Imagine that you are the chief executive officer (CEO), chief financial officer (CFO) or a director of a reporting issuer. Now imagine that you have just realized that your company will fail to meet its periodic continuous disclosure obligations. You can be certain that this default will result in a general cease trade order (CTO) being issued, effectively halting all trading in the securities of the issuer and bringing with it a large group of disgruntled investors and damage to the issuer's reputation. What can you do if you anticipate the issuer will fail to meet a periodic continuous disclosure deadline? You can limit the damage of a default by applying for a management cease trade order (MCTO) in accordance with National Policy 12- 203 Cease Trade Orders for Continuous Disclosure Defaults (the Policy), which was introduced on September 1, 2008. The MCTO will prohibit management and specific insiders from trading in the issuer's securities but not affect other security holders.
Scope of the Policy
The Policy effectively replaces CSA Staff Notices 57-301 and 57-303 and Ontario Securities Commission Policy 57-603. Generally, the Policy outlines the criteria that the CSA will utilize in deciding if a default or deficiency merits the issuance of a CTO or MCTO. The Policy applies to defaults or deficiencies with respect to the following periodic continuous disclosure obligations (Specified Requirements):
- annual or interim financial statements, management's discussion and analysis, and management reports of fund performance;
- annual information forms; and
- certification of filings under Multilateral Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings.
Non-periodic disclosure obligations, such as a material change reports, information circulars or technical disclosure required for mineral projects, are not governed by this Policy; however, issuers should be aware that, in certain circumstances, a regulator may choose to use the Policy as guidance.
When will default result in a CTO or MCTO?
The Specified Requirements help protect investors by ensuring they are provided with essential information that assists them in making informed decisions about the securities of a reporting issuer. The disclosure ensures that confidence is maintained in the integrity and fairness of capital markets. While the Canadian Securities Administrators (CSA) recognize that an issuer's failure to comply with the filing deadlines may be due to circumstances outside of its control, the overall concern with investor protection justifies, in the CSA's view, the threat or issuance of a CTO (as it provides a strong incentive to issuers to prevent a default or diligently rectify it). In the absence of an application for an MCTO, the principal regulator, usually the regulator where the issuer's head office is located, will generally issue a CTO for a Specified Requirement default.
There are key differences between a CTO and MCTO. A CTO will generally be issued where the issuer is not likely to rectify the default within a short period of time and where the circumstances leading to default are likely to continue, such as may be the case with issuers that no longer have an active business, are insolvent, or have lost a majority of their board members. A CTO will generally provide that no person or company may trade in or acquire the securities of the defaulting issuer. This can have dramatic consequences for an issuer, including the loss of the ability to access capital, deterioration of the issuer's goodwill, and investors who are angry because they are unable to sell their securities.
On the other hand, an issuer is eligible to apply for an MCTO if it demonstrates that it has a history of complying with continuous disclosure obligations, that the default will be rectified quickly (usually two months) and is not likely to be recurring. In addition the issuer must:
- be generating revenue or, if it is in the developmental stage, actively seeking business opportunities;
- have a significant number of directors, and the financial and human resources to rectify the default in a timely fashion;
- be listed on a Canadian Stock Exchange and not be thinly traded; and
- not be a defaulting issuer for any reason other than the default at issue.
Essentially, the MCTO is part of a 'voluntary' process where only management and specific insiders will be subject to the cease trade order. Unlike a CTO, an MCTO offers the significant advantages of allowing non-management and non-insider investors to continue to trade in the securities of an issuer and continued access for the issuer to financing. This can limit the damage a continuous disclosure default may have on an issuer's reputation. The principal regulator, if it considers an MCTO appropriate, retains the discretion to subject members of the board or other persons or companies to the MCTO.
Applying for an MCTO
An application to the principal regulator should be made two weeks in advance of the default, or if this deadline is missed despite the use of reasonable diligence, the application should be accompanied by an explanation for the delay. The application for the MCTO should include:
- a description of how the issuer satisfies the eligibility criteria;
- the identification of the default, the reasons for the default, and the anticipated duration of the default;
- a detailed remediation plan to remedy the default, along with a realistic timetable for doing so;
- consent of the parties subject to the MCTO;
- an undertaking of the issuer to refrain from acquiring securities from, or issuing securities to, insiders or employees, except if legally obligated; and
- a description of the issuer's blackout policies and other policies and procedures relating to insider trading.
An MCTO will not be issued until a default announcement is filed by the issuer, which the CSA expects to occur at least two weeks prior to default. As soon as an issuer determines that it will not meet the Specified Requirement deadline, it must determine whether the default or the events leading to the default constitute a material change. If so, a news release and material change report must be filed. If the material change report contains all the information required in a default announcement, the issuer need not issue a separate default announcement.
Once an MCTO is issued, the issuer must also file default status reports every two weeks providing updates on matters such as the progress in rectification of default or failure to meet the rectification plan. Failure to file the default status reports will result in a CTO being issued. An issuer may omit confidential information from the default announcement or default status report if the issuer reasonably considers the disclosure to be unduly detrimental to the interests of the issuer.
Consequences of a CTO or MCTO
A CTO or MCTO can not only damage the reputation of a reporting issuer, it can also sully the reputation of promoters, directors, CEOs or CFOs of issuers for 10 years after such an order. These individuals are required to disclose in certain public filings whether, at any time in the past 10 years, they were a director, CEO or CFO of any company that was subject of an MCTO or CTO that was in effect for at least 30 consecutive days while they held their office, or which MCTO/ CTO resulted from an event that occurred while they held their office. This disclosure is required even if the director, CEO or CFO was not named in the MCTO. A CTO and MCTO must be disclosed by:
- directors or executive officers in annual information forms and long form prospectuses;
- proposed directors in an information circular relating to the election of directors; and
- promoters in a short form prospectus.
In 2007 the Ontario Securities Commission issued 104 CTOs for failing to comply with continuous disclosure filing requirements, with the majority being issued for failing to file financial statements and management discussion and analysis on time. Approximately 75% of all cease trade orders resulted from the failure to file annual filings, and 25% resulted from failure to file interim filings. The disproportionate amount of CTOs issued for annual filings is likely a reflection of the additional preparation required and difficulties that reporting issuers encounter in obtaining auditor approval of their financial statements within the applicable filing deadlines.
The possibility of having any type of CTO issued against a reporting issuer underscores the importance of meeting the Specified Requirements. While management is involved in the 'hands on' day-to-day activities of an issuer, the reality for many directors reflects more of a 'hands-off ' approach. Nonetheless, directors must make it a priority to ensure they are apprised of the issuer's progress towards meeting the Specified Requirement filing deadlines by implementing a tickler system or equivalent. Failure to implement these processes puts promoters, CEOs, CFOs and directors at risk of being stigmatized and embarassed over disclosing a past default in public filings.
Should a default occur, issuers should monitor trading by management and other insiders and remind them of blackout periods and other related insider trading procedures and policies because of the increased risk that they may have access to material undisclosed information that would have been available to the public, if not for the default or deficiency.