Each year the Corporate Finance Branch (the “Branch”) of the Ontario Securities Commission (the “OSC”) releases a report providing an overview of the operational and policy work completed during the year, future policy initiatives and how the OSC interprets and applies its rules in certain areas. On October 4, 2018, the OSC released the 2017-2018 annual report (the “Annual Report”). Some of the key compliance and regulation highlights are discussed below.
Continuous Disclosure Review Program
The Branch reviews the continuous disclosure for reporting issuers where the OSC is the principal regulator. Reviews are either full reviews (a broad review of the issuer’s continuous disclosure) or issue-oriented reviews (focused on a specific accounting, legal or regulatory issue). Based on the full reviews, the following are some of the trends and guidance identified by the Branch:
- Management Discussion and Analysis: A reporting issuer’s MD&A is one of the top two documents the Branch most often requests issuers to refile or file in the first place. Common areas of deficiencies noted by the Branch are found in the discussion of liquidity and capital resources, operations, risks and uncertainties, changes in accounting policies (including initial adoption) and the summary of quarterly results. The Annual Report contains best practices to improve each of these areas.
- Mining Technical Reports: Mining technical reports are the second disclosure document most often requested to be refiled (or filed) by the Branch. The Branch continues to see non-compliant disclosure of preliminary economic assessments in technical reports.
- Non-GAAP Financial Measures: The prominence of non-GAAP disclosure and the lack of transparency continues to be of concern to the OSC. The Branch reminds issuers to follow the guidance in the Canadian Securities Administrators’ (the “CSA”) Staff Notice 52-306 (Revised) – Non-GAAP Financial Measures and provided the following summary of staff expectations regarding non-GAAP financial measures:
- state explicitly that the non-GAAP financial measure does not have any standardized meaning;
- name the non-GAAP financial measure in a way that distinguishes it from disclosure items specified, defined or determined under an issuer's GAAP and in a way that is not misleading;
- explain why the non-GAAP financial measure provides useful information to investors and the additional purposes, if any, for which management uses the non-GAAP financial measure;
- present with equal or greater prominence to that of the non-GAAP financial measure, the most directly comparable measure specified, defined or determined under the issuer's GAAP;
- provide a clear quantitative reconciliation from the non-GAAP financial measure to the most directly comparable measure specified, defined or determined under the issuer's GAAP;
- ensure that the non-GAAP financial measure does not describe adjustments as nonrecurring, infrequent or unusual, when a similar loss or gain is reasonably likely to occur within the next two years or occurred during the prior two years; and
- present the non-GAAP financial measure on a consistent basis from period to period.
Looking ahead, the OSC is replacing Staff Notice 52-306 (Revised) with Proposed National Instrument 52-112 – Non-GAAP and Other Financial Measures Disclosure, which is open for comment until December 5, 2018, to improve non-GAAP disclosure and we envision the staff expectations noted above will continue.
- Forward Looking Information: Forward looking information (“FLI”) should include valuable insight into the reporting issuer’s business and how the issuer plans to attain its objectives and targets. The Branch has included best practices and presentation tips in the Annual Report for forward looking information, which includes the following advice:
- clearly identify FLI so that readers are not confused and treat it as historical information;
- adequately describe the key assumptions used and how primary risks may impact future performance;
- disclose assumptions specific to the issuer;
- issuers presenting FLI for multiple years should ensure FLI is supported by reasonable qualitative and quantitative assumptions that are disclosed;
- include a discussion of the events and circumstances that occurred during the period and the IMPACT on the original target; and
- a comparison of the actual results to the future-oriented financial information (FOFI) or financial outlook originally disclosed in previous documents allows investors the opportunity to assess the reasonableness of previous disclosure and adjust their expectations.
- Investment Entities: Some reporting issuers determine that they meet the criteria to be an “investment entity” under IFRS 10 Consolidated Financial Statements and measure substantially all of their investments at fair market value through profit and loss, including their investment in subsidiaries. The Branch reminds such issuers that investee specific financial information and operational disclosure necessary to inform an investment decision must be provided.
- Crypto-asset Sector Disclosure: Given the significant growth in the blockchain and crypto-asset sector over the past year, the Annual Report reminds these entities that investors need to be provided with sufficient information to understand their business and disclosure must comply with National Policy 51-201 – Disclosure Standards.
The focus of issue oriented reviews changes each year. In fiscal 2018, the OSC published guidance on the following topics arising out of the issue oriented reviews: (1) distributions disclosures and non-GAAP financial measures in the real estate industry; (2) disclosure regarding women on boards and in executive officer positions; and (3) report on climate-change related disclosure project.
Fiscal 2018 saw an increase in the number of prospectuses reviewed over the prior fiscal year. A key factor for this increase was the increased interest in the cannabis sector. The following are some key takeaways from the Branch’s review of public offering documents:
- The OSC is currently reviewing the requirements for an issuer’s primary business as part of its policy initiative Reducing Regulatory Burden for Non-Investment Fund Reporting Issuers (see our previous blog post on this topic here).
- Deficiencies are found most frequently in the following areas of a prospectus: (1) description of the business and regulatory environment, (2) risk factors relating to the business and/or offering, (3) MD&A disclosure in a long form prospectus, and (4) use of proceeds. The Annual Report provides some best practices to improve disclosure in these areas.
- A receipt for a prospectus will not be issued where the aggregate of the proceeds being raised under a prospectus, together with other resources of the issuer, are insufficient to accomplish the purpose of the offering. Accordingly, the prospectus must contain clear disclosure on how the issuer intends to use the proceeds and on the issuer’s financial condition in order for the OSC to adequately assess whether to issue a receipt.
- Understanding that the cannabis industry varies in terms of legal and regulatory environment across jurisdictions, the Branch has provided some guidance on regulatory disclosure for issuers operating in Canada, the U.S. or foreign jurisdictions in the Annual Report.
Exempt Market Offerings
The Branch worked with the Compliance and Registrant Regulation branch to review issuers that accessed the exempt market repeatedly without using a dealer. The Annual Report identifies various issues found in terms of compliance with prospectus exemptions, including reliance on the accredited investor exemption without taking reasonable steps to verify that the purchaser meets the definition of “accredited investor” and non-compliance with the investment limits under the offering memorandum exemption. The Branch indicated in the Annual Report that it intends to continue integrating its compliance reviews with the Compliance and Registrant Regulation branch reviews for the upcoming year and will prioritize reviews of distributions in the real estate and mortgage sector.
Exemptive Relief Applications
Each year, the Branch reviews the applications for exemptive relief received. In fiscal 2018, applications in connection with reporting issuer status were the main type of application, followed by partial or full revocations of cease trade orders and exempt distributions. The Branch also noted that applications for relief from the business acquisition report requirements has decreased over the past two years.
The Branch also reviews the compliance of reporting insiders and issuers with insider reporting requirements. The Annual Report contains a number of tips and reminders for both reporting issuers and insiders. A key tip for reporting issuers is to ensure compliance with the exemptions under National Instrument 55-104 – Insider Reporting Requirements and Exemptions. For reporting insiders, one of the key tips is to review the continuous disclosure filings of the reporting issuer to ensure that they accurately reflect the reporting insider’s securities holdings and to report any discrepancies to the reporting issuer so that those can be cleaned up.
Designated Rating Organizations
The OSC has the authority to designate a credit rating agency as a designated rating organization. The Branch reviews these designated rating organizations using a risk-based approach. In 2018, Kroll Bond Rating Agency, Inc. was added as a designated rating organization for certain purposes. Looking ahead to 2019, the CSA is planning to amend National Instrument 25-101 – Designated Rating Organizations to reflect the European Union “equivalence/certification” regime.
In conjunction with its reviews, the Branch also considers trends and areas of concern that may require rule making, rule amendments or staff guidance. The following are areas of regulation and guidance that have benefited from, or will be seeing upcoming changes based on, the Branch’s review:
- Exempt Distribution Reporting: The exempt distribution reporting regime has seen various changes over the past year. In particular, on June 19, 2018 the CSA published final amendments to National Instrument 45-106 – Prospectus Exemptions (“NI 45-106”) to amend Form 45-106F1 – Report of Exempt Distribution, which came into force on October 5, 2018. See our previous blog post on these changes here.
- Foreign Issuer Resale Exemption: Effective June 12, 2018, amendments were made to OSC Rule 72-503 – Distributions Outside Canada. These amendments include a new exemption for a resale of securities (and underlying securities) by a “foreign issuer”, which is intended to facilitate participation by Canadian investors in prospectus-exempt offerings by foreign issuers.
- Syndicated Mortgages: Syndicated mortgages are currently exempt from registration and prospectus requirements in Ontario. Concerns have been raised about the current regulatory framework. Accordingly, on March 8, 2018 the OSC and the CSA published proposed amendments to NI 45-106 and National Instrument 31-103 – Registration Requirements, which would substantially harmonize the treatment of syndicated mortgages across the CSA. These amendments would include additional investor protections, such as enhanced disclosure requirements and removing the private issuer exemption.
- Climate Change-Related Disclosures: Disclosure around climate change continues to be a focus of the OSC. The Branch has plans for future work in this area, including: (i) development of guidance and educational initiatives, (2) analyzing risks and opportunities and financial impacts of climate change, and (3) consideration of new disclosure requirements regarding corporate governance in relation to climate change risks.
- Reducing Regulatory Burden for Non-Investment Fund Reporting Issuers: The Annual Report recognizes the pressure that the OSC faces to reduce the regulatory burden for non-investment fund reporting issuers. The OSC continues to look at ways to reduce the regulatory burden and deliver efficient and proportionate regulation. See our previous post on these initiatives here.
- Women on Boards and in Executive Officer Positions: There is now disclosure data from four annual reporting periods regarding women on boards and in executive officer positions pursuant to National Instrument 58-101 – Disclosure of Corporate Governance Practices. Based on these annual reviews, the OSC and CSA are currently reviewing the effectiveness of the National Instrument 58-101 requirements and assessing whether and what changes may be necessary to improve this regime. The purpose of any changes would be to promote effective corporate governance and decision-making through more diverse boards and executive composition.
- Faith-based, Not-for-profit Organizations Distributing Securities: The Branch is aware of several not-for-profit organizations that solicit and sell investment opportunities on a regular basis, including sale and solicitation to retail investors. Such not-for-profit organizations may not be in compliance with applicable securities laws, both the registration and prospectus requirements. As well, the Branch indicates that the activities being undertaken may extend beyond the not-for-profit issuer exemption under Section 2.38 of NI 45-106 and accordingly these not-for-profit organizations will need to comply with other prospectus exemptions.