Timely Disclosure

Timely Disclosure

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

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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5 things you should know about the latest CSA staff review on gender diversity

It’s fall, which means it’s time for the annual Canadian Securities Administrators staff review of disclosure made by public companies under Form 58-101F1 Corporate Governance Disclosure, particularly as it relates to gender diversity among corporate leadership. The 2018 review is the fourth such annual review, with previous reviews having been published in 2015, 2016, and 2017.

Here are the five things you should know about the 2018 staff review. For more details, access the full publication of CSA Multilateral Staff Notice 58-310 Report on Fourth Staff Review of Disclosure regarding Women on Boards and in Executive Officer Positions. Publication of the review’s full dataset follows later in the fall. In this post, the term “public company” refers to a reporting issuer captured in the 2018 staff review.[1]

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BCSC Proposes Electronic Filing of Annual Reports of Exempt Distributions

The British Columbia Securities Commission (BCSC) published proposed amendments (Proposed Amendments) to British Columbia Instrument 13-502 Electronic Filing of Reports of Exempt Distribution that would require investment fund issuers to use BCSC eServices when submitting Form 45-106F1s filed on an annual basis (currently these annual filings are submitted as paper filings to the BCSC).  The Proposed Amendments would allow payments to be made through BCSC eServices or by cheque.

The Proposed Amendments will result in all non-reporting issuer investment funds to set up a profile in the BCSC eServices in advance of their initial Annual Form 45-106F1 filing in B.C.

 The comment period is open until November 20, 2018.

OSC LaunchPad – Annual Summary Report

The Ontario Securities Commission released OSC Staff Notice 33-749 Annual Summary Report for Dealers, Advisers and Investment Fund Managers on August 23, 2018 (Staff Notice).

The Staff Notice included, at Part 1.3, a review of the recent activities of the OSC LaunchPad.  The LaunchPad is actively engaged with novel fintech businesses providing support in navigating regulatory requirements.  The Staff Notice highlighted the following key accomplishments of the OSC LaunchPad in fiscal 2017-2018:

  • 242 Meetings with fintech businesses and stakeholders
  • 156 requests for support received and direct support provided to fintech businesses
  • 55 events hosted by the OSC LaunchPad or in which it participated
  • 25 collaborative reviews with the Canadian Securities Adminstrators’ Regulatory Sandbox regarding novel business models that want to operate across Canada.

Although the industry was initially focussed on online advisors, online lenders and crowdfunding portals, OSC Staff advised in the Staff Notice that industry focus has largely shifted to cryptoasset-related businesses, including initial coin and token offerings, cryptoasset investment funds, traditional financial service businesses utilizing blockchain technology and crypto asset trading platforms.  In addition, the OSC Launchpad is seeing businesses focussed on RegTech services, technology-based compliance solutions and data analytics services.

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CSA Amends Requirements for Reporting Exempt Distributions

The Canadian Securities Administrators (CSA) published amendments (Amendments) to National Instrument 45-106 Prospectus Exemptions and CSA Staff Notice 45-308 Guidance for Preparing and Filing Reports of Exempt Distribution under 45-106 to change the information required within Form 45-106F1 Report of Exempt Distribution (Report).

The Amendments provide more flexibility regarding the certification requirement, streamline the information required to be gathered by filers and address certain concerns raised by foreign dealers and Canadian institutional investors.  The main changes to the Report are provided below.

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OSC Staff Notice Comments on Fund Manager Oversight of Related Party Service Providers

The Ontario Securities Commission released OSC Staff Notice 33-749 – Annual Summary Report for Dealers, Advisers and Investment Fund Managers on August 23, 2018 (OSC Staff Notice).

In the OSC Staff Notice, OSC staff identified that some investment fund managers (IFMs) have outsourced fund administration functions (including fund accounting and transfer agency) to related parties.  Under National Instrument 31-103 Registration Requirements, Exemptions and Ongoing Registrant Obligations, IFMs are required to establish a system of controls and supervision to ensure compliance with securities legislation and are responsible and accountable for all functions that they outsource to a service provider.  Accordingly, IFMs should not rely solely on the related service provider and assume that all obligations under securities legislation are being met.

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