National Policy 11-203 -- Existing and future mutual funds granted exemptions from National Instrument 81-102 Mutual Funds to engage in short-selling of securities up to 20% of net assets, subject to certain conditions and requirements -- Relief is necessary to implement the mutual funds' investment objectives and strategies -- Conditions imposed on amount and nature of short-selling to be conducted -- NI 81-102.
Applicable Legislative Provisions
National Instrument 81-102 Mutual Funds, ss. 2.6(a) and (c), 6.1(1), 19.1.
May 29, 2009
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
IN THE MATTER OF
THE PROCESS FOR EXEMPTIVE RELIEF
APPLICATIONS IN MULTIPLE JURISDICTIONS
IN THE MATTER OF
K.J. HARRISON & PARTNERS INC.
KJH CAPITAL PRESERVATION FUND
(THE "EXISTING FUND")
The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the Existing Fund and such other mutual funds as the Filer or affiliates of the Filer may establish in the future (the Future Funds and, together with the Existing Fund, the Funds, and each a Fund), for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation):
(a) exempting the Funds from the requirement contained in section 2.6(a) of NI 81-102 prohibiting a mutual fund from providing a security interest over a mutual fund's assets;
(b) exempting the Funds from the requirement contained in section 2.6(c) of NI 81-102 prohibiting a mutual fund from selling securities short; and
(c) exempting the Funds from the requirement contained in section 6.1(1) of NI 81-102 prohibiting a mutual fund from depositing any part of a mutual fund's assets with an entity other than the mutual fund's custodian,
(together, the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of the other provinces and territories of Canada.
Terms defined in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.
The decision is based on the following facts represented by the Filer:
1. The Filer is a corporation established under the laws of Ontario and is or will be the manager and sole distributor of each Fund.
2. Each Fund is or will become an open-end mutual fund trust established under the laws of the Province of Ontario of which the Manager is or will be the manager.
3. Neither the Filer nor the Existing Fund is, nor will any Future Fund be, in default of the securities legislation in any of the provinces or territories of Canada.
4. Each Fund is or will become a reporting issuer in the provinces of Ontario, British Columbia, Alberta, Manitoba and New Brunswick, or any other jurisdiction as required, and distributes or will distribute securities under a simplified prospectus and annual information form and is otherwise subject to NI 81-102.
5. The head office of the Filer and each Fund is or will be located in Ontario.
6. The Existing Fund is distributed under a simplified prospectus dated August 27, 2008.
7. The Filer proposes that each Fund be authorized to engage in a limited, prudent and disciplined amount of short selling. The Manager believes each Fund could benefit from the implementation and execution of a controlled and limited short selling strategy. This strategy would complement each Fund's primary objective of buying securities with the expectation of capital preservation.
8. The investment practices of each Fund will comply in all respects with the requirements of Part 2 of NI 81-102, except to the extent that each Fund has received permission from the applicable securities regulatory authorities or regulators of the Jurisdictions to deviate therefrom.
9. Any short sales made by a Fund will be subject to compliance with the investment objectives of such Fund.
10. In order to effect a short sale of securities, each Fund will borrow securities from either its custodian or a dealer (in either case, the "Borrowing Agent"), which Borrowing Agent may be acting either as principal for its own accounts or as agent for other lenders of securities.
11. Each Fund will implement the following controls when conducting a short sale:
(a) securities will be sold short for cash, with each Fund assuming the obligation to return to the Borrowing Agent the securities borrowed to effect the short sale;
(b) the short sale will be affected through market facilities through which the securities sold short are normally bought and sold;
(c) each Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sale is effected;
(d) the securities sold short will be liquid securities that:
(i) are listed and posted for trading on a stock exchange; and
(1) the issuer of the security has a market capitalization of not less than CDN $100 million, or the equivalent thereof, of such security at the time the short sale is effected; or
(2) the Fund has pre-arranged to borrow for the purpose of such sale; or
(ii) are bonds, debentures or other evidences of indebtedness of or guaranteed by the Government of Canada or any province or territory of Canada or the Government of the United States of America;
(e) at the time securities of a particular issuer are sold short:
(i) the aggregate market value of all securities of that issuer sold short by the Fund will not exceed 5% of the total net assets of the Fund; and
(ii) each Fund will place a "stop-loss" order with a dealer to immediately purchase for the Fund an equal number of the same securities if the trading price of the securities exceeds 120% (or such lesser percentage as the Manager may determine) of the price at which the securities were sold short;
(f) the Fund will deposit Fund assets with the Borrowing Agent as security in connection with the short sale transaction;
(g) the Fund will maintain proper books and records of all short sales and Fund Assets deposited with Borrowing Agents as security;
(h) the Fund will develop written policies and procedures for the conduct of short sales prior to conducting any short sales; and
(i) the Fund will provide disclosure in its simplified prospectus, or an amendment thereto, and its annual information form of the short selling strategies and the details of this exemptive relief prior to implementing the short selling strategy.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(a) the aggregate market value of all securities sold short by each Fund will not exceed 20% of the net assets of each Fund on a daily marked to market basis;
(b) each Fund holds "cash cover" (as defined in NI 81-102) in the amount, including the Fund assets deposited with Borrowing Agents as security in connection with short sale transactions, that is at least 150% of the aggregate market value of all securities sold short by each Fund on a daily marked to market basis;
(c) no proceeds from short sales of securities by a Fund are used by a Fund to purchase long positions in securities other than cash cover;
(d) each Fund maintains appropriate internal controls regarding its short sales, including written policies and procedures, risk management controls and proper books and records;
(e) any short sale made by a Fund is subject to compliance with the investment objectives of that Fund;
(f) the short selling relief does not apply to a Fund that is classified as a money market fund or a short-term income fund;
(g) for short sale transactions in Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall be a registered dealer in Canada and a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund;
(h) for short sale transactions outside of Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall:
(i) be a member of a stock exchange and, as a result, be subject to regulatory audit; and
(ii) have a net worth in excess of the equivalent of CDN$100 million determined from its most recent audited financial statements that have been made public;
(i) except where a Borrowing Agent is a Fund's custodian or a sub-custodian thereof, when the Fund deposits Fund assets with a Borrowing Agent as security in connection with a short sale transaction, the amount of Fund assets deposited with the Borrowing Agent does not, when aggregated with the amount of Fund assets already held by the Borrowing Agent as security for outstanding short sale of securities transactions of the Fund, exceed 10% of the net assets of the Funds, taken at market value as at the time of the deposit;
(j) the security interest provided by a Fund over any of its assets that is required to enable the Fund to effect short sale transactions is made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;
(k) prior to conducing any short sales, each Fund discloses in its simplified prospectus, or an amendment thereto, a description of: (a) short selling, (b) how the Fund intends to engage in short selling, (c) the risks associated with short selling, and (d) in the Investment Strategy section of the prospectus, the Fund's strategy and this exemptive relief;
(l) prior to conducting any short sales, each Fund discloses in its annual information form, or an amendment thereto, the following information:
(i) that there are written policies and procedures in place that set out the objectives and goals for short selling and the risk management procedures applicable to short selling;
(ii) who is responsible for setting and reviewing the policies and procedures referred to in the preceding paragraph, how often the policies and procedures are reviewed, and the extent and nature of the involvement of the board of directors or trustee in the risk management process;
(iii) whether there are trading limits or other controls on short selling and who is responsible for authorizing the trading and placing limits or other controls on the trading;
(iv) whether there are individuals or groups that monitor the risks independent of those who trade;
(v) whether risk measurement procedures or simulations are used to test the portfolio under stress conditions; and
12. prior to conducting any short sales, each Fund has provided to its securityholders not less than 60 days' written notice that discloses the Fund's intent to begin short selling transactions and has made the disclosure required in the Fund's simplified prospectus and annual information form as outlined in paragraph (k) and (l) above or the Fund's initial simplified prospectus and annual information form and each renewal thereof has included such disclosure.
This decision shall terminate upon the coming into force of any legislation or rule of the principal regulator dealing with the matter referred to in sections 2.6(a), 2.6(c), and 6.1(1) of NI 81-102.