Last week, the Ontario Securities Commission released a report based on a review of related party transaction disclosure in which it identified disclosure issues and provided guidance to issuers preparing required related party disclosure.
Generally, a related party transaction is a transaction between an issuer and a person that is a related party of the issuer at the time the transaction is agreed to, as a consequence of which the issuer directly or indirectly enters into certain specified transactions. Such transactions include where the issuer purchases an asset from or sells an asset to the related party, assumes or becomes subject to a liability of the related party, or issues securities to the related party. Related parties of an issuer include shareholders holding more than 10% of voting securities, directors, senior officers and each of their affiliates.
In Canada, related party transaction disclosure is required pursuant to financial statement disclosure requirements under IFRS (IAS 24), Form 51-102F1 Management's Discussion & Analysis and MI 61-101 Protection of Minority Security Holders in Special Transactions.
Specifically, OSC staff reviewed 100 issuers to assess compliance with disclosure requirements with a view to understanding the range of practice in respect of issuers' approval and disclosure of related party transactions. Ultimately, the OSC found that while financial and MD&A disclosure met most key disclosure requirements, a number of deficiencies were identified.
Under MI 61-101 disclosure in respect of a “related party transaction” is required to include certain specified information, including a description of the transaction and material terms, the purpose and business reasons for the transaction, the review and approval process followed by the issuer and the anticipated effect of the transaction on the issuer's business and affairs. This applies to both material change reports and information circulars prepared where minority security holder approval is required. The Companion Policy to MI 61-101 provides further guidance on ensuring security holders have sufficient information to make informed decisions and suggests safeguarding against the possibility for an unfair advantage for an interested party by having a special committee of disinterested directors carry out or review negotiations for certain transactions.
The Companion Policy to MI 61-101 also advocates that negotiations for a transaction involving an interested party be carried out by or reviewed and reported upon by a special committee of disinterested directors. OSC staff build upon this in the report and stated that the mandate of any such special committee should generally vest the special committee with full authority to negotiate the terms of the transaction, consider other alternative transactions, and consider whether the RPT is in the interests of, or fair to, security holders.
While MI 61-101 disclosure requirements were generally complied with, the report found that in some instances, issuers did not disclose information about insider participation in a private placement where the private placement was a material change for the issuer. According to OSC staff, when a material change report is filed where there is any insider participation, the material change report should contain information regarding the insider participation in the RPT, even where the insider participation is only a small part of the private placement.
Where an issuer has adopted or amended a code of business conduct and ethics (as recommended under National Policy 58-201), the issuer must file a copy on SEDAR. OSC staff found a number of cases where issuers either neglected to disclose whether they had a code or to file their codes on SEDAR.
Further, the report suggests that to enhance corporate governance disclosure under Form 58-101F1 in respect of the exercise by the board of independent judgment in circumstances where a director has a material interest, issuers could include more detailed disclosure in regards to identifying, evaluating and approving related party transactions. According to staff, this could include considering: (i) whether the board or a committee reviews and approves RPTs; (ii) whether a materiality threshold has been adopted to determine which RPTs are subject to independent review; (iii) whether the issue has rules, guidelines or procedures for RPTs conducted in the normal course of business; and (iv) whether the issuer has rules, guidelines or processes to satisfy itself that a non-material RPT is transacted at fair value.
While OSC staff found that related party information in financial statements generally complied with IFRS requirements, information regarding the relationships between a parent and its subsidiaries was the most common omission. Reiterating IAS 24, the report states that disclosure of the relationship should be made even where no transactions have occurred between the parties. OSC staff also noted that more descriptive disclosure provides additional transparency and, as a result, allows security holders to better assess the implications of the transactions, particularly in instances where the transactions are material or outside of the ordinary course.
Ultimately, OSC staff requested a prospective improvement in disclosure in 17% of the financial statements reviewed. An example of entity-specific disclosure was also included in the report.
While the report suggests that MD&A disclosure also generally met key requirements, in 47% of the MD&A reviewed, OSC staff found overly-generic disclosure that was not specific to the issuer. According to the report, MD&A disclosure often repeated disclosure made in the financial statements without providing additional information. Examples of generic disclosure included referring to an "officer" or "director" rather than identifying the individual.
For more information, see OSC Staff Notice 51-723.