Securities Law & Instruments

Headnote

Mutual Reliance Review System for Exemptive Relief Applications --

Relief granted from National Instrument 81-102 Mutual Funds to permit the Funds to use performance data of the Predecessor Funds in sales communications.

Relief granted to existing mutual funds and mutual funds to be established from National Instrument 81-102 Mutual Funds to permit short selling of securities up to 20% of net assets per fund, subject to certain conditions and requirements.

Applicable Legislative Provisions

National Instrument 81-102 Mutual Funds, ss. 15.6, 15.9(2), 2.6(a) and (c), 6.1(1), 19.1.

November 1, 2007

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

BRITISH COLUMBIA, ALBERTA, SASKATCHEWAN, MANITOBA, ONTARIO,

QUÉBEC, NEW BRUNSWICK, NOVA SCOTIA, PRINCE EDWARD ISLAND,

NEWFOUNDLAND AND LABRADOR, NORTHWEST TERRITORIES,

YUKON TERRITORY AND NUNAVUT TERRITORY

(the Jurisdictions)

AND

IN THE MATTER OF

THE MUTUAL RELIANCE REVIEW SYSTEM

FOR EXEMPTIVE RELIEF APPLICATIONS

AND

IN THE MATTER OF

FRONT STREET CAPITAL 2004

(the Filer)

AND

IN THE MATTER OF

FRONT STREET OPPORTUNITY FUNDS LTD.

 

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 Filer, on behalf of Front Street Opportunity Funds Ltd. (FSOF) and each current class of shares of FSOF (Existing Fund, and collectively, Existing Funds) or future class of shares of FSOF (Future Fund, and collectively, Future Funds, and together with the Existing Funds, the Funds) for which the Filer, or an affiliate of the Filer, hereafter becomes the manager, each of which is deemed to be a separate mutual fund under subsection 1.3(1) of National Instrument 81-102 Mutual Funds (NI 81-102), for a decision under the securities legislation of the Jurisdictions (the Legislation) exempting the Funds from the following requirements of the Legislation, subject to certain terms and conditions:

(a) the requirements contained in section 15.6 and subsection 15.9(2) of NI 81-102 which would prohibit Front Street Resource Opportunities Fund (Resource Fund) and Front Street Yield Opportunities Fund (Yield Fund), two of the Funds, from preparing sales communications which include performance data from any period prior to the date they became share classes of FSOF;

(b) the requirement contained in subsection 2.6(a) of NI 81-102 prohibiting a mutual fund from providing a security interest over a mutual fund's assets;

(c) the requirement contained in subsection 2.6(c) of NI 81-102 prohibiting a mutual fund from selling securities short; and

(d) the requirement contained in subsection 6.1(1) of NI 81-102 prohibiting a mutual fund from depositing any part of a mutual fund's assets with an entity other than the mutual fund's custodian.

Under the Mutual Reliance Review System for Exemptive Relief Applications:

(e) the Ontario Securities Commission is the principal regulator for this application; and

(f) 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 is a partnership established under the laws of Ontario and is the manager and promoter of the Existing Funds.

2. FSOF, formerly Front Street Rollover Fund Limited (Rollover Fund), is a corporation incorporated under the laws of Canada. Each Fund is or will be a class of shares of FSOF. The Filer, or an affiliate of the Filer, will be the manager of the Future Funds.

3. Each Fund is or will be a reporting issuer in all of the provinces and territories of Canada.

4. The Filer intends that FSOF operate pursuant to the requirements of National Instrument 81-104 Commodity Pools (NI 81-104) and filed a preliminary prospectus on August 15, 2007 compliant with the requirements of NI 81-104 with respect to each series of shares of the Existing Funds.

Reorganization & Performance Data

5. Front Street Long Short Income Fund (FSLSIF) is an investment trust established under the laws of Ontario and HSBC Trust Company of Canada is the trustee. The Filer is also the manager of FSLSIF. FSLSIF is currently a reporting issuer in all of the provinces of Canada. FSOF will become a reporting issuer in all the provinces and territories of Canada once a final prospectus is filed in the Jurisdictions and a decision document is issued by the Decision Makers in respect thereof. Each of Rollover Fund and FSLSIF have been in existence for more than 12 months.

6. At a meeting of the shareholders of Rollover Fund held on July 5, 2007, such shareholders approved a reorganization of Rollover Fund into a "capital class mutual fund" (the Reorganization) and further approved the merger of FSLSIF into FSOF following the Reorganization (the Merger), all as set out in the information circulars for each of the funds dated June 4, 2007 (the Circulars). At the adjourned meeting of the unitholders of FSLSIF held on July 16, 2007, such unitholders also approved the Merger. The Reorganization of FSOF was completed on August 8, 2007 and the Merger was completed on August 9, 2007 (the Effective Date).

7. Following the issuance of a decision document for its final prospectus, FSOF will offer multiple classes of shares, issuable in series, with each share class referable to a particular portfolio of assets. Five classes of shares are initially provided for: Resource Fund, Yield Fund, the Front Street Equity Opportunities Fund class of shares (Equity Fund), the Front Street Small Cap Opportunities Fund class of shares (Small Cap Fund) and the Front Street Cash Fund class of shares (Cash Fund). Three series of each class are initially being offered. Pursuant to subsection 1.3(1) of NI 81-102, each such share class is deemed to be a separate mutual fund.

8. The shareholders of Rollover Fund prior to the Reorganization had their existing shares in Rollover Fund re-designated as Front Street Resource Opportunities Fund class of shares, series A.

9. On August 9, 2007 the existing portfolio assets of FSLSIF were transferred to FSOF in return for Front Street Yield Opportunities Fund class of shares. These portfolio assets are maintained as a separate portfolio by FSOF, for the exclusive benefit of holders of the Yield Fund. As part of the Merger, unitholders of the FSLSIF received one Front Street Yield Opportunities Fund class of shares for each unit in FSLSIF held on the Effective Date.

10. Notwithstanding the Reorganization, the Yield Fund and the Resource Fund now are and in future will be managed substantially similar to FSLSIF and Rollover Fund, respectively, and any significant differences from the previous funds will be noted in any sales communications that include performance data.

11. Rollover Fund has not been subject to NI 81-102 from its inception, but has nevertheless been managed (and was required to be managed) by Front Street Investment Management Inc. (FSIMI), an affiliate of the Filer, in accordance with the investment restrictions and practices set forth in Part 2 of NI 81-102, except that Rollover Fund has engaged in short selling on substantially the same basis as Resource Fund is now seeking relief to be able to continue to do. Rollover Fund's offering document indicated that it had adopted the standard investment restrictions and practices described in NI 81-102 except for short selling and the pledging of its assets in respect thereof. A copy of these standard investment restrictions and practices was made available to investors upon written request.

12. FSLSIF was not subject to NI 81-102 from its inception, but has nevertheless been managed (and was required to be managed) by FSIMI substantially in accordance with the investment restrictions and practices set forth in Part 2 of NI 81-102. In particular, FSLSIF was required to comply with the requirements of sections 2.1, 2.2, 2.3 (a), (f) and (g), 2.4, 2.5, and 2.6 (a), (d), (f), and (h), and sections 2.7 to 2.17 inclusive, of NI 81-102. In addition, with respect to section 2.6(c), FSLSIF engaged in short selling on substantially the same basis as Yield Fund is now seeking relief to be able to continue to do.

13. Notwithstanding the Reorganization of Rollover Fund, which resulted in the formation of Resource Fund, the portfolio assets of Rollover Fund were not commingled with any other assets in the Reorganization, and the portfolio assets of Resource Fund immediately following the Reorganization were identical to the assets of Rollover Fund immediately prior to the Reorganization. Similarly, the portfolio assets of FSLSIF were not commingled with any other assets in the Merger, and the portfolio assets of Yield Fund immediately following the Merger were identical to the portfolio assets of FSLSIF immediately prior to the Merger.

14. On the basis of the foregoing, the Filer believes it would not be prejudicial to the public interest to grant the requested relief.

Short Selling

15. Both FSLSIF and FSOF prior to the Reorganization and Merger engaged in short selling.

16. The decision of the Filer to permit short selling by the Funds will be subject to the approval of FSOF's board of directors.

17. Each short sale made by a Fund will be subject to compliance with the investment objectives of such Fund. Any Fund which is classified as a "money market fund" within the meaning of NI 81-102 or a short-term income fund will not engage in short selling.

18. In order to effect a short sale, a Fund will borrow securities from either its custodian or a dealer (in either case, the Borrowing Agent), which Borrowing Agent may be acting either as principal for its own account or as agent for other lenders of securities.

19. Each Fund will implement the following controls when conducting a short sale:

(a) securities will be sold short for cash, with the Fund assuming the obligation to return to the Borrowing Agent the securities borrowed to effect the short sale;

(b) the short sale will be effected through market facilities through which the securities sold short are normally bought and sold;

(c) the Fund will receive cash for the securities sold short within normal trading settlement periods for the market in which the short sake is effected;

(d) the securities sold short will be liquid securities that:

(i) are listed and posted for trading on a stock exchange, and

A. the issuer of the security has a market capitalization of not less than CDN$300 million, or the equivalent thereof, of such security at the time the short sale is effected; or

B. the investment advisor has pre-arranged to borrow for the purposes of such short sale;

or

(ii) are bonds, debentures or other evidences of indebtedness of or guaranteed by the Government of Canada or any province or territory of Canada or the Government of the United States of America;

(e) at the time securities of a particular issuer are sold short:

(i) the aggregate market value of all securities of that issuer sold short by the Fund will not exceed 5% of the net assets of the Fund; and

(ii) the Fund will place a "stop-loss" order with a dealer to immediately purchase for the Fund an equal number of the same securities if the trading price of the securities exceeds 115% (or such lesser percentage as the Filer may determine) of the price at which the securities were sold short;

(f) the Fund will deposit Fund assets with the Borrowing Agent as security in connection with the short sale transaction;

(g) the Fund will keep proper books and records of all short sales and Fund assets deposited with Borrowing Agents as security;

(h) the Fund will develop written policies and procedures for the conduct of short sales prior to conducting any short sales; and

(i) the Fund will provide disclosure in its prospectus of the short selling strategies and the details of this exemptive relief prior to implementing the short selling strategy.

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 relief with respect to section 15.6 and subsection 15.9(2) of NI 81-102 is hereby granted to the Yield Fund and the Resource Fund, so as to permit the Yield Fund and the Resource Fund to disclose performance data in sales communications for the period when they operated as FSLSIF and Rollover Fund, respectively, provided the requirements of subsection 15.9(1) of NI 81-102 are complied with.

The decision of the Decision Makers under the Legislation is that the relief with respect to subsections 2.6(a), 2.6(c) and 6.1(I) of NI 81-102 is granted to each Fund (other than a Fund that is classified as a money market fund or a short-term income fund), provided that in respect of each Fund:

1. the aggregate market value of all securities sold short by the Fund does not exceed 20% of the net assets of the Fund on a daily marked-to-market basis;

2. the Fund holds cash cover (as defined in NI 81-102) in an amount, including the assets of the Fund deposited with Borrowing Agents as security in connection with short sale transactions, that is at least 150% of the aggregate market value of all securities sold short by the Fund on a daily marked-to-market basis;

3. no proceeds from short sales by the Fund or Future Fund are used by the Fund to purchase long positions in securities other than cash cover;

4. the Fund will maintain appropriate internal controls regarding its short sales including written policies and procedures, risk management controls and proper books and records;

5. any short sales made by a Fund will be subject to compliance with the investment objectives of the Fund;

6. for short sale transactions in Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall be a registered dealer in Canada and a member of a self-regulatory organization that is a participating member of the Canadian Investor Protection Fund;

7. for short sale transactions outside of Canada, every dealer that holds Fund assets as security in connection with short sale transactions by the Fund shall:

(a) be a member of a stock exchange and, as a result, be subject to a regulatory audit; and

(b) have a net worth in excess of the equivalent of CDN$50 million determined from its most recent audited financial statements that have been made public;

8. except where the Borrowing Agent is the Fund's custodian, when the Fund deposits Fund assets with a Borrowing Agent as security in connection with a short sale transaction, the amount of Fund assets deposited with the Borrowing Agent does not, when aggregated with the amount of Fund assets already held by the Borrowing Agent as security for outstanding short sale transactions of the Fund, exceed 10% of the net assets of the Fund, taken at market value as at the time of the deposit;

9. the security interest provided by a Fund over any of its assets that is required to enable the Fund to effect short sale transactions is made in accordance with industry practice for that type of transaction and relates only to obligations arising under such short sale transactions;

10. prior to conducting any short sales, the Fund discloses in its prospectus or an amendment thereto a description of: (a) short selling, (b) how the Fund intends to engage in short selling, (c) the risks associated with short selling, and (d) in the Investment Strategy section of the prospectus, the Fund's strategy and details of this exemptive relief; and

11. prior to conducting any short sales, the Fund discloses in its prospectus or an amendment thereto the following information:

(a) that there are written policies and procedures in place that set out the objectives and goals for short selling and the risk management procedures applicable to short selling;

(b) who is responsible for setting and reviewing the policies and procedures referred to in the preceding paragraph, how often the policies and procedures are reviewed, and the extent and nature of the involvement of the board of directors of the Fund in the risk management process;

(c) whether there are trading limits or other controls on short selling in place and who is responsible for authorizing the trading and placing limits or other controls on the trading;

(d) whether there are individuals or groups that monitor the risks independent of those who trade; and

(e) whether risk measurement procedures or simulations are used to test the portfolio under stress conditions;

12. prior to conducting any short sales, the Fund has provided to its security holders not less than 60 days' written notice that disclosed the Fund's intent to begin short selling transactions and the disclosure required in the Fund's prospectus or an amendment thereto as outlined in paragraphs 10 and 11 above, or the Fund's initial prospectus has included such disclosure; and

13. this relief shall terminate upon the coming into force of any legislation or rule of the Decision Makers dealing with matters referred to in subsections 2.6(a), 2.6(c) and 6.1(1) of NI 81-102.

"Vera Nunes"
Assistant Manager, Investment Funds
Ontario Securities Commission