Commission Approval of Rule: OSC Rule - 45-504 - Prospectus Exemptions for Distributions of Securities to Portfolio Advisors on Behalf of Fully Managed Accounts

Notice of Commission Approval OSC Rule

le 19 décembre 1997

NOTICE OF RULE UNDER THE SECURITIES ACT
RULE 45-504
PROSPECTUS EXEMPTION FOR DISTRIBUTIONS
OF SECURITIES TO PORTFOLIO ADVISERS ON BEHALF
OF FULLY MANAGED ACCOUNTS

Notice of Rule

The Commission has, under section 143 of the Securities Act (the "Act"), made Rule 45-504 Prospectus Exemption for Distributions of Securities to PortfolioAdvisers on Behalf of Fully Managed Accounts (the "Rule").

The Rule and the material required by the Act to be delivered to the Minister of Finance were delivered on December 17, 1997. If the Minister does not approvethe Rule, reject the Rule or return it to the Commission for further consideration, the Rule will come into force on March 2, 1998. If the Minister approves theRule, the Rule will come into force 15 days after it is approved.

Substance and Purpose of Rule

The purpose of the Rule is to provide relief from the prospectus requirements of the Securities Act (the "Act") for the distribution from treasury or by a "controlperson" of securities, other than securities of a mutual fund or non-redeemable investment fund, to managed accounts where a portfolio adviser makes theinvestment decision on behalf of the managed account. A managed account is defined in the Rule as "an investment portfolio account of a client established inwriting under which the portfolio adviser to the account makes investment decisions for the account and has full discretion to trade in securities of the accountwithout requiring the client's express consent to a transaction". A portfolio adviser is defined in the Rule as a portfolio manager, or a broker or investment dealerexempted from registration as an adviser under subsection 148(1) of the Regulation if that broker or investment dealer is not exempt from the by-laws orregulations of The Toronto Stock Exchange or the Investment Dealers' Association of Canada referred to in that subsection.

The Rule also imposes resale restrictions on the first trade in securities acquired in reliance on the Rule and provides relief from the registration requirements ofthe Act for the first trade in securities between certain managed accounts.

Background

Over the past several years, the Commission has seen a dramatic increase in the number of applications for relief from the prospectus requirements of the Actwhere, as part of an international or domestic offering, issuers or selling securityholders wish to be able to sell securities to portfolio advisers on behalf of theirmanaged accounts and the aggregate acquisition cost for the securities purchased for each managed account is less than $150,000. Often, these orders are soughtin the context of an international offering because the amount of securities available for distribution in Canada is limited, and the amount available for purchaseby individual managed accounts is less than $150,000. Applications requesting relief for specific issuances of securities have been granted by the Commissionsubject to certain conditions, including the condition that the aggregate acquisition cost of the securities purchased by the portfolio adviser on behalf of all themanaged accounts is not less than $150,000 and that each managed account, at the time of the purchase of the securities holds assets having an aggregate netasset value or an aggregate acquisition cost of not less than $150,000. The Rule generally provides the relief granted by the Commission in individual section 74rulings, but goes substantially further in that it does not require that the thresholds referred to in the previous sentence be satisfied for the relief under the Rule tobe available.

Summary of Rule

Subsection 2.1(1) of the Rule provides relief from the prospectus requirements of the Act for the distribution of securities to a managed account. The distributionmust either be a distribution from treasury or a "control person distribution" (a trade described in clause (c) of the definition of "distribution" in subsection 1(1)of the Act). Subsection 2.1(2) provides that the exemption in subsection 2.1(1) is not available either for the distribution of securities of a mutual fund or non-redeemable investment fund or, if an offering memorandum is delivered in connection with the distribution, unless the managed account is given a contractualright of action. The requirement to provide a contractual right of action will not apply if certain of the conditions in the Rule In the Matter of CertainInternational Offerings by Private Placement in Ontario (1997), 20 OSCB 1219 (formerly a Blanket Ruling) are satisfied. One of these conditions is the insertionof appropriate legends. In that regard, market participants should refer to a Notice of Commission staff ((1995), 18 OSCB 1350) regarding the appropriatenessof inserting additional disclosure.

The Commission notes that currently the definition of "offering memorandum" in Rule 14-501 Definitions does not include a document delivered in connectionwith a distribution under Rule 45-504. While the Commission anticipates amending Rule 14-501 Definitions in the near future, until such time as it does so, adisclosure document delivered in connection with a distribution under Rule 45-504 will not constitute an "offering memorandum" and paragraph 2.1(2)(b)requiring a contractual right of action will not apply.

Subsection 2.2 of the Rule provides that a managed account may trade a security acquired by a managed account under the exemption contained in subsection2.1(1) or from another managed account in the circumstance described in clause (iv) below only if (i) the first trade is made under a prospectus for which areceipt has been obtained from the Director, (ii) the first trade is made under an exemption in Ontario securities law from section 53 of the Act, (iii) certainconditions are satisfied, including that the hold period (as defined in the Rule) has elapsed from the later of the date of the acquisition of the security acquiredunder the exemption by the managed account first purchasing the security and the date the issuer of the security became a reporting issuer, or (iv) the first tradeis made between managed accounts managed by the same portfolio adviser. The reference in clause (iii) to the managed account first purchasing the securitymakes it clear that a managed account subsequently purchasing the securities can tack on the period the securities have been held by previous managed accountsfor the purposes of determining whether the hold period has elapsed.

Subsection 2.3 of the Rule provides that a managed account may trade an underlying security acquired directly or indirectly as a result of acquiring securitiesunder the exemption in subsection 2.1(1) or from another managed account in the circumstances described in clause (iv) above or acquired in the circumstancesdescribed in clause (iv) below only if (i) the first trade is made under a prospectus for which a receipt has been obtained from the Director, (ii) the first trade ismade under an exemption in Ontario securities law from section 53 of the Act, (iii) certain conditions are satisfied, including that the hold period (as defined inthe Rule) has elapsed from the later of the date of the acquisition of the security acquired under the exemption by the managed account first purchasing thesecurity and the date the issuer of the underlying security became a reporting issuer, or (iv) the first trade is made between managed accounts managed by thesame portfolio adviser. Section 2.3 allows for the "tacking" of hold periods based on the period of time the security acquired under the exemption in subsection2.1(1) has been held, but also prevents a conversion or exchange under clause 72(1)(f)(iii) and an exit from the "closed system" under subsection 72(5).

First trade relief for trades outside Ontario has generally been contained in section 74 rulings of this nature issued by the Commission. The Commission isproposing in Rule 72-501 Prospectus Exemption For First Trade in Certain Securities Over a Market Outside Ontario (1997), 20 OSCB 2053 to provide firsttrade relief outside Ontario on the conditions set out in that Rule for securities acquired in a distribution exempt from section 53 of the Act or under a provisionin a rule that prohibits a trade of the security except on certain conditions. If proposed Rule 72-501 is made and the conditions in that Rule are satisfied,securities acquired under section 2.1, 2.2 or 2.3, for the purposes of Ontario securities law, can be traded outside Ontario.

Section 2.4 of the Rule provides relief from the registration requirements of the Act for trades between managed accounts.

Finally, section 2.5 of the Rule requires certain reports to be filed and fees to be paid in connection with certain trades referred to in the Rule.

Summary of Written Comments Received by the Commission

Background

The proposed Rule was published for comment in the Ontario Securities Commission Bulletin on June 27, 1997 at (1997), 20 OSCB 3367. The Commissionreceived submissions on the proposed Rule from seven commentators. A list of the commentators is located in Appendix A to this Notice.

The Commission has considered the comments received, and thanks all commentators for providing their comments on the proposed Rule.

Discussion of General Comments on the Proposed Rule

All of the commentators supported the Commission's proposal to provide relief from the prospectus requirements of the Act under the proposed Rule. Onecommentator stated that the proposed Rule will simplify the procedures of offering international equity securities to Ontario investors by way of privateplacement and moreover, represents a cost-saving to issuers and investment banks in accessing the Ontario markets, thereby facilitating investment by Ontariopersons in international equities.

Many of the commentators noted that the proposed Rule helps to place portfolio advisers on a "more equal footing" with trust corporations registered under theLoan and Trust Corporations Act. Although the Rule may have this effect, it was not the primary objective of the Commission in adopting the Rule. The Rulewas developed to obviate the need for ad hoc discretionary applications which are routinely granted by the Commission and which do not raise regulatoryconcerns.

The majority of the commentators raised the concern that the relief has not been extended to distributions of securities of mutual funds, pooled funds establishedby a portfolio adviser for the benefit of its investment counsel clients or non- redeemable investment funds. The Commission recognizes that corollary reliefwould be necessary to facilitate the use of in-house pooled funds by portfolio advisers for discretionary managed account clients. As stated in the June 1997Notice accompanying the proposed Rule, the Commission continues to be of the view that the issues which arise in the context of developing an appropriateregulatory response to portfolio advisers who require more flexibility in the use of pooled funds to better serve their discretionary managed account clients aredifferent from those addressed by the Rule and will be considered by the Commission in that context.

Discussion of Specific Comments on the Proposed Rule

Part 1 - Definitions and Interpretation

Section 1.1 - definition of "portfolio adviser"

One commentator responded to the Commission's request for comment on the definition of "portfolio adviser" in the proposed Rule and indicated that theysupported the definition since there is no policy basis for distinguishing between a registered "portfolio manager" and a "broker" or "investment dealer".

Part 2 - Distribution of Securities to Portfolio Advisers on behalf of Managed Accounts

Section 2.1 - Prospectus Exemption

Subsection 2.1(1)

1. Imposition of Threshold Amounts as a Condition to the Granting of the Exemption

The commentators supported the elimination of the threshold amounts as a condition to granting the exemption. Four commentators expressly agreed with thebasis upon which the Commission decided to eliminate the threshold amounts as a condition to granting the exemption, namely that the portfolio adviser has thenecessary sophistication to make an investment decision without a prospectus in the context of a discretionary managed account. Another commentatorsupported the recognition by the Commission that it is the portfolio adviser making the investment decision on behalf of the client.

2. Portfolio Adviser Purchasing as Principal

The commentators supported the elimination of the threshold amounts so as to bring the exemption into line with that which is available to trust corporationsregistered under the Loan and Trust Corporations Act.

One commentator noted the difference between the relief provided under the proposed Rule and that which is provided to trust corporations under the Act. Thecommentator noted that because the prospectus exemption is limited to distributions from treasury or "control person distributions", a portfolio adviser isprevented from purchasing as principal under a prospectus exemption and later distributing the securities to its managed accounts. The Commission is of theview that the prospectus exemption contained in subsection 2.1(1) should be limited to distributions of treasury securities or securities held by a control person.This is consistent with those situations which have been the subject of ad hoc discretionary applications in the past and the principle underlying section 118 of theAct which prohibits a portfolio manager from causing any investment portfolio managed by it to purchase or sell the securities of any issuer from or to theportfolio manager and with National Policy No. 39 Mutual Funds (applicable to prospectus-qualified mutual funds), which currently restricts principaltransactions between portfolio managers and mutual funds. To expand the scope of the Rule to any distributions would allow portfolio advisers to purchase asprincipal and later allocate the securities to accounts managed by them which could raise issues of self-dealing.

The Rule would allow trades from one managed account to another managed account, but only if the two accounts have the same portfolio adviser at the time ofthe trade. Otherwise, the managed account would be subject to the usual private placement hold periods. The commentator questioned why portfolio advisersshould be subject to such a limitation when trust corporations are not. While the proposed Rule did not carry forward the conditions of ad hoc discretionary reliefunder section 74 of the Act, that each managed account be managed by the portfolio adviser at the time of the initial purchase and participated in the initialpurchase, the Commission is not prepared to expand the first trade relief to permit trades between managed accounts of one portfolio adviser and managedaccounts of another portfolio adviser.

The commentator referred to section 45 of the Securities Act (Quebec) (equivalent to subsection 72(2) of the Act) which includes an insurance company holdinga licence under the Act respecting insurance. The commentator suggested that appropriately registered or licensed insurance companies should enjoy the sameprospectus exemption as do trust companies and portfolio managers. The Commission has not received applications for discretionary relief from insurancecompanies in this context and does not propose to expand the Rule to insurance companies.

One commentator suggested an alternate approach to that which is reflected in the Rule. The commentator proposed that the Commission use its rule-makingauthority to provide that portfolio managers governed by the Act, the TSE By- Laws or the IDA Regulations be treated in the same fashion as trust companiesregistered under the Loan and Trust Corporations Act are treated under the Act. The commentator submitted that this would have the effect of simplifying theregulatory regime, ensuring equality of treatment (in light of substantially similar regulatory control) and ensuring that there is no regulatory arbitrage betweenthese two categories of investors. As placing portfolio managers on an equal footing with trust corporations was not the primary objective of the Commission inmaking the Rule, the Commission was not prepared to adopt the suggested approach.

Paragraph 2.1(2)(a) - Inapplicability of Draft Rule to Mutual Funds, Pooled Funds and Non-Redeemable Investment Funds

All but one of the commentators expressed the view that the use of pooled funds/mutual funds by portfolio managers as an efficient and cost-effective means ofhandling discretionary clients' holdings is a matter that should be dealt with by the Commission on a priority basis either through expanding the proposed Rule orthrough the development of a new rule dealing with this area directly. One commentator noted that this restriction exists only under Ontario law and not underany other jurisdiction in Canada.

One commentator made the point that in circumstances where total money under management on behalf of a client is well in excess of private placementminimums of $150,000, it fetters the discretion of a prudent portfolio manager to require that a minimum of $150,000 be invested in each in-house managedpooled fund in which that account is invested. The commentator submitted that this limitation does not operate in the best interest of investors.

The commentators urged the Commission to recognize that the realities of efficient portfolio management are such that the pooling of funds for investmentpurposes by way of unit trusts provides greater trading efficiencies, cost savings for the client and a model for fairness as between clients.

One commentator recommended that the exclusion for mutual funds and non-redeemable investment funds should only apply to a situation where the portfolioadviser sponsored or managed, or was related to an entity which sponsored or managed, the mutual fund or non-redeemable investment fund whose units theportfolio adviser was proposing to purchase on behalf of its fully managed accounts.

The Commission recognizes that the Rule deals with only one issue faced by portfolio managers when managing accounts on a discretionary basis and alsounderstands that corollary relief for discretionary money management through the use of in-house pooled funds is desired. As noted above under the GeneralComments section, the Commission continues to be of the view that this matter should be the subject of a separate rule initiative.

As stated in a footnote to the proposed Rule, the Commission takes the position that a rule dealing with discretionary money management through the use ofin-house pooled funds would likely contain different restrictive conditions than the conditions contained in the Rule. In particular, the Commission is consideringthe imposition of monetary thresholds with regard to individual managed accounts and the appropriateness of other safeguards contained in National Policy No.39 in the context of the creation and use of pooled funds for discretionary managed account clients.

Paragraph 2.1(2)(b)

1. Future-Oriented Financial Information

One commentator supported the Commission's decision not to require proposed National Instrument 52-101 Future- Oriented Financial Information to apply toan offering memorandum used in connection with a distribution under the Draft Rule for the reasons set out in the June 1997 Notice accompanying the proposedRule.

2. Contractual Right of Action

One commentator noted that it is likely that the Draft Rule will become a rule before the status of proposed Rule 71-501 International Offerings by PrivatePlacement in Ontario is finalized and accordingly, suggested that a proviso be included in paragraph 2.1(2)(b) so that the requirement to provide a contractualright of action would not apply if the Rule In the Matter of Certain International Offerings by Private Placement In Ontario (1997), 20 OSCB 1219 (the"International Offerings Rule") is applicable to the offering. The commentator submitted that provision could be made for this qualification to fall awayautomatically when proposed Rule 71-501 comes into effect.

The Commission agrees with the commentator and has added a paragraph (d) to subsection 2.1(2) so that the requirement to provide a contractual right of actionwill not apply if certain conditions of the International Offerings Rule are satisfied. The Commission is currently considering proposed Rule 71-501 and thechanges that should be made to the instrument in the context of the reformulation process.

Section 2.2 Restriction on First Trade in Securities

Section 2.3 Restriction on First Trade in an Underlying Security

Subsection 2.2(d) and 2.3(d)

One commentator supported the elimination by the Commission of the requirement that trades between managed accounts managed by the same portfolio adviserbe permitted only if each was a managed account managed by the portfolio adviser at the time of the original purchase of securities and participated in the initialpurchase. As described above under "Portfolio Adviser Purchasing as Principal", one commentator suggested that the Commission should go further and allowtrades between managed accounts of different portfolio advisers. The Commission was not prepared to adopt this suggestion.

Section 2.5 Filing Requirements and Payment of Fees

One commentator objected to the higher fees payable in connection with a distribution of securities of a mutual fund under a prospectus, as compared to adistribution of securities from treasury or from a "control person" under the prospectus exemption in the Rule.

The Commission is of the view that the Rule essentially extends the application of the private placement exemptions to purchases of securities from treasury orfrom a "control person" by portfolio advisers on behalf of fully managed accounts. Consistent with this approach, the same filing fee requirements apply to thecircumstances contemplated in the Rule as would be applicable to a private placement financing.

Other Changes

In finalizing the Rule, the Commission made a number of other changes, none of which are material. The more significant changes are as follows:

1. The definition of "managed account" was amended to add the words "established in writing" following the word "client". The definition was also amended bydeleting the word "all" before "investment decisions" and to change the words "absolute discretion" to "full discretion". These changes were made in order to beconsistent with industry practice as to the operation of managed accounts and is also consistent with the requirements of The Toronto Stock Exchange andInvestment Dealers' Association of Canada.

2. A new subsection 2.1(4) was added to provide that the contractual right of action requirement does not apply if certain conditions in the Rule In the Matter ofCertain International Offerings by Private Placement in Ontario (1997), 20 OSCB 1219 are satisfied. The Commission indicated in a footnote to proposed Rule45-504 that reformulated Rule 71-501 International Offerings by Private Placement in Ontario would contain this exception. As Rule 45-504 is being madebefore proposed Rule 71-501, it is necessary to provide for the exception in Rule 45-504.

Text of Rule

The text of the Rule follows.

DATED: December 19, 1997.

APPENDIX A

LIST OF COMMENTATORS ON THE DRAFT RULE

1. Connor, Clark & Lunn Investment Management Ltd.
2. CT Private Investment Counsel, a division of CT Investment Management Group Inc.
3. Investment Counsel Association of Canada
4. KBSH Private Asset Management, a division of Knight, Bain, Seath & Holbrook Capital
5. Ogilvy Renault
6. Osler Hoskin & Harcourt
7. TD Quantitative Capital, a division of TD Asset Management Inc., a wholly-owned subsidiary of The Toronto- Dominion Bank

ONTARIO SECURITIES COMMISSION RULE 45-504

PROSPECTUS EXEMPTION FOR

DISTRIBUTIONS OF SECURITIES TO PORTFOLIO ADVISERS

ON BEHALF OF FULLY MANAGED ACCOUNTS

PART 1 DEFINITIONS AND INTERPRETATION

1.1 Definitions - In this Rule

"hold period" means that period of either six, 12 or 18 months that would be applicable to a security, in the case of section 2.2, or an underlying security, in thecase of section 2.3, if the security or underlying security had been acquired under an exemption referred to in subsection 72(4) of the Act;

"managed account" means an investment portfolio account of a client established in writing under which the portfolio adviser to the account makes investmentdecisions for the account and has full discretion to trade in securities of the account without requiring the client's express consent to a transaction;

"portfolio adviser" means

(a) a portfolio manager; or

(b) a broker or investment dealer exempted from registration as an adviser under subsection 148(1) of the Regulation if that broker or investment dealer is notexempt from the by-laws or regulations of The Toronto Stock Exchange or the Investment Dealers' Association of Canada referred to in that subsection; and

"underlying security" means

(a) a security that is issued or transferred in accordance with the terms of a security acquired under the exemption in subsection 2.1(1); or

(b) any other security issued or transferred as a result of the conversion or exchange, directly or indirectly, of the first security referred to in clause (a) or asecurity referred to in this clause.

1.2 Interpretation - The term "special relationship", when used in reference to a person or company in a special relationship with a reporting issuer, shall beinterpreted in accordance with subsection 76(5) of the Act.

PART 2 DISTRIBUTION OF SECURITIES TO PORTFOLIO ADVISERS ON BEHALF OF MANAGED ACCOUNTS

2.1 Prospectus Exemption

(1) Section 53 of the Act does not apply to a distribution of securities to a managed account if

(a) the securities being distributed are securities that have not previously been issued; or

(b) the distribution is a control person distribution.

(2) The exemption contained in subsection (1) is not available

(a) for the distribution of securities of a mutual fund or non-redeemable investment fund; or

(b) if an offering memorandum is delivered in connection with the distribution, unless the managed account is given a contractual right of action and thecontractual right of action is described in the offering memorandum.

(3) The contractual right of action referred to in paragraph 2.1(2)(b) may be made subject to defences equivalent to defences available under subsection 130(2)of the Act.

(4) The condition in paragraph 2.1(2)(b) does not apply if the conditions in paragraphs A, C, D and F of the Rule In the Matter of Certain International Offeringsby Private Placement in Ontario (1997), 20 OSCB 1219 are satisfied.

2.2 Restriction on First Trade in Securities - A managed account may trade a security acquired by it under the exemption contained in subsection 2.1(1) or fromanother managed account in the circumstances described in paragraph (d) only

(a) if the first trade is made under a prospectus for which a receipt has been obtained from the Director;

(b) if the first trade is made under an exemption in Ontario securities law from section 53 of the Act;

(i) at the time of the trade, the issuer of the security is a reporting issuer,

(ii) in the case of a managed account that is in a special relationship with the reporting issuer, the managed account has reasonable grounds to believe that thereporting issuer is not in default under the Act or the regulations,

(iii) the hold period has elapsed from the later of the date of the acquisition of the security acquired under the exemption in subsection 2.1(1) by the managedaccount first purchasing the security and the date the issuer of the security became a reporting issuer,

(iv) no unusual effort is made to prepare the market or to create a demand for the security and no extraordinary commission or consideration is paid for thetrade, and

(v) the trade is not a control person distribution; or

(d) if the first trade is made between managed accounts managed by the same portfolio adviser.

2.3 Restrictions on First Trade in an Underlying Security - A managed account may trade an underlying security acquired by it directly or indirectly as a result ofacquiring securities under the exemption in subsection 2.1(1), or from another managed account in the circumstances described in paragraph 2.2(1)(d) or in thecircumstances described in paragraph (d) only

(a) if the first trade is made under a prospectus for which a receipt has been obtained from the Director;

(b) if the first trade is made under an exemption in Ontario securities law from section 53 of the Act;

(i) at the time of the trade, the issuer of the underlying security is a reporting issuer,

(iv) no unusual effort is made to prepare the market or create a demand for the security and no extraordinary commission or consideration is paid for the trade,and

(v) the trade is not a control person distribution; or

(d) if the first trade is made between managed accounts managed by the same portfolio adviser.

2.4 Registration Exemption for Certain First Trades - Section 25 of the Act does not apply to a trade described in paragraph 2.2(d) or 2.3(d).

2.5 Filing Requirements and Payment of Fees

(1) Within 10 days following a trade in reliance on the exemption in subsection 2.1(1), the seller of the securities shall file a report for the trade prepared inaccordance with Form 20 to the Regulation or any form that replaces that Form, and concurrently with the filing of the report pay the fee that would be payableunder the regulations for the filing of that Form or any replacement form.

(2) Within 10 days following a trade referred to in paragraph 2.2© or 2.3(c), the portfolio adviser, on behalf of the selling managed account, shall file a report forthe trade prepared in accordance with Form 21 to the Regulation or any form that replaces that Form, and concurrently with the filing of the report pay the feethat would be payable under the regulations for the filing of that Form or any replacement form.

(3) Within 10 days following a trade referred to in paragraph 2.2(d) or 2.3(d), the portfolio adviser, on behalf of the selling managed account, shall file a reportfor the trade that includes substantially the same information as is required in a report prepared in accordance with Form 20 to the Regulation or any form thatreplaces that Form, and concurrently with the filing of the report pay the minimum fee that would be payable under the regulations for the filing of that Form orany replacement form.