Securities Authorities Say Cannabis Producers’ Disclosure Falls Short

Securities regulatory authorities in Canada have found multiple shortfalls in the disclosure of reporting issuers who are licensed cannabis producers and emphasized the importance of proper valuation of cannabis plants and the disclosure of the risks of U.S. operations among requirements for regulatory compliance.

On October 10, 2018, the Canadian Securities Administrators (“CSA”) published Staff Notice 51-357 (the “Staff Notice”) summarizing a review conducted by securities regulatory authorities in Alberta, British Columbia, Ontario and Quebec of the disclosure provided by 70 reporting issuers involved in the cannabis industry.

The three categories of major issues that the Staff Notice identified were as follows:

  • Licensed cannabis producers often did not provide sufficient information in their financial statements or management discussion and analysis for investors to understand their financial performance.
  • Some licensed cannabis producers did not consistently comply with securities requirements for forward-looking information, guidance, providing balanced disclosure and certain other requirements.
  • 74% of issuers with cannabis operations in the U.S. did not sufficiently disclose risks related to their U.S. operations as required by CSA Staff Notice 51-352 (Revised) (the “U.S. Disclosure Expectations Notice”).

The regulatory authorities found significant shortfalls related to the proper valuation of the cannabis plants, which for biological assets such as cannabis, is their “fair value” under International Financial Reporting Standards. The Staff Notice noted that 100% of the licensed producers needed to improve their fair value and fair value-related disclosures. Such reporting issuers were not, but should be, providing the following disclosure:

  • A description of the valuation techniques and processes.
  • A description of the inputs used in the fair value measurement including quantitative information about significant unobservable inputs.
  • The level of the fair value hierarchy within which the fair value measurement is categorized.
  • The sensitivity of the fair value measurement to changes in certain inputs.
  • A discussion of any interrelationships between significant unobservable inputs and how they may affect fair value measurement.

In light of the illegality of cannabis at the federal level in the U.S., regulators emphasized their expectation that risks disclosed by issuers with U.S. operations would include:

  • A description of the nature of an issuer’s involvement in the U.S. marijuana industry.
  • Disclosure that marijuana is illegal under U.S. federal law and that enforcement of relevant laws is a significant risk.
  • Related risks including, among others, the risk that third party service providers could suspend or withdraw services and the risk that regulatory bodies could impose certain restrictions on the issuer’s ability to operate in the U.S.
  • A discussion of the issuer’s ability to access public and private capital, including which financing options are and are not available to support continuing operations.
  • A quantification of the issuer’s balance sheet and operating statement exposure to U.S. marijuana-related activities.
  • As further described in the U.S. Disclosure Expectations Notice, additional disclosures are expected depending on whether an issuer has direct, indirect or ancillary involvement with U.S. marijuana-related activities. For example, issuers with direct involvement are expected to provide a description of applicable regulatory frameworks, a discussion of internal procedures for monitoring compliance and a statement confirming compliance, amongst other things.

EKB’s Regulatory and Administrative team is experienced and knowledgeable in this area and can assist you further.