Copyright 2010, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, November 2010
The Canadian Securities Administrators (CSA) recently published for comment their proposed new regime for the registration in Canada of persons or companies that act outside Canada as managers of investment funds whose securities are sold into Canada. The proposals would represent another layer of Canadian regulatory requirements that would be relevant if off-shore investment funds are sold into Canada and could force off-shore investment fund managers to decide between either registering in Canada or excluding (or reducing the size of) Canadian residents' prospective investments in their funds.
The registration of investment fund managers should not be confused with the registration of portfolio managers of investment funds. Registration requirements applicable to portfolio managers have been a basic component of the securities regulatory regime for some time in Canada. The registration of "investment fund managers", which are entities that "direct the business, operations or affairs of an investment fund", is a new requirement that became applicable to Canadian-based managers in September 2009 (although registration did not become mandatory for one year for entities that were already acting as investment fund managers when the rules came into force).
Under Canadian provincial securities laws, an "investment fund" means a "mutual fund" or a "nonredeemable investment fund". A "mutual fund" means an issuer whose primary purpose is to invest money provided by its security holders and whose securities entitle the holder to receive on demand, or within a specified period after demand, an amount computed by reference to the value of a proportionate interest in the whole or in part of the net assets, including a separate fund or trust account, of the issuer. A "non-redeemable investment fund" means an issuer: (a) whose primary purpose is to invest money provided by its securityholders; (b) that does not invest for the purpose of exercising or seeking to exercise control of an issuer or being actively involved in the management of any issuer in which it invests, other than an issuer that is a mutual fund or a non-redeemable investment fund; and (c) that is not a mutual fund.
Investment fund managers are now subject to numerous requirements as requirements of registration, including: the appointment of a chief compliance officer who satisfies Canadian proficiency and experience requirements; certain capital and insurance requirements; reporting requirements to the securities commissions; and the requirements to comply with certain conflict of interest, business operation and client relationship rules.
The CSA had provided a two-year exemption until September 28, 2011, for investment fund managers that had head offices outside Canada, and indicated that they would publish a proposal on registration requirements for such entities, which they have now done.
The CSA indicate that the purpose of the requirement to register investment fund managers is to ensure that the managers of funds sold to Canadians have "sufficient proficiency, integrity and solvency to adequately carry out their functions", and in particular to deal with risks associated with the calculation of net asset value, the preparation of financial statements, the provisions of transfer agency or record-keeping services to the funds, and conflicts of interest between the fund manager and its investors. The CSA state that "these risks concern investors in any investment fund regardless of where the investment fund manager is located".
Summary of Proposals
The proposals would be effected by amending National Instrument 31-103 – Registration Requirements and Exemptions.
The proposals would continue the basic requirement (to come into effect September 28, 2011) that an investment fund manager of an investment fund whose securities are sold into Canada would have to be registered with the Canadian authorities unless it was able to satisfy one of the two following exemptions.
The De Minimis Exemption. An investment fund manager that does not have a physical presence in Canada will not be required to register if (among other requirements):
- the securities of its fund have been distributed in Canada only on a private placement basis to permitted clients (the list of permitted clients consists substantially of institutional investors and very high net worth individuals and is a subset of the concept of "accredited investors"; the list of permitted clients for this purpose is essentially the same as the list of permitted clients that applies where one is relying on the "international adviser" exemption from the requirement to register as an adviser in Canada);
- the investment fund is not a reporting issuer in any jurisdiction of Canada;
- as at the end of the most recently completed financial year of the investment fund manager:
- the fair value of the assets of any investment fund for which it acts as manager attributable to securities beneficially owned by residents of Canada is 10% or less of all the assets of such fund; and
- the fair value of the assets of all investment funds for which it acts as manager attributable to securities beneficially owned by residents of Canada is C$50 million or less; and
- the investment fund manager files certain forms attorning to the applicable Canadian jurisdiction and provides certain notices to the Canadian investors in the fund.
The Non-Solicitation Exemption. An investment fund manager of an investment fund will be "grandfathered" and not have to register in a Canadian jurisdiction if:
- the activities of the investment fund manager are not conducted from a physical place of business in that Canadian jurisdiction and neither the manager nor the investment fund are incorporated, created or formed by the laws of that Canadian jurisdiction;
- the investment fund is not a reporting issuer in any jurisdiction of Canada; and
- the investment fund has not "actively solicited" residents of that Canadian jurisdiction after September 28, 2011.
The CSA provide some commentary as to their interpretation of the meaning of "actively solicited". They state that active solicitation refers to "intentional actions taken by the investment fund or the investment fund manager to encourage a purchase of the fund's securities". This would include direct communication with residents in the jurisdiction to encourage their purchases, advertising in Canadian publications or other Canadian media, or purchase recommendations made by a third party (such as a dealer) to residents of the Canadian jurisdiction if that party is entitled to compensation by the investment fund or the investment fund manager.
The CSA have specifically invited comments on the calculations required to monitor the de minimis exemption's thresholds and whether the thresholds proposed are appropriate.
The CSA are also proposing a new notice requirement pursuant to which all registered international investment fund managers, as well as Canadian investment fund managers who don't have an office in a particular Canadian province or territory, would be required to provide a notice to investors informing them of its nonresident status and the risk that investors may not be able to enforce legal rights in the province or territory. The CSA have also specifically invited comments from international and domestic investment fund managers on complying with this proposed requirement.
Implications of Proposals
Extra-Territorial Reach of Canadian Securities Law. The proposals will have the effect of subjecting non- Canadian investment fund managers to the requirement to register in a Canadian province and comply with the Canadian requirements, unless they can satisfy one of the exemptions discussed above, notwithstanding that none of their activities in managing the investment fund take place in Canada. Registration would therefore apply to activities not carried out in Canada.
Additional Canadian Requirements for Off-Shore Investment Managers. The proposals would represent another layer of Canadian regulatory requirements that would be relevant if off-shore investment funds are sold into Canada. In particular, the investment fund manager would be subject to appointing a compliance officer that satisfied the Canadian proficiency requirements. Our experience with this type of issue in the past is that it can be challenging for non-Canadian entities without Canadian affiliates to be able to locate or qualify such an individual in their jurisdiction.
Exemption Not Available for Large Investments in Funds. The de minimis exemption will not be available for an off-shore manager of an investment fund proposing a private placement into Canada if one of the thresholds regarding the proportionate share or the size of the assets of the relevant funds attributable to Canadian resident investors is exceeded. Accordingly, existing or proposed investments by Canadian investors in off-shore investment funds in excess of the relevant thresholds will result in off-shore investment fund managers having to decide between either registering in Canada or excluding (or reducing the size of) Canadian residents' prospective investments in their funds. One or a few major Canadian institutional investors, such as pension funds, could cause an off-shore investment fund to exceed these thresholds.
Comment Period The comment period for these proposals will expire January 13, 2011.
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