Chou Associates Management Inc. and Chou Associates Fund
National Policy 11-203 -- Process for Exemptive Relief Applications in Multiple Jurisdictions -- Relief granted to permit a public investment fund to continue to hold securities of a related issuer purchased without IRC approval or consultation.
Applicable Legislative Provisions
Securities Act (Ontario), R.S.O. 1990, c. S.5, ss. 111(2)(c)(ii), 111(4), 117(1)1, 117(1)4, 121(2).
June 24, 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 CHOU ASSOCIATES MANAGEMENT INC. (the Filer) AND IN THE MATTER OF THE CHOU ASSOCIATES FUND (the Fund)
The principal regulator in the Jurisdiction has received an application (the Application) from the Filer on behalf of the Fund, for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation):
1. exempting the Fund from the requirements in the Legislation which prohibit the Fund from knowingly making an investment or holding an investment in an issuer in which a substantial security holder of the Fund has a significant interest (the Related Issuer Relief);
2. exempting the Filer from the requirements in the Legislation which require a management company to file a report within 30 days after the month end of every purchase or sale of securities between the mutual fund and any related person or company (the Purchase and Sale Reporting Requirement); and
3. exempting the Filer from the management reporting requirements in the Legislation which require a management company to file a report within 30 days after the month end in which an investment fund is a joint participant with one or more related persons or companies (the Management Reporting Requirement)
(paragraphs 2 and 3 are together, the Conflict of Interest Reporting Relief, and the Related Issuer Relief and the Conflict of Interest Reporting Relief are together, the Exemption Sought).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions:
(a) the Ontario Securities Commission is the principal regulator for the 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 all of the provinces and territories of Canada other than Ontario (together with Ontario, the Jurisdictions).
Defined terms contained in National Instrument 31-103 Registration Requirements (NI 31-103) and National Instrument 81-102 Investment Funds, (NI 81-102) have the same meaning in this decision unless otherwise defined.
This decision is based on the following facts represented by the Filer in respect of the Filer and the Fund.
1. The Filer is a corporation validly existing under the laws of the Province of Ontario. The Filer's head office is located in Toronto, Ontario.
2. The Filer is registered as an investment fund manager, portfolio manager and exempt market dealer in Ontario.
3. The Filer is the investment fund manager and portfolio manager of the Fund.
4. The Fund is an open-ended mutual fund established under the laws of the Province of Ontario. The Fund is a reporting issuer in each of the provinces of Canada and is subject to National Instrument 81-102 Investment Funds.
5. The Filer has appointed an independent review committee (IRC) under National Instrument 81-107 -- Independent Review Committee for Investment Funds (NI 81-107) for the Fund.
6. The investment objective of the Fund is to provide long-term growth of capital by investing primarily in equity securities of U.S. and foreign businesses considered by the Filer, in its capacity as investment fund manager of the Fund, to be undervalued.
7. The Fund is currently qualified for distribution under a simplified prospectus dated September 14, 2019 for which it received a receipt.
8. Other than as described in representation 12, neither the Filer nor the Fund is in default of the securities legislation of Canada.
The Related Issuer Relief
9. As of the fourth quarter of 2009, Financial Holdings Ltd. (Fairfax) first became a substantial securityholder of the Fund pursuant to section 110(2)(b) of the Legislation. As of December 31, 2019, Fairfax's status as a substantial securityholder of the Fund was maintained as it held approximately 20.8% of the units of the Fund.
10. On December 4, 2015, the Fund acquired a 2nd lien term loan (the EXCO Loan) issued by EXCO Resources, Inc. (EXCO). In January of 2016, the Fund acquired a bond issued by EXCO (the EXCO Bond). On December 4, 2015, Fairfax held approximately 9.1% of equity securities of EXCO (the EXCO equity securities).
11. On or about May 2017, Fairfax, without the knowledge of the Filer, increased its investment in EXCO above 10% for the first time to approximately 45.8% of the EXCO equity securities and as a result, pursuant to section 110(2)(a) of the Legislation, Fairfax acquired a significant interest in EXCO. The Fund did not purchase any further securities of EXCO in the form of loans, bonds or equity securities at the time Fairfax increased its position in EXCO in May 2017.
12. On January 15, 2018, EXCO filed for protection under US bankruptcy laws and on June 28, 2019, EXCO emerged from bankruptcy. As part of the bankruptcy proceedings, the Fund received common shares of EXCO (EXCO Shares) in exchange for its prior interest in EXCO in the form the of the EXCO Loan and the EXCO Bond. The Filer, on behalf of the Fund, voted positively in favour of the option to receive common shares in exchange for the EXCO loan and EXCO bond as part of EXCO's bankruptcy proceedings. This favourable vote meets the definition of 'purchase' as contemplated by s. 2.13(2)3 of the Companion Policy to NI 81-102 and the definition of 'investment' as contemplated by s. 110(1) of the Legislation. At the time of such purchase, Fairfax was a substantial securityholder of the Fund within the meaning of s. 110(2)(b) of the Legislation and also had a significant interest in EXCO within the meaning of s. 110(2)(a) of the Legislation. This purchase or investment was made without consultation with, or the approval of, the Fund's IRC, contrary to s. 6.2(1)(a)(i) of NI 81-107. Further, as this purchase was not on an exchange, the purchase and continued holding of the EXCO shares did not comply with s. 6.2(1)(a)(ii) of NI 81-107. The EXCO Shares are not traded on a recognized securities exchange and accordingly, are considered to be private shares.
13. The Fund does not wish to purchase any more EXCO Shares but wishes to continue holding the existing EXCO Shares in its portfolio. To do this, the Fund is seeking the Related Issuer Relief to enable it to continue to hold the EXCO Shares in its portfolio.
14. The Filer has obtained the approval of the Fund's IRC to allow the Fund to continue to hold EXCO Shares in its portfolio.
15. The EXCO shares are currently being valued at the lower of: (1) the Fund's current fair market value of the securities at US$9.5144 per share based on the restructuring estimates; and (2) the latest mean price of the third-party valuation report by Duff & Phelps LLC.
16. Not allowing the Fund to continue to hold the EXCO Shares could be prejudicial to the Fund because the Fund could be required to dispose of the Relevant Shares in adverse market conditions, and the Fund would not have the opportunity to realize the fair value of the EXCO Shares.
The Conflict of Interest Reporting Relief
17. The Filer, as portfolio manager of the Fund, caused the Fund to purchase EXCO Shares at a time when Fairfax, a substantial securityholder of the Fund, also had a significant interest in EXCO.
18. The Filer, as portfolio manager of the Fund, caused the Fund to participate as a joint participant with one or more other funds also managed by the Filer, in the purchase of EXCO Shares where Fairfax, a substantial securityholder of the Fund, had a significant interest in EXCO.
19. In the absence of the Conflict of Interest Reporting Relief, each of the Purchase and Sale Reporting Requirement and the Management Reporting Requirement would require the Filer to file, within 30 days of the end of the month in which each transaction occurs, a report of (i) every transaction of purchase or sale between the Fund and any related person or company and (ii) every transaction in which, by arrangement, a Fund, with one or more funds or related persons or companies, acts as a joint participant. The report in each case, would have to disclose the issuer of the securities purchased or sold, the class or designation of the securities, the amount or number of securities, the consideration, the name of the related person or company receiving a fee, the name of the person or company that paid the fee to the related person or company and the amount of the fee received by the related person or company.
20. Pursuant to NI 81-106, the Fund prepares and files interim and annual management reports of fund performance (MRFPs) that disclose any transactions involving a related party, including the identity of that related party, the relationship to the Fund, the purpose of the transaction, the measurement basis used to determine the recorded amount, and any ongoing commitments to the related party.
21. It is costly and time consuming for the Filer to also provide the reports required by the Purchase and Sale Reporting Requirement and the Management Reporting Requirement, which are substantially similar to the information required by NI 81-106 to be disclosed in the MRFPs, on a monthly and segregated basis for the Fund.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted provided that:
(i) the continued holding of EXCO Shares is consistent with, or necessary to meet, the investment objectives of the Fund;
(ii) the IRC of the Fund has approved the Fund's purchase and continued holding of the EXCO Shares in accordance with subsection 5.2(2) of NI 81-107;
(iii) the Fund does not purchase any further EXCO Shares;
(iv) the Filer, as the investment fund manager of the Fund, complies with section 5.1 of NI 81-107 and the Filer and the IRC comply with section 5.4 of NI 81-107 for any standing instructions the IRC provides in connection with the Fund's continued holding of the EXCO Shares or any future sale of the EXCO Shares from the Fund's portfolio; and
(v) no later than the time the Fund files its annual financial statements, and no later than the 90th day after the end of each financial year of the Fund, the Filer files with the securities regulatory authority or regulator the particulars of any investments made in reliance on the Exemption Sought.
Ontario Securities Commission
"Garnet W. Fenn"
Ontario Securities Commission