K.J. Harrison & Partners Inc. -- s. 74(1)
Headnote
Relief from the prospectus requirement of the Act to permit the distribution of pooled fund securities to managed accounts held by non-accredited investors on an exempt basis -- NI 45-106 containing carve-out for managed accounts in Ontario prohibiting portfolio manager from making exempt distributions of securities of its proprietary pooled funds to its managed account clients in Ontario unless managed account client qualifies as accredited investor or invests $150,000 -- portfolio manager providing bona fide portfolio management services to high net worth clients -- Not all managed account clients are accredited investors -- portfolio manager permitted to make exempt distributions of proprietary pooled funds to its managed accounts provided written disclosure is delivered to clients advising them of the relief granted -- portfolio manager is restricted from distributing proprietary pooled fund securities to parties other than its managed account clients.
Applicable Legislative Provisions
Securities Act, R.S.O. 1990, c. S.5, as am., ss. 53, 74(1) and 144(1).
Rules Cited
National Instrument 45-106 Prospectus and Registration Exemptions
National Instrument 31-103 Registration Requirements and Exemptions
August 25, 2011
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, c. S.5, AS AMENDED
(the "Act")
AND
IN THE MATTER OF
K.J. HARRISON & PARTNERS INC.
(the "Filer")
RULING
(Subsection 74(1) of the Act)
Background
The Ontario Securities Commission (the "Commission") has received an application from the Filer, on its own behalf, and on behalf of the KJH Funds (as defined below), for a ruling pursuant to subsection 74(1) of the Act, that distributions of securities of the KJH Funds to Secondary Managed Accounts (as defined below) of clients for which the Filer provides discretionary investment management services will not be subject to the prospectus requirement (the "Prospectus Requirement") under section 53 of the Act.
Interpretation
Defined terms contained in the Act and in National Instrument 14-101 Definitions have the same meaning in this ruling unless they are otherwise defined in this decision.
Representations
This decision is based on the following facts represented by the Filer:
1. The Filer is a corporation incorporated under the laws of Ontario. Its head office is in Toronto, Ontario.
2. The Filer is registered as an investment fund manager in Ontario and an investment dealer in each of Ontario, Alberta, British Columbia, Manitoba, New Brunswick and Quebec. In Ontario, the Filer's investment dealer license is in the category of Securities, Options and Managed Accounts. The Filer is a member of the Investment Industry Regulatory Organization of Canada.
3. The Filer is currently the investment fund manager and portfolio manager of seven open-ended mutual fund trusts offered pursuant to exemptions from the Prospectus Requirement (the "KJH Pooled Funds") and one open-ended mutual fund trust, KJH Capital Preservation Fund (the "Fund"), that is a reporting issuer in various Canadian jurisdictions.
4. The Fund is currently offered to investors pursuant to a simplified prospectus dated August 27, 2010, prepared pursuant to National Instrument 81-101 Mutual Fund Prospectus Disclosure, and has applied to the relevant securities regulatory authorities in Canada to cease to be a reporting issuer.
5. The KJH Pooled Funds are sold to investors pursuant to exemptions from the Prospectus Requirement (e.g. the accredited investor exemption or the $150,000 exemption in National Instrument 45-106 Prospectus and Registration Exemptions ("NI 45-106")) and are not reporting issuers.
6. The Filer may, in the future, be the investment fund manager of other open-ended investment funds that are not reporting issuers and whose securities are offered pursuant to exemptions from the Prospectus Requirement (together with the Fund and the KJH Pooled Funds, the "KJH Funds").
7. The Filer is or will be the investment fund manager, portfolio manager and principal distributor of each KJH Fund.
8. Caledon Trust Company is currently the trustee of the Fund and the KJH Pooled Funds.
9. The Filer, the Fund and the KJH Pooled Funds are not in default under the securities legislation in any province or territory of Canada.
10. The Filer provides discretionary investment management services ("Managed Services") to clients pursuant to managed account agreements between such clients and the Filer (each a "Managed Account Agreement"). Pursuant to a Managed Account Agreement, each client, in accordance with its investment objectives, authorizes the Filer to manage that client's investment portfolio on a fully-discretionary basis, which depending on its size, may be managed by the Filer on a segregated account basis or invested in one or more of the KJH Funds.
11. The Managed Services are provided by employees of the Filer who are registered under Ontario securities law to provide advice on securities to clients.
12. The Managed Services consist of the following:
(a) each client who accepts Managed Services executes a Managed Account Agreement whereby the client authorizes the Filer to supervise, manage and direct purchases and sales, at the Filer's full discretion on a continuing basis;
(b) the Filer's qualified employees perform investment research, securities selection and management functions with respect to all securities, investments, cash equivalents or other assets in that client's Managed Account (as defined below);
(c) each Managed Account holds securities as selected by the Filer, including where appropriate securities of one or more of the KJH Funds; and
(d) the Filer retains overall responsibility for the Managed Services provided to each client and has designated three senior officers to oversee and supervise such Managed Services.
13. The Filer's minimum aggregate balance for all the Managed Accounts of a client is usually $1,000,000. From time to time, the Filer will accept a person as a client who does not meet this minimum threshold if there are exceptional factors that have persuaded the Filer for business reasons to accept such person as a client and to waive its usual minimum aggregate balance.
14. Most Managed Account clients investing in securities of one or more of the KJH Funds will qualify as an accredited investor (as such term is defined in NI 45-106) (each such client a "Primary Managed Account") or will rely on another exemption from the Prospectus Requirement, such as the $150,000 exemption in NI 45-106. Over ninety-five percent of the total assets currently managed by the Filer are for clients that meet the definition of accredited investor or who purchase the KJH Funds in reliance on another exemption from the Prospectus Requirement.
15. From time to time, the Filer may provide Managed Services to clients with less than $1,000,000 under management, which will usually consist of family members of Primary Managed Account clients. These clients do not qualify as accredited investors and do not purchase securities of the KJH Funds in reliance on another exemption from the Prospectus Requirement, (the "Secondary Managed Accounts", and together with the Primary Managed Accounts, the "Managed Accounts"). The assets managed by the Filer for such Secondary Managed Accounts are incidental to the assets the Filer manages for Primary Managed Accounts. The Filer typically services the Secondary Managed Account clients as a courtesy to its Primary Managed Account clients.
16. As at March 31, 2011, the Filer had 25 Secondary Managed Account clients invested in the Fund which do not have a relationship with a Primary Managed Account client that is listed in paragraphs (i) to (v) of condition (b) of this decision and are not close business associates, employees or professional advisers to a Primary Managed Account client (the "Existing Clients"). As at March 31, 2011, these Existing Clients represented $1.845M in assets, which is 1.4% of the Fund's total assets and 0.4% of the Filer's total assets under management.
17. Investments in individual securities may not be ideal for the Secondary Managed Accounts clients, since they may not receive the same asset diversification benefits and may incur disproportionately higher brokerage commissions relative to the Primary Managed Account clients due to minimum commission charges.
18. NI 45-106 does not recognize a portfolio manager acting on behalf of a managed account in Ontario as being an accredited investor if that account is acquiring a security of an investment fund. In the absence of relief from the Prospectus Requirement, the KJH Funds will be available only to clients that are accredited investors in their own right or are able to invest a minimum of $150,000 in a KJH Fund in accordance with the requirements of NI 45-106. These requirements either act as a barrier to Secondary Managed Account clients investing in a KJH Fund, or may cause the Filer to invest more of a Secondary Managed Account client's portfolio in a KJH Fund than it might otherwise prefer to allocate.
19. To improve the diversification and cost benefits to Secondary Managed Account clients, the Filer wishes to distribute securities of the KJH Funds to Secondary Managed Account clients without a minimum investment. The Secondary Managed Account client would thereby be able to receive the benefit of the Filer's investment management expertise, regarding both asset allocation and individual stock selection, as well as receive the benefits of lower costs and broader asset diversification associated with pooled investments relative to direct holdings of individual securities.
20. Under the Managed Account Agreement, clients who invest in securities of the KJH Funds do not pay the Filer a management fee or performance fee in respect of such investments. Instead, the Filer charges a management fee and/or performance fee to each applicable KJH Fund based on its respective constating document. Each KJH Fund pays all administration fees and expenses relating to its operation. No sales or redemption fees are payable by Managed Account clients to invest in the KJH Funds.
21. If the Filer charges management fees or performance fees to a KJH Fund and the Filer invests, on behalf of a Managed Account, in securities of such KJH Fund, the necessary steps will be taken to ensure that there will be no duplication of fees between a Managed Account and the KJH Funds.
22. There will be no commission payable by a client on the sale of securities of a KJH Fund to a Secondary Managed Account, nor will referral fees be paid by the Filer to a person or company in connection with the referral to the Filer of Secondary Managed Account clients that invest in securities of a KJH Fund.
Ruling
The Commission being satisfied that the relevant test contained in subsection 74(1) of the Act has been met, the Commission rules that the relief from the Prospectus Requirement is granted in connection with the distribution of securities of the KJH Funds to Secondary Managed Accounts provided that:
(a) this Ruling will terminate upon the coming into force of any legislation or rule of the Commission exempting a trade in a security of a mutual fund to a fully managed account from the Prospectus Requirements;
(b) this Ruling will only apply with respect to a Secondary Managed Account, where the holder of the Secondary Managed Account is, and in the case of clauses (iii) to (vi) remains:
(i) an individual (of the opposite sex or same sex) who is or has been married to the holder of a Primary Managed Account, or is living or has lived with the holder of a Primary Managed Account in a conjugal relationship outside of marriage;
(ii) a parent, grandparent, child or sibling of either the holder of a Primary Managed Account or the individual referred to in clause (i) above;
(iii) a personal holding company controlled by an individual referred to in clause (i) or (ii) above;
(iv) a trust, other than a commercial trust, of which an individual referred to in clause (i) or (ii) above is a beneficiary;
(v) a private foundation controlled by an individual referred to in clause (i) or (ii) above; or
(vi) either an Existing Client or a close business associate, employee or professional adviser to a holder of a Primary Managed Account, provided that:
(A) there are exceptional factors that have persuaded the Filer for business reasons to accept such Existing Client or close business associate, employee or professional adviser as a Secondary Managed Account client, and a record is kept and maintained of the exceptional factors considered; and
(B) the Existing Clients plus the close business associates, employees and professional advisers to holders of Primary Managed Accounts shall not, at any time, represent more than two percent of the Filer's total Managed Account assets under management; and
(c) the Filer does not receive any compensation in respect of the sale or redemption of securities of the KJH Funds, including any redemption fees, and the Filer does not pay a referral fee to any person or company who refers Secondary Managed Account clients who invest in securities of the KJH Funds in reliance on this Ruling.