Canadian Securities Regulators Signal Increased Scrutiny for Cannabis M&A Disclosures

On November 12, 2019, the Canadian Securities Administrators (CSA), the organization that oversees securities regulations in the 10 Canadian provinces, released Multilateral Staff Notice 51-359 Corporate Governance Related Disclosure Expectations for Reporting Issuers in the Cannabis Industry (the “Guidance”). The Guidance specifically relates to the disclosures required in merger and acquisition transactions. The CSA expressed concern over the perceived inadequate transparency relating to the cross-ownership of financial interests involved in such transactions.

The rapid growth of the cannabis industry and the heightened pace of mergers and acquisitions has resulted in many cannabis companies and their directors and executive officers having a higher than usual crossover of financial interests. Often times these interests are intertwined within various management companies, leasing companies, real estate companies and across numerous license holders, as well as interests in investment advisory services entities and other transaction service providers that are receiving compensatory transaction fees.

The Guidance reiterates that in the disclosure document filed in connection with the transaction, the acquiror and/or the acquiree should disclose all relevant and material the cross-ownership of financial interests held by either by the acquirer, the acquiree, or either of their directors or executive officers.

“Investors need to understand the conflicts of interest that could arise when issuers have crossover of financial interests, because those conflicts could have implications for the possible M&A transaction,” said Louis Morisset, CSA Chair and President and CEO of the Autorité des marchés financiers.  We would advise, to avoid potential shareholder litigation, that the disclosure should go beyond the Canadian disclosure requirements and adhere to the more stringent related party transaction disclosure required under U.S. securities laws as many of the cannabis companies have US shareholders or dual listings in the US.

The second issued raised by the Guidance is the determination of director independence as a result of such cross-ownership of financial interests. The CSA stated that they have, “observed instances where cannabis issuers have identified board members as being independent, without giving adequate consideration to potential conflicts of interest or other factors that may compromise their independence.”  Again, the cross-over relationships should be reviewed to make a full independent determination.

It is important for reporting issuers to review closely all disclosures made in connection with a merger and acquisition. As a result of the release of the Guidance, the review conducted by the reporting issuer and its counsel is more critical than ever.  The board of the reporting issuer should review closely all potential conflicts among its members and should consult with its code of business conduct and ethics to ensure that all procedures have been followed relating to conflicts of interest, as well as considering the jurisdiction rules of its shareholder base.

The importance of proper disclosures has been highlighted by a recent proposed class action lawsuits filed against Canopy Growth and Aurora Cannabis, each lawsuit alleging that the companies made false and misleading statements or withheld material information in their securities filings. While the lawsuit is not related to statements in connection with an M&A transaction, these lawsuits do highlight the importance of reviewing closely all disclosures made in US and Canadian securities filings.

By: Nanette C. Heide and Justin A. Santarosa