Reasons for Decision: In the Matter of Biocapital Biotechnology and Healthcare Fund
IN THE MATTER OF
THE SECURITIES ACT
R.S.O. 1990, c. S. 5, AS AMENDED
AND
IN THE MATTER OF
THE EXEMPTION APPLICATION FILED BY
BIOCAPITAL BIOTECHNOLOGY AND HEALTHCARE FUND
AND BIOCAPITAL MUTUAL FUND MANAGEMENT INC.
CONCERNING NATIONAL INSTRUMENT 81-102
SUBSECTION 2.1(1)
| Hearing: | April 2, 2001 | ||
| Panel: | Paul M. Moore, Q.C. |
- |
Chair |
| John A. Geller, Q.C. | - | Commissioner | |
| R. Stephen Paddon, Q.C. | - | Commissioner | |
| Counsel: | Melissa Kennedy | - | For the Staff of the Ontario |
| Paul Dempsey | - | Securities Commission | |
| Chantal Mainville | - | ||
| Lisa Davis | - | For the Respondent | |
| Eric Levy | - |
REASONS FOR DECISION
Hearing and Review
This was a hearing and review by the Ontario Securities Commission under subsection 8(2) of the Securities Act (the "Act") of a decision of the Director refusing under section 19.1 of National Instrument 81-102 an application (the "Application") by the Applicants for an exemption for 180 days from the 10% concentration limit set out in subsection 2.1(1) of National Instrument 81-102, and opting out of the Mutual Reliance Review System ("MRRS") under section 9.1 of National Policy 12-201. This hearing and review was requested by BioCapital Biotechnology and Healthcare Fund (the "Mutual Fund") and BioCapital Mutual Fund Management Inc. (the "Applicants").
Issues
The issues in this hearing and review are:
1. In considering the Application, and in opting out of the MRRS, what weight, if any, should have been given by the Director under section 19.1 of National Instrument 81-102 and section 9.1 of National Policy 12-102, and should be given by the Commission under section 8 of the Act, to the decisions of the principal jurisdiction and the other non-principal jurisdictions under the MRRS?
2. Who has the onus in establishing the public interest under the Application?
3. Whose interest, in this case, should be considered in determining the public interest?
Decision
The Commission decided that the Application should be granted, and that Ontario should opt back into the MRRS, provided the Director was satisfied that the final prospectus adequately disclosed the risk to investors as a result of granting the exemption.
Facts
The following are the facts in this hearing and review:
(i) Background
BioCapital Investments Limited Partnership (the "Partnership") is a closed-end investment fund established under the laws of the Province of Quebec pursuant to a limited partnership agreement entered into on May 8, 1997. The units of the Partnership are held as to approximately 80% by the Fonds de Solidarité des travailleurs du Quebec ("Fonds de Solidarité"). A small percentage of the units are held by residents of Ontario. The units of the Partnership are listed on The Toronto Stock Exchange. They have been trading at a discount from the net value of the assets of the Partnership. In accordance with the Partnership's distribution policy, net income of the Partnership for the 2000 fiscal year generally would be distributed on or before March 31, 2001.
(ii) Reorganization
The general partner proposed a reorganization ("Reorganization") as a strategy for unlocking unitholder value, to create liquidity, and to allow a distribution of net income in respect of its 2000 fiscal year of the Partnership by distributing units of a new mutual fund formed for this purpose.
The Reorganization itself would consist of the transfer to the Mutual Fund of public company securities in the portfolio of the Partnership together with all of the cash held by the Partnership with certain exceptions in exchange for units in the Mutual Fund. The Partnership would then distribute these units to its limited partners.
(iii) Going Private Transaction
The Fonds de Solidarité agreed to support the Reorganization in return for a going private transaction (the "Going Private Transaction") whereby each limited partner, other than the Fonds de Solidarité, would be required to sell to the Fonds de Solidarité, and the Fonds de Solidarité would be required to purchase, the Partnership units not held by it payable as to 50% in cash and as to 50% in units of the Mutual Fund immediately following the completion of the Reorganization.
(iv) Prospectus
A preliminary simplified prospectus and a preliminary annual information form both dated February 19, 2001 were filed in all provinces of Canada for the purpose of qualifying units of the Mutual Fund for distribution.
The Reorganization, the Going Private Transaction and related arrangements were all made conditional upon the issue of a receipt for the final prospectus and the completion of the transactions by a certain date (originally March 31, 2001 but subsequently extended to a date shortly after the date of this hearing and review). The Fonds de Solidarité is not prepared to proceed with the transactions if the final prospectus is not receipted in Ontario.
(v) Stakeholder Approvals
The Reorganization and the Going Private Transaction must be approved by at least 2/3 of the votes cast by the partners at a meeting or meetings. The board of directors of the general partner established an independent committee (the "Independent Committee") to review the fairness of the transactions. The Independent Committee unanimously determined that the transactions are fair, from a financial point of view, to the partners of the Partnership other than the general partner and the Fonds de Solidarité and unanimously recommended to the board of directors of the general partner that the board of directors submit the transactions to the partners for approval with a recommendation to the partners that they vote in favour of the transactions. The Independent Committee received an independent valuation from PricewaterhouseCoopers LLP ("PWC") in connection with the transactions. In addition, the independent committee received a fairness opinion from PWC in respect of the transactions.
(vi) Mutual Fund
The Mutual Fund is a newly established open-end mutual fund trust with redeemable units. It will be managed by BioCapital Mutual Fund Management Inc. ("Manager"), a wholly owned subsidiary of BioCapital Management Group Inc., controlled by the same shareholders as the general partner of the Partnership. The Manager will receive an annual management fee based on the average daily net asset value of the Mutual Fund. Investment objectives and strategy of the Mutual Fund will be consistent with those of the Partnership except that the portfolio of the Partnership will consist primarily of securities of public companies in the bio- technology and health care industries. The investment manager is also a wholly-owned subsidiary of BioCapital Management Group Inc.
(vii) Problem
It was anticipated that the transfer of public company investments of the Partnership to the Mutual Fund would result in two of the investments exceeding the 10% concentration limit rule in subsection 2.1(1) of National Instrument 81-102. At the date of the Application the shares of ConjuChem Inc. ("ConjuChem") held by the Partnership represented approximately 22.06% of what would be the net asset value of the Mutual Fund and the shares of another investment held by the Partnership represented approximately 12.09% of what would be the net assets of the Mutual Fund. At the date of this hearing and review, by reason of dispositions, only the investment in ConjuChem still exceeded the 10% limit. To reduce its holdings in ConjuChem to below 10% of its net asset value, the Mutual Fund would be required to sell a significant number of ConjuChem shares. Expressions of interest to purchase a portion of the ConjuChem shares had recently been received by the Partnership but the Independent Committee did not approve the offer price. In view of the very light trading volumes in ConjuChem, it was reasonable to conclude that it would be difficult for the Mutual Fund to dispose of the required number of shares in the market in a very short time-frame without affecting the market value of the shares of ConjuChem. The immediate sale by the Mutual Fund of a sufficient number of shares of ConjuChem to bring the holding of such shares to below 10% of the Mutual Fund's net asset value could reasonably be expected to have a negative impact not only on the value of the shares of ConjuChem but also on the value of the units of the Mutual Fund. Counsel for the Applicants advised that 180 days should be a sufficient length of time to enable the Mutual Fund to arrange private placements or other methods of disposing of shares of ConjuChem at above fire-sale prices to bring the value of its remaining holdings in ConjuChem below t
(viii) Director's Refusal
Pursuant to section 3.2 of National Policy 12-201, Quebec was selected as the principal jurisdiction for the Application. All jurisdictions, other than Ontario, granted the exemption sought in the Application. The Director opted out of the MRRS and refused the Application. This hearing and review was brought on on an expedited basis in order to respect the purposes of streamlining, efficiency and harmonization represented in the MRRS.
Evidence
No evidence was adduced at this hearing and review by way of witnesses. However, many exhibits were filed. In addition, many factual matters were stated in argument by counsel for the Applicants. While most of the factual matter were acceptable to counsel for the Director, one set of facts was not. In particular, counsel for the Applicants submitted that the number of redemptions of Mutual Fund units that might take place during the first 180-days of the Mutual Fund would be limited for various reasons. Counsel for the Director maintained that this "evidence" put forth in argument by counsel for the Applicants was speculative.
While a hearing and review of the Director's decision by the Commission is not in the nature of a trial, it is important that any evidence adduced by counsel orally and not through witnesses be acceptable to counsel for the Director, much in the same way that the Director in making an original decision himself must be satisfied that factual matters conveyed to him are worthy of belief under the circumstances. Because this "evidence" was not acceptable to counsel for the Director, and was put in by counsel by argument and therefore without the opportunity of cross-examination or other testing on the part of counsel for the Director, the Commission decided to give no weight to such evidence. In any event, counsel for the Director maintained that the number of redemptions that were likely to occur was not relevant to the issues in this case. The Commission agrees with this submission.
Weight to be Given to Decisions of other Jurisdictions (Issue 1)
Turning to the first issue, what weight, if any should have been given by the Director under section 9.1 of National Policy 12-102 and section 19.1 of National Instrument 81-102, and should be given by the Commission under section 8 of the Act, to the decisions of the principal jurisdiction and the other non-principal jurisdictions?
It is clear that the Director and the Commission are not bound in any way by those decisions because section 9.1 of National Policy 12-102 reserves to the regulator in Ontario full discretion. Subsection 9.1(2) of the policy provides that "in opting out of the system for a particular application, a non-principal regulator is not making a decision on the merits of the application." The decision on the merits of an application (which would form the basis of an opt-out under the MRRS) would be an exercise of discretion not under National Policy 12-102, but under subsection 19.1(1) of National Instrument 81-102.
Subsection 19.1(1) of National Instrument 81-102 provides:
the regulator or securities regulatory authority may grant an exemption from this Instrument, in whole or in part, subject to such conditions or restrictions as may be imposed in the exemption.
Counsel for the Applicants suggested to the Commission that the mere fact that the principal jurisdiction and the other non-principal jurisdictions in Canada had granted the requested exemption based on the public interest should alone be persuasive as the reason for granting the exemption. To agree with this would amount to the substitution of the decision of the principal jurisdiction as the decision of the local jurisdiction. This is not the intent of the MRRS.
While the Director and the Commission each have unfettered discretion with respect to the Application, this does not mean that we should not give any weight to the decisions of the principal jurisdiction and the other non-principal jurisdictions once the factors relevant to determining the public interest (including those put forth and considered by the other jurisdictions under the MRRS) are considered in Ontario.
We are required to exercise our discretion in the public interest. In determining the public interest the purposes of the Act are relevant. They are set out in section 1.1 of the Act. The first purpose is to provide protection to investors from unfair, improper or fraudulent practices. The second purpose is to foster fair and efficient capital markets and confidence in capital markets.
We must not lose sight of the second purpose. The Ontario capital markets are part of the Canadian capital markets which in turn are part of the world-wide capital markets. Ontario cannot be seen to regulate its capital markets in isolation. The Partnership has unitholders in Ontario and in other provinces. One of the fundamental principles we are directed to have regard to in pursuing the purposes of the Act is set out in item 5 of section 2.1 of the Act. This requires us to have regard for the fact that "the integration of capital markets is supported and promoted by the sound and responsible harmonization and co-ordination of securities regulation regimes." This, in our view, involves not only the legislative aspect of designing rules but also the administrative and enforcement aspects of applying rules. Accordingly, it is in the public interest that the rules we administer be applied in a harmonious manner with the way the rules of other jurisdictions are applied in the particular circumstance, unless there is a clear and certain public policy reason for a contrary application.
Onus (Issue 2)
Counsel for the Applicants argued, and counsel for the Commission agreed, that under section 8 of the Act the Commission may decide de novo, and that the Applicants do not have the onus of showing that the Director was in error in making his decision. The Applicants have the same onus before the Commission that they had before the Director.
Subsection 61(1) of the Act requires the Director to issue a receipt for a prospectus unless it appears to the Director that it is not in the public interest to do so. The Director has no choice with respect to the issue of a receipt pursuant to this subsection unless the Director comes to the determination that issuing the receipt would not be in the public interest. The issuer has the benefit of the doubt under this subsection where requirements of the Act are met and it is not clear to the Director that it is not in the public interest to issue a receipt. This is consistent with the concept of fair and efficient capital markets and efficient administration of the Act allowing business to proceed without undue regulatory interference as long as there is timely, accurate and efficient disclosure of information and no unfair, improper or fraudulent practices. In our facts, of course, we are not under subsection 61(1).
Subsection 61(2) of the Act provides that the Director shall not issue a receipt for a prospectus if it appears to the Director, among other things, that the prospectus fails to comply in any substantial respect with any of the requirements of applicable provisions. The concentration limit rule in section 2.1 of in National Instrument 81-102 falls within the rules referred to in subsection 61(2) of the Act. In this situation, it is for the Director, or the Commission under section 8 of the Act, in considering whether to grant an exemption from the requirements of the rule to conclude that it would not be contrary to the public interest to grant such an exemption. In other words, the onus is in the first instance on the Applicants.
Whose Interest is the Public Interest (Issue 3)
Counsel for the Director submitted that in considering the public interest in the case at hand, only the interest of future investors under the prospectus should be taken into account. Counsel argued that the relief requested would be required only if a receipt for the prospectus were to be issued, and for this reason only the interests of those who might purchase under the prospectus should be taken into account when considering the public interest.
Counsel for the Applicants argued that the public interest should include all those who participate in the public markets, including the partners of the Partnership, all the shareholders of ConjuChem, the holders of units of the Mutual Fund who receive their units in the Reorganization and the Going Private Transaction, as well as future investors who purchase units under the prospectus.
Although the issue of a receipt for the prospectus will likely be a consequence of granting the Application, the Application is for an exemption under National Instrument 81-102. In considering an exemption under National Instrument 81-102, we are not constrained from considering the interests of all market participants when determining the public interest.
Unitholders of the Partnership are participants in the marketplace. They have a legitimate interest in trying to unlock the value of their investment. We are not obliged to ignore the desirability of the Reorganization for investors in the Partnership.
The shareholders of ConjuChem also are participants in the marketplace. We need to consider the impact that an improvident sale of ConjuChem shares would have on them as well as on the partners of the Partnership.
Counsel for the Director argued that the 10% concentration rule limit was in the public interest. She suggested that strong reasons should exist before an exemption is granted. Counsel for the Applicants argued that counsel for the Director was suggesting that the rule was sacrosanct. She referred to exemptions that have been granted where a mutual fund has been designed to track a specified index with one or more stocks in the index being weighted above the 10% limit.
Counsel for the Applicants put in evidence a report of a speech by the Chair of the Commission in which he stated that with the introduction of a mutual fund governance regime it might be possible to relax or change some of the prudent investment rules governing mutual funds, including the concentration limit rule. While these musings of the Chair of the Commission suggest that the concentration limit rule and other prudent rules now in place may not be sacrosanct in and of themselves, we do not take the possibility of change as justification in itself for granting the exemption in this case. However, we do not regard any of the prudent investment rules of National Instrument 81-102 as sacrosanct since exemptions from them are anticipated and provided for by section 19.1 of the instrument.
Counsel for the Applicants referred us to the decision of the Director dated April 19, 2000 in Royal Canadian Equity Fund Limited (2000) 23 OSCB 6508, in which an exemption to exceed the concentration limit rule was granted with regard to an investment in shares of Nortel Networks Inc. The concentration limited was exceeded when shares of Nortel Networks were distributed to shareholders of BCE Inc. Counsel for the Director responded that in the case of the distribution of shares of Nortel Networks the mutual funds involved were involuntary participants unlike in the current case where the Mutual Fund is an active participant in the Reorganization which would result in the violation of the concentration limit rule. Furthermore, counsel for the Director argued, the resultant investment in the shares of Nortel Networks was extremely liquid. In the case at hand, in contrast, the investment in ConjuChem is by admission illiquid. Counsel submitted that this was a material distinguishing factor. We agree with counsel for the Director. However, under all the circumstances of this case, we do not believe, on balance, that it tips the scale to require us to deny the exemption. We believe that in the circumstances of this case involving, as it does, the Reorganization and not merely a new issue of securities, the public interest would best be served by granting the exemption.
Disclosure
Item 2 of section 2.1 of the Act requires us to have regard to the fact that the fundamental principles for achieving the purposes of the Act include requirements for timely, accurate and efficient disclosure of information. Of course, disclosure is not an absolute answer to every request for an exemption. If it were then rules such as the concentration limit rule would not be necessary. Having said this, we believe it is important that where an exemption from the concentration limit rule is granted, the resultant risks should be adequately disclosed in the prospectus.
Temporary Nature of Relief
In weighing all these factors we also have considered that the Applicants have not asked for an open-ended exemption but rather have asked for a temporary exception from the concentration limit rule. Under the circumstances we fail to see the harm to the public interest if the exemption were granted for 180 days.
Alternative Proposal by the Director
The Director suggested to the Applicants a way of accomplishing their objectives without an exemption from the concentration limit rule. The suggestion was that the Reorganization and the Going Private Transaction proceed but that the prospectus be put on hold in Ontario. This could be accomplished without the receipting of the prospectus in Ontario because of the various exemptions available in the Act. When sufficient shares of ConjuChem had been sold over time the prospectus could be receipted without an exemption from the concentration limit rule. All this would be possible because National Instrument 81-102 would not apply to the Mutual Fund in Ontario until the Mutual Fund had received a receipt for the prospectus in Ontario.
Counsel for the Applicants stated that the alternative had been discussed with their clients and that the proposal was not acceptable from a business point of view. In particular, the Fonds de Solidarité was not prepared to proceed without the Mutual Fund having a prospectus qualified in Ontario.
We are not convinced that the Applicants were refusing the alternative suggested by the Director for any improper motive. We believe that the Director's business judgement should not be accepted as appropriate in the face of objections by the Applicants.
Conclusion
In the particular case before us, the Applicants have identified enough factors to allow us to exercise our discretion to grant the requested relief.
First, the existing investors in the Partnership have an interest in the proposed Reorganization. There was a valuation and a fairness opinion prepared. There will be a vote of investors in the Partnership on the matters. It is a condition of the Reorganization that the existing investors in addition to the Fonds de Solidarité, including those in Ontario, be in favour of the Reorganization. The Reorganization should enable them to realize value by eliminating the discount inherent in the market for their units of the Partnership.
Secondly, the principal regulator and the non-principal regulators besides Ontario have all concluded that the exemption should be granted. If Ontario refuses the relief requested, the transactions will not proceed. In considering the question of harmonization, we asked ourselves whether there is anything particular to the Ontario capital markets that is sufficiently different to the capital markets in the other provinces to justify a different result in Ontario. We have not been able to identify any particular difference which would justify a different position being taken by Ontario with respect to this Application.
Thirdly, we believe that the risks inherent in exceeding the concentration limit rule for 180 days and the fact that the ConjuChem investment is illiquid can be addressed, in the particular circumstances of this case, through adequate disclosure in the prospectus. Disclosure in itself is not a panacea justifying any exemption from an investment rule for mutual funds. However, it is a necessary and helpful ingredient where an exemption is justified. For this reason, any relief will be conditional upon the Director's being satisfied that the final prospectus contains adequate disclosure with respect to the risk inherent in the granting of the Application.
Fourthly, we note that the Applicants are not seeking a complete exemption from the concentration limit. What they are seeking is a temporary exemption for 180 days so that there will be sufficient time to sell down the investment in question in an orderly manner without facing the full consequences of a forced sale. Counsel for the Applicants advised the Commission in answer to a question that 180 days should be sufficient to realize a better value for the investment. It is in the public interest that the present investors realize as much value as possible for their existing investment.
The exercise of discretion in this particular case has not been easy. The fact the Director was influenced by the illiquidity of the ConjuChem shares and the absence of an applicable precedent formed a reasonable basis for his decision. Furthermore, we note that the Director co-operated with the Applicants to cause this hearing and review to be brought on speedily so as to preserve the ability of the Applicants to carry forward with the transactions if the matter were resolved by the Commission in their favour. This reflected a commendable desire on the part of the Director to make the MRRS work. His decision was easier knowing the Commission would be in a position to exercise its discretion de novo in a difficult case.
For all of the above reasons we determined to grant the Application for exemptive relief, subject to the condition that the Director be satisfied that there is adequate disclosure in the final prospectus of the risk involved in the granting of the Application.
April 25, 2001
Paul Moore, John A. Geller, R. Stephen Paddon