- Staff release interpretive guidance on the definition of “investment fund”
- Staff provide clarity regarding the implications of charging fixed rate administration fees and adjustment payments
- A change to the index of a mutual fund or exchange-traded fund that proposes to track a specified index is likely to be viewed as a change to the fund’s fundamental investment objective requiring prior security holder approval
On November 8, 2012, the Investment Funds Branch of the Ontario Securities Commission (OSC) released the eighth edition of the Investment Funds Practitioner (the Practitioner), providing fund managers and advisers with an overview of recent regulatory issues arising from public inquiries, applications for discretionary relief, prospectuses and continuous disclosure documents filed with the OSC.
DEFINITION OF “INVESTMENT FUND”
The OSC reconfirmed its position that an investment fund is an issuer that does not seek to exercise control over, or become involved in the management of, investee companies. In determining whether an issuer exercises “control” over, or is involved in the management of, an investee company, staff may consider various factors, including:
- whether the issuer holds securities representing more than 10% of the outstanding equity or voting securities of the investee company;
- any right of the issuer to appoint board or board observer seats on the investee company;
- restrictions on management, or approval or veto rights over decisions made by management, of the investee company by the issuer; or
- any right of the issuer to restrict the transfer of securities by other security holders of the investee company.
In staff’s view, the presence of any one or more of the above criteria is generally considered to be indicative of “control”. This new guidance expands on the concept of control in the definition of “non-redeemable investment fund” in the Securities Act (Ontario) and the Companion Policy to National Instrument 81-106 (NI 81-106), which distinguishes investment funds from holding companies, in part, on the basis that holding companies generally exert a significant degree of control over the companies in which they invest. Based on the Practitioner, staff’s view is that any degree of control or active involvement in the management of investee companies by an issuer would mean that the issuer is not an investment fund. We expect that this guidance will be of assistance to fund managers, including managers of private equity funds and other similar investment vehicles, in determining whether the continuous disclosure obligations under NI 81-106, the independent review committee (IRC) requirements under National Instrument 81-107 (NI 81-107) or the investment fund manager registration requirements under National Instrument 31‑103 are applicable to them or the funds they manage.
Bulleted Placeholders in Prospectuses
Staff reminds filers that certain bulleted placeholders for items such as the auditor’s name in an audit report, the minimum offering amount on the cover page of a long form prospectus, expenses and fees and the name of the custodian, should be disclosed at the time of preliminary filing rather than presented for the first time in the final prospectus filing.
Fixed Rate Administration Fees with Adjustment Payments
Some mutual funds charge an administration fee that is calculated as a fixed percentage of the fund’s net asset value. This fee is intended to compensate the manager for bearing most of the operating expenses of the fund. However, staff note that some investment fund managers have incorporated an adjustment payment into the administration fee, that becomes payable by a mutual fund in addition to the fixed administration fee, when the assets of the mutual fund fall below a specified threshold.
Staff remind investment fund managers that the introduction of a fixed administration fee, with or without an adjustment payment, will trigger the requirement for security holder approval under National Instrument 81-102 (NI 81-102). Staff’s view is that an adjustment payment is not consistent with investors’ general expectation of a fixed rate administration fee, noting that when the adjustment payment is triggered, the total administration fee payable as a percentage of the fund’s net asset value is no longer fixed and could potentially increase to a significant amount, depending on the magnitude of the decrease in the fund’s net asset value. Accordingly, where administration fees include an adjustment payment, staff are requesting disclosure of the maximum limit on the total adjustment fee payable as a percentage of the fund’s net asset value. This disclosure is intended to provide investors with greater transparency, predictability and clarity of what the administration fee will be under varying market conditions.
Linked Note Pricing Supplements
As part of the growing practice of filing subsequent prospectus supplements involving linked notes in draft form that are based on previously pre-cleared prospectus supplements, issuers should be aware that if a cover letter requesting pre-clearance does not accompany the filing, staff will presume that the supplement has not been filed for the purpose of pre-clearance, but rather for marketing purposes only. For draft prospectus supplements filed for marketing purposes only, staff request that the filing indicate that pre-clearance is not required and that a final prospectus supplement will follow in due course.
Investment Objectives for a Fund-of-Funds
In respect of fund-of-fund structures involving a oneto- one relationship between conventional mutual funds under common management, staff has indicated that the investment objective of the top fund must also disclose the specific investment objective of the bottom fund. Staff considers this disclosure appropriate for fund-of-fund structures that provide direct exposure to the portfolio of securities held by a bottom fund in these circumstances.
APPLICATIONS FOR EXEMPTIVE RELIEF
Index Funds – Change of Index
In staff’s view, a change to the index of conventional mutual funds and exchange-traded funds that propose to track specified indices (Index Funds) will likely be viewed as a change to the fund’s fundamental investment objective requiring prior security holder approval. Although many factors may be considered in making this determination, staff notes that the manner in which a fund is marketed may provide further evidence as to its fundamental nature. For example, if an Index Fund’s name or advertising suggests that it is an index fund or provides exposure to a specified index, then that may suggest that a change by that fund to the index being tracked is a change to its fundamental investment objective.
Use of Past Performance in the Prospectus
Applications for relief to use past performance data are commonly submitted in the context of fund mergers or the conversion of a closed-end fund to a newly established mutual fund. As mentioned by staff in the December 2011 Investment Funds Practitioner, issuers are reminded that applications for relief to use past performance data should also contemplate the use of past performance data in the Fund Facts. Applications should include all aspects of past performance data that will be referenced in the Simplified Prospectus and Fund Facts (for example, disclosure of the management expense ratio in the Fund Facts).
CONTINUOUS DISCLOSURE AND PROCESS MATTERS
Commencement of Quarterly Advertising Review
Staff announced the commencement of a review program pursuant to which it will select and review the advertising and marketing materials from four to six investment fund managers (across a wide spectrum of fund types, including conventional mutual funds, closedend funds, exchange-traded funds, commodity pools and labour-sponsored investment funds) on a quarterly basis. Selected participants will be asked to provide all advertisements and marketing materials used during the previous quarter and to describe their marketing policies and procedures.
Changes in IRC Composition
NI 81-107 specifies that an individual may not serve on an IRC for longer than six years unless the investment fund manager agrees to such reappointment. As NI 81-107 has been in force for nearly six years, staff anticipate that 2013 may observe several changes to IRC composition from many investment funds. Staff remind funds and IRC members that notification of changes to IRC composition are required to be submitted to the fund’s principal regulator and disclosed in the annual IRC report to security holders.
In addition to the above, the Practitioner also highlights a number of other issues which may be of interest to filers, including the proper use of images in prospectus filings and exemptive relief issues in relation to managed accounts and potential sub-adviser conflicts of interest matters.