It has been just over one year since cannabis was legalized in Canada. The rapid expansion of the cannabis industry has resulted in a remarkably high number of cross-ownership of companies.
The Canadian Securities Administrators (“CSA”) have published Staff Notice 51-359 (the “Staff Notice”) to provide further guidance to cannabis issuers on disclosure required in respect of certain significant corporate transactions. Specifically, the CSA observed inadequate transparency related to mergers, acquisitions and other significant corporate transactions, and deficient disclosure in respect of corporate governance practices.
Disclosure of Financial Interests in Significant Corporate Transactions
The CSA noted that it has been common for cannabis issuers and their directors or executive officers to participate in the financing of other cannabis issuers. This has led to a high amount of cross-ownership of financial interests amongst cannabis issuers and their directors and executive officers. With the significant growth of the cannabis industry contributing to the frequency of mergers, acquisitions and other significant transactions (“M&A Transactions”) in the cannabis industry sector, the CSA has observed various instances where cannabis companies and their insiders have had undisclosed financial interests in these transactions. When these interests remain undisclosed, investors are deprived of material information in assessing the merits of a particular transaction and certain key elements of a transaction, such as purchase price, timing and contingent payments, may require re-examination in the context of fully disclosed cross-ownership.
The CSA further noted that in the context of M&A Transactions, cross-ownership disclosure may be required even if the amount of financial interest does not trigger the specified quantitative disclosure thresholds under securities law.
The Staff Notice explains that the appropriate disclosure document required to provide the transparency that investors need will depend on the structure of the proposed transaction, whether the issuer is the purchaser or the target, and the requirements of the stock exchange on which the issuer’s securities are listed.
Board Member Independence
With respect to the corporate governance practices of cannabis issuers, the CSA noted several instances in which board members of an issuer were identified as being independent, without reference to, or analysis of, potential conflicts of interest or other factors that could affect independence. The Staff Notice invites cannabis issuers to reassess whether their board members are truly independent and whether they have a direct or indirect material relationship with the issuer that could affect their independence.
One particular example of a potentially problematic corporate governance practice that the CSA noted is the situation where the chair of the board also serves as the chief executive officer of the issuer. The CSA maintains the view that this dual role undermines investor confidence in the ability of the board to operate independently and to provide the necessary oversight for the issuer.
In terms of best practices, the Staff Notice encourages issuers to adopt a written code of business conduct and ethics, which can include provisions for when and how conflicts of interest are to be disclosed, as well as provisions regarding disclosure of cross directorship and executive positions in the context of M&A Transactions.