Mutual fund in Ontario (non-reporting issuer) exempt from naming the issuer of certain short positions in its portfolio -- must provide alternative portfolio disclosure.
National Instrument 81-106 Investment Fund Continuous Disclosure, s. 3.5(1).
January 2, 2007
IN THE MATTER OF
NATIONAL INSTRUMENT 81-106
INVESTMENT FUND CONTINUOUS DISCLOSURE
IN THE MATTER OF
SPROTT ASSET MANAGEMENT INC.
IN THE MATTER OF
SPROTT HEDGE FUND L.P.
SPROTT HEDGE FUND L.P. II
SPROTT BULL/BEAR RSP FUND
SPROTT OPPORTUNITIES HEDGE FUND L.P.
(each a Fund, and collectively the Funds)
The Ontario Securities Commission (OSC) received an application from the Applicant for a decision pursuant to section 17.1 of National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106) exempting each Fund and any future mutual funds managed by the Applicant which are not reporting issuers (collectively, with the Funds, the Sprott Funds) from the requirement in paragraph 3.5(1)1 of NI 81-106 to include in the statements of investment portfolio prepared for the Sprott Funds the name of the issuer of the securities sold short by the Sprott Funds (the Statement of Investment Portfolio Requirement).
This Order is based on the following facts represented by the Applicant:
1. The Applicant is a corporation incorporated under the laws of Ontario. The Applicant is the manager of each of the Funds and will be the manager of any future Sprott Funds.
2. Sprott Hedge Fund L.P., Sprott Hedge Fund L.P. II and Sprott Opportunities Hedge Fund L.P. were each formed under the Limited Partnerships Act (Ontario). Sprott Bull/Bear RSP Fund is a trust established under the laws of the province of Ontario.
3. Sprott Hedge Fund L.P. and Sprott Hedge Fund L.P. II entitle their unitholders to redeem units monthly commencing 6 months from the date of purchase with 90 days prior notice. Sprott Opportunities Hedge Fund L.P. entitles its unitholders to redeem units monthly commencing 6 months from the date of purchase with 30 days prior notice. Sprott Bull/Bear RSP Fund allows the redemption of its units by a unitholder monthly with 7 days prior notice. In respect of the Sprott Bull/Bear RSP Fund, redemptions made within 180 days from the date of purchase are subject to a 3% penalty. Given these redemption features, the Applicant understands that the OSC considers each of the Funds to be a "mutual fund" as defined under securities legislation. The Funds are not reporting issuers.
4. Each of the Funds is an "investment fund" as that term is defined in NI 81-106 and is subject to the financial disclosure requirements therein.
5. As part of its investment strategy, each Fund makes extensive use of a short selling strategy pursuant to which the Applicant, as investment manager, short sells securities it believes to be overvalued and/or have deteriorating fundamentals such as decreasing market share, sales or earnings or other negative factors. The Applicant manages the long and short positions of a Fund according to its view of the domestic and international economy and market trends in order to seek to optimize absolute returns. The allocation of long and short positions will vary. Short positions generally comprise around 50% of a Fund's portfolio of assets and occasionally can comprise up to 90%.
6. As at August 30, 2006, the Funds had an aggregate of 3,485 unitholders with $1.0 billion of assets. The Applicant replicates this investment strategy in respect of other offshore funds which it manages which, together with the Funds, had $1.5 billion of assets as at August 30, 2006.
7. Each of the Funds employs a "buy and hold" strategy with respect to its investments, meaning they don't trade in and out of positions at a high rate. Because of this strategy, short positions disclosed in the statement of portfolio assets often remain open when the financial statements are distributed notwithstanding the 90 and 60 day delays in distribution of the annual and interim financial statements. Expressed as a percentage of the positions which were held on the date of the statements, the number of positions of the Funds which remained opened at the time of distribution of the statements ranged from 73% to 98% (for the period from December 31, 2005 to March 31, 2006) and from 68% to 98% (for the period from June 30, 2006 to August 31, 2006).
8. Prior to NI 81-106 coming into effect, the Funds disclosed in their statements of portfolio assets short positions by industry. The Funds also disclosed: (i) the average cost and market value of the short positions; and (ii) each short position as a percentage of net assets of the Fund.
9. The Applicant is concerned that the Statement of Investment Portfolio Requirement could cause harm to the Funds because publishing information on short positions increases the risk of predatory marketing practices, such as short squeeze initiating trades, which could cause losses to the Funds. This is especially a concern for the Funds given their size and the number of their unitholders and the buy and hold element of the Funds' short selling strategy. Once a short squeeze has been initiated, the Applicant has limited options for protecting the Funds from harm and therefore believes that relief from the Statement of Investment Portfolio Requirement as requested is the best option to protect the Funds from harm.
The Director is satisfied that it would not be prejudicial to the public interest to grant the requested relief and orders that the Sprott Funds are exempt from the Statement of Investment Portfolio Requirement provided that for each Sprott Fund:
(i) the statement of investment portfolio discloses short positions by industry;
(ii) the statement of investment portfolio shows the average cost and market value of each industry category;
(iii) the statement of investment portfolio shows the percentage of net assets represented by short positions for each industry category;
(iv) the name of the issuer is disclosed for short positions that exceed 5% of a Sprott Fund's net assets;
(v) the offering documents for the Sprott Funds disclose the particulars of this exemption; and
(vi) this order terminates upon the coming into force of any legislation or rule of the OSC dealing with paragraph 3.5(1)1 of NI 81-106 or any matters relating to the disclosure of short positions by investment funds.