Publication
title
The Canadian Securities Administrators Venture Further into the Corporate Governance Arena
DATE
February 2, 2004
EXPERTISE
- The CSA propose disclosure against new recommended governance guidelines including:
- a majority of independent directors
- a written board mandate
- regularly scheduled meetings of independent directors
- an independent chair or lead director
- independent nominating and compensation committees
- Final Audit Committee Instrument
- will apply on the earlier of the first AGM of the issuer after July 1, 2004, and July 1, 2005
- requires a financially literate independent committee of at least three members
- drops the disclosure requirement for financial expert(s)
- requires enhanced disclosure on audit committee members
- provides new temporary exemptions from independence and financial literacy requirements
- Final CEO/CFO Certification Instrument
- requires certification for financial years and interim periods beginning on or after January 1, 2004 (a table of filing requirements is included)
- requires no certification of internal or disclosure controls for a significant period
- requires no CEO/CFO conclusion about the effectiveness of internal controls, but this is being considered by the CSA
- Final Auditor Oversight Instrument
- auditors of public issuers are required to participate in the CPAB oversight program
INTRODUCTION
The Canadian Securities Administrators (the "CSA") took a further step into the corporate governance arena by publishing proposed Multilateral Policy 58-201 Effective Corporate Governance (the "Proposed Policy") and Multilateral Instrument 58-101 Disclosure of Corporate Governance Practices (the "Disclosure Instrument") on January 16, 2004. The Proposed Policy and the Disclosure Instrument are initiatives of all members of the CSA except Quebec and British Columbia. The Proposed Policy and the Disclosure Instrument recommend best practices in corporate governance and represent an evolution from the initial corporate governance guidelines introduced in 1995 by the TSX. The TSX has indicated that it will revoke its corporate governance guidelines when the Proposed Policy and the Disclosure Instrument come into force. Comments on the Proposed Policy and the Disclosure Instrument must be received by April 15, 2004.
In addition, the CSA have now published final instruments on the composition and function of audit committees (the "Audit Committee Instrument"), the certification of annual and interim filings (the "Certification Instrument") and the oversight of auditors (the "Auditor Oversight Instrument"). These instruments were published for comment in June 2003 (the "June Proposals") and are expected to come into force on March 30, 2004.1 For complete details of the June Proposals, see our July 2003 information bulletin entitled The CSA Propose Reforms to Enhance Investor Confidence" on the Ogilvy Renault website.
THE PROPOSED GOVERNANCE GUIDELINES
The Proposed Policy is based on TSX guidelines, the listing standards of the New York Stock Exchange, the Sarbanes-Oxley Act of 2002 and other regulatory and market developments. The Proposed Policy is not prescriptive. Rather it encourages issuers to adopt the suggested standards but to implement them flexibly and sensibly, taking into consideration their particular circumstances.
The Proposed Policy reflects the traditional Canadian approach of "comply or not, but do disclose" and in that sense differs from the rules imposed on audit committees. Under the Disclosure Instrument issuers will be required to disclose in their AIF if they are in compliance with the guidelines and if not, to disclose why the board considers it appropriate not to comply. An issuer which has a business code of conduct and ethics must also file the code and all amendments to the code on SEDAR. Disclosure of a waiver of the code in favour of a director or senior officer must also be promptly disclosed by news release.
The CSA recognize that the field of governance is evolving and have indicated that they intend to review the guidelines during the two years following implementation. One of the important effects of moving the regulation from the TSX to the securities regulators is that disclosure against the guidelines will be enforced by the regulators and failure to disclose will be a breach of provincial securities laws.
The Proposed Policy makes recommendations regarding board independence, the roles of the board and management, directors' education, board assessment and selection of directors and the compensation of senior officers. The Proposed Policy includes the following recommendations:
Independence of the Board
- a majority of the directors should be "independent"
- the independent directors should hold separate, regularly scheduled meetings
- the chair should be independent and, if not, an independent lead director should be appointed
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 interfere with the exercise of the member's independent judgment. Certain relationships are deemed to preclude independence.2
As in the United States, certain relationships which preclude independence for purposes of serving on the audit committee will not affect the independence of a proposed director.
Defining the Role of the Board and Management
- adoption of a written mandate under which the board assumes responsibility for:
- satisfying itself as to the integrity of the senior officers and as to their creation of a culture of integrity;
- adopting a strategic planning process;
- identifying risks and ensuring implementation of systems to manage risk;
- succession planning;
- adopting a communication policy;
- ensuring the integrity of internal control and management information systems; and
- 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
- adopting position descriptions for the chair, directors, committee chairs and the CEO
Education and Orientation
- comprehensive orientation for new directors and continuing education for directors
Board Assessment and Selection of Directors
- nominating committee composed of independent directors
- written charter setting out the purpose, responsibilities, operations and reporting of the nominating committee
- 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
Compensation of Senior Officers
- compensation committee composed of independent directors
- written charter setting out the purpose, responsibilities, operations and reporting of the compensation committee
- responsibility for evaluating the CEO and making compensation recommendations
- responsibility for recommendations on non-CEO 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 deter wrongdoing
Differences from TSX Guidelines
The new guidelines differ from the fourteen existing TSX guidelines, including by recommending a written board mandate, a code of business conduct and ethics, position descriptions, fully independent compensation and nominating committees with written charters and by imposing responsibility on the directors for overseeing organizational integrity.
Application of the Policy
The Proposed Policy and Disclosure Instrument, once enacted, will apply to all reporting issuers3 other than investment funds, SEC foreign issuers, designated foreign issuers, certain exchangeable security and credit support issuers4 and issuers of asset-backed securities. Unlisted issuers or issuers who are not listed on a designated exchange (venture issuers), which will include TSX Venture Exchange issuers, will only be required to disclose with reference to the guidelines concerning the composition of the board, written board mandates and codes of business conduct and ethics.
FINAL REQUIREMENTS FOR AUDIT COMMITTEES
The Audit Committee Instrument aims to minimize conflicts of interest between management and an issuer's external auditor by requiring an independent audit committee responsible for the appointment, compensation, retention and oversight of the external auditor. Issuers, other than venture issuers, will be required to have an audit committee consisting of at least three members, all of whom are independent from the issuer and all of whom are or will be financially literate. Audit committees will be required to have a written charter.
Independence is based upon whether or not the nominee has a direct or indirect material relationship with the issuer. Relationships that preclude independence are outlined in the Audit Committee Instrument and include those individuals who would not be considered independent under the Proposed Policy. In addition, those individuals who receive compensatory fees from an issuer (see "Meaning of Independence" below) or who are an affiliated entity5 of the issuer or any subsidiary will not be considered independent for the purpose of serving on the audit committee.
The Audit Committee Instrument departs from the June Proposals in several significant ways, most of which provide greater flexibility for issuers. The principal areas of change are:
- No Designation of Financial Expert(s). The requirement to disclose whether an issuer has a financial expert on its audit committee has been dropped. The requirement, which mirrored that contained in the Sarbanes-Oxley Act of 2002, evoked concerns regarding the increased liability of directors publicly designated as experts and the resulting reluctance on the part of such experts to serve on audit committees, as well as more practical concerns as to whether there would be individuals with sufficient expertise who would meet the proposed standard. The requirement has now been replaced with a requirement to disclose, for each member of the audit committee, that member's education and experience that relate to his or her responsibilities as a member of the audit committee.
- Pre-Approval of Non-Audit Services. The Audit Committee Instrument now specifically allows the committee to satisfy the requirement to approve non-audit services by the external auditor by adopting procedures and policies. Pre-approval policies and procedures must be detailed as to the particular service, and this requirement will not be satisfied by establishing broad categories of approval. The audit committee must clearly understand what it is being asked to pre-approve and such policies must not amount to a delegation of the approval function to management. Monetary limits should not be the only basis for pre-approval.
- Meaning of Independence. The prescribed relationships which preclude independence have also been more closely conformed to the SEC and NYSE rules from which they were derived. The Audit Committee Instrument now provides that an immediate family member of a proposed member of the committee must be or, within the last three years, have been an executive officer, not merely an employee, of the issuer to preclude a finding of independence in respect of the proposed member. The Audit Committee Instrument has also clarified that non-executive chairs and vice-chairs (unless they acted as such on a full-time basis) will not be considered non-independent by reason of those positions alone. Interim CEOs will also not be considered non-independent by reason of that position alone.
- The rule regarding advisors and consultants provides that an individual who has a relationship with the issuer pursuant to which he or she may accept advisory, consulting or other fees from an issuer or any subsidiary will not be independent. Directors' fees or fees for acting as a part-time chair or vice-chair and fixed amounts received under retirement or deferred compensation plans that are not contingent on continued service will not be taken into consideration. The acceptance of advisory, consulting or compensatory fees includes the indirect acceptance of fees by certain members of the individual's immediate family and by consulting or advisory entities of which the person is a partner or member. The CSA have resisted allowing a de minimis amount of such fees, but have removed the three-year look-back provision contained in the June Proposals. As a result, former partners of advisory firms will be allowed to be audit committee members unless they are otherwise not independent.
- In addition, the Audit Committee Instrument precludes a director from serving on the issuer's audit committee if he or she or an immediate family member receives, or received in the previous 3 years, more than $75,000 annually in direct compensation from an issuer or subsidiary (other than in respect of service as a director or as a part-time chair or vice-chair and excluding deferred or retirement compensation not contingent on continued service).
- Closely-Controlled Issuers. The Audit Committee Instrument provides an exemption from the independence requirement where a director would be independent but for the fact that he or she is a director of an affiliated entity. In response to comments received on the June Proposals regarding the inability of a controlling shareholder who is an individual to participate in an issuer's audit committee, the exemption has been extended to allow a member who, for that reason, is not independent, to sit on the audit committee, provided the member is not also an executive officer, general partner or managing member (or an immediate family member of a person holding such position) of a publicly traded affiliated entity. However, such a member will not be permitted to be the chair of the audit committee and a majority of the members must still be independent. The board will also need to be satisfied that the individual is able to act impartially in performing his or her duties and that the appointment is in the best interests of the shareholders. Reliance on the extended closely-controlled issuer exemption requires disclosure.
- New Exemptions from the Independence and Financial Literacy Requirements. The Audit Committee Instrument has introduced two temporary exemptions. An audit committee member will be exempt from the independence requirement for a maximum of two years if:
- he or she is not an employee or officer of the issuer or an immediate family member of an employee or officer; and
- he or she does not receive advisory, consulting or other fees from the issuer or a subsidiary as described under "Meaning of Independence"; and
- he or she is not an affiliated entity of the issuer or any subsidiary.
- In addition, a director who is not financially literate may be appointed to the audit committee provided he or she becomes financially literate within a reasonable length of time. In order to rely on this exemption, an issuer must disclose the name of such member and the date of expected financial literacy. In order to rely on either of the above exemptions, the board must determine that reliance on the exemption will not materially adversely affect the ability of the audit committee to act independently and otherwise satisfy the rule.
- Exempt Issuers. The Audit Committee Instrument has expanded the categories of issuers which will be exempt from the requirements. Reporting issuers that are investment funds, prescribed exchangeable security and credit support issuers, asset-backed security issuers, SEC foreign issuers and designated foreign issuers are exempt. A subsidiary entity that has non-participating, non-convertible preferred shares traded will also be exempt from the requirements provided its parent is subject to the Audit Committee Instrument or comparable U.S. rules.
- Venture issuers are exempt from the audit committee composition requirements but have limited disclosure obligations. U.S.-listed issuers are exempt from the audit committee requirements provided they are in compliance with the audit committee rules of their marketplace and, if a Canadian issuer, they make certain disclosures.
The Audit Committee Instrument also provides helpful clarification of the following points:
- Financial Literacy. The Companion Policy clarifies that financial literacy does not mean that it is necessary for a member of the audit committee to have comprehensive knowledge of GAAP or GAAS.
- Audit Committee Approval of Earnings Press Releases. The Audit Committee Instrument clarifies that the audit committee must review annual and interim earnings press releases of the issuer prior to public release, but not profit warnings and similar guidance.
The Audit Committee Instrument comes into force on March 30, 2004, assuming ministerial approval, but will not apply until the earlier of the issuer's first annual meeting after July 1, 2004, and July 1, 2005.
FINAL CERTIFICATION INSTRUMENT
The Certification Instrument will come into effect on March 30, 2004, subject to ministerial approval, but is subject to transitional arrangements. The purpose of the Certification Instrument is to improve the quality of an issuer's disclosure by requiring the chief executive officer ("CEO") and the chief financial officer ("CFO") to certify, in prescribed form, that based on their knowledge, an issuer's annual and interim filings6 do not contain a misrepresentation or omit to state a material fact and that the issuer's financial statements and the other financial information contained in the annual and interim filings fairly present the financial condition of the issuer.
The CEO and the CFO will also be required to certify at a later time with the annual and interim filings that they have designed or supervised the design of, and have implemented
- internal controls to reasonably ensure that the issuer's financial statements are fairly presented in accordance with GAAP; and
- disclosure controls and procedures to reasonably ensure that material information is made known to them by others within the organization.
The Certification Instrument will be applicable to all issuers regardless of size.
The annual certification will only apply to financial years beginning on or after January 1, 2004. In addition, for financial years ending on or before March 30, 2005, the CEO and CFO will only be required to provide a "bare" certificate regarding the financial statements and other financial information and will not need to certify with respect to the issuer's disclosure and internal controls. This transitional arrangement is intended to give issuers sufficient time to implement and document the appropriate controls and procedures. As a result of the amendments, issuers will have a significant period to implement and document these controls and procedures.
The interim certification requirement only applies to financial periods beginning on or after January 1, 2004. Again a "bare" certificate as described above is allowable for any interim period that occurs prior to the end of the first financial year in respect of which an issuer is required to file a full certificate.
The Certification Instrument addresses and clarifies certain aspects of the June Proposals, including the following:
- Internal Controls. No conclusion as to the effectiveness of internal controls will be required to be included in the certification. This is being considered as a separate CSA initiative and at the same time the CSA will consider whether auditor attestation of such controls will be necessary.
- Guidance on Disclosure and Internal Control. Further guidance has been given in the Companion Policy as to what constitutes disclosure controls and what constitutes internal control over financial reporting. The Certification Instrument clarifies that disclosure controls are intended to embody controls and procedures addressing the quality and timeliness of disclosure, whereas internal control over financial reporting focusses on the actual financial reporting, including the maintenance of appropriate records, recording of transactions and other related methods. The Companion Policy does not provide a prescriptive definition of either term, again recognizing that the exact controls an issuer puts in place will depend on its particular circumstances.
- Fair Presentation. The CSA has again confirmed that, like the Sarbanes-Oxley Act of 2002, certification as to fair presentation will not be permitted to contain the qualification that the financial information is in accordance with GAAP as stated in an external auditor's report. The fair presentation certification is broader than GAAP. However, the CSA have not provided a formal definition of the term.
- Exemptions. The CSA have clarified that the Certification Instrument will apply to income trusts and issuers of asset-backed securities, but again have emphasized that the appropriate controls and procedures may vary from issuer to issuer. Prescribed exchangeable security and credit support issuers will be exempt from the Certification Instrument. Finally, issuers who are in compliance with the U.S. federal securities instrument implementing the certification requirement of the Sarbanes-Oxley Act of 2002 and who file their U.S. certificate contemporaneously in the United States and Canada and whose Canadian GAAP financial statements, if any, are covered by the United States certification, will not be subject to the certification requirements.
PUBLIC AUDITOR OVERSIGHT
The CSA have also introduced the Auditor Oversight Instrument. The Auditor Oversight Instrument will take effect, assuming ministerial approval, on March 30, 2004 and requires reporting issuers to have an auditor's report from an auditor who is a participant in the Canadian Public Accountability Board ("CPAB") oversight program for auditing firms and in compliance with any restrictions or sanctions imposed by the CPAB. The Auditor Oversight Instrument will apply if the auditor's report is dated on or after March 30, 2004 and the prescribed period for registration with the CPAB has expired. The rule applies to foreign companies which are reporting issuers in Canada, but their foreign audit firms will have until July 19, 2004 to register with the CPAB.
- Multilateral Instrument 52-110 Audit Committees, Companion Policy 52-110 CP, Multilateral Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings, Companion Policy 52-109 CP and National Instrument 52-108 Auditor Oversight . The instruments are to be adopted in all jurisdictions except British Columbia, which is a party to National Instrument 52-108 but will not be adopting the audit committee and certification instruments. The instruments will be subject to transitional arrangements.
- A director or proposed nominee will be considered to have a material relationship with an issuer if he, she or an immediate family member is (or looking back three years has been):
- an employee or executive officer of the issuer;
- a partner, employee or affiliated entity of a current or past internal or external auditor of the issuer;
- an executive officer of an entity on whose compensation committee any executive of the issuer serves; or
- in receipt of more than $75,000 in direct compensation annually 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).
- The Proposed Policy will not apply to reporting issuers who are reporting issuers only in Quebec and/or British Columbia.
- "Exchangeable security issuers" and "credit support issuers" are defined in National Instrument 51-102 Continuous Disclosure. "SEC foreign issuer" and "designated foreign issuer" are defined in National Instrument 71-102 Continuous Disclosure and Other Exemptions Relating to Foreign Issuers.
- Affiliated entity excludes a person who owns 10% or less of any class of voting securities of the issuer and is not an executive officer of the issuer.
- Annual and interim filings mean an issuer's AIF, annual and interim financial statements, and annual and interim MD&A disclosure.
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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