Canadian public companies are contending with many issues stemming from the COVID-19 pandemic. This alert provides insight on the specific issue of earnings guidance, including reviewing some fundamental concepts on timely disclosure.
1. Timely disclosure generally
The first and simplest rule is that reporting issuers are obliged by securities rules to immediately disclose any material change. Stock exchange rules and policies also require issuers to make prompt disclosure of any material information. The key question in determining whether information is material is whether it would “reasonably be expected to have a significant effect on the market price or value of the securities”.
In the current market conditions, featuring both demand and supply shocks, many issuers are experiencing business impacts that amount to a material change or new material information. For example, an interruption in operations that is communicated to customers, may also have to be communicated separately to investors in the form of either a material change report or a news release. As these new developments are announced by the issuer, the issuer should, at the same time, consider whether previously issued earnings guidance should be revised or withdrawn. Ultimately, the risk to public companies that do not make timely disclosure is that they are exposed to a potential securities class action for failure to make timely disclosure of any material changes, as discussed further below.
2. Role of earnings guidance in Canadian securities law
There is no specific requirement in Canadian securities rules to issue earnings or other financial guidance. All guidance is therefore provided voluntarily by issuers. However, if an issuer does provide guidance, it is then subject to specific rules pertaining to that guidance, which are contained in National Instrument 51-102 Continuous Disclosure Obligations (the Instrument).
Part 4A of the Instrument governs forward-looking information (FLI) issued in writing. FLI is defined as:
disclosure regarding possible events, conditions or financial performance that is based on assumptions about future economic conditions and courses of action, and includes future-oriented financial information with respect to prospective financial performance, financial position or cash flows that is presented as a forecast or a projection;
A “financial outlook” and “future-oriented financial information” (FOFI) are subsets of FLI. They both have technical definitions set out in the Instrument, but in essence, FOFI is financial-related FLI that is “presented in the format of” certain financial statements, being a statement of financial position (or balance sheet), income statement or statement of cash flows. True FOFI is relatively uncommon. A financial outlook, broadly speaking, is any other financial-related FLI. A financial outlook is the technical term for the most common forms of earnings guidance, which are generally provided in quarterly earnings releases. Examples of financial outlooks also include statements as to expected revenue, profit or loss, earnings per share and R&D spending.
An issuer may disclose a financial outlook or FOFI under securities rules, as long as the disclosure is “based on assumptions that are reasonable in the circumstances”. In addition, issuers must limit the period covered by FOFI or a financial outlook to a period for which the information can be reasonably estimated. Securities regulators have indicated that in many cases, that time period will not go beyond the end of the issuer’s next fiscal year. In disrupted business conditions, it may be necessary for issuers to change their typical time horizon for providing guidance (i.e., it may only be possible to provide quarterly guidance, as opposed to annual guidance). If it is simply not possible to formulate reasonable assumptions, it would be appropriate to fully withdraw all guidance, as opposed to revising guidance.
3. Requirement to update
Section 5.8 of the Instrument requires issuers to update previously-issued FLI in the issuer’s next management discussion and analysis (MD&A). This requires discussion of any events that occurred during the period that could impact previously disclosed FLI in respect of future periods. The issuer is also required to discuss the expected differences. An issuer is mostly exempted from this rule if it has already issued a news release in respect of the applicable events, and it refers to that news release in its MD&A. Section 5.8, in effect, establishes that MD&A is the “last chance” to update previously-issued guidance.
In addition, it may be necessary to update guidance before the next MD&A if changing circumstances amount to a “material change” (as distinct from “material information”). A material change is “a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer”, or a decision to implement this type of change “made by the board of directors or other persons acting in a similar capacity or by senior management of the issuer, who believe that confirmation of the decision by the board of directors or such other persons acting in a similar capacity is probable”. The Supreme Court of Canada has stated in the seminal case of Kerr v Danier Leather Inc. that “a change in intra‑quarterly results is not itself a change in the issuer’s business, operations or capital and, for that matter, does not necessarily signal that a material change has occurred. Sales often fluctuate (as here) in response to factors that are external to the issuer.” In the context of the Danier Leather decision, the external factor was unfavourable weather, which, like the COVID-19 situation, is similarly unpredictable and outside of the issuer’s control.
4. Policy for updating guidance
If an issuer discloses FLI in writing, it must include warning language, including the issuer’s policy for updating FLI, if that policy goes beyond the requirement in Section 5.8 of the Instrument to update FLI when the next MD&A is issued. Most issuers actually use their caution language to disclaim any obligation to update guidance, unless required by law. Despite this, some issuers will update guidance earlier than required, as they feel there is a market expectation for them to do so. If an issuer has disclosed a policy for updating guidance that goes beyond minimum legal requirements, it should follow its policy.
5. Cautionary language
Cautionary statements in news releases and other documents containing FLI take on greater importance in volatile business and market conditions. The warning language, in addition to being a requirement of the Instrument, can provide a “safe harbour” to the issuer in respect of reliance by anyone who has bought or sold securities on the basis of the disclosure. That is, if such a person were to make a claim against the issuer for having lost money by virtue of reliance on the FLI, the issuer may have a defence based on properly drafted warning language. While cautionary language should never be boilerplate, it is now doubly important for cautionary statements to be thoughtful and tailored to current circumstances.
6. Risk factors in MD&A and AIF
Cautionary statements often refer to risk factors in the issuer’s MD&A and AIF. While the cautionary statement in an earnings news release should specifically call out the handful of the most important risks and assumptions relating to the issuer’s guidance, it is helpful for the issuer’s risk factors to contain discussions of the specific anticipated and possible impacts of the COVID-19 pandemic, and costs and operational changes associated with the issuer’s response plans.
7. Rapidly changing circumstances and insider trading
With circumstances changing so rapidly, it is sometimes difficult to discern whether a material change has occurred or new material information exists. Premature disclosure should be avoided. If in doubt as to whether circumstances warrant an announcement, consider establishing a trading blackout (that may be general or apply to “insiders only”, based on the issuer’s insider trading policy).
8. Normal course issuer bids (NCIB)
A normal course issuer bid (share buyback) is a tool that is available to issuers to help support their share price. NCIBs are generally used when the issuer’s board feels that the shares are undervalued. Boards must always consider whether supporting the issuer’s share price through an NCIB is worth using up precious cash. Many credit agreements also contain covenants that may restrict share buybacks without lender consent. In addition, purchases under an NCIB can only commence at time when there is no material undisclosed information. If an issuer wishes to implement a new NCIB, or make purchases under an existing NCIB, it may be necessary to fully update the market with all recent information, including any changes to guidance. Once an NCIB is in place, it can continue to operate through changing circumstances under an automatic share purchase plan, if one has been established.