Originally published in Blakes Bulletin on Securities Law, April 2007
On March 30, 2007, the Canadian Securities Administrators (CSA) published for comment a replacement of Multilateral Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings (MI 52-109). If enacted, proposed National Instrument 52- 109 (Proposed NI 52-109) would require management to evaluate an issuer’s internal control over financial reporting (ICFR) and provide management’s discussion and analysis (MD&A) disclosure about their conclusions on the effectiveness of ICFR based on such evaluation.
The CSA members (other than British Columbia) had previously published for comment, on February 4, 2005, Multilateral Instrument 52-111 Reporting on Internal Control Over Financial Planning and an amended and restated Multilateral Instrument 52-109 Certification of Disclosure in Issuers’ Annual and Interim Filings (2005 Proposal) (for a summary of the 2005 Proposal, see February 2005 Blakes Bulletin on Securities Law, Proposed National Rule on Internal Control over Financial reporting and related Amendments to Certification Requirements). The 2005 Proposal was substantially similar to the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404 Rules) and would have required management of issuers (other than venture issuers and investment funds) to evaluate the effectiveness of the issuer’s ICFR, as of the end of the issuer’s financial year, against a suitable framework. It would have also required such issuers to file management and auditor reports regarding the issuer’s ICFR. However, after review and consultation and in light of the delays and debate in the U.S. over the implementation of the SOX 404 Rules, on March 10, 2006, the CSA stated that it would not proceed with the 2005 Proposal.
Proposed NI 52-109 represents an approach that balances the costs associated with internal control reporting and certification requirements with the benefits from increasing management’s focus on, and accountability for, the quality of ICFR. The most significant changes from the 2005 Proposal are that (i) the ICFR requirements in Proposed NI 52-109 would apply to venture issuers, and (ii) Proposed NI 52-109 would not require an issuer to obtain from its auditor an internal control audit report expressing an opinion concerning management’s assessment of the effectiveness of an issuer’s ICFR.
Significant Changes In Proposed NI 52-109
The following are the key features of Proposed NI 52-109 when compared with the current MI 52-109:
- Guidance on Design of Disclosure Controls – Issuers are required to cause their certifying officers to design, or supervise the design of, disclosure controls and procedures (DC&P) and ICFR. Proposed NI 52-109 provides more guidance than the current MI 52-109 on the components in such design. Proposed NI 52-109 also allows issuers to limit the scope of their design to exclude controls of certain underlying entities so long as this limitation is disclosed in its MD&A.
- Guidance on Evaluation of Effectiveness of ICFR – Certifying officers will be required to certify in their annual certificates that they have evaluated the effectiveness of the issuer’s ICFR at the financial year end and that they have caused the issuer to disclose in its annual MD&A their conclusions from this evaluation. Proposed NI 52-109 provides guidance on how this evaluation should be undertaken.
- Increased MD&A Disclosure – The issuer’s annual MD&A will include disclosure about its ICFR, including a description of the process for evaluating the effectiveness of the ICFR, the conclusions of such evaluation, any "reportable deficiencies" in the design or operation of ICFR and any remediation plan in place to address such "reportable deficiencies".
- Expanded Application – The requirements will apply to all reporting issuers, other than investment funds, in all Canadian jurisdictions. Proposed NI 52-109 allows a "design accommodation" for venture issuers under certain circumstances.
Guidance on Design of Disclosure ControlsProposed NI 52-109 would require an issuer to cause its certifying officers to design or supervise the design of DC&P and ICFR. Although Proposed NI 52-109 does not require specific components for DC&P or ICFR, the proposed Companion Policy provides more guidance than the current MI 52-109 on the components that should be included.
In determining the full scope of these components, the CSA suggest that certifying officers should use a top-down, risk-based approach in the design process and should design such components using their judgment, acting reasonably, giving consideration to various factors particular to an issuer, including its size, nature of business and complexity of operations. The Companion Policy contains significant guidance on how this approach should be undertaken. Proposed NI 52-109 allows the certifying officers of an issuer to limit the scope of the design of its ICFR to exclude controls, policies and procedures of underlying entities in which an issuer has an interest such as proportionately consolidated entities, variable interest entities and businesses that the issuer acquired not more than 90 days before the end of the period to which the certificate relates. However, the issuer must disclose in its MD&A the scope of this limitation and summary financial information of such underlying entities.
Guidance on Evaluation of Internal Control over Financial ReportingProposed NI 52-109 does not prescribe how the certifying officers should conduct their evaluation of an issuer’s ICFR. However, the proposed Companion Policy does provide guidance on the tools that they should use in their evaluations. In the Companion Policy, the CSA also indicates that the nature, timing and extent of evaluation procedures necessary for certifying officers to obtain reasonable support for the effective operation of ICFR depends on the level of risk each component is designed to address.
Increased MD&A DisclosureThe 2005 Proposal would have required an issuer’s certifying officers to disclose any "material weakness" in the design or operation of ICFR. The threshold for meeting the definition of "material weakness" would have been whether there was "more than a remote likelihood" that a material misstatement would not be prevented or detected. Proposed NI 52-109 instead requires an issuer’s certifying officers to identify and disclose a "reportable deficiency" in the design or operation of ICFR. This definition incorporates the threshold of a deficiency that would cause a "reasonable person to doubt that the design or operation of ICFR provides reasonable assurance regarding the reliability of financial reporting", thereby incorporating a standard of reasonableness.
If the certifying officers of an issuer identify a reportable deficiency in design or operation existing at the end of the annual or interim period, they can not certify that the issuer’s ICFR is effective. However, the certifying officers may certify that the issuer has committed to a remediation plan to address the reportable deficiency prior to filing the certificate. In this situation, the certificate should describe the reportable deficiency, the remediation plan to address it and the completion date or expected completion date of the remediation plan.
Under Proposed NI 52-109, an issuer will be required to disclose in its MD&A:
- the certifying officers’ conclusions about the effectiveness of its ICFR;
- a description of the ICFR evaluation process;
- a description of any reportable deficiency in the operation of its ICFR and the issuer’s plans, if any, to remediate any such reportable deficiency;
- a statement identifying the control framework used to design its ICFR, or a statement that they did not use a framework, as applicable; and
- if applicable, any limitation in the scope of the design of its ICFR.
Unlike the 2005 Proposal, there is no exemption for venture issuers from the ICFR requirements under Proposed NI 52-109. However, the CSA suggest that Proposed NI 52-109 addresses the cost concern for implementing comprehensive ICFR to smaller issuers by (i) eliminating the requirement for an internal control audit opinion contemplated in the 2005 Proposal, and (ii) allowing a "design accommodation" for venture issuers.
The "design accommodation" under Proposed NI 52-109 enables a venture issuer to disclose a reportable deficiency without having an immediate remediation plan in place so long as the venture issuer discloses in its annual or interim MD&A a description of the reportable deficiency, why it cannot be reasonably remediated, the risks relating to the deficiency and how the venture issuer has mitigated those risks. If the reportable deficiency continues to exist through other reporting periods, the venture issuer must continue to include this level of disclosure in its applicable MD&A.
Annual And Interim Certificate Requirements
Proposed NI 52-109 expands the full annual and interim certificates to include representations that:
- the certifying officers have evaluated, or caused to be evaluated under their supervision, the effectiveness of the issuer’s ICFR as of the financial year end (annual certificate only);
- the issuer has disclosed in its annual/interim MD&A all information as required under Proposed NI 52-109 (see above under "Increased MD&A Disclosure"); and
- the certifying officers have disclosed to the issuer’s auditors, the board of directors and audit committee any fraud that involves management or other employees who have a significant role in the issuer’s ICFR (annual certificate only).
An issuer is permitted to file an annual/interim certificate that excludes certifications relating to ICFR if the issuer’s first annual/interim period following its IPO ends on or before the 90th day after it became a reporting issuer or ends on or before the 90th day after completion of a reverse takeover involving the issuer.
If adopted, NI 52-109 would repeal and replace MI 52-109 and would apply to all reporting issuers other than investment funds. The proposed effective date of NI 52-109 is June 30, 2008. Since all issuers, other than investment funds, must certify the design of their internal controls for financial years ending after June 29, 2006, the CSA members believe that the period between these two dates provides an adequate amount of time for issuers to prepare for and complete an evaluation of their ICFR systems.
Request For Comments
Interested parties are invited by the CSA to submit written comments on Proposed NI 52-109 by June 28, 2007. In their summary of Proposed NI 52-109, the CSA have itemized specific requests for comment on the approach they propose to take for most areas of regulation or reporting covered by Proposed NI 52-109.
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