Canada: Being A Public Company In 2007: Taking Stock Of Recent Developments

Last Updated: November 6 2007
Article by Cornell Wright

Reprinted with permission from the 2007/2008 Lexpert/CCCA Corporate Counsel Directory and Yearbook, 6th Edition.

Canadian companies and their directors and officers are facing intense scrutiny from regulators, stock exchanges, institutional investors, shareholders and the media. Regulators in both Canada and the United States have been very active in imposing new governance and disclosure requirements and are increasingly vigilant in enforcing those requirements. In addition, directors’ duties, conflicts of interests and processes of deliberation are being scrutinized more closely by investors and the courts, significantly increasing the exposure of directors to lawsuits and potential liability.

These developments, and others, have created new risks for Canadian public companies and their directors and officers.


Canadian securities regulators have adopted or proposed a number of rules to strengthen investor confidence in the public filings of companies. The Canadian rules are substantially similar to comparable provisions of the U.S. Sarbanes-Oxley Act of 2002 (S-Ox) and U.S. stock exchange requirements. Some of the measures are being phased in over time, and certain companies (e.g., foreign and venture issuers) receive slightly different treatment. Highlights of these initiatives are discussed below.

CEO and CFO Certification Requirements

The CEO and CFO of every public company are being required to personally stand behind financial statements and other documents. They must personally certify several aspects of the company’s disclosure:

  • integrity of interim and annual filings;
  • design and evaluation, and disclosure of conclusions as to the effectiveness, of disclosure controls and procedures; and
  • design of, and disclosure of material changes in, internal control over financial reporting.

These certifications take on even greater significance given that the civil liability regime described below imposes personal liability for damages on directors and officers for disclosure violations.

Evaluation of Internal Control over Financial Reporting

In March 2007, Canadian securities regulators proposed new requirements for CEO and CFO certifications and related disclosure pertaining to internal control over financial reporting. The proposed rules would apply beginning with financial years ending on or after June 30, 2008. (Cross-border companies would be exempt if they comply with the SEC’s internal control rules and auditor attestation requirements under section 404 of S-Ox.)

Under the proposed rules, CEOs and CFOs would have to evaluate the effectiveness of the company’s internal control over financial reporting and make the following new certifications: (a) they have disclosed to the company’s auditors, audit committee and board of directors any fraud involving management or other employees with a significant role in internal control over financial reporting; and (b) the company’s MD&A (i) describes the process used to evaluate the controls; (ii) discloses the CEO’s and CFO’s conclusions about the effectiveness of the controls; (iii) identifies any reportable deficiencies; and (iv) describes the company’s remediation plans.

Canadian companies will not be required to obtain an auditor’s attestation of the effectiveness of internal control over financial reporting, as is required of U.S. and cross-border companies under SEC rules.

The regulators are also proposing certain new requirements relating to the design of internal control. Since CEOs and CFOs are already required to design (or supervise the design of) internal controls, the new requirements are primarily aimed at enhancing the design certifications and MD&A disclosure rather than changing the substance of the design requirement. Specifically, CEOs and CFOs would have to certify that the issuer’s MD&A discloses (a) any reportable deficiencies relating to the design of internal controls; (b) the remediation plans for any design deficiencies; (c) summary financial information for entities that were permitted to be excluded from the design; and (d) the control framework used to design the controls or a statement that no framework was used.

Role and Composition of Audit Committees

Every public company must have an audit committee that complies with the requirements of the audit committee rule adopted by Canadian securities regulators.

The audit committee must be composed of at least three members, and, with limited exceptions, each member must be "independent" and "financially literate."

For a director to be independent, the board of directors must determine that the director has no direct or indirect material relationship with the company, its parent or any of its subsidiaries. A "material relationship" is defined as a relationship that could, in the board’s view, reasonably interfere with the exercise of a director’s independent judgment. The rule also identifies a number of specific relationships and circumstances that result in a director being deemed to have a material relationship with the company, and therefore not being independent. In interpreting the rules related to independence, a board should consider the overall philosophy and approach of the corporate governance rules and recommended best practices, and the definitions of independence used by institutional investors and proxy advisory firms.

For a director to be financially literate, he or she must have the ability to read and understand a set of financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to those that can reasonably be expected to be raised by the company’s financial statements. Companies are also required to disclose every audit committee member’s education and experience in financial matters.

The audit committee’s responsibilities include (a) recommending to the board the external auditor to be nominated by the board for appointment by the shareholders, and the auditor’s compensation; (b) overseeing the auditor’s work, including the establishment of a direct reporting relationship; (c) preapproving all non-audit services provided by the auditor; (d) reviewing financial statements, MD&A and earnings news releases before public release; (e) ensuring that appropriate procedures are established to receive complaints and anonymous tips regarding accounting, auditing and internal control matters; and (f) ensuring that appropriate policies are established to hire employees or partners of the external auditor.

The independence requirements set forth in the rule have created a new standard for measuring a director’s ability to exercise independent judgment is measured. In addition, the direct responsibilities of the audit committee bring with them a heightened exposure to personal liability. Individuals with accounting and related financial expertise are increasingly in demand as audit committee members and chairs.

Disclosure of Corporate Governance Practices

Canadian securities regulators have adopted a set of corporate governance guidelines that reflect best practices and an accompanying disclosure rule that requires public companies to describe specific aspects of their governance practices.

The governance guidelines are substantially similar to the listing standards of the New York Stock Exchange and reflect current North American best practices in governance. These guidelines deal with matters such as board composition; meetings of independent directors; board mandate; position descriptions of the CEO, board and committee chairs; orientation and continuing education; code of business conduct and ethics; nomination of directors; compensation; and regular board assessments.

The corporate governance guidelines are not mandatory. However, they represent securities regulators’ views of best practices in corporate governance matters, and public companies are encouraged to consider them when formulating their own governance practices. This feature—voluntary compliance coupled with a disclosure requirement—distinguishes the Canadian approach from mandatory listing standards adopted by the U.S. stock exchanges for U.S. companies.

Failure to provide adequate corporate governance disclosure is a breach of securities laws and can expose the company to enforcement proceedings and sanctions. Regulators have indicated that they will use their continuous disclosure reviews to ensure that corporate governance disclosure reflects what is actually happening in the boardroom and is not merely boilerplate. The TSX is also monitoring corporate governance disclosure, and any listed company with deficient disclosure may be required to publish amended disclosure in its next quarterly report. Continuing non-compliance could result in suspension or delisting.

A best practice is by definition not an articulation of existing practice, but rather of a standard that regulators wish practices to move toward. However, as companies’ actual practices move toward an articulated best practice, accepted norms are changing. What was previously accepted practice is no longer so. As a result, companies that fail to move toward best practices accepted by others in the market, by definition, may not have taken due care.

The issue of best practices was discussed in a highly anticipated decision of the Delaware Supreme Court in which it unanimously affirmed a lower court’s ruling that the board of directors of The Walt Disney Company did not breach its fiduciary duties or act in bad faith in the hiring and subsequent termination of its former president, Michael Ovitz, despite the board’s failure to adhere to corporate governance best practices. This decision set a high threshold for establishing a breach of the duty of good faith, and ultimately vindicated the Disney directors. However, that took nearly 10 years of litigation and required a lengthy trial. Trials not only increase legal costs, but are unpredictable given the court’s need to make evidentiary and credibility determinations. It would be far better and more cost-efficient for boards of directors to adhere to best practices and procedures and, thus, avoid costly and unpredictable litigation.


In March 2007, Canadian securities regulators proposed an overhaul of the disclosure rules for executive compensation to improve the quality and transparency of executive compensation disclosure. The proposed rules would replace the current requirements, introduced in 1994, and would require significant changes in disclosure and compensation-setting practices. Although the proposals are similar in substance to the rules recently adopted by the SEC, the proposed Canadian rules depart from the SEC rules in several important respects in an attempt to clarify and simplify those elements of the SEC rules that have been criticized as being confusing or overly complicated as well as to maintain the more principles-based approach favoured by the Canadian regulators. The proposed rules would apply to the 2008 annual proxy season for companies with a financial year ending on or after December 31, 2007.

Highlights of the proposed rules are as follows:

  • The summary compensation table would have a column for total compensation (including the dollar value of stock, option and similar incentive awards, based on the compensation cost of these awards as reflected in a company’s financial statements).
  • The "named executive officers" (NEOs) would be determined by total compensation, rather than just salary and bonus.
  • A new "compensation discussion and analysis" would explain the rationale for specific compensation programs and decisions for individual executives.
  • More specific disclosure would be required of potential payments to NEOs on termination of their employment, including quantification of the total amounts payable in various scenarios.

In the United States, legislation has been approved by the House of Representatives that, if adopted, would give shareholders an advisory vote on executive compensation at annual meetings, a right popularly referred to as shareholders having a "say on pay". However, Canadian institutional investors have indicated they are watching "say on pay" developments in the United States with interest and intend to press Canadian companies to voluntary adopt say on pay advisory votes.

Many Canadian companies are reviewing their option-granting practices in anticipation of those practices being scrutinized by Canadian regulators and shareholders, as has occurred in the U.S. in the wake of various backdating scandals. This issue is likely to receive lesser attention in Canada as different regulatory requirements reduce the opportunity for Canadian companies to backdate or time option grants. For example, under TSX rules, companies may not set option exercise prices on the basis of market prices that do not reflect material information that management is aware of but that has not been publicly disclosed. The TSX has also been active in cautioning companies against granting options during a "blackout period", whether or not there is material undisclosed information during that period. In addition, the exercise price for an option must not be lower than the market price of the underlying shares at the time the option is granted. Insiders are also required to publicly report, within 10 days, any change in their direct or indirect beneficial ownership of or control or direction over securities, including options.

Effective June 30, 2007, the TSX revised its rules requiring shareholder approval of security-based compensation plans to provide that all amendments to those plans, including amendments of a housekeeping or administrative nature, must be approved by shareholders unless they include a detailed amendment provision specifying that no shareholder approval is required. Amendment provisions must be approved by shareholders and must specify the types of amendments that require shareholder approval. In light of this change, many companies have been seeking shareholder approval of new amendment provisions so that they can make housekeeping changes, accelerate vesting, effect early expiration and add cashless exercise features without shareholder approval. Under TSX rules, certain types of amendments (such as to allow for a repricing of insiders’ options) may not be made without specific shareholder approval regardless of the amendment provision.


Under Ontario’s regime of statutory civil liability for secondary market disclosure, which came into force on December 31, 2005, companies, directors, officers and others have potential liability for misleading public disclosure and failing to make timely disclosure of material changes. This statutory regime is similar to the statutory liability regime that has existed for prospectuses for many years.

Under this regime, companies, directors, officers and others are liable for damages suffered by any investor who buys or sells a company’s securities during a disclosure violation. A disclosure violation begins when a misrepresentation about the company is made in a public document or an oral statement, or when the company fails to make timely disclosure of a material change in its affairs; the violation ends when the disclosure is corrected or made. A plaintiff need not prove that he or she relied on the misrepresentation or failure to make timely disclosure. This statutorily deemed reliance removes a major obstacle to successfully suing on the basis of common law misrepresentation and to qualifying to bring a class action.

The court will generally determine each defendant’s responsibility for the plaintiff’s losses and each defendant will be liable for its proportionate share of the damages. In most circumstances, the liability of directors and officers is capped at the greater of $25,000 and half of the individual’s compensation for the last year; the liability of companies is capped at the greater of $1 million and 5% of the company’s market capitalization. Clearly, this can be a very high threshold for a major public company. However, directors and officers who act "knowingly" in a violation may be fully liable, on a joint and several basis, for all damages.

Fewer claims have been brought under the civil liability regime than were anticipated when it was introduced. Some speculate that this is because of the liability caps and strike suit protections that, for example, require a plaintiff to obtain leave of the court before bringing a lawsuit and to convince the court that the suit is being brought in good faith and has a reasonable possibility of success. The full impact of this new liability regime will not be known until the courts have considered its operation in various circumstances and common disclosure practices emerge. In the meantime, the increased risk of personal liability for directors and officers has focused companies’ attention on the need to have effective disclosure controls and procedures throughout the organization.

The additional pressure imposed by civil liability on disclosure decisions is being felt in the M&A context in particular. Although many legal practitioners maintain that the rules have not changed, directors are clearly concerned. This concern has increased because in February 2007, the Ontario Securities Commission approved a settlement with AIT Advanced Information Technologies Corporation and its CEO in connection with the failure to make timely disclosure of AIT’s 2002 merger with 3M Company. As part of the settlement, 3M, as the successor to AIT, agreed that AIT had acted contrary to the public interest by failing to make timely disclosure of the merger transaction and AIT’s CEO at the time agreed that he had acted contrary to the public interest by authorizing, permitting or acquiescing in AIT’s failure to make timely disclosure of the transaction. Both 3M and the CEO were required to pay the OSC’s costs and additional fees. Unfortunately, the facts in this case are relatively unusual and the settlements do not provide issuers with much specific guidance on meeting their disclosure obligations while negotiating an M&A transaction. A hearing involving a director of AIT who was also a partner of the firm’s external law firm has been set for July 2007. That hearing may result in a clearer indication of the OSC’s approach to disclosure in these circumstances.


In an era in which boardroom conduct is under increasing scrutiny, the Supreme Court of Canada’s decision in Peoples Department Stores Inc. (Trustee of) v. Wise has brought more uncertainty to the law in Canada. The decision may facilitate investor lawsuits against directors personally, alleging breach of their duty of care. The decision is relevant to directors and corporate counsel in a number of respects. First, the Supreme Court decided that a director’s duty of care is owed not just to the corporation, but also directly to creditors and other stakeholders. This aspect of the decision radically departs from well-established corporate law principles. Taken literally, it means that investors can sue directors personally for failing to meet their duty of care. Second, the Court decided that the duty of care does not vary with the particular background and experience of a director. This makes clear that a director’s lack of experience does not lower the standard of care to which the director will be held. However, the decision could also have the perverse effect of lowering the bar for directors with special expertise. Finally, the Supreme Court strongly affirmed the "business judgment rule," under which Canadian courts defer to the business judgment of the directors if their decision is "within a range of reasonableness" and they have acted "prudently and on a reasonably informed basis." While not new law, this aspect of the decision strongly reinforces the position that unconflicted directors who carefully consider all reasonable alternatives are protected from liability in making business decisions.

In Kerr v. Danier Leather Inc., the Ontario Court of Appeal affirmed, consistent with its prior decisions and the decision of the Supreme Court in Wise, that courts are to treat management’s judgments on business matters with deference. The Court of Appeal in Danier held that a forecast made by senior management in an IPO prospectus is an exercise in business judgment and that courts should not second-guess management’s opinions as long as they fall within a range of reasonableness. The Court of Appeal’s decision was appealed to the Supreme Court, whose decision is pending. The Supreme Court’s decision will have important implications for public offerings of securities in Canada and the standards for disclosure and representations in prospectuses.

Decisions in two recent Delaware Court of Chancery actions Louisiana Municipal Police Employees’ Retirement System v. Crawford (Caremark) and In re Netsmart Technologies, Inc. Shareholder Litigation have focused attention on conflicts of interest in the M&A environment. The Caremark decision involved a "merger of equals" between Caremark Rx, Inc. and CVS Corporation. The Netsmart decision involved Netsmart being taken private by two private equity firms with Netsmart’s management team continuing to manage the company. In both cases, the Court issued injunctions requiring corrective disclosure before the proposed transactions could be submitted to shareholders for approval.

Although not binding on a Canadian court, these decisions are clearly relevant to an interpretation of the duty of directors to maximize shareholder value and avoid conflicts of interest that invite litigation. Red flags that should alert target boards include the following: management signs a confidentiality agreement with one bidder and allows it to begin due diligence before a special committee is formed to oversee the strategic transaction; management conducts a due diligence process without close oversight by the special committee; management has too much access to the special committee’s deliberations; management prefers a private equity transaction with the expectation of superior employment and financial rewards from a strategic acquisition and, to this end, conducts its own separate negotiations regarding future employment incentives and terms; and lack of proper and timely documentation of special committee proceedings.

The recent decision of the Ontario Court of Appeal in Ventas, Inc. v. Sunrise Senior Living Real Estate Investment Trust has stirred much debate in Canadian M&A circles about the extent to which directors can contract out of their fiduciary duties. In that case, following an auction process, Sunrise entered into a purchase agreement with Ventas that provided that Sunrise could not waive or fail to enforce the standstill provisions in confidentiality agreements entered into with other bidders. When an unsuccessful bidder subsequently made an unsolicited bid, Ventas applied for a court order to require Sunrise to enforce that bidder’s standstill and consequently not accept, or even consider, its bid. Interestingly, the purchase agreement contained a "fiduciary out" clause, but that clause did not apply where, as here, the unsolicited offer was made in breach of a standstill that Sunrise was obligated to enforce. The order was granted by the trial court and upheld on appeal. In its reasons, the Court of Appeal explained that the genesis of the fiduciary out was the duty of the directors in a circumstance such as this to maximize shareholder value. The Court clarified, however, that this duty does not prevent directors from agreeing to certain limitations on the exercise of the fiduciary out if they consider it is in the best interests of their corporation to do so. The Court concluded that the Sunrise trustees had complied with their fiduciary duties by setting up an auction process, in consultation with professional advisers, that was designed the maximize the price obtained obtained for Sunrise’s assets. The Court stated that the Sunrise trustees did not fail in the exercise of their fiduciary duties simply by agreeing in the purchase agreement to preclude unsuccessful bidders from coming in after the auction was concluded and attempting to top the winning bid.


This new regulatory environment, together with the additional investor and media scrutiny of corporate governance practices, has altered the dynamics at the board level, among executives in management and between the board and management. As a result, more independent directors (especially those considered "financially literate") are being sought. Directors are taking their responsibilities more seriously and demanding timely and relevant information, firm meeting dates, an annual board agenda and leadership through the board’s involvement in important strategic decisions. Many boards now have an independent lead director who acts as a point of contact for the independent directors on the board.

Directors are also increasing their use of advisers–both regular corporate advisers and independent advisers–to deal with complex accounting, compensation, legal and human resources issues. Establishing a due diligence defence is often greatly assisted by reliance on the report of an outside expert such as a lawyer, an accountant or a financial adviser. However, directors must satisfy themselves that the expert has the appropriate qualifications and experience to advise on the particular question and has had access to all information relevant in the circumstances. Directors must also understand the expert’s assumptions and analysis, and cannot passively accept the expert’s advice. In the Disney case, the Delaware court suggested that litigation could have been avoided if the compensation committee had, among other things, appropriately engaged and documented the expert’s advice.

Directors, themselves subject to close scrutiny regarding independence, are increasingly vigilant regarding the potential for conflicts among their advisers. In the M&A context, this has led more boards and special committees to take the cautious approach of retaining separate advisers who have no roles or relationships with other parties in the transaction. The issue of conflicts was addressed in a recent decision of the Delaware Court of Chancery (In re Tele-Communications, Inc. Shareholder Litigation). In that decision, the Court questioned the quality and independence of the advice received in light of the special committee’s reliance on the company’s legal and financial advisers.

Directors are paying more attention to D&O insurance coverage and becoming more sophisticated in their demands for coverage. Apart from limits, D&O issues now include careful attention to the divergent needs of, and the potential for conflicts among, the company, management and outside directors. Boards are much more involved in D&O decisions and are increasingly requesting legal representation to ensure that they are adequately protected.

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.

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