 6.

{104} Supra note 39 at paras 12-13.

{105} Ibid at para 14.

{106} Ibid at para 15.

{107} Ibid at para 17.

{108} Ibid at para 20.

{109} Ibid at paras 18-19.

{110} Ibid at para 21.

{111} Supra note 88 at para 7.

{112} Ibid at para 10.

{113} Ibid at para 9.

{114} Ibid at para 11.

{115} Ibid at para 7.

{116} Ibid at para 12.

{117} Supra note 39 at para 22.

{118} Supra note 88 at para 13.

{119} Ibid at para 14.

{120} Biovail, supra note 7 at para 376.

{121} Supra note 35.