On July 29, 2011, the Canadian Securities Administrators (CSA) published for comment significant changes to the regulatory regime for venture issuers. The proposed rules in National Instrument 51-103 are intended to streamline and tailor venture issuer disclosure in order to make disclosure requirements more suitable for issuers at this stage of development. The proposals address continuous disclosure and governance obligations as well as disclosure for prospectus offerings and certain exempt offerings. Until October 27, 2011, the British Columbia Securities Commission, and other securities commissions in Canada, will accept comments regarding the proposed instrument.
Although the existing framework accommodates venture issuers, often these issuers must read an entire regulatory instrument, including inapplicable sections, in order to determine the venture issuer requirements. The new instrument consolidates the venture issuer requirements from NI 51-102, NI 52-109, NI 52,110 and NI 58-101. Further, the new instrument will not have companion policies, but instead will have short guidance notes in the body of the instrument.
Among the changes proposed under the new instrument is a revised definition of venture issuer. Unlike the current definition, the new definition will exclude debt-only issuers, preferred share-only issuers and issuers of securitized products. The proposed venture issuer definition also excludes issuers which are subject to BC Instrument 51-509 Issuers Quoted in the U.S. Over-the-Counter Markets.
The proposed instrument would replace the governance, disclosure and certification obligations of venture issuers currently covered by the following:
- NI 51-102 Continuous Disclosure Obligations;
- NI 52-109 Certification of Disclosure In Issuers’ Annual and Interim Filings;
- NI 52-110 Audit Committees; and
- NI 58-101 Disclosure of Corporate Governance Practices.
As a result, consequential amendments to the above instruments are being made.
The proposals are not intended to have any material impact on other instruments dealing with continuous disclosure obligations. The following instruments will continue to apply to venture issuers:
- NI 51-101 Standards of Disclosure for Oil and Gas Activities;
- NI 43-101 Standards of Disclosure for Mineral Projects;
- NI 52-107 Acceptable Accounting Principles and Auditing standards;
- NI 52-108 Auditor Oversight; and
- NI 54-101 Communication with Beneficial Owners of Securities of a Reporting Issuer.
The following is a brief summary of the key proposals under the new instrument.
Governance and Continuous Disclosure
Mid-Year report requirement
One of the most noteworthy changes proposed under the new instrument is the option for venture issuers to voluntarily provide (or omit) first and third quarter financial disclosure and associated MD&A. Venture issuers will only be required to file a mid-year report. The mid-year report will include a six-month interim financial report, associated MD&A and CEO/CFO certifications and must be filed within 60 days of the end of the mid-year period.
In effect, investors looking to invest in a venture issuer that has elected not to file first and third quarter financial statements will be limited to financial disclosure that could be more than six months old. Although the proposal will affect the availability of current financial disclosure, the CSA states that it will give issuers more time to focus on developing a successful business. The CSA further states that the proposed semi-annual reporting obligations are similar to those already in place in several reputable international markets in Europe, Africa and Australia.
Annual report requirement
The new instrument proposes that venture issuers be required to prepare and file an annual report within 120 days of their financial year-ends. Currently, there is no such requirement. The annual report requirement combines into one document: business, governance and executive compensation disclosure; audited annual financial statements and associated MD&A; and CEO/CFO certifications. Some of the significant disclosure requirements introduced by the annual report include: a description of the business; a comparison of research and development expenses compared against executive compensation and general and administrative expenses; biographical disclosure of executives; material contract summaries; trading by insiders; trading price information; and outstanding securities.
Unlike annual information forms (AIF), which venture issuers are only required to prepare to access the short form prospectus offering system and the exempt offering regimes, all venture issuers will be required to prepare an annual report. Like an AIF, the annual report will grant venture issuers access to the short form prospectus offering system and the exempt offering regimes that currently require the preparation of an annual information form.
The current format of required periodic disclosure, consisting of separate MD&A, financial statements, CEO/CFO certifications, information circulars, and, in some cases, annual information forms, requires that each of these documents be capable of standing on its own. As such, some duplication between the documents is necessary to ensure that they each provide a complete picture. This duplication, however, creates additional compliance costs for issuers as they must ensure that each of the documents conforms to the rules and with the other documents. The CSA believes that the new form of annual report, which encapsulates all annual disclosure, will reduce this duplication and provide investors with a more complete, concise summary of the issuer’s business.
The proposed instrument requires that a certificate be attached to both the annual report and mid-year report which is signed by the CEO, CFO and two directors. The certificate would provide the certifications currently required under NI 52-109 (i.e. that the CEO and CFO certify the absence of misrepresentations and fair presentation of the disclosure). Because the annual report would include disclosure that is not currently required in the annual filings of venture issuers (e.g. executive compensation disclosure), the certificate will apply to a broader range of disclosure than under the current requirements.
Non-management requirements for audit committees
Subject to 52-110, current securities laws do not impose any minimum level of independence on the audit committees of venture issuers. This reflects an acknowledgement that it can be difficult for venture issuers to attract and retain independent directors. The proposed instrument contains a requirement that the majority of the members of the audit committee not be officers or employees of the issuer or its affiliates. This requirement is similar to that which exists under many Canadian corporate statutes. By introducing it into the new instrument, all venture issuers will be subject to the requirement, with oversight by securities regulators.
Elimination of business acquisition reports (BARs) and enhanced material change reporting
The new instrument eliminates BARs, which means that, in these types of transactions, venture issuers will be subject instead to enhanced material change reporting. The CSA also proposes a requirement to disclose “Disclosable Events”, which would include material related entity transactions and “significant transactions” (i.e. significant acquisitions, significant dispositions and restructuring transaction). Transactions would be significant when the value of the acquired asset or business represents 20% of the venture issuer’s market capitalization.
Under the new instrument, venture issuers would report material changes and Disclosable Events on the same form with greater specificity than is currently required for a material change report. Generally, financial statements would not be required unless an acquisition was of 100% significance to the venture issuer.
Corporate governance requirements relating to conflicts of interest, related party transactions and insider trading
The proposed instrument introduces two further governance obligations.
Conflict of interest requirements – The board of directors will have to take steps reasonably designed to ensure that they are made aware of, and have an opportunity to discuss, consider and address each perceived conflict of interest between the directors and executive officers and the venture issuers and each proposed material related party transaction.
Trading policies – Venture issuers will have to take steps reasonably designed to deter persons having a special relationship with it and in possession of undisclosed material information from engaging in illegal insider trading or related illegal activities, such as tipping or encouraging others to transact in the venture issuer’s securities. The new requirement is not intended to change the existing statutory prohibitions against these illegal activities or to shift responsibility away from insiders. The focus of the new requirement is to encourage venture issuers to implement practices to contain undisclosed material information, such as establishing trading black-outs during the periods of time when undisclosed material information exists but cannot be properly disclosed.
The new instrument proposes that annual reports, mid-year reports and information circulars need not be mailed to shareholders if an alternative “notice and access” system is used. An issuer relying on the notice and access system would be required to issue a news release with prescribed disclosure when the applicable document is filed, make the document available on a website (including SEDAR) and send a copy, free of charge, within three days of receiving a request for such document from a shareholder.
Stream-lined information circular requirements
The proposed information circular form is a streamlined version of the requirements that currently exist under National Instrument 51-102. The CSA proposes that only disclosure necessary in respect of the matters to be voted upon be provided. Executive compensation and corporate governance disclosure would not be required in the information circular; however, that information would be required in the venture issuer’s annual report. Biographical information with respect to continuing directors would not be required unless it had not been included in the most recent annual report. The information circular would cross-reference the applicable disclosure made in the most recently filed annual report.
The CSA states that moving this disclosure from the information circular to the annual report should reduce the length of information circulars and the associated printing and mailing costs (for those issuers that are required or voluntarily choose to mail them).
Tailoring executive compensation and governance disclosure
The CSA proposes to combine into one section the disclosure of executive and director compensation. The rationale for the change is that for venture issuers there is generally a small group of individuals running the company and there may be a fair degree of overlap between the board and management. As such, it may be useful to see all forms of compensation in one table. The CSA’s proposal does not adopt the concept of “named executive officer” or NEO as used in NI 51-102. Instead, disclosure is required of the compensation paid to all directors and executive officers.
The CSA proposes that disclosure be provided for the CEO, CFO and any individual whose compensation exceeded that of either the CEO or CFO, on an individual basis; but for other executive officers and other directors, the disclosure can be aggregated. The new instrument does not adopt the $150,000 disclosure threshold used in NI 51-102 which threshold results in disclosure only being provided for executive officers paid in excess of $150,000.
The CSA proposals also contemplate a simplified form of compensation disclosure. The various pension benefit and long term incentive plan disclosures contemplated in NI 51-102 have been replaced with a single table requiring disclosure of all compensation. The CSA is not proposing a compensation discussion and analysis requirement, but venture issuers would be required to disclose whether they used a peer group to establish compensation for their executives and whether they have tied compensation to any performance criteria.
The CSA also proposes that details of management agreements and severance packages be disclosed and that related party transactions and indebtedness be disclosed proximate to compensation disclosure. Disclosure of outstanding stock options and compensation securities is expected to be addressed in a single table and it is anticipated that it too would be disclosed in proximity to executive compensation disclosure.
Lastly, the CSA proposes to exclude certain elements of existing governance disclosure, including:
- how the board of directors facilitates independent judgment;
- steps taken to encourage a culture of ethical conduct; and
- the results of board self-assessments.
The CSA’s rationale for not including these items is that they are either covered by a substantive governance requirement or the disclosure is not typically applicable to the governance practices of venture issuers.
Prospectus and Certain Exempt Offering
The second aspect of the new instrument relates to the offering disclosure that a venture issuer would provide to distribute securities. For example, the new instrument modifies the disclosure requirements for a long form prospectus filed by an issuer conducting an initial public offering under NI 41-101. Under the new instrument, the issuer would be permitted to provide essentially the type of disclosure required in an annual report in place of the disclosure required by NI 41-101. In addition, the disclosure requirements under 41-101F1 will be modified by the introduction of a proposed new form that conforms prospectus disclosure to that required by an annual report under the new instrument.
The CSA states that most trading occurs in the secondary market rather than the primary market. Because of this, the CSA has developed requirements designed to ensure that the disclosure required in the primary market and the secondary market is consistent. This has largely been accomplished with respect to senior issuers. However, this is not necessarily the case in the venture market as venture issuers are not required to prepare and file an AIF (unless they propose to file a short form prospectus or conduct an exempt offering that requires the filing of an AIF). Through the introduction of the annual report (among other new features of the instrument), the enhancements to secondary market disclosure are significantly enhanced. Investors, whether buying directly from the issuer or in the secondary market, will have access to similar venture issuer disclosure.
The new instrument also proposes that only two years of audited financial statements be required in an IPO prospectus of a proposed venture issuer, as compared to the current three-year requirement