Next Edge Bio-Tech Plus Fund et al.
Headnote
NP 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- Approval of merger of existing conventional mutual fund into new alternative mutual fund -- approval required because merger does not meet the criteria for pre-approved reorganizations and transfers in National Instrument 81-102 -- merging funds may be considered not to have substantially similar investment objectives or fee structures -- merger will not be a tax deferred transaction -- approval granted subject to securityholder approval.
Applicable Legislative Provisions
National Instrument 81-102 Investment Funds, ss. 5.1(1)(f), 5.5(1)(b), 5.6(1), 5.7(1)(b) and 19.1(2).
December 1, 2020
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 NEXT EDGE CAPITAL CORP. ("Next Edge" or the "Filer") AND NEXT EDGE BIO-TECH PLUS FUND (the "Terminating Fund") AND NEXT EDGE BIOTECH AND LIFE SCIENCES OPPORTUNITIES FUND (the "Continuing Fund", together with the Terminating Fund, the "Funds")
DECISION
Background
The principal regulator in the Jurisdiction (the "Decision Maker") has received an application from the Filer on behalf of the Funds for a decision under the securities legislation of the Jurisdiction (the "Legislation") approving the proposed merger, as further described below, of the Terminating Fund into the Continuing Fund (the "Merger") pursuant to paragraph 5.5(1)(b) of National Instrument 81-102 Investment Funds ("NI 81-102") (the "Approval Sought").
Under National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Ontario Securities Commission is the principal regulator for this application; and
(b) the Filer has provided notice that section 4.7(1) of Multilateral Instrument 11-102 Passport System ("MI 11-102") is intended to be relied upon in British Columbia, Alberta, Saskatchewan, Manitoba, Québec, New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward Island.
Interpretation
Terms defined in National Instrument 14-101 Definitions, NI 81-102 and MI 11-102 have the same meaning if used in this decision, unless otherwise defined herein.
Representations
This decision is based on the following facts represented by the Filer:
The Filer and the Funds
1. Next Edge is a corporation incorporated under the laws of Canada with a head office in Toronto.
2. Next Edge is registered as: (i) an Investment Fund Manager in Ontario, Québec and Newfoundland and Labrador; (ii) a Portfolio Manager in Alberta and Ontario; and (iii) an Exempt Market Dealer in Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario, Québec and Saskatchewan.
3. Next Edge is the manager and trustee of each of the Funds.
4. The Terminating Fund and the Continuing Fund are each: (i) open-ended mutual fund trusts, established under the laws of Ontario by a declaration of trust, governed by the provisions of NI 81-102; and (ii) reporting issuers as defined under the applicable securities legislation of each province of Canada. The Continuing Fund is also an "alternative mutual fund" under NI 81-102.
5. Class A Units and Class F Units of the Terminating Fund are currently qualified for sale in each of the provinces of Canada pursuant to a simplified prospectus ("SP"), annual information form ("AIF") and related Fund Facts each dated October 25, 2019 (the "Terminating Fund Offering Documents"). The Filer has obtained exemptive relief in order to extend the lapse date of the Terminating Fund Offering Documents to December 31, 2020. Class A1 Units and Class F1 Units of the Terminating Fund were also formerly qualified for distribution but have been removed from the Terminating Fund Offering Documents because they are no longer publicly offered.
6. Securities of the Continuing Fund are qualified for sale in each of the provinces of Canada pursuant to a SP, AIF and related Fund Facts dated November 3, 2020 (the "Continuing Fund Offering Documents" and together with the Terminating Fund Offering Documents, the "Offering Documents").
7. The net asset value ("NAV") for a Fund is calculated on a daily basis at the end of each day the Toronto Stock Exchange is open for trading in accordance with such Fund's valuation policy and as described in the applicable Offering Documents.
8. Neither the Filer, nor either Fund, is in default of any of the requirements of the securities legislation of any of the provinces and territories of Canada.
Reasons for the Approval Sought
9. The Filer intends to reorganize the Funds by merging the Terminating Fund into the Continuing Fund such that securityholders of the Terminating Fund will become securityholders of the Continuing Fund.
10. The Filer has concluded that regulatory approval for the Merger is required under subsection 5.5(1)(b) of NI 81-102. The Filer has further concluded that pre-approval for the Merger under section 5.6(1) is unavailable, because:
(a) In view of the Filer, contrary to subsection 5.6(1)(a) of NI 81-102:
(i) the fundamental investment objective of the Continuing Fund may not be considered to be "substantially similar" by a reasonable person to the investment objective of the Terminating Fund. The Continuing Fund is an "alternative mutual fund", whereas the Terminating Fund is a "conventional" mutual fund. In addition, the Terminating Fund may only invest in issuers based in Canada and the United States, whereas there is no geographic limitation in respect of which the Continuing Fund may invest; and
(ii) the fee structure of the Continuing Fund may not be considered to be "substantially similar" by a reasonable person to the fee structure of the Terminating Fund as the performance fee of the Continuing Fund is not calculated with reference to a performance benchmark. In contrast, as a conventional mutual fund, the performance fee of the Terminating Fund is calculated with reference to a performance benchmark; and
(b) The Merger will be completed on a taxable basis and will not be a "qualifying exchange" or other form of tax-deferred transaction under the Income Tax Act (Canada) (the "Tax Act") contrary to subsection 5.6(1)(b) of NI 81-102.
11. Except as noted above, each of the other conditions for pre-approval under subsection 5.6(1) of NI 81-102 will be met in respect of the Merger.
12. The Filer has concluded that the Merger is not a material change for the Continuing Fund, including for purposes of section 5.1(1)(g) of NI 81-102. The Continuing Fund is a newly launched fund. Disclosure regarding the Merger has been included in the initial Fund Facts of the Continuing Fund such that any investor purchasing units of the Continuing Fund in advance of the Effective Date (as defined below) will do so with full knowledge that the Merger will be implemented, provided all necessary approvals are obtained. There will, therefore, be no "change" that would impact an investor's decision to purchase or hold units of the Continuing Fund.
The Proposed Merger
13. Subject to receipt of all necessary regulatory approvals and the outcome of the vote of securityholders of the Terminating Fund, the Merger is anticipated to be effective on or about December 18, 2020 (the "Effective Date").
14. Pursuant to subsection 5.1(1)(f) of NI 81-102, the Terminating Fund will seek approval of its securityholders for the Merger at a special meeting to be held virtually on or about December 15, 2020 (the "Meeting").
15. Pursuant to National Instrument 81-107 Independent Review Committee for Investment Funds, the independent review committee of the Funds (the "IRC") has reviewed the proposed Merger as a potential "conflict of interest" matter and the process to be followed in connection with the Merger. The IRC has determined that the Merger, if implemented, will achieve a fair and reasonable result for the Funds.
16. The board of directors of the Filer will approve the Merger.
Securityholder Disclosure
17. A press release and a material change report were issued and filed on SEDAR on October 15, 2020, in accordance with applicable securities law, with respect to the proposed Merger. The Terminating Fund Offering Documents were also amended to include disclosure with respect to the Merger in accordance with applicable securities law. The SP, AIF and, as noted, the Fund Facts of the Continuing Fund also disclosed the proposed Merger with the Terminating Fund, including the anticipated Effective Date.
18. A notice of meeting, a management information circular (the "Circular") and a form of proxy in connection with the Meeting (collectively, the "Meeting Materials") were mailed to securityholders of the Terminating Fund of record as of November 6, 2020 and filed on SEDAR by November 23, 2020. The Meeting Materials disclosed that securityholders of the Terminating Fund would be able vote to approve the Merger by proxy until 11:59 p.m. on the date of the Meeting, namely December 15, 2020.
19. The Circular provided securityholders of the Terminating Fund with sufficient information to permit them to make an informed decision as to whether to approve the Merger.
20. The Circular, among other things, included a description of:
(a) the Continuing Fund, including certain prospectus-level disclosure concerning the Continuing Fund, including information in respect of its: investment objective and strategies; risk rating; investment structure; registered plan eligibility; portfolio management responsibility; NAV; fees and expenses; annual returns; valuation procedures; and distribution policy and the similarities and differences between the Terminating Fund and the Continuing Fund with respect to such matters;
(b) the differences between the Continuing Fund, as an alternative mutual fund, and the Terminating Fund, as a conventional mutual fund. More specifically, the Circular described that the Continuing Fund is permitted to use strategies generally prohibited to conventional mutual funds (such as the Terminating Fund), such as the ability to invest more than 10% of its NAV in securities of a single issuer, the ability to invest in physical commodities or specified derivatives, to borrow cash, to short sell beyond the limits prescribed for conventional mutual funds and to employ leverage;
(c) the tax implications of the Merger;
(d) the potential benefits of the Merger;
(e) the process for implementing the Merger; and
(f) the recommendation of the IRC of the Funds in respect of the Merger.
21. As part of the Meeting Materials, securityholders of the Terminating Fund were provided with the most recently filed relevant corresponding Fund Facts for the Continuing Fund. The Circular also disclosed that securityholders were able obtain the SP and AIF of the Continuing Fund from the Filer upon request or on SEDAR at www.sedar.com. As the Continuing Fund is new, the Circular further disclosed that annual and interim financial statements and annual and interim Management Reports of Fund Performance for the Continuing Fund are not yet available. Accordingly, investors of the Terminating Fund have the opportunity to consider such information prior to voting on the Merger.
22. The Circular further disclosed that:
(a) the Filer will pay for the costs of the Merger;
(b) securityholders will have the right to redeem the securities of the Terminating Fund up to the close of business on the Effective Date;
(c) in the event the Merger is not approved, the Filer will terminate the Terminating Fund; and
(d) following the Merger, pre-authorized chequing plans, systematic withdrawal plans and other active optional services which had been established with respect to the Terminating Fund, will be re-established with respect to the Continuing Fund unless securityholders or their advisor advise Next Edge otherwise.
Merger Implementation
23. The Merger will be structured substantially as follows:
(a) The value of the Terminating Fund's portfolio and other assets will be determined at the close of business on the Effective Date.
(b) Prior to the Merger, as required, the Terminating Fund will sell any securities in its portfolio that do not meet the investment objective and investment strategies of the Continuing Fund. As a result, the Terminating Fund may temporarily hold cash or money market instruments and may not be fully invested in accordance with its investment objective for a brief period of time prior to the Merger being effected. Any accumulated loss carry-forwards of the Terminating Fund, as well as any losses arising from the disposition of the assets in its portfolio, will remain with the Terminating Fund and will not be available to be deducted against taxable income, including taxable capital gains, of the Continuing Fund that arise after the Merger. The Circular provided securityholders with information about such tax implications.
(c) As required, the Terminating Fund will declare, pay and automatically reinvest a distribution to its securityholders of net realized capital gains and net income, if any, to ensure that it will not be subject to tax for its current tax year.
(d) The Terminating Fund's assets and liabilities will be transferred to the Continuing Fund. In return, the Continuing Fund will issue to the Terminating Fund securities of the Continuing Fund having an aggregate NAV equal to the value of the assets transferred to the Continuing Fund.
(e) Immediately thereafter, securities of the Continuing Fund received by the Terminating Fund will be distributed to securityholders of the Terminating Fund in exchange for their securities in the Terminating Fund on a dollar-for-dollar and class-by-class basis, as follows.
Terminating Fund
Continuing Fund
Class A units
Class A units
Class F units
Class F units
Class A1 units
Class A units
Class F1 units
Class F units
(f) Each securityholder of the Terminating Fund will receive units of the Continuing Fund with a value equal to the value of their units of the Terminating Fund.
(g) The Terminating Fund will be wound-up as soon as practicable and, in any case, within 30 days following the Merger.
24. The right of securityholders of the Terminating Fund to purchase, or switch their, securities of the Terminating Fund will cease as of the close of business two days prior to the Effective Date.
25. The portfolio and other assets of the Terminating Fund to be acquired by the Continuing Fund as a result of the Merger will be acceptable to the portfolio advisor of the Continuing Fund prior to the Merger and consistent with the investment objective of the Continuing Fund.
26. Next Edge will pay the costs associated with the sale of securities in the Terminating Fund's portfolio that do not meet the investment objective and investment strategies of the Continuing Fund, including brokerage commissions.
27. No sales charges or costs or expenses will be payable by the Funds or investors in the Funds in connection with the Merger, including the acquisition by the Continuing Fund of the investment portfolio of the Terminating Fund.
28. As noted, the Filer will pay for the costs of the Merger. These costs consist mainly of legal, proxy solicitation, printing, mailing, brokerage costs and regulatory fees.
Tax Implications -- Terminating Fund Securityholders
29. Although the Merger will be conducted on a taxable basis, in view of the Filer, it is in the best interest of the securityholders of the Funds to complete the Merger on a taxable basis. A taxable trust-to-trust merger is tax neutral for tax-exempt securityholders of the Terminating Fund. In addition, the Filer expects that, in most cases, securityholders in non-registered accounts will have accrued losses on their units of the Terminating Fund which will be realized on the Merger.
Tax Implications -- the Terminating Fund
30. Given the compatibility of the portfolios of each Fund, the Filer does not currently anticipate that the Terminating Fund will be required to dispose of any portfolio assets in order to align its portfolio with that of the Continuing Fund in advance of the Merger. Any tax consequences flowing to the Terminating Fund as a result of the Merger will therefore result from the transfer of portfolio assets to the Continuing Fund in connection with the Merger itself. Currently, the Terminating Fund has approximately $1.6 million in unrealized capital gains in its portfolio assets. Upon the Merger, the Terminating Fund will transfer its portfolio assets to the Continuing Fund on a taxable basis and will therefore anticipate realizing approximately $1.6 million in net capital gains from such disposition. However, as the Terminating Fund has approximately $6.0 million in non-capital loss carryforwards and current year expenses, the aforementioned gains will be completely sheltered such that the Terminating Fund will not realize any net capital gains from the dispositions in its taxation year in which the Merger occurs. As a result, based on information currently available, the Filer anticipates that the Terminating Fund will not be required to make an additional distribution of income to securityholders prior to, or in respect of, the Merger in order to avoid liability for non-refundable income tax under Part I of the Tax Act for the taxation year in which the Merger occurs.
Benefits of the Merger
31. The Filer believes that the Merger will be beneficial to securityholders of the Terminating Fund for the following reasons:
(a) The management fees of both classes of the Continuing Fund will be lower than those of the corresponding classes of the Terminating Fund. In particular, Class F units of the Continuing Fund will not be subject to a management fee. The Merger therefore has the potential to lower costs for securityholders. However, the performance fee of the Continuing Fund, unlike the Terminating Fund, is not calculated with reference to a performance benchmark or index. Consequently, it is possible that the Continuing Fund may be subject to a performance fee on a more consistent basis than the Terminating Fund would otherwise be.
(b) The Continuing Fund will have a broader investable universe than the Terminating Fund (both in terms of the types of issuers that may be invested in and their geographic location). As a result, the Continuing Fund may have access to additional investment opportunities, increased liquidity and greater flexibility when making investment decisions.
(c) As noted, the Continuing Fund will be an "alternative mutual fund" under NI 81-102 and will therefore have more flexibility to use investment strategies not permitted for conventional mutual funds, such as the Terminating Fund. For example, the Continuing Fund has the ability to invest more than 10% of its net asset value in securities of a single issuer, to invest in physical commodities or specified derivatives, to borrow cash, to short sell beyond the limits prescribed for conventional mutual funds and to employ leverage. The Merger will therefore provide securityholders with continued exposure to a similar portfolio of assets but with the added potential to enhance returns through the use of leverage and other strategies available to the Continuing Fund as an "alternative mutual fund".
(d) It is anticipated that the broader investment mandate and investment strategies may provide the Continuing Fund with a greater ability to raise new capital than that of the Terminating Fund. The ability to raise new capital may therefore permit the Continuing Fund to take advantage of economies of scale with the possibility of lower annual expenses for the Continuing Fund (and thereby lower the management expense ratio borne by securityholders). In addition, the ability to attract assets to the Continuing Fund will benefit investors by ensuring that the Continuing Fund is a viable, long-term, attractive investment vehicle for existing and potential investors.
(e) As noted, none of the costs and expenses associated with the Merger will be borne by the Terminating Fund or securityholders. All such costs will be borne by Next Edge.
32. The Filer has determined that it would be in the best interests of the Fund and their investors and not prejudicial to the public interest to receive the Approval Sought.
Decision
The Decision Maker is satisfied that the decision meets the test set out in the Legislation for the Decision Maker to make the decision.
The decision of the Decision Maker under the Legislation is that the Approval Sought is granted provided the Filer obtains the prior approval of securityholders of the Terminating Fund for the Merger prior to the Effective Date.
"Darren McKall"
Manager, Investment Funds & Structured Products Branch
Ontario Securities Commission