Chou Associates Management Inc. and Chou Associates Fund
National Policy 11-203 Process for Exemptive Relief Applications in Multiple Jurisdictions -- relief granted from self-dealing restrictions in subsection 4.2(1) of NI 81-102 and paragraph 13.5(2)(b) of NI 31-103 to permit a mutual fund to sell portfolio assets to affiliates of the fund's manager -- proposed sale concerns illiquid securities of a private issuer to help the fund reduce its illiquid asset exposure -- relief subject to certain conditions including approval of the proposed sale by the independent review committee and a top-up provision in the event the market value of the securities increases above the purchase price paid by the affiliates within 6 months of completion of the proposed sale.
Applicable Legislative Provisions
National Instrument 81-102 Investments Funds, paragraph 3 of subsection 4.2(1) and section 19.1.
National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, ss. 13.5(2)(b) and 15.1.
April 4, 2023
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 CHOU ASSOCIATES FUND (the Fund)
The principal regulator in the Jurisdiction has received an application from the Filer, on its behalf and on behalf of the Fund, for a decision under the securities legislation of the Jurisdiction of the principal regulator (the Legislation) for exemptions from:
(a) paragraph 3 of subsection 4.2(1) of National Instrument 81-102 Investment Funds (NI 81-102) which restricts an investment fund from purchasing a security from or selling a security to an associate or affiliate of a partner, director or officer of the investment fund or of the manager, portfolio adviser or trustee of the investment fund (the Self-Dealing Relief); and
(b) paragraph 13.5(2)(b)(i) of National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations (NI 31-103) which restricts a registered adviser from knowingly causing an investment fund for which it acts as an adviser to purchase or sell a security from or to the investment portfolio of a responsible person (the Inter-Fund Trade Relief, together with the Self-Dealing Relief, the Exemption Sought),
to permit the Filer and the Fund to effect the Proposed Sale (as defined below).
Under the Process for Exemptive Relief Applications in Multiple Jurisdictions (for a passport application):
(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, Nova Scotia, Prince Edward Island, and Newfoundland and Labrador (together with the Jurisdiction, the Jurisdictions).
Terms defined in National Instrument 14-101 Definitions, MI 11-102, NI 81-102 and NI 31-103 have the same meaning if used 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.
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 Filer is not in default of securities legislation in any of the Jurisdictions.
5. 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 Jurisdictions.
6. Units of the Fund are currently distributed under a simplified prospectus dated September 23, 2022.
7. The investment objective of the Fund is to provide long-term growth of capital by investing primarily in equity securities of US and foreign businesses that the Filer considers undervalued.
8. The Filer has established an independent review committee (IRC) in respect of the Fund in accordance with the requirements of National Instrument 81-107 Independent Review Committee (NI 81-107)
9. Other than in respect of the restriction concerning illiquid assets in subsection 2.4(2) of NI 81-102, the Fund is not in default of any of the requirements of the securities legislation in any of the Jurisdictions.
10. Wintaai Holdings Ltd. (Wintaai) is a corporation validly existing under the laws of the Province of Ontario.
11. Chou USA Inc. (Chou USA, and together with Wintaai, the Affiliates) is a corporation validly existing under the laws of the state of Delaware.
12. Francis Chou is a director and controlling shareholder of the Filer and the Affiliates. As such, the Filer and the Affiliates are affiliated companies under the Legislation.
13. The primary business of each Affiliate is to act as a holding company.
14. Neither Wintaai or Chou USA are a reporting issuer in any of the Jurisdictions and are not considered an "investment fund" as that term is defined in securities legislation.
15. The Filer has proposed to cause the Fund to sell 500,000 common shares of Exco Resources Inc. (EXCO) from its investment portfolio to the Affiliates (the Proposed Sale).
16. EXCO is a private issuer that is not listed for trading on an exchange. The Fund originally acquired the EXCO common shares pursuant to a corporate restructuring in which certain EXCO debt instruments held by the Fund were converted to common shares. The EXCO common shares held by the Fund are considered "illiquid assets" as that term is defined in NI 81-102. The Fund does not hold any illiquid asset other than the EXCO common shares.
17. The Affiliates are proposing to purchase the EXCO common shares as principal under the Proposed Sale. Absent the Self-Dealing Relief, the Fund would not be permitted to sell the EXCO common shares to the Affiliates.
18. The Filer, as the portfolio manager of the Fund, and the Affiliates, as affiliated companies of the Filer who have access to the investment decisions the Filer makes on behalf of the Fund, are each a "responsible person" to the Fund as that term is defined in NI 31-103. Absent the Inter-Fund Trade Relief, the Filer would not be permitted to cause the Fund to sell the EXCO common shares to the Affiliates under the Proposed Sale.
19. The Proposed Sale is intended to reduce the percentage of net assets of the Fund that is made up of illiquid assets as the Fund has exceeded the 90-day period prescribed in subsection 2.4(2) of NI 81-102 during which it was permitted to hold more than 15% of its net asset value in illiquid assets. The Filer has been using its commercially reasonable efforts to reduce the Fund's investments in EXCO common shares but, as of March 28, 2023, the EXCO common shares comprise approximately 23% of the Fund's net assets. This is primarily the result of a significant increase in valuation of the EXCO common shares provided by the Valuator (defined below), coupled with a reduction in net asset value of the Fund due to certain redemptions.
20. Since 2018, the Filer has retained Kroll, LLC (formerly known as Duff & Phelps LLC) (the Valuator), a firm which is independent of the Filer and the Affiliates, to provide an independent valuation of the EXCO common shares held by the Fund approximately every six months. According to the most recent valuation prepared as of December 31, 2022, the latest mean price of the EXCO common shares is US$21.08 per share.
21. Under the Proposed Sale, the Fund would sell a portion of its EXCO common shares to the Affiliates at the latest mean price determined by the Valuator. Completion of the Proposed Sale would reduce the Fund's holding in EXCO common shares to approximately 14% of net assets, in compliance with the liquidity restriction in s.2.4 of NI 81-102. The Proposed Sale would be completed in two tranches, one to each of Wintaai and Chou USA. Chou USA will purchase 375,000 shares of EXCO common shares at a price of US$21.08 per share, for total proceeds of US$7,905,000. Wintaai will purchase 125,000 shares of EXCO common shares at a price of US$21.08 per share for total proceeds of US$2,635,000. In total, the Affiliates will purchase 500,000 shares of EXCO common shares for total proceeds of US$10,540,000. Notwithstanding this two-tranche approach, the sale of the EXCO shares shall be completed as soon as practicable upon receipt by the Filer of this decision document.
22. The Filer is seeking to sell the EXCO common shares to the Affiliates mainly for two reasons. Firstly, the EXCO common shares cannot be readily disposed of through market facilities in a timely manner. The approval of the directors of the Affiliates has been sought and received in respect of the Proposed Sale and, thus, the Filer can ensure the transaction is completed expeditiously. Secondly, the current trading price of the EXCO common shares is much lower than the fair market value determined by the Valuator because of different market forces in the "over the counter" market. As a result, the Filer believes it is the most appropriate and efficient arrangement to have the Affiliates purchase the EXCO common shares from the Fund at the latest mean price of US$21.08 per share to protect the unitholders' interest.
23. The terms of the Proposed Sale include a 'top-up' provision whereby if, after 6 months following completion of the Proposed Sale, the market value of the EXCO common shares sold to the Affiliates increases above the purchase price paid by the Affiliates, the Affiliates will pay the difference to the Fund within three business days after the expiry of the 6-month period (the Top Up). Conversely, if during that period the market value of the EXCO common shares decreases below the purchase price paid by the Affiliates, the Affiliates will absorb that decrease in price and the Fund will not be required to make up the difference. The Valuator will determine the market value of the EXCO common shares after the 6-month period for the purpose of the Top Up.
24. The Fund remains able to satisfy redemption requests by unitholders of the Fund.
25. Pursuant to section 5.1 of NI 81-107, the Filer has referred the Proposed Sale to the Fund's IRC. The Proposed Sale will not proceed unless the IRC determines that the Proposed Sale will achieve a fair and reasonable result for the Fund and approves the Proposed Sale pursuant to section 5.2 of NI 81-107.
26. The Filer submits that the Proposed Sale is in the best interests of the Fund to reduce the amount of illiquid assets held by the Fund, and that the Proposed Sale represents the business judgment of the Filer uninfluenced by considerations other than the best interests of the Fund. The Filer has proposed the Proposed Sale free from any influence by an entity related to it and without taking into account any consideration relevant to an entity related to it.
The principal regulator is satisfied that the decision meets the test set out in the Legislation for the principal regulator to make the decision.
The decision of the principal regulator under the Legislation is that the Exemption Sought is granted, provided:
1. The EXCO common shares are not listed for trading on an exchange;
2. There are no changes to the material terms of the Proposed Sale, including the purchase price for the EXCO common shares;
3. The IRC approves the Proposed Sale;
4. The terms of the Proposed Sale include the Top Up provision as described in representation #23;
5. The Filer receives no remuneration with respect to the Proposed Sale. With respect to the delivery of EXCO common shares, the only expenses that may be incurred by the Fund are nominal administrative charges levied by the custodian and/or recordkeeper of the Fund for recording the trades and/or any charges by a dealer in transferring the securities; and
6. The Filer keeps written records of the Proposed Sale including the value assigned to the EXCO common shares delivered to the Affiliates, for 5 years after the end of the Fund's fiscal year in which the Proposed Sale takes place, the most recent two years in a reasonably accessible place.