On August 7, 2013, a panel of Commissioners of the British Columbia Securities Commission released its decision to dismiss allegations that (i) a Vancouver-based TSX Venture Exchange listed mining company, Canaco Resources Inc. (Canaco), its CEO and President and three of its directors had breached securities laws by not immediately press releasing new infill drill results and issuing a material change report; and (ii) that such officer and such directors had failed to act in the best interests of Canaco, and acted against the public interest, by issuing stock options to certain directors and employees prior to the public disclosure of such drill results.
The panel's approach was to seek to determine, in the first instance, whether the drill results in question were material in the context of Canaco. After reviewing applicable law relating to the test to be applied to determine materiality and also relying heavily on the expert reports of two professional geologists as to the nature of the drill results, the panel found that the new drill results would not reasonably have been expected to significantly affect the market price or value of Canaco's shares. Having determined that the new drill results were not material to Canaco, all allegations were dismissed.
Although the decision is of potential interest to all reporting issuers, it should be of particular interest to resource companies, because the heart of the decision was the application of materiality concepts to results of infill drilling by a junior exploration company.
During the relevant period (approximately September to December 2010), Canaco was focused on exploration drilling at its Magambazi gold deposit at its Handeni property in Tanzania, East Africa (Canaco has since changed its name to Orca Minerals and spun out its Tanzanian assets into a separate company). Its President and CEO was also its qualified person for the purposes of National Instrument 43-101 – Standards of Disclosure for Mineral Projects (NI 43-101) and had significant experience as a director and officer of exchange-listed companies. The three directors named in the allegations (two other directors were not named) were independent directors with many years of experience in the mining industry and one had significant public company experience. The drill hole assay results in question were from eight holes drilled in the fall of 2010, which formed part of Canaco's ongoing exploration program.
Specific Allegations by Staff
The facts relied upon by Staff of the BCSC in making their allegations included the following:
- the press releases ultimately issued by Canaco described some of the drill results as "spectacular new drill results",
- certain emails among the directors described the results as "just beautiful", "spectacular" and "fantastic news",
- Canaco staggered the timing of press releases ultimately issued disclosing the drill results,
- analysts had issued highly positive reports on the same days as Canaco issued its press releases,
- before announcing the drill results, significant numbers of stock options were issued to management and the directors, and
- in December, the TSX Venture Exchange ordered Canaco to announce the remaining drill results and required the repricing of the options which had been granted (to provide for an exercise price reflective of the post disclosure market price).
Staff also suggested that the "close working relationship" of the analysts with Canaco's management and directors was relevant.
The respondents' position in defending against Staff's allegations included the following:
- the drill results were not material,
- the directors had specifically asked management whether the drill results were material (and were told they were not) before agreeing to issue the options,
- the timing and staggered nature of the press releases were the result of strategic determinations related to the end of a hold period from a private placement offering by Canaco, scheduled investor road shows, as well as a desire to maintain a stream of news and a concern that making a one-time disclosure of all results might motivate another company that had made claims against Canaco's project to re-open the fight,
- drill results were only disclosed once the related assay results had been obtained, and
- the timing for the granting of the options was the result of a narrow window between black-out periods.
As might be expected, the respondents provided the panel with reports of two separate expert geologists to the effect that these drilling results were not material. As well, the respondents provided the panel with the report of a financial economist to the effect that the market for Canaco's shares was not, in fact, efficient and therefore there was no basis for the respondents to believe that the drill results would have a significant effect on the market price of Canaco's shares.
The Panel's Decision
The panel found the reports of the geologists highly relevant in determining that the drill results were not material. The panel rejected the report as to the non-efficiency of the market for Canaco's shares – noting that materiality is determined on the assumption that the market is efficient, and stating that to suggest otherwise would result in no information being material for certain issuers (which the panel described as an "absurd interpretation").
What appears to have been critical in the panel's finding in favour of the respondents with respect to materiality, was that:
- the drill results came from holes that formed part of Canaco's "infill drilling" program, intended to further define and confirm existing known mineralization rather than extend the boundaries of mineralization;
- Canaco had a history of periodically releasing drill results and therefore its "story" would have been well known by investors who would have seen that the new drill results were consistent with existing expectations from a geological perspective; and
- the new drill results did not vary significantly from previous results, and any anomalies reflected in the new drill results (very high grades and widths found in two of the holes) would very likely be eliminated from the data through the industry practice of "top-cutting" prior to the calculation of a mineral resource.
The panel was careful to note that, as reflected in previous OSC, Ontario Court and Supreme Court of Canada decisions, the test to be applied to determine materiality was an objective test, from the point of view of a reasonable investor. It was irrelevant, therefore, to the panel that the directors made reference to the new drill results in emails as "fantastic news" and "just spectacular".
The panel also noted that hindsight should not form part of the materiality analysis and therefore any actual increase in Canaco's share price following release of the new drill results was irrelevant (and any actions taken by the TSX Venture Exchange based on the views of its staff were also irrelevant). The materiality test is to be based only on information available to a company and its directors at the relevant time. Further, the fact that Canaco chose to stagger the release of the drill results, both because the quality assurance and quality control process provided the results in a staggered fashion, and because Canaco wanted to provide some positive news following the upcoming end of an investor hold period and then periodically during the anticipated schedule of investor roadshows, was irrelevant to the Panel's determination because the drill results were not material.
Interestingly, the panel found that even if the directors had believed that the drill results were material, their opinion would not be determinative (since the test was an objective assessment of the likely impact from the point of view of a reasonable investor).
Either explicity or by inference, the Panel's decision reminds the reader that there is no bright line uniform point at which drilling results will cease to be material, but rather it is highly fact specific having regard to the circumstances of the subject issuer. As such:
- (as noted by the Panel) a higher threshhold for materiality will apply to a larger issuer with more properties and more diversity to its business, and
- (as noted by the Panel) the materiality of drilling results must be viewed having regard to the other facts which have previously been disclosed over time by the issuer.
Given that a determination of materiality is highly fact and circumstance specific, we would suggest that this decision is likely more useful as a reminder of important concepts than as a specific precedent. In determining whether drill results are material, management and the directors must:
- consider the results in the context of the project, and in the context of the issuer's portfolio of projects,
- consider what these results "add to the mix" of what has previously been disclosed (the panel here concluded that these particular infill drilling results, but not necessarily all infill drilling results, did not materially alter "the mix"), and
- remember the importance of taking a consistent, and not merely a "convenient and episodic" approach to what is disclosed.
We would also caution that although the panel found the description of these drill results in Canaco's press release (i.e., "spectacular new drill results") to be irrelevant, the Companion Policy to NI 43-101 states that the Canadian Securities Administrators will take descriptions in an issuer's disclosure into account when forming their views as to materiality. As well, there can be no assurance that a panel hearing a similar case in the future may not (even if not acknowledged by the panel members) be impacted by the issuer's disclosure. Accordingly, we would suggest that it remains extremely important that the wording of press releases and other disclosure be carefully done to try to maintain a properly balanced message.
Although the respondents were ultimately successful at the hearing, a significant cost of capital and management attention (including 12 days for the hearing itself) had to be diverted to defending against Staff's allegations.
Read the full decision here.
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