The Corporate Finance Branch of the Ontario Securities Commission (OSC) recently published OSC Staff Notice 51-728 Corporate Finance Branch 2016-2017 Annual Report (Report), which outlines the policy views of, and related guidance from, the OSC on a number of issues that arose during its annual continuous disclosure review program and ongoing review of offering documents and exemptive relief applications.
The following is a summary of certain key areas of the OSC’s policy views and related guidance from the Report, much of which builds off of the issues the OSC has recently focused on, that may affect capital market transactions and that issuers should keep in mind going forward.
Non-GAAP Financial Measures
In the Report, the OSC expresses its continued concern with the use of non-GAAP financial measures. The report emphasizes the OSC’s concerns about the prominence being given to non-GAAP financial measures over generally accepted accounting principles (GAAP) financial measures in issuers’ disclosures, the lack of visibility and clarity of the adjustments being made and the appropriateness of the adjustments themselves.
The Report provides examples of the OSC’s expectations for the use of non-GAAP financial measures by issuers in certain industries. For example, the Report addresses the use of non-GAAP financial measures by mining issuers to describe production costs at producing mines and free cash flow at development projects; the use of payout ratios by real estate investment trust issuers; and the use of EBITDA (earnings before interest, tax, depreciation and amortization), adjusted EBITDA and earnings per share by technology and biotechnology issuers.
Issuers should be aware that the OSC will continue to carefully review the use of non-GAAP financial measures over the next year and, in what appears to be the OSC’s harshest stance to date, it has indicated that it is willing to initiate regulatory action in cases where issuers provide disclosure that the OSC considers misleading or otherwise contrary to the public interest. These highlighted issues should be of particular interest for issuers who are expecting to actively participate in the public capital markets as they have the potential to impact the OSC prospectus review process and issuers’ access to capital markets.
Social Media Disclosure
Issuers often provide investors with information about their business and operations using social media platforms. The Report indicates that the OSC has the same expectations for social media disclosure as they do for other types of disclosure, meaning issuers must avoid early, selective or misleading disclosure and ensure that all material information is simultaneously filed on the System for Electronic Document Analysis and Retrieval. The OSC strongly encourages the adoption of a social media governance policy to enhance the integrity of disclosures provided in regulatory filings and on social media. For additional information on social media disclosure, see our March 2017 Blakes Bulletin: New Medium, Same Expectations: CSA Cautions Canadian Public Issuers on Use of Social Media.
Business Acquisition Reports (BAR)
The OSC provides additional guidance on how to determine whether an acquisition is an asset or business acquisition for the purposes of the BAR requirement. The Report states that the OSC generally considers the acquisition of a separate entity, subsidiary or division to be an acquisition of a business, and that in certain circumstances, the acquisition of a component of a company may constitute the acquisition of a business, regardless of whether financial statements for the business were previously prepared. Issuers are encouraged to consult with the OSC prior to filing if there is uncertainty as to whether an acquisition constitutes a business acquisition for securities law purposes. With respect to exemptive relief from the BAR requirements, the Report reminds issuers that the cost or time involved in preparing and auditing financial statements are irrelevant to the OSC when granting relief.
Forward-Looking Information (FLI)
Another topic that the OSC continues to focus on is FLI. The OSC is concerned by the continued use of generic factors and assumptions that are not quantified. In particular, the OSC is concerned with the lack of reasonable and sufficient assumptions supporting some issuers’ FLI and the time period covered by FLI (as it is required to be limited to a period for which the information can be reasonably estimated). The Report states that, in many cases, such reasonable time period will not go beyond the end of the reporting issuer’s next fiscal year. Notably, the Report indicates that the OSC may raise comments on the reasonableness of the time period of FLI presented by an issuer, and where FLI is presented for multiple years and is not sufficiently supported by reasonably qualitative and quantitative assumptions, the OSC may ask an issuer to limit the FLI to a shorter period. This new guidance has the potential to impact the use of long-term (e.g., three-to-five year) targets and forecasts in issuers’ initial public offering (IPO) prospectuses, a practice that has seen increased use in Canada over the last few years. The OSC further advised that where an issuer is projecting aggressive growth targets without the benefit of historical experience, it will expect the issuer should be able to show a reasonable basis for those targets, including the key drivers behind the projected growth with reference to specific plans and objectives that support the projected growth; and why management believes that each of the targets/FLI are reasonable. In addition to its impact on public disclosure going forward, this may have an immediate impact on issuers who are in the midst of an IPO or other prospectus offering and who may be required to amend their FLI disclosure or limit it to a shorter period of time.
The Report also reminds issuers of requirements to update previously disclosed FLI when events or circumstances are likely to cause actual results to differ materially from the previously disclosed FLI, and include a comparison of actual results to previously disclosed financial outlook, which we anticipate they will expect to see addressed by way of update in an issuer’s interim or annual management discussion and analysis, as the case may be.
Financial Statement Disclosure for Certain Significant Acquisitions
The Report states that, where an issuer is raising proceeds to fund an acquisition that is larger than its current business or that will make up a material portion of its business, the issuer should consider whether the prescribed disclosure for significant acquisitions in the prospectus rules is adequate or whether additional disclosure is required for the prospectus to contain full, true and plain disclosure. While it is unclear when and what additional disclosure would be required, the Report indicates that issuers with an existing annual information form (AIF) should consider if the AIF needs to be supplemented with disclosure on the acquisition in the prospectus and whether the inclusion of additional audited financial statements (beyond what is required for BAR-level reporting) is necessary. This indicates that issuers may benefit from having discussions with the OSC pre-filling, regarding certain significant acquisitions, in order to ensure that an issuer’s prospectus disclosure is sufficient, and avoid potential disclosure issues.
Primary Business in an IPO
The Report affirms the OSC’s position that three years of financial statements (two years for a venture issuer) must be included in an IPO prospectus for each business acquired by an issuer during those three years (or two years in the case of a venture issuer) if the business forms part of the issuer’s “primary business”. The Report indicates that the significance test is not the only consideration for determining whether financial statement disclosure is necessary. It also confirms the OSC’s position that full financial disclosure is required in a prospectus for any business that represents more than half of the issuer’s overall business, even if it is not a part of the issuer’s “primary business”. Issuers contemplating an IPO should consider these financial disclosure obligations early in the IPO process with their legal advisors, especially issuers that have completed any acquisitions in recent years, in order to determine whether, among other things, the issuer would benefit from engaging in any pre-filing discussions with the OSC.
Sufficiency of Proceeds and Financial Condition of an Issuer
The Report reminds issuers that the OSC can withhold a receipt for a prospectus in certain circumstances, including where the aggregate proceeds raised are considered to be insufficient to accomplish the stated purpose of the offering. Therefore, it is important that issuers disclose their financial position, including any liquidity concerns, as well as how they intend to use the net proceeds raised in the offering.
The Report also cautions issuers that the OSC may refuse to issue a receipt for a base shelf prospectus if the structure of the base shelf prospectus is not appropriate because of the issuer’s financial condition or uncertainty of financing. This situation may arise when an issuer does not have sufficient cash resources to continue operations or to complete developmental milestones over the next 12 months or their audited financial statements contain a “going concern” note. In these circumstances, the OSC may request that issuers withdraw the base shelf prospectus and file a short form prospectus with a minimum subscription amount or a fully underwritten commitment, or arrange for additional committed sources of financing.
The authors also wish to acknowledge the contributions of Kate Palumbo, Student-at-Law.
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