Covington Venture Fund Inc. - MRRS Decision
Headnote
Mutual Reliance Review System for Exemptive Relief Applications -- MRRS -- Exemption granted to a labour sponsored investment fund from restrictions on incentive fees -- relief is consistent with prior relief granted to predecessor funds of the Filer.
Applicable Legislative Provisions
National Instrument 81-102 -- Mutual Funds, ss. 7.1, 19.1.
April 9, 2008
IN THE MATTER OF
THE SECURITIES LEGISLATION OF
BRITISH COLUMBIA, ALBERTA, MANITOBA,
ONTARIO, QUEBEC, NEW BRUNSWICK,
NOVA SCOTIA, PRINCE EDWARD ISLAND,
NEWFOUNDLAND AND LABRADOR
(the "Jurisdictions")
AND
IN THE MATTER OF
THE MUTUAL RELIANCE REVIEW SYSTEM
FOR EXEMPTIVE RELIEF APPLICATIONS
AND
IN THE MATTER OF
COVINGTON VENTURE FUND INC.
(the "Filer")
MRRS DECISION DOCUMENT
Background
The local securities regulatory authority or regulator (the "Decision Maker") in each of the Jurisdictions has received an application from the Filer for a decision under section 19.1 of National Instrument 81-102 - Mutual Funds ("NI 81-102") from section 7.1 of NI 81-102 to permit the payment of incentive fees which are not calculated in a manner permitted by NI 81-102 (the "Requested Relief"). The Requested Relief is sought for Class A Shares, Series I, II and III (the "Pre-Existing Shares") and Class A Shares, Series VIII and IX (the "New Shares"). The Requested Relief is sought in all of the Jurisdictions for the Pre-Existing Shares. However, the Requested Relief is sought for the New Shares in Ontario only.
Under the Mutual Reliance Review System for Exemptive Relief Applications:
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) this MRRS decision document evidences the decision of each Decision Maker.
Interpretation
Defined terms contained in National Instrument 14-101 - Definitions have the same meaning in this decision unless they are defined in this decision.
Representations
This decision is based on the following facts represented by the Filer:
Prior Relief
1. The Ontario Securities Commission granted exemptive orders similar to the Requested Relief to four predecessor funds of the Filer including: New Generation Biotech (Balanced) Fund Inc. ("NGBF"), E2 Venture Fund Inc. ("E2"), New Millennium Venture Fund Inc. (formerly New Millenium Internet Ventures Fund Inc.) ("NMV") and Venture Partners Balanced Fund Inc. ("VPB", and collectively with NGBF, E2 and NMV, the "Exempted Predecessors"). The exemptive orders granted to the Exempted Predecessors will continue to be relied upon by the Fund in connection with the incentive fee payable on the Class A Shares, Series IV, V and VI.
The Filer
2. The Filer is registered as a labour sponsored investment fund corporation under the Community Small Business Investment Funds Act (Ontario) (the "Ontario Act") and is registered as a labour sponsored venture capital corporation under the Income Tax Act (Canada) ("Federal Tax Act"), as amended. The Filer is a mutual fund as defined in subsection 1(1) of the Securities Act (Ontario) (the "Act").
3. The Filer is a corporation under the Canada Business Corporations Act by articles of amalgamation dated January 6, 2006. The Filer was formed by the amalgamation ("Amalgamation") of six labour sponsored funds, including the Exempted Predecessors.
4. A final prospectus for the Filer dated January 30, 2008 (the "Prospectus") qualifying for distribution in Ontario the Pre-Existing Shares other than the Class A Shares, Series I and the New Shares was filed and a final receipt was received from the Ontario Securities Commission (the "Commission") on February 1, 2008.
5. The Filer has retained Covington Capital Corporation (the "Manager") to perform the Filer's daily administrative operations, engage and supervise the service providers of the Filer and to work with such service providers to develop and refine the investment strategy and criteria of the Filer. The Manager and the Filer's sponsor are responsible for the organization and creation of the Filer.
6. The Manager has retained Genesys Capital Partners Inc. and Quantum Leap Asset Management Limited (collectively, the "Investment Specialists") to assist the Filer to develop and refine the investment strategy and criteria of certain components of the Filer and to assist the Filer with implementation of the investment strategy by identifying, structuring and monitoring all of the investments made with net proceeds allocated to each of the Investment Specialists.
Key Terms
7. The term "Class A Investment Portfolio" is defined in the Prospectus to mean the eligible investments of the Filer made with capital raised from the Class A Shares of the Filer.
8. The term "Eligible Business" has the meaning ascribed in the Prospectus as an "eligible business entity" as defined in the Federal Tax Act, which is also an "eligible business" as defined in Part III of the Ontario Act.
9. The term "Eligible Investment" is defined in the Prospectus to mean an eligible investment as defined in the Federal Tax Act and Part III of the Ontario Act in an Eligible Business, or any other investment that is an eligible investment under the applicable legislation.
Performance Bonus
10. The Filer proposes to pay the incentive fee described herein to the Manager in respect of the Pre-Existing Shares and the New Shares. The Prospectus provides that the Manager will be entitled to received a performance bonus (the "Performance Bonus") based on the realized gains and the cumulative performance of the Class A Share Investment Portfolio of the Filer attributable to the Pre-Existing Shares and/or the New Shares, as applicable. Before any Performance Bonus is paid on the realization of an Eligible Investment, the Class A Share Investment Portfolio on which the Performance Bonus is paid must have:
(a) earned sufficient income to generate a rate of return on Eligible Investments greater than the average of the 5 year GIC rate of the five major banks plus 2% on an annualized basis. The income on Eligible Investments includes investment gains and losses (realized and unrealized) earned and incurred since July 31, 2007 in respect of the Pre-Existing Shares and since the date of the investment of the New Shares (the "Commencement Date");
(b) earned income from the particular investment which provides a cumulative investment return at an average annual rate in excess of 8% since the Commencement Date; and
(c) fully recouped an amount equal to all principal invested in the particular investment.
11. Subject to all of the above, the Performance Bonus will be an amount equal to up to 20% of all income earned from the particular investment, provided that the three thresholds in representation 10 are achieved.
12. The threshold return shall be calculated on a compound annual basis only on capital actually invested in Eligible Investments.
13. The Performance Bonus can only generate a payment to the Manager at the time the gain on a particular investment is realized. Positive performance of the Class A Share Investment Portfolio after a particular gain is realized will not enable the Manager to look back in time and pay a bonus on a gain realized at a time when that portfolio hurdle precluded the payment of a bonus.
14. The Performance Bonus will be paid to the Manager and will be allocated among the Manager and the Investment Specialists as determined by the Manager, it its sole discretion.
15. The Performance Bonus does not conform to the requirements of section 7.1 of NI 81-102. The Performance Bonus is based on realized gains and the cumulative performance of the Class A Share Investment Portfolio of the Filer (and not in relation to a benchmark). The Performance Bonus is not based on the total return of the Filer because reserves are not included in the Class A Share Investment Portfolio and because the quantum of the Performance Bonus is calculated on an investment-by-investment basis.
16. The Filer is a labour sponsored investment fund. A labour sponsored investment fund is designed to 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 conventional mutual funds offered to the public.
17. The basis for payment of 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 the labour sponsored fund industry. The Filer believes that it needs to be able to offer an incentive fee arrangement similar to those of other venture capital funds in order to attract the necessary professional expertise to be able to carry out the investment operations and its mandate, which is a mandate already recognized by the Regulation to the Act.
18. The Prospectus for the Filer:
(a) fully discloses that Filer considers the Performance Bonus to be appropriate given the disclosed investment objectives and strategies of the Filer; and
(b) provides an explanation of why the management fees and the Performance Bonus are appropriate for the Fund.
Pre-Existing Shares
19. This decision with respect to the Pre-Existing Shares is only based on the following facts represented by the Filer:
(a) The adoption of the Performance Bonus for the Pre-Existing Shares was approved by the holders of the Pre-Existing Shares at an annual and special meeting of shareholders of the Filer held on November 22, 2007. The Performance Bonus was described in the information circular dated October 19, 2007 issued in respect of that meeting (the "Circular").
(b) The shares of a predecessor by amalgamation to the Filer which converted into the Pre-Existing Shares were offered to the public in each of the Jurisdictions. The Class A Shares, Series I are no longer offered to the public. The Class A Shares, Series II and Class A Shares, Series III are currently offered for sale only in the Province of Ontario.
(c) The independent review committee of the Filer approved the adoption of the Performance Bonus in respect of the Pre-Existing Shares on January 9, 2008.
(d) The Commencement Date of July 31, 2007 in respect of the Performance Bonus for the Pre-Existing Shares was described in the Circular. July 31, 2007 is an appropriate date to use as the Commencement Date because it is the effective date of a valuation of the Filer's assets performed by the independent auditors of the Filer in accordance with the requirements of section 14 of the Ontario Act. Such valuation is performed in conjunction with the audit of the financial statements of the Filer by such auditors.
New Shares
20. This decision with respect to the New Shares is only based on the following facts represented by the Filer:
(a) The Filer amended its articles on November 13, 2007 in order to create and designate share provisions for the New Shares.
(b) The New Shares were first offered to the public, in the province of Ontario only, pursuant to an amendment to a prospectus of the Filer dated November 14, 2007.
(c) All holders of New Shares purchased their shares pursuant to the Prospectus, or the previously amended prospectus subsequent to November 14, 2007 pursuant to a disclosure document which described the Performance Bonus as being payable, subject to regulatory approval.
Decision
Each of the Decision Makers is satisfied that the test contained in NI 81-102 that provides the Decision Maker with the jurisdiction to make the decision has been met.
The decision of the Decision Makers under NI 81-102 is that the Filer is exempted from section 7.1 of NI 81-102 in respect of the Performance Bonus disclosed in the Prospectus, provided that the Prospectus of the Filer:
(i) discloses that the Filer considers the Performance Bonus to be appropriate given the investment objectives and strategies of the Filer;
(ii) contains an explanation of why the Performance Bonus is appropriate for the Filer; and
(iii) contains an explanation of the Performance Bonus calculation for partial dispositions of an Eligible Investment.
The relief provided herein is conditional upon compliance with all other applicable provisions of NI 81-102.