Canada: New Rule On Internal Controls To Be Effective In December 2008

Last Updated: September 29 2008

The Canadian Securities Administrators have now published the new National Instrument 52-109 – Certification of Disclosure in Issuers' Annual and Interim Filings (NI 52-109), which is scheduled to come into force on December 15, 2008. NI 52-109 and its requirements will then apply to annual and interim filings of all reporting issuers (except investment funds) for financial periods ending on or after that date. Consequently, issuers with December 31 year ends will need to reflect these new requirements in their year end filings.

This final publication of NI 52-109 follows the CSA proposal for a new internal controls rule that was published for comment earlier this year (the 2008 Proposal). Our article describing this proposal can be found in the June 2008 issue of The Material Change Report at http://www.blgcanada.com - go to Publications. The CSA have acted quickly, after the comment period for the 2008 Proposal expired on June 17, to assess the comments received and then publish NI 52-109 for final implementation. The 2008 Proposal in turn reflected various substantial comments that were received by the CSA in response to their earlier proposal on internal controls in March 2007.

NI 52-109 in its final form is substantially the same as the 2008 Proposal. The most significant new provisions in NI 52-109 will 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 require issuers to provide, based on this evaluation, disclosure in their management discussion and analysis (MD&A) about their conclusions regarding the effectiveness of the issuer's ICFR (in addition to the disclosure now required regarding DC&P).

Pursuant to NI 52-109 with respect to issuers other than venture issuers:

  • 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 to be a "material weakness"; and
  • 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.

These new 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 issuer's filings do not contain misrepresentations and they fairly present the financial condition of the issuer;
  • 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 MD&A.

Venture issuers are permitted to use a certificate which does not include representations relating to the establishment and maintenance of DC&P and ICFR.

Further Details Of NI 52-109

Control Framework

NI 52-109 will require 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 Companion Policy to NI 52-109 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.

Material Weakness

Where an issuer (other than a venture issuer) determines that a "material weakness" exists in the design or operation of its 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.

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.

Scope Limitations

Under NI 52-109, in certain circumstances 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 proportionately consolidated entities and variable interest 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. There will have to be disclosure of any exclusions in the applicable MD&A and also summary financial information will have to be provided for the excluded entities.

Venture Issuer Certificates

NI 52-109 will allow the certificates filed by venture issuers not to refer to DC&P or ICFR and not to include the related disclosures in their MD&A. Venture issuers' forms of certificates include a note setting out how the certificates differ from those of non-venture 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. The form of these initial certificates includes a note explaining how they differ from a regular certificate.

Cross-Border Issuers

As is currently the case, 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 under NI 52-109, these issuers may file their U.S. certificates and related documents with the CSA.

Companion Policy

The new Companion Policy published with NI 52-109 provides 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.

Conclusion

The publication of the final version of NI 52-109 brings to a close the long process of changing the requirements for internal controls. Subject to the applicable ministerial approvals being obtained in certain provinces, the expected effective date of NI 52-109 is December 15, 2008 and the provisions are to apply to all annual and interim filings for periods ending on or after that date.

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