Securities Law & Instruments


Headnote

National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions – revocation of existing exemptive relief from incentive fee requirement contained in s 7.1 of NI 81-102 – granting of exemptive relief from incentive fee requirement contained in s 7.1 of NI 81-102 under revised terms – revised terms not substantially different from those granted under previous exemptive relief decision.

Applicable Legislative Provisions

National Instrument 81-102 Investment Funds, section 7.1, and section 19.1.

August 7, 2018

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
B.E.S.T. INVESTMENT COUNSEL LIMITED
(the Filer)

AND

IN THE MATTER OF
B.E.S.T. TOTAL RETURN FUND INC.
(the Fund)

DECISION

Background

The principal regulator in the Jurisdiction has received an application from the Filer on behalf of the Fund for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) (a) exempting the Fund from section 7.1 of National Instrument 81-102 Investment Funds (NI 81-102) in respect of the proposed Performance Bonus (as defined below) and as disclosed in the Preliminary Prospectus (as defined below) (the Incentive Fee Relief) and (b) to revoke and replace the Previous Decision (as defined below) (the Revocation) (the Incentive Fee Relief and the Revocation are 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 subsection 4.7(1) of Multilateral Instrument 11-102 Passport System (MI 11-102) is intended to be relied upon in each of the other provinces of British Columbia, Alberta, Saskatchewan, Manitoba, New Brunswick and Prince Edward Island (the Other Jurisdictions).

Interpretation

Terms defined in NI 81-102, National Instrument 14-101 Definitions, and MI 11-102 have the same meaning if used in this decision, unless otherwise defined.

The terms set out below have the following meanings:

Disposition Date means the date the Fund receives the proceeds, whether in cash, securities or other property, from the disposition of an Eligible Investment (as defined below).

Eligible Business means an eligible business as defined in the Ontario Act (as defined below).

Eligible Investment means an eligible investment in an Eligible Business which qualifies as an eligible investment under the Ontario Act and the Federal Act (as such terms are defined below).

Federal Act means the Income Tax Act (Canada), as amended.

Investment Advisor means the Filer, in its capacity as investment advisor of the Fund.

Investment Portfolio means, at any point in time, the Eligible Investments of the Fund other than investments in Reserves (as defined below).

Manager means the Filer, in its capacity as manager of the Fund.

Net Asset Value Per Share when used with reference to Class A Shares or Class C Shares, is determined by subtracting the value of the liabilities of the Fund (including any accrued performance fees) and the stated capital of the Class B Shares, from the value of the assets of the Fund and dividing the resulting amount by the total number of outstanding Class A Shares and Class C Shares at the date such value is determined.

Ontario Act means the Community Small Business Investment Funds Act, 1992 (Ontario), as amended.

Performance Bonus means the bonus that the Manager and the Investment Advisor are entitled to share in as soon as practicable after the Disposition Date of an Eligible Investment based on the gains and income earned from each Eligible Investment.

Previous Decision means the ruling of the Ontario Securities Commission, Re: RoyNat Canadian Diversified Fund Inc. dated December 19, 2003.

Reserves has the meaning ascribed by subsection 204.8(1) of the Federal Act and includes money in cash or on deposit with qualified financial institutions, debt instruments of or guaranteed by the Canadian federal government, debt obligations of provincial and municipal governments, Crown corporations and corporations listed on designated Canadian stock exchanges, guaranteed investment certificates issued by Canadian trust companies, and qualified investment contracts.

Representations

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

1.             The Fund was incorporated under the Canada Business Corporations Act by articles of incorporation dated October 31, 2003, as amended on November 30, 2004 and December 20, 2005. It is registered as a labour-sponsored investment fund corporation under the Ontario Act and as a labour-sponsored venture capital corporation under the Federal Act.

2.             The Fund is a mutual fund under the Legislation. The Fund has filed a preliminary prospectus for a distribution of securities in the Jurisdiction and the Other Jurisdictions (the Preliminary Prospectus).

3.             The Fund is sponsored by the Christian Labour Association of Canada, The Society of Energy Professionals and The International Federation of Professional and Technical Engineers Local 164. Its primary objective is to generate interest and dividend income as well as long-term capital appreciation through investments in a diversified portfolio of small and medium-sized private and public companies.

4.             The authorized capital of the Fund consists of an unlimited number of Class A Shares, an unlimited number of Class B Shares and an unlimited number of Class C Shares. The Christian Labour Association of Canada owns the one issued and outstanding Class B Share. All of the Class C Shares are owned by John M.A. Richardson, the Chief Executive Officer of the Fund.

5.             The Filer acts as the Fund’s Manager and Investment Advisor and provides investment advisory services to the Fund and sources and monitors its investments.

6.             The Preliminary Prospectus discloses amendments to (a) the annual management fee (Management Fee), (b) the annual investment advisory fee (Investment Advisory Fee) and (c) the Performance Bonus, if any, payable by the Fund to the Manager which compensation has not been amended since the Fund’s inception (these amendments are referred to collectively as the Fee Changes).

7.             The Fee Changes will:

(a)           reduce the Management Fee to 1% of the aggregate Net Asset Value Per Share attributable to the Class A Shares. This change represents a simplification of the Management Fee structure, which is currently the sum of 1.5% of the Net Asset Value Per Share attributable to the Class A Shares up to $100 million and 1.25% of the Net Asset Value Per Share attributable to the Class A Shares above that threshold;

(b)           simplify and reduce the Investment Advisory Fee to 1% of the aggregate Net Asset Value Per Share attributable to the Class A Shares. The Investment Advisory Fee is currently 2% of the Net Asset Value Per Share of the Class A Shares up to $100 million and 1.75% of the Net Asset Value Per Share attributable the Class A Shares above that threshold; and

(c)           amend the Performance Bonus by lowering the hurdle rates specifying the level of performance that must be achieved before the Manager and Investment Advisor are eligible to receive any Performance Bonus, as follows:

(i)            the hurdle requiring the Fund as a whole to have generated a return more than 2% above the average annual rate of return of the five-year Guaranteed Investment Certificates (GICs) offered by a Schedule I Canadian chartered bank will be reduced to require the Fund to outperform such GICs by 0.75%;

(ii)           the requirement that the Fund must have recouped an amount equal to all of the principal invested in a particular investment prior to paying the Performance Bonus on any full or partial disposition will remain unchanged; and

(iii)          the hurdle requiring an individual realised investment to have earned a compounded annual rate of return that equals or exceeds 12% per annum before the Manager and Investment Advisor are entitled to receive the Performance Bonus with respect to the realization of that investment, will be reduced to require a compounded annual rate of return that equals or exceeds 6% per annum.

8.             The calculation of the Performance Bonus that the Manager and Investment Advisor are entitled to receive once those hurdles have been surpassed, will be modified as follows:

(a)           the Investment Advisor will receive all gains and income earned on a particular investment in excess of a 6% compounded annual rate of return up to and including an amount representing an 8% compounded annual rate of return calculated beginning on the later of September 1, 2018 or the date of the acquisition of such investment by the Fund. This reduces the rate of return that must be achieved on a particular investment before the Investment Advisor is entitled to payment of 100% of such gains and income earned on such particular investment, which is currently calculated based on all gains and income earned on the particular investment in excess of a 12% compounded annual rate of return up to and including a 15% compounded annual rate of return; and

(b)           all gains and income earned on a particular investment in excess of an 8% compounded annual rate of return calculated beginning on the later of September 1, 2018 or the date of the acquisition of such investment by the Fund, will be allocated 16% to the Investment Advisor, 4% to the Manager and 80% to the Fund. This represents a reduction of the threshold at which the Investment Advisor and the Manager participate in such gains and income earned on a particular investment, from the current threshold of a 15% compounded annual rate of return.

9.             Under the proposed compensation structure in paragraph 7 and 8 above, neither the Manager nor the Investment Advisor shall be entitled to receive the Performance Bonus amount with respect to a particular investment, unless the following conditions precedent are met:

(a)           the total net realized and unrealized gains and income from the Fund from its portfolio of Eligible Investments since inception must have generated a return greater than the average annual rate of return on five-year GICs offered by a Schedule I Canadian chartered bank plus 0.75%;

(b)           the compounded annual rate of return (including realized and unrealized gains and income) from the particular Eligible Investment since its acquisition by the Fund must equal or exceed 6% per annum; and

(c)           the Fund must have recouped an amount equal to all principal invested in the particular Eligible Investment.

10.          The Performance Bonus is payable as soon as practicable after the Disposition Date of an Eligible Investment. The Fund will not pay the Performance Bonus on any partial dispositions of an Eligible Investment unless and until the Fund receives (from all dispositions of that investment on a cumulative basis) an amount equal to at least the full amount of the principal invested in the Eligible Investment.

11.          The Fee Changes were described in detail in the management information circular of the Fund dated January 31, 2018 delivered in connection with the annual and special meeting held on February 28, 2018 (the Meeting) to approve the amendments to the Performance Bonus. They also appear in the blackline of the Preliminary Prospectus marked to show changes from the Fund’s prospectus dated December 16, 2016.

12.          The Filer believes that the recalibration of the Fund’s fee structure under the Fee Changes reflects current market and interest rate conditions, making the Fund more marketable while improving the net yield for holders of Class A Shares as the size of the Fund grows. The Fee Changes reduce the Fund’s Management Fee and Investment Advisory Fee (i.e. the fixed portion of the compensation) from a current aggregate of 3.5% to 2% and provide the Filer with the potential for increased deferred, contingent compensation through the Performance Bonus.

13.          The proposed changes will apply to the Performance Bonus calculation on and after September 1, 2018. The current Performance Bonus hurdles and thresholds will continue to apply prior to that date and will be carried forward.

14.          The original Performance Bonus was approved by the Ontario Securities Commission by way of the Previous Decision.

15.          Section 7.1 of NI 81-102 provides that a mutual fund shall not pay, or enter into arrangements that would require it to pay, and no mutual fund shall be sold on the basis that an investor would be required to pay, a fee that is determined by the performance of the mutual fund, unless the calculation and payment of the fee complies with paragraphs 7.1(a), (b) and (c). Paragraph 7.1(a) requires that the fee be calculated with reference to a benchmark or index. Paragraph 7.1(b) requires that the payment of the fee be based on a comparison of the cumulative total return of the mutual fund against the cumulative total percentage increase or decrease of the benchmark or index for the period that began immediately after the last period for which the performance fee was paid. Paragraph 7.1(c) requires that the method of calculation of the fee and details of the composition of the benchmark or index are described in the prospectus of the mutual fund.

16.          Like the original Performance Bonus in respect of which exemptive relief was granted under the Previous Decision, the amended Performance Bonus does not conform to the requirements of paragraphs 7.1(a) and (b) of NI 81-102. In particular, the Performance Bonus is not determined in relation to a benchmark and is not based on the total return of the Fund.

17.          The Fund is a labour-sponsored investment fund; a labour-sponsored investment fund is designed to allow and encourage the public to invest in a vehicle that makes venture capital investments. The making of venture capital investments is substantially different from the types of investments generally made by public mutual funds.

18.          Except for the reduction of the hurdle rates described in paragraph 7 above and the reduction of the payment thresholds described in paragraph 8 above, the Performance Bonus remains unchanged from the Previous Decision. Under the amended Performance Bonus, the Fund will still have to outperform the rate of return on five-year GICs offered by a Schedule I Canadian chartered bank on a portfolio-wide basis, recoup an amount equal to the principal invested in an individual realized investment, and have earned in excess of a specified annualized rate of return on that investment before any Performance Bonus is payable in respect of an individual investment.

19.          The Performance Bonus is appropriate in light of the nature of venture capital investing and is consistent with those commonly used in the venture capital industry, and in particular, in private venture capital funds. The Fund’s board of directors believes that the Fund needs to be able to continue to offer an incentive fee arrangement similar to those of other venture capital funds in order to incentivize and to attract and retain the necessary professional expertise to be able to carry out the Fund’s objectives and maximize shareholder returns.

20.          The proposed changes to the Performance Bonus were reviewed and recommended by the Fund’s independent review committee and unanimously approved at the Meeting by the holders of Class A Shares and the holder of the Class B Share, voting together as a class.

21.          The final prospectus for the Fund will:

(a)           disclose that the Manager and Investment Advisor consider the Performance Bonus appropriate given the investment objectives and strategies of the Fund;

(b)           provide an explanation of why the Performance Bonus is appropriate for the Fund; and

(c)           provide an explanation of the Performance Bonus calculation for partial dispositions of an Eligible Investment.

22.          The Filer believes that the proposed Performance Bonus changes are fair and reasonable and in the best interests of the Fund and its shareholders for the following reasons:

(a)           the changes reflect current interest rate and market conditions;

(b)           the Filer is voluntarily reducing the Management Fee and Investment Advisory Fee from a current aggregate of 3.5% to 2% per annum, which will result in a lower management expense ratio;

(c)           the Performance Bonus changes together with the reduction of the Management Fee and Investment Advisory Fee should make the Fund more marketable and increase the potential of the Fund to raise additional capital;

(d)           the Filer intends to start actively marketing the Class A Shares again in 2018. Although the Performance Bonus is expected to increase as a result of the proposed Fee Changes, as the size of the Fund grows, the lower Management Fee and Investment Advisory Fee are expected to more than offset that increase and significantly improve the net yield to holders of Class A Shares as a result of the lower management expense ratio; and

(e)           the Filer has agreed to reimburse any investor that wishes to redeem Class A Shares on or after September 1, 2018 up to and including November 15, 2018 for the amount of any redemption withholding incurred under the Federal Act in connection with such redemption. This will allow any investor that disagrees with the Performance Bonus changes to redeem their Class A Shares without penalty.

23.          The Filer respectfully submits that the Fee Changes are in the best interests of the Fund and its shareholders.

Decision

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

A.            Prior to September 1, 2018:

(a)           The Management Fee will be an annual amount equal to 1.50% of the aggregate Net Asset Value Per Share attributable to the Class A Shares on the first $100 million of the aggregate Net Asset Value Per Share attributable to the Class A Shares and 1.25% of the aggregate Net Asset Value Per Share attributable to the Class A Shares on the aggregate Net Asset Value Per Share attributable to the Class A Shares in excess of $100 million.

(b)           The Investment Advisory Fee will be an annual amount equal to 2% of the aggregate Net Asset Value Per Share attributable to the Class A Shares on the first $100 million of the aggregate Net Asset Value Per Share attributable to the Class A Shares and 1.75% of the aggregate Net Asset Value Per Share attributable to the Class A Shares on the aggregate Net Asset Value Per Share attributable to the Class A Shares in excess of $100 million.

(c)           The Manager and the Investment Advisor are entitled to share in the Performance Bonus as soon as practicable after the Disposition Date of an Eligible Investment based on the gains and income earned from each Eligible Investment. No Performance Bonus shall be paid by the Fund in respect of the realization of an Eligible Investment, unless on the Disposition Date of such Eligible Investment:

(i)            the total net realized and unrealized gains and income from the Fund from its portfolio of Eligible Investments since inception must have generated a return greater than the average annual rate of return on five-year GICs offered by a Schedule I Canadian chartered bank plus 2%;

(ii)           the compounded annual rate of return (including realized and unrealized gains and income) from the particular Eligible Investment since its acquisition by the Fund must equal or exceed 12% per annum; and

(iii)          the Fund must have recouped an amount equal to all principal invested in the particular Eligible Investment.

The Fund will not pay the Performance Bonus on any partial dispositions of an Eligible Investment unless and until the Fund receives (from all dispositions of that investment on a cumulative basis) an amount equal to at least the full amount of the principal invested in the Eligible Investment.

Provided that the payment of the Performance Bonus does not reduce returns to shareholders on the Investment Portfolio below the thresholds outlined in (i)-(iii) above, the proceeds from the disposition of each particular Eligible Investment in each calendar quarter of the Fund, after deducting the costs of such investment and the proceeds of disposition paid to the Fund, shall be allocated and paid as follows:

(i)            the Investment Advisor shall receive all gains and income earned from each particular Eligible Investment in excess of the 12% compounded annual rate of return contemplated in (ii) above, up to and including an amount representing a 15% compounded annual rate of return earned from the particular Eligible Investment.

(ii)           all gains and income earned on each particular Eligible Investment in excess of a 15% compounded annual rate of return earned from the particular Eligible Investment shall be allocated and paid in the following proportions:

(A)           16% to the Investment Advisor; and

(B)           4% to the Manager.

The Fund will retain the other 80% of such gains and income.

The Performance Bonus will be calculated and paid quarterly in arrears based upon realized gains, calculated on the last day of the last month of each calendar quarter.

B.            On and after September 1, 2018:

(a)           The Management Fee will be an annual amount equal to 1.0% of the aggregate Net Asset Value Per Share attributable to the Class A Shares.

(b)           The Investment Advisory Fee will be an annual amount equal to 1.0% of the aggregate Net Asset Value Per Share attributable to the Class A Shares.

(c)           The Manager and the Investment Advisor are entitled to share in the Performance Bonus as soon as practicable after the Disposition Date of an Eligible Investment based on the gains and income earned from each Eligible Investment. No Performance Bonus shall be paid by the Fund in respect of the realization of an Eligible Investment, unless on the Disposition Date of such Eligible Investment:

(i)            The total net realized and unrealized gains and income from the Fund from its portfolio of Eligible Investments for the period (A) since inception to August 31, 2018 must have generated a return greater than the average annual rate of return on five-year GICs offered by a Schedule I Canadian chartered bank plus 2% and (B) commencing on September 1, 2018 must have generated a return greater than the average annual rate of return on five-year GICs offered by a Schedule I Canadian chartered bank plus 0.75%;

(ii)           The compounded annual rate of return (including realized and unrealized gains and income) from the particular Eligible Investment for the period (A) since its acquisition by the Fund to August 31, 2018 must equal or exceed 12% per annum and (B) commencing on September 1, 2018 must equal or exceed 6% per annum from the later of September 1, 2018 or the date of its acquisition by the Fund; and

(iii)          The Fund must have recouped an amount equal to all principal invested in the particular Eligible Investment.

The Fund will not pay the Performance Bonus on any partial dispositions of an Eligible Investment unless and until the Fund receives (from all dispositions of that investment on a cumulative basis) an amount equal to at least the full amount of the principal invested in the Eligible Investment.

Provided that the payment of the Performance Bonus does not reduce returns to shareholders on the Investment Portfolio below the thresholds outlined in (i)-(iii) above, the proceeds from the disposition of each particular Eligible Investment in each calendar quarter of the Fund, after deducting the costs of such investment and the proceeds of disposition paid to the Fund, shall be allocated and paid as follows:

(i)            The Investment Advisor shall receive all gains and income earned from each particular Eligible Investment for the period (A) since its acquisition to August 31, 2018 in excess of the 12% compounded annual rate of return contemplated in (ii) above, up to and including an amount representing a 15% compounded annual rate of return earned from the particular Eligible Investment and (B) commencing on September 1, 2018, the Investment Advisor receives all gains and income earned from each particular Eligible Investment in excess of the 6% compounded annual rate of return contemplated in (ii) above, up to and including an amount representing an 8% compounded annual rate of return from the particular Eligible Investment from the later of September 1, 2018 or the date of its acquisition by the Fund.

(ii)           All gains and income earned on each particular Eligible Investment for the period (A) since its acquisition to August 31, 2018 in excess of a 15% compounded annual rate of return earned from the particular Eligible Investment and (B) commencing on September 1, 2018 in excess of an 8% compounded annual rate of return earned from the particular Eligible Investment from the later of September 1, 2018 or the date of its acquisition by the Fund, shall be allocated and paid in the following proportions:

(I)            16% to the Investment Advisor; and

(II)           4% to the Manager.

The Fund will retain the other 80% of such gains and income.

The Performance Bonus will be calculated and paid quarterly in arrears based upon realized gains, calculated on the last day of the last month of each calendar quarter.

“Darren McKall”
Manager, Investment Funds and Structured Products Branch
Ontario Securities Commission