The publication for comment by the Canadian Securities Administrators of a further proposal to replace Multilateral Instrument 52-109 – Certification of Disclosure in Issuers' Annual and Interim Filings (MI 52-109) comes after much debate.
This revised proposal (the New Proposed Instrument), which would be a National Instrument, reflects various substantial comments that were received by the CSA in response to their earlier proposal on internal controls in March 2007 (the 2007 Proposal).
The New Proposed Instrument, like the 2007 Proposal, would require CEOs and CFOs to certify that they have performed an evaluation of the issuer's internal control over financial reporting (ICFR) in addition to its disclosure controls and procedures (DC&P), and also to provide, based on this evaluation, management discussion and analysis (MD&A) disclosure about their conclusions regarding the effectiveness of the issuer's ICFR and DC&P.
There are several important changes in the New Proposed Instrument from the 2007 Proposal:
- issuers will be required to use a control framework in
the design of ICFR;
- the threshold for reporting a weakness in an
issuer's ICFR is now to be a "material
weakness" rather than a "reportable
deficiency" (which was the concept from the 2007
- an issuer will 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; and
- the officers of venture issuers will not have to make
representations relating to the establishment and maintenance
of DC&P and ICFR (this provision has effectively already
been implemented by various blanket orders or notices).
These proposed requirements will be added to what is now required for an issuer's CEO and CFO to certify on an ongoing basis that, among other things:
- the annual filings do not contain a
- there is fair presentation of financial statements and
other financial information;
- they have designed DC&P and ICFR or caused them to be
designed under their supervision;
- they have evaluated the effectiveness of the DC&P and
caused the issuer to disclose the conclusions about the
evaluation in the issuer's annual MD&A; and
- they have caused the issuer to disclose certain changes
in ICFR in the issuer's annual and interim
The proposed new Companion Policy is also substantially different from the 2007 Proposal and provides much more detailed and helpful guidance on topics such as fair presentation, financial condition and reliability of financial reporting, material weaknesses in ICFR, self-assessments, compensating controls and mitigating procedures, use of a service organization or specialist for an issuer's ICFR, significant weakness in DC&P and disclosure of an external auditor report on ICFR.
Details of the Proposed Changes
The New Proposed Instrument requires that an issuer (other than a venture issuer) use a suitable control framework to design its ICFR. A suitable control framework is one established by a body or group that has followed appropriate due-process procedures, including the broad distribution of the framework for public comment, which are the same criteria set out in the applicable U.S. rules. The CSA does not require the use of a particular control framework and sets out in the Proposed Companion Policy various examples of suitable frameworks that an issuer could use to design ICFR, such as Risk Management and Governance: Guidance on Control published by The Canadian Institute of Chartered Accountants and Internal Control – Integrated Framework published by The Committee of Sponsoring Organizations of the Treadway Commission.
The 2007 Proposal contained the concept of "reportable deficiency" and that has now been replaced in the New Proposed Instrument by the concept of "material weakness". Material weakness is defined to mean "a deficiency, or a 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." This tracks the U.S. definition under the applicable Sarbanes-Oxley requirements.
The New Proposed Instrument requires that if an issuer (other than a venture issuer) determines that it has a material weakness relating to design of ICFR at the end of the applicable annual or interim period covered by its filings, it has to disclose in its MD&A for that period:
- a description of the material weakness and its effect on
the issuer's financial reporting and ICFR; and
- the issuer's plan, if any, or any steps it has
already taken, for remediating the material weakness (the
2007 Proposal contained a requirement to actually remediate
any such disclosed material weakness).
Under the New Proposed Instrument, an issuer (other than a venture issuer) will be able to limit the scope of its design of DC&P and ICFR to exclude controls, policies and procedures of certain underlying entities in which the issuer has an interest and a business that the issuer has acquired not more than 365 days before the end of the period to which the certificate relates. This limitation is different from the 90-day scope limitation period that was in the 2007 Proposal. There would have to be disclosure of any exclusions in the applicable MD&A and also summary financial information would have to be provided for the excluded entities.
Venture Issuer Certificates
The New Proposed Instrument would allow the certificates filed by venture issuers to not refer to DC&P or ICFR and venture issuers would not have to include the related disclosures in their MD&A. Venture issuers' certificates would include a note setting out how the certificates differ from those of nonventure issuers.
First Certificates After an IPO, Reverse Take-over or Ceasing to be a Venture Issuer
The CEO's and CFO's first certificates filed after an IPO, reverse take-over or ceasing to be a venture issuer can omit all references to ICFR and DC&P. These initial certificates would include a note explaining how they differ from a regular certificate.
As is currently the case under MI 52-109, cross-border issuers that comply with the applicable SEC requirements would not have to separately comply with the Canadian rules. Instead of filing the Canadian certificates, these issuers could file their U.S. certificates and related documents with the CSA.
This latest CSA proposal on internal controls is open for public comment until June 17, 2008. The proposed effective date is December 15, 2008 and would apply to all annual and interim filings for periods ending on or after that date. It will be interesting to see whether the proposed changes are now more acceptable to the capital 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.