Securities Law & Instruments

Headnote

National Policy 11-203 Process for Relief Applications in Multiple Jurisdictions – relief granted from the investment fund self-dealing restrictions in the Securities Act (Ontario) to allow pooled funds to invest indirectly through the use of derivatives entered into with related counterparties in securities of underlying funds under common management – relief subject to certain conditions.

Applicable Legislative Provisions

Securities Act (Ontario), R.S.O. 1990, c. S.5, as am., ss. 111(2)(a), (b) and (c)(ii), 111(4), 112.

December 8, 2016

IN THE MATTER OF

THE SECURITIES LEGISLATION OF

ONTARIO

(the Jurisdiction)

AND

IN THE MATTER OF

THE PROCESS FOR EXEMPTIVE RELIEF APPLICATIONS

IN MULTIPLE JURISDICTIONS

AND

IN THE MATTER OF

BMO NESBITT BURNS INC. (the Filer)

AND

IN THE MATTER OF

BMO PRIVATE PREFERRED SHARE POOLED PORTFOLIO

(the Initial Top Fund) AND

ANY OTHER POOLED FUND (as defined below)

MANAGED BY THE FILER IN THE FUTURE

(the Future Top Funds, and together with the Initial Top Fund, the Top Funds)

AND

IN THE MATTER OF

BMO PREFERRED SHARE FUND

(the Initial Underlying Fund) AND

ANY OTHER NI 81-101 FUND (as defined below) MANAGED BY THE FILER,

OR AN AFFILIATE OF THE FILER, IN THE FUTURE

(the Future Underlying Funds and, together with the Initial Underlying Fund, the Underlying Funds)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer, on behalf of the Top Funds, for a decision under the securities legislation of the Jurisdiction (the Legislation) exempting each Top Fund from the following restrictions under the Legislation in respect of the investment further described below by a Top Fund in an Underlying Fund directly, or indirectly through one or more derivative instruments entered into with Related Counterparties (as defined below):

(a)           the restriction prohibiting an investment fund from knowingly making an investment in any person or company who is a substantial security holder of the investment fund, its management company or its distribution company;

(b)           the restriction prohibiting an investment fund from knowingly making an investment in a person or company in which the investment fund, alone or together with one or more related investment funds, is a substantial security holder;

(c)           the restriction prohibiting an investment fund from making an investment in an issuer in which any person or company who is a substantial security holder of the investment fund, its management company or its distribution company, has a significant interest;

(d)           the restriction prohibiting an investment fund or its management company or its distribution company from knowingly holding an investment described in (a), (b) or (c) above;

(e)           the restriction prohibiting an investment fund or its management company or its distribution company from entering into any contract or other arrangement that results in its being directly or indirectly liable or contingently liable in respect of any investment described in (a) or (b) above; and

(collectively, the Requested Relief).

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

1.             the Ontario Securities Commission is the principal regulator for this application; and

2.             the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in Alberta (and together with the Jurisdiction, the Applicable Jurisdictions).

Interpretation

Defined terms contained in National Instrument 14-101 Definitions and MI 11-102 have the same meaning if used in this decision, unless otherwise defined. In this decision, the following terms have the following meanings:

NI 81-101 Fund means an open-ended “mutual fund” for the purposes of, and that is a reporting issuer under, the securities legislation of the Applicable Jurisdictions, that is subject to National Instrument 81-102 Investment Funds (NI 81-102) and that has a current simplified prospectus prepared, filed and receipted under the securities legislation of the Applicable Jurisdictions in accordance with National Instrument 81-101 Investment Fund Distributions.

Pooled Fund means an open-ended “mutual fund” for the purposes of, and that is not a reporting issuer under, the securities legislation of the Applicable Jurisdictions, the securities of which are issued solely pursuant to prospectus exemptions in accordance with National Instrument 45-106 Prospectus Exemptions (NI 45-106) and the Legislation.

BMO means Bank of Montreal, a Canadian chartered bank.

Related Counterparty means BMO or a Guaranteed Affiliate of BMO.

Guaranteed Affiliate of BMO means a wholly owned affiliate of BMO where BMO has assumed responsibility for the obligations of that affiliate.

Representations

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

The Filer and Affiliates

1.             The Filer is a corporation incorporated under the laws of Canada and its head office is in Toronto, Ontario. 

2.             The Filer is registered as an investment fund manager in Ontario, Quebec and Newfoundland and Labrador, as a futures commission merchant in Ontario, as a dealer (futures commission merchant) in Manitoba, as a derivatives dealer in Quebec and as an investment dealer in all provinces and territories of Canada.

3.             BMO Investments Inc. (BMO Investments) and BMO Asset Management Inc. (BMO AM), both affiliates of the Filer, are each registered as an investment fund manager in Ontario, Quebec and Newfoundland and Labrador. BMO Investments is also registered as a mutual fund dealer in all provinces and territories of Canada. BMO AM is also registered as a commodity trading manager in Ontario and as a portfolio manager and exempt market dealer in all provinces and territories of Canada.

4.             Each of the Filer, BMO Investments and BMO AM is a wholly-owned subsidiary of BMO, and as such BMO is a substantial securityholder of the Filer, BMO Investments and BMO AM.

5.             The Filer is not a reporting issuer in any jurisdiction of Canada. Each of the Filer, BMO Investments, BMO AM and BMO PIC (as defined below) is not in default of securities legislation of any jurisdiction in Canada.

The Top Funds

6.             The Initial Top Fund will be a Pooled Fund established as a trust under the laws of Ontario.

7.             Each Future Top Fund will be a Pooled Fund established as a trust, corporation or limited partnership under the laws of Ontario.

8.             The Filer will be the investment fund manager of the Top Funds.

9.             A registered portfolio manager that is not related to the Filer or its affiliates will be the portfolio manager of the Initial Top Fund. A registered portfolio manager either affiliated with or that is not related to the Filer or its affiliates will be the portfolio manager of the Future Top Funds.

10.          CIBC Mellon Trust Company will be the custodian of the Initial Top Fund. A trust company incorporated, and licensed or registered, under the laws of Canada or a jurisdiction in Canada, or a bank listed in Schedule I, II or III of the Bank Act (Canada) or a qualified affiliate of such bank or trust will be the custodian of each Future Top Fund.

11.          The registered portfolio manager of the Top Fund will have complete discretion to invest and reinvest all or part of a Top Fund’s assets, and will be responsible for executing or arranging for the execution of all portfolio transactions in respect of a Top Fund.

12.          Each Top Fund will have its own separate investment objectives, strategies and, if applicable, investment restrictions.

13.          To achieve its investment objectives, each Top Fund will invest substantially all of its assets, either directly, or indirectly through one or more derivative instruments entered into with Related Counterparties (as defined below), in securities of an Underlying Fund.

Underlying Funds

14.          The Initial Underlying Fund is a NI 81-101 Fund established as a trust.

15.          The Initial Underlying Fund is not in default of securities legislation of any jurisdiction of Canada.

16.          Each Future Underlying Fund will be a NI 81-101 Fund established as a trust, corporation or limited partnership under the laws of a province of Canada.

17.          BMO Investments is the investment fund manager and BMO AM is the portfolio manager of the Initial Underlying Fund.

18.          The Filer or an affiliate of the Filer may be the trustee and will be the investment fund manager of the Future Underlying Funds. A registered portfolio manager either affiliated with or that is not related to the Filer or its affiliates will be the portfolio manager of the Future Underlying Funds.

19.          The Initial Underlying Fund has, and each Future Underlying Fund will have, its own separate investment objectives, strategies and investment restrictions.

20.          Each of the Underlying Funds calculates and will calculate its net asset value (NAV) and offer redemptions at least at the same frequency as the applicable Top Fund.

Fund-On-Fund Structure

21.          The Initial Top Fund is expected to invest substantially all of its assets indirectly through the use of derivative instruments such as options and forwards in Series I units of the Initial Underlying Fund, but may also invest directly in Series I units of the Initial Underlying Fund (the Initial Fund-on-Fund Structure). For Series I units of the Initial Underlying Fund, separate fee and expense arrangements are negotiated by BMO Investments with, and paid by, each Series I investor outside the Initial Underlying Fund.

22.          The investment of a Future Top Fund in an Underlying Fund will be structured substantially similarly, including as to fee structure (except as described below), to the investment of the Initial Top Fund in the Initial Underlying Fund (the Future Fund-on-Fund Structure, and together with the Initial Fund-on-Fund Structure, the Fund-on-Fund Structure).

23.          Each investor in a Top Fund (other than the Filer or an affiliate of the Filer as a seed capital investor) will be a client of an affiliate of the Filer (in the case of the Initial Top Fund, BMO Private Investment Counsel Inc. (BMO PIC)) (each an Adviser), who has entered into a discretionary investment management agreement (IMA) with the Adviser. Each Adviser is or will be registered as a portfolio manager in all applicable provinces and territories of Canada.

24.          The Fund-on-Fund Structure is designed:

(a)           to provide each Top Fund with an efficient and cost-effective manner of pursuing portfolio diversification versus directly purchasing portfolio securities; and

(b)           to provide clients of an Adviser with a means of obtaining exposure to the Underlying Fund at superior pricing compared to securities of the Underlying Fund they are eligible to acquire directly, thus resulting in lower overall fees for such clients.

25.          The fee structure of the Initial Fund-on-Fund Structure will be as follows:

(a)           each investor in the Initial Top Fund will pay a fee to the Adviser for the services provided by the Adviser in accordance with the terms of the IMA between the investor and the Adviser (the Advisory Fee). This fee is independently negotiated between the investor and the Adviser and will be paid outside the Initial Top Fund. The Adviser will pay the Filer a portion of this fee (that would otherwise be retained by the Adviser) for the management and administration of the Initial Top Fund in connection with each investment by the Adviser’s clients in the Initial Top Fund;

(b)           when the Initial Top Fund invests in the Initial Underlying Fund through derivative instruments, no management fees or administration fees or other fees will be payable by the Initial Top Fund or the Initial Underlying Fund. No amounts in addition to the Advisory Fee will be paid by any client of an Adviser as a result of being invested in the Initial Top Fund. In addition, any derivative instruments used by the Initial Top Fund to invest indirectly in the Initial Underlying Fund will be acquired from a Related Counterparty at no cost. There will be no embedded fees or expenses in any derivative instruments used by the Initial Top Fund;

(c)           if the Initial Top Fund were to invest directly in Series I units of the Initial Underlying Fund, rather than indirectly through derivative instruments, the Initial Top Fund would pay BMO Investments a management and administration fee in an amount to be negotiated between the Initial Top Fund and BMO Investments; however, the aggregate cost associated with investing in the Initial Underlying Fund through the Initial Top Fund, including all fees and expenses that reduce the value of the investment, and calculated before taking into account any tax benefit if any, would be less for the client of the Adviser than the aggregate cost associated with investing directly in the series of securities of the Initial Underlying Fund with the lowest aggregate cost which the client of the Adviser would be eligible to acquire (currently, Series O units of the Initial Underlying Fund). The Initial Top Fund would only invest in Series I units of the Initial Underlying Fund directly to the extent that it was unable to invest indirectly, through the use of derivative instruments, on terms satisfactory to the portfolio manager of the Initial Top Fund; and

(d)           no incentive fees will be payable.

26.          The fee structure of any Future Fund-on-Fund Structure will be substantially similar to that of the Initial Fund-on-Fund Structure except that:

(i)            the Filer may charge a fee to a Future Top Fund in addition to or in substitution for any portion of the Advisory Fee to be paid by the Adviser to the Filer; and/or

(ii)           there may be embedded fees or expenses in any derivative instruments a Future Top Fund enters into with Related Counterparties;

provided (1) that the aggregate cost associated with investing in an Underlying Fund through the Future Fund-on-Fund Structure, including all fees and expenses that reduce the value of the investment, and calculated before taking into account any tax benefit if any, is less for the client of the Adviser than the aggregate cost associated with investing directly in the series of securities of the applicable Underlying Fund with the lowest aggregate cost which the client of the Adviser would be eligible to acquire, and (2) that no management fees or incentive fees contemplated in (i) or (ii) above would be payable by a Future Top Fund that, to a reasonable person, would duplicate a fee payable by the Underlying Fund.

27.          The use of derivative instruments will allow the Filer to retain the fee paid to it by the Adviser (in the case of the Initial Top Fund, BMO PIC) rather than pay a portion of such fee to an affiliate of the Filer as the management fee of the Underlying Fund, and may additionally provide tax efficiency for certain investors.

28.          Where a Top Fund invests indirectly in an Underlying Fund through derivative instruments entered into with a Related Counterparty, a registered portfolio manager that is not related to the Filer or its affiliates will manage and make decisions regarding the investments of the Top Fund. The unrelated registered portfolio manager of the Top Fund will only enter into a derivative instrument to gain exposure to an Underlying Fund with a Related Counterparty where such portfolio manager determines that the pricing and terms of such derivative instrument are at least as favourable as the pricing and terms which such portfolio manager could otherwise obtain from a counterparty that is not a Related Counterparty.

29.          No Top Fund will invest, either directly or indirectly through derivative instruments, in more than one Underlying Fund.

30.          No Top Fund will also be an Underlying Fund.

31.          Any direct or indirect investment through derivative instruments made by a Top Fund in an Underlying Fund will be consistent with the investment objectives, investment strategies, investment restrictions, risk profile and other principal terms of the Top Fund.

32.          Each of the Top Funds will prepare annual audited financial statements and interim unaudited financial statements in accordance with National Instrument 81-106 Investment Fund Continuous Disclosure (NI 81-106) and will otherwise comply with the requirements of NI 81-106 applicable to them. The holdings by a Top Fund of securities of an Underlying Fund will be disclosed in the financial statements of the Top Fund.

33.          The amounts invested from time to time in an Underlying Fund by a Top Fund, alone or together with other Top Funds or other investment funds managed by an affiliate of the Filer, may exceed 20% of the outstanding voting securities of the Underlying Fund. As a result, each Top Fund could, either alone or together with other Top Funds or other investment funds managed by an affiliate of the Filer, become a substantial securityholder of an Underlying Fund. The Top Funds and investment funds managed by an affiliate of the Filer are, or will be, related mutual funds by virtue of common management by the Filer or an affiliate of the Filer.

34.          BMO currently owns more than 10% of the outstanding voting units of the Initial Underlying Fund, which holding is primarily for hedging purposes. BMO and its affiliates may similarly hold more than 10% of the outstanding voting securities of a Future Underlying Fund for similar hedging or seed capital requirement purposes, or hold more than 20% of the outstanding voting securities of a Top Fund for seed capital requirement purposes. As such the Initial Fund-on-Fund Structure results, and a Future Fund-on-Fund Structure may result, in a Top Fund investing in an Underlying Fund in which a person or company who is a substantial security holder of the Top Fund, the Filer or an affiliate of the Filer has a significant interest.

35.          A Top Fund using a derivative instrument to obtain exposure to an Underlying Fund could result in its being directly or indirectly liable in respect of an investment in such Underlying Fund which it would otherwise be prohibited from investing in in the circumstances described above in paragraphs 33 and 34.

36.          The derivative instruments used by a Top Fund to obtain exposure to an Underlying Fund may be viewed as an investment in the Related Counterparty.

37.          The Fund-on-Fund Structure complies with all the requirements of section 2.5 of NI 81-102. The Requested Relief is required because the Top Funds are not currently subject to the requirements of NI 81-102 and therefore cannot rely upon the exemptions contained in subsection 2.5(7) of NI 81-102.

38.          The Fund-on-Fund Structure represents the business judgment of responsible persons uninfluenced by considerations other than the best interests of each Top Fund.

Decision

The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.


The decision of the principal regulator under the Legislation is that the Requested Relief is granted provided that:

(a)           securities of the Top Funds are distributed in Canada solely pursuant to exemptions from the prospectus requirements in NI 45-106 and the Legislation;

(b)           the Initial Underlying Fund is, and each Future Underlying Fund will be, a “mutual fund” under the securities legislation of the Applicable Jurisdictions to which NI 81-102 and NI 81-101 applies;

(c)           the investment, either direct or indirect through derivative instruments entered into with Related Counterparties, by a Top Fund in an Underlying Fund is compatible with the investment objectives of the Top Fund;

(d)           where a Top Fund invests indirectly in an Underlying Fund through derivative instruments entered into with a Related Counterparty, a registered portfolio manager that is not related to the Filer or its affiliates will manage and make decisions regarding the investments of the Top Fund;

(e)           any derivative instrument used by a Top Fund to invest indirectly in an Underlying Fund will be acquired from a Related Counterparty;

(f)            no Top Fund enters into a transaction to obtain exposure to, or purchases securities of, an Underlying Fund, unless at the time of the transaction, the Underlying Fund holds no more than 10% of its NAV in securities of other investment funds, unless:

(i)            the Underlying Fund is a “clone fund” (as defined in NI 81-102);

(ii)           the other investment fund is a “money market fund” (as defined in NI 81-102); or

(iii)          the securities of the other investment fund are “index participation units” (as defined in NI 81-102) issued by an investment fund;

(g)           no management fees or incentive fees, including any embedded fees in any derivative instruments used by a Future Top Fund to indirectly invest in an Underlying Fund, are payable by a Top Fund that, to a reasonable person, would duplicate a fee payable by the Underlying Fund for the same service;

(h)           no sales fees or redemption fees are payable by a Top Fund in relation to its purchases or redemptions of securities of an Underlying Fund;

(i)            the aggregate cost associated with investing in the Underlying Fund through the Fund-on-Fund Structure, including all fees and expenses that reduce the value of the investment, and calculated before taking into account any tax benefit if any, is less for the client of the Adviser than the aggregate cost associated with investing directly in the series of securities of the Underlying Fund with the lowest aggregate cost which the client of the Adviser would be eligible to acquire;

(j)            the Filer will cause the Top Fund to not vote the securities of an Underlying Fund held, either directly or indirectly through derivative instruments, by the Top Fund at any meeting of the securityholders of the Underlying Fund; however, a Top Fund may arrange for such securities to be voted by the beneficial holders of securities of the Top Fund;

(k)           the offering memorandum, where available, or other disclosure document of a Top Fund, will be provided to investors in a Top Fund prior to the time of investment and will disclose:

(i)            that the Top Fund will invest substantially all of its assets in an Underlying Fund and is expected to do so indirectly through the use of derivative instruments entered into with Related Counterparties, but may also do so by investing directly in securities of the Underlying Fund;

(ii)           that the Filer or an affiliate of the Filer is the investment fund manager and/or portfolio manager of both the Top Fund and the Underlying Fund, as applicable, and the potential conflicts of interest relating to such relationships;

(iii)          each substantial securityholder of the Filer, of an affiliate of the Filer or of a Top Fund that also has a significant interest in an applicable Underlying Fund, the approximate amount of the significant interest they hold, on an aggregate basis, expressed as a percentage of the applicable Underlying Fund’s NAV, and the potential conflicts of interest which may arise from such relationships;


(iv)          the fees and expenses payable by the Underlying Fund that the Top Fund will invest in and the embedded fees or expenses in any derivative instruments used by a Future Top Fund;

(v)           that investors in the Top Fund are entitled to receive, on written request and free of charge, the following relating to the Series I securities of the Underlying Fund in which the Top Fund invests directly or indirectly through derivative instruments:

1.             the most recently filed Fund Facts document;

2.             the most recently filed simplified prospectus and annual information form;

3.             the most recently filed annual financial statements and any interim financial statements filed after;

4.             the most recently filed management report of fund performance (MRFP) and any interim MRFP filed after; and

5.             any other continuous disclosure document that the Underlying Fund may make available to its investors.

“Deborah Leckman”

Commissioner

Ontario Securities Commission

“Grant Vingoe”

Vice-Chair

Ontario Securities Commission