Christopher L. Doerksen

On January 30, 2020, the SEC issued new guidance on the use of metrics in a company’s MD&A, as well as proposed amendments that would significantly simplify and modernize the requirements for MD&A and related financial disclosures. The guidance and proposed amendments will be of most interest to companies that file with the SEC on Form 20-F or 10-K. For more details, see governancecomplianceinsider.com/sec-provides-guidance-on-the-use-of-metrics-in-mda-also-proposes-amendments-to-simplify-and-modernize-mda-and-related-financial-disclosures/.

On September 17, 2019, the Financial Post reported that British Columbia Investment Management Corporation (BCIMC), one of Canada’s largest pension funds, inadvertently failed to report to the U.S. Securities and Exchange Commission (SEC) $2.46 billion of its holdings in 98 Canadian companies, accounting for more than 20 percent of the investments required to be reported to the SEC. The reason – it appears that BCIMC’s investments in Canadian companies that report with the SEC (often referred to as “cross-listed” companies) were inadvertently omitted. The Financial Post reported that this was not the first time BCIMC had made errors in its SEC filings, citing a series of prior amendments filed to correct data from 2010 to 2015. The ramifications for BCIMC are currently uncertain. The first step in avoiding this type of mistake is being aware that a Canadian investor may be required to file reports with the SEC regarding certain of its investments – not just investments in U.S. public companies, but also investments in Canadian securities that are listed on a U.S. national securities exchange, such as the NYSE, the NYSE American, or Nasdaq, or that are otherwise subject to ongoing SEC reporting requirements. The second step is to learn about investor-side SEC reports and their different triggers. For example, a Canadian investor may be required to file with the SEC, among other things: Form 13F.  Any institutional investment manager (including both an entity that invests for its own account, and an individual or entity that exercises investment discretion over others’ accounts) that exercises investment discretion over US$100 million or more in equity securities that are registered with the SEC under Section 12 of the Securities Exchange Act of 1934, equity securities of closed-end investment companies and certain other equity securities (collectively referred to as Section 13(f) Securities), and that uses any instrumentality of U.S. commerce in the course of its business, must file quarterly reports with the SEC on Form 13F, reporting its holdings in all Section 13(f) Securities. Section 13(f) Securities include securities of Canadian companies that are cross-listed on the NYSE, the NYSE American or Nasdaq, or that are otherwise the subject of SEC reporting obligations. Therefore, a Canadian investment manager may become subject to Form 13F filing requirements even if it invests exclusively in securities of Canadian companies. Schedules 13D or 13G.  Any person, wherever located, that beneficially owns more than 5% of a class of Section 13(f) Securities, including any class of Canadian securities that is a Section 13(f) Security, must file beneficial ownership reports on either Schedule 13D or 13G regarding this specific holding. In determining whether a person beneficially owns more than 5% of a class, the person’s ownership must be calculated as if the person had exercised any options, warrants and other rights that the person is permitted to exercise within the next 60 days. Form 13H.  Any person that is a large trader of NMS securities must periodically file a Form 13H with the SEC. NMS securities include securities listed on a U.S. national securities exchange, such as NYSE, the NYSE American or Nasdaq, and certain related securities. A large trader is a person that effects transactions in NMS securities, as principal or as agent, using any instrumentality of U.S. commerce or the facilities of any U.S. national securities exchange, in an aggregate amount equal to or greater than (i) during one day, either two million shares or shares with a fair market value of US$20 million, or (ii) during one month, either twenty million shares or shares with a fair market value of US$200 million. Forms 3, 4 and 5.  Any person, wherever located, that is a director or executive officer, or the beneficial owner of more than 10% of any class of equity securities, of a “domestic issuer” that is registered with the SEC pursuant to Section 12 of the Securities Exchange Act, but excepting certain passive institutional investors, must file beneficial ownership and trading reports on these forms. While most Canadian cross-listed issuers are not considered “domestic issuers,” some Canadian companies (typically those that file SEC reports on Forms 10-K, 10-Q and 8-K) are, due to their level of U.S. ownership and other U.S. ties. The third step is to work with counsel to understand, in greater depth than this post can provide, whether the investor may be required to file any of these forms. Counsel can discuss with you corporate and decision-making structures and investment limits that can help restrict the circumstances requiring a report, as well as the information required to be included in reports, and how best to ensure the required information is gathered, processed, and filed on a timely basis. Investment managers with large and diverse portfolios often have the most significant work to do, due to the number of their public investments.

As reported earlier today on our Cannabis blog, the Delaware Secretary of State’s office is now threatening to prevent the formation of companies that it identifies as having the purpose of being involved in the cannabis industry. For more information, see dorseycann.com/delaware-takes-action-against-formation-of-cannabis-companies/.

In November 2018, the U.S. Securities and Exchange Commission (SEC) adopted new mining disclosure standards applicable to all SEC reporting companies, except those that report exclusively under the Multijurisdictional Disclosure System (MJDS). While the new rules will not take effect until 2021, that date is quickly approaching. Mining and mineral royalty companies should brook no further delay in their preparations. Below are a few of the important steps to get ready to comply with the new standards: Determining whether the company must or should comply with the SEC’s new requirements.  Does the company file a Form 20-F or Form 10-K annual report with the SEC? If the company files on MJDS Form 40-F, how certain is it that the company will remain MJDS eligible, will remain a foreign private issuer, and will not need to use any non-MJDS registration forms? Does the company envision a future U.S. registration and listing? Does it have joint venture or other partners that will require an SEC-compliant technical report? Will an SEC-compliant technical report be useful for other reasons, such as marketing the property, the company, or a royalty on the property? Updating technical reports, as necessary.  If an SEC-compliant technical report will be required, or useful, a company’s qualified persons (QPs) under Canada’s National Instrument 43-101 (43-101) will need to be advised. The company will need to confirm whether the existing QPs are eligible to be QPs under SEC standards and whether they have a sufficient understanding of the new SEC rules to update the technical reports as required. A timeline and budget will need to be agreed with the QPs. In updating the reports, the QPs will need to determine whether the methodology used and determinations made under 43-101 are consistent with the new SEC standards and add to the report all SEC-mandated disclosures. Companies that are commissioning new technical reports may avoid the need for amendments by ensuring the standards used for the initial report satisfy both 43-101 and the SEC rules. Evaluating the agreements between the company and its QPs regarding the provision of any necessary expert consents.  While QPs named in certain SEC filings have long been required to provide expert consents, this requirement will expand to additional forms. The passage of the SEC’s new rules has increased awareness among QPs and within large engineering firms of the potential liability associated with being named as a QP. Some engineering firms have already started to push back, in a manner similar to audit firms, requiring new engagements or assurance procedures as a condition to providing a consent or resisting consent in situations in which they feel exposed. Companies should evaluate any existing agreements with their QPs regarding the provision of expert consents and consider whether changes may be appropriate to help ensure that such consents can be reliably obtained for a reasonable cost. Planning for new disclosures in SEC filings.  Companies that file on non-MJDS forms such as Form 20-F or Form 10-K should begin to map out the other technical disclosures that will need to appear in their SEC annual reports and other filings. For companies not already subject to 43-101, this may include obtaining technical reports for the first time. Quality assurance.  Mining companies have long asked their Canadian counsel for assistance in working with QPs, reviewing draft technical reports, and reviewing other technical disclosures to help verify compliance with 43-101. Companies subject to the SEC rules should now involve U.S. counsel in a similar manner and allow additional time for review of the technical disclosure as a result of the newness of the rules.

Many of our Canadian clients have decided to list their stock in the United States on the NYSE American exchange, instead of Nasdaq. Why? Stock price flexibility is a big factor. In Canada, it’s considered perfectly normal for a company to have stock with a price of $2, $1, $0.50 or even $0.10 per share. Not in the United States. Here, there is a long tradition of regulations and stock exchange rules disfavoring companies whose shares trade at low prices, regardless of their total market capitalization. Back in the 1990s, there were three main stock exchanges – Nasdaq, the American Stock Exchange, and for larger companies, the NYSE. While each of the exchanges imposed minimum stock price requirements, the American Stock Exchange rules permitted the exchange to grant exceptions in appropriate cases. The availability of this exception allowed the American Stock Exchange to become the preferred choice of Canadian companies with lower stock prices who did not want to complete a reverse stock split in order to list in the United States. Over time, so many Canadian companies listed there, instead of Nasdaq, that Canadian companies with higher stock prices began to join them. Things have changed a bit since those days. The American Stock Exchange has become part of the NYSE family, now known as the “NYSE American” exchange, and its rules no longer allow a waiver of its minimum stock price requirements. That said, the NYSE American has continued the tradition of being the most flexible of the major U.S. stock exchanges when it comes to stock price. For an initial listing, the NYSE American requires a minimum stock price of $2 in many cases, and $3 in others. Nasdaq allows these prices only on its lower tier Capital Market, and subject to certain restrictions that are not imposed by the NYSE American. For the Nasdaq Global Market, a price of $4 is required. Perhaps more importantly, a company that is listed on Nasdaq is subject to delisting if its stock price declines and stays below $1. For the NYSE American, the threshold is a much lower $0.20.[1] While every company hopes that its stock price will increase, the reality is that many companies have volatile stock prices. In areas such as mining, energy, cannabis, and technology, a change in market conditions, a financing overhang, or the failure of a single property or product can result in steep stock price declines. The stock price may also decline slowly over time as a company grows, issues more shares, and becomes a much larger, more valuable company. It’s here where the NYSE American rules really shine, in helping companies minimize the risk that they will be delisted due to a low stock price, or required to undertake a potentially value-damaging reverse stock split in order to avoid a delisting. To see how this works in practice, consider a company listing on the Nasdaq Capital Market at $2. This company could be delisted or required to complete a reverse split if its stock experiences an overall price decline, during the lifetime of the listing, of more than 50%. For a company listing on the Nasdaq Global Market at $4, this threshold is an improved 75%, but only due to the higher starting price. By comparison, a company with a stock price of $2 listing on the NYSE American must lose more than 90% of its stock price before the NYSE American would consider delisting the stock due to low stock price. While many Canadian companies still list on Nasdaq, stock price flexibility continues to give the NYSE American a leg up when all other things are equal.   [1] The NYSE American Company Guide permits the exchange to delist a security if it trades at a “low price” for a substantial period of time. As a matter of policy, the NYSE American considers a price below $0.20 to be a “low price.”

The SEC has proposed revisions to the definition of an “accelerated filer” that would exempt most companies that have both a public float of common equity of less than $700 million and annual revenues of less than $100 million from the requirements of Section 404 of the Sarbanes-Oxley Act (SOX 404). If adopted, these revisions would exempt many Canadian cross-reporting companies from the SOX 404 auditor attestation requirement, thereby reducing the cost of cross-border reporting. The proposal is subject to a 60-day public comment period. Additional information is available in the SEC’s press release regarding the proposed new amendments here: sec.gov/news/press-release/2019-68.

You are invited to join us on February 26, 2019, at 11 am PT/2 pm ET, for a webinar discussing the SEC’s new mining disclosure rules. On October 31, 2018, the SEC adopted final rules effecting a complete overhaul of the technical disclosure requirements applicable to companies engaged in material mining operations, including royalties. Upon effectiveness in 2021, the new rules will replace the SEC’s decades-old guidelines, set forth in Industry Guide 7. The new rules will bring the U.S. reporting regime closer to global reporting standards, and will apply to all SEC reporting companies except those that report exclusively under the Canada-U.S. MJDS system. We will be providing an overview of the new rules, and how U.S. domestic, Canadian, other foreign, and even MJDS filers will be affected. The registration page and details about CLE/CPD credit are available here: dorsey.com/newsresources/events/event/2019/02/understanding-the-secs-new-mining-disclosure-rules. A written discussion of the SEC’s new mining disclosure rules (in Q&A format) is available here: dorsey.com/newsresources/publications/client-alerts/2019/02/new-mining-disclosure-rules-2019.

We have written about this in the past [here], but the message bears repeating each year. It is easy to overlook that employment agreements, change-in-control agreements, and severance agreements with U.S. taxpayers frequently contain provisions that subject them to U.S. Internal Revenue Code Section 409A ("Section 409A"), and failure to comply can result in onerous tax penalties. However, to the extent that rights under such agreements are not yet vested, it may be possible to correct them before year-end without penalty. Even if rights under an agreement are vested, in some cases correction is available with payment of reduced penalties under IRS correction programs. It is important to remember that U.S. residents, and U.S. citizens regardless of country of residence, are taxed on worldwide income. This means that compensatory arrangements for employees and directors who are U.S. citizens working outside the U.S. will be subject to U.S. federal income tax. If compensation arrangements have not been reviewed for Section 409A compliance, we recommend doing so now, especially with respect to arrangements that will or may become vested during 2019. For a more detailed explanation, see our Dorsey publication from October 6, 2015 here.

With the legalization of marijuana going into effect in Canada tomorrow, October 17, we encourage our Canadian contacts to be careful when crossing the U.S. Border. For more information, see the recent article authored by Dorsey’s Immigration Practice Group posted on our Cannabis Blog here: dorseycann.com/at-the-intersection-of-cannabis-and-u-s-immigration-law-issues-that-canadians-and-other-non-citizens-should-be-aware-of/.

The SEC’s settlement with Tesla and Elon Musk teaches us some important corporate governance lessons on monitoring and vetting executive use of social media. As background, on August 7, 2018, the markets were surprised by a series of tweets initiated by Elon Musk, the CEO of Tesla, Inc., in which Musk mused about taking Tesla private at $420 per share (a significant premium to the then-market price), with funding secured. The stock price jumped, trading in Tesla stock was halted, and Tesla rushed to catch up with official announcements. The deal didn’t happen, and it was questioned whether Musk was really serious, and whether funding was really “secured.” The SEC commenced an investigation. On September 27, 2018, the SEC announced charges against Musk for securities fraud in connection with his tweets, which it said were inaccurate and misleading. Among the remedies sought was a permanent ban on Musk being eligible to serve as a director or officer of any public company, effectively seeking to sever him from Tesla, a company of which he is the heart and soul. Tesla’s stock dropped 14%. If this remedy was included by the SEC as leverage, that leverage worked, and on September 29, 2018, the SEC announced a settlement with Musk, as well as charges against and a settlement with Tesla. Tesla’s stock increased 17%. As part of the settlement, Musk will remain Tesla’s CEO and a director, but Musk and Tesla agreed that: Musk will step down as Tesla’s Chairman for at least three years and be replaced as Chairman by an independent director; Tesla will appoint two additional independent directors; Tesla will establish a committee of independent directors and put in place additional controls and procedures to oversee Musk’s communications; and Musk and Tesla will each pay $20 million to harmed investors under a court-approved process. The SEC alleges that Tesla failed to implement adequate disclosure controls and procedures over Musk’s use of Twitter. Tesla had publicly announced in 2013 that Musk’s Twitter account would be among the means by which Tesla intended to release material information, Musk had amassed 22 million Twitter followers, and important information about Tesla had been released through this account, but the SEC says that Tesla had not adopted any specific policies regarding Musk’s use of Twitter, such as procedures to determine whether proposed tweets were accurate and complete, and whether they contained information requiring disclosure in Exchange Act reports. In effect, the SEC says Tesla had given Musk carte blanche to release material information about Tesla, without subjecting it to the normal controls to which other, more formal, types of disclosures would be subject, and as a result, the market was misled. Investors harmed included short sellers and those who purchased shares after Musk’s announcement temporarily drove up stock prices, only to see those prices drop afterwards. The SEC’s settlement with Tesla and Musk teaches us some important corporate governance lessons: If a public company allows its executives to use Twitter or other social media accounts to disclose material information about the company, it is not enough to notify the public that material disclosures may be made by these means. Companies must ensure that their disclosure controls and procedures adequately cover executives’ use of social media. In deciding what disclosure controls and procedures to implement, consideration should be given to such matters as: what topics are permitted or prohibited; procedures for review and approval of disclosures before they are made; the inclusion of risk factors or other cautionary or explanatory language to help prevent disclosures from being potentially misleading; coordination of social media disclosures with other company disclosures as needed to satisfy public reporting requirements; and monitoring actual disclosures and resulting market and media reactions for any surprises. Companies that do not allow executives to use social media accounts to disclose material information should adopt policies clearly prohibiting such use, and monitor executives’ use of social media for any inadvertent violations of policy.  

As a continuation of our August 9 post regarding the deadline for Canadian companies to file a Form D for a private placement in the United States, we now address the questions, “What if our company missed the deadline to file a Form D with the SEC?” And, more importantly, “Have we lost our ability to rely upon the exemption?” The good news is that the exemption provided by Regulation D is not dependent upon the filing of the Form D. So, an issuer that fails to file the Form, or files it late, need not be concerned about the liability associated with a non-exempt offering. However, the failure to file exposes the issuer to risk of administrative action and possible loss of the ability to rely upon Regulation D in the future, and a willful failure to file Form D is a potential criminal violation. Accordingly, a company that discovers it has inadvertently failed to file a Form D with the SEC by the 15th day after the date of first sale of securities in an offering is best served by making the filing late unless counsel can identify an available alternative exemption. Unless the offering is otherwise exempt from state law, a late filed Form D must also be filed with, and a filing fee paid to, any state in which purchasers are located that requires such a filing. States differ in their response to late filings. Some states welcome them, and are happy to get the filing fees. Many states, including Illinois, impose an additional late filing fee when the filing is late. A few states, including Hawaii, have claimed that an exemption from state law is not available if the Form D is filed late, and demanded that the company give investors the right to get their money back. While I believe this view misinterprets federal law, it will usually be worth checking whether the late Form D must be filed in any of the states that take this position or that impose an onerous late filing fee and, if so, whether an alternative exemption is available under state law that would allow the company not to file the Form D in that state.

Canadian companies that sell securities to U.S. investors under Regulation D must file a Form D with the SEC within 15 days after “the date of first sale.” Most people would assume that the closing of the offering is the date of sale. However, in the instructions to Form D, the SEC explains that the date of first sale is “the date on which the first investor is irrevocably contractually committed to invest, which, depending on the terms and conditions of the contract, could be the date on which the issuer receives the investor's subscription agreement or check.” Therefore, the deadline for the Form D will depend on the wording of the agreement and how those words are interpreted under the governing law of the agreement. Companies whose agreements say a subscription is “irrevocable” should consider what that language is intended to mean. If it is intended to mean that the subscriber is contractually obligated to purchase the securities, regardless of whether the company has accepted the subscription agreement, then the receipt of the subscription may begin the 15-day clock and the Form D may be late by the date of closing. This problem can be addressed either by rewording the subscription agreement or by filing a Form D at the start of the offering, covering the maximum amount that may be sold in the offering. If instead, the “irrevocable” language is intended to be effective only upon the company counter-signing the agreement, the company should refrain from counter-signing the agreement until it is ready to begin the 15-day clock for filing of the Form D. Next week we will address the consequences of filing a Form D late.

Since January 1, 2016, the SEC has publicly released its correspondence relating to 60 comment letters sent to Canadian issuers with respect to annual reports filed on Form 40-F pursuant to the Canada-U.S. Multi-Jurisdictional Disclosure System (MJDS). We have analyzed the content and key takeaways from these letters, including: The SEC’s most common areas of focus; Recent trends; and Common errors to be avoided. Background The MJDS system allows Canadian issuers that satisfy certain market capitalization and other requirements to file an annual report with the SEC on Form 40-F. Except for a few items, a Form 40-F does not impose U.S. disclosure requirements upon a Canadian issuer and, instead, includes and relies upon the disclosures contained in the issuer’s annual information form, MD&A, and audited financial statements filed in Canada. The incremental requirements of Form 40-F include that the issuer’s financial statements comply with IFRS as issued by the IASB or be reconciled to U.S. GAAP, that the audit report meet certain requirements, that the auditor be independent, that certain disclosures be included with respect to the issuer’s disclosure controls and procedures and internal control over financial reporting, that certain officer certifications and third-party consents be included, and that certain additional MD&A disclosures be included. While the limited nature of Form 40-F reduces the number of areas in which the SEC may comment, Congress has directed the SEC to review the filings of SEC reporting issuers at least once every three years. For this reason, all companies that report with the SEC, even those that report under the MJDS, should expect their filings to be reviewed from time to time. If upon such review, the SEC has questions or believes that the issuer’s filing is deficient, it may provide comments to the issuer by letter. The issuer must then respond to the SEC’s comments, and may need to amend its filings to address the comments. Industry Breakdown The industry breakdown of the 60 most recent Form 40-F comment letters was: Twenty-four to companies involved in mining, mineral exploration, or the holding of mineral royalties or minerals; Five to energy companies; Five to technology and telecommunications companies; Four to life sciences companies; Four to banking and insurance companies; Three to real estate companies; and Six to companies involved in other industries, including transportation, manufacturing, entertainment, publishing, and professional services. Repeat Letters An issuer’s chance of receiving a comment letter may increase once the SEC has taken an interest in the issuer’s filings. The recipients of the comment letters included nine issuers who received a comment letter in both of the fiscal years covered by our review. Self-Inflicted Wounds Some comments could easily have been avoided. For example: Six letters noted technical problems with the audit report (missing auditor name, signature, date, or entire report; or failed to say financials comply with IFRS “as issued by the IASB”); Four noted technical problems with officer certifications or the internal control attestation report (wrong period, date, or content; or missing entirely); Four noted technical problems with the content of the controls sections of the Form 40-F; Three related to non-IFRS measures that the SEC considered misleading because terms were used inconsistently or the titles of the terms did not match the definitions (e.g., using the term EBITDA but calculating it in a manner inconsistent with market norms); Two noted technical problems with the contractual obligation table; and Two objected to an issuer’s conclusion that disclosure controls were effective when the issuer had disclosed that internal controls were ineffective. Paying Attention The SEC pays attention to an issuer’s website and earnings calls and may comment on inconsistencies between the Form 40-F and these other disclosures or raise other comments based on these disclosures. For example, several comment letters asked issuers about their business activities in sanctioned countries based on disclosures on their website. One letter questioned why management touted improvements in internal controls on the earnings call but disclosed no material change in internal controls in its Form 40-F. Another requested a different presentation of revenues based on sales information disclosed on an earnings call. Most Common Topics By far the most common topic of an SEC comment letter was the issuer’s financial disclosures. Forty-two of the 60 letters included comments relating to the issuer’s financial statements, audit report, auditor, or MD&A. These included, among others: Twenty-four with questions regarding revenue recognition policies, breakout of revenues by product (usually asking why further breakouts of revenue were not provided), methodology and disclosures around asset valuation and capitalization of expenditures, tax assets and rates, depletion/depreciation, or impairment analysis; Thirteen with questions about the accounting treatment of a specific other matter; and Nine requesting improvements to the disclosure of period-to-period changes, a particular accounting analysis, liquidity, cash flow, or other matters. Second-most common was comments relating to technical disclosure requirements for issuers involved in the mining or oil & gas industries, accounting for 13 of the 60 letters. Ten letters addressed mining company technical disclosures, including supplemental requests for copies of technical reports, studies, or other information in support of disclosures (the SEC does not require such reports to be publicly filed, unless also filed in Canada and material), and comments relating to: the issuer’s failure to comply with NI 43-101 (compliance with NI 43-101 is a pre-requisite for not complying with SEC Industry Guide 7); the issuer’s failure to update reserve calculations, for past production or more generally; and inconsistent or unclear disclosures. Three letters related to oil & gas company technical disclosures, all of which requested enhanced disclosures and alleged failures to satisfy FASB disclosure standards. The third-most common topic of the comment letters was comments relating to deficiencies in the officer certifications or disclosures relating to disclosure controls and internal controls. This topic was addressed in eight of the 60 comment letters, most of which related to failures to satisfy the form requirements. Fourth-most common was comments inquiring about the issuer’s business dealings in sanctioned countries (usually Sudan and Syria) or with companies known to operate in those countries and the adequacy of any related disclosures, usually triggered by the SEC’s realization that this may be relevant to the issuer. Seven of the 60 letters included such inquiries. Waves and Trends Comment letters have tended to come in waves. The letters from January 2016 through June 2017 dealt primarily with financial statement and MD&A issues; Two of the three letters issued to real estate companies were issued in the same week of September 2016; All of the letters issued to banks were issued in March 2017; All of the letters dealing with oil & gas technical disclosures were issued in the fourth quarter 2017; and Eight of the 10 letters dealing with mining technical disclosures were issued between June and December of 2017. It’s not yet clear if the shift toward commenting on mining technical disclosures is a trend. Lessons To reduce the likelihood of SEC comments, a Canadian issuer that files SEC annual reports on Form 40-F should attend to the technical compliance of its audit report, officer certifications, controls disclosures, and other Form 40-F mandated disclosures; include a robust and understandable MD&A; avoid the inconsistent or misleading use of non-IFRS terms; and, for resource extraction issuers, comply with the technical disclosure requirements applicable to it under Canadian and U.S. laws.  

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.

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.

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/).  

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.

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.

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.

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.

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.

A Canadian company that proposes to grant stock options or other types of equity compensation to persons in the United States must comply with the securities laws of the state in which the recipient is located, unless the type of equity being issued (e.g., the underlying common shares, in the case of options to purchase common shares) is listed on a “national securities exchange” such as the NYSE, Nasdaq, and NYSE MKT. This means that private companies, Canadian public companies that are not listed in the United States, and Canadian companies that are listed in the United States only in over-the-counter markets such as the OTCQX, OTCQB, or Pink Sheets, are required to comply with state securities laws. Canadian companies should not assume that because they have taken the requisite steps under U.S. federal laws, such as registering the underlying securities by filing a Form S-8 with the SEC or complying with an exemption from registration under SEC Rule 701, that no further actions are required. While some states’ laws do not require additional actions to be taken, many states impose requirements that differ from federal laws. For example, Some states require that an application for exemption be filed and accepted by the state, or another type of notice be filed, and a fee be paid, prior to making the first equity award in that state. Some states’ exemptions from registration requirements restrict the types of awards that can be made, the types of persons that can receive awards, and the types of companies that can rely on the exemption. For example, some states’ exemptions are unavailable for awards to consultants and non-employee directors, are subject to bad boy disqualifications, are available only for certain types of equity plans, or are unavailable for awards made on an SEC-registered basis. Some states have no specific exemption for equity-based compensation, and a company seeking to make equity-based awards in those states must either register the plan or comply with another type of exemption, such as an exemption that might be available for a private placement to a limited number of persons satisfying certain investment criteria. The State of California imposes substantive requirements on the plan itself, including terms related to the number of securities to be issued, minimum vesting criteria, minimum post-termination exercise periods, information delivery requirements, and shareholder approval requirements, in addition to the requirement to file a notice and pay a fee.

Canadian manufacturers who sell products through U.S. distributors should ensure that they take appropriate action to establish their U.S. intellectual property rights, and to deal clearly with those rights in their cross-border distribution agreements. In a recent post on Dorsey’s IP blog, The TMCA, Sandra Edelman discusses the difficulties encountered by Covertech Fabricating, a Canadian manufacturer of protective packaging and reflective insulation, in establishing that it was the rightful owner of the trademarks in its branded products, not its U.S. distributor. Read her analysis of the recent court decision here: thetmca.com/who-owns-that-trademark-the-manufacturer-or-the-exclusive-distributor/

This week, the SEC approved a rule that would require broker-dealers to settle most securities transactions on a T+2 basis (shortening the current regime from T+3), effective September 5, 2017. See additional information in the post from our partner Jason Brenkert here. Will Canadian regulators follow suit?