Variation of a prior order to permit a labour sponsored investment fund to pay certain specified distribution costs out of fund assets contrary to section 2.1 of National Instrument 81-105 Mutual Fund Sales Practices. Variation granted on the condition that the distribution costs are included in the management expense ratio.
Securities Act (Ontario), R.S.O. 1990 c. S.5., as am., s. 144.
National Instrument 81-105 Mutual Fund Sales Practices.
IN THE MATTER OF
THE SECURITIES LEGISLATION OF ONTARIO
IN THE MATTER OF
AN APPLICATION TO THE ONTARIO SECURITIES COMMISSION
IN THE MATTER OF
COVINGTON STRATEGIC CAPITAL FUND INC.
WHEREAS the Ontario Securities Commission (the "Commission") has received an application dated December 14, 2004 (the "Application") from Covington Strategic Capital Fund Inc. (the "Fund") for an exemption under section 9.1 of National Instrument 81-105 - Mutual Fund Sales Practices ("NI 81-105") from the applicability of Section 2.1 of NI 81-105 with respect to payments by the Fund to registered dealers.
In the Application, the Fund represented the following:
1. The Fund was incorporated under the laws of the Province of Ontario by articles of incorporation dated November 18, 2003. The sponsor of the Fund is the Canadian Professional Police Association (CPPA) (the "Sponsor").
2. The Fund is registered as a labour sponsored investment fund corporation under the Ontario Act, and qualifies as a prescribed labour-sponsored venture capital corporation under the Income Tax Act (Canada), as amended. The Fund is a mutual fund pursuant to the securities legislation of the Province of Ontario.
3. The Fund filed a (final) prospectus on January 9, 2004 in connection with the initial and continuous public offering of the Class A Shares, Series I (the "Series I Shares") and the Class A Shares, Series II (the "Series II Shares") to the public in Ontario (the "2004 Final Prospectus"), which 2004 Final Prospectus was receipted by the Ontario Securities Commission (the "Commission") on January 12, 2004.
4. The Commission provided the Fund with an order dated January 9, 2004 exempting the Fund from Section 2.1 of NI 81-105 (the "2004 Order") with respect to the 2004 Final Prospectus. The 2004 Order expired on November 30, 2004.
5. The Fund filed the Pro-Forma Prospectus on December 7, 2004 in connection with the continuous public offering of the Series I Shares and the Series II Shares to the public in Ontario.
6. The authorized capital of the Fund consists of an unlimited number of Class A Shares issuable in series of which the Series I Shares and the Series II Shares have been created as of the date hereof, an unlimited number of Class B Shares and an unlimited number of Class C Shares, issuable in series, of which 290,902.42 Series I Shares and 119,693.99 Series II Shares are issued and outstanding, no Class C Shares are issued or outstanding and 200 Class B Shares are issued and outstanding and held by the Sponsor.
7. The Fund makes investments in eligible Canadian businesses as defined in the Ontario Act. In general terms, eligible Canadian businesses are public or private companies carrying on business in Ontario with less than 500 employees and less than $50 million of total assets. The Fund invests primarily in Canadian independent software vendors that develop software applications that may run on one or more Microsoft platforms, and intends to develop and grow investee businesses in cooperation with the Fund's strategic partners.
8. The Fund's Manager will pay to registered dealers selling Class A Shares a commission of 10% of the offering price in respect of the sale of Series I Shares and a commission of 6% of the offering price in respect of the sale of Series II Shares. Investors who purchase Class A Shares will not pay any sales commissions directly. Such sales commissions will not be charged to nor amortized by the Fund, and instead the following distribution costs (collectively, the "Distribution Costs") will be paid in the manner set forth below:
(a) with respect to the Series I Shares, (i) the Fund will pay to the Manager a monthly distribution services fee equal to 0.160% of the original issue price of the issued and unredeemed Series I Shares and (ii) after a period of eight years, the Fund will pay a service fee to registered dealers equal to 0.5% annually of the Net Asset Value of the Series I Shares held by clients of the sales representatives of such registered dealers (the "Series I Service Fee"); and
(b) with respect to the Series II Shares, (i) the Fund will pay to the Manager a monthly distribution services fee equal to 0.096% of the original issue price of the issued and unredeemed Series II Shares and (ii) the Fund will pay a service fee to registered dealers equal to 0.5% annually of the Net Asset Value of the Series II Shares held by clients of the sales representatives of such registered dealers (the "Series II Service Fee" and collectively with the Series I Service Fee, the "Service Fees").
The monthly distribution services fee is intended to reimburse the Manager for financing costs incurred to fund the payment of commissions, including an amount for interest and a one-time financing commitment fee payable in connection with such financing.
9. The structural elements of the Fund relating to the payment of commissions are consistent with the legislative requirements contemplated under the Ontario Act. Gross investment amounts will be paid to the Fund as opposed to, for example, first deducting a commission and remitting the net investment amount to the Fund, in order to ensure that the entire amount paid by an investor is eligible for applicable federal and Ontario tax credits which arise on the purchase of the Series I Shares and Series II Shares of the Fund. Subsection 25(4) of the Ontario Act, for example, provides that the provincial tax credit is a defined percentage of the amount received by a labour sponsored investment fund corporation as equity capital on the issue. Accordingly, it is tax efficient for the Fund to pay the Distribution Costs directly as outlined above.
10. Section 2.1 of NI 81-105 would prohibit the Fund from paying the Service Fees related to the trailing commissions to registered dealers.
11. An alternative commission arrangement at point of sale which serves to reduce the net amount invested in Fund securities is not practical in the context of the Fund's operations, since such an arrangement would prejudice an investor in Series I Share and/or Series II Shares by reducing the quantum of the tax credit otherwise available.
12. The structural characteristics of the Fund are substantially equivalent to other labour sponsored investment funds. The inability of the Fund to incur distribution costs directly would likely distinguish the fund in its expense characteristics from other labour sponsored investment funds, such that the Fund would be difficult to assess in the context of competitive funds and would be at a competitive disadvantage.
13. The (final) prospectus to be filed by the Fund hereafter will disclose the payment by the Fund of the Distribution Costs and that the Fund is responsible for payment of those expenses.
14. The Fund undertakes to comply with all other provisions of NI 81-105. In particular, the Fund undertakes that all Service Fees paid by it will be compensation permitted to be paid to participating dealers under NI 81-105.
THE DECISION of the Commission, based on the information and representations contained in the Application, and for the purposes described in the Application, is that the Fund shall be exempt from the prohibition in Section 2.1 of NI 81-105 in order to permit the Fund to pay the Service Fees directly as disclosed in the (final) prospectus provided that:
(a) the Service Fees are otherwise permitted by, and paid in accordance with, NI 81-105;
(b) the Fund will in its financial statements expense the Service Fees in the fiscal period when incurred and will ensure that Service Fees are being included in the Fund's calculation of its management expense ratio;
(c) the summary section of the prospectus of the Fund (the "Summary Section") has full, true and plain disclosure explaining to investors that they indirectly support the payment of the sales commission as the Manager pays the sales commissions when a purchaser purchases his or her Class A Shares but the Manager is compensated by the Fund for the payment of sales commissions (and the provision of various other services) through the fees paid in respect of general and investment advisory services and funding services described in the Summary Section. The Summary Section must be placed within the first 10 pages of the prospectus;
(d) the Fund shall include in the Summary Section a summary table of fees and expenses payable by the Fund in the following format:
Summary of Fees, Charges and Other Expenses Payable by the Fund
Type and Amount of Fee Description
(e) the summary table shall also include the annual management expense ratio of the Fund for each of the last five completed financial years of the Fund with a brief description of the method of calculating the management expense ratio and the annual returns of the Fund for each of the last five completed financial years of the Fund; and
(f) this exemption shall cease to be operative with respect to the Commission on the date that a rule or regulation replacing or amending section 2.1 of NI 81-105 comes into force.
January 4, 2005.
"Susan Wolburgh Jenah"