Palos Equity Income Fund and Palos Management Inc.

Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- a mutual fund is granted exemptions from Regulation 81-102 respecting Mutual Funds to engage in short selling of securities up to 20% of net assets, subject to certain conditions and requirements.

Applicable Legislative Provisions

Regulation 81-102 respecting Mutual Funds, ss. 2.6(a), 2.6(c), 6.1(1), 19.1.

February 23, 2011

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

QUÉBEC AND ONTARIO

(the "Jurisdictions")

AND

IN THE MATTER OF

THE PROCESS FOR EXEMPTIVE RELIEF

APPLICATIONS IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF

PALOS EQUITY INCOME FUND

(the "Fund")

AND

PALOS MANAGEMENT INC.

(the "Filer")

DECISION

Background

The securities regulatory authority or regulator in each of the Jurisdictions (each a "Decision Maker") has received an application from the Filer, on behalf of the Fund, for a decision under the securities legislation of the Jurisdictions (the "Legislation") pursuant to section 19.1 of Regulation 81-102 Mutual Funds ("Regulation 81-102") to exempt the Fund from the following requirements of the Legislation:

(a) the requirement contained in subsection 2.6(a) of Regulation 81-102 prohibiting a mutual fund from providing a security interest over its portfolio assets;

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

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

(collectively, the "Exemption Sought")

Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a dual application):

(a) the Autorité des marchés financiers is the principal regulator for this application;

(b) the Filer has provided notice that section 4.7(1) of Regulation 11-102 respecting Passport System ("Regulation 11-102") is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick, Nova Scotia, Prince Edward Island and Newfoundland and Labrador; and

(c) the decision is the decision of the principal regulator and evidences the decision of the securities regulatory authority or regulator in Ontario.

Interpretation

Terms defined in Regulation 14-101 Definitions and Regulation 11-102 have the same meaning if used in this decision, unless otherwise defined.

Representations

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

1. The Filer is a company constituted under the Companies Act (Québec) on June 20, 2001. The head and registered office of the Filer is located in the province of Quebec.

2. The Filer is the investment fund manager of the Fund and is registered under the securities legislation of each of the provinces of Canada as an investment fund manager and a portfolio manager. The Filer is not in default of securities legislation in any of the provinces of Canada.

3. The Fund is constituted as a mutual fund trust under the laws of Québec and is governed by an amended and restated trust agreement dated January 7, 2011 (the "Declaration of Trust").

4. The Fund was initially settled as a unit trust pursuant to a trust agreement dated January 3, 2008 (the "Original Declaration of Trust"). The Original Declaration of Trust was subsequently amended on January 7, 2011 in order to appoint BNY Trust Company of Canada as the trustee of the Fund ("the Trustee").

5. The head and registered office of the Trustee is located in the province of Ontario.

6. The Fund will be a reporting issuer in each of the provinces of Canada and will distribute its securities under a simplified prospectus and an annual information form. The investment practices of the Fund will comply in all respects with the requirements of Part 2 of Regulation 81-102, except to the extent that the Fund has received permission from the applicable securities regulatory authorities or regulators of the Jurisdictions to deviate therefrom, including the Exemption Sought.

7. The Fund has previously distributed its securities on a prospectus-exempt basis in accordance with Regulation 45-106 respecting Prospectus and Registration Exemptions.

8. The Fund is not in default of securities legislation other than with respect to the financial statements filing requirement set out in sections 2.1 and 2.3 of Regulation 81-106 respecting Investment Fund Continuous Disclosure ("Regulation 81-106"). The Fund did not file its annual financial statements for the 2008 and 2009 financial years and did not prepare and file its financial statements for the 2008, 2009 and 2010 completed interim periods. The Filer has since undertaken to deliver the applicable financial statements of the Fund prepared in accordance with Regulation 81-106 to all securityholders of the Fund and has implemented appropriate internal disclosure controls and procedures to ensure that the Fund complies with its continuous disclosure obligations as a reporting issuer.

9. The Filer proposes that the Fund be authorized to engage in a limited, prudent and disciplined amount of short selling. The Filer is of the view that the Fund could benefit from the implementation and execution of a controlled and limited short selling strategy. This strategy would operate as a complement to the Fund's primary discipline of buying securities with the objective that they will appreciate in value.

10. In order to effect a short sale, the 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.

11. The Fund will implement the following controls when conducting a short sale:

(a) securities will be sold short for cash, with the Fund assuming the obligations 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 sale is effected;

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

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

(A) the issuer of which has a market capitalization of not less than CDN $100 million, or the equivalent thereof, at the time the short sale is effected; or

(B) which the Fund's investment advisor has pre-arranged to borrow for the purposes of such short sale; or

(ii) that 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 total 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 120% (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's portfolio assets with the Borrowing Agent as security in connection with the short sale transaction; and

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

Decision

Each of the Decision Makers is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.

The decision of the Decision Makers under the Legislation is that the Exemption Sought is granted provided that:

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

2. the Fund holds "cash cover" (as defined in Regulation 81-102) in an amount, including the Fund's portfolio assets 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 made by the Fund are used by the Fund to purchase long positions in securities other than cash cover;

4. for short sale transactions in Canada, every dealer that holds the Fund's portfolio 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;

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

6. for short sale transactions outside of Canada, every dealer that holds the Fund's portfolio 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, subject to a regulatory audit; and

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

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

8. the security interest provided by the Fund over any of its portfolio assets 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;

9. prior to conducting any short sales, the Fund will disclose in its simplified prospectus a description of: (i) short selling, (ii) how the Fund intends to engage in short selling activities, (iii) the risks associated with short selling, and (iv) in the "Investment Strategies" section of the simplified prospectus, the Fund's short selling strategy and this exemptive relief;

10. prior to conducting any short sales, the Fund will disclose in its annual information form the following information:

(a) in the "Investment Restrictions" section, a description of this exemptive relief;

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

(c) 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 Filer in the risk management process;

(d) the 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;

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

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

The Exemption Sought 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) and (c) and 6.1(1) of Regulation 81-102.