REASONS AND DECISION
[1] On July 7, 2011, the Ontario Securities Commission (the“Commission”) issued a notice of hearing in this matter pursuant to sections 127 and 127.1 of the Securities Act, R.S.O. 1990, c. S.5, as amended (the “Act”) in connection with a statement of allegations (the “Statement of Allegations”) issued by Staff of the Commission (“Staff”) on the same day.
[2] Staff alleges multiple breaches by Crown Hill Capital Corporation (“Crown Hill Capital” or “CHCC”) of its fiduciary duty and/or duty of care under section 116 of the Act in connection with the actions and transactions referred to in theStatement of Allegations. Staff also alleges that disclosure made by CHCC in a management proxy circular of the Crown Hill Fund (the “Crown Hill Fund” or “CHF”) dated June 3, 2009 was inadequate and materially misleading, and that CHCC caused CHF to enter into a transaction that breached its Declaration of Trust. Staff also alleges that CHCC failed to have written policies and procedures required by Ontario securities law to address conflict of interest matters. Staff also alleges that Wayne Lawrence Pushka (“Pushka” and collectively with CHCC, the “Respondents”), as President and Chief Executive Officer and a director of CHCC, authorized, permitted or acquiesced in the conduct of CHCC that breached the Act and in so doing is deemed pursuant to section 129.2 of theAct to have also not complied with the Act. Staff also alleges that the foregoing conduct of the Respondents was contrary to the public interest and harmful to the integrity of Ontario capital markets. (See the summary of Staff’s allegations commencing at paragraph 40 of these reasons, theRespondents’ submissions (commencing at paragraph 43 ofthese reasons) and the matters we must determine set out in paragraph 74 of these reasons.)
[3] The hearing of this matter took place over 14 hearing days from May 9, 2012 to September 18, 2012.
[4] These are our reasons and decision in this matter.
Crown Hill Capital Corporation
[5] Crown Hill Capital was a company incorporated under the laws of Ontario. At the relevant time, it was theinvestment fund manager (“IFM”) and trustee of the Crown Hill Fund or its predecessor funds, MACCs Sustainable Yield Trust (“MACCs”) and Crown Hill Dividend Fund (“CHDF”). As such, CHCC had a fiduciary duty as an IFM under section 116 of theAct and as an IFM and trustee pursuant to the CHF Declaration of Trust and under the declarations of trust of its predecessor funds. At the relevant time, CHCC and its affiliates were wholly-owned by Pushka, directly or indirectly. When we refer to CHCC in these reasons, that reference includes its various affiliates.
Wayne Lawrence Pushka
[6] Pushka is a resident of Ontario. He was the President and Chief Executive Officer and a director of CHCC and held those positions at all relevant times for the purposes of these reasons. At all relevant times, Pushka was registered with theCommission as an Investment Counsel and Portfolio Manager and had been registered in that capacity since at least 2006. CHCC has been an IFM for over ten years. During the relevant time, Pushka was director and sole officer of Crown Hill Asset Management Inc. (“CHAM”), which was the portfolio manager of Crown Hill Fund and its predecessor funds until it was replaced by Robson Capital Management Inc. (“Robson”) on January 16, 2009 (see paragraphs 28 and 355 of these reasons).
Crown Hill Fund
[7] At all relevant times, Crown Hill Fund was a publicly traded closed-end investment fund established under a declaration of trust as restated from time to time (the “CHF Declaration of Trust”). CHCC was both the IFM and trustee under that declaration of trust. The units of CHF traded on the Toronto Stock Exchange. Both MACCs and CHDF were publicly traded closed-end investment funds.
[8] At all relevant times, the CHCC board of directors (the“CHCC Board”) consisted of Pushka, Thomas I. A. Allen (“Allen”) and Terry A. Jackson (“Jackson”). Allen and Jackson were independent of Pushka and constituted a majority of themembers of the CHCC Board. There was no legal requirement that a majority of the CHCC Board be independent. Except as otherwise indicated in these reasons, Allen and Jackson participated in all of the CHCC Board meetings referred to in these reasons and approved all of the actions and transactions taken or approved at those meetings. Accordingly, all of the actions and transactions approved by the CHCC Board were approved by a majority of independent directors. Allen testified at the hearing.
[9] Allen is an experienced businessperson and director, and a former securities lawyer with a leading Canadian law firm. Jackson is also an experienced businessperson in the financial industry. Allen and Jackson are of unquestioned integrity.
[10] At all relevant times, CHF’s Independent Review Committee (the “IRC”) under National Instrument 81-107 – Independent Review Committee for Investment Funds (“NI 81-107”) consisted of Andrew Fleming (“Fleming”) (see paragraph 70(c) of these reasons), John N. Campbell (“Campbell”) and Mark L. Maxwell (“Maxwell”). There is no dispute that themembers of the IRC were independent of CHCC and Pushka. Except as otherwise indicated in these reasons, all of themembers of the IRC participated in all of the IRC meetings referred to in these reasons and approved all of the actions taken or approved at those meetings. Fleming testified at thehearing.
[11] Maxwell is an experienced businessperson with a long history in the asset management business in Ontario. Campbell is an experienced director and businessperson in thetransportation and other industries. Fleming, Campbell and Maxwell are equally of unquestioned integrity.
[12] On or about February 1, 2008, a subsidiary of CHCC purchased the rights to the management services agreements for MACCs, a closed-end investment fund. CHCC and its subsidiary then amalgamated and CHCC thereby became theIFM and trustee for MACCs. CHCC financed the purchase ofthe MACCs management services agreements itself.
[13] CHCC purchased the rights to the MACCs management services agreements at least in part in order to be able to spread CHCC’s fixed costs of managing CHDF over the larger asset base of MACCs and CHDF.
[14] CHCC’s management fees are calculated based on thenet asset value (“NAV”) of the funds it manages. If the NAV of the funds increase, so do the fees paid to CHCC, and if theNAV falls, the fees paid to CHCC also decline. There is nothing unusual in that. That is the accepted compensation arrangement for IFMs in the investment fund industry.
[15] As a result, however, CHCC received a direct financial benefit from any increase in the NAV of the funds it managed. One of the ways to increase management fee revenue is for an IFM to acquire the rights to manage another fund. Such funds are then often merged with the investment funds then managed by the IFM. Unitholders may benefit from a fund merger because a merger potentially increases the liquidity offund units because more units are outstanding.[1] Unitholders may also benefit from a fund merger because the fixed costs of managing the funds are allocated over the larger number of units outstanding. As a result, the management expense ratio (or “MER”)[2] of a fund following a merger typically declines as a percentage of NAV. However, because themanagement fees and other variable expenses remain relatively constant, the positive impact on MER of allocating fixed costs over a larger unitholder base diminishes as the NAV of a fund increases. Another way to reduce MER is for an IFM to be more efficient in the management of a fund or group of funds; for example, by negotiating more favourable terms with third party service providers.
[16] The NAV of the CHDF was approximately $24.2 million as of December 31, 2005 and approximately $8.7 million as ofDecember 31, 2007. Clearly, the NAV of the CHDF fell significantly over that period. As of July 23, 2008, CHDF had a NAV of $6.4 million (see paragraph 374 of these reasons for information with respect to subsequent CHF NAVs). As of June 6, 2008, CHDF had experienced “another year of high redemptions” (see paragraph 201 of these reasons).
[17] In 2005, CHDF paid management fees to CHCC in theamount of $156,161. For the one-year period ended December 31, 2007, the management fees paid by CHDF to CHCC were $75,717, less than half of what they had been in 2005. For theyear ended December 31, 2008, CHDF paid management fees to CHCC of $44,218 (see paragraph 522 of these reasons for information with respect to increases in management fees as a result of the fund mergers described in these reasons).
[19] CHCC was the IFM and trustee for CHDF from May 19, 2004 until CHDF was merged with MACCs. From the date that the MACCs management services agreements were acquired by CHCC to the date that MACCs was merged with CHDF, CHCC was also the IFM and trustee for MACCs.
[20] CHAM was CHDF’s portfolio manager before CHDF’s merger with MACCs, and became MACCs’ portfolio manager on August 1, 2008. Upon the merger of MACCs and CHDF, CHAM became the portfolio manager of the continuing fund, which was named the Crown Hill Fund. CHAM was the portfolio manager of CHF until it was replaced by Robson on January 16, 2009 (see paragraph 355 of these reasons).
[22] In March 2008, Pushka recommended to the CHCC Board a strategy of increasing CHDF assets under management through fund mergers. The expressed purpose for pursuing that strategy was to benefit unitholders by providing increased liquidity for their units, because of thelarger number of units outstanding, and a reduction in MER by spreading the fixed fund costs over a larger number of units.
[23] On April 30, 2008, CHCC filed a MACCs management proxy circular (the “June 08 Circular”) with the Commission and sent copies of the circular to MACCs unitholders in connection with a special meeting of unitholders to be held on June 4, 2008. The June 08 Circular recommended that unitholders vote to approve proposed changes to the MACCs Declaration of Trust. The letter to unitholders that accompanied the June 08 Circular stated that CHCC was “proposing amendments to the declaration of trust in order to facilitate mergers with other closed-end investment funds from time to time” without the need for unitholder approval (see paragraphs 190 to 195 of these reasons).
[24] The MACCs unitholders approved the changes to theMACCs Declaration of Trust, which was amended and restated as of June 4, 2008. On June 6, 2008, the CHCC Board approved further amendments to the MACCs Declaration ofTrust, which was restated as of that date (see paragraph 202 and following of these reasons).
[25] On July 25, 2008, CHCC filed a CHDF management proxy circular (the “August 08 Circular”) with the Commission and sent copies of the circular to CHDF unitholders in connection with a special meeting of unitholders to be held on August 28, 2008. The August 08 Circular recommended that unitholders vote to approve proposed changes to the CHDF Declaration ofTrust to facilitate a merger with one or more other closed-end funds without the need for unitholder approval, subject to certain criteria (see paragraph 238 of these reasons). Thechanges were approved by unitholders at the August 28, 2008 meeting. CHDF’s Declaration of Trust was amended and restated as of that date.
[26] MACCs and CHDF were merged on December 30, 2008, with MACCs as the continuing fund. As a result, MACCs’ Declaration of Trust became the declaration of trust for thecontinuing fund. Prior to the merger, CHDF had a NAV ofapproximately $6.4 million and MACCs had a NAV ofapproximately $3.8 million. As a result of the merger ofMACCs with CHDF, the NAV of the continuing fund increased to approximately $10.2 million (see paragraph 374 of these reasons) and the continuing fund was named the Crown Hill Fund.
[27] In August 2008, Pushka initiated discussions with a third party fund manager to purchase the rights to the management services agreement for the Fairway Diversified Income and Growth Trust (that agreement is referred to in these reasons as the “Fairway Management Agreement” and that fund is referred to as the “Fairway Fund”) with the aim of merging the Fairway Fund with MACCs and CHDF. (Ultimately, themerger of CHDF with MACCs occurred before the merger ofCHF with the Fairway Fund.)
[28] On January 16, 2009, Robson was appointed theportfolio manager of CHF to replace CHAM (see paragraph 355 of these reasons). That appointment was made in order to permit CHF to lend approximately $1.0 million to an affiliate ofCHCC (see paragraph 30 below) in order to finance CHCC’s purchase of the rights to the Fairway Management Agreement (see paragraph 357 of these reasons).
[29] CHCC acquired the rights to the Fairway Management Agreement on January 20, 2009 and became the IFM of theFairway Fund.
[30] That acquisition was carried out through the following transactions. On January 20, 2009, Crown Hill Fund loaned $995,000 to a numbered company wholly-owned by Pushka (that loan is referred to in these reasons as the “Fairway Loan” and that numbered company is referred to in these reasons as “CHCC Holdco”) that owned all of the outstanding shares ofCHCC. CHCC Holdco used the funds to subscribe for additional shares in the capital of CHCC. CHCC guaranteed theobligations of CHCC Holdco to repay the loan and CHCC Holdco pledged the shares of CHCC as security. CHCC then used the subscription proceeds to purchase the shares of a numbered company which owned the rights to the Fairway Management Agreement. On the same day, the numbered company was amalgamated with CHCC and CHCC thereby became the IFM of the Fairway Fund. Three days later, on January 23, 2009, CHF was merged with the Fairway Fund; thecontinuing fund was named the Crown Hill Fund. Following themerger, CHF had a NAV of approximately $44 million (see paragraph 374 of these reasons). We refer to the transactions described in this paragraph as the “Fairway Transaction”.
[31] Subsequent to the completion of the Fairway Transaction, Pushka advised the CHCC Board at a meeting held on March 27, 2009 that, as a result of the merger of CHF with the Fairway Fund (and the previous merger of CHDF and MACCs), trading in the units of the Crown Hill Fund on theTSX had increased from approximately 40,000 units per month in December 2008 to approximately 600,000 units per month in March 2009 (see paragraph 262 of these reasons). Clearly, that was a very material increase in the volume of trading of CHF units.
[33] In May 2009, Pushka entered into discussions with theowners of the management services agreements for theCitadel Group of Funds (as defined in paragraph 34 below) to acquire the rights to those agreements (the “Citadel Management Agreements”). At the time, the Citadel Group ofFunds had an aggregate of approximately $1.0 billion ofassets under management.
[34] The Citadel Group of Funds was comprised of thefollowing 13 funds: the Citadel Diversified Investment Trust, the Citadel Premium Income Fund, the Equal Weight Plus Fund, the Citadel HYTES Fund, the Citadel S-1 Income Trust Fund, the Citadel SMaRT Fund, the Citadel Stable S-1 Income Trust, the Energy Plus Income Fund, the Financial Preferred Securities Corporation, the Series S-1 Income Fund, theSustainable Production Energy Trust, the CGF Mutual Funds Corporation and the CGF Resources 2008 Flow-Through LP (collectively, the “Citadel Group of Funds”).
[35] On June 3, 2009, CHCC caused Crown Hill Fund to acquire indirectly the rights to the Citadel Management Agreements for a purchase price of $28 million (the “Citadel Acquisition”) pursuant to the transaction described in paragraph 399 of these reasons. CHF acquired those rights because CHCC was not itself able to finance the purchase price.
[36] Following the acquisition by CHF of the rights to theCitadel Management Agreements, Pushka intended to merge at least eight funds in the Citadel Group of Funds with the Crown Hill Fund which would be the continuing fund. The Citadel funds proposed to be merged with the CHF were: Citadel Diversified Investment Trust, Citadel Premium Income Fund, Equal Weight Plus Fund, Citadel HYTES Fund, Citadel S-1 Income Trust Fund, Citadel SMaRT Fund, Citadel Stable S-1 Income Fund, and Series S-1 Income Fund (collectively, the“Citadel Funds”). Ultimately, only five of the Citadel Funds were merged with CHF in December 2009. As a result of those mergers, the NAV of the continuing fund increased to approximately $237 million (see paragraph 374 of these reasons).
[37] On June 4, 2009, Crown Hill Capital publicly announced that CHF had acquired the rights to the Citadel Management Agreements and that CHCC proposed to carry out a “Reorganization” as the first step in the process to cause themergers of the Citadel Funds with CHF (see paragraph 403 ofthese reasons for the definitions of the terms “Reorganization” and the “Citadel Transaction”). Crown Hill Capital sent to CHF unitholders a notice of meeting and a management proxy circular dated June 3, 2009 (the “June 09 Circular”) in connection with a special meeting of CHF unitholders to be held on June 29, 2009 to approve theReorganization. The Reorganization would have constituted a related party transaction between CHF and CHCC if it had been completed (see paragraph 450 of these reasons).
[38] As a result of the intervention by Staff, the June 29, 2009 CHF unitholder meeting was not held, the Reorganization did not take place and CHF’s acquisition of the rights to theCitadel Management Agreements was restructured. A portion of the $28 million purchase price was repaid to CHF and thebalance became a loan by CHF to CHCC. We understand that by the time of this hearing that loan had been repaid to CHF in full.
[39] The Respondents and Staff agreed that none of theevents that occurred after the end of June 2009 would be thesubject matter of this proceeding. There were, however, some references in the evidence to events subsequent to that date.
[40] The following is a summary of Staff’s allegations contained in the Statement of Allegations. Staff alleges that, during the period from April 2008 to and including June 2009:
(a) CHCC caused Crown Hill Fund and its predecessor funds to:
(i) enter into a series of transactions to have CHCC acquire, either initially or ultimately, the management services agreements for other non-redeemable investment funds and bring about mergers of those funds with the CHF. In doing so, CHCC and Pushka acted primarily in their own interests rather than that of the Crown Hill Fund, contrary to section 116 ofthe Act and contrary to the public interest;
(ii) in two instances (in connection with the Fairway Loan and the Citadel Acquisition), use Crown Hill Fund’s assets to finance CHCC’s acquisition of the rights to the management services agreements for other non-redeemable investment funds as a means whereby CHCC would increase the assets under its management and thereby increase its management fees. In doing so, CHCC caused Crown Hill Fund to breach its investment requirements and/or exposed it to unnecessary risks, contrary to section 116 of the Act and contrary to thepublic interest;
(b) CHCC did not act honestly, in good faith and in the best interests of unitholders of the predecessors to CHF, contrary to section 116 of the Act, in increasing the management fees payable by the funds to CHCC, loosening the investment requirements or restrictions and/or broadening CHCC’s powers, including by means of the merger of CHDF with MACCs;
(c) CHCC and Pushka benefited from the acquisition of theFairway Management Agreement and the subsequent merger of CHF and the Fairway Fund because CHCC’s management fees increased as a result;
(d) CHCC as a trustee and manager had a conflict ofinterest in causing CHF to lend money to CHCC’s parent which also created a continuing conflict of interest as CHCC was in substance the creator of CHF;
(e) CHCC did not act honestly, in good faith and in the best interests of the Crown Hill Fund and/or did not act with thedegree of care, diligence and skill of a reasonably prudent person in the circumstances, contrary to section 116 of theAct, in causing CHF to enter into the Fairway Transaction when CHCC, among other things:
(i) failed to assess the results of the prior acquisition and merger of CHDF with MACCs;
(ii) failed to fully explore sources of financing for thepurchase of the Fairway Management Agreement so as to avoid unnecessary and continuing conflicts;
(iii) failed to consider and evaluate all the risks, costs and expenses associated with the proposed Fairway Transaction, including the additional costs of retaining additional portfolio managers; and/or
(iv) appointed Robson despite the fact that Robson had little or no experience in managing a portfolio of securities of thesize and nature of the Crown Hill Fund;
(f) CHCC caused CHF to indirectly acquire the rights to theCitadel Management Agreements that put CHF in the position of having control over, and indirect responsibility for, themanagement of the Citadel Group of Funds, contrary to thepublic interest;
(g) CHCC caused CHF to acquire indirectly the rights to theCitadel Management Agreements for $28 million, an amount that constituted more than 60% of its assets at the time, before any CHF unitholder meeting took place, and made disclosure in the June 09 Circular that was inadequate and misleading in the circumstances, contrary to Ontario securities law including section 116 of the Act, and contrary to thepublic interest;
(h) CHCC caused CHF to use more than 60% of its assets to acquire the rights to the Citadel Management Agreements contrary to CHF’s Investment Strategy and its Investment Restrictions set out in sections 5.2 and 5.3 of CHF’s Declaration of Trust and thereby failed to act honestly, in good faith and in the best interests of CHF and its unitholders and to exercise the degree of care, diligence and skill that a reasonably prudent person would exercise in thecircumstances, contrary to section 116 of the Act and/or contrary to the public interest;
(i) CHCC caused CHF to indirectly acquire the rights to theCitadel Management Agreements and failed to consider, avoid and/or minimize the risks of significant losses as well as thecosts and expenses associated with the Citadel Transaction, contrary to section 116 of the Act and/or contrary to thepublic interest;
(j) by structuring the Citadel Transaction as it did and by causing CHF to indirectly acquire the rights to the Citadel Management Agreements, CHCC acted primarily in its own interests (and those of Pushka) rather than the interests ofCHF, contrary to section 116 of the Act and/or contrary to thepublic interest;
(k) CHCC failed to act honestly, in good faith and in the best interests of Crown Hill Fund and/or did not act with the degree of care, diligence and skill of a reasonably prudent person in the circumstances, contrary to section 116 of the Act and contrary to the public interest, by:
(i) failing to assess the results of the prior acquisitions and mergers and to consider the current situation of theCrown Hill Fund, the need for mergers with the Citadel Funds and the purported benefits of such mergers;
(ii) failing to consider the appropriateness of causing theCrown Hill Fund to acquire the rights to the Citadel Management Agreements so as to use fund assets as a means of financing CHCC’s ultimate acquisition of those agreements;
(iii) failing to consider financing alternatives for theacquisition of the rights to the Citadel Management Agreements and/or determine fair and reasonable terms for such financing;
(iv) failing to properly assess and seek to avoid or minimize the risks of significant losses to CHF as well as all the costs and expenses associated with the Citadel Acquisition, theReorganization and the mergers of the Citadel Funds with CHF;
(v) causing CHF to expend 60% of its assets to acquire therights to the Citadel Management Agreements without first making timely and accurate disclosure to CHF and its unitholders; and
(vi) providing inadequate and misleading disclosure in theJune 09 Circular as described in the Statement of Allegations;
(l) during the relevant time, CHCC did not have written policies and procedures in place to address conflicts ofinterest, contrary to section 2.2 of NI 81-107;
(m) Pushka as President and Chief Executive Officer and a director of CHCC and, indirectly as its sole shareholder, authorized, permitted or acquiesced in the conduct of CHCC that constituted breaches of section 116 of the Act and, in so doing and pursuant to section 129.2 of the Act, Pushka is deemed also to have breached the Act and acted contrary to the public interest;
(n) Pushka as President, Chief Executive Officer and a director of CHCC, in authorizing the conduct described above, failed to act honestly, in good faith and in the best interests ofthe Citadel Funds [emphasis added] and/or did not act with thedegree of care, diligence and skill of a reasonably prudent person in the circumstances, contrary to section 116 of theAct and/or contrary to the public interest by, among other things:
(i) seeking to bring about the mergers of the Citadel Funds and CHF without seeking and obtaining the approval ofthe unitholders of the Citadel Funds in advance;
(ii) failing to consider the current situation of the Citadel Funds and whether there were any benefits for each of those funds merging with CHF; and/or
(iii) failing to evaluate and seek to minimize all the risks, costs and expenses associated with the mergers for theCitadel Funds and their unitholders including any tax implications; and
(o) the conduct engaged in by CHCC and Pushka as described above violated Ontario securities laws as specified in the Statement of Allegations. In addition, that conduct compromised the integrity of Ontario’s capital markets, was abusive to Ontario capital markets and was contrary to thepublic interest.
[41] A chronology of the events considered in these reasons is set out in Schedule “A” to these reasons.
[43] The Respondents submit that they, together with theCHCC Board and the IRC, made decisions to proceed with thetransactions at issue in this proceeding, honestly, in good faith and in the best interests of CHF and its unitholders. Thetransactions at issue were carefully structured, on the advice of highly qualified legal counsel, to comply with the provisionsof Ontario securities law. All of those transactions were approved by the independent directors of CHCC and recommended by the IRC.
[44] Further, the Respondents submit that there is no evidence that the transactions impugned by Staff were commercially improvident and certainly were not outside therange of reasonable business alternatives. The Respondents submit that there was a clearly articulated business rationale for each transaction and that the business judgment rule applies to the decisions to implement them. As a result, theRespondents submit that the Commission should not now second-guess those business decisions.
Amendments to MACCs Declaration of Trust
[45] The Respondents submit that Staff’s complaints about the amendments to MACCs Declaration of Trust are confined to an increase in management fees, the loosening ofinvestment restrictions and the broadening of CHCC’s powers as an IFM. The Respondents submit that Staff expanded their allegations in relation to the MACCs amendments in their submissions to include the amendment of redemption rights and the process by which the amendments were made. TheRespondents say that Staff’s focus on the amendment ofmanagement fees and redemption rights in isolation is plainly inappropriate. As Allen testified, the amendments were considered as a whole and determined to be in the best interests of the CHF as a package.
[46] The Respondents submit that the amendments were made to give authority to CHCC to carry out a merger strategy in a timely and cost effective manner and to produce a workable constating document that would serve the“continuing fund” as new funds were merged with it. TheRespondents submit that the amendments have to be viewed in their totality with a view to balancing the interests of thefund as a whole and not in isolation. A commercially reasonable fee structure was also implemented with a view to the long-term health of CHF.
[47] The Respondents submit that the error of focusing on particular amendments in isolation is clearly shown in relation to the changes to redemption rights. Staff erroneously assumes that when it comes to redemption rights, “more is always better”. This is clearly not the case from theperspective of the CHF. The evidence was consistent that theexisting redemption rights had been detrimental to CHF by allowing the rapid erosion of assets.
[48] Staff’s narrow approach is repeated with respect to theamendments to the MACCs Declaration of Trust on September 25, 2008 to allow CHCC to increase its management fees to 1%. Staff’s submission is effectively that any increase in costs to the unitholders of CHF (and its predecessors) is automatically not in their best interests and therefore a breach of section 116 of the Act.
[49] The Respondents submit that the CHF Declaration ofTrust, as restated from time to time, has served CHF since January 2009 without incident or complaint. Staff has led no evidence to demonstrate that the terms of the previous MACCs Declaration of Trust would have achieved a superior outcome for CHF.
Loan to Facilitate the Fairway Transaction
[50] The Respondents submit that Staff has provided no support for the proposition that a loan from an investment fund to its IFM can never be in the best interests of a fund. It is unclear why such a loan can “never” be in the best interests ofthe fund merely as a result of a conflict of interest that it raises. The Respondents say that this position is contradicted by the very existence of NI 81-107, which contemplates transactions occurring notwithstanding conflict matters. Further, the regulatory regime contemplates related party transactions which raise conflict of interest matters. By having an IRC review such transactions, a balance is struck by providing protection to the CHF on the conflict matters, but at the same time not foreclosing the approval and implementation of potentially beneficial transactions.
[51] The Respondents identified the relevant “conflicts ofinterest” arising from the transactions impugned by Staff, presented those conflicts to the IRC together with all of theinformation relevant to the conflicts, and obtained its recommendations to proceed. The IRC was aware that a loan from CHF to CHCC was a conflict of interest, and, in the case of the Fairway Loan, were presented with a detailed discussion document setting out in detail the issues surrounding the loan (that document is referred to in these reasons as the “Pushka Memorandum”; see paragraph 304 and following of these reasons). They were aware that the specific terms of the loan were a matter of potential conflict of interest.
[52] The Respondents submit that Staff’s allegations fail to distinguish between a related party transaction between two parties who have a special relationship prior to the transaction, and a true conflict of interest, where the interests of two parties are not aligned. In this case, there was no conflict ofinterest in the Fairway Transaction because both the CHF and CHCC would benefit from the transaction. The view that theinterests of the CHF and CHCC were aligned with respect to the Fairway Transaction was shared by the IRC.
[53] The Respondents submit that they acted in good faith and that the record is clear that the Fairway Transaction was only undertaken after extensive review and analysis by theCHCC independent directors and the IRC in the months leading up to the transaction. In particular, the concept ofusing a loan from CHF to CHCC to finance the acquisition of a management agreement was discussed at three separate meetings of the CHCC Board and two meetings of the IRC. It was also the subject of a legal opinion of Stikeman Elliott LLP (“Stikeman”), which concluded that the loan could be made in compliance with Ontario securities law (see the discussion related to reliance on legal advice commencing at paragraph 595 of these reasons).
[54] Staff alleges that CHCC did not “fully explore” possible third-party financing for the Fairway Transaction. It is clear that CHCC did explore financing options through the discussions with an investment banker suggested by one of the directors. Moreover, the Respondents submit that Staff failed to present any evidence of other available alternatives to the Fairway Loan that would have provided a superior economic result for CHF unitholders or which would have presented a superior method for completing the Fairway Transaction.
[55] The Respondents submit that the fact that CHCC did not have a written conflicts manual at the time of the Fairway Transaction is immaterial to the allegations that theRespondents breached their fiduciary duties under section 116 of the Act. CHCC was not required to have a written policies and procedures manual in respect of the matters at issue in this proceeding.
[56] The Respondents say that in recommending the Fairway Transaction, the IRC was aware, and considered, that one effect of the merger could be increased management fees paid to CHCC as IFM as a result of CHF becoming a larger fund.
[57] The Respondents submit that the Fairway Loan was made for the sole purpose of facilitating the acquisition ofthe Fairway Management Agreement in order to effect themerger of CHF with the Fairway Fund. The related party element of the transaction was entirely manageable and was reviewed and implemented appropriately. It is evident that theloan terms were commercially reasonable. Staff has led no evidence that such terms were not within the range ofcommercially reasonable terms.
Retainer of Robson
[58] The Respondents submit that there is no evidence that Robson was unqualified to provide portfolio management services for a small closed-end investment fund such as CHF. Robson’s portfolio management fee was commercially reasonable. The decision to retain Robson is the type ofdecision taken in the normal course by an IFM, and is supportable as a stand-alone decision.
The Citadel Transaction
[59] Staff submits that the investment by CHF in the rights to the Citadel Management Agreements was made for CHCC’s benefit and not for the benefit of CHF. The Respondents submit that this allegation runs contrary to all of the evidence and is hard to reconcile with the fact that the transaction was approved by all of CHCC’s directors, including Allen and Jackson. The latter directors were independent directors who had no personal interest in the outcome and had no motivation other than to act in CHF’s best interests. The Citadel Transaction could not have proceeded had Allen or Jackson not voted in favour of it. In order to make the finding requested by Staff, the Commission would effectively have to find that both Allen and Jackson ignored their fiduciary duties to the CHF. That is plainly not the case.
[60] CHCC’s ultimate conclusion, after considerable analysis and diligence, was that the Citadel Acquisition was beneficial to CHF. While CHCC was unable to implement theReorganization due to the intervention of Staff, the alternative negotiated with Staff was successful and CHF’s investment was repaid in full as originally intended, albeit without thePreferred Return (as defined in paragraph 429 of these reasons).
[61] The Respondents note that, in Staff’s view, the fact that the revenue stream from the rights to the Citadel Management Agreements would eventually revert to CHCC is evidence that CHCC was acting exclusively in its own interest. This erroneous view ignores the following three important aspects of the Citadel Transaction:
(a) the structure of the proposed Joint Venture (referred to in detail in paragraph 402 of these reasons), including theexistence of the senior and subordinated interests in the Joint Venture, was to be the subject of a vote of CHF unitholders. If, for some reason, CHF unitholders were opposed to theReorganization or if they wanted a higher return, they could have voted against the transaction. However, the unitholders overwhelmingly supported the Reorganization;
(b) CHCC subordinated its interest to that of CHF by ensuring that CHF would be repaid its entire investment, plus the Preferred Return, before CHCC would receive any revenues. If the transaction was not profitable for CHF, it would also not be profitable for CHCC; and
(c) because CHCC would be the manager of the Citadel Funds, it follows that CHCC would be entitled to receive management fees. That interest was subordinated to theinterest of CHF and was essentially security for CHF for thereceipt of its investment and the Preferred Return.
[62] The Respondents submit that Staff has attacked theFairway Transaction and the Citadel Acquisition on the basis that there was an irreconcilable conflict of interest resulting from CHCC causing CHF to invest assets to acquire themanagement contracts for the Fairway Fund and the Citadel Group of Funds. However, Staff can point to no provision ofOntario securities law that was breached, and Staff’s submissions are utterly divorced from applicable legal principles. The Respondents submit that the regulatory regime has recognized that related party transactions and conflicts ofinterest may arise and that transactions can nonetheless proceed provided appropriate precautions are taken, as they were in this case. The Respondents submit that there is no allegation in the Statement of Allegations that CHCC failed to follow NI 81-107 regarding conflict of interest matters. (We note that there is an allegation by Staff that CHCC did not have written policies or procedures in place to address conflicts ofinterest contrary to section 2.2 of NI 81-107 and the public interest; see paragraph 40(l) of these reasons.)
[63] Staff has submitted that the Citadel Acquisition was unprofitable and therefore an improvident transaction. TheRespondents submit that unless Staff can show that thetransaction was outside the range of reasonable commercial alternatives, Staff’s submission is unfounded.
[64] The Respondents submit that Staff erroneously relies on the “run-off” analysis that Pushka provided to the sellers ofthe rights to the Citadel Management Agreements during negotiations to establish the revenue stream that would be available to support CHF’s investment. Staff falsely assumes that the revenue stream reflected in that schedule could not have been increased by any means other than the successful completion of the anticipated mergers of the Citadel Funds with CHF, as CHCC was proposing. The Respondents submit that Staff failed to consider whether there were any other scenarios by which the revenue stream from the Citadel Management Agreements could be increased through good management of the funds. In taking this approach, Staff fails to give any credit to the business judgment of CHCC. It is clear that experienced and financially knowledgeable business people were keenly focused on the economics of the Citadel Acquisition. If Staff intended to attempt to prove that theCitadel Acquisition was likely to be unprofitable, they should have made that allegation in the Statement of Allegations and called evidence, likely expert evidence, to prove it. Instead, theRespondents submit Staff relies on questionable inferences based on erroneous assumptions.
[65] Staff submits that CHCC could not have accomplished the mergers of the Citadel Funds with CHF that CHCC was planning because some of the Citadel Funds would not meet the criteria of the permitted merger provisions[3] contained in the relevant declarations of trust. Staff implies that CHCC had overlooked these criteria. However, the Respondents submit that was exactly the assessment that CHCC carried out. CHCC concluded that the relevant permitted merger criteria would be met and that it would be in the best interests of the Citadel Funds to proceed with the mergers. Staff has submitted no evidence that this was not a reasonable assessment. Moreover, this was a matter of business judgment.
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