Legg Mason Canada Inc. et al - ss. 74(1), 121(2)(a)(ii)
Headnote
Relief from the prospectus requirements of the Act to permit the distribution of pooled fund units to certain fully managed accounts on an exempt basis -- Relief from self-dealing prohibition of the Act to allow in specie transfers between pooled funds or mutual funds and managed accounts.
Applicable Legislative Provisions
Securities Act, R.S.O., c. S.5, as am., ss. 53, 74(1), 118(2)(b), 121(2)(a)(ii).
Rules Cited
National Instrument 81-102 Mutual Funds.
National Instrument 45-106 Prospectus and Registration Exemptions.
April 4, 2006
IN THE MATTER OF
THE SECURITIES ACT,
R.S.O. 1990, c. S.5, AS AMENDED (the "Act")
AND
IN THE MATTER OF
LEGG MASON CANADA INC. ("LMC")
AND
LEGG MASON CANADA LIQUIDITY PLUS POOL
LEGG MASON CANADA TREASURY PLUS POOL
LEGG MASON CANADA INCOME PLUS POOL
LEGG MASON (C$) U.S. VALUE POOL
LEGG MASON PRIVATE CAPITAL
MANAGEMENT U.S. EQUITY POOL
LEGG MASON/BRANDYWINE GLOBAL
FIXED INCOME POOL
LEGG MASON FIXED INCOME ALPHA POOL
LEGG MASON CANADIAN EQUITY ALPHA POOL
(the "Existing LMC Pooled Funds")
RULING AND ORDER
(Subsection 74(1) and
Clause 121(2)(a)(ii) of the Act)
Background
The Ontario Securities Commission (the "Commission") has received an application from LMC on behalf of itself, the Existing LMC Pooled Funds and any pooled fund established and managed by LMC after the date hereof (a "Future LMC Pooled Fund", and together with the Existing LMC Pooled Funds, the "LMC Pooled Funds"), for:
(a) a ruling, pursuant to subsection 74(1) of the Act, that distributions of units of the LMC Pooled Funds to Managed Accounts (as defined below) will not be subject to the prospectus requirements under section 53 of the Act (the "Prospectus Requirements"); and
(b) an order, pursuant to clause 121(2)(a)(ii) of the Act, that In Specie Transfers (as defined below) between the LMC Pooled Funds or the LMC Mutual Funds (as defined below) and the Managed Accounts are exempted from the prohibition in paragraph 118(2)(b) of the Act which prevents a portfolio manager from knowingly causing any investment portfolio managed by it to purchase or sell the securities of any issuer from or to the account of a responsible person, any associate of a responsible person or the portfolio manager (the "Self-Dealing Prohibition").
Representations
This Ruling and Order is based on the following facts represented by LMC:
1. LMC is a corporation existing under the laws of Canada. Its head office is located in Toronto, Ontario.
2. LMC is the manager, trustee, and portfolio adviser of the LMC Pooled Funds. The LMC Pooled Funds are not qualified for distribution to the public under a prospectus as LMC distributes the LMC Pooled Funds pursuant to prospectus exemptions and LMC's dealer registrations or exemptions therefrom.
3. The LMC Pooled Funds are open-end mutual fund trusts established under the laws of Ontario. Each LMC Pooled Fund meets the definition of mutual fund as defined in the Act.
4. LMC is also the trustee, manager and portfolio adviser of a family of mutual funds known as the Legg Mason Canada Funds (the "LMC Mutual Funds"). The LMC Mutual Funds are qualified for distribution pursuant to a simplified prospectus, are subject to National Instrument 81-102 Mutual Funds ("NI 81-102") and are governed by a declaration of trust that is separate from that governing the LMC Pooled Funds. LMC also distributes units of the LMC Mutual Funds to Managed Accounts pursuant to their simplified prospectus and LMC's dealer registrations or exemption therefrom, but, unlike the LMC Pooled Funds, the LMC Mutual Funds may also be distributed to retail investors by third party dealers. The LMC Mutual Funds that exist as of the date of this Ruling and Order are listed in Schedule A hereto.
5. In Ontario, LMC is registered under the Act as an adviser in the categories of investment counsel and portfolio manager. LMC is also registered as a commodity futures manager under the Commodity Futures Act (Ontario) and as a dealer in the category of mutual fund dealer, but is exempt from membership with the Mutual Fund Dealers Association of Canada.
6. LMC primarily provides discretionary portfolio management services to investment management accounts ("Managed Accounts") of clients, under which LMC, pursuant to a written agreement made between LMC and each client, makes investment decisions for the client's Managed Account and has full discretionary authority to trade in securities for the Managed Account without obtaining the specified consent of the client to the trade.
7. The Managed Account services are provided by employees of LMC who meet the proficiency requirements of an advising officer or advising representative under Ontario securities law.
8. LMC's minimum overall account balance for each private client who has a Managed Account is $1,000,000. This minimum balance requirement may be waived at LMC's discretion, and, from time to time, LMC accepts clients with less than $1,000,000 under management ("Smaller Accounts"). Clients with Smaller Accounts consist primarily of family members of, or entities that have some other form of relationship with, clients of LMC that do meet LMC's $1,000,000 minimum aggregate account balance. However, there may be other factors that may persuade LMC for business reasons to waive the minimum aggregate balance and to accept a Smaller Account. LMC typically agrees to service Smaller Accounts as a courtesy to its Managed Account clients that satisfy the minimum balance requirement, or with the expectation that the Smaller Account will satisfy the minimum balance requirement in the near future.
9. While clients who have Managed Accounts that meet LMC's minimum aggregate account balance are, in almost all cases, accredited investors, clients with Smaller Accounts do not always so qualify. As LMC acting on behalf of the Managed Accounts is not an accredited investor as regards the LMC Pooled Funds, LMC cannot service all of its Managed Account clients by using the LMC Pooled Funds. This restriction makes it impossible for some of LMC's Managed Accounts, particularly its Smaller Accounts, to partake in much of LMC's investment management expertise, as well as the broader asset diversification and the lower costs associated with pooled fund investments relative to investments in individual securities having regard to minimum commission charges. While it is possible to distribute units of the LMC Mutual Funds (which are distributed pursuant to a simplified prospectus) to all of its Managed Accounts, LMC does not offer its full range of investment expertise through prospectus-qualified mutual funds. Moreover, pooled funds are the preferred investment vehicle for investment by Managed Accounts as they have lower associated operating costs.
10. In order to afford Managed Account access to individuals who would not generally be considered to have sufficient assets to warrant the establishment of a Managed Account due to related cost and asset diversification considerations, LMC is hereby applying for relief to permit it to distribute units of the LMC Pooled Funds to the Managed Accounts, including the Smaller Accounts, on an exempt basis.
11. Distributions of units of the LMC Pooled Funds are made primarily to Managed Accounts. However, LMC may also distribute units of the LMC Pooled Funds by subscription agreement to accredited investors who do not have Managed Accounts.
12. Units of the LMC Pooled Funds are "related issuers" and "connected issuers" of LMC within the meaning of Ontario securities law. Therefore, in addition to entering into a written discretionary portfolio management agreement, clients who establish a Managed Account with LMC are also provided with LMC's Statement of Policies and provide LMC with their informed written consent to the exercise of LMC's discretionary authority to include in their Managed Account units of the LMC Pooled Funds.
13. LMC has prepared, and will maintain, an offering memorandum for the LMC Pooled Funds (the "Offering Memorandum") which it will deliver to prospective Managed Account clients before entering into an investment management agreement. This will assist such clients in providing their informed written consent to allow LMC to exercise its investment discretion to purchase units of the LMC Pooled Funds on their behalf.
14. The LMC Pooled Funds that are distributed to Managed Accounts pay no management fees. In addition, neither LMC nor the LMC Pooled Funds pay fees or commissions to any person in connection with the distribution of units of the LMC Pooled Funds. LMC may, from time to time, pay referral fees to persons who refer Managed Accounts, including Smaller Accounts, to LMC. However, neither LMC nor the LMC Pooled Funds pay any referral fees in connection with the referral of Smaller Accounts that invest in units of the LMC Pooled Funds. The only management fees that are paid by a Managed Account that holds units of an LMC Pooled Fund are paid directly to LMC pursuant to the discretionary investment management agreement that is entered into between LMC and every Managed Account.
15. The LMC Pooled Funds are not hedge funds. LMC manages the LMC Pooled Funds in substantially the same way it manages the LMC Mutual Funds so that the LMC Pooled Funds substantially comply with NI 81-102. In all material respects, the LMC Pooled Funds are essentially the same as the LMC Mutual Funds, except that they are not reporting issuers and are not distributed through third parties. The LMC Pooled Funds comply with those provisions of National Instrument 81-106 Investment Fund Continuous Disclosure that apply to mutual funds that are not reporting issuers in a particular province or territory of Canada.
Relief from the Prospectus Requirements
16. LMC is not considered to be an accredited investor as regards an LMC Pooled Fund in Ontario only for the purposes of the accredited investor exemption available pursuant to National Instrument 45-106 Prospectus and Registration Exemptions ("NI 45-106"). In subsection 1.1(q) of NI 45-106 the term "accredited investor" is defined to include "a person acting on behalf of a fully managed account managed by that person, if that person
(i) is registered or authorized to carry on business as an adviser or the equivalent under the securities legislation of a jurisdiction of Canada or a foreign jurisdiction, and
(ii) in Ontario, is purchasing a security that is not a security of an investment fund".
As a result of paragraph (ii) of this definition, a distribution of units of an LMC Pooled Fund to a Managed Account in Ontario is not exempt from the Prospectus Requirements of the Act.
Relief from the Self-Dealing Prohibition
17. LMC wishes to permit payment, in whole or in part, for LMC Pooled Fund units and LMC Mutual Fund units purchased by a Managed Account to be made by making good delivery of securities held by such Managed Account to an LMC Pooled Fund or LMC Mutual Fund, as the case may be, provided those securities meet the investment criteria of the applicable LMC Pooled Fund or LMC Mutual Fund.
18. Similarly, after a redemption of units of an LMC Pooled Fund or LMC Mutual Fund by a Managed Account, LMC may permit payment, in whole or in part, of redemption proceeds to be satisfied by making good delivery of securities held in the investment portfolio of an LMC Pooled Fund or LMC Mutual Fund, as the case may be, to such Managed Account, if those securities meet the investment criteria of the Managed Account (the transactions described in this paragraph and the previous paragraph are collectively referred to as "In Specie Transfers").
19. As LMC is the portfolio manager of the Managed Accounts, it would be considered a "responsible person" under subsection 118(1) of the Act with respect to the Managed Accounts. Furthermore, each of the LMC Pooled Funds and the LMC Mutual Funds is an "associate" of LMC under the Act because LMC serves as trustee of the LMC Pooled Funds and the LMC Mutual Funds.
20. Unless the requested relief is granted, the Self-Dealing Prohibition will prohibit LMC from causing a Managed Account to make an In Specie Transfer of securities of any issuer to or from any of the LMC Pooled Funds or LMC Mutual Funds of which LMC is the trustee.
Ruling and Order
The Commission being satisfied that the relevant tests contained in subsection 74(1) and clause 121(2)(a)(ii) of the Act have been met, the Commission:
1. rules pursuant to subsection 74(1) of the Act, that the distribution of units of the LMC Pooled Funds to Managed Accounts shall not be subject to the Prospectus Requirements, provided that:
(a) this Ruling will terminate upon the coming into force of any legislation or rule of the Commission exempting a trade by a fully managed account in securities of mutual funds from the Prospectus Requirements;
(b) this Ruling shall only apply where the holder of the Smaller 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 Managed Account that is an accredited investor, or is living or has lived with such holder of a Managed Account in a conjugal relationship outside of marriage;
(ii) a parent, grandparent, child or sibling of either the holder of a Managed Account that is an accredited investor or the individual referred to in clause (i);
(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) a close business associate, employee or professional adviser to a holder of a Managed Account that is an accredited investor provided that:
(1) in each instance, there are exceptional factors that have persuaded LMC for business reasons to accept such person as a Smaller Account client and waive LMC's minimum aggregate balance, and a record is kept and maintained of the exceptional factors considered; and
(2) the Smaller Account clients acquired through such relationships to a holder of a Managed Account that is an accredited investor shall not at any time represent more than five percent of LMC's total Managed Account assets under management; and
(c) LMC and the LMC Pooled Funds do not pay any fees or commissions to any person in connection with the distribution of LMC Pooled Fund units, and neither LMC nor the LMC Pooled Funds pay referral fees to any person in connection with the referral of Smaller Accounts that invest in units of the LMC Pooled Funds; and
2. orders pursuant to clause 121(2)(a)(ii) of the Act that the Self-Dealing Prohibition shall not apply to LMC in connection with the payment of the purchase or redemption price of units of an LMC Pooled Fund or LMC Mutual Fund by In Specie Transfers between the Managed Accounts and an LMC Pooled Fund or LMC Mutual Fund, as the case may be, provided that:
(a) in connection with the purchase of units of an LMC Pooled Fund or LMC Mutual Fund by a Managed Account:
(i) LMC obtain the prior written consent of the relevant Managed Account client before it engages in any In Specie Transfers in connection with the purchase of units;
(ii) the LMC Pooled Fund or the LMC Mutual Fund, as the case may be, would at the time of payment be permitted to purchase those securities;
(iii) the securities are acceptable to the portfolio advisor of the LMC Pooled Fund or LMC Mutual Fund, as the case may be, and consistent with such fund's investment objective;
(iv) the value of the securities is at least equal to the issue price of the securities of the LMC Pooled Fund or LMC Mutual Fund for which they are payment, valued as if the securities were portfolio assets of that fund;
(v) the account statement next prepared for the Managed Account shall include a note describing the securities delivered to the LMC Pooled Fund or LMC Mutual Fund, as the case may be, and the value assigned to such securities; and
(b) in connection with the redemption of units of an LMC Pooled Fund or LMC Mutual Fund by a Managed account:
(i) LMC obtain the prior written consent of the relevant Managed Account client to the payment of redemption proceeds in the form of an In Specie Transfer;
(ii) the securities are acceptable to the portfolio advisor of the Managed Account and consistent with the Managed Account's investment objective;
(iii) the value of the securities is equal to the amount at which those securities were valued in calculating the net asset value per security used to establish the redemption price;
(iv) the holder of the Managed Account has not provided notice to terminate its discretionary investment management agreement with LMC; and
(v) the account statement next prepared for the Managed Account shall include a note describing the securities delivered to the Managed Account and the value assigned to such securities; and
(c) LMC does not receive any compensation in respect of any sale or redemption of units of an LMC Pooled Fund or LMC Mutual Fund (other than redemption fees disclosed in the offering documents of the funds), and, in respect of any delivery of securities further to an In Specie Transfer, the only charge paid by the Managed Account is the commission charged by the dealer executing the trade.
Schedule A
Legg Mason Canada Funds
Legg Mason T-Plus Fund
Legg Mason Private Client Canadian Bond Portfolio
Legg Mason Canadian Index Plus Bond Fund
Legg Mason Canadian Active Bond Fund
Legg Mason Accufund
Legg Mason Diversifund
Legg Mason Private Client Canadian Equity Portfolio
Legg Mason Canadian Core Equity Fund
Legg Mason North American Equity Fund
Legg Mason Canadian Growth Equity Fund
Legg Mason Brandywine Fundamental Value U.S. Equity Fund
Legg Mason Batterymarch U.S. Equity Fund
Legg Mason U.S. Value Fund
Legg Mason International Equity Fund