Regulatory and legal risks abound in developing business areas, such as the recently legalized cannabis industry in Canada. One of the key challenges for industry participants that are reporting issuers relates to meeting disclosure obligations. Canadian securities regulators in a number of provinces, including Ontario, British Columbia and Québec, recently issued supplementary guidance in respect of corporate governance disclosure expectations directed toward reporting issuers in the cannabis industry (see CSA Staff Notice 51-359 Corporate Governance Related Disclosure Expectations for Reporting Issuers in the Cannabis Industry).
The supplementary guidance is being provided in response to Staff’s observation of instances of inadequate transparency relating to cross-ownership of financial interests by reporting issuers in the cannabis industry, or directors/officers of those reporting issuers and to other “deficient” corporate governance disclosures. While the Staff Notice is directed at the cannabis industry, Staff notes that it applies equally to other issuers, including companies in emerging and high growth industries.
- Evidences the importance and focus of the provincial securities regulators on detailed corporate governance disclosure, board independence and the disclosure of conflicts of interest, particularly in high growth sectors such as cannabis.
- Reporting issuers operating in such sectors, including cannabis, have effectively been put on notice that they are under increased scrutiny.
- Cross-ownership, including overlapping debt and equity interests, or other business relationships is an area of particular focus.
- Issuers and their advisors should therefore conduct appropriate due diligence to identify potential cross-ownership concerns in the context of a particular transaction and ensure that appropriate disclosure is provided to securityholders to permit them to make a reasonably informed decision about the merits of the applicable transaction.
- Highlights the need for reporting issuers to consider the impact of relationships or any other factors that could reasonably be expected to interfere with the exercise of a director’s independent judgment, in addition to the specific ‘bright line’ tests outlined in applicable securities law independence tests.
- Adoption of a robust code of business conduct and ethics is encouraged, including to provide standards for ethical decision making and compliance and for addressing actual, potential or perceived conflicts of interest.
- A likely indication of increased proactive enforcement activity to come in the cannabis industry, especially in instances where corporate governance and other disclosure is regarded as deficient.
- Staff specifically note that they will monitor compliance in the areas highlighted in the Staff Notice and will take “appropriate regulatory action when warranted.”
- Reporting issuers in this sector should pay particular attention to the matters raised in the Staff Notice, and consider their susceptibility and preparedness for regulatory inquiries should they arise.
Disclosure of financial interests in M&A transactions
Staff indicate that cannabis issuers have higher than usual cross-ownership that has resulted from rapid growth in the cannabis industry, which has itself resulted in many issuers and their directors and officers having participated in the financing of other issuers.
Staff also indicate that cross-ownership of cannabis issuers by other issuers and/or by their directors and officers is material information in the context of M&A or other significant corporate transactions. This cross-ownership may result in conflicts of interest that might lead investors to examine other variables in the context of these transactions, such as purchase price, transaction timing or contingent payments.
Staff’s expectation is therefore that detailed disclosure of the cross-ownership of financial interests (held either by the acquirer, the acquiree, or either of their directors or officers) should be made in the applicable disclosure document.
Independence of board members
The regulators also note that they have seen examples where cannabis issuers identify board members as independent, without giving adequate consideration to potential conflicts of interest or other factors that may compromise their independence. This includes, for example, personal or business relationships with other directors and officers of the issuer that have not been properly considered in the determination of independence.
The regulators caution those in the industry to consider the impact of relationships and any other factors that may compromise director independence, including whether or not disclosure of these factors is warranted in the circumstances.
Under NI 58-101 Disclosure of Corporate Governance Practices, issuers are required to disclose their corporate governance practices, including practices relating to their board and guidelines related to ethical business conduct and the ability of directors to exercise independent judgment. Independent directors must not have a director or indirect ‘material relationship’ with an issuer. NI 52-110 Audit Committees defines this as being a relationship which could, in the view of the board, be reasonably expected to interfere with the exercise of a director’s judgment.
Staff indicate that investors want to know that structures are in place to permit the board to operate independently (including, for example, making the chair of the board an independent director, or, where this is not possible, appointing an independent director as lead director).
The regulators also took the opportunity to encourage issuers to adopt a written code of business conduct and ethics, which includes standards for ethical decision making and compliance, and which addresses challenging situations (including conflicts of interest) that may arise during the normal course of business.
Understanding and meeting disclosure requirements often raise challenges for public companies, particularly in emerging or developing businesses where the market itself is new. Guidance from regulators as to their expectations should help navigate risks.
By Lawrence E. Ritchie, John M. Valley and Lia Bruschetta, Osler
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