Canadian Securities Law : Canadian Securities Lawyer & Attorney : Stikeman Elliott Law Firm : Montreal, Ottawa, Calgary, Vancouver, Montreal, Toronto

Corporate Disclosure -
A Restatement May Be Considered a Material Change

In June of 2004, the management of CP Ships determined that its financial statements would have to be restated. While this determination was made in June, the amount of the required restatement was only known in August. Public disclosure by CP Ships of the fact occurred in August 2004, once the amount had been determined.

Reporting issuers are required to disclose material changes:

• immediately through a news release; and

• within ten days of the date upon which the change occurs through a material change report.

In a news release dated July 7, 2005, the OSC stated that the determination by CP Ships that its financial statements would have to be restated constituted a material change that should have been disclosed, even though the quantum of the restatement had not yet been established. This is consistent with recently revised OSC Staff Notice 51-711 - Refilings and Corrections of Errors, which contemplates that "material" errors may or may not constitute material changes, and says that even in the latter case OSC staff is of the view that "investors should be informed immediately by way of a news release." This notice also now states that the determination that a material error occurred is discloseable, and that disclosure should not be delayed until the next required filing or earnings press release, "even if the issuer requires more time to investigate and quantify all aspects of the error."

The CP Ships position and Notice 51-711 both seem to be potentially at odds with the OSC staff position, as approved by the Commission, reflected in the recent Agnico-Eagle settlement. In Agnico-Eagle, rock fall events that occurred at a mine in early February 2003 were found to have become discloseable only in mid-March, after they were properly understood and management had determined that an unavoidable gold production shortfall would result. According to Notice 51-711, in contrast, time to fully analyze and understand the problem may not be contemplated.

Insider Trading

The investigation conducted by OSC staff also revealed that four insiders of CP Ships may have traded in securities of the company at a time when insiders knew that the financial results for the second quarter of 2004 were expected to be materially below analysts' publicly disclosed estimates. The OSC concluded that the expectation that financial results would be below estimates was a material fact. Trading with knowledge of a material fact would generally constitute insider trading. Although the trades were authorized by a member of senior management or the chairman of the company and the insiders had articulated their intention to sell the shares well in advance of their knowledge of the financial results, or had unrelated reasons to sell the shares, the OSC stated in a news release that the trades "may not have been in the public interest and that such conduct could have formed the basis of proceedings" against the insiders.

This aspect of the OSC staff warning seems to conflict with both NP 51-201 - Disclosure Standards and Toronto Stock Exchange (TSX) requirements. NP 51-201 contemplates that both a "significant increase in near-term earnings prospects" and "unexpected changes in the financial results for any periods" may be material information, and TSX requirements require immediate disclosure of all material information. Thus it is unclear why OSC staff did not conclude that CP Ships should not have immediately disclosed this expected discrepancy with analysts' consensus earnings, as was the case with the error in the financial statements.

Application of "Credit for Cooperation" Principles

While OSC staff considered that the events summarized above could have formed the basis of proceedings against both CP Ships and its insiders, the OSC chose to apply the principles set forth in OSC Staff Notice 15-702 - Credit for Cooperation, and issued a warning letter to CP Ships. OSC Staff Notice 15-702 provides that the OSC may reduce the consequences of a breach of securities laws where the persons involved show cooperation during the course of an investigation and have self-policed, self-reported and self-corrected the matters under investigation. In this case, cooperation was demonstrated by:

• establishing a special committee to investigate the issues;

• meeting with the staff of the OSC;

• publicly disclosing that the OSC was conducting an investigation and that the trading by the insiders should not have taken place;

• providing all relevant documents;

• giving the OSC unlimited access to the special committee's advisors;

• the restitution to CP Ships by the insiders of the amount representing the loss avoided on their trades (Cdn$1.4 million); and

• reviewing and revising its insider trading and corporate disclosure policies.

Additionally, CP Ships agreed that the restitution paid to it by the four insiders would be re-directed to the MFDA Investor Protection Corporation, the new contingency fund for mutual fund dealers.

Conclusion

The CP Ships incident is a very public example of the OSC's Credit for Cooperation approach in action, and represents something of a road map for what the OSC staff considers cooperation to be. In addition, it demonstrates OSC staff's approach to financial statement and other disclosure errors and restatements, and how OSC staff views expected divergence from analysts' predictions. Unfortunately, in the latter case, the inconsistency of the warning represented by the OSC's press release with other OSC and TSX pronouncements creates some uncertainty, which is never helpful to issuers or their advisors in grappling with difficult disclosure issues.