Exemption granted to labour sponsored investment fund corporation to permit it to pay certain specified distribution costs out of fund assets contrary to section 2.1 of National Instrument 81-105 Mutual Fund Sales Practices. Exemption granted on the condition that the distribution costs so paid are permitted by, and otherwise paid in accordance with the National Instrument.
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am.
National Instrument 81-105, s. 2.1.
January 30, 2007
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, C.S.5, AS AMENDED (THE ACT)
IN THE MATTER OF
COVINGTON VENTURE FUND INC.
The Ontario Securities Commission (the Commission) has received an application from the Fund for an exemption pursuant to subsection 9.1 of National Instrument 81-105 -- Mutual Fund Sales Practices from section 2.1 of NI 81-105 to permit the Fund to make certain payments to registered dealers.
Defined terms contained in National Instrument 14-101 - Definitions have the same meaning in this decision unless they are defined in this decision.
This decision is based on the following facts represented by the Fund:
1. The Fund is a corporation formed by way of an amalgamation pursuant to the Canada Business Corporations Act on January 6, 2006 (the Amalgamation) of six predecessor funds,
a. Triax Growth Fund Inc.,
b. New Millennium Venture Fund Inc.,
c. New Generation Biotech (Balanced) Fund Inc.,
d. E2 Venture Fund Inc.,
e. Venture Partners Balanced Fund Inc. and
f. Capital First Venture Fund Inc. (collectively, the Predecessor Funds).
2. The Fund is registered as a labour sponsored investment fund corporation under the Community Small Business Investment Funds Act (Ontario) and as a labour-sponsored venture capital corporation under the Income Tax Act (Canada).
3. Covington Capital Corporation (the Manager) is the current manager of the Fund.
4. The Fund is a mutual fund as defined in the Act.
5. The Fund has filed a preliminary prospectus dated December 11, 2006 (the Preliminary Prospectus) in the Province of Ontario in connection with the proposed offering to the public of Class A Shares, Series II and Class A Shares, Series III in the capital of the Fund.
6. The authorized capital of the Fund consists of an unlimited number of Class A Shares, issuable in series (collectively, the Class A Shares) and an unlimited number of Class B shares in the capital of the Fund (the Class B Shares).
7. As of the date hereof, the Fund has seven series of Class A Shares currently issued and outstanding which were issued to shareholders of the Predecessor Funds as part of the Amalgamation. No series of Class A Shares are currently qualified for distribution to the public. All of the issued and outstanding Class B Shares are owned by the Canadian Federal Pilots Association (the Sponsor) as of the date hereof.
8. The Fund proposes to pay directly to registered dealers certain costs associated with the distribution of its Class A Shares, Series II and Class A Shares, Series III. These costs include a sales commission of 10% of the selling price for each relevant Class A share, Series II subscribed for and a sales commission of 6% of the selling price of each relevant Class A share, Series III subscribed for (the Sales Commission).
9. The additional 4% sales commission that is payable for the Class A Shares, Series II, as compared to the sales commission for the Class A Shares, Series III is in lieu of any service fees payable before the eight anniversary of the date of issue of the Class A Shares, Series II of the Fund. For the Class A Shares, Series III, the Manager will pay to dealers, out of the fees it receives from the Fund, a service fee equal to 0.50% annually of the net asset value of the Class A Shares, Series III of the Fund held by clients and sales representatives of the dealers.
10. Prior to the Amalgamation, the managers of some of the Predecessor Funds arranged financing of the sales commissions for some of the Predecessor Funds. In return for arranging such financing, the managers of the Predecessor Funds were paid distribution services fees of 0.16% paid monthly by the respective Predecessor Fund on unredeemed Class A shares, Series II; and 0.096% monthly on unredeemed Class A shares, Series III (the Distribution Services Fees) that were issued and outstanding for less than eight years. Distribution Services Fees will not be charged on the Class A Shares, Series II and the Class A Shares, Series III that will be qualified by the Fund to be issued pursuant to the Prospectus. Distribution Services Fees will continue to be paid on the Class A Shares, Series II and the Class A Shares, Series III that were sold by the Predecessor Funds prior to the Amalgamation.
11. The Fund may also pay for the reimbursement of co-operative marketing expenses (the Co-op Expenses) incurred by registered dealers in promoting sales of the Class A Shares, pursuant to co-operative marketing agreements a Fund may enter into with such dealers.
12. All of the costs associated with the distribution of Class A Shares including, among other things, the Sales Commission and the Co-op Expenses are fully disclosed in the Preliminary Prospectus and will be disclosed in the final prospectus of the Fund. The Sales Commission and the Co-op Expenses are collectively referred to as the "Distribution Costs".
13. For accounting purposes, the Fund will expense the Distribution Costs in the fiscal period when incurred and will not defer and amortize any Sales Commissions and Co-op Expenses.
14. To ensure that the entire subscription price paid by a subscriber of Class A Shares is taken into account for the purpose of determining the applicable federal and provincial tax credits, the gross investment amount will be paid to the Fund in respect of each subscription, as opposed, for example, to the net amount obtained after deducting the Sales Commission from the subscription price.
15. Due to the structure of the Fund specifically and labour funds, in general, the most tax efficient way for the Distribution Costs to be financed is for the Fund to pay them directly. As a result, after the inception of NI 81-105, LSIFs in existence prior to NI 81-105's adoption and virtually all of those created after, have sought relief from securities regulators, including Commission, to allow sales commissions to be paid directly by the funds. Each of the Predecessor Funds except for Capital First Venture Fund Inc. which was created in 2003/2004 had applied for and had received relief respecting the ability to make payments directly respecting the Sales Commissions and Co-op Expenses. Capital First Venture Fund Inc. had only applied to the Commission to request relief respecting the ability to make Co-op Expense payments directly and had received this relief.
16. The management information circular (the Circular) provided to the then shareholders of each of the Predecessor Funds prior to the shareholders' meetings during which the shareholders approved the Amalgamation included certain information about how sales commissions would be paid if the Fund began to offer securities to the public in the future. The Circular indicated that the Manager of the Fund would endeavour to find financing that was similar to that enjoyed by the some of the Predecessor Funds. In return for arranging such financing, the Manager would be paid a Distribution Services Fee of 0.16% paid monthly by the Fund on unredeemed Class A Shares, Series II; and 0.096% monthly on unredeemed Class A Shares, Series III.
17. In the event the Manager was unable to secure financing to pay the sales commissions at all or at rates that it considered to be uneconomical, the Circular disclosed that the Fund would be obligated to pay the Sales Commissions itself.
18. The Manager, or its affiliate, are the only members of the organization of the Fund, other than the Fund itself, available to pay the Distribution Costs. Without the requested discretionary relief, the Manager is not able to secure a third party financing at suitable rates in order to pay the Distribution Costs.
19. Any loans taken by the Manager to finance the Distribution Costs would result in an increased management fee chargeable to the Fund of an amount equal to the borrowing costs incurred by the Manager plus an amount required to compensate the Manager for any risks associated with fluctuations in the net asset value of the Fund.
20. Requiring the Manager to pay the Distribution Costs in a circumstance where the Manager has not been able to secure financing at suitable rates and to do so while granting an exemption to other labour funds and permitting such funds to pay similar Distribution Costs directly, would put the Fund at a permanent and serious competitive disadvantage with their competitors.
21. The Fund undertakes to comply with all other provisions of NI 81-105. In particular, the Fund undertakes that all Distribution Costs paid by it will be compensation permitted to be paid to participating dealers under NI 81-105.
The Commission is satisfied that the test contained in NI 81-105 that provides the Commission with the jurisdiction to make the decision has been met.
The decision of the Commission under NI 81-105 is that the Fund is exempted from section 2.1 of NI 81-105 to permit the Fund to pay the Distribution Costs, provided that:
a) the Distribution Costs are otherwise permitted by, and paid in accordance with, NI 81-105;
b) the Distribution Costs are accounted for in the Fund's financial statements in the manner described above;
c) the summary section of the final prospectus has full, true and plain disclosure explaining to investors that they pay the Sales Commission indirectly, as the Fund pays the Sales Commission using investors' subscription proceeds, and this summary section must be placed within the first 10 pages of the final prospectus; and
d) this Decision shall cease to be operative with respect to the Commission on the date that a rule replacing or amending section 2.1 of NI 81-105 comes into force.