Legal cannabis in Canada is still in its infancy, but the rate of growth has been revolutionary. A shifting regulatory landscape, the feverish pace of innovation and the push towards international expansion are just some of the challenges cannabis issuers face in their rapidly expanding industry. This past year has been a challenging one for cannabis issuers in the capital markets for other reasons, as they strain under the weight of frequent headlines highlighting a lack of good governance and disclosure practices by issuers in the sector. Predictably securities regulators have weighed in, reinforcing the notion that investor protection is paramount and that issuers must take more care when it comes to disclosing certain financial interests and governance matters.
Going forward, reporting issuers operating in the cannabis industry should expect increased regulatory scrutiny of their continuous disclosure documents. Citing a history of "inadequate transparency," the securities regulators in Ontario, British Columbia, Québec, New Brunswick, Saskatchewan, Manitoba, and Nova Scotia (collectively, the Regulators) released Multilateral Staff Notice 51-359 – Corporate Governance Related Disclosure Expectations for Reporting Issuers in the Cannabis Industry (the Staff Notice), which is intended to provide supplementary guidance relating to the disclosure of financial interests in the context of M&A transactions, as well as the independence of board members. While targeted towards cannabis issuers, the Staff Notice also references issuers in other emerging industries, hinting that the guidance provided may apply to more than just issuers in the cannabis space.
Disclosure of Financial Interests in M&A Transactions
The Staff Notice notes the disproportionately high degree of cross-ownership of financial interests among cannabis issuers and their directors and executive officers, pointing to the industry-standard practice of established cannabis issuers seeding the emerging ones. The Regulators take the view that, in the context of M&A transactions, disclosure of cross-ownership is material to investors when making investment decisions and may lead investors to re-examine other variables that may not otherwise be considered if the cross-ownership is not disclosed, such as purchase price, transaction timing and certain contingencies. The Regulators believe that such non-disclosure may lead investors to challenge the merits of such transactions more rigorously. Cannabis issuers should act accordingly and ensure that adequate disclosure is made with respect to cross-ownership in M&A transactions, whether involving the purchaser, target, or the directors and officers of either.
Disclosure of Corporate Governance Matters
Responding to persistent observations of deficient disclosure related to corporate governance policies and practices, the Staff Notice calls for cannabis issuers to strengthen their disclosure practices to align with National Policy 58-201 – Corporate Governance Guidelines, particularly in respect of board independence and the ethical conduct of directors. Independent directors must not have a direct or indirect 'material relationship' with the issuer, which is defined as a relationship that could, in the view of the issuer's board, be reasonably expected to interfere with the exercise of a director's independent judgment. In reaching this conclusion, boards are encouraged to consider potential conflicts of interest and other factors that may compromise independence, such as personal or business relationships with other directors and officers of the cannabis issuer. Boards should also generally consider the circumstances in which material relationships and compromising factors warrant disclosure to investors.
Cannabis issuers can manage conflicts arising due to cross-ownership of financial interests or conflicts amongst directors in various ways. Disclosure documents relating to an M&A transaction should adequately disclose the cross-ownership of financial interests based on the broader materiality requirements of the document. Some of the typical documents relating to an M&A transaction and their required disclosures are summarized as follows:
- Material Change Report: sufficient disclosure with respect to material changes to enable a reader to appreciate the significance and impact of the change without having to refer to other disclosure documents.
- Take-Over Bid Circular: sufficient disclosure with respect to matters that would reasonably be expected to affect the decision of investors to accept or reject an offer to acquire securities.
- Information Circular: sufficient disclosure to enable investors to form a reasoned judgment concerning matters being acted upon, including mergers, arrangements and other similar transactions.
- Listing Statements & Prospectus: must contain full, true and plain disclosure of all material facts relating to the securities being distributed.
Cannabis issuers are encouraged to adopt a written code of business conduct and ethics that addresses, among other things, conflicts of interest among directors and provides direction on disclosing these conflicts to the public. Such a code may also include guidance on the disclosure of cross-ownership and other compliance matters in the context of M&A transactions.
The Staff Notice indicates that securities regulators will continue to monitor these problem areas and take appropriate enforcement action when warranted. Accordingly, cannabis issuers should review their existing disclosure and ensure that steps are taken going forward to address the concerns of the Regulators outlined in the Staff Notice