Canada Cross-Border Transactions

The recent settlement agreement between Kinross Gold Company and the Securities and Exchange Commission is a reminder to Canadian cross-listed companies that it is not enough to adopt a parent-company level anti-corruption policy designed to promote compliance with the Foreign Corrupt Practices Act (FCPA). Effective implementation and monitoring at the operating level is also needed. In Kinross’ case, the SEC charged, in effect, that Kinross had acquired two African mining operations from a third party, was aware of deficiencies in the mines’ controls at the time of acquisition, failed to timely put in place appropriate controls, and then failed to maintain them once implemented. Specifically, SEC alleged that Kinross awarded a logistics contract to a company preferred by Mauritian officials, despite concerns that the awardee exhibited poor performance at high cost without going through Kinross’ own bidding procedures, and engaged in contracts with politically connected consultants without conducting necessary, heightened due diligence. The SEC found these deficiencies constituted a violation of books and records and internal auditing controls provisions of federal securities law. In order to resolve these charges, and without admitting SEC’s findings, Kinross agreed to pay the SEC a penalty of $950,000, comply with a cease-and-desist order, and undertake to report on remedial measures. For more details, see the April 2018 edition of our Anti-Corruption Digest, which is available at  https://www.dorsey.com/newsresources/publications/newsletters/2018/04/anti-corruption-digest-april-2018.

Like Canada, the United States has federal legislation protecting employees with disabilities. While Canada has the Canadian Charter of Rights and Freedoms and the Canadian Human Rights Act, the United States has the Americans with Disabilities Act (“ADA”). While both Canadian and U.S. laws protect disabled employees from discrimination, the ADA has very specific procedures and requirements for accommodating employees with disabilities that even sophisticated U.S. employers frequently get wrong. Below is a discussion of several key concepts under the ADA that employers in the United States should know about. An employer has a duty to provide an employee with a “disability” with “reasonable accommodations” that will allow the employee to perform the “essential functions” of his or her job. The definition of each of these terms is essential to complying with the ADA. While the definition of a “disability” is complex, a rule of thumb is that a disability is any condition that interferes with a person’s life, except for the most minor interference. Basically, if an employee has any sort of health condition and either asks for help or the employer is put on notice that the employee needs help, the employer’s duty to accommodate is triggered. When in doubt, it’s a disability. An “essential function” is one where the reason the position exists is to perform the function. This can be tricky to define in edge cases; however, some easy examples are a data entry specialist’s ability to enter data into a spreadsheet, a manual laborer’s ability to lift a minimum amount of weight, or a receptionist’s ability to communicate with people visiting the employer’s premises. Examples of non-essential functions include a receptionist’s ability to lift heavy objects or a secretary’s ability to do data entry. These are abilities that are nice to have, but are not central to the job. Accurate and detailed job descriptions are important for defining a job’s essential functions. If a certain ability or function is not listed in an employee’s job description, it is much harder for the employer to claim that function is essential. Just because a function is described as essential in a job description does not mean that a court will agree, however. Employers must make sure that functions described as essential are in fact essential. A “reasonable accommodation” is an accommodation that allows an employee to perform his or her essential functions, and which does not pose an undue burden on the employer. What constitutes an undue burden depends upon the size and financial resources of the employer. A small company might not be required to buy an expensive piece of speech-to-text software to allow an employee who cannot type to work on a computer, but a large company with significant resources might be required to do so. Similarly, a large employer might be required to give an employee recovering from surgery several months of unpaid leave with job projection, while a small employer might be allowed to hire a replacement sooner if the small employer cannot function without someone in the role. Employers determine what accommodations to provide through the “interactive process.” When an employer is put on notice that an employee has a disability and may require an accommodation, the employer is obligated to start a dialogue with the employee and the employee’s healthcare provider regarding what accommodations, if any, would allow the employee to perform his or her essential job functions. Much of the art of ADA compliance lies in appropriately communicating with employees and their healthcare providers through the interactive process. Employers cannot simply tell the employee what accommodations they are willing to make upfront on a “take it or leave it” basis. Rather, employers must engage in a back-and-forth dialogue with the employee and his or her healthcare provider and at least consider accommodations suggested by the healthcare provider. Employers should never reject any but the most outrageous accommodation requests out of hand. An employer’s duty to accommodate under the ADA is one of the most difficult aspects of employment law in the United States. Even sophisticated employers can run into trouble, and employer’s new to U.S. law should line up outside legal support in advance to help them navigate.

Canadian companies relying on Rule 701 under the Securities Act of 1933 to exempt their U.S. awards of stock options and other types of compensatory equity (such as RSUs and PSUs), need to track on an ongoing basis the amount of grants being made in the United States. If they anticipate that the aggregate dollar amount of the awards, calculated under Rule 701, will exceed US$5 million in any 12-month period, they must also prepare and deliver Rule 701-mandated disclosure documents. Just this month, the SEC announced a financial settlement with a privately-held fintech company, Credit Karma, Inc., relating to Credit Karma’s failure to provide stock option holders with the financial statements, risk factors, and other disclosures required by Rule 701 when its stock option awards exceeded US$5 million over 12 months. In the settlement, Credit Karma agreed that due to these disclosure failures, there was no valid securities exemption, and the company had violated the registration requirements of the Securities Act. This, notwithstanding that only a small fraction of the stock options were actually exercised. Failure to comply with Rule 701 can also subject a company to additional consequences, including state enforcement actions, rescission offers to investors, and, in extreme cases, criminal prosecution. While a company should always obtain advice from a knowledgeable securities lawyer, some key facts to know about calculating Rule 701 limits include: In the case of options, the sale is deemed to have been made at the time of the grant of the options, and the value is determined based on the exercise price of the options; In the case of other securities, the calculation is made at the time of sale, or in the case of a deferred compensation plan when the irrevocable election to defer is made, and the value is determined based on all of the consideration received or to be received by the company for the sale of the securities; and The SEC has taken the position that disclosure requirements are triggered by a company’s expectation that it will exceed US$5 million in a 12-month period, even if it has not yet exceeded US$5 million. Rule 701 imposes further restrictions on which advice should be obtained by companies making equity awards in the United States, including limits on the types of companies that can make an award, the types of persons who can receive an award, resale restrictions, and the aggregate maximum amount that can be awarded even if Rule 701 disclosures are provided.

We are frequently asked to review Canadian companies’ stock option, restricted share unit (RSU), performance share unit (PSU), deferred share unit (DSU), and other stock-based compensation plans for U.S. securities law purposes, because awards are expected to be made to U.S. residents. For companies that are cross-listed and file reports with the Securities and Exchange Commission (SEC), the intention is typically to register the underlying securities by filing a Form S-8 with the SEC. For companies that do not file SEC reports – whether publicly traded in Canada or privately held – the intention is typically to rely on the exemption provided by Rule 701 under the Securities Act of 1933 and exemptions under the securities laws of the states in which awards will be granted. Some of the most common U.S. securities issues we see in connection with Canadian stock-based compensation plans include: 1.  Defining the class of persons eligible to receive awards in a manner broader than is permitted under Form S-8 or Rule 701, especially: Allowing grants to consultants that are entities, or that are involved in investor relations or fundraising activities; Allowing grants to consultants’ employees; and In the case of Rule 701, allowing grants to employees of subsidiaries that are not majority-owned. 2.  Failing to realize when a plan is subject to U.S. securities laws and requires registration or an exemption, or the treatment of securities as restricted securities, especially: Plans that involve open market purchases or that otherwise involve the delivery of shares that were previously free trading, such as an open market employee share purchase plan (ESPP) or a trust funded with free trading securities; and Plans in which a participant elects to forego cash in exchange for a long-term investment that itself is ultimately settled in cash, such as an executive deferred compensation plan or a director DSU plan. 3.  Unqualified covenants of the company to take all steps necessary to comply with applicable law, which could be interpreted as requiring a non-reporting company to file an SEC registration statement and become an SEC reporting company if the company has inadvertently made U.S. awards that are not exempt from registration. 4.  Failing to include provisions required by U.S. state laws, when grants will be made in states that require the inclusion of specific terms in the plan. 5.  In the practical aspects of plan implementation and the making of awards, including: Making awards that do not comply with U.S. federal or state laws because such laws were not evaluated prior to the time of grant; and Using forms of award agreement that have not been tailored for U.S. residents.

On February 26, the SEC published interpretive guidance to assist public companies in preparing disclosures about cybersecurity risks and incidents. The SEC’s new guidance reinforces and expands on its October 2011 guidance, emphasizing the importance of adopting sound cybersecurity policies and procedures and safeguards against insider trading in the event of a potentially material cybersecurity breach. Read more about the new guidance in our recent eUpdate: www.dorsey.com/newsresources/publications/client-alerts/2018/03/sec-issues-new-cybersecurity-guidance.

While the recently enacted U.S. tax reform legislation did not overhaul executive compensation to the extent proposed in early forms of the bill, Section 162(m) of the U.S. Internal Revenue Code was dramatically revised in a way that affects Canadian companies that file reports with the SEC and that employ, or may in the future employ, executives in the United States. Previously, Section 162(m) limited the amount of compensation that an SEC reporting company that was a “domestic issuer” for securities law purposes, or its subsidiaries, could deduct with respect to its most senior executives. Important for many of our Canadian clients, we believe that under the rule changes, U.S. tax deductions for compensation paid to key executives of any SEC reporting company, including foreign private issuers, and their subsidiaries, will now be subject to the limitations of Section 162(m). In addition, the rule changes eliminate a major exception for qualifying performance-based compensation. This article identifies the important changes to Section 162(m) and addresses the limited transition and grandfathering opportunities companies should now consider. Section 162(m), as amended, limits the amount of compensation an SEC reporting company can deduct with respect to its CEO, CFO, and the next three highest earners in the company’s controlled group to US$1 million per individual per year. As mentioned above, compensation paid to key U.S. executives of foreign private issuers likely no longer escapes the reach of Section 162(m). It appears that regulations that formerly exempted key employees from public companies that were not subject to SEC proxy statement requirements (i.e., were not obligated to file a summary compensation table) have been undermined by the revised Section 162(m). Included in Section 162(m)(3) is now a statement that covered employees, aside from the CEO and CFO, are determined without regard to whether the compensation of such employees is required to be reported to shareholders. Absent any future clarifying regulations from the U.S. Treasury to the contrary, foreign private issuers should take note that certain key employees will be considered covered employees under Section 162(m) going forward. To the extent that compensation paid to a covered employee was intended to be claimed as a compensation expense deduction on a corporation’s U.S. federal income tax return, it will be important to recognize that any such compensation in excess of US$1 million annually to a covered employee will not be deductible. A major exception that exempted qualifying performance-based compensation from the reach of this limitation has been removed effective in 2018. Therefore, whereas public companies had been able to deduct large compensatory payments above the basic US$1 million limit to key executives relating to the exercise of stock options and/or the issuance of stock awards payable because of the achievement of pre-set performance objectives, this exception will no longer be available going forward. Removal of the performance-based exception will disadvantage public companies that have intentionally structured their compensation to be predominantly performance-based in order to deduct key employee compensation to the greatest extent possible. However, the overall reduction in the U.S. corporate income tax rate from 35% to 21% in the tax legislation will more than compensate for any lost deductions in most cases. Once an executive is a “covered employee” of a company for purposes of Section 162(m), the executive now will remain a covered employee forever. As a result, compensation deductions for payments made after an executive is no longer among the company’s top earners, whether received as severance, or even paid to beneficiaries after an executive’s death, will be limited under Section 162(m). While there have been reports of some companies reacting to the loss of the performance-based compensation exception under Section 162(m) by shifting executive compensation formerly payable as performance-based to base salary, the impact on employers generally remains to be seen. We encourage companies to discuss with U.S. tax counsel how the revisions to Section 162(m) may impact the ability to deduct compensation paid to key officers who are covered employees. In particular, a transition rule under the new Section 162(m) rules exempts remuneration paid pursuant to written binding contracts in effect as of November 2, 2017, from the new rules, so long as such contracts have not been materially modified or extended. The transition rule may impact whether and to what extent a company decides to modify arrangements such as employment agreements, deferred compensation plans, and bonus plans. Understanding how the transition rules impacts a company’s existing arrangements will allow for planning opportunities to maximize compensation deductions and the tracking of disallowed compensation deductions going forward.

The default rule in most U.S. states is at-will employment. This means that either the employee or the employer may terminate the employment relationship at any time, without notice, for any reason—other than a discriminatory or retaliatory reason. A reason is discriminatory if it is based upon an individual’s status as a member of a protected class, such as race, gender, national origin, or religion. A reason is retaliatory if it relates to an individual’s protected activity, such as whistleblowing or raising concerns regarding the terms and conditions of employment. Parties can opt out of the default at-will rule by entering into an employment agreement that provides the employee with severance unless the employee is terminated for “cause” or quits without “good reason.” Unlike Canada, which has a rich body of law explaining what does and does not constitute “cause,” it is completely up to the parties in the United States to decide what constitutes cause and put that definition into the employment agreement. Getting this definition right is extremely important, and Canadian companies with employees in the United States that do not pay close attention to such language might be stuck paying substantial severance to employees whom they would have a right to terminate for cause under Canadian law. Most U.S. employment agreements for high-level employees provide for severance benefits ranging from a few months to a few years of pay upon the termination of employment if the company terminates the employee without “cause” or the employee quits for “good reason” as defined in the employment agreement. The definition of “cause” can vary widely from agreement to agreement and is often the subject of intense negotiation between the company and the employee. Many agreements only allow the company to terminate for cause if the employee engages in extreme misconduct, such as a felony or an act of dishonesty that has a substantial negative impact on the company. Other agreements allow the company to terminate for cause if the employee fails to competently perform the employee’s job duties. Often times, the agreement will require that the employee be given notice and an opportunity to cure any failure that would otherwise constitute cause for termination. Some but not all agreements also allow the employee to quit and receive severance if the employee quits for “good reason” as defined in the employment agreement. “Good reason” is often defined to include a material reduction in the employee’s duties or compensation, or a requirement that the employee relocate. Good reason may also be tied to a change in control over the company, such that the employee’s right to quit for good reason and receive severance only arises if the company changes ownership. Canadian companies purchasing U.S. businesses can find themselves hamstrung by definitions of “cause” and “good reason” that make it very difficult to fire or even control wayward executives that were brought along as part of the deal. Cause definitions that require extreme misconduct by the executive tie the company’s hands in situations where the executive is merely performing poorly or not following the board’s directives. Good reason definitions that allow an executive to quit if the executive’s duties are changed or curtailed make it difficult to put new management in place where the executive and the board fail to see eye-to-eye on how the company should be run. U.S. courts tend to give the benefit of the doubt to the employee when assessing whether cause or good reason exists under an employment agreement, and companies that want to retain the right to terminate an employee for poor performance without paying severance should make sure that poor performance is explicitly included in the definition of cause. Alternatively, if a company is agreeing to a very employee-friendly definition of cause, it should be prepared to pay out the severance provided for in the employment agreement in all but the most extreme cases of employee misconduct. Business acquisitions usually start with the best of intentions and goodwill between the parties. No one goes into such a deal expecting it to go sideways. However, it is very important that Canadian companies looking to take on U.S. employees know what they are getting into in terms of severance obligations—and negotiate definitions of “cause” and “good reason” that reflect the company’s expectations.

The SEC is aiming to finalize its new mining disclosure rules within the next year, according to statements made last week by William Hinman, Director of the SEC’s Division of Corporation Finance, at the Securities Regulation Institute. For more details regarding the SEC’s original 2016 proposal to revamp the rules, and reactions by industry, see our summary of the initial proposal (here: www.dorsey.com/newsresources/publications/client-alerts/2016/07/new-mining-disclosure-rules) and our last blog post (here: crossbordercounselor.com/status-check-on-the-secs-proposed-overhaul-of-the-mining-disclosure-regime/).  

The United States Public Company Accounting Oversight Board (PCAOB) issued new standards for auditor’s reports that will effect Canadian issuers who are SEC registered. The initial changes go into effect for issuers with fiscal years ending after December 15, 2017. Our understanding is that some Canadian auditors for issuers who are MJDS eligible will try to combine the Canadian and U.S. requirements into one auditor’s report that complies with both sets of rules, while other Canadian auditors will prepare their reports solely in compliance with the new PCAOB requirements as Canadian rules permit auditors for dually registered issuers to file auditor’s reports solely in compliance with PCAOB standards. Canadian issuers who are not MJDS eligible should continue to comply with the PCAOB standards for their auditor’s reports. The new auditor’s report includes updated formatting and disclosure requirements. These changes include provisions requiring statements in the auditor’s report disclosing the auditors’ tenure and independence, and form standardizations, including new section titles to guide readers. The requirement that the auditor’s report disclose “critical audit matters,” which are matters arising from the audit of the financial statements that have been communicated or were required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involve specially challenging, subjective, or complex auditor judgment, will only take effect for audits of fiscal years ending on or after June 30, 2019, for large accelerated filers; and for fiscal years ending on or after December 15, 2020, for all other companies to which the requirements apply. The full order by the SEC with respect to the changes can be found at the following link: https://www.sec.gov/rules/pcaob/2017/34-81916.pdf Issuers should reach out to their auditors if they have any questions on the changes to the auditor’s report.

About 18 months have passed since the U.S. Securities and Exchange Commission (SEC) published its bold attempt to modernize the disclosure requirements for mining companies that are listed on U.S. stock exchanges or otherwise report to the SEC. With final rules not yet adopted, the fight for a streamlined reporting regime continues. The SEC’s proposed overhaul was spawned by industry request – specifically, a request by the Society for Mining, Metallurgy & Exploration (SME), the leading professional society of mining professionals in the United States, that the SEC bring its disclosure requirements into the modern age and adopt a new disclosure regime based on the Committee for Mineral Reserves International Reporting Standards (CRIRSCO) standards. CRIRSCO-based standards have been adopted in most countries with advanced mining disclosure regimes, including Canada and Australia. Industry was concerned that the existing rules under SEC Industry Guide 7, nearly 35 years old, were hampering the ability of U.S. mining companies and U.S. trading markets to compete by, among other things, prohibiting the disclosure of mineral resources that have not yet been determined to be mineral reserves. As a result, in June 2016, the SEC proposed a new CRIRSCO-based disclosure system that would bring U.S. disclosure requirements more in line with Canada and other jurisdictions. One might think that such a proposal, to modernize rules at the request of industry to benefit American business, would find easy adoption following the election of Donald Trump and the appointment of a Republican Chairman and majority to the SEC, but that hasn’t been the case. Overhauling a system that has been in place for 35 years is a difficult thing to do at any time. The election of Donald Trump likely delayed the process further. The President’s party controls the chairmanship and majority of seats on the SEC, so the election resulted in the resignation of the Democratic Chairman that had overseen the initial proposal. Months of uncertainty passed before her replacement was sworn in. The new Republican Chairman was not appointed until May 2017, seven months ago, without any background on the proposed new mining rules and undoubtedly bringing his own ideas and interests to the table. President Trump also campaigned on a platform of eliminating regulation, and while the proposals were intended to benefit industry, they require passing additional regulations. Finally, but perhaps most importantly, the proposals were not as well-received by the mining industry as the SEC had undoubtedly hoped. Most industry organizations, companies, and law firms that commented on the proposals were supportive of the idea of modernization, but felt that the SEC’s proposals were too prescriptive and varied in too many ways from CRIRSCO standards, thereby imposing an administrative burden on companies, especially those reporting in more than one jurisdiction. Worst of all for many of our Canadian clients, the new rules as proposed would have eliminated the ability of Canadian companies that file SEC reports on non-MJDS forms such as Form 20-F or 10-K from including National Instrument 43-101 (NI 43-101) information in their SEC filings, even if these disclosures were mere supplements to SEC disclosure. The SEC received a lot of feedback to digest. According to the staff, they are continuing to review and consider the comments received. While it’s not a secret, few are aware that the National Mining Association (NMA), the national trade organization of the mining industry, and the SME have teamed up to present the SEC with an alternative proposal for modernizing the SEC’s mining disclosure rules. The NMA and SME have proposed that instead of working from the framework of the SEC’s 2016 proposals, the SEC merely amend the content of Industry Guide 7. The NMA and SME have recommended that Guide 7, as revised, allow companies to disclose estimates of mineral resources in addition to mineral reserves, allow reserves to be established in a pre-feasibility study, not require disclosure to be attributed to a qualified person, limit required disclosures to those that are material, and limit the information required to be disclosed by those holding passive mining interests such as royalties, all without imposing the more detailed, prescriptive requirements contained in the SEC’s 2016 proposals. Of most interest to Canadian companies, the NMA/SME proposal would allow foreign companies that are subject to and required to disclose information in compliance with another CRIRSCO-based standard, such as NI 43-101, to comply with such other standard in lieu of, and in full satisfaction of, the SEC standards, subject only to a requirement to include a reconciliation of any material differences. The NMA/SME proposal includes a specific note that for Canadian companies subject to NI 43-101, reconciliation would generally not be required (due to the lack of material differences between NI 43-101 and the NMA/SME proposed version of Guide 7). If the SEC accepts the NMA/SME proposal, most smaller Canadian companies that do not satisfy the market capitalization requirements of the Multi-Jurisdictional Disclosure System (MJDS) will find it easier and less expensive to file with the SEC than in prior years. Whether the SEC will do so, we cannot say.

California is now accepting applications for temporary cannabis licenses. For more information, see www.dorsey.com/newsresources/publications/client-alerts/2017/12/ca-opens-applications-for-temporary-cannabis.

Financial assurance and reclamation bond requirements can be a significant cost and regulatory burden for Canadian issuers with mining projects in the United States. Over the last several years, companies with U.S. mining projects have waited while the U.S. Environmental Protection Agency (EPA) has considered expanding the financial responsibility requirements applicable to the hardrock mining industry. On December 1, 2017, EPA released a pre-publication version of a final rule determining that imposing CERCLA 108(b) financial responsibility requirements on the hardrock mining industry was unwarranted.[1] The Final Rule satisfies a court-ordered timeline and rejects a proposed rule, published in January 2017,[2] which proposed regulations imposing CERCLA 108(b) financial responsibility requirements on operators of hardrock mining facilities. Based on information provided during the public comment period and EPA’s re-evaluation of the rulemaking record, EPA determined that finalizing the proposed rule and establishing financial responsibility requirements for the industry was inappropriate because: “the degree and duration of risk associated with the modern production, transportation, treatment, storage or disposal of hazardous substances by the hardrock mining industry does not present a level of risk of taxpayer funded response actions that warrant imposition of financial responsibility requirements.”[3] EPA’s decision is significant for the mining industry, as EPA had estimated that the proposed rule would cost the industry approximately $111-171 million annually to address an estimated $15 million in annual unfunded clean-up costs.[4] For more information, see Ben Machlis’ recent eUpdate on the EPA’s Decision available here:  www.dorsey.com/newsresources/publications/client-alerts/2017/12/a-win-for-the-mining-industry   [1] Final Rule: Financial Responsibility Requirements under CERCLA Section 108(b) for Classes of Facilities in the Hardrock Mining Industry, EPA-HQ-SFUND-2015-0781, Pre-Publication Copy (Dec. 1, 2017). [2] Proposed Rule: Financial Responsibility Requirements under CERCLA Section 108(b) for Classes of Facilities in the Hardrock Mining Industry, 82 Fed. Reg. 3,388 (Jan. 11, 2017). [3] Final Rule, at 47. [4] Id. at 7.

On November 16, 2017, California published the long awaited rules and regulations to implement voter approved Proposition 64, the Adult Use of Cannabis Act of 2016, which legalized adult use of cannabis in the State of California. The California Legislature passed and the Governor signed into law the Medicinal and Adult-Use Cannabis Regulation and Safety Act (MAUCRSA), which creates the general framework for the regulation of both commercial medicinal and adult-use (recreational) cannabis. The State agencies that regulate cannabis, the Bureau of Cannabis Control (distribution, testing, retail and microbusiness), Department of Food and Agriculture (cultivation) and Department of Public Health (manufacturing), established new regulations under an “emergency” rule-making process for commercial medicinal and adult-use (recreational) cannabis industries. The “emergency” regulations will be followed by a formal rule-making process beginning next year. California’s new cannabis regulations will be of interest to the growing number of Canadian companies and investors involved in the cannabis industry. The regulations include: Temporary Permits – In December 2017, California will begin accepting on-line applications for temporary business permits. Priority application review will be provided for annual licenses applicants that were in operation under the Compassionate Use Act prior to September 1, 2016. Temporary permits will be good for four months (120 days) for cannabis businesses, which may be extended for two 90-day extensions (only if the temporary licensee has applied for an annual license). There is no fee for temporary permits. Cannabis businesses will need local approval for conducting commercial cannabis activities, which must be demonstrated to receive a temporary permit. Beginning January 1, 2018, an email notification will be issued from the State confirming that a temporary permit has been approved. Transitional Rules – Licensed cannabis companies will have a six-month grace period (until July 1, 2018) to sell products in their inventory (with specified labeling) that do not comply with regulation (testing and labeling) guidelines and may work with other licensed businesses without worrying about whether their permits are for medical and recreational activities. During the transitional period, licensees will not be required to use the State’s track-and-trace system but will need to complete manifests and other paperwork to keep track of cannabis products. Two Types of Licenses – There will be two types of licenses: A-License (adult use) and M-License (medical cannabis). It is unclear whether an A-license can be used for a medical dispensary or a business would require separate A and M licenses. Testing labs may test cannabis goods for both types of licenses. License Fees/Activities – Annual cannabis license fees are based on a sliding scale ranging from $800 to $120,000 based on activity and revenues. Activities include retail operations, cannabis events, distribution, cultivation, manufacturing and products, laboratory testing and microbusiness (multiple commercial cannabis activities are permitted under one license). Retail Operations:  Adult-use cannabis sales are limited to adults 21 years and over. Stores cannot be located within 600 feet of schools (K-12 school, day care center, or youth center), must close by 10:00 p.m., and must have 24-hour surveillance. There are limitations on purchases (adult-use customers may purchase up to one ounce and medical patients up to eight ounces or more with physician’s note). Only medical cannabis patients or their caregivers will be permitted to receive free cannabis products or samples. Products must be packaged, tested and labeled. Advertising is limited. Distribution:  Only a licensed distributor may transport cannabis. Cannabis Manufacturing and Products:  The California Department of Public Health (CDPH) is responsible for regulation of manufacturing of cannabis. Manufacturing licenses (A-License and M-Licenses) fall under four license types: Type 7: Extraction using volatile solvents; Type 6: Extraction using non-volatile solvents or mechanical method; Type N: Infusions; and Type P: Packaging and labeling only. All cannabis products must contain a State-mandated warning label and the CDPH-issued universal symbol and must be tested. Edible products may not be in shapes that may appeal to children – no human beings, animals, insects, or fruit shapes. There are limits on THC content. Licensees must have written procedures for inventory control, quality control, transportation, security and cannabis waste disposal. Good manufacturing practices must be followed. Cannabis Cultivation:  The California Department of Food and Agriculture regulates the cultivation of commercial cannabis. Cultivation of cannabis is divided into three categories: Cultivators (commercial cultivators); Nurseries (cloning and seed propagation) and Processors (trimming, drying, curing, grading, or packaging). Testing Laboratories:  All cannabis goods must meet certain health and safety standards before they can be sold to consumers. To ensure that cannabis goods meet those standards, a representative sample of the cannabis goods must be tested by a licensed testing laboratory. The regulations provide the minimum laboratory-operation requirements, which would include requirements such as sampling procedures, personnel qualifications, standard operating procedures, and recordkeeping requirements. Ownership­ – License “owners” must submit fingerprints (via the Department of Justice’s Live Scan service) and background information including any past criminal convictions. An “owner” includes the CEO, a board member, a person holding 20% or more ownership interest and any person participating in the direction, control, or management of the person applying for a license. Individuals that are employed by the State of California or district attorney’s offices and law enforcement agencies are prohibited from holding a license when the duties of their employment have to do with enforcement of cannabis regulations. Financial Interests – The license application must disclose the holders of “financial interests” (any investment, loan or any other equity interest), including the holder’s name, birth date and a government issued ID. Holders of financial interests that are not required to be listed: (a) a bank or financial institution whose interest constitutes a loan; (b) individuals whose only financial interest in the commercial cannabis business is through an interest in a diversified mutual fund, blind trust, or similar instrument; (c) individuals whose only financial interest is a security interest, lien, or encumbrance on property that will be used by the commercial cannabis business; and (d) individuals who hold a share of stock that is less than 5 percent of the total shares in a publicly traded company. Labor and Employment – License applicants with more than 20 employees must attest that they have entered into a labor peace agreement (in which the employer agrees not to resist organizing attempts by its workers) and provide a copy to the Bureau of Cannabis Control. If no such agreement exists, the license applicant will have to provide a notarized statement indicating that the company will enter into a labor peace agreement. Surety Bond – License applicants must obtain a surety bond of $5,000, payable to the State as obligee, to ensure payment of cost incurred for the destruction of cannabis product necessitated by violation of the MAUCRSA or regulations. For a more complete summary of the regulations visit: www.dorsey.com/newsresources/publications/client-alerts/2017/11/ca-emergency-cannabis-regulations   Federal Law Warning: The United States federal government regulates drugs through the Controlled Substances Act (21 U.S.C. § 811), which places controlled substances, including cannabis, in a schedule. Cannabis is classified as a Schedule I drug. A Schedule I controlled substance is defined as a substance that has no currently accepted medical use in the United States, a lack of safety for use under medical supervision and a high potential for abuse. The Department of Justice defines Schedule 1 controlled substances as “the most dangerous drugs of all the drug schedules with potentially severe psychological or physical dependence.” The United States Federal Drug Administration has not approved the sale of marijuana for any medical application. State laws regulating cannabis are in direct conflict with the federal Controlled Substances Act, which makes cannabis use and possession federally illegal.  

Tax reform efforts by Congress are ongoing, and the substance of the tax bills remains fluid. However, for foreign corporations with U.S. operations, there are some specific potential risks to consider, such as additional limitations on the deductibility of interest, the migration from a “worldwide” system of taxation to a territorial system, and the use of certain border adjustments. Canadian corporations with U.S. operations may want to consider including a risk factor in their periodic reports or offering documents regarding the potential impact of U.S. tax reform. A sample risk factor (based on the current iteration of the tax bills) is below. As the tax bills are amended during the legislative process, the language of the risk factor may need to be edited prior to use. Possible U.S. federal income tax reform could adversely affect us. The new U.S. administration and certain members of the U.S. House of Representatives have stated that one of their top legislative priorities is significant reform of the Internal Revenue Code. Proposals by members of Congress have included, among other things, changes to U.S. federal tax rates, imposing significant additional limitations on the deductibility of interest, allowing for the expensing of capital expenditures, the migration from a “worldwide” system of taxation to a territorial system, and the use of certain border adjustments. There is substantial uncertainty regarding both the timing and the details of any such tax reform. The impact of any potential tax reform on our business and on holders of our common shares is uncertain and could be adverse. [Prospective investors should consult their own tax advisors regarding potential changes in U.S. tax laws.]

There are a couple of recent developments that we would like to remind issuers to keep in mind for their upcoming annual reports. Foreign private issuers who prepare their financial statements in accordance with the International Financial Reporting Standards (“IFRS”) will be required to file their annual audited financial statements in XBRL format in respect of any period ending after December 15, 2017 (i.e., for a December 31 company, beginning with any Form 20-F or Form 40-F for the fiscal year ending December 31, 2017). The following is a link to a Dorsey blog posting about this topic from earlier this year: https://governancecomplianceinsider.com/compliance-with-xbrl-for-foreign-private-issuers-that-prepare-their-financial-statements-in-accordance-with-ifrs-required-beginning-with-annual-reports-for-fiscal-periods-ending-on-or-after-december-1/. Foreign private issuers who file their financial statements in accordance with IFRS should reach out to their EDGAR agents now to start the process as it takes a significant amount of time to prepare the template for an issuer’s first XBRL filing. While there is a 30-day grace period for first time filers that would permit an issuer to file the XBRL exhibit by amendment, issuers that wait until the last minute to start the process may miss the grace period deadline. In addition, foreign private issuers who file their Annual Reports on Form 20-F should also remember that they are required to include hyperlinks in the exhibit index to the underlying document. The links may be included in the exhibit list prior to the signature page. In those circumstances, issuers are no longer required to include an exhibit index after the signature page. The following is a link to a Dorsey article prepared on this topic from earlier this year: https://www.dorsey.com/newsresources/publications/client-alerts/2017/03/sec-adopts-use-of-exhibit-hyperlinks-in-filings.

Over the last few years, many Canadian junior resource companies and startup companies have cut back on their legal spend, not necessarily undertaking a legal review of each new private placement of securities, or limiting their review to a Canadian one. Yet over this same time frame, the applicable U.S. rules and relevant interpretations have changed, and previously vetted forms may not be current. Indications that your U.S. law compliance practices in offering and selling securities could use a good scrub include the following: You don’t know the definition of a “foreign private issuer” or whether your company is one; You don’t know if your company has a “substantial U.S. market interest” in the class of securities you are offering; You don’t know what “bad boy disqualifications” are or who they apply to, or you can’t remember the last time the company’s insiders completed disqualification questionnaires; Your U.S. subscription agreements refer to Rule 506 and not Rule 506(b); Your U.S. subscription agreements treat an investor with a net worth of $1 million as an accredited investor, without subtracting certain items relating to the investor’s principal residence; Your warrant exercise forms don’t require all warrant holders to check an appropriate box to help you determine whether U.S. law applies to the exercise and confirm compliance with a U.S. exemption where required; Your offering includes warrants, but your subscription agreements don’t include U.S. provisions relating specifically to the warrants; or You aren’t checking the U.S. legal requirements when you draft your equity compensation plans or when you grant stock options, RSUs, PSUs, ESPP participation, or other types of compensatory equity to a U.S. resident. The risk of non-compliance includes rescission rights for investors, restatement of financial statements, and civil or criminal enforcement actions by regulators, so it’s important to regularly review your forms to ensure they are up to date.

A Canadian company (the employer) historically has not issued equity-based awards to employees of its U.S. subsidiaries, but it now is considering doing so. Past posts have addressed potential U.S. income tax pitfalls and the need for careful review of the plan and award agreements prior to the grant of restricted stock units (RSUs) and deferred share units (DSUs) to individuals who are subject to U.S. federal income tax on compensatory income. You can read the DSU blog entry here and the RSU blog entry here. Let’s assume careful review and drafting have addressed potential U.S. tax issues in terms of the written documents. What are common mistakes that can arise in administering the U.S. awards? A common error with respect to RSUs awarded to U.S. employees is to overlook the correct timing of U.S. employment tax obligations (as distinguished from federal income tax withholding obligations). Confusion can arise when, for U.S. tax purposes, the substantial risk of forfeiture lapses earlier than the year in which the RSUs will be settled/paid out. For purposes of this discussion, when we use the term “vesting” it means the lapse of a substantial risk of forfeiture. Below are examples of how confusion can arise. Many RSUs provide for immediate settlement upon satisfaction of service-based vesting conditions. In such a case (and absent any “retirement vesting” provision as discussed below) federal income tax and FICA are due essentially at the same time, i.e. when the RSUs vest and are paid out. Some RSUs by their terms delay the income tax event by deferring the payment until an event or date that will occur later than vesting. However, in contrast to income tax withholding, which occurs when shares or cash in settlement of RSUs are actually or constructively received, the FICA tax event cannot be delayed. FICA tax is due for RSUs upon vesting, even if payment/settlement is delayed. One common oversight is failing to take into consideration the impact that “retirement vesting” in an RSU award will have on FICA tax timing. In the absence of retirement vesting provisions, an RSU that has a service-based vesting period frequently will be settled (shares delivered or cash settlement) immediately upon vesting. In such a case, both federal income and FICA withholding will apply at the time of vesting/settlement. In contrast, if an RSU award provides that it will not be forfeited if the individual retires prior to the scheduled vesting date, the RSU will be vested when the participant becomes eligible to retire (because there will be a lapse of the service-based substantial risk of forfeiture), notwithstanding that settlement of the RSU may not occur until the original settlement date. Even if the RSU will be settled on the earlier of the scheduled vesting date and the date of retirement, this will not solve the problem. This is because the risk of forfeiture lapses when the participant is eligible to retire, whether or not he or she in fact retires at that time. Thus FICA taxes will be due at grant if the individual already has met the criteria for retirement, or at the time during the vesting period that an individual first meets the criteria for retirement. This obligation to withhold and pay employment taxes before the RSUs are settled/paid out may be an unpleasant surprise for the employer and the participant. There are some alternative timing rules for FICA withholding that can provide some (but not complete) relief. We’ll discuss them in a future post. As a reminder, U.S. taxpayers are taxed on worldwide income, regardless of where they reside. U.S. taxpayers are: (i) U.S. citizens regardless of residency; (ii) non-resident aliens (“green card” holders); and (iii) non-citizens, non-green card holders who have a “substantial presence” in the United States under the U.S. income tax laws (but exceptions to this category apply – careful analysis of the facts and applicable tax treaties required).

One of the most difficult and costly aspects of developing mining projects in the United States is the permitting requirements under the Clean Water Act (CWA). The Trump administration is currently undertaking a rulemaking process to examine and redefine the scope of the CWA. Companies with mining projects in the United States should consider participating in the rulemaking process to assure that their interests are represented. In 2015, the U.S. Environmental Protection Agency (EPA) and the U.S Army Corps of Engineers (Corps) (collectively the Agencies) adopted final regulations redefining the term “waters of the United States,” which defines the scope of federal regulatory jurisdiction under the CWA. States, industry groups, and environmental organizations immediately challenged the rule in the federal courts, and a nationwide stay issued by the 6th Circuit Court of Appeals has prevented the Agencies from implementing the 2015 regulations. In light of the circumstances, and pursuant to an Executive Order from President Trump, dated February 28, 2017, the Agencies are currently reviewing the definition of “waters of the United States” under the CWA. The Agencies have proposed a two-step process for this review. First, in July, the Agencies proposed a rule to repeal the 2015 regulations and re-codify the regulations that existed prior to 2015. The public comment period for this proposed rule runs through September 27, 2017. Second, the Agencies will propose new regulations substantively redefining “waters of the United States” and the scope of CWA Jurisdiction. This rulemaking is particularly important for natural resource companies because the breadth of topographic features to which the CWA applies has a major impact on project permitting. Natural resources projects are generally subject to two types of CWA permits. Under Section 402 of the CWA, parties are required to obtain a National Pollutant Discharge Elimination System (NPDES) permit from the EPA, or a delegated state agency, for any point sources where pollution may enter into waters of the United States. Under Section 404 of the CWA, parties are required to obtain a 404 permit from the Corps prior to the discharge of dredge or fill material into waters of the United States. The cost and timing for permitting and the feasibility of natural resources projects can largely depend on whether topographic features within or near a project are considered “waters of the United States” and subject to these CWA permitting requirements. Thus, the Agencies review of the scope of the definition for “waters of the United States” should be of particular interest to anyone operating, permitting, or investing in natural resource projects in the United States. As part of their review process pursuant to the February 28th Executive Order, the Agencies recently announced they would hold 11 sessions this Fall to give stakeholders an opportunity to provide recommendations on a revised definition of “waters of the United States.” Nine of the 11 sessions will be tailored for specific industries, with the stakeholder session for “Mining” scheduled for October 31, 2017, from 1pm to 3pm ET. Registration for each of the stakeholder sessions will close one week prior to the scheduled date of the session. The Agencies will also be accepting written recommendations and comments on the rulemaking process, which should be submitted on or before November 28, 2017. Over the past several years, Dorsey has represented mining companies in rulemaking processes under the CWA and similar environmental statutes, through participation in stakeholder meetings and the submission of comments that communicate to the regulatory agencies our mining clients’ concerns and objectives. The Federal Register notice announcing the schedule of public sessions is available at www.gpo.gov/fdsys/pkg/FR-2017-08-28/pdf/2017-18214.pdf. Information on registering for the sessions is available at www.epa.gov/wotus-rule/outreach-meetings.

The recent data breach at Equifax, a major credit rating agency, has provided an unexpected reminder of the importance of well-structured insider trading policies. Following last week’s announcement of the data breach, it was disclosed that certain Equifax executives, including its Chief Financial Officer, sold a portion of their holdings after the cyberattack was discovered, but before the news was publically announced. While Equifax has stated that the executives had “no knowledge of the intrusion at the time they sold their shares,” the developing story illustrates some of the risks attendant to sales of securities by insiders of public companies. Canadian issuers registered with the SEC or trading in the U.S. markets will find the recent article by Dorsey partners Cam Hoang and Gary Tygesson to be a helpful reminder of the key issues to consider in adopting or reviewing an insider trading policy: www.dorsey.com/newsresources/publications/client-alerts/2017/09/equifax-data-breach.

On September 5, 2017, the U.S. House of Representatives overwhelmingly passed (by a vote of 403-3) the Improving Access to Capital Act. The Act directs the SEC to amend Regulation A+ to allow SEC reporting issuers to use Regulation A+ when raising capital, and to deem their SEC periodic reports to satisfy the periodic and current reporting requirements of Tier 2 of Regulation A+. The Act is now being considered by the U.S. Senate. If the Act becomes law, it will increase the alternatives available to SEC reporting companies in seeking additional capital. Smaller public companies that are not listed on Nasdaq or the NYSE, and are therefore subject to state securities regulation in respect of their capital raising activities, may find Regulation A+ especially attractive, because an offering under Tier 2 of Regulation A+ is preempted from state securities regulation other than the potential requirement to make a notice filing, consent to service of process, and pay a filing fee.

In the United States, employers are required to pay employees overtime (1.5 times the employee’s hourly rate) for hours worked over 40 per week. In some states, such as California, employers are required to pay overtime if employees work more than 8 hours in a day. Like Canada, U.S. employees may be exempt from overtime requirements if they meet certain criteria. However, such exemptions under U.S. law are frequently more complicated than their Canadian counterparts, and even sophisticated U.S. employers frequently get them wrong. In 2016, U.S. employers spent nearly $700 million on class-action settlements of wage and hour claims. This does not include amounts U.S. employers spent paying judgments and attorneys’ fees. The three major categories of exempt employees under the U.S. Fair Labor Standards Act (which governs overtime pay) are the so-called “executive,” “administrative,” and “professional” exemptions: Similar to the Canadian exemption for managers, U.S. law exempts so-called “executive” employees from overtime. Employees must customarily and regularly direct the work of at least two or more other full-time employees or their equivalent to qualify for the executive exemption. Such employees must also have the authority to hire or fire other employees, or the employee’s recommendations as to the hiring, firing, advancement, or promotion of other employees must be given particular weight. To qualify for the “administrative” exemption, an employee’s primary duty must be the performance of office or non-manual work directly related to the management or general business operations of the employer or the employer’s customers. The employee’s duties must be separate from the production of goods or rendition of services that the employer is in the business of providing. Accountants and human resources professionals can fall into this category. To qualify for the “professional” exemption, the employee must perform work requiring advanced knowledge that is intellectual in character and that usually requires some sort of prolonged course of study. Doctors, attorneys, and accountants with advanced degrees are good examples. For each of these exemptions, the employee’s job must require the exercise of discretion and judgment regarding matters of significance to the company. The authority to commit the company to large contracts or to spend significant amounts of the company’s money are good examples. Also, to qualify for any of these exemptions, employees must be paid a salary of at least $455 per week. There are additional exemptions for so-called “creative professionals,” “computer employees,” and “outside sales employees” as well. U.S. employers frequently misapply these exemptions. To qualify for the “creative professional” exemption, the employee’s primary duty must involve invention, imagination, and originality in a field of artists or creative endeavor. The key to this exemption is the distinction between creativity and technical skill. An employee that makes technical drawings or reproductions would not qualify, but an employee that creates original works of art would. The “computer employees” exemption is often a trap for employers. The mere fact that an employee uses a computer or is technically proficient with computer hardware or software is not enough. The employee must design, develop, analyze, or create computer software or hardware systems on behalf of the employer. Low-level tech support does not qualify, but computer programmers and systems designers do. Another frequently misapplied exemption is the “outside sales employees” exemption. Many U.S. employers mistakenly classify their in-house sales staff as exempt. However, to qualify for this exemption, a salesperson has to work primarily on the road, traveling to customers. Employees that primarily work a phone, either at home or at the employer’s office, do not qualify. All of these exemptions often sound clear on paper. The Vice President of Sales, the head of accounting, and the company’s in-house lawyer are all clearly exempt. But what about the assistant manager at a retail location? What about a mid-level accounting professional? Many employees fall into a gray area. The consequences of misclassifying employees can be severe. An employer that misclassifies its force of 50 salespeople could easily end up owing over a million dollars in overtime in a class action suit. These claims are also very expensive to research and litigate. If a company fails to record the hours worked of a misclassified employee, a U.S. Court will start with the presumption that the employee’s own testimony regarding his or her hours worked is accurate, and the employer will have the burden of proving otherwise. Canadian companies looking to operate or acquire businesses in the United States should carefully assess their own and their targets’ wage and hour practices and make sure they are consistent with U.S. law.

Canadian companies should carefully structure and document loans and advances to their U.S. subsidiaries. If loans to U.S. subsidiaries are not properly structured and documented, such loans may be recharacterized as equity investments for U.S. federal income tax purposes, and important U.S. tax benefits will be lost. Properly structured loans are treated as debt for U.S. federal income tax purposes with favorable tax treatment. The U.S. subsidiary may deduct interest paid in computing taxable income. Such interest payments to its Canadian parent corporation are generally not subject to U.S. withholding tax under the Canada – U.S. income tax treaty. Repayment of the principal amount is generally not subject to U.S. tax for both the U.S. subsidiary and Canadian parent corporation. Loans which are recharacterized as an equity investment do not qualify for favorable tax treatment. The U.S. subsidiary cannot deduct interest paid in computing taxable income. Interest and principal payments will be treated as dividends to the extent of current or accumulated earnings and profits of the U.S. subsidiary. Dividends are subject to U.S. withholding tax of 5% or 15% under the Canada – U.S. income tax treaty. Loans should be properly documented with promissory notes and, in some cases, loan agreements. This documentation should include, at a minimum: an unconditional obligation to pay a sum certain by the U.S. subsidiary, a stated interest rate, the applicable currency (Canadian or U.S. dollars), payment terms (demand or one or more fixed dates), a maturity date, and creditors’ rights provisions. Evidence showing that the U.S. subsidiary has a reasonable expectation of repaying the loan is very important. At a minimum, internal projections should be prepared showing the U.S. subsidiary has the capacity to repay the loan. For larger loans, consideration should be given to obtaining a debt capacity report from a financial advisory or accounting firm. Beginning in 2018, new regulations under Code Section 385 will require that certain loans meet detailed documentation rules to avoid automatic recharacterization as equity. U.S. and Canadian transfer pricing rules will require certain documentation supporting the interest rate charged on the loan. A discussion of the transfer pricing rules is beyond the scope of this summary.

Readers listed on the NYSE will want to note a recent rule change. Effective immediately, notification of public announcements regarding dividends or stock distributions must be provided to the NYSE at least ten minutes prior to public release, even after market close. Read more in the post from our partner Jason Brenkert here: https://governancecomplianceinsider.com/nyse-rule-change-requires-ten-minutes-advance-notice-of-public-announcement-of-dividends-or-stock-distributions/

This week the SEC Division of Economic and Risk Analysis published a new report including a wealth of data regarding recent trends in public offerings and private placements of securities. The report includes a number of interesting facts about U.S. private placement practice, including: In the last few years, issuers have raised 2-3 times more capital through Regulation D than through Rule 144A. Rule 506(b) remains the most popular way to raise capital under Regulation D, with 97% of all funds raised under Rule 506 being raised under Rule 506(b), rather than the newer Rule 506(c), with issuers choosing not to take the additional steps required by Rule 506(c) to generally solicit investors. Only 6% of Rule 506(b) offerings in the most recent years have contemplated sales to non-accredited investors. Brokers are more likely to be used in Rule 506(c) generally solicited offerings, at 33% of new offerings compared with only 17% of new offerings under Rule 506(b). The issuer fails to file a Form D in as many of 10% of all unregistered offerings eligible for the Rule 506 exemption. The number of Regulation A offerings qualified by the SEC has taken off, from less than 10 per year before the “Regulation A+” amendments (which increased the maximum offering amount to $50 million) to more than 80 in 2016; however, Regulation A still represents a small fraction of the funds raised under Regulation D or Rule 144A. This is consistent with what we are seeing from our Canadian clients who conduct private placements in the United States. Most issuers that rely on a safe harbor are continuing to rely on Rule 506(b), limiting their offering to accredited investors with no general solicitation, or relying on Rule 144A, to allow for a quicker and more streamlined approach. However, Regulation A+ offerings are becoming more popular where the benefits warrant the extra time and expense. The complete SEC report is available at: www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf.

Canadian companies and their outside counsel occasionally ask about the ability to grant early exercise incentive stock options (“ISOs”) to limit the impact of the U.S. alternative minimum tax (“AMT”) to their U.S. employees. However, due to fairly counterintuitive U.S. federal tax regulations, structuring options in this manner may expose optionees to negative tax consequences in the event of a disqualifying disposition (defined below). This post reviews the tax effects of early exercise ISOs and compares the tax results to alternative structures. Early Exercise ISO Tax Consequences With any early exercise option, the optionee is permitted to initially exercise their entire stock option by paying the full option exercise price, but will receive back restricted stock with the same vesting schedule as the original option. Employees will usually file a Section 83(b) election as permitted within 30 days following the transfer of the restricted stock. In 2004, final ISO regulations clarified that Section 83(b) elections filed on restricted shares acquired via early exercise ISOs are only effective for AMT purposes and not for ordinary compensation tax purposes. In the best case where both ISO holding periods are met (the shares acquired via ISO are held at least two years from the date of grant and at least one year from the date of exercise, prior to sale), the entire spread between the sale price and the exercise price paid will be taxed as long-term capital gain. However, if either holding period is not met, a “disqualifying disposition” occurs. Assuming that an 83(b) election was timely filed within 30 days following exercise, then upon a disqualifying disposition, the difference between the fair market value of the shares on the date the underlying restricted stock vests less the exercise price paid for the shares is compensation income that will be reported on the employee’s Form W-2 in the year of sale (or if less, the amount realized in the sale less the exercise price).[1] In addition, the capital gains holding period will only begin on the date the underlying restricted stock vests.[2] To the extent the stock price increased or decreased from the date of restricted stock vesting, such change will be short-term or long-term capital gain or loss, as applicable. This tax result means that early exercise ISOs become risky to an optionee in the event of a disqualifying disposition. While reducing AMT income is a positive result, a disqualifying disposition results in a potentially large amount of compensation income and/or short-term capital gain. The optionee often has little control over whether a disqualifying disposition will occur, such as if all shares are sold in connection with an acquisition of the issuer or if the optionee’s shares are repurchased following termination from employment. Early Exercise NSO Tax Consequences As compared to an ISO, the exercise of a non-qualified stock option (“NSO”) is not a preference item for AMT purposes. If an optionee early exercises a NSO, an 83(b) election will be respected for compensation purposes and the optionee will only recognize compensation income equal to the fair market value of the shares on the date of exercise less the option’s exercise price. This income will be subject to applicable withholding for federal and state payroll taxes, including FICA. However, if the option is early exercised shortly following the option grant date, as is often the case, there is typically minimal (or zero) spread to recognize as compensation up front. The 83(b) election also starts the capital gains holding period. Thereafter, the vesting of the underlying restricted stock received upon the early exercise will not result in any further compensation income to the optionee. Upon disposition of the stock, capital gain or loss will be recognized in the year of sale, which will be long-term if the stock is held at least one year from the date of early exercise. Therefore, in contrast to early exercise ISOs, early exercise NSOs can reduce the exposure to gain being characterized as short-term capital gain to the one year after the early exercise, provided the 83(b) election is timely filed. In addition, by exercising and filing an 83(b) election shortly following grant, recognition of compensation income may be limited or eliminated. Early exercise ISOs have an overhang for up to two years following the date of grant where a disqualifying disposition could result in both compensation income and short-term capital gain recognition. For these reasons, as illustrated in the examples below, we find early exercise NSOs to be preferable to early exercise ISOs in most cases. This is especially true with respect to companies where (i) there is a possibility of acquisition within two years following the date of grant, (ii) the optionees have sufficient capital to early exercise the awards, and (iii) the optionees see a meaningful upside for the company at the time of early exercise (or the amount needed to early exercise is relatively small). Example 1 A startup company grants early exercise ISOs for 1000 shares to an employee at $0.05 per share on June 1, 2017, subject to a vesting schedule where 50% vests on June 1, 2018, and the remaining 50% vests on June 1, 2019.  Participant early exercises on June 5, 2017 while shares are still worth $0.05 per share and files an 83(b) election recognizing $0 in income, which is effective only for AMT purposes. Upon exercise, the participant receives restricted shares with the same two-year vesting schedule. When 50% of the shares vest on June 1, 2018, the fair market value has risen to $5 per share. On March 1, 2019, the company is sold via a stock purchase agreement for $10 per share. All unvested equity awards are accelerated and the shares held by the participant are sold in the deal, resulting in a disqualifying disposition, as both ISO holding periods were not met. Participant recognizes compensation income equal to the spread between FMV on the date the restricted stock vested less the exercise price paid: For the 500 shares that vested on June 1, 2018, 500 x $(5.00 - .05) = $2,475. For the 500 shares that vested in connection with the March 1, 2019, transaction, 500 x $(10.00 - .05) = $4,975. Total compensation income recognized due to disqualifying disposition is $2,475 + $4,975, or $7,450. The capital gains holding period begins on the date of restricted stock vesting. Because both tranches of restricted stock vested less than a year prior to the March 1, 2019, transaction, the $10,000 received in the stock sale less (i) $7,450 previously recognized as compensation income and (ii) $50 in total exercise price paid, or $2,500, is short-term capital gain. Example 2 Assume the same facts as Example 1, but with an early exercise NSO instead: The 83(b) election on June 5, 2017, results in $0 in compensation recognition and also begins the capital gains holding period. No compensation income is recognized with the vesting of the underlying restricted shares, as there is no disqualifying disposition concept applicable, and the 83(b) election was effective for compensation tax purposes. Upon the sale of the company on March 1, 2019, the entire $10,000 received minus the $50 amount paid in exercise price, or $9,950, will be recognized as long-term capital gain. Example 3 Assume the same facts as Example 1, but with a regular ISO grant (without the early exercise feature) that is exercised immediately prior to the March 1, 2019, transaction: No compensation income recognized at the time of exercise under the ISO rules. The March 1, 2019, sale of the shares will be a disqualifying distribution, characterizing the full $10,000 received minus the $50 amount paid in exercise price, or $9,950, as compensation income.   [1] U.S. Treas. Reg. Sec. 1.422-1(b), Ex. 2. [2] Id.

Citing concerns over economic harm, President Trump has targeted his predecessor’s climate change agenda. He has sought reversal of a number of key Obama regulations, directives, and other actions, including the Clean Power Plan and the U.S. participation in the Paris accords. The overall blueprint for these actions is found in his March 2017 Executive Order on Promoting Energy Independence and Economic Growth. This order lays out for the Environmental Protection Agency and Department of Interior, as well as other agencies, specific actions to take to promote the development and use of domestically produced oil, gas, coal, and nuclear power. The agencies are only now beginning to undertake these actions, which could have dramatic impacts on the expansion of the mining, oil and gas, and power sectors in the United States, as well as on Canadian companies investing in these sectors or trading in these fuels with the United States. Of course, the path forward will be somewhat uncertain as any actions will be challenged in court by a revitalized environmental community. For more information, see our partner Jim Rubin's recent article featured in Trends, a newsletter published by the American Bar Association Section of Environment, Energy, and Resources: www.americanbar.org/publications/trends/2016-2017/july-august-2017/trump-seeks-to-uproot-the-obama-climate-change-agenda.html

Occasionally, we will see Canadians or Canadian companies assume that they can authorize as many shares for issuance as they want when forming a Delaware corporation, or that they can authorize shares without par value. That’s technically true, but Delaware will make you pay dearly for it, up to $180,000 per company per year. A Delaware corporation must pay the state an annual franchise tax. This tax is initially based on the number of authorized shares. Provided the authorized shares have a stated par value, the tax assessment can be re-calculated on an assumed par value basis using a formula that involves the number of shares authorized for issuance by the certificate of incorporation, the number of shares actually issued and outstanding, the par value of the shares, and the issuer’s total assets. For a properly formed Delaware subsidiary, the annual tax is usually $175. The tax is often more for an operating parent company, but by setting the authorized capital and par value appropriately, the tax can be managed. Unfortunately, we have seen situations where Delaware companies have been formed or acquired without adequate advice, resulting in a $180,000 annual tax. Among other situations, this can occur when no par value shares are authorized, or when the number of shares authorized is a large number compared to a small number of shares actually outstanding, and the franchise tax obligation may fluctuate annually based on the company’s total assets.