How Well Do You Know Your OM? Sound Advice for Directors & Signing Officers of an Alberta Issuer
By: Lorie Wheeler
As a director and signing officer of an issuer preparing and filing an offering memorandum (OM), you must take care to limit the risks associated with misrepresentations and deficient disclosure. Failure to take proper care may expose you to civil liability, substantial expense, and reputational damage. This article provides an overview of the civil liability and regulatory action most likely to affect you as a director and signing officer of an Alberta issuer, and the policies and procedures that may be implemented to reduce the likelihood of misrepresentations or deficient disclosure.
Consequences of Misrepresentations
If an OM contains a misrepresentation at the time when a security offered under the OM is purchased, the purchaser will have a right of action for damages against you as a director and signing officer of the issuer. This is regardless of whether the purchaser actually relied on the misrepresentation when making the purchase.
A misrepresentation includes an untrue statement of a material fact; an omission to state a material fact that is required to be stated, and an omission to state a material fact that is necessary in order for a statement not to be misleading. In addition, any misrepresentation in a record incorporated by reference in an OM will be deemed to be contained in the OM.
You do have a number of defences available to you against an action for misrepresentation. Specifically, you will not be liable if you can prove that (i) on becoming aware of the misrepresentation, you withdrew consent to the OM and gave reasonable notice to the issuer of the withdrawal and the reason for it, (ii) with respect to any part of the OM made on authority of an expert, you did not have reasonable grounds to believe that there had been a misrepresentation, or you did not fairly represent the report, opinion or statement of the expert, and (iii) with respect to the non-expert parts of the OM, you conducted sufficient investigation and did not believe that there had been a misrepresentation.
Rather than relying on defences after the fact, the best way to avoid liability is to take proper steps to ensure that the OM does not contain any misrepresentation at the time of purchase and that procedures are in place to update the OM disclosure as necessary.
Common Deficiencies That May Result in Misrepresentations
The Multilateral Canadian Securities Administrators Staff Notice 45-309 Guidance for Preparing and Filing an Offering Memorandum dated April 26, 2012 (the ‘OM Guidance’) sets out common deficiencies in OMs that may result in misrepresentations, including
- Failing to update the OM when distributions are ongoing: You must ensure that the OM does not contain a misrepresentation when you sign the OM certificate and when the OM is delivered to prospective purchasers. This is an ongoing obligation and the OM should be updated to reflect any material changes. Financial information must also be updated appropriately while distributions under the OM are ongoing.
- Failing to include sufficient information to make an informed investment decision: An OM must provide a prospective purchaser with sufficient information to make an informed investment decision. It may be necessary to provide disclosure regarding certain related entities, for example, with respect to use of offering proceeds.
- Inadequately disclosing the issuer’s business: The OM must provide sufficient information about the issuer’s business and development. Consider using tables where appropriate. It may be necessary to include information about resources required for product development, prospective competition, and business structure, such as an organizational chart.
- Failing to provide balanced disclosure: The OM must not present an unrealistic or excessively promotional picture to prospective purchasers. General Risk Factor disclosure stating that no assurances are given will not be sufficient to render the OM balanced and realistic.
- Inadequately disclosing available funds and use of available funds: The section of the OM regarding available funds is intended to provide information on currently available alternate forms of funding, not the possibility of future financing. Any working capital deficiencies, commissions or offering costs should also be disclosed. In respect of use of available funds disclosure, start-ups offering bonds may have to include in their disclosure the need to use some of the offering funds for interest payments considering that it may take three or more years to begin generating cash flow from the project.
- Inappropriately reallocating available funds: Disclosure that funds may be reallocated does not entitle the issuer to open-ended use of the funds without sound business reasons related to the stated business of the issuer.
- Omitting key terms of material agreements: In particular, compensation and cost of assets with respect to transactions with related parties must be disclosed and, in some cases, explained. Attaching an agreement to an OM or making it available upon request are not a substitute for providing a summary of key terms.
- Omitting compensation disclosure: Compensation paid to directors, officers or promoters, including indirect compensation paid through a related party and compensation that is paid to an individual’s professional corporation or holding company, must clearly and completely disclosed. Compensation includes any form of remuneration, such as cash, shares, and options.
- Inadequately disclosing management experience: Disclosure of management experience should not be overly promotional or too generic. Simply listing prior occupations or general descriptions such as “has over 15 years of real estate experience” are insufficient for a prospective purchaser to evaluate management’s background.
- Disseminating material forward-looking information not included in the OM: Issuers may not provide sales literature or other documents that use forward-looking information not included in the OM. Forward-looking information included in an OM must comply with sections 4A.2 and 4A.3 of National Instrument 51-102 Continuous Disclosure Obligations.
- Omitting required interim financial reports: It is important for issuers to establish processes to update interim financial statements when OMs are updated.
- Omitting key elements of financial statements: The OM Guidance notes that a number of issuers have not included all key elements of the financial statements or complied appropriately with Canadian GAAP.
- Failing to obtain required audits: OMs must include audited financial statements. First-year financial statements must be audited as well as financial statements for the most recently completed year.
- Omitting required audit reports or including non-compliant audit reports: The audit reports must comply with all the applicable requirements. Auditors’ reports should not contain a qualified opinion and must be prepared in the specified form.
- Inappropriately using a Notice to Reader: Some issuers have included a Notice to Reader stating “Readers are cautioned that these financial statements may not be appropriate for their purposes.” This type of statement is not permitted as financial statements included in the OM must comply with the OM requirements and are as a result appropriate for the purposes of the OM.
- Failing to prepare financial statements in accordance with appropriate accounting principals: Financial statements included in an OM must comply with National Instrument 52-107 Acceptable Accounting Principles and Auditing Standards, regardless of whether the issuer is a reporting issuer. The financial statements must be prepared in accordance with Canadian GAAP applicable to publicly accountable enterprises, which has transitioned to International Financial Reporting Standards (IFRS) for fiscal years beginning on or after January 1, 2011. Investment fund financial statements will transfer to IFRS for the financial years beginning on or after January 1, 2014.
Steps to Take to Avoid Misrepresentations
There are a number of steps that you can take to reduce the chances of misrepresentations or deficient disclosure while preparing an OM, including:
- Developing (and periodically reviewing) formal policies regarding OM disclosure to show due diligence;
- Developing procedures to ensure that you immediately become aware of any changes that may require updates to the OM and take appropriate measures to ensure that the OM is updated accordingly;
- Establishing a committee to review and approve OMs prior to distribution and creating related processes and policies, or establishing a formal chain of responsibility and communication;
- Documenting procedures used to reach disclosure decisions;
- Making use of expert reports and opinions where appropriate;
- Reviewing your current practices against the standards set out in the OM Guidance
Serious consequences may result from misrepresentations or deficiencies in an OM. However, with proper planning and advice, directors and signing officers involved in the OM process can reduce the risks associated with these offerings.