Copyright 2008, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Securities Regulation, October 2008
The Ontario Securities Commission (the OSC) recently released its 2008 Corporate Finance Branch Report. This report discusses the results of the OSC's continuous disclosure reviews during the previous year and provides guidance regarding the issues that the OSC will focus on as part of its targeted reviews in the upcoming year.
The following is a list of some of the common continuous disclosure issues identified by the OSC, together with the OSC's comments thereon.
Management's Discussion & Analysis (MD&A)
Liquidity and Capital Resources. Boilerplate disclosure is inadequate. A more detailed analysis of liquidity is required, including a quantified and analytical discussion of financial resources and commitments, as well as an identification of the material risks associated with an issuer's principal source of liquidity.
Results of Operations. A brief analysis of results of operations is insufficient. A detailed, analytical and quantified discussion of the various factors that affect revenues and expenses must be included by issuers.
Risks and Uncertainties, Related Party Transactions and Changes in Accounting Policies. The incorporation of disclosure by reference to an issuer's financial statements and/or Annual Information Form may not satisfy disclosure requirements – the MD&A must be a self-contained document that complements and supplements the financial statements.
Revenue Recognition. Revenue recognition must meet all of the criteria set out in the Canadian Institute of Chartered Accountants Handbook (the CICA Handbook) Section 3400 Revenue. In addition, adequate disclosure of revenue recognition policies in accordance with Emerging Issues Committee pronouncements must be included.
Stock-Based Compensation and Volatility. When calculating expected volatility to establish stock option expense, the factors outlined in the Appendix to CICA Handbook Section 3870 Stock-based compensation and other stock-based compensation payments must be considered. In some cases this was not done and, as a result, these expenses were understated.
Intangibles. For some assets on issuers' balance sheets (e.g., land use rights and plantation rights), there does not seem to be a standard meaning or method of valuation. The disclosure should clearly explain what the asset consists of, how value is attributed to the asset and the basis for amortizing the asset.
Cash and Cash Equivalents. Disclosure as to the components of cash and cash equivalents, the extent to which their use was restricted or the related policies for determining their composition is required by Handbook Section 1540 Cash flow statements.
Industry Specific Deficiencies
Banking. While additional disclosure has been provided regarding higher risk financial instruments, hedging of financial instruments and off-balance sheet conduits and special purpose entities, further quantitative and qualitative disclosure on how fair values of financial instruments are determined in the absence of quoted market prices should also be provided.
Mining. In addition to a number of common deficiencies in technical disclosure, particularly relating to the certification by qualified persons preparing such disclosure, key issues for the industry are the appropriate measurement of stock option expense, the use of non-GAAP financial measures and the valuation of mining properties.
Manufacturing and Retail. The OSC's reviews for these industries focused on hedging or derivative use to reduce foreign currency exposure, inventory and intangible asset valuation, and revenue recognition. The OSC found deficient disclosure on the accounting policy for inventory valuation and impairment/write-down provisions, as well as the general deficiencies discussed above.
Real Estate. Issuers are expected to provide full disclosure and analysis in their MD&A liquidity sections on the impact of the global credit market environment and how they intend to address any problems that arise as a result. In addition, where issuers use funds from operations as a cashflow measure, a reconciliation to the most comparable GAAP measure is required, as the OSC believes that it is fairly presented only when reconciled to cash flows from operating activities as presented in the issuer's financial statements.
Entertainment and Communications. Given the restructuring of issuers in these industries, the OSC's focus remains on instances where there may be a potential impairment of an issuer's goodwill or intangible assets and examining the quality of discussion related to non-GAAP financial measures. The consolidation in these industries has also resulted in some issuers diversifying the products they currently deliver, or developing new products for new or emerging markets, which has given rise to some of the revenue recognition deficiencies discussed above.
Targeted Review Results
Financial Instruments. The OSC's review of issuers' implementation of the new financial instruments accounting standards that became effective for fiscal years starting on or after October 1, 2006 revealed deficiencies as to the disclosure of the adoption of the new standards, the measurement of investments at cost rather than fair value, the presentation of foreign exchange translation gains and losses on a self-sustaining foreign operation, the review of embedded derivatives within contracts and the identification and measurement of derivatives upon inception of contracts.
Environmental Reporting. The OSC's targeted review found that disclosure provided by issuers was often boilerplate and did not provide meaningful information to investors, including the disclosure of environmental liabilities and risks. OSC Staff Notice 51-716 Environmental Reporting, discussed in our March 2008 Blakes Bulletin on Securities Regulation/Environmental Law – Ontario Securities Commission Seeks Improved Environmental Disclosure, provides additional detail and summarizes the results of the OSC's targeted review, while offering guidance for issuers to consider when discussing environmental matters in their continuous disclosure documents.
Non-Bank Sponsored Asset-Backed Commercial Paper (ABCP). The OSC's reviews focused on valuation in an illiquid market and disclosure of non-bank ABCP in financial statements and MD&A. The OSC required some issuers to provide further disclosure in future filings on the methods and assumptions used to determine fair market value and the impact of non-bank ABCP holdings on the issuer's ability to meet cash needs and planned growth objectives.
Stock Options Backdating. Reviews of the backdating of options and the timing of option grants based on expectations of stock price movements resulted in a number of investigations by the Enforcement Branch.
Insider Reporting Deficiencies
Insider Issues. The OSC's review identified two common deficiencies in transaction reporting by insiders: the use of the settlement date, rather than the trade date, for reporting the date of transactions and failure to report the grant of derivatives (e.g., options, warrants or rights) and any subsequent expiration of these securities. In addition, a number of deficiencies regarding insider profiles were found, including failures to report changes in status and the incorrect reporting of the manner in which securities are held.
The OSC also identified a number of developing issues it was examining. Among other matters, the OSC is reviewing the use of derivatives to avoid early warning and similar securities law requirements based on the concepts of "beneficial ownership" and "control and direction", such as using swaps during a take-over bid to accumulate a substantial economic position in an issuer without public disclosure.
Priorities for Targeted Reviews
Finally, the OSC set forth its current priorities for targeted reviews in the upcoming year as follows:
Financial Instruments. Given the difficulty issuers have had with the implementation of the new financial instrument provisions discussed above in fiscal 2008, the OSC will review the implementation of the new CICA Handbook provisions that apply to interim and annual financial statements relating to fiscal years beginning on or after October 1, 2007 which focus on exposures to risks and how those risks are managed.
Non-GAAP Financial Measures. The OSC will review any non-GAAP financial measures, even those considered common to an industry, to ensure that the recommendations in Staff Notice 52-306 Non-GAAP Financial Measures are considered and that the disclosures are not misleading.
Inventories. Targeted reviews will be conducted to assess compliance with recently issued CICA Handbook Section 3031 Inventories, which applies to interim and annual financial statements for fiscal years beginning on or after January 1, 2008.
Forward-Looking Information. The OSC will conduct targeted reviews to determine the level of compliance with the new disclosure requirements for forward-looking information that came into effect in 2008 and include definitions for future-oriented financial information (FOFI) and financial outlook. These new requirements include a blanket prohibition on disclosing any kind of forward-looking information without a reasonable basis, including FOFI, financial outlooks or other forward-looking information, and establish the requirements when such information is disclosed.
Fair Value of Illiquid Securities. In light of current market conditions, a review of the valuation of illiquid securities will be conducted focusing on, among other items, the methodologies used, the internal process in place to determine and assess fair value and compliance with CICA Handbook and securities law requirements.
Going Concern. Targeted reviews will be conducted to assess and facilitate compliance with new requirements under amended CICA Handbook section 1400 General Standards of Financial Statement Presentation that apply to interim and annual financial statements for fiscal years beginning on or after January 1, 2008, with a focus on management's assessment of an entity's ability to continue as a going concern when preparing financial statements, along with disclosure of material uncertainties that may affect an entity's ability to continue as a going concern.
The full text of the OSC's Corporate Finance Branch Report 2008 can be found, together with a copy of this bulletin, at Blakes website under our Publications – Corporate Finance and Securities Regulation section
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