Securities Law & Instruments

Headnote

Variation of a prior order to permit a labour sponsored investment fund to pay 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.

Statutes Cited

Securities Act (Ontario), R.S.O. 1990 c. S.5., as am., s. 144.

Rules Cited

National Instrument 81-105 Mutual Fund Sales Practices.

January 12, 2005

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

ONTARIO, NOVA SCOTIA AND NEW BRUNSWICK (THE "JURISDICTIONS")

AND

IN THE MATTER OF

THE MUTUAL RELIANCE REVIEW SYSTEM

FOR EXEMPTIVE RELIEF APPLICATIONS

AND

IN THE MATTER OF

RETROCOM GROWTH FUND INC. (THE "FUND")

AND

RETROCOM INVESTMENT MANAGEMENT INC. (THE "MANAGER")

(COLLECTIVELY, THE "FILER")

 

MRRS DECISION DOCUMENT

Background

On January 26, 1999, an order was granted to the Fund by the Ontario Securities Commission and Nova Scotia Securities Commission (collectively, the "Previous Decision") for an exemption permitting the Fund to make certain payments to participating dealers and their representatives in connection with the distribution of shares of the Fund. The Previous Decision was adopted by the New Brunswick Securities Commission on January 16, 2001.

The local securities regulatory authority or regulator (the "Decision Maker") in each of the Jurisdictions has received an application from the Filer for a decision (the "Requested Relief") under the securities legislation of the Jurisdictions (the "Legislation") to revoke the Previous Decision and replace it with this decision to reflect:

(a) that the Fund will now charge sales commissions paid on the sale of shares of the Fund to retained earnings as share issue cost as they occur;

(b) that the Fund will issue an additional new series of Class A Shares of the Fund with an alternative sales commission structure to that which currently exists in respect of the distribution of Class A Shares; and

(c) consequential variations to the Previous Decision as are necessary to reflect changes in the Fund since the date of the Previous Decision.

Under the Mutual Reliance Review System for Exemptive Relief Applications

(a) the Ontario Securities Commission is the principal regulator for this application, and

(b) this MRRS decision document evidences the decision of each Decision Maker.

Interpretation

Defined terms contained in National Instrument 14-101 Definitions have the same meaning in this decision unless they are defined in this decision.

Representations

This decision is based on the following facts represented by the Filer:

1. The Filer's head office is located at 135 Queens Plate Drive, Suite 400, Toronto, Ontario, M9W 6V1.

2. The Fund is a corporation amalgamated under the laws of Canada on April 26, 2000 and is a reporting issuer under the Legislation and is not on the list of defaulting reporting issuers maintained pursuant to the Legislation.

3. The Manager is a corporation incorporated under the laws of Ontario on January 16, 1995 and acts as the manager of the Fund pursuant to the terms of a written agreement made between the Manager and the Fund (the "Management Agreement").

4. The Fund is registered as a labour sponsored investment fund corporation under the Community Small Business Investment Funds Act (Ontario) (the "Ontario Act") and as a registered labour-sponsored venture capital corporation under the Income Tax Act (Canada) (the "Federal Act") and is a prescribed labour-sponsored venture capital corporation by regulation under the New Brunswick Income Tax Act (the "New Brunswick Act").

5. The Fund is a mutual fund which makes investments in small and medium-sized Canadian businesses which are eligible investments for the Fund under the Federal Act, the Ontario Act and, in respect of funds raised in Nova Scotia prior to December 31, 2004, the Equity Tax Credit Act (Nova Scotia) (the "Nova Scotia Act"), and which are subject to certain investment commitments made to the Minister of Finance (New Brunswick).

6. The Class A Series I Shares and Class C Series 10 Shares of the Fund are currently distributed in the Jurisdictions pursuant to a prospectus dated January 14, 2004 (the "Existing Prospectus"). Class C Series 10 Shares will cease to be distributed on the lapse date of the Existing Prospectus.

7. The Fund has filed a preliminary and pro forma prospectus dated December 14, 2004 (the "Prospectus") with the securities regulatory authorities in each of the Jurisdictions, pursuant to which the Fund intends to distribute Class A Series I Shares, Class A Series V Shares and Class C Series 11 Shares once a receipt for a final prospectus has been issued by the principal regulator. The Prospectus is a preliminary prospectus in respect of the Class A Series V Shares and Class C Series 11 Shares.

8. As at November 30, 2004, the Fund had issued and outstanding (i) in the aggregate, 2,377,971.002 Class A Series I Shares, Class A Series II Shares, Class A Series III Shares and Class A Series IV Shares (referred to hereinafter, collectively with the Class A Series V Shares, as "Class A Shares") and (ii) in the aggregate, 4,674,338.713 Class C Series 1 Shares, Class C Series 2 Shares, Class C Series 3 Shares, Class C Series 4 Shares, Class C Series 5 Shares, Class C Series 6 Shares, Class C Series 7 Shares, Class C Series 8 Shares, Class C Series 9 Shares and Class C Series 10 Shares (referred to hereinafter, collectively with the Class C Series 11 Shares, as "Class C Shares"), having an aggregate net asset value of $70,070,635.04. The Class A Series II Shares, Class A Series III Shares and Class A Series IV Shares of the Fund were issued in connection with the amalgamation of the Fund with Sportfund Inc. on April 26, 2000, pursuant to a court-approved plan of arrangement. These shares are not qualified for sale by prospectus.

9. The Class A Shares and Class C Shares are equity shares, with the Class A Shares entitling the holder to receive tax credits under the Federal Act, the Ontario Act and the New Brunswick Act, as applicable, and the Class C Shares designed for institutional investors, having a prohibition on redemption for a five-year period following their issue and during such period an entitlement to a cumulative preferential dividend.

10. Section 2.1 of National Instrument 81-105 (the "National Instrument") prohibits the Fund, in connection with the distribution of its securities, from making payments or providing benefits to dealers participating in the distribution of its securities, including the payment of sales commissions to, or the reimbursements of costs or expenses incurred or to be incurred by such dealers. The Previous Decision exempted the Fund from section 2.1 of the National Instrument, subject to certain conditions.

11. The Fund currently pays a commission to registered dealers in the amount of 6.0% of the gross proceeds derived on the sale of Class A Series I Shares. As detailed in the Prospectus, the Fund will pay a commission to registered dealers in the amount of 10% of the gross proceeds derived on the sale of Class A Series V Shares and 2.0% of the gross proceeds derived on the sale of Class C Series 11 Shares.

12. The Fund is responsible for all marketing expenses incurred in connection with the Fund and may, from time to time, enter into expense reimbursement programs with dealers distributing Class A Series I and V Shares which provides for the reimbursement by the Fund of advertising, mailing and other expenses incurred by such dealers in the promotion of Class A Series I and V Shares (the "Marketing Expenses").

13. The Fund currently provides registered dealers with a monthly servicing commission equal to 1/12th of 0.5% of the average net asset value of Class A Shares (other than Class A Series V Shares) held by the clients of such dealers exclusive of Class A Shares purchased prior to September 1, 1997. As detailed in the Prospectus, the Fund will provide registered dealers, after a period of eight years, with a monthly servicing commission equal to 1/12th of 0.5% of the average net asset value of Class A Series V Shares held by the clients of such dealers. No monthly servicing commission is payable before the eighth anniversary of the date of issue of Class A Series V Shares.

14. For accounting purposes, all Marketing Expenses and monthly servicing commissions will be expensed in the fiscal period when incurred.

15. Until August 31, 2004, sales commissions payable by the Fund on the Class A Shares were amortized by the Fund over a period of 8 years in the financial accounts of the Fund, and were recoverable on a declining basis, at the rate of 0.75% per annum, in the event Class A Shares of the Fund were redeemed by the holders thereof prior to the expiry of an 8 year period following the purchase thereof. Sales commissions payable by the Fund on the Class C Shares were amortized by the Fund over a period of five years in consequence of the prohibition on redemption of Class C Shares during such period.

16. As a result of the implementation, effective for financial years beginning on or after October 1, 2003, of Section 1100 of the CICA handbook ("Section 1100"), labour sponsored investment funds, including the Fund, are no longer permitted to defer and amortize commissions on a straight line basis over an eight year period. The Fund now charges commissions to retained earnings as a share issue cost as the expenses are incurred, a practice that is consistent with Section 1100.

17. The payment of commissions on the sale of Class A Shares and Class C Shares by the Fund is an event contemplated under the Federal Act, the Ontario Act, the New Brunswick Act and the Nova Scotia Act.

18. The Prospectus discloses the payment by the Fund of the distribution expenses incurred by the Fund as described in paragraphs 11, 12 and 13 (collectively, the "Distribution Costs") and discloses that the Fund is responsible for payment of these expenses.

19. The Management Agreement between the Fund and the Manager does not provide a mechanism for the Manager's assumption of the obligation to pay the Distribution Costs and accordingly, compliance by the Fund with section 2.1 of the National Instrument would require a renegotiation of such Management Agreement and the approval of the shareholders of the Fund to the extent any renegotiated agreement results in an increase in the costs and expenses incurred by the Fund.

20. The Manager is capitalized only to the extent necessary for its operations, is dependent on management fee revenue derived from the Fund under the Management Agreement for the purpose of satisfying its ongoing obligations, and would need to renegotiate the quantum of its management fees received from the Fund to the extent it assumed responsibility for the Distribution Costs incurred in respect of the Fund.

21. The Fund desires to continue to incur directly the Distribution Costs. The Fund and the Manager will comply with all of the relevant provisions of the National Instrument, other than the prohibition contained in section 2.1 of the National Instrument against the Fund paying the Distribution Costs. The Distribution Costs payable to participating dealers are compensation permitted to be paid to participating dealers under the National Instrument.

Decision

Each of the Decision Makers is satisfied that the test contained in the Legislation that provides the Decision Maker with the jurisdiction to make the decision has been met.

THE decision of the Decision Makers under the Legislation is that the Requested Relief is granted to permit the Fund to pay the Distribution Costs, provided that:

1. the Distribution Costs are otherwise permitted by, and paid in accordance with, the National Instrument;

2. the Distribution Costs are being included in the Fund's calculation of its management expense ratio for fiscal years beginning on or after September 1, 2003;

3. the Fund will in its financial statements expense the monthly servicing commissions and Marketing Expenses as described in paragraphs 12 and 13 in the fiscal period when incurred; unless any securities laws applicable to the Fund from time to time specifically require accounting treatments other than as described;

4. the summary section (the "Summary Section") of the Prospectus of the Fund has full, true and plain disclosure explaining to investors that they indirectly support the payment of the 6.0% Class A Series I sales commission and the 10% Class A Series V sales commission as the Fund pays such commissions out of the proceeds from the sale of Class A Series I and V Shares of the Fund, and the Summary Section must be placed within the first 10 pages of the prospectus;

5. the Fund shall include in the Summary Section a summary table of fees and expenses payable by the Fund in substantially the following format:

Summary of Fees, Charges and Other Expenses Payable by the Fund

Type and Amount of Fee
Description

6. 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

7. this exemption shall cease to be operative with respect to each Decision Maker on the date that a rule or regulation replacing or amending section 2.1 of the National Instrument comes into force.

"Wendell S. Wigle"
Commissioner
Ontario Securities Commission
 
"Suresh Thakrar"
Commissioner
Ontario Securities Commission