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On an annual basis reporting issuers can benefit from reviewing the results of the Canadian Securities Administrators’ (the “CSA”) continuous disclosure (“CD”) review program.
The CD review program has the goal of identifying material disclosure deficiencies in the public disclosure records of listed issuers in order to maintain the reliability and accuracy of the information made available to investors. Robust and accurate CD is necessary to strengthen investor confidence and maintain efficient capital markets. The CSA’s CD review program has the purpose of promoting CD compliance and providing CD-related education and best practices.
The CSA conducts full reviews of issuer CD as well as narrower issue-oriented reviews. In 2010, the number of full reviews the CSA conducted increased by 13% and the number of issue-oriented reviews increased by 31%.
CSA Staff Notice 51-332 (the “Staff Notice”) provides listed issuers with valuable information as to areas of concern to the CSA in respect of CD, as well as examples of insufficient disclosure and suggested improvements to such deficient disclosure. A link to the full text of the Staff Notice is found here: http://osc.gov.on.ca/documents/en/SecuritiesCategory5/csa_20100709_51-332_cd-review.pdf
As a result of CSA CD reviews, disclosure made by issuers is given one of the five following designations, listed in order of increasing severity:
- No Action Required – If the CSA is satisfied with the standard of CD, the issuer is not required to take any action in respect of its CD filings and disclosure.
- Prospective Changes – If the CSA notes disclosure deficiencies, the issuer is informed that certain changes or enhancements must be made in the issuer’s next filings.
- Education and Awareness – If the CSA selects an issuer for a review based on that issuer’s risk profile, the issuer will receive a proactive letter from the CSA outlining certain enhancements to disclosure that the issuer should consider for its next filings. The education and awareness category was newly created in 2009.
- Refiling – If the CSA identifies significant deficiencies, the issuer must amend and re-file certain CD documents.
- Enforcement Referral / Default List/ Cease Trade Order – The CSA may determine that critical deficiencies warrant adding the issuer to the default list, to cease-trade the securities of the issuer or to refer he issuer to the applicable CSA enforcement branch.
Prospective Change findings were the most common in 2010, (as in 2009) representing 43% of the CD review outcomes. Most of such Prospective Changes pertained to new disclosure requirements.
The CSA uses a risk-based approach and focuses on the effects of the current economic climate, as well as regulatory changes in narrowing its CD review focus to select issuers at higher risk of non-compliance. As market forces change, so too does the CSA’s risk-based focus. Issuers should be alert to the effects that recent events in the financial markets may have on their own CD.
The pending implementation of International Financial Reporting Standards (“IFRS”) informed a great deal of the issue-oriented reviews conducted in 2010, as did National Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings and Form 51-102F6 – Statement of Executive Compensation (with respect to financial years ending on or after December 31, 2008) or National Instrument 51-102 – Continuous Disclosure Obligations.
A discussion of the common disclosure deficiencies found in full reviews follows:
Financial Statement Deficiencies
Improper disclosure of measurement methods and accounting policies account for many financial statement-related disclosure deficiencies. Specifically, the CSA noted that disclosure in respect of financial instruments, revenue recognition, goodwill and capital were areas of particular weakness.
Issuers should ensure that disclosure in respect of financial instruments includes:
- Methods of measuring financial instruments and, in instances where an evaluation technique is used, a discussion of the assumptions applied by the issuer in determining fair values for each class of financial assets or liabilities. These factors and assumptions must be appropriate for the current economic climate.
- Complete information in respect of liquidity and credit risk;
- Aging analysis in respect of past due accounts receivable balances; and Sensitivity analysis related to market risks.
As revenue recognition tends to have a significant impact on an issuer’s financial results, revenue recognition policy should be explicitly stated in a clear and concise manner. Disclosure considered to be adequate by the CSA clearly articulates the triggers for revenue recognition and the basis for revenue from each of the issuer’s products or services and also includes disclosure in respect of any credit terms, rights of return or conditions.
The CSA notes that disclosure with respect to the methodology used to conduct goodwill impairment testing remains an ongoing disclosure concern. Current economic and market conditions are both factors affecting the carrying value of assets and should be fully discussed.
Issuers should provide a summary of quantitative data about what each issuer manages as capital and include a discussion of whether they have met their capital management objectives.
In the Staff Notice, the CSA notes that Managements’ Discussion and Analysis (“MD&A”) is a critical CD document by virtue of providing investors with disclosure of important risks, trends and material information that may not be fully reflected in the issuer’s financial statements. The CSA expresses concerns about the generic disclosure found in many issuers’ MD&A and lists the following five critical deficiencies:
- Operations – Issuers should be careful to include a meaningful discussion and analysis, including a quantitative and qualitative analysis, of operating results, financial condition and liquidity. The CSA advises issuers to describe the reason for any material movements in the issuer’s income statement or any material variances to allow investors to determine whether the issuer’s past performance will be indicative of its future performance.
- Liquidity – If an issuer is anticipating or has had a working capital deficiency, there is an obligation to disclose that issuer’s ability to meet obligations as same become due and, importantly, to include a discussion of how the issuer intends to remedy the deficiency. Investors should be provided with adequate disclosure and analysis in the MD&A to determine whether the issuer will have adequate financial resources available to meet its operating needs.
- Risk – Material risks and uncertainties that could cause reported financial information not to be indicative of future operating results or not to be indicative of the issuer’s future financial position must be disclosed. The Staff Notice reiterates the importance of taking current economic and market conditions into consideration when determining and disclosing such risks and uncertainties.
- Related Parties – Issuers are reminded to disclose the business purpose informing related party transactions, as opposed to simply stating that a related party transaction occurred. Both quantitative and qualitative aspects of the related party transaction should be included in this disclosure.
- Critical Accounting Estimates – Issuers must discuss the methodology and assumptions used in determining critical accounting estimates, including assumptions, underlying accounting estimates pertaining to highly uncertain matters at the time of making the estimation, known trends, commitments, events or uncertainties that will materially affect the methodology or the assumptions that the issuer used. The disclosure must also include why the accounting estimate is reasonably likely to change from period to period and why it may have a material impact on financial presentation.
Oil & Gas Disclosure Deficiencies
The Staff Notice makes note that some oil and gas issuers are conflating technical terms and using such terms in a way that are not defined in the Canadian Oil and Gas Evaluation Handbook (the “COGEH”). This conflation of terms could cause misleading disclosure, particularly when the term “reserve” is used when describing resource volumes other than reserves.
In additional to the foregoing, the CSA conducted various issue-related reviews, not all of which are mentioned below. Salient disclosure deficiencies included in the various issue-related reviews include:
Mining and Technical Disclosure
- The name of the authors of scientific and technical reports is not always provided, nor are the certificates and consents of Qualified Persons (as such term is defined in National Instrument 43-101 – Standards of Disclosure for Mineral Projects “NI 43-101”)
- Historical estimate disclosure (especially as such disclosure pertains to the source and the data of such estimates) is not always included;
- Information on issuers’ websites and corporate presentation does not always comply with NI 43-101.
Oil and Gas Technical Disclosure
- All of the information required under National Instrument 51-101 – Standards of Disclosure for Oil and Gas Activities is not always provided and, when it is provided, such disclosure is often inconsistent;
- A discussion of important economic factors and uncertainties affecting particular portions of an issuer’s reserves data is not always present.
Issuers who will not be able to continue as a going concern must provide complete disclosure of this risk in their financial statements and MD&A.
Market conditions at the time of the issue-related reviews led the CSA to target issuers in particular industries with a higher risk of triggering asset impairment. The main deficiency found in the course of this review of the timing of the recording of impairments, the completeness of the methodology used in the impairment analysis and disclosure of accounting policies related thereto was that issuers tend to make insufficient disclosure of asset impairments.
Areas of Focus for Fiscal Year 2011
The Staff Notice highlighted the following issue-oriented reviews will be conducted in fiscal year 2011 by the CSA. The specific issues are subject to change, depending on the then-current economic climate: (i) IFRS transition disclosure; (ii) material contracts; (iii) corporate governance; and (v) follow-up review of the certification compliance review.