The July 14, 2014 Ontario Budget legislation[1] includes amendments (Amendments) that extend the investment restrictions in Part XXI of the Securities Act (Ontario) (Act) to closed-end funds.
"Substantial securityholder" restriction
Under these restrictions, a manager now must aggregate the holdings across all of its mutual funds and closed-end funds under common management to determine whether the 20% threshold for being a "substantial securityholder" of an issuer has been crossed.
While, in some ways, this requirement is similar to the upcoming amendments to National Instrument 81-102 Mutual Funds (NI 81-102) that will apply section 2.2 of NI 81-102 to closed-end funds, there are several important differences:
- the section 2.2 restriction is calculated on a fund-by-fund basis (it does not aggregate across investment funds under common management), and
- the section 2.2 restriction will not come into effect for existing closed-end funds until March 21, 2016.
Transition
A new provision grandfathers investments legally made by closed-end funds prior to the Amendments coming into effect on July 24, 2014[2]. However, the transition provisions appear to have two technical flaws:
- Mutual funds may still be required to reduce investments that otherwise were legally made before July 24, 2014 if the position, when aggregated with the holdings of closed-end funds under common management, exceeds 20% of the voting securities of an issuer[3].
- The Amendments immediately prohibit any new fund-on-fund investment (including a distribution reinvestment) by an existing closed-end fund that owns more than 20% of an underlying fund, even though the related exemption from this prohibition for permitted fund-on-fund investments will not come into effect until March 21, 2016[4].
Fasken Martineau has advised Ontario Securities Commission (OSC) staff of these issues.
New compliance systems
For managers currently managing mainly closed-end funds, this is a new restriction and will require that they establish procedures for monitoring aggregate holdings to avoid making a prohibited investment in the future. For managers of mutual funds who also manage closed-end funds, they will need to modify their current procedures to include the holdings of their closed-end funds in the aggregated position.
Executing portfolio trades through affiliated dealers
The Amendments also apply subsection 115(1) of the Act to closed-end funds, thereby prohibiting a closed-end fund from paying an affiliated dealer to execute a portfolio trade unless done pursuant to a contract that has been disclosed in the fund's prospectus. Since existing closed-end funds would not have disclosed any such contracts in their previous prospectuses, they will be unable to access this carve-out. Fasken Martineau has advised OSC staff of this issue.
General issues with the Part XXI restrictions
In addition to the drafting points described above, there are several lingering issues associated with Part XXI of the Act that should be clarified by the OSC, not the least of which is the meaning of "under common management". This is the test for identifying the investment funds which must aggregate their holdings for determining if they are a "substantial securityholder" of an issuer. Current competing interpretations are that funds are under common management if:
- they have the same manager (even if they have different portfolio advisers),
- they have the same portfolio advisor (even if they have different managers), or
- they have different managers and/or portfolio advisers that are affiliated with each other.
When creating this restriction, the drafters were addressing a concern that no single management company should have control over an issuer through the funds it manages[5]. Accordingly, funds should be considered "under common management" only if the same entity exercises the voting rights of the securities held by those funds. This would be consistent with the principles underlying the disaggregation provisions of NI 62-103 which, unfortunately, do not expressly refer to the "substantial securityholder" test in clause 111(2)(b) of the Act[6].
Additional material
For ease of reference, Fasken Martineau has prepared a consolidated version of Part XXI of the Act which incorporates the Amendments and can be accessed through the links below.
[1] Bill 14 An Act to implement Budget measures and to enact and amend various Acts, Royal Assent on July 24, 2014.
[2] Subsection 111(4) of the Act.
[3] See pre-existing subsection 111(3) of the Act which still requires a mutual fund in Ontario to divest any investment described in section 111 (as amended) made between September 15, 1979 and July 24, 2014.
[4] The exemption for fund-on-fund investing by closed-end funds is contained in subsection 2.5(7) of NI 81-102. However, section 2.5 will not apply to existing closed-end funds until March 21, 2016.
[5] See the 1969 Report of the Canadian Committee on Mutual Funds and Investment Contracts at paragraphs 12.70 to 12.74.
[6] The "applicable provisions" and "applicable definitions" referenced in Part 5 of National Instrument 62-103 The Early Warning and Related Take-Over Bid and Insider Reporting Issues do not include section 111 of the Act.
