Canada: Canadian Securities Regulators Propose New Regime For Venture Issuers

Introduction

The Canadian Securities Administrators have published a Notice and Request for Comment in relation to Proposed National Instrument 51-103 Ongoing Governance And Disclosure Requirements for Venture Issuers (the "Proposed Instrument") and accompanying amendments to other instruments. These proposals are designed to introduce a new regulatory regime for venture issuers¹ intended to streamline and tailor issuer disclosure to reflect the needs and expectations of venture issuer investors and to make the disclosure requirements for venture issuers more suitable and manageable for issuers at this stage of development. The deadline for submitting comments to the Canadian Securities Administrators relating to the Proposed Instrument is October 27, 2011.

According to the Canadian Securities Administrators, the overarching goals of the proposed amendments are to provide more tailored disclosure to enhance informed investor decision making in this segment of the market and to revise the prospectus and exempt offering regime for venture issuers to more closely conform to the new governance and disclosure regime.

The most significant proposals introduced by the Proposed Instrument are:

• The elimination of three and nine month interim financial statements and associated MD&A;
• introduction of a new mid-year report including a six month interim financial report, associated MD&A and CEO/CFO certifications;
• introduction of a new annual report combining into one document corporate governance and executive compensation disclosure, audited financial statements, associated MD&A and CEO/CFO certifications;
• streamlining of the information circular requirements to provide only that disclosure strictly necessary in respect of the matters to be voted upon;
• elimination of Business Acquisition Reports in favour of material change report-style reporting, via a "Report of Material Change, Material Related Entity Transaction or Major Acquisition";
• introduction of tailored director and executive compensation reports in a single section of the new annual report document (as opposed to the information circular);
• introduction of substantive corporate governance obligations addressing conflicts of interest, related party transactions and insider trading; and
• requiring the delivery of disclosure documents only on request, in lieu of mandatory mailing requirements.

The Most Significant Proposals

Elimination of Three and Nine Month Interim Financial Statements and Associated MD&A

One of the more significant proposals is to eliminate the requirement to produce three and nine month interim financial statements and associated MD&A. The rationale behind this proposal is that publicly traded issuers in certain high-profile international markets such as the U.K., Europe and Australia are not required under their securities laws to provide three and nine month interim financial statements. Although regulatory comparability with U.S. standards can be important to market participants in Canada to attract U.S. investors, the Canadian Securities Administrators feel this concern is less applicable to the venture markets as issuers are more likely to be raising funds on a more regional basis.

Venture issuers would still have the option to elect to voluntarily file interim financial reports and/or MD&A for three and nine month interim periods. Should a venture issuer elect to file optional interim financial reports, it would be required to do so for a minimum period of two years.

New Mid-Year Report

The Proposed Instrument would require a mid-year report that includes a six month interim financial report, associated MD&A and CEO/CFO certifications. The mid-year report would be required 60 days after the end of the mid-year period. The mid-year report would require details of material related party transactions and disclosure of securities transactions by reporting insiders in the venture issuer's securities during the prior six months, as well as other minor, routine disclosure.

New Annual Report

The Proposed Instrument will require venture issuers to prepare and file a new form of disclosure document, an annual report, within 120 days of their financial year end. The annual report will combine into one document business governance and executive compensation disclosure, audited financial statements, associated MD&A and CEO/CFO certifications. The rationale behind this proposal is that an annual report would assist investors by providing a document that annually consolidates key disclosure. Additionally, because the annual report will be treated as equivalent to an Annual Information Form for this purpose, venture issuers would have access to the short form prospectus offering system as well as to the exempt offering regimes that currently require the preparation of an AIF.

The proposed annual report differs from an AIF in a number of ways including: only requiring a two-year business history rather than a three year history, not requiring disclosure of interests of experts, simplifying the business disclosure and consolidating both the biographical and the compensation disclosure for directors and executive officers.

The proposed annual report differs from the current annual MD&A requirements in that it would eliminate disclosure of selected annual financial information and the two-year summary of quarterly results. The proposed annual report instead provides new requirements to disclose objectives, targets and milestones and performance against those targets.

For mining venture issuers, a NI 43-101 technical report will be triggered if the issuer's annual report contains disclosure of the type that would trigger a technical report under paragraph 4.2(1)(j) of NI 43-101 (i.e., first time disclosure of mineral resources, mineral reserves or a preliminary economic assessment or a change to that disclosure, if that change constitutes a material change for the issuer).

Replacement of Current Corporate Governance, Disclosure and Certification Obligations

The Proposed Instrument would replace the corporate governance, disclosure, and certification obligations of venture issuers which are currently covered by NI 51-102 Continuous Disclosure Requirements, 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. Consolidating these four instruments would eliminate or reduce many duplicative provisions such as definitions and instructions as well as removing duplicative disclosure requirements. The Proposed Instrument would eliminate companion policies and replace them with short guidance notes in the body of the instrument. The text of the new rules would be shorter as they would not include disclosure requirements for matters that are not generally applicable to venture issuers.

Streamlining Information Circular Requirements

The Proposed Instrument contains an information circular form that is a streamlined version of the requirements that currently exist under NI 51-102 (i.e., Form 51-102F5). It is proposed that only disclosure strictly 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, as this information would instead be required in the annual report.

Elimination of Business Acquisition Reports

The current Business Acquisition Report requirement would be eliminated under the Proposed Instrument. These type of business acquisition transactions would be subject instead to material change report-style reporting, via a "Report of Material Change, Material Related Entity Transaction or Major Acquisition". Financial statements would only be required for acquisitions that are deemed to be significant to the issuer, the significance threshold being 100% of the issuer's market capitalization.

Tailored Director and Executive Compensation Disclosure

The Proposed Instrument would have the disclosure of executive and director compensation in a single section of the new annual report document (as opposed to the information circular). The rationale behind this 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. The Proposed Instrument would require disclosure to be provided for the CEO, CFO and any individual whose compensation exceeded that of the CEO or CFO on an individual basis, but for other executive officers and other directors, the disclosure would be aggregated.

The extensive pension benefit and long term incentive plan disclosure required under current executive compensation disclosure rules would be replaced with a single table requiring disclosure of all compensation, of whatever nature. This reflects the typically simpler compensation arrangements of venture issuers. Venture issuers would be required to disclose whether they used a peer group to establish compensation for their executives and whether they tie compensation to any performance criteria.

In addition, details of management agreements, severance arrangements and related party transactions and indebtedness would be required to be disclosed in the annual report proximate to compensation disclosure.

Another section of the annual report would require disclosure of board committees and their members and compliance with corporate governance requirements. Venture issuers would be required to disclose any relationships that board members may have that could reasonably be expected to affect their ability to exercise independent judgment in particular circumstances.

Substantive Corporate Governance Requirements

The Proposed Instrument includes substantive corporate governance requirements addressing conflicts of interest, related party transactions and insider trading. The board of directors of a venture issuer would 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 issuer and any of its directors or executive officers and each proposed material related entity transaction. A venture issuer would also have to take steps reasonably designed to deter persons in a "special relationship," while in possession of undisclosed material information, from engaging in illegal insider trading, tipping or encouraging others to trade in the venture issuer's securities.

Delivery of Disclosure Documents

The Proposed Instrument would require the delivery of disclosure documents only on request, in lieu of mandatory mailing requirements. Annual reports, mid-year reports, and information circulars would not be required to 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 was filed, make it available electronically on a website and send a copy, free of charge, within three days of a request by a shareholder. The proxy form, together with a notice setting out information similar to that which would be provided in the news release, would be required to be sent to shareholders.

Prospectus and Certain Exempt Offerings

The Proposed Instrument would modify the disclosure obligations required of venture issuers in connection with a long form prospectus under NI 41-101. The disclosure currently required under Form 41-101F1 would be modified by way of the introduction of a proposed new form of long-form prospectus to be used by venture issuers.

The proposals would modify the prospectus historical financial statement requirements to require only two years of audited financial statements in connection with an initial public offering. The requirement for BARs and associated financial statements would be removed in connection with an offering, although financial statements would be required for reverse take-overs and acquisitions that are 100% significant (based on the market capitalization test referred to above). Additionally, three and nine month interim financial reports and associated MD&A would not be required in connection with a prospectus offering or one of the exempt offering disclosure regimes.

The proposals would additionally modify the documents required to be incorporated by reference in the case of a short form prospectus under NI 44-101, a qualifying issuer offering memorandum under NI 45-106 and the TSXV short form offering document under NI 45-106. These changes are designed to permit incorporation by reference into a short form prospectus, TSXV short form offering document or qualifying issuer offering memorandum of the continuous disclosure documents required under the Proposed Instrument rather than the continuous disclosure documents currently required under NI 51-102.

Consequential amendments to NI 43-101 are being proposed to introduce the filing of a preliminary short form prospectus as a trigger to file a technical report for venture issuers.

Conclusion

Please note that this is a summary only of the most significant proposals contained in the Proposed Instrument. If you have any questions concerning this bulletin or the Proposed Instrument, please contact the authors or your usual contact at Davis LLP.

Footnotes

1. The Proposed Instrument introduces a new definition of "venture issuer", which, unlike the current definition, will exclude debt-only, preferred share-only issuers and issuers of securitized products. Debt-only, preferred share issuers that meet the current definition of "venture issuer" in NI 51-102 Continuous Disclosure Obligations will continue to be subject to the NI 51-102 venture issuer requirements. The proposed definition also excludes issuers which are subject to BC instrument 51-109 Issuers Quoted in the U.S. Over-the-Counter Markets.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.