On November 12, 2019, the staff of the securities commissions of Ontario, British Columbia, Québec, New Brunswick, Saskatchewan and Nova Scotia (collectively, Staff) issued Multilateral Staff Notice 51-359 Corporate Governance Related Disclosure Expectations for Reporting Issuers in the Cannabis Industry (Staff Notice) regarding corporate governance-related disclosure expectations for reporting issuers in the cannabis industry. While the Staff Notice was directed towards cannabis industry reporting issuers, Staff note that the content is equally relevant to other issuers, including those operating in emerging growth industries.
Staff note that the growth of the cannabis industry over the past few years, in addition to an increase in M&A activity in the space, has led to a significant degree of crossover of financial interests, such as overlapping debt and equity interests, or other business relationships. Staff also point out that they have observed instances where directors are identified as independent, but where adequate consideration may not have been given to factors that may compromise that independence.
The Staff Notice concludes that reporting issuers, including cannabis issuers and issuers in other emerging growth industries, should ensure that governance-related disclosures sufficiently address concerns about conflicts of interest.
Disclosure of financial interests in M&A transactions
According to the Staff Notice, many directors and executives of cannabis companies participated in early rounds of financing of their respective cannabis issuer and, as the market expanded, of other cannabis issuers. This participation has caused a higher than normal degree of cross-ownership of financial interests among cannabis issuers and their directors and executive officers.
The regulators have observed a number of mergers, acquisitions or other significant corporate transactions in which the purchaser or target (or a director or officer of either entity) has a financial interest in the other entity that was not adequately disclosed to ensure transparency to market participants. Staff are of the view that there should be detailed disclosure regarding the cross-ownership of financial interests that are held by the purchaser or target, or their directors or officers. Staff’s position is that this information is “material information for investors and their investment/voting decisions, and should be disclosed in the applicable disclosure document” to enable securityholders to make more informed decisions about the merits of a transaction.
The document that contains the relevant disclosure will vary from transaction to transaction, but could include a material change report, prospectus, take-over bid circular, information circular, prospectus or a listing / filing statement. Regardless of the form of document required to be filed, the Staff Notice reminds issuers to disclose the cross-ownership of financial interests based on an adequately broad reading of the materiality requirements of the applicable disclosure document.
Disclosure regarding the independence of board members
The Staff Notice states that the regulators have observed instances where cannabis issuers have failed to give adequate consideration to potential conflicts of interest before identifying the board members as “independent”. Such conflicts of interest or other factors that might compromise a director’s independence include, for example, a director’s personal or business relationships with other directors and executive officers of the issuer. In addition to considering the impact of such relationships or other factors on a director’s independence, the Staff Notice also reminds issuers of their obligation to consider whether disclosure of such matters is warranted.
In the Staff Notice, the regulators state that they have observed instances where the chair of the board and the chief executive officer of the cannabis issuer are the same individual, even though National Policy 58-201 Corporate Governance Guidelines suggests that the chair should be an independent director to ensure that suitable structures are in place to permit the board to operate independently.
The Staff Notice encourages cannabis issuers to adopt a written code of business conduct and ethics, which could include ethical decision-making standards, provisions around how and when conflicts of interest should be disclosed, and provisions regarding the disclosure of cross-directorships and officer positions in the M&A context.
While governance ‘growing pains’ are commonplace for high-growth companies operating in emerging market industries, cannabis issuers would be well-advised to take a proactive approach to adopting improved governance standards and procedures. Dentons applauds the Staff Notice for providing much needed awareness of best practices for corporate governance and conflict of interest disclosure at a time when the cannabis industry needs to increase transparency and build trust with capital market participants. Although the Staff Notice does not establish any new disclosure requirements, it reinforces the expectations of the Canadian securities regulators as the cannabis industry becomes subject to greater scrutiny and matures. Cannabis issuers will need to continue to undertake regular assessments of governance requirements and actively solicit feedback from stakeholders and advisors, including developing a plan for the successful adoption and implementation of new governance practices, as well as prioritizing adherence to existing policies.
Dentons’ leading Cannabis group will continue to work closely with existing industry stakeholders and publish insights on these important developments. For more information on how the Staff Notice impacts cannabis market participants, please contact Eric Foster, Kim Lawton or Stuart Ruffolo.