Written By Aaron Sonshine and Christopher Travascio
On November 12, 2019, the Canadian Securities Administrators (CSA) published Multilateral Staff Notice 51-359 Corporate Governance Related Discourse Expectations for Reporting Issuers in the Cannabis Industry ("MSN51-359") to address what securities regulators in Ontario, Quebec, New Brunswick, Saskatchewan, Manitoba and Nova Scotia (collectively, "securities regulators") see as a lack of transparency in the disclosure and vetting of financial interests by cannabis reporting issuers.
Improved Disclosure of Financial Interests in Corporate Transactions
The cannabis sector has experienced significant growth in the past few years driven by a surge of commercial transactions and M&A activity. Included in such dealings are instances where cannabis issuers and their directors and executive officers contribute to the financing of other cannabis issuers. This practice has resulted in an industry that securities regulators perceive as having an above average cross-ownership of financial interests, be it overlapping debt, equity, or other business relationships.
The concern, from a regulator's point of view, is that parties (and their directors/executive officers) to a commercial transaction or M&A deal are failing to adequately disclose financial interests in the counterparty. MSN51-359 takes the position that cross-ownership of financial interests is material information that should be disclosed to investors through applicable disclosure documents regardless of how strong the interest may be. Securities regulators want investors to have sufficient information to address concerns about potential conflict of interests and to better scrutinize the terms of a transaction.
Push for Stronger Scrutiny of Independent Directors
A related issue is that board members identified by cannabis reporting issuers as independent may not actually be so upon further scrutiny. MSN51-359 suggests that cannabis issuers are failing to appreciate material relationships when considering a director's independence. A material relationship is any relationship which could, in the view of the board, be reasonably expected to interfere with the exercise of a director's independent judgement. Material relationships may include personal or business relationships that directors have with other directors and executive officers.
Independent directors are a staple of good corporate governance as they enable a board to exercise independent judgement. To improve board independence in the cannabis space, MSN51-359 asks reporting issuers to better examine relationships and other factors that may compromise a director's independence and consider whether disclosure of these factors is justified. For guidance on corporate governance practices, reporting issuers should turn to National Instrument 58-101 Disclosure of Corporate Governance Practices and National Policy 58-201 Corporate Governance Guidelines.
To better deal with conflicts of interest and other ethical challenges, MSN51-359 encourages issuers to adopt a written code of business conduct and ethics that assists issuers in determining standard practices for ethical decision-making and compliance. The code may include provisions that describe when and how conflicts of interests or cross-ownership are disclosed.
What Does this Mean for Reporting Issuers?
Reporting issuers, especially those in cannabis and other growth industries, should appreciate the impact that conflicts of interest have on investor decision making. At a practical level, reporting issuers should be prudent in identifying and disclosing material information related to conflicts of interest in applicable continuous disclosure documents.