Staff at the Canadian Securities Administrators (the "CSA") have published a recent notice (see here) based on a review conducted by the securities regulatory authorities in Alberta, British Columbia, Ontario and Québec. Staff reviewed the disclosure of 70 reporting issuers operating in the cannabis industry. This review included reporting issuers with varying levels of involvement in the industry and with operations in different countries.
Staff were seeking to highlight good disclosure practices for issuers in the cannabis industry so that investors are provided with transparent information about financial performance and risks and uncertainties, to support informed investing decisions. Staff noted that the cannabis industry had benefited from increasingly permissive legal frameworks and had grown significantly as an emerging public market sector. The review identified industry specific disclosure deficiencies, which are notable given the recent rapid growth of this industry and perhaps in recent weeks, the volatility experienced in and around the implementation of federal legalization.
The review identified three categories of what they felt were substantive disclosure deficiencies.
Licensed cannabis producers ("LPs") often did not provide sufficient information in their financial statements and management’s discussion and analysis ("MD&A") for an investor to understand their financial performance, including:
Impact of Fair Value Accounting on Financial Statements. LPs often included fair value adjustments in the 'cost of goods sold' in their statements of profit and loss ("P&L"). Issuers with agricultural operations are required to measure biological assets (i.e. living plants) at their fair value under International Financial Reporting Standards ("IFRS"). The CSA expects issuers to separately disclose unrealized gains and or losses due to fair value changes on growth of biological assets, and realized fair value amounts included in the cost of inventory sold.
Accounting Policies Related to Biological Assets. Most LPs had a P&L line item called 'production costs' or 'costs of goods sold' put failed to breakdown the composition of the item. The CSA expects issuers to clearly disclose what it considers to be a direct or indirect cost of production associated with biological assets, which P&L line item(s) these direct and indirect costs are recorded in, and whether the direct/indirect costs of biological assets are capitalized or expensed as incurred.
Expense Costs Related to Biological Assets/ Cost of Cannabis Sold. CSA encouraged issuers who expense biological assets as incurred to provide supplemental information in their MD&A, such as the impact that capitalization of direct and indirect costs related to biological assets would have had on the P&L so that investors have information about the cost of cannabis sold in the period regardless of whether the issuer elects to capitalize or expense biological assets.
Presentation of a Gross Profit Subtotal. Staff noted issuers that expense direct and indirect costs of biological assets should consider an alternative to the common 'gross profit' subtotal item in their P&L in order to male it explicit that costs of these assets includes costs incurred on good which have not yet been sold.
Fair Value Measurement Process. 100% of the LPs reviewed needed to improve their fair value and fair value related disclosures. Investors must be able to understand the judgements management makes about growing cannabis plants at various stages prior to harvest and the notice provides examples of how the disclosure can be improved, including providing a description of the valuation techniques and processes.
Non-GAAP Financial Measures Developed in Response to Fair Value. LPs should clearly disclose how non-GAAP financial measures are calculated to show the cost of production after excluding non-cash fair value adjustments. LPs should also ensure that reconciling items and assumptions used to calculate non-GAAP measures are fully explained.
Some issuers did not consistently comply with securities requirements for forward-looking information, guidance for providing balanced disclosure and certain other requirements, including:
Production Estimates. LPs making announcements about anticipated production capacity in new facilities should disclose related material factors and assumptions which should further be based on specific and comprehensive details, referencing how each assumption contributes to the projection.
Misleading or Unbalanced Disclosure. Existing and potential cannabis industry issuers must ensure that announcements are balanced and not misleading including, in many cases, enhancing disclosure by stating factors upon which a transaction is contingent (for example, regulatory approval).
Impairment. Issuers with material cannabis-related assets should perform appropriate impairment testing in response to impairment events, including industry-wide changes in cannabis valuations or regulatory frameworks.
Material Contracts. Cannabis industry issuers that are substantially dependent on licenses to cultivate or sell cannabis, or on leased facilities, should consider filing these as material contracts under existing continuous disclosure requirements.
Regulatory Frameworks. Cannabis industry issuers operating outside North America should provide disclosure about the foreign regulatory frameworks that are applicable to them (similar to obligations on cannabis industry issuers with U.S. cannabis related activities discussed below).
Issuers with U.S. Cannabis Operations
74% of issuers with cannabis operations in the U.S. did not provide sufficient disclosure about the risks related to their U.S. operations to satisfy the disclosure expectations set out in CSA Staff Notice 51-352 (Revised) - Issuers with U.S. Marijuana-Related Activities (see here). CSA staff reiterated the following relevant disclosure expectations:
a description of the issuer's involvement in the U.S. cannabis industry;
a statement disclosing that marijuana is illegal under U.S. federal law and that enforcement of such laws is a significant risk;
disclosure of related risks, such as the possibility of third party service providers withdrawing services or that regulatory bodies may impose certain restrictions on the issuer's ability to operate in the U.S.;
a discussion pertaining to the issuer's ability to access public and private capital, including the financing options available; and
a quantification of the issuer's balance sheet and operating statement exposure to U.S. marijuana-related activities.
Additional disclosure may be required dependent upon whether the issuer has a direct, indirect or ancillary involvement with U.S. marijuana-related activities.
Where deficient disclosure was identified during the CSA staff review, issuers either committed to prospective improvements or, when the deficiencies were pervasive, refiled certain documents.
Endeavor Law can assist issuers with Canadian securities law continuous disclosure, compliance and regulatory matters. Endeavor Law will always seek to provide competitive pricing for any legal services requested and is pleased to discuss fee arrangements that suit any potential client.
Does not constitute legal or other advice and must not be used as a substitute for legal advice from a qualified legal professional in your jurisdiction who has been fully informed of your specific circumstances. Information may not be up-dated subsequent to its initial publication and may therefore be out of date at the time it is read or viewed. Always consult a qualified legal professional in your jurisdiction.