Timely Disclosure

Timely Disclosure

Updates and Commentary on Current issues in M&A, Corporate Finance and Capital Markets

Think Before You Send: The Legal Risks of Emails and Text Messages from Personal Accounts

If the Hillary Clinton email scandal wasn’t a clear enough lesson that one should not conduct “official” work using personal electronic communication tools (be it personal email, texts or other methods), a number of recent court decisions have required executives to produce communications from their personal accounts and devices. Executives and advisors should not assume that communications using methods other than corporate email will somehow be protected or otherwise not find the light of day in the event of a dispute or investigation.

John Schnatter v. Papa John’s International, Inc.

During an earnings call in November 2017, John Schnatter (“Schnatter”), the founder of Papa John’s International, Inc. (the “Company”), criticized the National Football League’s handling of the dispute between players and owners regarding national anthem protests. Some months later, Forbes reported that Schnatter had used a racial slur during a Company diversity training exercise. Schnatter subsequently resigned as chairman of the Company’s board of directors (the “Board”) at the Board’s request, but declined to resign as a director. The Board then established a special committee which decided to terminate agreements that the Company had with Schnatter.

In the wake of these events, Schnatter requested books and records from the Company, including emails and text messages from personal accounts and devices of the Company’s executives.

On January 15, 2019, the Court ordered the Company to permit Schnatter to inspect the personal accounts and devices of certain executives that were used to communicate about the possibility of changing Schnatter’s relationship with the Company. Chancellor Bouchard stated that executives should expect to provide such information in litigation if they choose those mediums to discuss corporate matters. Although there is no bright-line rule with respect to the inspection of executive’s personal accounts and devices, Chancellor Bouchard noted several factors that influenced the Court’s decision, including:

  • the Company’s directors did not have Company email addresses; and
  • the Company did not introduce at trial “a policy indicating that it views any information from the personal accounts or on the personal devices of its directors or officers to be ‘personal unrestricted information’ outside the control of the Company.”

In re Appraisal of Kate Spade & Co.

In 2017, former shareholders of Kate Spade & Co. (“Kate Spade”) sought appraisal of their securities following Coach Inc.’s (“Coach”) acquisition of Kate Spade. In response to interrogatories, Kate Spade asserted that none of its executives engaged in communications over email or text from their personal accounts or devices concerning the negotiation of the transaction with any executives of Coach. However, documents produced by Kate Spade indicated the possible existence of text messages between two of the executives. The former shareholders then moved to compel the production of such communication arguing that some of the executives had prior social relationships that could have given Coach an advantage in the negotiation process.

In a transcript ruling, the Court ordered Kate Spade to produce the relevant text messages. Chancellor Bouchard took the opportunity to discuss the value that can be derived from text messages: “It has been my experience that text messages can be the source of a lot of probative information in cases, particularly when they’re covered with emojis and other things of that nature. … Maybe a text message will show a personal relationship. Maybe it won’t show that. But, frankly, just the precision of timing of exactly when certain things happened is extremely important in cases. … And so I have found, frankly, text messages to be probative in that regard.”

Takeaways

These cases should serve as a useful reminder that directors, officers and advisors should endeavor to conduct company business only on their company accounts and devices and not on their personal accounts and devices. Once it is established that an executive uses a personal email account or device to conduct company business, those personal accounts or devices will likely be subject to discovery, which could result in sensitive or embarrassing personal information being produced. Although these rulings are not binding on courts in Canada, it was not too long ago that the Ontario Superior Court of Justice allowed a tier-one Canadian bank to inspect the emails of its former executives in connection with their move to form a competing financial services firm.

In order to protect information on an executive’s personal devices and accounts, companies should consider: (1) providing company email addresses and devices to the exectuive on which to communicate regarding company business; and (2) adopting a policy restricting the communication of company business on personal accounts and devices.

Competition Act and Investment Canada Act Thresholds Announced for 2019

The Competition Bureau announced the 2019 transaction-size pre-merger notification threshold under the Competition Act increased to C$96 million from C$92 million, effective February 2, 2019. Innovation, Science and Economic Development Canada also announced new foreign investment review thresholds under the Investment Canada Act, effective January 1, 2019.

For more information about the new thresholds under the Competition Act and Investment Canada Act, see the Competition Chronicle.

Power and Influence: New CBCA Registration Requirements for Private Companies

 

As of June 13, 2019, private corporations incorporated under the Canada Business Corporations Act (CBCA) must maintain a register regarding individuals who have “significant control” over the corporation through direct or indirect influence. This requirement was one of several new initiatives included in Bill C-86, the Budget Implementation Act, 2018, No. 2 which received Royal Assent on December 13, 2018.

New Conditions

Individuals will fall within the category of having significant control if the following triggers are present:

  • ability to control the corporation through indirect or direct influence; or
  • being the beneficial or registered owner of, or having the control or direction over, either indirectly or directly, a “significant number of shares” of the corporation (the threshold for such control is being 1) the owner of 25% or more of the outstanding shares of the corporation or 2) owning 25% or more of the outstanding number of voting shares of the corporation.

Non-Compliance Penalties

The punishment for intentionally disregarding the new requirements will consist of six months imprisonment and/or a fine up to $200,000. Parties potentially impacted by these consequences include shareholders, corporations, directors and officers.

Registration Requirements

The register for individuals with significant control of the corporation must contain the information below:

  • name, birthdate and latest address;
  • jurisdiction of residence for tax purposes;
  • date when individual obtained significant control and ceased to hold significant control of the corporation;
  • description of how the individual has significant control of the company;
  • description of the reasonable steps taken by the corporation in each financial year to ensure the register is complete and accurate; and
  • any other prescribed information as set forth in any regulations.

After the register has been created the corporation must be diligent as it pertains to keeping it up to date through at least one check during the fiscal year to see if additional individuals satisfy the significant control category.

The exact mechanics concerning the preparation and maintenance of the register will be shared through upcoming registration requirements.

Increased Transparency

Despite the new registration requirements currently applying only to private corporations formed under the CBCA, this move is a part of a potentially growing trend. Recent Recommendations in the House of Commons Standing Committee on Finance’s report on the Proceeds of Crime (Money Laundering) and Terrorist Financing Act highlight a potential transition to a universal registry to be applied both federally and to the respective provinces and territories.

The U.S. Government Shutdown: Ripple Effects North of the Border

Now in its fifth week, the U.S. federal government shutdown has become the longest in U.S. history. The partial shutdown began on December 22, 2018, following a stalemate between Congress and President Donald Trump over funding for a wall at the Mexican border. Many government services and agencies have been halted: NASA, the Smithsonian museums, the National Gallery of Art, the National Park Service. Others, like the postal service, social security, the Pentagon and the FBI, remain open due to the critical nature of the services they provide. To date, more than 800,000 federal employees have been furloughed or are working without pay, resulting in more than US$200 million in unpaid wages every workday. By tomorrow, federal district courts will have run out of funds.

North of the border, the situation is not as dire, although Canada is feeling the ripple effect of the budget impasse. For one, Canadian businesses contracting directly with the U.S. government are likely searching for ways to cope with, and in some cases survive, the shutdown. Travellers heading south may experience delays as many Transportation Security Administration workers have been calling in sick, refusing to work without pay. And as a result of partial closures at the U.S. Department of Agriculture (USDA) and the Food and Drug Administration (FDA), Canadian restaurants and grocery stores may be under pressure to find alternative sources of produce in cases where routine assessment or clearance by the USDA or the FDA is required for food imports into Canada.

Not the least of the negative ramifications of the shutdown this side of the border has been the impact on Canada’s capital markets.

Since December 27, 2018, the U.S. Securities and Exchange Commission (SEC) has been operating with very limited staff. Departments that perform key functions, such as monitoring the markets and responding to emergencies, continue to operate pursuant to the agency’s Operations Plan Under a Lapse in Appropriations and Government Shutdown. The SEC’s Division of Enforcement, for instance, continues to monitor the Tips, Complaints and Referrals system for reports alleging misconduct or harm to investors. Applications for restraining orders and investigations into fraud remain in play. The SEC’s electronic filing system, EDGAR, also remains open, allowing filers to obtain access codes and make certain filings.

A number of the SEC’s major functions have been temporarily discontinued, however. Non-emergency interpretative advice is currently unavailable, so inquiries relating to cross-border mergers, for example, are being put on hold. Processing of new and pending applications for exemptive relief and non-emergency assistance to Canadian authorities under any bilateral or multilateral arrangements have been suspended. And although the SEC continues to receive registration statements, offering statements and other documents, declaring registration statements effective and approving offerings have been halted, leading to a growing backlog of applications by registrants and issuers in the United States and Canada alike. Long-anticipated IPOs will need to wait for the standoff to end.

It is unclear how long the shutdown will last. Analysts estimate, though, that if the fallout continues for an extended period of time, the American economy (and consequently the Canadian economy) could face significant setbacks. For the sake of all those affected by the shutdown, including Canadian businesses and individuals, it is hoped that the standstill will come to an end sooner rather than later.

Streamlining Processes and Procedures: Objectives for the Burden Reduction Task Force

Recently, the Ontario Securities Commission, in coordination with the Ministry of Finance, created a Burden Reduction Task Force. The goal of this initiative is to enable Ontario’s businesses and markets to innovate, better compete with other jurisdictions and flourish as the regulatory load is reduced while not diminishing the safeguards in place for Ontario investors.

This Task Force will support the Government of Ontario’s Open for Business Action Plan by identifying short- medium- and long-term steps that can benefit Ontario by facilitating increased competitiveness by saving money and time for investors, issuers, registrants and other members in the financial markets. The comprehensive consultation is fully supported by the government and seeks to enable the transformation of inefficient past practices.

Areas for Market Input

The Task Force has selected various areas of interest where it encourages feedback from stakeholders concerning ways to reduce unnecessary burdens that include:

  • Increased efficiencies concerning day-to-day engagement with the OSC through cost savings as it pertains to procedural or operational processes
  • Eliminating filings and forms which are not needed or unnecessarily difficult for market participants along with providing easier access to information provided by the OSC
  • Harmonization of OSC requirements with other jurisdictions thereby reducing inconsistencies and costs

Engagement

By March 1 stakeholders are encouraged to share suggestions with the OSC by using the Burden Reduction Survey or through e-mail at comments@osc.gov.on.ca. On March 27 market participants interested in discussing proposed changes should join the OSC hosted roundtable which will require the submission of a comment letter to the OSC.

The Big MAC: Affirmed

Days ago, the Supreme Court of the State of Delaware issued an order succinctly affirming the Delaware Court of Chancery’s judgment from October this year that found Fresenius Kabi AG had no obligation to close its proposed merger with Akorn, Inc. and Fresenius properly terminated the merger agreement on April 22, 2018 largely as a result of Akorn having suffered a material adverse effect (MAC).

The Court of Chancery’s decision is notable for a number of reasons, but the main attraction is the fact that the decision is generally understood to represent the first time a Delaware court has allowed a buyer to walk away from a public company merger on the basis of a contractual MAC provision.

Why it Matters

Merger agreements almost always allow the buyer to “walk” if the target suffers a MAC before closing or if the target’s representations are not true at closing subject to a MAC qualifier. As a result, the MAC definition is often hotly contested notwithstanding the fact that prior to Akorn nobody was successful in walking away on the basis that a MAC occurred. The Delaware courts have been very reluctant to find a MAC, trying to balance respect for the written terms of an agreement with an aversion to facilitating buyer’s regret.

The Decision

In a 246 page document, the Court of Chancery described the question of whether Akorn had experienced a MAC as a “straightforward issue” of contractual interpretation. It helped that the facts were ugly: during each of the four quarters following signing, on a year-over-year basis, Akorn’s revenues declined between 29% and 34%, its operating income declined between 84% and 124%, and its earnings per share declined between 96% and 300%. In reaching its decision, the Court of Chancery confirmed prior guidance that a MAC must be both “material when viewed from the longer-term perspective of a reasonable acquirer” and “durationally significant”.

Conclusion

The case does not create new law, but it does confirm that it is possible to find a MAC and provides a factual point of reference that others will turn to when a MAC is inevitably asserted in the future. Although not binding on courts in Canada, the decision is expected to be highly influential given the lack of jurisprudence on the point in Canada and the fact that the Delaware Courts are considered the leading commercial courts in the United States.

Weeding-out a Lack of Disclosure

On October 10, 2018, the Canadian Securities Administrators (CSA) issued CSA Staff Notice 51-357 Staff Review of Reporting Issuers in the Cannabis Industry (Staff Notice) summarizing a review of the disclosure of 70 reporting issuers[1] in the cannabis industry (Cannabis Issuers). The purpose of the review was to highlight best disclosure practices and common deficiencies among Cannabis Issuers. The CSA concluded that Cannabis Issuers need to improve their disclosure in the following areas:

  • insufficient information is provided by licensed cannabis producers (LPs) in their financial statements and their Management’s Discussion & Analysis (MD&A);
  • Cannabis Issuers are sometimes not consistently complying with securities requirements to provide forward-looking information and balanced disclosure; and
  • 74% of Cannabis Issuers that currently engage in, or are developing, cannabis-related activities in the U.S. (U.S. Cannabis Issuers) failed to include adequate disclosure as set out in CSA Staff Notice 51-352 (Revised) Issuers with U.S. Marijuana-Related Activities (U.S. Disclosure Notice) about the risks related to their U.S. operations.

Findings

The CSA focused their review on the following areas: a need for more transparent financial disclosure, U.S. Cannabis Issuers and their disclosure requirements and other key considerations.

  1. Financial Disclosure

Impact of Fair Value Accounting on Financial Statements

LPs are required to measure living plants or biological assets at their fair value under International Financial Reporting Standards. The CSA noted that LPs often did not properly disclose fair value amounts in their statement of profit and loss. As such, the CSA reported that investors were unable to understand how much LPs actually paid to produce their cannabis.

The CSA have concluded that LPs should disclose both:

  • unrealized gains/losses resulting from fair value changes relating to the growth of cannabis; and
  • any realized fair value amounts included in the cost of inventory sold.

Disclosure of Accounting Policies Related to Biological Assets

The Staff Notice concluded that the majority of LPs had profit and loss line items allocated to “production costs” or “cost of goods sold”. However, LPs did not typically discuss the composition of these line items. Therefore, LPs should consider:

  • identifying the direct and indirect costs of the production associated with cannabis; and
  • whether the direct and indirect costs of cannabis are capitalized or whether they are expensed.

If these costs are expensed as they are incurred, the CSA concluded that LPs typically did not include sufficient financial disclosure relating to:

  • the price of the cannabis sold;
  • the calculation of the gross profit subtotal;
  • the fair value measurement process; and
  • non-GAAP financial measures (an example includes, “cash cost per gram”).
  1. Issuers with U.S. Cannabis-Related Activities

The Staff Notice referenced the U.S. Disclosure Notice and reminded Cannabis Issuers that US Cannabis Issuers are expected to disclose:

  • a description of the Cannabis Issuer’s involvement in the U.S.;
  • disclosure that cannabis is illegal under U.S. federal law and any significant risks associated with this, such as restrictions provided by regulatory bodies;
  • a quantification of the Cannabis Issuer’s balance sheet and operating statement which identifies exposure to U.S. cannabis-related activities;
  • an analysis of the Cannabis Issuer’s ability to access public and private capital; and
  • additional disclosures depending on whether the Cannabis Issuer has direct, indirect or ancillary involvement in U.S. cannabis activities.

The CSA have been actively reviewing U.S. Cannabis Issuers’ disclosure and as a result of the review conducted, in connection with drafting the Staff Notice, 17% of U.S. Cannabis Issuers were required to refile their most recent MD&A.

  1. Other Key Considerations

The CSA highlighted other important considerations for Cannabis Issuers which included:

Material Contracts – Consider filing licence agreements or lease facility agreements as material contracts.

Regulatory Frameworks – For those operating outside North America, appropriate disclosure must be made relating to the international regulatory framework applicable to their business. For example, the need for Cannabis Issuers with U.S. operations to disclose recent statements made by the U.S. Customs and Border Protection Agency about the admissibility of those working in, or facilitating the legal cannabis industry into, the United States.

Production Estimates – When disclosing anticipated production capacity in new facilities, consider disclosing the material factors and assumptions related to those projects.

Conclusion

Moving forward, Cannabis Issuers should consider reading the Staff Notice to ensure their disclosure conforms to CSA guidance. For further information on the Staff Notice or continuous disclosure requirements, please contact a member of our Corporate Finance & Securities Law Group.

[1]       Of the 70 Cannabis Issuers reviewed, 21 were LPs, 23 were U.S. Cannabis-Issuers and 31 were classified as other Cannabis Issuers.

A Strong Voice for Enhanced Corporate Governance: Commonsense Principles 2.0

Recently, a group of prominent executives released an open letter and document known as Commonsense Principles 2.0. Signatories include Mark Machin of the Canada Pension Plan Investment Board and Warren Buffett of Berkshire Hathaway. The purpose of the letter and the principles is to encourage companies to embrace a long-term view and enhance trust between investors and companies to improve the health of public capital markets. By virtue of the parties to the letter and the thoughtful nature of the principles themselves, the principles are expected to have a meaningful influence on governance practice and debate. Although American in focus, the principles and issues they address are meaningful for Canadian companies and investors as well.

The Commonsense Principles 2.0 update a set of principles known as the Commonsense Principles of Corporate Governance, released slightly more than two years ago. The revised principles generally reflect incremental, yet important, changes. For example, the first principle, which concerns the directors’ duty of loyalty and care, previously stated that the directors’ loyalty “should be to the shareholders and the company”. The revised principle now states that “[d]irectors are accountable to shareholders and owe duties of loyalty and care to the company” and that director performance “should be evaluated through a company’s long-term performance, financial and otherwise”. Other changes largely reflect recent developments in governance best practices in areas such as director elections, shareholder engagement and proxy access and the explicit change that the principles should apply to asset managers and institutional asset owners.

Each of the letter’s signatories has committed to applying the principles in their businesses. A list of the companies and investors that have agreed to follow the principles will be maintained on the website for Columbia Law School’s Millstein Center for Global Markets and Corporate Ownership. However, the authors acknowledge that there is significant variation among public companies, and that not every principle will be applied in the same fashion (or at all) by every company, board or institutional investor.

The Supreme Court of Canada Green Lights National Securities Regulatory Regime–Who Will Drive Ahead?

The Supreme Court of Canada (SCC) released its decision on November 9, 2018, holding that the proposed co-operative pan-Canadian securities regulator, known as the Cooperative Capital Markets Regulatory System (CCMR), is constitutional.

Background and Analysis

The CCMR first emerged in 2014 following the rejection of an earlier proposal by the SCC in 2011 on the basis that the main thrust of the earlier proposal was for the federal government to regulate, on an exclusive basis, all aspects of the trade in securities in Canada.

The CCMR was developed by Ontario, British Columbia, Saskatchewan, Prince Edward Island, New Brunswick, Yukon, and Canada and is comprised of four key elements:

  1. A federal law, the Capital Markets Stability Act, addressing criminal matters, matters related to systemic risk and national data collection;
  2. Uniform provincial/territorial securities laws based on a model Capital Markets Act;
  3. A national securities regulator, the Capital Markets Regulatory Authority, whose powers would be delegated to it by the federal, provincial and territorial governments; and
  4. A council (Council of Ministers) comprised of the ministers responsible for capital markets regulation in the participating provinces/territories and the federal Minister of Finance that would supervise the Capital Markets Regulatory Authority and approve certain proposed legislative changes and regulations.

Quebec and Alberta opposed the CCMR, and Quebec referred the matter to the Quebec Court of Appeal.  The Quebec Court of Appeal took issue with the fourth element of the CCMR on the basis that the Council of Ministers and its power to amend legislation and adopt regulations infringes on the legislative sovereignty of the participating jurisdictions and reflects an impermissible delegation of authority.

The matter was then referred to the SCC, who unanimously reached a different conclusion. Namely, that the Constitution of Canada authorizes the implementation of the CCMR, and that the proposed system does not improperly fetter provincial sovereignty and does not entail an impermissible delegation by the Parliament of Canada of law-making authority, and that the proposed federal act does not exceed the authority of Parliament over provincial powers related to the regulation of trade and commerce.

Next Steps

Although the decision removes uncertainty as to the constitutional validity of the proposed system, provincial and territorial legislatures are not required to join.  It remains to be seen if, and which of, the various governments will move forward on the proposed system.

The New Liquid Alt Funds Regime – and some changes for conventional mutual funds and closed-end funds

On October 4, 2018, the Canadian securities administrators published the final version of the amendments that will create a new regime for liquid alternative mutual funds (alt funds).

The regime will come into effect on January 3, 2019 and could provide retail investors with greater access to alternative investment strategies, including leveraged and market neutral portfolios.

Leverage

Key to the regime is the ability of alt funds to use leverage. The leverage limit is effectively set at 4X the alt fund’s net asset value (NAV) and can be achieved through a combination of derivatives (alt funds are not required to hold cover for their derivatives), short selling (alt funds do not need to set aside cash cover for their short sales, and can reinvest their short sale proceeds in additional long positions) and borrowing. There will be a cap set at 50% of NAV for the aggregate amount of exposure through short sales and borrowing, with a further cap of 10% per issuer sold short (other than government securities). These caps are somewhat arbitrary within the overall 4X leverage limit, but are based on the investment restrictions the securities regulators saw in the closed-end fund space. Accordingly, 130/30 funds and other levered funds can be launched as alt funds, but the 50% cap on short sales means that a market neutral fund using a pairs trading strategy will need exemptive relief.

Interestingly, the final amendments include a new feature allowing alt funds to enter into derivatives with counterparties who do not have a designated rating.

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