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HIGHLIGHTS OF THE UNIFIED APPROACH

• single initiative of all CSA members on governance
• guidelines not mandatory
• disclosure requirements mandatory
• TSX to adopt guidelines as basis for disclosure
• guidance provided for income trusts on application of guidelines
• definition of independence refined

INTRODUCTION

On October 29, 2004, the Canadian Securities Administrators (the "CSA") published proposed National Policy 58-201 Corporate Governance Guidelines (the "Proposed Policy") and National Instrument 58-101 Disclosure of Corporate Governance Practices (the "Disclosure Instrument"). The Proposed Policy and the Disclosure Instrument are initiatives of all members of the CSA. This represents a significant departure from governance proposals published earlier this year which were not endorsed by all CSA members. Given the multiplicity of governance initiatives in the Canadian markets, this united approach is a welcome change from earlier CSA member initiatives. Comments on the Proposed Policy and the Disclosure Instrument must be received by December, 2004. For background information see Notice: Request for Comments.

The CSA have also published proposed Amendments to Multilateral Instrument 52-110 Audit Committees (the "Audit Committee Amendments") which amend the definition of independence to reflect more closely the definitions used in the United States for directors and audit committee members and make certain technical amendments to the Audit Committee Instrument. Comments on the Audit Committee Amendments must be received by January 27, 2005.

In January 2004 all members of the CSA except Quebec and British Columbia published proposed governance guidelines and disclosure requirements (the "January Proposal"). In the spring of 2004, British Columbia, Quebec and Alberta published an alternate proposal (the "Alternate Proposal"). The Alternate Proposal required disclosure of an issuer's governance practices by category but did not require disclosure of an issuer's governance practices against a set of best practices as in the January Proposal.

The Proposed Policy and the Disclosure Instrument contain elements of both the January Proposal and the Alternate Proposal. The Proposed Policy provides guidance on governance practices for all issuers other than investment funds. The Disclosure Instrument requires non-exempt issuers to make prescribed disclosure regarding their governance practices with the aim of increasing the transparency of governance practices of issuers in the market. Where an issuer does not follow a particular guideline, it generally must disclose what the board of directors does to facilitate the objective of the proposed guideline. This represents a departure from the January Proposal which required an issuer to justify why it did not adopt a particular governance practice, raising concerns that issuers might adopt the practices regardless of whether they were suitable for a particular issuer.

The guidelines contained in the Proposed Policy represent an evolution from the TSX corporate governance guidelines initially introduced in 1995. The TSX has concurrently published a proposal which states that once the CSA initiatives are finalized, the TSX intends to replace its governance guidelines with a requirement that TSX-listed issuers make disclosure in accordance with the Disclosure Instrument. See TSX Request for Comment - Corporate Governance Policy.

THE PROPOSED GOVERNANCE GUIDELINES

The Proposed Policy attempts to achieve a balance between investor protection and fair and efficient markets. It also attempts to recognize the greater number of smaller and controlled issuers in the Canadian market. The Proposed Policy is not prescriptive but is intended to provide guidance to issuers. It encourages issuers to consider the suggested standards in developing their own practices. The Proposed Policy therefore adopts a more traditional Canadian approach of providing guidance regarding governance rather than imposing mandatory rules as is the practice in the United States. The CSA recognize that governance practices are constantly evolving and have indicated that they intend to review the guidelines periodically.

The guidelines contained in the Proposed Policy relate to board independence, the roles of the board and management, directors' education, board assessment, selection of directors and the compensation of senior officers. The guidelines contained in the Proposed Policy are based on the January Proposal. The Alternate Proposal did not provide any guidelines. The principal changes to the January Proposal are noted. The Proposed Policy includes the following key recommendations:

Independence of the Board

• a majority of the directors should be "independent".
• the independent directors should hold separate, regularly scheduled meetings. A new requirement not contained in the January Proposals is the necessity for an issuer to disclose the number of such meetings, although not the attendance of the independent directors.
• the chair should be independent and, if not, an independent lead director should be appointed and act as the effective leader of the board.

The Proposed Policy and the Disclosure Instrument adopt a definition of independence contained in the Audit Committee Instrument. The general test is that a director will be independent if he or she has no direct or indirect material relationship with the issuer. A material relationship exists where the directors are of the view that the relationship could reasonably be expected to interfere with the exercise of the member's independent judgment. Certain relationships which are deemed to preclude independence are then described. The relationships which will preclude independence for directors are the subject of the Audit Committee Amendments and are discussed below.

For issuers who are reporting issuers only in British Columbia, this definition of independence is not applicable; instead independence is based upon whether a reasonable person would conclude that the director is in fact not independent of management or of a significant shareholder.

Defining the Role of the Board and Management

• adoption of a written mandate under which the board assumes responsibility for the stewardship of the issuer, including responsibility for:
• satisfying itself, to the extent feasible, as to the integrity of the executive officers and as to their creation of a culture of integrity;
  1. adopting a strategic planning process;
  2. identifying risks and ensuring implementation of systems to manage such risks;
  3. succession planning;
  4. adopting a communication policy;
  5. internal control and management information systems; and
  6. developing an approach to corporate governance. A separate corporate governance committee comprised of non-management directors, a majority of whom are independent directors, may be established to fulfill
  7. The requirement contained in the January Proposal that the mandate set out matters requiring board approval and the board's expectations of management has been deleted.
• adopting position descriptions for the chair, committee chairs and CEO. The proposal to have a description of the general role of director that was contained in the January Proposal has been deleted and replaced with a recommendation that the written mandate of the board outline the expectations and responsibilities of directors.
• the mandate should set out methods for receiving feedback from shareholders (which it is suggested could include establishing a process for direct communication between shareholders and independent directors).

Education and Orientation

• comprehensive orientation for new directors and continuing education for all directors.

Board Assessment and Selection of Directors

• nominating committee composed of independent directors.
• written charter of the nominating committee setting out its purpose, responsibilities, membership, structure, operations and manner of reporting to the board.
• in considering potential nominees, the committee should consider the skills and competencies required of the whole board, each existing director and each proposed nominee.
• the board should regularly assess the effectiveness of the board as a whole and of each individual director. The assessment should consider the board mandate and committee charters and in the case of an individual director, the applicable position description(s).

Compensation of Senior Officers

• compensation committee composed of independent directors.
• written charter of the compensation committee setting out its purpose, responsibilities, membership, structure, operations and manner of reporting to the board.
• responsibility for evaluating the CEO and determining compensation or making compensation recommendations to the board. The guidance in the January Proposals did not expressly provide for the compensation committee to determine compensation.
• responsibility for recommendations on non-CEO officer and director compensation, incentive and equity-based plans.
• reviewing executive compensation disclosure prior to release.

Code of Conduct and Ethics

• adoption of a written code of business conduct and ethics setting out standards designed to promote integrity and deter wrongdoing.
• board responsibility for monitoring compliance with code, and any waiver of code for the benefit of a director or executive officer to be granted only by board or committee.

THE DISCLOSURE INSTRUMENT

The Disclosure Instrument will require issuers to disclose their corporate governance practices in their management information circular (or Annual Information Form (AIF) if no circular is prepared). The January Proposal required the disclosure to be contained in an issuer's AIF. Where a guideline set out in the Proposed Policy is not the governance practice of an issuer, the disclosure prescribed requires a description of how the board ensures the objective of the guideline has been met. The Disclosure Instrument also enhances the disclosure required by the January Proposal in the following ways:

• the independence of each director must be disclosed and the basis for the determination that a director is non-independent must be set out. The January Proposal merely required disclosure as to whether a majority of directors were independent.
• any other directorships that a director holds must be disclosed.
• the number of separately held meetings of the independent directors must be stated, although attendance statistics for such meetings are not required.

An issuer which has a business code of conduct and ethics must also file the code and all amendments to the code on SEDAR. The requirement contained in the January Proposal to disclose a waiver of the code in favour of a director or officer by press release has been deleted. The CSA have however indicated in the Proposed Policy that conduct of a director or officer which represents a material departure from a business code will likely be considered to be a material change triggering the material change reporting requirements of securities laws.

Unlisted issuers or issuers which are not listed on a designated exchange (venture issuers), which will include TSX Venture Exchange issuers, will be required to generally disclose their governance practices, which is similar to the approach proposed in the Alternative Proposal.

The Proposed Policy and Disclosure Instrument state that, in an income trust, the functions of a corporate issuer, its board or management may be performed by the trustees, board or management of a subsidiary of the trust, or the board, management or employees of a management company. Income trust issuers are instructed to apply the guidelines and disclose their governance practices recognizing that the functions may be performed by all or any of such persons.

APPLICATION OF THE POLICY AND INSTRUMENT

The Proposed Policy provides guidance to all issuers. The Disclosure Instrument, once enacted, will apply to all reporting issuers other than investment funds, SEC foreign issuers, designated foreign issuers, certain exchangeable security and credit support issuers and issuers of asset-backed securities. A new exemption has been introduced for wholly-owned subsidiaries which have no listed equity securities provided the parent company is subject to the Disclosure Instrument or comparable US rules.

DEFINITION OF INDEPENDENCE

The Audit Committee Instrument which was introduced in March 2004 requires issuers, other than venture issuers, to have an audit committee consisting of at least three members, all of whom are independent from the issuer. Independence for the purposes of the Proposed Policy, the Disclosure Instrument and the Audit Committee Instrument is based upon whether or not the nominee has a direct or indirect material relationship with the issuer. Certain relationships will preclude independence. The Audit Committee Amendments to the definition of independence clarify certain uncertainties identified in the Audit Committee Instrument and facilitate cross-referencing to the Proposed Policy and Disclosure Instrument.

The Audit Committee Amendments adopt two sets of relationships that will preclude independence. The first set of defined relationships, which is based upon New York Stock Exchange Corporate Governance Rules relating to independent directors, will preclude directors or nominees from being considered independent for purposes of the Proposed Policy, the Disclosure Instrument and the Audit Committee Instrument. The second set of relationships, which is based upon the requirements of the SEC for independent audit committee members, will prevent certain directors from being considered independent under the Audit Committee Instrument for purposes of serving on an audit committee.

A director or proposed nominee to a board will be considered to have a material relationship with an issuer which precludes his or her independence:

1. if he, she or an immediate family member is, or has been within the last three years, an employee or executive officer of the issuer (in the case of immediate family members independence will only be affected if the immediate family member is or was an executive officer);
2. if he or she is a partner or employee of the issuer's internal or external auditor or was within the last three years a partner or employee and personally worked on the issuer's audit during that time;
3. if his or her spouse, minor child or stepchild, or child or stepchild who shares a home with him or her, is a partner or employee of the issuer's internal or external auditor and, if an employee, participates in its audit, assurance or tax compliance practice, or was within the last three years a partner or employee of the internal or external auditor and personally worked on the issuer's audit during that time;
4. if he, she or an immediate family member is, or has been within the last three years, an executive officer of an entity on whose compensation committee any executive of the issuer serves or served; or
5. if he or she or an immediate family member who is employed as an executive officer receivedmore than $75,000 in direct compensation from the issuer (other than for service as a director or part-time chair or vice-chair and not including fixed amounts received under a retirement or deferred compensation plan that are not contingent on continued service) during any twelve month period within the last three years.

It is not necessary to consider relationships that ended prior to March 30, 2004. The Audit Committee Amendments provide that the term "issuer" includes both parent and subsidiary entities of the issuer.

In addition, for the purposes of serving on an audit committee, a director will not be considered independent:

1. if he or she (or his or her spouse, minor child or stepchild, or child or stepchild who lives in the same home as that individual) may accept any advisory, consulting or other compensatory fee from the issuer or any subsidiary (other than compensation for acting as a director or retirement compensation); or
2. if he or she is an affiliated entity of the issuer or any subsidiary.

Certain clarifying amendments to the Audit Committee Instrument have also been introduced. These include specifically precluding a full-time non-executive chairman, but not a part-time chair, vice-chair or interim CEO, from being a member of the audit committee. Venture issuers will also be required to disclose the education and experience of their audit committee members.

CONCLUSION

The unified approach taken by the CSA in producing the Proposed Policy and Disclosure Instrument and the proposed notice of the TSX accepting the Disclosure Instrument are welcome changes in Canadian corporate governance. It remains to be seen whether the Canada Business Corporations Act will be amended as proposed in May 2004 to introduce corporate governance requirements, thereby providing an additional layer of regulation for Canadian issuers subject to that legislation.

The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault or any member of the Firm on the points of law discussed.

©OGILVY RENAULT 2004 - All Rights Reserved

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