Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, May 2008
- Proposed national instrument would distinguish between
venture issuers and non-venture issuers
- Management would be required to evaluate an
issuer's internal control over financial reporting
(ICFR) and provide MD&A disclosure about their
conclusions on the effectiveness of ICFR
- Guidance provided on how the design of ICFR and the
evaluation of ICFR should be undertaken
- New certificate would be available for venture
- Identified material weaknesses would not have to be
remediated but issuers would have to disclose its plans, if
any, to remediate material weaknesses
The Canadian Securities Administrators (CSA) recently published for comment a revised 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 — Certification of Disclosure in Issuers' Annual and Interim Filings (Proposed NI 52-109) would distinguish between (i) "venture issuers", meaning reporting issuers that are not listed on the Toronto Stock Exchange (TSX) or a major exchange or quotation and reporting system outside of Canada, and (ii) "non-venture issuers", meaning reporting issuers that are not venture issuers (referred to herein as issuers).
Proposed NI 52-109 would require management of issuers to evaluate the issuer's internal control over financial reporting (ICFR) in addition to its disclosure controls and procedures (DC&P), and provide management's discussion and analysis (MD&A) disclosure about their conclusions on the effectiveness of the issuer's ICFR and DC&P based on such evaluation.
The CSA had previously published for comment, on March 30, 2007, a proposed National Instrument 52-109 (2007 Proposal). For a summary of the 2007 Proposal, see our April 2007 Blakes Bulletin on Securities Law Proposed Replacement of Instrument Relating to Internal Control Reporting and Certification Requirements on Blakes Web site in our Publications — Corporate Finance & Securities Regulation section.
The most significant changes in Proposed NI 52-109 from the 2007 Proposal are (i) a new form of certificate for venture issuers which does not include representations relating to the establishment and maintenance of DC&P and ICFR, (ii) that issuers are required to use a control framework in the design of ICFR, (iii) that the threshold for reporting a weakness in an issuer's ICFR is a "material weakness" rather than a "reportable deficiency" and (iv) that an issuer does not have to remediate a material weakness that exists as at the end of the period covered by its annual or interim filings, but must disclose its plans, if any, to remediate such material weakness.
SIGNIFICANT CHANGES IN PROPOSED NI 52-109
The key features of Proposed NI 52-109 when compared with the current MI 52-109 are set out below. Other than the description of the new certificate available for venture issuers, the following requirements under Proposed NI 52-109 apply solely to issuers and do not apply to venture issuers.
Additional Guidance On Design Of Disclosure And Internal Controls
Proposed NI 52-109 explicitly requires that issuers establish and maintain DC&P and ICFR, whereas the current MI 52- 109 only requires certifying officers to certify that they have designed 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 DC&P and ICFR to exclude DC&P controls, policies and procedures of underlying entities in which the issuer has an interest such as proportionately consolidated entities, variable interest entities and businesses that the issuer acquired not more than 365 days before the end of the period to which the certificate relates (this compares to a 90-day period in the 2007 Proposal). However, the issuer must disclose in its MD&A the scope of this limitation and summary financial information of such underlying entities.
Evaluation Of Internal Control Over Financial Reporting
Certifying officers of issuers 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 does not prescribe how the certifying officers should conduct their annual evaluation of an issuer's ICFR. However, the proposed Companion Policy does provide guidance on the tools that they should use in their evaluation, which includes self-assessments. In the proposed Companion Policy, the CSA also indicate 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.
Guidance is also provided in the proposed Companion Policy to assist certifying officers in determining whether a deficiency is addressed by a compensating control or a mitigating procedure and how that determination affects their conclusions on the effectiveness of ICFR.
Control Framework For Issuers
Proposed NI 52-109 requires an issuer to use a control framework in the design of its ICFR. This requirement was not included in the 2007 Proposal. The proposed Companion Policy states that the framework used should be a suitable control framework that is established by a body or group that has followed due-process procedures. Although the CSA have not mandated the use of any particular framework, the proposed Companion Policy refers to certain examples, such as:
- the Risk Management and Governance: Guidance on
Control (COCO Framework), formerly known as Guidance of
the Criteria of Control Board, published by the Canadian
Institute of Chartered Accountants;
- the Internal Control — Integrated
Framework (COSO Framework) published by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO);
- the Guidance on Internal Control (Turnbull
Guidance) published by the Institute of Chartered Accountants
in England and Wales.
A smaller issuer may also refer to Internal Control over Financial Reporting — Guidance for Smaller Public Companies published by COSO, which provides guidance to smaller companies on the implementation of the COSO Framework.
Increased MD&A Disclosure
Rather than referring to the concept of a "reportable deficiency" as set out in the 2007 Proposal, Proposed NI 52-109 requires an issuer's certifying officer to identify and disclose a "material weakness" in the design or operation of its ICFR, the definition of which was adopted from the U.S. definition of "material weakness" under Section 404 of the Sarbanes-Oxley Act of 2002. The threshold for meeting the definition of a "material weakness" is whether there exists "a deficiency, or combination of deficiencies in ICFR such that there is a reasonable possibility that a material misstatement of the reporting issuer's annual or interim financial statements will not be prevented or detected on a timely basis." If the certifying officers of an issuer identify a "material weakness" in the design or operation of its ICFR which exists as at the end of the period covered by its annual or interim filings, they cannot certify that the issuer's ICFR is effective. Under Proposed NI 52-109, an issuer is required to disclose in its annual and interim MD&A:
with respect to material weaknesses:
- a description of each material weakness in the design
or operation of its ICFR;
- the impact of the material weakness on the
issuer's financial reporting and its ICFR;
- the issuer's current plans, if any, or any
actions already undertaken, for remediating the material
- a description of each material weakness in the design or operation of its ICFR;
- the certifying officers' conclusions about the
effectiveness of its ICFR (annual only);
- the name of the control framework used in the design of
its ICFR; and
- if applicable, any limitation in the scope of the design
of its ICFR.
Expanded Certificates For Issuers
Proposed NI 52-109 expands the required full annual and interim certificates currently applicable to issuers to include representations from its certifying officers that:
- the issuer has disclosed in its annual/interim MD&A
information regarding the effectiveness of its ICFR and any
material weakness identified therein (see above under
"Increased MD&A Disclosure"); and
- the certifying officers have disclosed to the
issuer's auditors and the board of directors or the
audit committee any fraud that involves management or other
employees who have a significant role in the issuer's
As an alternative to the full annual certificate, Proposed NI 52-109 permits issuers to file annual certificates that exclude certifications relating to ICFR for the first financial period after an initial public offering or reverse takeover.
New Certificates For Venture Issuers
Instead of requiring venture issuers to file full annual and interim certificates, Proposed NI 52-109 allows venture issuers to file a "venture issuer basic certificate" which does not include representations relating to the establishment and maintenance of DC&P and ICFR. The basic certificate includes a "note to reader" explaining how the basic certificate differs from the certificate required to be filed by issuers.
A venture issuer filing a basic certificate is no longer required to discuss in its annual or interim MD&A the design or operating effectiveness of DC&P or ICFR. However, if a venture issuer files a basic certificate and chooses to discuss the design or operation of one or more components of its DC&P or ICFR in its annual or interim MD&A, the CSA suggest in the proposed Companion Policy that the venture issuer should include a discussion in such MD&A that is similar to the disclosure in the "note to reader" on its basic certificate. A venture issuer may, at its option, still file a full certificate.
Venture issuers are also permitted under Proposed NI 52-109 to file annual certificates that exclude certifications relating to ICFR for the first financial period after becoming a non-venture issuer (i.e., listed on the TSX or a major exchange or quotation and reporting system outside of Canada, with some exceptions).
If adopted, Proposed 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 Proposed NI 52-109 is December 15, 2008 and Proposed NI 52-109 would apply to all annual and interim filing for periods ending on or after that date.
REQUEST FOR COMMENTS
Interested parties are invited by the CSA to submit written comments on Proposed NI 52-109 by June 17, 2008.
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.