Front Street Alternative Asset Fund Inc. - MRRS Decision

Headnote

MRRS exemptive relief granted to a labour sponsored investment fund from certain mutual fund requirements and restrictions on incentive fees.

Rules Cited

National Instrument 81-102 - Mutual Funds, ss. 7.1, 19.1.

December 13, 2005

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

BRITISH COLUMBIA, ALBERTA, SASKATCHEWAN,

MANITOBA, ONTARIO, NEW BRUNSWICK,

NOVA SCOTIA, PRINCE EDWARD ISLAND,

NEWFOUNDLAND AND LABRADOR

(the Jurisdictions)

AND

IN THE MATTER OF

THE MUTUAL RELIANCE REVIEW SYSTEM

FOR EXEMPTIVE RELIEF APPLICATIONS

AND

IN THE MATTER OF

NATIONAL INSTRUMENT 81-102 MUTUAL FUNDS

AND

IN THE MATTER OF

FRONT STREET ALTERNATIVE ASSET FUND INC.

(the Fund)

MRRS DECISION DOCUMENT

Background

The local securities regulatory authority or regulator (the Decision Maker) in each of the Jurisdictions has received an application from the Fund for a decision under the securities legislation of the Jurisdictions (the Legislation) for the Fund to be exempt, pursuant to subsection 19.1 of NI 81-102, from Part 7 of NI 81-102 to pay the Performance Bonus (defined herein) (the Requested Relief).

The Ontario Securities Commission has received an application for a decision to revoke and replace a Prior Ontario Decision (defined herein) with this MRRS Decision Document pursuant to section 144 of the Securities Act (Ontario)(the Act).

Under the Mutual Reliance Review System for Exemptive Relief Applications (MRRS),

(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 Fund (formerly Terra Firma Emerging Companies Fund 2004 Inc.) is a corporation incorporated under the Business Corporations Act (Ontario) by articles of incorporation dated October 30, 2003.

2. The Fund is registered as a labour sponsored investment fund under the Community Small Business Investments Fund Act (Ontario).

3. The Fund became a reporting issuer in Ontario by a way of prospectus receipt dated January 9, 2004. The Fund has subsequently redeemed all its outstanding Class A shares effective October 19, 2004.

4. The Fund is a mutual fund as defined in the Legislation. A preliminary prospectus to re-establish the Fund, dated October, 21 2005, was filed with the Decision Makers. The Fund will, upon the issuance of a receipt for a final prospectus, distribute securities in each of the Jurisdictions.

5. The Fund sought and received an Ontario decision on January 9, 2004 (the Prior Ontario Decision) exempting the Fund from Part 7 of NI 81-102 in relation to incentive fees.

6. Front Street Capital 2004 will be the manager of the Fund (the Manager) and Front Street Investment Management Inc. will be the investment advisor of the Fund (the Investment Advisor).

7. As disclosed in the prospectus, "eligible investment" means an investment which, at the time of purchase, qualifies as an investment in an eligible business as defined in the Community Small Business Investment Funds Act (Ontario) and the Income Tax Act (Canada). Eligible investment excludes liquid investments.

8. For the purpose of the relief in this letter, "income" means all interests, dividends, fees, capital gains and other distributions received by the Fund from its investment in eligible investments.

9. The Fund will pay to the Investment Advisor in respect of each fiscal year of the Fund a performance bonus per unit (the Performance Bonus) equal to the lesser of 20% of all income earned from the eligible investments, and (ii) the portion of that amount that does not reduce returns to shareholders on the Investment Portfolio below a cumulative annualized threshold return at least equal to the rate for 91-day t-bills plus 300 bps, calculated quarterly and then averaged for the year.

Notwithstanding the foregoing, no Performance Bonus will be payable with respect to any fiscal year of the Fund unless the Investment Portfolio has:

(a) earned sufficient income to generate a rate of return on eligible investments in excess of a cumulative annualized threshold return of at least equal to the rate for 91-day t-bills plus 300 bps, calculated quarterly and then averaged for the year. The income on eligible investments includes gains and losses (realized and unrealized) earned and incurred since the inception of the Fund, and

(b) earned income form an eligible investment which provides, since the date of investment, a cumulative investment return at an average annual rate at least equal to the rate for 91-day t-bills plus 300 bps, calculated quarterly and then averaged for the year.

10. The Performance Bonus does not conform to the requirements of section 7.1 of NI 81-102. The Performance Bonus is based on realized gains and the cumulative performance of the venture portfolio (and not in relation to a benchmark). The Performance Bonus is not based on the total return of the Fund because liquid investments are not included in the Fund's portfolio of eligible investments.

11. The Fund is designed to encourage the public to invest in a vehicle that makes venture capital investments. The making of venture capital investments is substantially different from the types of investments generally made by public mutual funds.

12. The basis for payment of the Performance Bonus, as described in paragraph 9 (the Incentive Arrangement), is appropriate in light of the nature of venture capital investing and is consistent with the incentives used in the venture capital industry, and in particular, in private venture capital funds. The Fund believes that it needs to be able to offer an incentive fee arrangement similar to those of other venture capital funds in order to attract the necessary professional expertise to be able to carry out the investment operations and its mandate.

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 provided that:

(a) The final prospectus of the Fund will:

(i) fully disclose that the Investment Advisor considers the Performance Bonus and the Incentive Arrangement to be appropriate given the disclosed investment objectives and strategies of the Fund;

(ii) provide an explanation of why the Performance Bonus and the Incentive Arrangement are appropriate for the Fund; and

(iii) provide an explanation of the Performance Bonus calculation for partial dispositions of an eligible investment.

(b) The relief provided herein is conditional upon compliance with all other applicable provisions of NI 81-102.

Further, the Ontario Securities Commission under section 144 of the Act hereby revokes and replaces the Prior Ontario Decision with respect to the Fund with this MRRS Decision Document.