A UK dispute sheds light on the duties of a dissident director

By Nader Hasan (Toronto) and Joe Bricker on May 10, 2019 Posted in Proxy Battles, Shareholder Activism

A recent decision of the UK’s High Court — Stobart v Tinkler [2019] EWHC 258 (Comm) — has been released following a dispute between directors of a large infrastructure company (the “Company”). The decision, and the circumstances preceding it, serve as a cautionary tale about the duties of a dissident director and of board members in the context of proxy contests.

The board dispute was initiated by a founder and significant shareholder of the company (the “Dissident Director”). After his resignation from the office of CEO in 2017, the Dissident Director remained with the Company as a director and employee. Shortly thereafter his relationship with the rest of the board, and in particular with the board’s independent chairman, began to break down. These tensions boiled over in the months leading up to the company’s 2018 AGM. During this period the Dissident Director had numerous private discussions with shareholders without the board’s knowledge or consent. At these meetings, he aired his grievances about the board and particularly the manner in which the company was being run under the leadership of the chairman. He also wrote an open letter to the Company’s shareholders in his capacity as “executive director” expressing similar views. The other members of the board took steps to deal with the dissident: They established a board committee (independent of the Dissident Director and the chairman) to address the Dissident Director’s conduct, made two public communications to shareholders regarding the issues, and authorized transfers of treasury shares into an employee benefit trust, with the expectation (revealed later) that the independent trustee of the trust would vote the shares in favour of the recommendation of the board and the proxy advisory firm Institutional Shareholder Services.

At the AGM, the incumbent board was re-elected, including the Dissident Director and the chairman whom he had sought to displace. The following day the board voted to remove the Dissident Director as a director. Subsequently, the dispute was brought into the courts, with the Company claiming that the Dissident Director had breached his fiduciary duty to the company. The Dissident Director counterclaimed for a declaration that the vote to remove him from the board was invalid. When the dust had settled, the court made a finding that both the Dissident Director and the board had breached their fiduciary duties in the course of their infighting. The “guerrilla tactics” that the Dissident Director used to reassert control over the company (including the private meetings and the “seriously misleading” letter to shareholders) were deemed to constitute a “serious” breach of the duties the Dissident Director owed to the Company as a director and employee. For the board’s part, their decision to allocate shares with the intention to influence the results of the election also constituted a breach of their fiduciary duty, as they clearly acted with an improper, self-interested purpose.

This decision, while not binding in Canada, is an interesting refresher on basic corporate governance principles. Among the most important takeaways is that the duties a director owes to a company places constraints on that director’s ability to act as a dissident. Directors, of course, should feel free to think independently and dissent from the majority viewpoint. However, directors should carefully reflect on their response and approach before proceeding with any actions.

The authors would like to thank Eric Vice, articling student, for his assistance in preparing this legal update.

Shareholder Activism Reaches Record Levels

By Monica Wong (Toronto) on April 29, 2019 Posted in Corporate Governance, Proxy Battles, Shareholder Activism

Activist Insight recently published the sixth edition of its annual report, entitled “The Activist Investing Annual Review 2019” (the “Review”). The Review analyzes recent global shareholder activism trends, forecasts expected developments in 2019, and highlights and compares jurisdictional data.

Oh, Canada: Increased Canadian Activism

As the Review outlines, 2018 was a notable year in Canada for shareholder activism. Not only did one of the biggest proxy fights of the year stem from Canada, but 75 Canadian companies received public demands from activist investors. The number of public demands received last year is significant considering there were 56 Canadian target companies in 2017. Activist Insight attributes this increase, in part, to greater activity in Canada’s basic materials industries, which accounted for 37% of Canadian targets in 2018. Canadian companies received the third highest number of public demands in the world. Australia narrowly surpassed Canada as 78 Australian companies received public demands last year. With regards to the number of activist short campaigns in 2018, Canada came in second place. Not surprisingly, the U.S. took first place by having 98 bets against companies, while Canada had 22.

M&A activism in Canada decreased by 2.4 percentage points from 2017 to 2018, which was a more modest decline than in Europe. By contrast, Australia and the U.S. showed increases of 2.2 and 7.7 percentage points, respectively.

The Review also noted that board representation demands increased at a faster rate than settlement agreements. Of the 48 board seats obtained in 2018 in Canada by activist nominees, 30 were won by settlement and the remaining seats were achieved by vote.

Looking Back at 2018

The Review identified the following overarching trends of shareholder activism in 2018:

Riding the wave. The success of many activist investors had a ripple effect around the world and served as encouragement for others. As a result, the sustained efforts of activists led to further success in obtaining board seats and securing proposed improvements. Activists were undeterred even when companies used defense tactics, such as high insider ownership and dual-class stock.
The M&A machine. There was a marked increase in worldwide mergers and acquisitions (“M&A”) that were related to activism, as most of the year’s high-profile battles were accompanied by a deal. Further, over 60% of demands saw an activist advocating for a deal, and hostile or unsolicited bids acted as springboards for activists to demand even higher offers. Certain activists also employed the strategy of encouraging a company to put itself up for sale, despite a lack of bidders.
Good governance vs. ESG concerns. Despite the world’s growing interest in environmental, social and governance (“ESG”) issues, there was a particular focus on governance and shareholder rights. It was hypothesized that this heightened concern relating to governance led to there being fewer ESG proposals. However, many ESG issues may not have been on proxies due to them being resolved by way of negotiation.
Global increase in activism. Outside of the U.S., there was a record level of shareholder engagement as over 400 companies received requests from activists. These 400 companies represented 47% of all target companies in 2018.
Settlements abound. There was a significant rise in companies reaching settlements with activist shareholders. This represents a growing acceptance by companies of such investors as important stakeholders, and a willingness to consider and accommodate reasonable activist suggestions.

The 2019 Forecast

Looking forward, the Review projected a variety of trends in 2019, including:

Eyes overseas. If U.S. valuations revert to their past highs, American activists will likely turn their attention to the U.K., Germany and Japan.
Continued ESG Concerns. ESG will continue to be a consistent theme in 2019, which will lead to specialists being particularly sought after by activists and advisory companies.
Dark deal days ahead. It is expected that a flurry of transactions and related activism will take place in 2019, particularly in the mining and energy sectors. However, the total number of deals is likely to decrease, while attempts of hostile takeovers increase.

The complete Review may be obtained from Activist Insight here.

The author would like to thank Sarah Pennington, articling student, for her assistance in writing this legal update

Share Buybacks & Executive Compensation: Aligning Management’s Incentives

By Robert Corbeil (Toronto) and Joe Bricker on April 22, 2019 Posted in Corporate Finance, Corporate Governance, Securities

As we previously discussed, the use of share buybacks has accelerated in recent years, both in Canada and the United States. This has sparked anxious debate over the extent to which buybacks can form part of an effective long-term growth strategy. Particularly in the United States—where buybacks hit a record of more than $1 trillion USD in 2018 following tax reforms—commentators have blamed buybacks for various ills, including wage stagnation, income inequality, and underinvestment in R&D. In response, some U.S. legislators have sought to curb their use, such as by tying buybacks to conditions including paying employees a certain hourly wage, and providing a minimum number of paid sick days.

What motivates buybacks in the first place? Simply put, share buybacks are used to return cash to shareholders, and are therefore an alternative to paying a dividend. Typically, buybacks are used during periods in which other investment opportunities (such as acquisitions) are unappealing. Buybacks are also often used by a company’s management to signal that they believe their shares are undervalued.

The debate concerning share buybacks is complex and politically charged. There is, however, one issue on which many commentators have found common ground: the need to align executive compensation with the use of share buybacks. Executive compensation packages are almost always tied to long-term company performance by paying out at least a portion of compensation in shares or share options. Yet recent studies have shown that in the days following a share buyback, executives are significantly more likely to cash out the shares they received as part of their compensation packages. Specifically, in a speech by SEC Commissioner Robert Jackson, he revealed that in half of the 385 buybacks studied, at least one executive sold his or her shares in the following month. Further, twice as many company insiders sold shares in the eight days following a buyback announcement than on an ordinary day.

This means that some executives are able to capture the short-term increase in share price which tends to follow a buyback announcement, which calls into question their motivations for doing so. As Commissioner Jackson put it, if executives believe that a buyback is the right long-term strategy for their company, “they should want to hold the stock over the long run, not cash it out once a buyback is announced. If corporate managers believe that buybacks are best for the company, its workers, and its community, they should put their money where their mouth is.”

To be sure, buybacks may often form part of an effective long-term strategy, and it is not clear to what extent this study might be replicated in the Canadian context. Nonetheless, shareholders, boards, and compensation committees would be well-advised to closely review their executive compensation packages to safeguard against the mere appearance of the opportunistic use of buybacks. Specifically, stakeholders can take two steps to ensure that the incentives set through executive pay are properly aligned. First, performance metrics in compensation packages should be structured to negate temporary effects of share buybacks. Second, a 2017 study revealed that few companies disclose the details concerning their share buyback decision-making. Companies should be urged to provide detailed disclosure of the decision-making driving a buyback. In addition, compensation committees should be required to approve an executive’s decision to sell his or her equity stake in the period following a buyback, and should justify why this is in the best interests of the company. Together, these reforms would ensure that buybacks are only used when truly in the best long-term interest of the company.

The authors would like to thank Felix Moser-Boehm, articling student, for his assistance in preparing this legal update.

When defamation in hostile proceedings leads to serious consequences

By Nader Hasan (Toronto) and Joe Bricker on April 11, 2019 Posted in Litigation, Proxy Battles, Shareholder Activism, Uncategorized

It will come as no surprise to those who have participated in a proxy fight to learn that these disputes can be heated affairs. Parties to a fight will routinely seek to discredit the other side to bolster their own narrative or otherwise gain a strategic advantage. In such an atmosphere, it can be difficult to draw the line between behaviour that’s merely aggressive and behaviour that crosses into unethical or illegal territory. A recent U.S. District Court case, Eshelman v. Auerbach et al, provides an example of the serious consequences that can ensue for those who cross this line.

A federal jury in North Carolina awarded Fredric Eshelman over $22 million USD in damages after finding that he had been defamed by Puma Biotechnology Inc. The defamatory statement arose in the course of a campaign launched by a dissident against Puma. The goal of the campaign was to increase Puma’s board from five directors to nine, and to fill at least one of the new seats with a representative favourable to the dissident’s cause. Puma opposed the bid, labelling it a “wasteful and unproductive campaign” and quickly mounting a defense.

As one aspect of its defense, Puma released a publicly-available investor presentation setting out the reasons why shareholders should vote against the dissident’s proposal. A number of slides in the presentation were stated that the dissident “continues to demonstrate a lack of integrity.” These slides focused on his tenure as CEO of a pharmaceutical company, and in particular on the details of a clinical trial fraud committed by an employee of that company. The narrative ended with the following message: “Puma’s Board does not believe that someone who was involved in clinical trial fraud that was uncovered by the FDA should be on the Board of Directors of a public company; particularly a company that is in the process of seeking FDA approval.”

Puma ultimately won 80% of the shareholder vote on the dissident’s proposal. However, this victory may have lost its lustre when the dissident filed a lawsuit alleging that Puma has defamed him, and caused lasting damage to his reputation, with its public accusation that he had been “involved in clinical trial fraud.” According to the dissident, this was a false characterization of his role in the fraud, which has been concealed from him by the guilty actor. The jury agreed with him not only on this point, but also that Puma had acted maliciously and with the sole intention of defeating the dissident’s efforts in the proxy fight.

For Canadian defamation disputes, it is unlikely that damages would amount to anything close to the award in this case, given the relative uncommonness of civil juries and punitive damages. Nevertheless, there are lessons to be taken away from this harsh reproach of Puma’s conduct. Adversaries in proxy contests need to be careful about disparaging remarks about the other side, regardless of where they are made—whether in a presentation, in communications with other shareholders, in proxy circulars, or elsewhere. While the issuer in this case may have defeated the dissident campaign for board seats, it paid a steep price for its allegations against him.

The authors would like to thank Eric Vice, articling student, for his assistance in preparing this legal update.

Addressing Flawed Corporate Culture

By Simone Nash (Toronto) on April 8, 2019 Posted in Corporate Governance

A glimpse at recent news headlines is telling of a mass social awakening underway. From the #MeToo movement to public reprimand against organizations’ unrealistic sales targets, it is clear that it is becoming increasingly important for companies to foster a positive “corporate culture”. These scandals, once in the public eye, can have long-lasting damaging effects on businesses’ profitability, brand, and marketability. Indeed, as noted in this previous post, millennials’ investment decisions are heavily influenced by a company’s brand.

But when these scandals do arise, what recourse is available? An article by Jennifer G. Hill, a Professor of Corporate Law at the University of Sydney Law School, identified the following forms of liability as means of addressing flawed corporate culture:

Criminal Liability of Corporations: Hill noted that a coherent theory of corporate criminal liability with respect to misconduct involving flawed corporate cultures is elusive. The famous House of Lords decision, Tesco Supermarkets Ltd v Nattrass, [1972] AC 153 (which was later criticized as being overly-stringent) held that the requisite mental and conduct elements are only attributable to the entity if they can be traced to the top of the corporate hierarchy. In Canada, the Supreme Court similarly held that in order to trigger corporate criminal liability, the actor-employee who physically committed the offence must be the “directing mind” of the corporation. Accordingly, actions undertaken by those without decision-making authority, but that nonetheless impact corporate culture, may go unpunished.
Criminal Liability of Directors and Officers. Hill explained that individuals who intentionally commit criminal acts in the corporate setting can, of course, be prosecuted for that conduct. However, while directors and senior officers may be responsible for creating a corporation’s flawed corporate culture, their action (or inaction) will usually fall outside of established principles of criminal liability. In this respect, it is an onerous undertaking to prove the requisite mens rea and to apply these principles to a director or officer’s omissions.
Civil Liability for Breach of Directors’ Duties. A third possibility is civil liability for breach of duties to oversee, recognize, and address ethical risks that arise from a flawed corporate culture and result in corporate wrongdoing. The business judgment rule, however, offers capacious protection in Canada. Conversely, Australian courts have taken the opposite approach, and are increasingly categorizing directors’ duties as “public obligations” that carry an important social function. Australian case law further provides that directors have an obligation to oversee and monitor the activities of the company, and that their failure to do so can amount to a breach of the required duty of care.

Despite the recent media-attention, Hill noted that many of these forms of liability are ill-suited to achieve director and officer accountability. As it stands, shareholders and consumers that wish to bring claims against corporations for liability arising from flawed corporate culture may be more likely to find redress in class action proceedings. For example, the secondary market liability provisions in Ontario’s Securities Act provide a statutory cause of action for misrepresentations in disclosure documents. In the meantime, social pressure from consumers and investors may have the strongest influence to address an entity’s flawed corporate culture.

The author would like to thank Elana Friedman, articling student, for her assistance in writing this legal update

Access to Corporate Records Amidst Controversy

By Hugo Margoc (Toronto) on April 1, 2019 Posted in Corporate Governance, Shareholder Activism

The rights of shareholders and directors to access corporate books and records is undisputed, but what about the rights of a former Chief Executive Officer, especially when the termination was contentious?

US Jurisprudence:

In the United States, a recent decision by the Delaware Court of Chancery dealt with this scenario. In that case, the CEO was involved in a highly publicized controversy believed to be injurious to the company’s image. An investigation was launched, and a special committee was formed, and the relationship quickly deteriorated. The board severed contractual ties with him, and sought his resignation despite him being the chief executive officer, founder, majority stockholder, chairman of the board, and spokesman of the company. The CEO resigned of his position, and stepped down as chairman of the board, but refused to resign as a director. He then made a request to access the corporate books and records, which was largely denied by the company, claiming that his request was motivated by improper purposes.

The issue was brought in front of the Court, specifically citing Delaware General Corporation law Section 220, which states that any shareholder may request corporate records through a written demand, stating a “proper purpose”, which is defined as being one which is reasonably related to a person’s interest as a shareholder. The Court in this case, found that although the former CEO had a personal interest related to his termination in inspecting the records, this did not defeat his stated purpose which was to investigate whether or not the board fulfilled its fiduciary duty to the company and the shareholders as part of its investigation and termination of him. Therefore, it ruled in favor of the former CEO, and found he is entitled to inspect the books and records including texts, emails, and the like on personal devices.

Canadian Jurisprudence:

Canadian law on the right of directors to access books and records is even broader. A director need not provide a reason for his or her inspection. If a company suspects that some improper purpose is involved, the burden lies with it to prove its objections. The presumption is that the director is exercising his or her right for a proper purpose unless there is “clear proof that the director intended to abuse the confidence to materially injure the corporation”. In Tyler v. Envacon Inc., the company suspected that the director intended to use the information in the records in support of ongoing litigation between the company and another company that she was a director of. In FlexITy Solutions Inc. v. Sotirakos, the company objected to disclosure on the basis that it was motivated by the director’s personal litigation against the company. In both cases, it was determined that a director of a corporation has an unconditional right to inspect books and records, and the director was entitled to access.

The right to access is granted by virtue of Section 20(1) of the CBCA that has analogous provisions in Canadian provincial corporate statutes, which allows, shareholders, creditors and directors with the right to inspect and take copies of records.

Implications on Corporate Governance:

As noted in a recent article, director’s nearly unfettered right to books and records poses significant concerns for corporate governance. Especially in light of the #metoo movement and the various racial scandals that have plagued several corporations, boards’ handling of director misconduct should be carried out with heightened diligence. Whether it is related to misconduct, or whether the corporation is dealing with an activist shareholder, the individual may use sensitive information to gain leverage and exert pressure over the board. The Delaware decision is particularly worrying, because the Court determined that if personal devices were used to communicate company business, that data will also become subject to the books and records disclosure requirements. This significantly broadens the scope of what could potentially be available for shareholders and directors, and escalates the dangers of having that information misused. Since the presumption lies in favor of the shareholder, corporations will certainly have a difficult hurdle to pass in showing “clear proof” arising out of even the best founded suspicions. Therefore, boards should put in place a framework that allows contentious matters involving shareholders to be dealt with promptly, while exercising enhanced vigilance in record keeping practices.

The author would like to thank Maha Mansour, articling student, for her assistance in writing this legal update.

Privacy Breaches: The Question of When, Not If

By Shreya Gupta (Toronto) on March 25, 2019 Posted in Uncategorized

In recent years, a spate of high-profile privacy breaches have made it increasingly clear to consumers and regulators that businesses must take stronger precautions in safeguarding user data and protecting privacy rights. These incidents have become so common that for many companies, the question of whether they will fall victim to cybercrimes has become a matter of when, not if.

The consequences of a privacy breach may be drastic. Companies such as Equifax, Yahoo, and Target – which have all suffered data breaches involving more than 100 million customer accounts – have borne significant reputational costs. Given the importance of the collection and use of consumer data to many business models in the digital economy, these reputational harms usually translate into a long-term loss of business. Significant privacy breaches also tend to attract consumer class action lawsuits, and may result in a substantial decline in a company’s share price.

Companies faced with a privacy breach also had to face the growing ire of regulators, who have begun to move away from self-regulatory approaches and towards more robust oversight models. For example, under both the EU General Data Protection Regulation (GDPR) and the Canadian Personal Information Protection and Electronic Documents Act (PIPEDA), companies faced with a privacy breach may now be required to report those incidents. Specifically, PIPEDA requires companies that have suffered a data breach resulting in a “real risk of significant harm” to report the incident to the Privacy Commissioner of Canada. Companies must additionally report such a breach to the affected individuals and to any third-party organizations or government institutions if doing so might mitigate the harm done to the affected individuals. Failure to notify is punishable by a fine of up to $100,000 per violation, and may also help ground a data breach class action.

In light of the myriad reputational, financial, and regulatory consequences that can flow from a privacy breach, companies must spend greater resources on safeguarding their customers’ data and on preparing response plans that help minimize the fallout of a breach. While the optimal approach will vary depending on the size and nature of the organization, there are a number of key strategies that companies should consider, including:

strengthening ongoing employee training and education;
acquiring cyber liability insurance;
appointing a Chief Privacy Officer; and
identifying external advisors that can help respond to a breach, such as public relations firms and specialist legal advisors.

Companies should view their investment into cyber security as an opportunity to distinguish themselves from the competition and not simply as a necessary cost of doing business. According to research conducted by PWC, consumers are increasingly losing faith in the ability of companies to handle their personal data responsibly.

The message is clear: consumers seek greater control over their data and want businesses to be more responsive and transparent. Businesses that convincingly address these concerns and empower their users will be rewarded with greater customer loyalty are better positioned to retain their customers in the event they suffer a breach.

The author would like to thank Felix Moser-Boehm, articling student, for his assistance in writing this legal update.

Lesson Learned: An Examination of Trends in Shareholder Proposals

By Peter Valente (Toronto) on March 15, 2019 Posted in Proxy Access, Proxy Battles, Shareholder Activism

Shareholder proposals are often viewed as an essential tool for maintaining corporate accountability, but what role do they play in shaping corporate governance? ISS Analytics recently published a study (the Study) that reviewed the impact of shareholder proposals on corporate governance practices among U.S. companies since 2000. The Study offers helpful insights into shifting trends in corporate governance and investor attitudes, and provides important lessons for Canadian issuers.

A brief history of shareholder proposals in the U.S.

According to the Study, after a significant surge in the number of governance proposals in the early 2000s, the number of proposals in the U.S. dealing with environmental and social (E&S) issues has, over the last two years, overtaken the number of governance proposals. This is likely as a result, at least in part, of successful adoption of such governance proposals by issuers over time. A similar trend is developing in Canada, where environmental proposals and human rights proposals were, according to Kingsdale Advisors’ 2018 Canadian Proxy Season Review, the second and third highest categories of proposals in 2018 (respectively), surpassed only by proposals relating to executive compensation.

Four types of shareholder proposals

According to the Study, there are four main categories of shareholder proposals. The first category consists of proposals with high voter support that are easily adoptable by the target company. Examples include: majority voting standard for election of directors, proxy access, and the removal of poison pills. Such proposals usually diminish in number once broadly adopted in the market. For example, in 2006 there were approximately 80 shareholder proposals on ballots relating to adoption of majority voting standard, with just 10% S&P 500 companies having such practice in place. In 2018, 91% of S&P 500 companies had adopted the practice, with virtually no majority voting standard proposals on the horizon.

The second category of proposals relate to governance practices with medium support but which may be difficult to implement. As a result, these types of proposals are often not adopted quickly. While such proposal campaigns recur year-over-year, there is usually only incremental adoption over time. For example, in 2006 there were approximately 40 proposals filed seeking an independent chair. Approximately 10% of S&P 500 companies had an independent chair in place at the time. By 2018, the number of proposals had decreased to approximately 35, but about 28% of S&P 500 companies had an independent chair in place. Despite this incremental increase, 91% of S&P 500 companies had independent board leadership in 2018, either through adoption of an independent chair or through an independent lead director (up from 68% in 2008). Many of today’s governance proposals in the U.S. appear to fall in this category.

The third category consists of proposals that have high shareholder support but are ultimately mandated market-wide, through laws, regulation or accounting standards, effectively dispensing with the need for a shareholder proposal. Finally, the fourth category consists of proposals with short life spans that fail to garner significant support from shareholders. Nonetheless, such proposals may be later revived and find more support in the future. Proxy access proposals, for example, were largely unsuccessful in the early 2000s, but are enjoying significantly more support recently in the U.S.

More governance proposals going to the ballots

The Study further observed that more governance proposals are appearing on ballots, rather than being withdrawn as a result of successful negotiation with boards of directors. The number of withdrawn proposals in the U.S. has dropped significantly recently (to 8% in 2017 and 11% in 2018, compared to a historical average of 25% between 1994 and 2016). This is likely because such proposals are less likely to receive majority support from voters, and boards are less motivated to settle as a result. Interestingly, the opposite trend is observed for E&S proposals, where a record 48% of proposals were withdrawn by proponents in 2018.

A relatively similar trend is observed in Canada. By October 2018, 11 of the 17 submitted proposals relating to executive compensation were voted on (slightly down from the 14 of the 15 that made it to a vote in 2017). In contrast, of the 18 E&S proposals submitted in 2018 in Canada, half were withdrawn.

Shifting trends

While U.S. governance proposals over the last two decades have spanned a broad variety of governance practices, more recent governance proposals appear to be more narrow in focus, targeting practices that have not yet achieved market-wide consensus. The balance of governance proposals have either been widely adopted or discarded altogether. The increase in E&S proposals (and their mounting adoption) also demonstrates an evolution in investor attitudes, which are now increasingly advocating for environmental and social accountability.

Canadian issuers stand to benefit from taking heed of corporate governance trends demonstrated by the evolution of shareholder proposals in the U.S. Such trends may foreshadow the types of proposals, and shifting investor priorities, that could gain traction in Canada (as was the case with proxy access proposals). Observing such trends can assist Canadian issuers with better anticipating, and preparing for, incoming proposals in the future.

The author would like to thank Ahmed Labib, articling student, for his assistance in writing this legal update.

The Importance of Corporate Governance in Cannabis Companies

By Robert Corbeil (Toronto) on March 12, 2019 Posted in Corporate Governance

Every year The Globe and Mail’s Report on Business ranks governance of Canada’s corporate boards in the “Board Games.” In the recently published 2018 edition, the boards of directors of 242 companies and trusts in the S&P/TSX index were assessed. The companies are awarded points for various categories, namely, board composition, shareholding and compensation, shareholder rights, and disclosure. Companies with more stringent governance policies in place are awarded higher points. For example, a company with two-thirds independent directors will be awarded more points for that category than a company that has the majority of its directors being related directors. Notably, three of the companies in the bottom 10 of the Board Games are cannabis companies.

Why it’s important?

Oftentimes, investors are more tolerant of less mature companies (such as cannabis companies) lacking good corporate governance. These investors may prefer management spending resources on more pressing issues such as complying with federal and provincial regulations on marketing, selling and packaging. This forgiveness in the market combined with favourable regulatory outlook has led many cannabis companies to enjoy good performance despite poor governance practices.

The effects of strong corporate governance are not always clear and can seem more important for companies when times are bad rather than when times are good. However, over the long term, an independent board, strong controls, transparency and shareholder rights generally increase market value.

Maintaining a higher share price is important for cannabis companies that wish to expand through equity financing. Many cannabis companies in Canada have gone public by way of reverse takeovers (RTOs) rather than by traditional initial public offerings (IPOs). Contrary to IPOs, RTOs do not necessarily involve a financing component, and as such, when a secondary offering is eventually performed by the cannabis company, a higher share price will result in increased financing. Whether the cannabis company has gone public through an IPO or an RTO, having a higher share price improves prospects in a secondary offering.

A corporation may also want a higher share price to prevent a hostile takeover. We expect to see continued hostile activity in the cannabis sector as the industry matures and consolidates.

How to improve

There are some simple steps cannabis companies can undertake to improve their corporate governance practices. Shifting the board mix away from the founders to more independent directors, disclosing processes for the board stock ownership, or implementing board self-evaluation procedures are some steps that can create more stringent governance practices that will be of value to investors.

The author would like to thank William Chalmers, articling student, for his assistance in writing this legal update.

Could a national securities regulator hinder shareholder activism in Canada?

By Joseph Palmieri (Toronto) on February 20, 2019 Posted in Uncategorized

Canada is the only G20 country without a national securities regulator. Despite coordination among the provinces and territories, the current regime is often thought to encourage shareholder activism – whether by permitting forum shopping for more favourable regulations or given the reality that decentralized efforts mean scarcer resources to combat unwelcome tactics. However, after decades of discussion and debate, the Supreme Court of Canada released a decision late last year which could lead to the adoption of a single regulator, dubbed the Capital Markets Regulatory Authority (CMRA).

While the Supreme Court judgement paves the way for a pan-Canadian regulator, political and practical difficulties (including Alberta and Quebec’s continued opposition to the unified regime) suggest that it will likely be some time before expectations materialize. Nevertheless, we move one step closer to the implementation of a national regulator and relatedly, a new forum for activist investors:

A simplified system. Having one body oversee Canada’s capital markets means cross-border securities legislation and streamlined filings. This new framework will allow boards and activists to act quickly and in a cost-effective manner while waging, defending and negotiating activist battles. One can also expect more consistent legal reasoning (in contrast with the Eco Oro decision in which provincial bodies proffered differing views on similar points of law).
A platform for meaningful disclosure. A centralized regulator creates the prospect of uniform national rules, and by extension, eliminates the incentive for forum shopping. While strides have been made to require purposeful disclosure, provincial and territorial regulators have generally adopted a conservative approach. For instance, in Ontario, the call for gender diversity on boards and in executive positions was met with “comply-or-explain” requirements, as opposed to quotas. Practically speaking, if a regulator was to implement such requirements, companies refusing to comply could simply relocate to another province or territory where quotas or targets do not exist. A pan-Canadian regulator closes such loopholes and allows for more robust disclosure requirements without the fear of losing company listings. In some cases, this may strengthen the basis upon which activists build their platforms, while in others, it may rid of the need for activist efforts where they serve as a stimulus for change or increased transparency.
Stronger regulatory enforcement. A unified regulator equates to an increase in resources that can be devoted to investigation and enforcement. One could imagine the potential impact which stricter and more consistent enforcement might have upon activist contests. For instance, activist short-selling campaigns are on a rapid rise in Canada. Securities regulators are often called upon to investigate companies or silence short sellers whose social media commentary can now move markets. A single regulator may be empowered with a newfound authority and better equipped to investigate and respond to such allegations.
Slower reactions to new developments. On the other side of the spectrum, competing provincial interests within the national scheme may mean delayed responses to changes on the ground. New regulations or amendments to legislation will require approval by a council of provincial ministers and the federal Minister of Finance. Any disagreements over proposed changes may thwart the regulator’s ability to react in a timely manner and deliver corresponding guidance. This delay may prolong periods of ambiguity and leave a wide range of options for activist activity in moments of uncertainty.
Loss of industry-specific expertise. One of the benefits provided by the current structure is the interaction with a regulator familiar with local industries. Given the geographical concentration of certain industries, provincial and territorial regulators often have industry-specific knowledge. For instance, the Alberta Securities Commission is known for having extensive knowledge of the oil and gas industry. With the consolidation of thirteen Canadian regulators, companies and activists may encounter a panel that lacks context or specialized knowledge required to govern certain proceedings or appreciate industry dynamics.
Substantive changes. Some groups have critiqued the proposed legislation for failing to adopt investor protections. Specifically, initiatives previously available at the provincial level may not be assumed by the new federal body. As an example, the CMRA’s current mandate does not include financial incentives for whistle-blowers or an investor advisory panel, both of which are provincial initiatives implemented by the Ontario Securities Commission. Although the CMRA’s mandate is far from finalized, the loss of such programming may heighten the appetite for activist action.

While the Court’s decision certainly serves as a marker of change, the future of securities regulation remains riddled with uncertainty for companies, investors and activists alike. In the interim, perhaps the US experience is telling: despite having one of the strongest and most well-resourced national regulators, the US still has one of the most active markets for shareholder activism in the world. As Canada moves in lockstep with its international peers, chances are, the Canadian experience will prove similar.