On March 2, 2012, the staff of the Canadian Securities Administrators (CSA) published CSA Staff Notice 41-317 – Corporate Finance Prospectus Guidance – Concerns regarding an issuer’s financial condition and the sufficiency of proceeds from a prospectus offering (the Staff Notice). In the Staff Notice, the CSA staff explain how they intend to review disclosure of an issuer’s financial condition when considering whether or not to issue a receipt for a prospectus.
Although it relates primarily to issuers with short-term liquidity concerns or offerings that do not appear to CSA staff to be raising sufficient proceeds, the Staff Notice provides a useful overview of CSA staff’s views on a number of prospectus disclosure matters. It reiterates concerns that the CSA members (in particular, the Ontario Securities Commission (OSC), in OSC Staff Notice 52-719 – Going Concern Disclosure Review from December 2010) have been raising over the past few years in guidance and in comment letters on prospectuses. The guidance in this Staff Notice, in particular regarding disclosure of risk factors, may also be a helpful reminder for issuers who are preparing documents that may be incorporated by reference in a short form prospectus of certain areas of regulatory concern.
Sufficiency of Proceeds
The CSA staff note that consideration of an issuer’s financial condition is a critical part of every prospectus review. Thus, in addition to adequate disclosure of the issuer’s financial condition and any going concern risk, the regulators will require that an issuer have sufficient resources to meets its short-term liquidity requirements and to accomplish the purpose of the offering. Expanding on the OSC staff guidance in OSC Staff Notice 52-719, the Staff Notice provides the following guidelines regarding required sufficiency of resources, based on the issuer’s stage of development:
The Staff Notice then lists a number of comments that can be expected from the regulators in their review of a prospectus. For example, if a preliminary prospectus is filed without the offering amount and pricing information, the CSA staff will request a blacklined draft of the final prospectus including the omitted disclosure not less than two days before filing of the final materials (estimated pricing information may be acceptable). Issuers may already be familiar with requests to receive copies of “green sheets” or marketing materials, which CSA staff indicate will be reviewed in order to assess whether the final offering amount is substantially less than originally anticipated.
In addition to expressing concerns about the appropriateness of offerings without a minimum subscription condition for an issuer in financial difficulty, the CSA staff note that a base shelf prospectus may not be appropriate for issuers in financial difficulty given the issuer’s financial condition and uncertainty of financing, since incremental drawdowns may be insufficient to satisfy an issuer’s short-term liquidity requirements. CSA staff indicate a number of points on which they may request submissions in order to determine whether an issuer in financial difficulty may use a base shelf prospectus. These points include the issuer’s intention to file a prospectus supplement in the near future and the proposed nature and timing of any offerings, the availability of other sources of financing, and details regarding concrete development milestones that would advance the issuer’s business objectives and are expected to be completed in the next 12 months.
Essentially, the CSA staff will be focused on ensuring that they have sufficient information to assess the issuer’s short-term liquidity requirements and assessing whether the issuer will be able to continue operations for a reasonable period of time.
Disclosure Concerning Use of Proceeds
The Staff Notice sets out the views of CSA staff regarding adequacy of disclosure regarding use of proceeds, indicating that adequate use of proceeds disclosure should be detailed rather than general in nature, and should include: a) the principal purposes of the proceeds (with a breakdown of the uses and allocations of the proceeds), b) the significant events that must occur for the relevant business objectives to be accomplished (i.e., what is required to meet the next milestone), and c) detailed disclosure regarding how the proposed offering may be used to address a situation of negative cash flow from operating activities. The CSA staff note, in particular, that for mining issuers general statements referring to completion of a phase of an exploration program may not be sufficient disclosure. The CSA staff remind issuers that the statement “for general corporate purposes” is not considered to be sufficient use of proceeds disclosure.
The CSA staff indicate that they may require written representations (made to them and included in the prospectus as forward-looking information in compliance with applicable disclosure rules regarding this type of information) as to the number of months that an issuer will be able to continue operations given its financial condition. If the representations appear to be unreasonable or inconsistent with prior disclosure, they may request a supporting cash flow forecast accompanied by management assumptions.
The Staff Notice reiterates concerns expressed by CSA staff in the past regarding insufficient or “boilerplate” disclosure of risk factors and provides examples of elements that issuers who have “going concern risk” (an expression that was described in OSC Staff Notice 52-719 as referring to issuers whose management has “identified material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern”) should consider including in their risk factors disclosure about their financial condition, including: quantification of losses, deficits, negative cash flow, debt levels; how the issuer expects to remedy the liquidity or solvency issues; the implications to the issuer’s liquidity, capital resources, operations and its ability to remain a going concern; and the period of time the proceeds raised under the prospectus are expected to fund operations.
Issuers in Financial Difficulty Will Face Heightened Scrutiny
Generally, the Staff Notice indicates that issuers in financial difficulty – in particular, issuers with going concern risk – will be subject to heightened scrutiny when filing a prospectus, and in certain cases may be required to include additional disclosure that prospectus form requirements would otherwise only require of a junior issuer. However, the CSA staff emphasize in the Staff Notice that disclosure alone may not be sufficient to satisfy their concerns. Issuers in financial difficulty should consider the guidance in the Staff Notice carefully before deciding to file a prospectus – particularly a base shelf prospectus, for which the CSA staff may be unwilling to issue a receipt at all.
The more substantive scrutiny by the CSA staff of the ways in which a public offering will actually assist in solving an issuer’s financial issues is in some ways reminiscent of the review by the Toronto Stock Exchange of submissions required to be made by an issuer in financial difficulty seeking to rely on the “financial hardship exemption” from securityholder approval for certain transactions, as provided in TSX Staff Notice 2009-0003, likely because the investor and market protection concerns behind the increased scrutiny are similar.
In its 2011 Annual Report, the OSC indicated that 49% of its prospectus reviews had resulted in changes to the prospectus and that common changes included enhancements to disclosure regarding the use of proceeds, plan of distribution and risk factors. The guidance in the Staff Notice addresses these areas as they apply to issuers in a financial hardship context, but these are clearly areas of concern for CSA staff generally and this guidance may therefore be worth considering when preparing any public offering documents. For issuers in financial hardship this guidance will be essential when considering whether a contemplated offering is the appropriate way to meet the issuer’s financing needs.