10TH EDITION Governance Insights 2020 Lessons and Guidance for a New Decade The information in this publication should not be relied upon as legal advice. We encourage you to contact us directly with any specific questions.
© 2020 Davies Ward Phillips & Vineberg LLP. All rights reserved. 10TH EDITION Governance Insights 2020
Lessons and Guidance for a New Decade
Davies Governance Insights 2020 is a comprehensive report analyzing the trends that have shaped the corporate governance landscape and those that are expected to define the next decade. Based on extensive research data, the report provides an essential overview of the diverse issues facing Canadian public companies today and practical guidance to help boards stay ahead of these challenges and position their organizations for long-term success.
For more information on any of the issues raised in this report or to explore how we can bring value to your board and governance teams, contact one of our experts listed under Key Contacts at the end of the report.
i Contents
Executive Summary Chapter 03 01 Navigating Financial Distress: Key Considerations for Directors Chapter 01 33 Special Committees: Governance Safeguards for Conflict of Interest Chapter 04 Transactions and Shareholder Activism High-Stakes Situations Abates, but Not for Long: 05 Significant Activity and Developments in 2020 49 Chapter 02 Risky Business: The Board’s Role in Enterprise Chapter 05 Risk Management Let’s Take This Online: 21 Virtual Shareholders’ Meetings in 2020 and Beyond 67
Chapter 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis 83
ii Chapter 07 Database and Beyond Gender: Methodology Diversity and 139 Inclusiveness Now and Going Forward Notes 97 140
Chapter 08 Contributors ESG and Climate Change in the Shadow of 150 COVID-19: “E,” “S” & G Are Here to Stay Key Contacts 111 151
Chapter 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush” 125
iii Executive Summary
It is fitting that the 10th anniversary edition of our Davies Governance Insights report coincides with the start of a new decade, a milestone that typically invites reflection on where we’ve been and what the coming years may hold. Before the end of last year, however, no one could have predicted that a “black swan” event in the form of a virus would bring the world to its knees in a matter of weeks. By March 2020, COVID-19 was declared a global pandemic, shuttering economies, shaking stock exchanges and upending businesses in nearly every industry and geographic corner of the world. In corporate boardrooms, directors found themselves scrambling to respond to a crisis for which there is no playbook. COVID-19 added an extra layer of challenges for directors to consider, from operational and supply chain disruptions to sharp declines in demand and revenue, to employee concerns and liquidity constraints. Layered on these demands were a heightened degree of scrutiny on leadership and risk management and the need to carefully balance short-term priorities with long-term goals.
1 Davies | dwpv.com Despite the unprecedented nature and scope of primacy model toward a broader stakeholder-driven COVID-19, the crisis should not be viewed as an isolated model of corporate governance that calls on issuers to event. For decades, systemic shocks have been on consider the interests of a wider range of stakeholders, the rise, whether in the form of global financial crises, including employees, customers, suppliers, communities digital revolutions, political uprisings, natural disasters and the environment. The practical result is that or pandemics. At the same time, in the 10 years that today’s directors must proactively manage the evolving we have been publishing Davies Governance Insights, and often competing needs of a diverse group of massive shifts in the technological, environmental, socio- constituencies in increasingly complex situations. economic and geopolitical environments have reshaped the expectations and operating context of businesses. If there’s one silver lining in this challenging time, it’s Over the past decade, we have also witnessed a that upheaval can lead to new understanding and meteoric rise in the concentrated accumulation of opportunities. This multidimensional crisis has exposed wealth by asset managers (including Vanguard Group, cracks in business policies and practices that might BlackRock, Inc. and State Street Global Advisors) not otherwise have come to light, thereby opening and giant institutional investors (including a number the door for much-needed change. When the dust of Canadian pension plan funds), which are wielding settles, boards and management teams will have the increased influence over a wide range of environmental, opportunity to tap into the learnings from their COVID-19 social and governance (ESG) matters. During this period, responses in order to reset strategies and build more climate change has risen to the forefront of corporate resilient governance structures that can prevail through governance trends, culminating in the January 2020 future shocks. This will necessitate looking beyond letter from BlackRock CEO Larry Fink announcing the business space to set in place good governance initiatives to “put sustainability at the center of practices that will sustain the business for the longer [BlackRock’s] investment approach.” And more recently, term. Only by considering and implementing these widespread recognition of institutionalized racism and practices and strategies will companies be sufficiently calls for change in the wake of George Floyd’s death prepared to respond and recover when – not if – the next have brought the discussion of racial diversity to the disruption occurs. boardroom. In this context, change and disruption should be viewed as the expectation, not the exception. With these overarching themes in mind, the issues discussed in this report can be grouped into three Moreover, when combined with the enormous human distinct, yet interwoven, principles that should guide an and economic toll caused by COVID-19, these changes issuer’s approach to governance over the next decade. have brought new significance to the role of the “S” in ESG matters, and have highlighted the importance of fully integrating ESG factors into a company’s governance, strategy and operations. The crisis has also accelerated the push to move beyond a shareholder-
Governance Insights 2020 2 Executive Summary (Cont'd)
1. RESPOND QUICKLY TO IMMEDIATE – The economic disruption caused by COVID-19 has CHALLENGES resulted in many otherwise healthy companies facing financial distress and possible insolvency. We provide When the unexpected strikes, boards must act swiftly an overview of the duties, obligations and potential and decisively to address urgent concerns, without liabilities of directors of distressed companies and the losing sight of long-term objectives. The following tools available to preserve their value in chapters discuss the key issues for consideration and Chapter 3, Navigating Financial Distress: Key the legal and regulatory frameworks that govern their Considerations for Directors. application.
– In high-stake situations, special committees can be 2. ADOPT A PROACTIVE APPROACH TO valuable tools in helping boards fulfill their legal duties GOVERNANCE and mitigate risks associated with conflicts of interest in corporate decisions. We outline tips on when boards Staying ahead of trends and taking a strategic approach should consider striking special committees and to an issuer’s governance, instead of merely reacting provide practical insights on how to developments and compliance requirements, can to effectively carry out their mandates in make the difference between a company leading or Chapter 1, Special Committees: Governance lagging in an industry in the decade ahead. The following Safeguards for Conflict of Interest Transactions chapters explore issues that we expect to remain in the and High-Stakes Situations. spotlight and be subjected to heightened scrutiny in the coming years. – Crisis situations such as COVID-19 test a company’s enterprise risk management (ERM) frameworks – Shareholder activism has become a fixture in Canadian and practices. We review boards’ responsibility for and global capital markets. While COVID-19 caused a overseeing ERM and discuss practical measures that temporary decline in activist demands, we expect the boards can use to strengthen their risk-management slowdown to be fleeting. We outline the year’s most oversight functions and weather a crisis in notable trends and provide practical guidance for both Chapter 2, Risky Business: The Board’s Role in issuers and shareholders in Chapter 4, Shareholder Enterprise Risk Management. Activism Abates, but Not for Long: Significant Activity and Developments in 2020.
3 Davies | dwpv.com When the dust settles, boards and management teams will have the opportunity to tap into the learnings from their COVID-19 responses in order to reset strategies and build more resilient governance structures that can prevail through future shocks.
– Virtual shareholders’ meetings, which were almost – Significant events in 2020 have expanded the non-existent in Canada prior to 2019, have become the diversity discussion beyond gender to include race new normal in the COVID-19 era. We examine how the and ethnicity. We discuss the evolving expectations pandemic has changed the landscape of shareholders’ being placed on Canadian organizations and provide meetings and discuss key considerations for issuers practical steps for boards and executive teams to contemplating a move to virtual meetings now and in keep pace with the rapidly evolving landscape the future in Chapter 5, Let’s Take This Online: Virtual in Chapter 7, Beyond Gender: Diversity and Shareholders’ Meetings in 2020 and Beyond. Inclusiveness Now and Going Forward.
– Executive pay has long been a contentious issue, – The short-term focus on economic survival in the wake and COVID-19 has accelerated pre-existing trends of COVID-19 has not quieted demands relating to ESG and introduced new challenges. We explore how matters and calls for sustainable business practices. public issuers have adjusted their compensation We discuss the major ESG trends and initiatives that structures in response to unexpected disruptions and have unfolded in parallel with and, in some cases, in provide guidance for boards considering recalibrating response to the pandemic in their compensation plans in Chapter 6, Executive Chapter 8, ESG and Climate Change in the Shadow Decisions: Compensation Trends In and Outside of of COVID-19: “E,” “S” & G Are Here to Stay. Times of Crisis. – Two years into legalization, governance challenges encountered by participants in Canada’s burgeoning 3. LOOK TO THE FUTURE cannabis industry can provide instructive guidance The urgency required by a crisis like COVID-19 can push on pitfalls to avoid. We analyze three key governance long-term objectives to the side. However, adopting practices that should be considered by startups and a forward-looking mindset will help businesses build those in other emerging growth industries in resilience against future disruptions and position them Chapter 9, Governance in a Nascent Industry: for long-term success. The following chapters consider Lessons from Canada’s “Green Rush.” issues that we predict will endure into the next decade.
Governance Insights 2020 4 CHAPTER 01
Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
5 Davies | dwpv.com Special committees have increasingly been used by corporate boards since they first emerged during the wave of M&A activity in the 1980s as a way to manage conflicts of interests. Special committees, which are typically subcommittees of an entity’s board comprised of independent directors and formed for a specific and time-limited purpose, serve as procedural safeguards and can be critical tools in ensuring that boards fulfill their legal duties and mitigate litigation and other risks. In this chapter, we explore when special committees can or should be used in the transactional context and in other high- stakes situations and how best to define their mandates. We also provide practical guidance on how, once established, they can most effectively carry out their mandates.
Governance Insights 2020 6 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
Legal Background: A Refresher The creation of a DIRECTORS’ DUTIES special committee The creation of a special committee can help directors discharge their legal can help directors duties. In exercising their authority as directors of the corporation, directors have two main legal duties: the fiduciary duty and the duty of care. discharge their legal duties. In – Fiduciary duty. This duty requires directors to act honestly and in good faith with a view to the best interests of the corporation. Directors must act in exercising their accordance with the trust placed in them by the corporation and its various authority as stakeholders without abusing their positions for undue personal gains. In considering the best interests of the corporation, directors should also directors of the consider the interests of relevant stakeholders, including different groups of corporation, securityholders, as well as employees and creditors.1 The best interests of the corporation need not be measured against short-term profits; boards can directors have two (and often should) take a long-term view. For more detail on the evolution main legal duties: of directors’ fiduciary duty toward more robust consideration of competing stakeholder interests, including recent amendments to the Canada Business the fiduciary Corporations Act (CBCA), see Davies Governance Insights 2019.2 duty and the – Duty of care. Directors are expected to exercise the care, diligence and duty of care. skill that a reasonably prudent person would exercise in comparable circumstances. They must strive to apprise themselves of the matter at hand and analyze and consider it as diligently as any other person would do in a similar situation. Documenting the matters reviewed and information considered, including advice received, is an effective way to evidence that the directors actually exercised their duty of care as required.
LEGAL PROTECTIONS FOR DIRECTORS
Canadian courts have recognized that directors, as opposed to judges, are best positioned to determine what is in the best interests of the corporation. They have accordingly shown deference to the business judgment of directors so long as their decisions lay within a range of reasonable alternatives. This “business judgment rule” protects directors who have made a reasonable decision from being second-guessed by the courts or being held liable for their decisions. Though the decisions need not be perfect or right, they must be made honestly, prudently, in good faith and on an informed basis.
7 Davies | dwpv.com Moreover, directors are not expected to be experts in every field. For this reason, Canadian law provides for a “reasonable diligence defence” against allegations of a The usual legal defences will not breach of directors’ duties. A director can avail herself or typically be afforded to directors in a himself of the defence if she or he made a decision based on reasonable and good faith reliance on the financial position of conflict. There are several statements or reports of the corporation, a report or situations in which a director may be advice of an officer or employee of the corporation, or a report of a professional such as a lawyer, accountant or personally interested in a decision appraiser, subject to certain caveats. to be made, which may in turn lead
These protections, however, will not typically be the director (even inadvertently) to afforded to directors in a position of conflict. There are breach her or his fiduciary duty. several situations in which a director may be personally interested in a decision to be made, which may in turn lead the director (even inadvertently) to breach her – Significant institutional investors of an issuer have or his fiduciary duty. In cases of an actual or potential repeatedly expressed concerns to the CEO and the conflict of interest, the director may be statutorily board chair about the lacklustre performance of the required to disclose her or his interest and/or to abstain issuer’s market price relative to what they believe to from discussions or voting on the matter. In addition, an be the intrinsic value; the last three board meetings issuer’s board mandate, governance guidelines and/or have included lengthy discussions with the CEO about code of business conduct and ethics, as well as specific strategic alternatives. conflict of interest policies, may impose additional procedures and protections to manage actual or – The chair of the audit committee of an issuer has perceived conflicts of interest. received a well-documented whistleblower complaint alleging bribery of foreign government officials at the In cases where disclosure and/or abstention is not company’s foreign operations. The whistleblower has enough to allow the director and the board as a whole also intimated that he will likely raise the complaint to fulfill their required duties, a special committee may directly with the RCMP. provide the necessary procedural safeguards.
– The board of an issuer has received an open letter When to Strike a Special from a group of investors alleging various governance failures, including a lack of independence between Committee: Five Scenarios certain board members and management, and demanding the resignation of all of the governance Consider the following scenarios: committee’s members, failing which the investors have – The chair of the board of an issuer has received an threatened to launch a proxy contest to replace them. unsolicited bid from a 15% shareholder for all of the outstanding shares of the company at a 35% premium over market value and has called a board meeting to consider the offer and formulate a response.
Governance Insights 2020 8 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
– In response to a request from an issuer’s controlling shareholder through its two nominees on the board, the board of directors of the issuer plans to consider Although insider bids are the whether and on what terms to implement a significant sole circumstance in which share buyback program. Canadian securities law mandates In each of these scenarios, a board would likely the establishment of a special consider whether to establish a special committee of independent directors to assist it in making sound committee of independent directors, decisions and fulfilling its stewardship responsibilities a previous notice issued by CSA to the corporation. The composition, mandate and compensation of the committee members will vary Staff and the reasons given recently in each scenario, with the board ultimately making by the OSC in The Catalyst Capital determinations with respect to each matter. Group Inc. (Re) decision involving Statutory Requirements for HBC provide critical guidance on Special Committees the roles of boards and special committees in a wider range Although all of the above five scenarios could conceivably call for a special committee, securities law of “material conflict of interest prescribes the formation of a committee in only one transactions.” of them. If an insider (e.g., 10%-plus shareholder) of an issuer makes a bid for the issuer, Multilateral Instrument 61-101 – Protection of Minority Security Holders in Special provide critical guidance on the roles of boards and Transactions (MI 61-101) mandates that the board of special committees in a wider range of “material conflict the target set up a special committee of independent of interest transactions” – namely, any transactions directors, in addition to other measures, to ensure that that give rise to substantive concerns regarding the the process and outcome have integrity and are fair to protection of minority securityholders.3 The CSA Staff minority shareholders. MI 61-101 also prescribes various notice and Catalyst decision advocate for the use of disclosure obligations that the target is required to meet special committees in all material conflict of interest in the context of an insider bid. transactions, not just those prescribed by MI 61-101. They also remind issuers that once a special committee Additionally, although insider bids are the sole process is undertaken for transactions that involve circumstance in which Canadian securities law significant conflicts of interest, it will be subject to the mandates the establishment of a special committee of same procedural and disclosure standards that would independent directors, a previous notice issued by Staff apply if a special committee were legally required. More of the Canadian Securities Administrators (CSA) and details about the CSA’s guidance and the key takeaways the reasons given recently by the Ontario Securities from the Catalyst decision are contained in our bulletins Commission (OSC) in The Catalyst Capital Group Inc. “OSC Articulates Expectations of Special Committees in (Re) decision involving Hudson’s Bay Company (HBC) Conflict of Interest Transactions: The HBC Privatization”4
9 Davies | dwpv.com and “OSC Provides Guidance on Special Committees and Disclosure in Conflict of Interest Transactions: The HBC Privatization Part II.”5
Whether or not required by law, striking a special committee is more widely considered a best practice that can provide a significant degree of protection to a board and help mitigate concerns about actual or perceived conflicts of interest when they exist. And increasingly, as discussed below, such committees are being used both in the transactional context and in dealing with major legal proceedings, investigations and other high-stakes situations that issuers encounter. Special Committees as a Governance Best Practice
Beyond potential significant transactions, there are many other instances in which boards will consider striking a special committee as a governance best practice. These include significant “bet-the-house” litigation, sensitive internal investigations and shareholder activism matters. While some boards also set up special committees to address unexpected crises, like the COVID-19 pandemic, this work can also be carried out by a standing or ad hoc committee of the board. In each case, a variety of factors will influence the optimal process to put in place.
REASONS TO STRIKE A SPECIAL Whether or not required by law, COMMITTEE striking a special committee is more In the above scenarios and others, an issuer and the widely considered a best practice that board itself may derive many benefits from setting up a special committee comprised of a subset of board can provide a significant degree of members. First and foremost, as a smaller group, a committee will often be better able to focus on, analyze protection to a board and help mitigate and consider the relevant issues, especially in cases concerns about actual or perceived where time is of the essence. conflicts of interest when they exist.
Governance Insights 2020 10 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
Second, an appropriately composed special committee may ensure that the board’s consideration of the issues is not influenced by any interest that a director may have in a particular transaction or any relationship a director may In the event of have with other parties involved in the matter. This reduces the risk of a conflict, a potentially whether actual or perceived. contentious Finally, establishing a special committee of directors who are not distracted transaction, courts in their deliberations by interests other than those of the corporation and its key stakeholders will assist the board in demonstrating that it has followed and securities the appropriate processes in discharging the legal duties and stewardship regulators will likely obligations placed on it. look favourably
TIPS FOR STRIKING A SPECIAL COMMITTEE IN THE upon a board that TRANSACTIONAL CONTEXT forms a special As discussed above, court cases and decisions by securities regulators provide committee early a patchwork of important guidelines for companies to follow in striking a special committee. Drawing on these decisions and our expertise in advising boards in in the process these situations, we provide below best practices for boards to consider when leading up to a striking a special committee to oversee a significant transaction. These tips will help protect the integrity of a board’s decision-making process and, importantly, transaction, before may also protect the board in the event that a dispute lands before a judge or a the proposed panel of a securities commission. transaction is – Strike it early. In the event of a potentially contentious transaction, courts negotiated and and securities regulators will likely look favourably upon a board that forms a special committee early in the process leading up to a transaction, before the before important proposed transaction is negotiated and before important decisions are made decisions are (or rights are given up). made (or rights are > Although each case differs and the exact nature of the special committee’s given up). involvement in negotiations will depend on the surrounding context, evidence of a special committee playing an active role in negotiations from the outset, either directly or through advisers, is important.
> Early involvement of the special committee provides the greatest protection to a board. If preliminary negotiations are carried out by interested parties such as a conflicted CEO or conflicted directors before a special committee assumes control, there should be evidence that these negotiations were non-binding and subject to robust review; in those cases, the board should ensure that the special committee is empowered
11 Davies | dwpv.com to conduct an independent analysis and make recommendations with respect to any outcomes from such early negotiations. The board should establish and approve a mandate for the special > In the Catalyst case, The Catalyst Capital Group Inc. complained to the OSC of abusive or coercive committee that is sufficiently conduct and disclosure deficiencies in response broad to give the committee to a going-private transaction led by an insider of HBC. The OSC stressed the importance of a robust authority, allowing it special committee’s timely formation; in that case, to exercise judgment, make the special committee was not given authority over the transaction until a proposal had already been decisions and provide meaningful presented and decisions had already been made recommendations. to share certain information and waive a standstill restriction with certain members of the bidder group. In the plan of arrangement fairness hearing, the court also questioned the delay, noting that the > If a special committee’s mandate is too narrow or lack of a special committee invited the possibility of constrained, it is likely to face criticism for lacking a compromised transaction. the discretion and authority needed to provide the precise safeguards a committee is intended to > Boards should also be aware of the OSC’s decision create. in Magna International Inc. (Re)6 in which case Magna’s management led the negotiation of the > In Magna, the OSC criticized the process, noting transaction without involvement or oversight from that the mandate of the committee was too narrow. the special committee even though management In that case, the special committee was only was in a conflict of interest position. The special charged with reviewing and considering the one committee was only struck late in the process, proposal on the table, and the sole key decision effectively constraining the committee members left for the committee was whether it should with a “take it or leave it” decision. be submitted to shareholders for approval. The committee did not have the authority to consider – Give it broad authority. The board should establish whether the proposal was fair and reasonable or and approve a mandate for the special committee in the best interests of the corporation, or whether that is sufficiently broad to give the committee robust alternatives were more desirable. authority, allowing it to exercise judgment, make decisions and provide meaningful recommendations. Courts and regulators will not look favourably upon a committee mandate that restricts the committee to reviewing only the proposal on the table without considering other reasonable alternatives, including the status quo.
Governance Insights 2020 12 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
Spotlight: Defining the Special Committee’s Mandate
The mandate of the special committee is an important – Size and composition of the committee. The governance document. Setting out its purpose, scope, appropriate size of a special committee will be driven duties and powers, the mandate is the committee’s by various factors. Generally, the optimum is to have backbone. It is critical that the mandate is broad yet a sufficiently small group that can act quickly and sufficiently precise so that the committee is both focus on the matters under consideration, while empowered and accountable. A committee’s mandate ensuring the members have the requisite skills and should address the following items: experiences needed to bring proper consideration to the various issues. Typically, members should be both – Process for selecting a chair. In some cases, the independent and disinterested, as well as have the board selects the chair, whereas in other cases, the time and the necessary competencies. There may be committee itself makes that determination. If there circumstances when the committee is not composed is a concern that the independence of the process entirely of independent directors, but such decisions might be tainted by the board making the selection, must be carefully made with the benefit of legal then it may be better for the committee members to advice. Particularly in the context of a material conflict decide who should serve as chair. The chair should be of interest transaction, it would be rare for a special independent and have a strong understanding committee to include non-independent directors. of the business and the proposed transaction. The chair should also have the requisite “soft” skills – Committee’s authority and powers. The best practice needed to build consensus and diffuse conflicts, is for the special committee to review, supervise and, as well as be able and willing to stand firm against if required, negotiate the transaction and consider interested parties who may attempt to inappropriately alternatives to what is being proposed (including the influence the committee. status quo). In the context of an internal investigation, the special committee should have a broad mandate to conduct, receive and review the documents and records that the committee deems necessary. The mandate should expressly state that the committee has the authority to engage independent advisers without board approval, external interference or involvement of interested parties.
13 Davies | dwpv.com Generally, the optimum is to have a sufficiently small group that can act quickly and focus on the matters under consideration, while ensuring the members have the requisite skills and experiences needed to bring proper consideration to the various issues.
– Parameters for assessing independence. The committee should establish a process to assess the independence of committee members, advisers and consultants, and address circumstances that may affect their independence. MI 61-101 sets out several bright-line factors that disqualify a director from being considered independent in a transaction. For example, directors who are themselves interested parties to the transaction, as well as directors who are or have been employees of an interested party or its advisers (in the 12 months prior to a transaction) are disqualified from serving on the special committee. In other instances, MI 61-101 sets out principles on which to make judgments about the independence of potential committee members. Whether or not an issuer is required to comply with MI 61-101, the factors set out in the instrument are useful to consider in assessing the independence of potential committee members.
– Committee outputs. The special committee’s mandate should speak to the deliverables expected from the committee, including what decisions it can make versus what must be presented as recommendations to the board for its approval. Most commonly, a special committee is charged with making recommendations to the full board, with the full board in turn being the ultimate approval authority.
Governance Insights 2020 14 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
SPECIAL COMMITTEE TRENDS IN CANADA: OUR FINDINGS
Fee Components
Our research on special committee compensation is based on a sampling of fees paid by Canadian public companies, as publicly disclosed in their proxy circulars, to special committee members in connection with transactions during the period from 2016 to mid-2020 (2020 H1).7 Our research reveals that this compensation most typically includes three components: (1) a lump-sum retainer for the non-chair committee members (either on a monthly basis or fixed for the entire mandate); (2) an additional fee per meeting attended by the members (and, in some cases, an incremental fee that applies only after a certain number of meetings have been attended); and (3) a separate, and typically higher, lump-sum retainer for the committee chair. In several cases, issuers provide either a retainer fee or a per meeting fee (but not both), and may not provide any greater compensation to the committee chair than that provided to the other members.
TABLE 1-1: Canadian Public Company Special Committee Fees (2016–2020 H1)‡
Fee High Low Median‡ Average‡ Retainer fee $50,000 $0 $20,000 $25,426 Meeting fee $38,000 $0 $1,400 $3,069 Chair retainer fee $100,000 $0 $25,750 $32,833
‡ Note: For purposes of these calculations, fees payable in U.S. dollars were converted to Canadian dollars and fees payable on a “per month” basis were multiplied by 12 months to calculate an annual equivalent. In addition, in each instance, if no retainer, meeting and/or chair retainer fee was paid, the nil instances were removed from the data sample for purposes of calculating the median and average figures above.
Increasing Prevalence of Special Committees
The prevalence of special committees is partly FIGURE 1-1: Special Committees Disclosed driven by the relative robustness of M&A by Canadian Public Issuers (2016–2020 H1) activity, shareholder activism and other drivers of situations that typically promote the use of 30 special committees. Our research indicates that the incidence of special committees disclosed 25 23 by Canadian issuers in our study universe has 20 increased over the five-year period from 2016 to 17 the mid-point of 2020. For example, 17 special 15 15 14 As of committees have been disclosed in the first six June 2020 months of 2020 (2020 H1), holding between 1 10 9 and 39 meetings per committee. In all of 2019, 23 special committees were disclosed, holding 5 between 1 and 16 meetings per committee. 0 In contrast, in 2018, 2017 and 2016, our study 2016 2017 2018 2019 2020 universe disclosed a total of 14, 15 and 9 special committees, respectively.
15 Davies | dwpv.com Compensating Special Committees: Factors for Consideration Deciding what, if any, additional Deciding what, if any, additional compensation to grant to the committee chair and other directors serving on a special committee is not formulaic. A variety of compensation factors play into that decision, which should be made by the board at the time to grant to the of forming the committee and establishing its mandate. Consideration should be given to the following factors, among others: committee chair and other directors – the issuer’s broader compensation philosophy for director compensation; – the scope of the committee’s mandate; serving on a – the expected time commitments of the committee members; special committee – the number of members on the committee; is not an exact – the nature and quantum of fees paid to members of other standing and ad hoc committees of the board (whether past or current); and science. A variety – market practice and trends for special committee compensation. of factors play
In arriving at its decision, the board should anticipate that any remuneration paid into that decision, to special committee members will likely need to be publicly disclosed in the which should issuer’s subsequent proxy circular, given the requirement to disclose all direct or indirect compensation paid, payable, awarded, granted, given or otherwise be made by the provided to a director in any capacity, including committee fees, under Form board at the time 51-102F6 of National Instrument 51-102 – Continuous Disclosure Obligations. of forming the Discharging Its Mandate: Best Practices for committee and Special Committees establishing its mandate. Generally, the members of the special committee should be seen as having taken adequate steps toward discharging their duties to act on an informed basis if the committee acts without conflicts of interest, retains appropriate legal and financial advisers to assist in its investigations, takes sufficient time to address the matters before it, questions its advisers rather than passively receiving information, actively participates in the process and reports its conclusions to the full board.
Governance Insights 2020 16 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
The following are 10 recommended best practices to assist a special committee in best discharging its mandate and limiting its members’ liability: Courts in both Canada and the United States have been Establish and maintain independence. Members of particularly critical of decisions 1 the special committee and the committee’s legal and financial advisers should typically be kept independent that have been made by boards or from the corporation’s management and from any interested proponent in the transaction or situation. special committees without taking Doing so can be critical to enabling the committee to reasonable time for deliberation in formulate its recommendation to the board free of any perceived bias. circumstances in which there was no crisis or urgency to justify haste. – The special committee should have separate closed meetings. Directors other than the committee members, representatives of the corporation’s be delivered to the directors as far as possible in management and representatives of any proponent advance of any meeting and adequate time should be of a potential transaction or situation should not be taken during the meeting to facilitate their thorough permitted to attend meetings, except at the request of consideration. the committee and then solely to provide information requested by the committee. The special committee – Courts in both Canada and the United States have should not be given instructions or directions by any been particularly critical of decisions that have interested persons. been made by boards or special committees without taking reasonable time for deliberation in Obtain all relevant information. The special circumstances in which there was no crisis or urgency 2 committee must be able to demonstrate that it to justify haste. Committees can protect themselves has gathered all relevant information relating to its from criticism by ensuring directors have sufficient mandate. The committee should not rely exclusively on time to fulfill their duties. the corporation’s management to provide information as a matter of course. The committee, with the assistance A special committee should of its advisers, should form its own views about the Consider alternatives. not restrict itself to considering one particular information it requires in order to discharge its duties, 4 course of action, but instead review all reasonably should insist that such information be provided and available alternatives to determine which is in the best should probe the information received. interests of the corporation. The committee should consider steps that may be appropriate to pursue to Diligently review all information and documents. create or develop alternatives potentially more desirable 3 The special committee and its advisers should from the corporation’s perspective. conduct a thorough and diligent review of all information and documents relevant to its mandate. Members of the committee must be given a reasonable amount of time to do so. All documents and information should
17 Davies | dwpv.com Retain expert advisers. While there FAIRNESS OPINIONS: CONSIDERATIONS 5 is no legal requirement for a special FOR SPECIAL COMMITTEES committee to seek financial, legal or other advice, failing to do so can increase Neither MI 61-101 nor corporate law expressly requires a the risk that the committee will not be transaction to be accompanied by a fairness opinion from the adequately informed and that it will not corporation’s financial adviser that the transaction’s terms be able to properly fulfill its mandate. are fair, from a financial standpoint, to the shareholders. This These advisers should actively assist the is in contrast to formal valuations, which can be required for committee in formulating its views and certain insider bids, issuer bids, related party transactions and any recommendations to the board. The business combinations regulated by the instrument. Therefore, particular circumstances of each case boards and special committees must determine whether will also inform whether a committee may one or more fairness opinions are required and, if so, the be entitled to rely on the corporation’s appropriate terms and financial arrangements for the advisers’ external counsel and/or other advisers, engagement. Those terms can be critical to the outcome of a or will require separate, independent transaction, including in determining whether a transaction is legal and/or financial advisers to help it fair and reasonable to the shareholders or may be subject to discharge its duties. legitimate opposition.
In transactions involving material conflicts of interest, – Although not all directors may be regulators expect disclosure of situations in which a fairness qualified to independently analyze opinion was requested but the financial adviser was not able the findings and recommendations of or willing to provide it. the financial and legal advisers, the committee members should satisfy When an opinion is obtained, the public disclosure should themselves that the advisers’ review was provide shareholders with a meaningful understanding of thorough and complete. Courts will not the opinion and how it was considered by the board or the be inclined to give much weight to expert special committee. The disclosure should include details of the opinions believed to have been based on financial adviser’s compensation, independence, methodology inadequate preparation; accordingly, the and financial metrics used. Increasingly, in the transactional committee should require the advisers to context, in addition to a fairness opinion provided to the full document the factual and analytical basis board, a second fairness opinion prepared by an independent of their work and should review their financial adviser for the special committee may be appropriate. advisers’ reports critically. One of more long-form opinions, and more detailed disclosure by the issuer concerning the opinions, may also be prudent, Avoid overreliance on fairness depending on the surrounding context. 6 opinions. Special committees should remember that advisers are not Importantly, prior financial work products could amount to a a substitute for the committee’s own prior valuation in law and trigger disclosure obligations under considered judgment. The committee will MI 61-101. Accordingly, management and boards of public be called upon to exercise its judgment issuers should also be careful when preparing valuation-like with a view to broader interests than those analyses of the company or its securities in circumstances represented by the expert alone. in which they may not wish the details to become publicly disclosable in the future.
Governance Insights 2020 18 CHAPTER 01 Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations
Actively participate in the decision. Courts and 7 securities commissions may be critical of decisions made by special committees that have not actively Special committees established to participated, directly or through their advisers, in review material conflict of interest reviewing or structuring matters that they have been called upon to consider. This is especially in cases in transactions under MI 61-101 should also which the corporation’s management may be interested. be cognizant of the OSC’s “real-time”
Document the process. Minutes should be review of those transactions. 8 prepared and maintained, in real time, for all meetings of the special committee. The minutes should Maintain confidentiality. It is critical that the special be sufficiently detailed to indicate the manner in which committee’s deliberations remain confidential the committee fulfilled its mandate and to summarize the 10 throughout its process. Members of the committee should advice received. Committee members should be aware not disclose or discuss with outside parties any information of confidentiality and privilege considerations; certain about its deliberations or its likely recommendations. All discussions, such as those covered by litigation privilege, comments about the committee’s work should come from may need to be recorded in camera and/or in separate a designated spokesperson, whether those comments minutes. Special committees established to review are made to the corporation’s management, an interested material conflict of interest transactions under MI 61-101 party, shareholders or the media. should also be cognizant of the OSC’s “real-time” review of those transactions, which may result in a request for Ultimately, the duties of directors on a special committee copies of the meeting minutes. are similar to those that apply generally to directors. The committee’s actions may be subject to legal challenge if Present a report to the board. The special it can be established that its decision was not made in committee should summarize its deliberations and 9 the best interests of the corporation; was implemented conclusions in a report to the full board. The committee’s for an improper purpose, such as to benefit a particular legal and financial advisers should be available, if not stakeholder at the expense of the corporation; or was not present, at any meeting of the board at which the reasonable in the circumstances. committee’s report is to be considered in order to respond to any questions concerning the advisers’ With respect to their duty of care, directors on special recommendations or analyses. committees may have greater liability risk for a breach of duty, since they have more information about and are more – There should be no need for significant additional actively involved in the proposed matter than the other analysis of any potential course of action by the directors. Members of the committee will also have closer full board if the special committee, together with contact with the advisers retained to advise the committee its advisers, has created a record demonstrating a and will have a different time frame within which to consider thorough analysis. the information presented to them. It is thus prudent for the special committee to consider whether appropriate indemnities and insurance are in place to protect the directors from incurring personal loss as a result of their role on the committee.
19 Davies | dwpv.com Our Take: Carefully Assess the Need for a Special Committee
Given the increased scrutiny of board and committee However, striking a special committee will not always processes by courts and regulators, not to mention be the optimal approach. Although the nimbleness of investors and other stakeholders, we expect the use of a special committee may sometimes lead boards to special committees to continue to trend upward. Special favour its establishment – as we saw with many boards committees are increasingly becoming important and grappling to help their companies identify and respond to more prevalent procedural safeguards for boards in a the varied impacts of the COVID-19 pandemic – in other wide range of transactions, as well as in the context of cases major projects, transactions or situations should significant litigation, internal investigations, shareholder be brought before, and evaluated by, the full board. activism and other high-stakes situations. Consider, Boards should consult with external legal counsel to for example, the formation of a special committee by determine the best path forward in any particular case. the board of CannTrust Holdings Inc. to investigate and oversee the remediation of internal non-compliance with Lastly, the existence of a special committee will not its core licences, discussed in Chapter 9, Governance automatically protect the board against an otherwise in a Nascent Industry: Lessons from Canada’s “Green faulty or flawed process. The board must ensure that Rush.” While there is no one-size-fits-all blueprint, in an the committee has an effective mandate and discharges increasing number of cases, the formation of a special its duties appropriately. If executed correctly, a special committee at the earliest possible stage may be the most committee provides a strong safeguard of process, prudent approach; in some situations, such as those mitigating litigation risk or the risk of an adverse ruling involving actual or perceived conflicts of interest, it may before a securities regulator or a court. even be practically required.
Governance Insights 2020 20 CHAPTER 02
Risky Business: The Board’s Role in Enterprise Risk Management
21 Davies | dwpv.com The swift and varied responses to the COVID-19 pandemic are directly shaping how companies view and manage risk. One of the most significant and lasting corporate governance implications of COVID-19 will be its impacts on boards’ oversight role of issuers’ enterprise risk management (ERM) frameworks. ERM is the process of planning and controlling the activities of an organization with a view to protecting and enhancing stakeholder value by managing the uncertainties around the achievement of organizational objectives.8 As the COVID-19 dust settles, directors are likely to find themselves exposed to greater scrutiny and accountability for ERM from regulators and stakeholders. In this chapter, taking lessons learned from the pandemic crisis, we review boards’ responsibility for overseeing ERM and discuss practical measures that boards can adopt to strengthen and improve their risk management oversight.
Governance Insights 2020 22 CHAPTER 02 Risky Business: The Board’s Role in Enterprise Risk Management
A Board’s Responsibility in Overseeing Risk Management
The board’s responsibility for risk management derives largely from directors’ fiduciary duty, duty of care and duty to manage under corporate and securities laws, stock exchange requirements and governance best practices. To be clear, day-to-day business operations and risk management are management’s responsibility. Directors are responsible for obtaining reasonable assurance that senior management has identified the company’s principal risks and put in place appropriate risk management policies and procedures that are consistent with the organization’s risk appetite.
As discussed in our bulletin “Canadian Directors Should Heed Recent U.S. Caremark Litigation,”9 Canadian directors should be aware of the recent uptick in U.S. claims permitted by Delaware courts alleging a failure by directors to make a good faith effort to monitor corporate operations, including overseeing key risks – otherwise known as a Caremark claim. Although Canadian courts have yet to explicitly recognize a Caremark duty owed by Canadian directors, the principle has been considered in the context of a Canadian securities regulator’s public interest jurisdiction.10 It is easy to contextualize such a duty within the duties owed by directors under Canadian law particularly in circumstances in which directors knew or ought to have known of potential problems or concerns.
FIGURE 2-1: Model ERM Framework
Board Risk Oversight
Risk Appetite & Tolerance
Corporate Culture
Strategy Development and Business Objectives
Monitoring Risk and Identification Performance
Risk Mitigation Risk and Controls Assessment
23 Davies | dwpv.com Enterprise risk is increasingly an area that stakeholders expect boards to actively monitor as part of their ultimate oversight responsibilities. A recent global Risk oversight responsibilities are survey carried out by the Institute of Risk Management typically divided between the board (U.K.) found that 94% of companies believe COVID-19 strengthens the case for prioritizing ERM within an as a whole and board committees, organization.11 Vanguard Group – one of the world’s particularly when committees with largest investment management companies with over US$6.2 trillion in global assets under management the requisite expertise have been – recently signalled an expectation that portfolio established. companies dedicate an increasing amount of time to identifying and governing material risks, particularly as the risks facing organizations become more diverse knowledge in areas where risk plays a critical role, 12 and complex. Similarly, Institutional Shareholder including in evaluating and approving the company’s Services Inc. (ISS) and Glass, Lewis & Co. (Glass Lewis) strategic plan. On the other hand, using a dedicated recommend that shareholders withhold votes for risk committee may better enable a smaller group of individual directors or committee members with records directors to conduct a “deep dive” into the relevant 13 of poor or inadequate risk oversight. issues. Alternatively, many Canadian issuers have opted for a hybrid approach, assigning specific core risk ALLOCATING RISK OVERSIGHT management issues to standing committees having RESPONSIBILITY TO THE BOARD AND ITS expertise in the relevant areas (e.g., human capital COMMITTEES risks assigned to the human resources committee, compensation risks to the compensation committee and Risk oversight responsibilities are typically divided environmental and compliance risks to an environmental between the board as a whole and board committees, committee). Each committee then reports to the full particularly when committees with the requisite board on its risk management activities and the full expertise have been established. For instance, it is board, in turn, assumes ultimate responsibility for ERM common for the audit committee to oversee and report with the benefit of the more focused information and to the board on risks relating to an issuer’s accounting recommendations received from each committee. and auditing practices. Similarly, it is typical for a nominating committee to oversee CEO succession As Figure 2-2 demonstrates, the overwhelming majority planning and the related risks. of companies on the TSX Composite Index have elected not to establish a dedicated risk committee.14 Most There is often debate regarding where risk oversight Composite Index companies assign responsibility for generally should reside at the board level. Some certain specialized risks to committees with a particular advocate for a dedicated risk committee to discharge expertise, while keeping risk oversight the ultimate directors’ risk oversight function. One concern with responsibility of the full board. In our view, this approach delegating risk oversight to a subset of directors is is often the most prudent one. that it instills in the committee members an in-depth understanding of the company’s principal risks, while potentially leaving other directors without the requisite
Governance Insights 2020 24 CHAPTER 02 Risky Business: The Board’s Role in Enterprise Risk Management
However, good governance is never a “one-size-fits-all” solution and some companies may benefit from having a dedicated risk committee. Companies faced with complex and specialized risks – such as financial institutions and utility companies – can benefit from the focused attention of a risk committee. Boards have wide discretion to define the mandate of the risk committee. Thoughtful consideration should be given to the types of risks that fall within the scope of a risk committee charter. As a general principle, assigned risks should be focused and clearly defined, but not so focused as to constrain the committee’s role, especially as the issuer continues to evolve. Similarly, the board should determine the appropriate frequency of periodic reporting on risk management outcomes, clearly communicate expectations related to the risk committee’s activities and ensure the dissemination of material risk information to the larger board (i.e., the risk committee should not operate as a stand-alone, isolated committee).
FIGURE 2-2: Percentage of Composite Index Issuers with Dedicated Risk Committees (2016–2020 H1)
245 250 242 237 228 Issuers without a 14% 14% 15% 211 dedicated risk committee 14% 200 16% Issuers with a dedicated risk committee 150
86% 86% 86% 85% 100 84%
50
0 2016 2017 2018 2019 2020 H1
COMMITTING TO A CULTURE OF TRANSPARENCY AND ACCOUNTABILITY
Experience has shown that fostering an enterprise-wide culture that promotes appropriate risk awareness and behaviours should be a top priority for boards. As Figure 2-1 above shows, corporate culture provides the scaffolding for a company’s ERM program. A strong corporate culture at the top helps shape 10% management’s and employees’ attitudes toward risk and enables organizations to quickly perceive risk and adapt to change in1.7% a crisis. For example, recent enforcement action taken by the United Kingdom’s Serious Six or more Fraud8% Office (SFO) and the Department of Justice against Airbus highlights that a culture of compliance and 1.1% 0.6% risk awareness matters. In 2019, the SFO entered0.6% into its seventh deferred prosecution agreement (DPA) with Airbus for a 2.6%record-setting penalty of €3.6 billion.15 The DPA involved several counts of failure to prevent 6% 2.0% 0.6% bribery under the United Kingdom’s anti-corruption1.8% 1.6% legislation. Despite Airbus’s strong compliance policy on
1.3% 4%
5.2% 4.9% 4.9% 25 2%Davies | dwpv.com 3.9%
0% 2015 paper, a breakdown in corporate culture at the most senior level rendered it largely ineffective. An open and positive risk culture at the board level can encourage the organization as a whole to pay closer attention to risk mitigation and prevention. Practical Steps to Improve the Board’s Risk Oversight Function
Building a resilient ERM oversight framework within the corporate governance apparatus is not a precise science; rather, it is highly dependent on the circumstances and industry of each company, among other factors. With that said, boards can adopt measures to facilitate robust oversight of ERM so that directors satisfy their obligations under Canadian law and the expectations of key stakeholders (see Figure 2-3).
FIGURE 2-3: Practical Measures to Enhance Risk Management Structures
Define the Issuer’s Risk Appetite and Seek Out and Tolerance Know the Issuer’s Incorporate Top Risks External Advice
Steanline Keep Track Risk-Related of Risk Disclosure Risk Responsibilities Oversight Prepare and Maintain Accurate Actively Monitor and Complete Operations Records
Consider the Recognize that Board's Risk Certain Oprations Oversight Continually May Be Subject to Competency Heightened Risk Evaluate Oversight Controls
Governance Insights 2020 26 CHAPTER 02 Risky Business: The Board’s Role in Enterprise Risk Management
1. DEFINE THE ISSUER’S RISK APPETITE AND TOLERANCE Determining and understanding the Risk is an inherent part of any business strategy. level of risk that is acceptable or As a starting point, the board should be involved in defining the organization’s risk appetite and tolerance. (in some cases) necessary to achieve Determining and understanding the level of risk that is acceptable (or in some cases necessary) to an issuer’s established business achieve an issuer’s established business and strategic and strategic objectives are critical objectives are critical first steps. This is especially so in times of uncertainty when an understanding of risk first steps. appetite can help a board quickly adjust the strategy or change course. The board should ensure that the issuer’s risk appetite and its associated thresholds are 3. KEEP TRACK OF RISK RESPONSIBILITIES clearly articulated and widely understood within the Regardless of an organization’s size, industry or organization (and by its partners), and that they are complexity, every director and member of senior integrated into every business decision-making process management must understand one another’s roles in at each level. the overall risk oversight framework. As risk oversight becomes increasingly complex, a coordinated response 2. KNOW THE ISSUER’S TOP RISKS is imperative. Without clarity on ownership of specific responsibilities, redundancies and lapses can occur. To navigate the organization’s risks (and opportunities), Boards should be armed with a list of the individuals it is critical that every director be familiar with key responsible for each enterprise-wide risk and the extent enterprise-wide risks. Boards should work closely to which responsibilities may overlap. with management to understand the likelihood and impact of the top risks facing the issuer in the short and long terms. On this front, boards should stay 4. ACTIVELY MONITOR OPERATIONS current with the issuer’s ever-evolving risk profile. Board measures must extend beyond implementing As the COVID-19 pandemic has shown, some risks controls and deferring to management to execute. The may fall away while others rise to prominence. Keeping board’s evaluation and monitoring of those controls are an up-to-date understanding of top risk priorities can equally critical. Those measures require, among other increase the board’s ability to adapt in the face of things, that the board adhere to adopted controls and change and uncertainty. policies; meet regularly and allocate time on the board (or committee) agenda to risk-related issues; review, consider and challenge (if necessary) risk-reporting; and facilitate timely and regular communication with management. Investors and other corporate stakeholders increasingly expect boards to have more frequent oversight for risk management, and not merely delegate consideration of those matters to annual strategic reviews.
27 Davies | dwpv.com 5. RECOGNIZE THAT CERTAIN OPERATIONS MAY BE SUBJECT TO HEIGHTENED RISK Industries that Industries that are subject to substantial governmental regulation or have operations linked to human health, life or sustainability issues – such as food, are subject cannabis, pharmaceuticals, medical devices, mining and transportation – may to substantial be subject to greater risk that requires proportionately heightened and more active oversight. In those instances, assigning risk oversight to one or more governmental subcommittees of the board may be appropriate. regulation or have
In particular, a monoline organization should ensure that robust controls operations linked are implemented and its “mission critical” operations and risks are closely to human health, monitored, given the importance of a single product or limited number of products to its operations. Consider, for example, some of the important life or sustainability governance lessons learned from Canada’s “Green Rush,” including the recent issues – such as CannTrust Holdings Inc. saga, discussed in Chapter 9, Governance in a Nascent Industry: Lessons from Canada’s “Green Rush.” Creating a board committee food, cannabis, specifically tasked with overseeing such product(s) or core risks may be pharmaceuticals, advisable for some businesses. Ultimately, however, it will often be prudent for the full board to be actively involved in oversight of key risks or issues that are medical devices, central to the business. mining and transportation – may 6. CONTINUALLY EVALUATE OVERSIGHT CONTROLS be subject to greater The evolution of operations or market circumstances, as well as the broader context in which a company operates, naturally necessitate an adaptive risk that requires oversight function. A board should regularly evaluate its oversight practices and proportionately pressure-test key assumptions. COVID-19 has brought this need into sharper focus. Many issuers have had their established practices and procedures heightened and upended, revealing gaps or deficiencies in their internal controls and thus more active demanding rapid adaptation to implement new measures to reflect their new modes of operations. As of the date of this publication, COVID-19 is still testing oversight. every company’s business continuity plan (BCP). Once the crisis abates, boards should take the opportunity to conduct a post-mortem on its BCP’s relative success and continue to make business continuity planning a strategic imperative in advance of the next unforeseeable event.
Governance Insights 2020 28 CHAPTER 02 Risky Business: The Board’s Role in Enterprise Risk Management
7. CONSIDER THE BOARD’S RISK 9. STREAMLINE RISK-RELATED OVERSIGHT COMPETENCY DISCLOSURE
To provide input to senior executives regarding Boards should take the opportunity to review their risk critical risk issues on a timely basis, directors must disclosure practices to ensure that their disclosure understand the business and industry, as well as provides market participants with clear, concise how a changing environment may affect the issuer’s and insightful information that is entity-specific. As business model. The nominating committee should highlighted in several notices by the Canadian Securities regularly assess board composition to ensure the Administrators (CSA),16 including the “COVID-19: board has the requisite skill sets and independence Continuous Disclosure Obligations and Considerations to provide effective risk oversight. In some cases, for Issuers Presentation,”17 regulators (in addition to a director’s personal or business relationships can investors) are strongly encouraging issuers to avoid impair that director’s independence generally or his or lengthy, repetitive, vague or “boilerplate” disclosure her impartiality with respect to the specific issues or in their annual information forms, prospectuses, and risks at play. Independence is not a static concept and forward-looking information disclaimers. Instead, issuers should be assessed regularly with regard to the nature should disclose current and future risks facing the of the decision or information being placed before the company, how they relate to company strategy and board to ensure its responsibilities or decisions are not how they may have resulted in adjustments in company undermined by conflict. objectives.18 Similarly, strong risk oversight disclosure should explain both the board’s ERM framework and the steps that have been taken to overcome risk oversight 8. PREPARE AND MAINTAIN ACCURATE AND challenges. COMPLETE RECORDS
Board and committee minutes should be prepared in 10. BE A TRENDSETTER – SEEK OUT AND a timely fashion and be reasonably detailed in respect INCORPORATE EXTERNAL ADVICE of the board’s oversight function. All deliberative processes on risk, including the process undertaken, The ERM landscape is constantly evolving. Staying the documents considered, the advice received and the abreast of new trends, tools, techniques and best decisions made, should make their way into a board’s practices can add a competitive edge to the board’s or committee’s minutes. Although there is no standard ERM program. Boards are advised to avail themselves approach to preparing minutes, nor is there a fixed of the numerous resources available to improve board amount of detail for all issuers to include, it is important function. Industry experts can offer new insights and to maintain an accurate, complete and precise record encourage innovation. Boards can and should conduct that contains sufficient detail to identify the key factors emergency drills and exercises that emulate a crisis that the board (or the committee) considered. The event in the core areas most relevant to their businesses. process of producing a record of decision-making These exercises can expose weaknesses in a board’s and oversight imposes a discipline on directors that or management’s emergency preparedness or ERM arguably drives better preparation, engagement controls. and due consideration.
29 Davies | dwpv.com Spotlight: Responding to an Active Crisis
Crisis situations such as COVID-19 often call for heightened board oversight. The pandemic has forced many issuers to confront not only how to maintain adequate board oversight but also how to adapt existing oversight controls to manage operational uncertainties. Taken together, these concerns highlight that improving, strengthening and ultimately stress-testing ERM programs should be a primary concern for boards.
In times of emergency or crisis, ERM processes and procedures should be thoughtfully reconsidered in order to keep pace with a company’s changing risk profile. The traditional process of annually identifying, assessing and reassessing risks may be unsuited to an environment of unprecedented uncertainty and market volatility. Boards are encouraged to adopt an open-minded and flexible perspective with an eye to translating risk into strategic value. Adapting to the new norm will require that boards re-examine conventional assumptions about risk oversight and actively seek opportunities to capitalize on the dynamic landscape.
Adjustments such as scheduling more frequent meetings and/or the board chair more frequently liaising with management and committee chairs would be prudent in times of crisis to ensure the board is receiving timely, accurate and balanced information. At the same time, the board must be careful not to usurp management’s responsibility for day-to-day operations.
COVID-19 has thrust the issue of board preparedness to the forefront of corporate stakeholder concern. The pandemic reminds us that while a rare and unexpected event with significant consequences can happen, that event’s adverse impact can be mitigated through attentive board oversight.
Governance Insights 2020 30 CHAPTER 02 Risky Business: The Board’s Role in Enterprise Risk Management
Looking Ahead: Key Enterprise Risks Facing Boards As technological disruption is expected to increase, companies Risk exposure faced by a company will ultimately depend on a myriad of factors, including the should focus on their ability to make organization’s industry, strategic plan and competitive necessary and timely adjustments landscape. Below, we discuss five key risks that, in our view, warrant prioritization by boards in the years ahead. to embrace and respond to the Understanding the key risks facing a business and forces of change. ensuring that directors and management possess the skills and expertise needed to tackle these issues are critical first steps in risk preparedness. operation. As technological disruption is expected to increase, companies should focus on their ability to 1. ECONOMIC HEADWINDS make necessary and timely adjustments to embrace and respond to the forces of change. As discussed in Given the cyclical nature of global markets, the next our Davies Governance Insights 201920 in the context of economic downturn is more a question of when than next generation governance organizations, resistance to if. COVID-19 has heightened concerns of an economic change can be futile and ultimately lead to the demise of downturn in domestic and international markets caused a company. by the pandemic’s abrupt disruption to world economies. These concerns have been further intensified by growing geopolitical uncertainty, such as the 2020 U.S. 3. CYBERSECURITY THREATS presidential election and the implications of the U.K.’s While COVID-19 remains a major focus of boards, departure from the European Union. In the face of such cybersecurity has emerged as a key related risk, uncertainty, boards should consider the increased particularly as many companies temporarily (and information flow regarding general economic and in some cases, permanently) adopt a work-from- geopolitical conditions and their impact on company home model. Management should understand when performance, and should re-evaluate the company’s cybersecurity threats or breaches need to be escalated financial scenario planning and stress testing. to the board. Relatedly, board members should have a clear understanding of the ownership of cybersecurity 2. TECHNOLOGICAL DISRUPTION risk and whether that risk warrants or necessitates delegation to a specialized committee. For the CSA, the Rapidly developing technologies such as automation, cybersecurity practices of Canadian public companies machine learning, blockchain and artificial intelligence continue to be a priority area, reinforcing the need to have emerged as significant market forces reshaping develop robust practices and provide detailed disclosure the business landscape. Increasingly, as discussed in about them.21 our Davies Governance Insights 2018,19 technologies are becoming more disruptive and in some industries intimately integrated with business strategy and
31 Davies | dwpv.com 4. SUCCESSION PLANNING AND TALENT MANAGEMENT Our Take: ERM Low unemployment in the global markets generally, combined with changes in attitudes toward work, have created Is a Strategic challenges for companies in attracting and retaining talent. We expect that companies will continue to face human Imperative for capital challenges, including in their efforts to sustain a talent pipeline with the skills and expertise needed to adapt to a fast-paced environment. To excel in All Boards a digital age, companies need to ensure their workforces possess the necessary technical and specialized knowledge. The scope and magnitude of the COVID-19 crisis have Succession planning in particular needs thrown into sharp focus the central importance of to be considered from a more holistic risk governance. Regulators, shareholders and other perspective that extends beyond the role stakeholders are calling for more effective risk oversight of a CEO. performance and disclosure. The pandemic crisis has also underscored the importance of rethinking strategy and risk 5. REGULATORY UNCERTAINTY management. In this sense, risk management should serve as the guidepost in an organization’s strategic planning Regulatory change and scrutiny will process, providing direction on the level of risk a company continue to have a material impact on is willing to tolerate in achieving its organizational goals. operations. According to a recent global A robust risk oversight function cannot stop the spread survey of over 1,000 board members and of COVID-19 or the occurrence of a black swan event. But executives spanning various industries,22 companies that have taken steps to plan for unforeseen, there is an overarching perception that extraordinary events will be better positioned to recover regulatory oversight is expanding, which from an adverse event and translate risk into a strategic and is likely to lead to even greater disruption. competitive advantage. Recent examples of significant regulatory change have occurred in the areas of privacy, the environment and social issues. In addition, recent geopolitical disputes have resulted in tariffs and other disruptive trade practices.23 Not planning for regulatory change and scrutiny can result in unexpected costs to production and delivery, which will affect the overall financial health of the organization.
Governance Insights 2020 32 CHAPTER 03
Navigating Financial Distress: Key Considerations for Directors
33 Davies | dwpv.com The emergence of COVID-19 fundamentally reshaped our economy and the way we do business in a matter of weeks. These changes are likely to continue as the pandemic runs its course. The stresses and uncertainty brought on by the pandemic have led to unprecedented economic disruption, including to supply chains, liquidity and spending patterns. These and other factors pose a continuing challenge for many corporate directors. For financially distressed issuers, pandemic-induced changes to business operations could make recovery more difficult, and may set the standard for how their board members can and should respond to unexpected events in the future. In this chapter, we explore the duties, obligations and potential liabilities of directors of entities facing financial distress and the tools available to help organizations navigate through and out of a financial crisis.
Governance Insights 2020 34 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
Conduct in the Boardroom: What Directors Need to Know In a business environment that is DUE DILIGENCE REQUIREMENTS IN A FINANCIAL CRISIS experiencing daily Canada’s corporate law sets out several foundational duties for directors, changes, directors including the requirement for directors to safeguard the corporation’s interests while supervising its management and affairs.24 Directors’ actions do not need will likely not be to be perfect, only reasonable in light of the circumstances and what they judged with the knew or should have known at the time.25 In a business environment that is experiencing daily changes, directors will likely not be judged with the benefit of benefit of future future knowledge regarding the pandemic or the economy, but rather on what knowledge regarding they knew when the decisions were made. the virus or the The easiest way to refute an accusation that a director did not properly oversee economy, but rather the corporation during these uncertain times is to show that he or she acted with due diligence. In a crisis or rapidly developing situation, additional efforts on what they knew may be required to ensure that directors are properly discharging their fiduciary when the decisions duties. Some questions that may have been routine may become more urgent. were made. However, Directors may want explicit – for example, written – assurances from in a crisis or rapidly management that legally required remittances to the government, including employee withholding taxes and corporate taxes, are up-to-date and kept in developing situation, segregated accounts. Expert advice may be required, particularly about supply additional efforts may chain and exchange rate issues, or about the consequences of defaulting on key contracts. Consideration should be given to limitation periods for enforcing be required to ensure or preserving rights through tolling or standstill agreements. Caution must also that directors are be taken to avoid acting overly aggressive as a creditor of other financially distressed companies. Dividend and share buyback policies, where they properly discharging exist, should be reviewed and, if possible, amended to reflect the issuer’s new their duties. financial reality. All of these actions or positions will likely be scrutinized by lenders, creditors and other third parties.
35 Davies | dwpv.com Spotlight: Dividend and Share Buyback Considerations
In response to pending or expected financial constraints, program(s).28 On the other hand, if a board one of the first tasks for the board and management is has already declared a dividend, that declaration to identify ways to increase or preserve the issuer’s cash created a debt obligation by the issuer to its position. For example, in the wake of COVID-19, several shareholders, and the board cannot simply reverse Canadian and American public companies suspended or its decision absent clear insolvency issues. halted their dividend or buyback programs to prepare for the uncertain impact of the pandemic.26 A variety of other factors will also be relevant to the board’s decision whether to suspend, delay or reduce However, the decision to suspend, halt and/or terminate future dividend payments, as will be the case with these programs is not always a simple one – especially buyback programs. Dividend and buyback decisions for reporting issuers with a long history of paying form part of an issuer’s broader capital allocation dividends and/or buying back shares. This history and liquidity strategy, which the board (or a special can create investor expectations about the program’s committee) will want to re-evaluate holistically. The long-term availability, especially in the early days before timing of these decisions, particularly in the context of the issuer’s deteriorating financial condition has been potential future insolvency proceedings that have not yet generally disclosed. been disclosed, will need to be carefully considered.
Under Canadian law, generally, a corporation cannot pay Additionally, any policy changes with respect to dividends or repurchase or redeem issued shares if it dividends, buybacks or other capital allocation or is, or after the payment would be, insolvent.27 However, liquidity decisions should take into account the issuer’s the term “insolvent” has different meanings under disclosure record and obligations, both past and different laws, leading to situations in which it may be future. For example, a decision to suspend dividends unclear whether the issuer is subject to the restrictions and/or halt buybacks will often constitute a material on such payments. Other statutory considerations change.29 A board that is even in the preliminary stages may also apply. For instance, access to government of considering such a course of action should consult support through the Coronavirus Aid, Relief, and with legal counsel to avoid potential secondary market Economic Security (CARES) Act in the United States liability for the issuer and its directors and officers. might preclude the continued payment of dividends or buybacks even if a board wished to continue the
Governance Insights 2020 36 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
Directors should keep detailed and accurate records of their board and committee meeting attendance, their contributions to company oversight and any dissents on corporate votes. Much of this information is typically contained in the minutes of board meetings, which should be maintained Due Diligence in real time and reviewed for accuracy when received. Directors who can in Financial Crisis: prove that they acted with due diligence can often insulate themselves from personal liability for a corporation’s failure to complete certain Checklist for required actions.30 Directors
DIRECTORS’ DUTIES IN TIMES OF FINANCIAL CRISIS c Review customer/ supplier agreements During a time of financial crisis, directors should be aware that their responsibility is primarily, but not exclusively, to the corporation. Although c Review cash positions/ directors have a fiduciary obligation to the corporation, which requires liquidity position them to act honestly and in good faith for its best interests, they also may have duties to other stakeholders, which can include groups as diverse as c Review key financing creditors, shareholders and employees, though this duty is somewhat less agreements robust.31 According to the Supreme Court of Canada, while the duty owed c Review insurance to the corporation is mandatory, the one owed to various stakeholder policies groups could arise in appropriate circumstances.32 The Court has also said that obligations to these stakeholders include a duty of care and a duty to not act oppressively against them.33 As discussed in detail in our Davies Governance Insights 2019,34 these obligations have since been codified into the Canada Business Corporations Act (CBCA).
In addition, courts and legislators are increasingly taking into account the evolving expectations of investors, other stakeholders, and society at large. As discussed in Chapter 8, ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay of this report, this may require directors to consider a variety of environmental, social and governance (ESG) factors and the growing (and sometimes inconsistent) expectations concerning a corporation’s purpose or its role as a good corporate citizen. The practical effect is that directors need to assess a range of competing interests in carrying out their duties and exercising their business judgment, which can be particularly challenging in times of financial distress.
When these obligations conflict, as they often do, directors must prioritize the corporation’s well-being. However, in doing so, they should not favour the interests of one group of interested parties over another.35
37 Davies | dwpv.com When Could Directors Be Held Personally Liable? Directors should be aware of the potential liabilities associated with LEGISLATIVE SOURCES OF PERSONAL their positions and how these LIABILITY liabilities relate to their directors Federal laws prescribe a number of situations in which directors may be held personally liable when the and officers (D&O) insurance or corporation becomes insolvent – for example: corporate indemnity agreements.
– unpaid wages up to six months;36
37 – unpaid source deductions for taxes; Directors should be aware of the potential liabilities – unpaid Canada Pension Plan premiums, plus interest;38 associated with their positions and how these liabilities – unpaid Employment Insurance premiums, plus interest relate to their directors and officers (D&O) insurance or and penalties;39 corporate indemnity agreements. Proving that a director – unpaid GST/HST, plus interest and penalties;40 exercised due diligence may exonerate them of some, but not all, types of statutory personal liability arising in – up to $10,000 for bankruptcy offences if convicted the context of corporate financial distress. and indicted;41 and – unusual incentive payments or benefits made within the past year when the corporation was insolvent.42 PROTECTIONS AGAINST PERSONAL LIABILITY Provincial laws typically cover areas such as When an issuer begins entering the “zone” or “vicinity” of employment, health and safety, and environmental insolvency, directors should not only remind themselves obligations, and may also result in personal liability for of the scope of their personal liability, but also of directors. For instance, directors in Ontario could be the protections available to them. These protections convicted if they fail to inform the provincial Ministry will generally take one of three possible forms – an of the Environment about a contaminant being indemnity from the issuer, an indemnity trust fund, or discharged.43 Other liabilities may also apply, depending D&O insurance. Since there is no bright-line rule to on whether provincial employment laws or the Canada identify when a corporation has entered the zone of Labour Code44 apply, or whether the corporation is insolvency, directors should look to the corporation’s publicly traded. capacity to satisfy its liabilities as they come due, the availability of external funding, and the balances of the For example, directors of publicly traded issuers may corporation’s credit facilities as indicators of potential face liabilities related to their obligations under securities financial distress. laws, such as failing to comply with ongoing and periodic disclosure requirements by not appropriately communicating a change to share buyback programs.45 Other liabilities may arise if a director allows the issuer to violate the law or its obligations, or if the director trades in the issuer’s shares on the basis of important information that is not generally available to the public.46
Governance Insights 2020 38 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
– Indemnity. To help insulate directors from the risks associated with their positions, issuers may agree to pay for costs associated with civil, criminal or Directors may be subject to personal investigative proceedings against a director for liability in situations in which the honest and good faith actions taken on behalf of the corporation.47 However, unless this promise is secured corporation itself is not liable. against a tangible asset, it may not provide adequate The two lawsuits that a director protection when the corporation becomes insolvent. In those cases, the obligations to the directors will is most likely to face arising from be considered against other debts, and they may their positions are oppression and only return cents on the dollar or nothing at all. After a corporation begins insolvency or restructuring derivative actions. proceedings, directors may be protected through a court ordered “D&O Charge” if they agree to keep their positions.48
– Trust fund. The corporation may choose to set up POTENTIAL LITIGATION RISKS trusts to fund potential indemnity obligations. During Directors may also be subject to personal liability in insolvency or restructuring proceedings, funds held in situations in which the corporation itself is not liable. a D&O trust remain available to directors and officers. The two lawsuits that a director is most likely to face Since the funds are held on behalf of directors, they arising from their positions are oppression and remain out of creditors’ reach. Directors should derivative actions. be mindful of when funds were placed in the trust, since payments made after the corporation became Oppression actions may be brought by any relevant insolvent may be reversed.49 corporate stakeholder, including employees and creditors.50 A party or group bringing the oppression – D&O insurance. D&O insurance serves a similar action needs to prove two elements: (1) it had a purpose to a corporate indemnity, although the reasonable expectation, and (2) that expectation was corporation pays premiums to a third party that violated by conduct that was “oppressive,” or was carries the risk of proceedings against directors. “unfairly prejudicial” or “unfairly disregarded interest.”51 As with other types of insurance policies, the terms, conditions and scope of coverage can vary. Directors When considering if a stakeholder has a reasonable must ensure that they are familiar with the terms of the expectation, the court will consider: commercial practice, policy and that premiums are up-to-date. If coverage the nature of the corporation, the relationship between has lapsed, it may prove difficult or very expensive to the parties, past practice, steps the claimant could have obtain protection after the corporation has started taken to protect itself, agreements and representations, experiencing financial difficulty. and the fair resolution of conflicting interests between stakeholders.52
39 Davies | dwpv.com When a corporation is insolvent and there is not enough capital to satisfy everyone, there is a greater risk that affected parties will feel that their legitimate expectations were not met. Directors should implement the When a corporation proper infrastructure to allow for ongoing, meaningful engagement with is insolvent and there key stakeholder groups and ensure these groups are kept up-to-date on the organization’s strategic direction. The Supreme Court of Canada is not enough capital has said that personal liability is more likely to be imposed on a director to satisfy everyone, whose conduct was carried out in bad faith, a director who took an active role in originating the conduct, and a director who personally there is a greater benefited from the transaction or behaviour.53 When the board makes a risk that affected decision “within a range of reasonable choices,” a court is likely to defer to its business judgment.54 parties will feel that their legitimate Derivative actions are especially relevant to publicly traded corporations. Here, shareholders of the corporation can “step into its shoes” and seek expectations were redress on its behalf if permitted by a court. The shareholder needs not met. Directors to establish that: (1) something wrong or improper was done to the public issuer, (2) the relief sought would benefit the issuer, and (3) the should implement shareholder has no personal interests that are especially affected by the proper the wrongful conduct.55 In an insolvency context, this may be relevant if the shareholders have reason to believe that the company’s financial infrastructure to challenges were the result of mismanagement rather than circumstance. allow for ongoing,
Derivative and oppression actions are similar in many ways and can meaningful be sought simultaneously, as shown in Ernst & Young v Essar Global engagement with Fund Limited.56 Ernst & Young, the monitor of a corporation under Companies’ Creditors Arrangement Act (CCAA) protection, started an key stakeholder oppression action against Essar Global Fund Limited, claiming that it groups and ensure had been exercising de facto control over the corporation to prioritize its interests.57 Essar argued that Ernst & Young should have used these groups are a derivative action since the claim asserted was a corporate claim kept up-to-date on belonging to the debtor company.58 The Court of Appeal rejected this argument by confirming that either an oppression or a derivative action the organization’s would have been appropriate under these circumstances since Essar’s strategic direction. actions harmed both the corporation and its shareholders.59
Governance Insights 2020 40 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
Spotlight: Best Practices – Remaining Informed and Engaged
Directors’ duties, and the standards by which board Know your duties. Directors should understand to decisions are measured, do not change when a 2 whom their duties are owed, and how this could shift corporation is facing financial distress. Decisions made if the issuer enters the zone of insolvency or becomes by directors who devote sufficient time to making fully insolvent. Typically, best practice is to obtain the advice informed decisions (including with the benefit of advice of external legal counsel concerning those duties from appropriate legal and financial advisers), on a early on in the process, as applicable to the particular reasonable basis and without conflict, should continue circumstances of the issuer. to receive deference under the business judgment rule. However, for boards of issuers on the verge of Understand when courts will defer to your or in financial distress, performing those duties can 3 business judgment. Directors should understand become much more challenging, especially given the the business judgment rule and what is meant by urgency such situations typically demand. The following “reasonable” in the context of the business decisions are the top 10 practices for directors of financially and circumstances the business is facing. distressed companies, which we discuss in greater detail throughout this chapter. Keep yourself informed and communicate often. 4 Directors should stay informed and be kept up to Understand when you may be held liable. Directors date by management and trusted external advisers. 1 should familiarize themselves with the remedies Lines of communication should remain open between and sources of liability that apply when organizations the board and key stakeholders, which may require experience financial distress. These sources include more frequent meetings and the formation of a special environmental liability and pension plan liability, as committee to oversee decisions regarding financial well as liabilities under corporate, tax, securities, and distress and next steps. insolvency laws. Understand your organization’s governance. 5 Directors should be familiar with the governance systems and protocols in place and ensure their adequacy. Minute books, corporate records, financial reporting and payment systems must be kept current and operational.
41 Davies | dwpv.com Decisions made by directors who devote sufficient time to making fully informed decisions (including with the benefit of advice from appropriate legal and financial advisers), on a reasonable basis and without conflict, should continue to receive deference under the business judgment rule.
Familiarize yourself with the financials. Directors should 6 monitor the issuer’s liquidity position, capital resources, financial stability and compliance with financial covenants. They should also understand the trade-off between short-term liquidity and organizational longevity.
Approve where appropriate. Directors should approve 7 dividends, share redemptions, and the like only after a comprehensive review of the issuer’s key financials. Payments may need to be stopped or reduced where appropriate.
Protect yourself. Directors should ensure that they have 8 entered into appropriate indemnification agreements with the issuer. Also critical is having in place adequate D&O insurance coverage and understanding what that coverage entails, while appreciating that protections offered in normal circumstances may not be available or may change in the event of insolvency.
Understand when to consider insolvency options. Directors 9 should ensure that the issuer carries on operations only if it can meet its existing obligations or the directors reasonably expect that any new obligations will be satisfied. If not, protocols should be put in place to manage these obligations. Insolvency advice should be obtained, and an insolvency plan developed.
Identify conflicts of interest. Directors should remain 10 attuned to actual, potential or perceived conflicts of interest and retain independent counsel where appropriate.
Governance Insights 2020 42 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
Responding to Financial Distress: Steps for Directors Putting an insolvency plan in As soon as it appears likely that an issuer will exhaust its credit, directors should obtain insolvency advice and consider the merits of selling, restructuring or place early gives a liquidating the business. Separate counsel may be required to advise directors corporation more on their duties, on the one hand, and to advise the corporation about its options, on the other. Even if a special committee of the board is struck to assist the opportunities board in evaluating its options, ultimately, the board must pass a resolution to survive authorizing the sale, liquidation or reorganization of the corporation. A further discussion about the role of special committees in different contexts can be the downturn found in Chapter 1, Special Committees: Governance Safeguards for Conflict of and return to Interest Transactions and High-Stakes Situations. profitability. It also Putting an insolvency plan in place early gives a corporation more opportunities makes it more to survive the downturn and return to profitability. It also makes it more likely that a sale or reorganization will be successful and reduces the probability that likely that a sale key infrastructure will be seized by a secured creditor. An insolvency plan may or reorganization involve taking a step back to determine whether the issues that the corporation is facing are in the form of short-term liquidity challenges or longer-term issues will be successful that necessitate reorganizing or liquidating the business. and reduces the probability that TABLE 3-1: Formal and Informal Insolvency Options key infrastructure Informal Processes Formal Processes will be seized by a Sale of assets Companies’ Creditors Arrangement Act secured creditor.
M&A, divestiture Bankruptcy and Insolvency Act
Conversion of debt to equity Canada Business Corporations Act
Renegotiating key agreements N/A
43 Davies | dwpv.com CHOOSING AN INSOLVENCY REGIME OUT-OF-COURT WORKOUTS
Canada has two main insolvency regimes – governed In addition to the options available to by the Bankruptcy and Insolvency Act (BIA) and the issuers under the BIA and the CCAA, CCAA. To access either regime, the corporation must be businesses can also restructure their insolvent. This term is interpreted with some differences debts without involving the courts by depending on whether relief is being sought under the negotiating with creditors. Such a process BIA or the CCAA, although courts have been willing to is referred to as an out-of-court workout interpret access broadly under both regimes.60 Only and is done in the shadow of both the companies with at least $5 million in debt can access the BIA and the CCAA regimes. In addition, CCAA, whereas companies of any size can use the BIA.61 various “bankruptcy-adjacent” laws, such Additional advice should be obtained for corporations as the CBCA, also come into play and with assets or operations outside Canada or where inform these workouts.62 Out-of-court another jurisdiction’s laws may apply. workouts are more feasible for smaller and/or closely held corporations dealing In general, the CCAA process is more flexible and can with a few key creditors. The essential allow corporations with complex structures to pursue aspect of an out-of-court workout is more novel and creative solutions to restructure their that all stakeholders compromising their affairs. This process was historically used to reach positions must agree to it. Often, out- an agreement with creditors that would allow the of-court workouts take place with one corporation to continue in business. However, it has secured lender (or syndicate) while the increasingly been used for liquidation purposes, with the trades continue to be paid in the ordinary court-appointed officer – the monitor – reporting to the course. Further, out-of-court workouts court on the corporation’s ongoing financial situation are best suited for situations in which and on its efforts to develop a plan of arrangement or no operational fix is needed. When the negotiations with creditors.63 The CCAA’s principles- requisite factors are in place, and where based approach requires extensive court involvement, courts may become overwhelmed, out- which can increase both the cost and the complexity of-court workouts can offer an agile of the proceedings.64 This process may not be mechanism for businesses to move appropriate for corporations with smaller debts and forward with the support of their creditors. highly strained liquidity. It is expected that out-of-court workouts While a CCAA proceeding takes place, current will become more common as government management typically continues to run the business, supports run out and businesses need to although personnel changes may be required by make decisions about how to restructure creditors as part of the negotiations.65 Management their debts in the face of pandemic-related and other key personnel may be encouraged to stay with constraints on access to the courts. This the entity through an employee retention or incentive trend has already been observed in the plan, though care must be taken to ensure that these United States. plans are reasonable.66 As of August 10, 2020, 41 corporations, including Cirque du Soleil, Reitmans, Aldo, and DAVIDsTEA, have been granted CCAA
Governance Insights 2020 44 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
protection this year, compared with 38 in all of 2019. It is expected that corporations will increasingly seek CCAA protection as the pandemic runs its course. The choice of which regime to proceed under is based on many In contrast, the BIA is based more on rules than principles, which reduces both the cost and the factors, including the nature and complexity of the proceedings.67 This process can scope of the issuer’s assets and be used to either reorganize a corporation’s affairs or liquidate them. Unlike the CCAA, if the plan is rejected by debts, the financing available for creditors, the company automatically becomes bankrupt restructuring, the number of creditors and begins to liquidate.68 During the liquidation, the corporation and its assets are controlled by an external and whether the issuer has any trustee who acts for the benefit of the creditors. current or pending litigation against it.
Outside Canada’s insolvency regimes, the CBCA also offers an increasingly popular option to restructure a corporation. A corporation can apply to a court for an DECIDING HOW TO PROCEED order approving an arrangement provided that (1) it is The choice of which regime to proceed under is based not possible for the corporation to effect a fundamental on many factors, including the nature and scope of change under any other provision of the CBCA, and (2) the issuer’s assets and debts, the financing available the corporation is not insolvent.69 Unlike the CCAA, there for restructuring, the number of creditors and whether is no court-appointed monitor and, instead, fairness the issuer has any current or pending litigation against opinions are obtained in support of the proposed it. The viability of the entity’s products, industry and reorganization. In addition, a CBCA arrangement must business model should also be considered. For example, be reviewed by the office of the director appointed under industries that experienced financial difficulty before the CBCA.70 Although the director may take a position on the pandemic may be more successful with a sale or the transaction, ultimate approval remains with the same liquidation than a restructuring proceeding. court that hears CCAA proceedings.
A restructuring proceeding under both the BIA and the The primary benefits of proceeding under the CBCA CCAA can allow for releases of directors’ liabilities.71 include the speed and flexibility offered to accomplish Under the CCAA, the release can be authorized an arrangement and the avoidance of potential when there is a connection between the claim being stigma associated with insolvency. However, a CBCA compromised and the restructuring achieved by the restructuring may only involve the compromise of plan.72 However, a release is not available if directors bondholders, debenture holders, and equity holders’ made misrepresentations to creditors or were engaged rights. In contrast, the CCAA contemplates the in wrongful or oppressive conduct.73 compromise of every type of claim that may arise from the insolvency of a corporation. Further, there is also the possibility that a CBCA plan of arrangement could be converted into a CCAA proceeding, with the added expense and time arising from two proceedings.
45 Davies | dwpv.com Spotlight: Examples of Boards’ Approaches to Financial Distress
TABLE 3-2: Director Best Practices
The following chart illustrates best practices taken by directors of financially distressed companies that have gone through CCAA proceedings.
Corporation Actions Taken by Directors
Canwest Global – Retained independent legal and financial advisers Communications Corp. – Formed a special committee to oversee the restructuring; that committee made all material (2009)74 restructuring decisions – Retained two Chief Restructuring Advisers to deal with the separate interests of Canwest Media and Canwest Papers, which each had separate legal and financial advisers – Non-independent directors resigned on CCAA filing
Nortel – Majority of directors resigned, and replacements experienced in insolvency and restructuring were appointed (2011)75 – Appointed a Chief Restructuring Officer who reported to the board – Appointed separate legal advisers for the directors
Sino-Forest – Formed a special restructuring committee with independent directors Corporation – Independent lawyers hired to advise the independent directors (2012)76 – Senior management implicated in fraud were replaced
The Cash Store – Independent directors appointed and directed an internal investigation into potential related party transactions Financial Services Inc. – A special, independent restructuring committee of the board was struck and supported by external (2014)77 auditors and lawyers, as well as a Compliance and Regulatory Affairs Officer – Appointed a Chief Restructuring Officer on filing, who oversaw the restructuring, terminated five members of senior management and directed counsel in pursuing claims against directors
US Steel Canada Inc. – Appointed two independent directors with restructuring expertise (independent directors constituted (2014)78 a majority) – Retained independent financial and legal advisers – Appointed a Chief Restructuring Officer before seeking CCAA protection
CannTrust Holdings Inc. – Struck an independent committee of the board to investigate alleged regulatory non-compliance and (2020)79 oversee its remediation – Independent directors hired external legal advisers
Lydian Canada – Struck a special committee of the board to direct the restructuring efforts Ventures Corp. – Hired external financial and legal advisers for the board (2020)80
Governance Insights 2020 46 CHAPTER 03 Navigating Financial Distress: Key Considerations for Directors
Spotlight (Cont'd)
TABLE 3-3: Potential Pitfalls
The following chart illustrates the steps taken by directors of a financially distressed company that was subsequently the subject of litigation.
Corporation Actions Taken by Directors
Essar Steel Algoma Inc. – Three independent directors resigned after attempts to (2016)81 create a restructuring committee and engage outside experts were voted down by the board – Remaining directors declined to follow independent counsel’s advice to fulfill its equity commitment – When nearing CCAA filing, a special committee of directors was constituted with external advisers, though the independence and agency of these directors were questioned in litigation – Directors remained in office despite allegations of conflict and concerns about their independence
In successful restructurings, the directors formed special committees to investigate wrongdoing, consider options for continued financial viability or expressly consider the possibility of restructuring. More details about the use and best practices for special committees can be found in Chapter 1, Special Committees: Governance Safeguards for Conflict of Interest Transactions and High-Stakes Situations. These committees usually comprise independent directors and rely on external legal and financial experts. In Essar’s case, its refusal to heed the advice of its independent directors undoubtedly created complications for it. Even after a restructuring committee had been established, Essar was plagued by disputes and litigation questioning the board’s engagement and whether the committee was truly independent. The Essar insolvency should act as a reminder that the timing of decisions and directors’ independence as well as their ability to guide the corporation through uncertain times are key factors to the success of a potential restructuring.
47 Davies | dwpv.com Our Take: A Successful Response Starts Early
The dizzying pace of change in 2020 has only amplified the urgency of a corporate director’s oversight responsibilities. Acting sooner rather than later gives a business more avenues to successfully emerge from a financial crisis and improve the likelihood of achieving long-term viability. Similarly, directors will be better able to anticipate and insulate themselves from the risk of personal liability with an up-to-date understanding of where their company stands regarding its key legal obligations. Insolvency plans for the business and independent legal (and often financial) advice, for the whole board and individual directors if necessary, are critical tools to have in place both during the COVID-19 crisis and beyond.
Governance Insights 2020 48 CHAPTER 04
Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
49 Davies | dwpv.com By the start of 2020, shareholder activism had become a fixture in Canadian capital markets. Although activism levels had been declining to some degree in recent years, most public companies are now conditioned to the reality that an activist could emerge at any time; the breadth of activism has widened and an increasing number of shareholders, including institutional shareholders, have been willing to speak out. When the COVID-19 pandemic took hold in North America in the heart of the 2020 proxy season, activism activity declined. Macro concerns appeared to cause activists to take a more cautious approach despite the many potential opportunities that emerged. We expect this slowdown to be fleeting. The pandemic has left a number of issuers weakened in its wake, while public M&A activity has maintained a steady pace. These conditions will provide enticing opportunities to even the most conservative activist. In this chapter, we summarize trends in activist demands throughout 2020 and share insights for both issuers and shareholders navigating the current climate. We round out our discussion with some practical guidance on settlements and their varied terms.
Governance Insights 2020 50 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
The 2020 Context The decline When the COVID-19 pandemic hit North American markets in early 2020, uncertainty prevailed, stock markets tanked and business activity floundered, in the number leading some to predict a vast and fertile territory for activist investors. With of Canadian some public companies experiencing stock price declines not seen since the 2008 financial crisis and activism firmly established in Canada, these companies predictions did not seem unreasonable. However, in the first half of 2020, subject to public activist activity in Canada decreased substantially. According to data from Activist Insight, the first six months of 2020 witnessed a 43% decline in the activist demands number of public activist demands in comparison with the same period in through the first 2019.82 Hostile bid activity was scarce during the same period, with only one hostile bid formally commenced. half of 2020 to June 30 (H1) is While the slowdown in activism may have provided some comfort to public issuers striving to recover from the pandemic, this lower level of activity is sizable – down by likely to be only temporary. With issuers continuing to grapple with the financial and operational effects of COVID-19 and M&A activity picking up steam, the more than 40% opportunities these developments present for activists will likely entice them compared with back into the fray. In fact, Canadian public M&A levels have remained relatively strong in 2020, suggesting that some issuers may seek a sale transaction as a the corresponding safe exit from continued uncertainty. And with that level of activity, issuers and period in 2019. bidders alike will find themselves exposed to potential M&A activism. Issuers looking to bulletproof sale transactions and activists seeking to challenge deals However, Canada will need to weigh various considerations. One of the most aggressive possible was not an strategies in these circumstances is to use a “mini-tender” to build a sufficiently sizable minority position to leverage better transaction terms or an alternative outlier in this offer. This tactic was used in two high-profile transactions in 2019, discussed respect. Globally, below under “Mini-Tenders as a New Tool in M&A Activism?” activist demands Activist Demands in 2020: Key Highlights declined by 31% compared with ACTIVISM DEMANDS DOWN DUE TO COVID-19 the corresponding The decline in the number of Canadian companies subject to public period in 2019. activist demands through the first half of 2020 to June 30 (H1) is sizable (see Figure 4-1) – down by more than 40% compared with the corresponding period in 2019. However, Canada was not an outlier in this respect. Globally, activist demands declined by 31% compared with the corresponding period
51 Davies | dwpv.com in 2019.83 As we expected (contrary to some market speculation), activists also appeared to be adversely affected by the pandemic and opted to be more cautious in response to the state of significant uncertainty. Moreover, the pandemic’s impact was accentuated by hitting North America hardest right in the heart of the 2020 proxy season. While a struggling issuer may appear to be an easy target for an activist, a thoughtful activist will often be unwilling to seek a turnaround strategy when the very survival of whole sectors of the economy is at stake.
Quite apart from the macroeconomic considerations that dampened activism, the restrictions on large indoor gatherings meant that annual shareholders’ meetings had to move to an online, virtual setting. For technical and other reasons, it is almost impossible to conduct a contested virtual meeting without agreement between the issuer and the activist (see Chapter 5, Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond for a discussion of virtual meetings, including COVID-19’s impact on contested and contentious situations). Even when the technical challenges can be overcome, a virtual setting does not lend itself to the same attention and press coverage that a traditional in-person contested meeting typically attracts. This lack of exposure might also have limited the appeal of launching a proxy campaign, given that the success of an activist’s campaign largely depends on its ability to garner the support of an issuer’s other major shareholders. As a result, contested meetings were scarce in the first half of 2020.
When assessing the number of Canadian-listed issuers subject to activist demands generally (which includes formal proxy contests), we note that the first half of 2020 yielded the lowest H1 total of the previous eight years, as shown in Table 4-1 below.
FIGURE 4-1: Number of Canadian Issuers Subject to Activist Demands (2013 H1–2020 H1)
70
60 58
50 46 47 42 40 36 36 33 30 24 20
10
0 2013 H1 2014 H1 2015 H1 2016 H1 2017 H1 2018 H1 2019 H1 2020 H1
Source: Activist Insight
Governance Insights 2020 52 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
ACTIVIST DEMANDS CONTINUED TO FOCUS ON BOARD-RELATED ACTIVISM
While overall activism declined in the first half of 2020, the principal objectives of public demands that were made in respect of Canadian public issuers followed a pattern consistent with the prior seven years, with by far the highest proportion being board-related demands, as shown in Figure 4-2.
FIGURE 4-2: Public Demands to Canadian Issuers by Type of Activism (2013 H1–2020 H1)
60 2013 H1 2014 H1 50 2015 H1 2016 H1 40 2017 H1 2018 H1 2019 H1 30 2020 H1
20
10
0 Balance Sheet Board-Related Business M&A Activism Other Remuneration Activism Activism Strategy Governance
Source: Activist Insight
M&A activism, so-called balance sheet activism and activist demands related to business strategy declined substantially in 2020 H1 compared with corresponding While overall activism declined in periods in prior years. M&A activism was temporarily the first half of 2020, the principal reduced by the initial halt in M&A activity in March 2020 in response to the pandemic. With respect to demands objectives of public demands that relating to business strategy, other governance and were made in respect of Canadian compensation-related issues, not surprisingly, in the first half of 2020 many activists saw little merit or public issuers followed a pattern prospect of success in pushing strategies aimed at consistent with the prior seven years, value-enhancement within these areas, when most public issuers and investors were focused on survival, with by far the highest proportion and a variety of other factors entirely outside activists’ being board-related demands. control were driving issuers’ financial and stock price performance.
53 Davies | dwpv.com ACTIVISM WAS MORE OFTEN DRIVEN BY ONE-OFF SITUATIONS
Of those Canadian activist situations that did arise in 2020 H1, the highest proportion (almost one-third) was driven by “concerned shareholders,” meaning individual shareholders or groups of shareholders that attempted to effect change typically at a single company in response to poor performance or other grievances, as shown in Figure 4-3.84 Concerned shareholders can be distinguished from a variety of other types of activists – for example, those with a primary, partial or occasional focus on using activism as an investment strategy or engaged shareholders that escalate their otherwise typical investment stewardship responsibilities only to protect and enhance shareholder value at companies within their portfolio.85 Typically, “one-off situations” are advanced by former directors or management, or other insiders or related parties. This year represented the highest proportion of one-off activist situations in the last eight years, and is a continuation of a trend toward an increase in the proportion of one-off activist events and the proportion of insider-driven activist situations. We expect that these one-off activist situations may have arisen in 2020 regardless of the pandemic, although COVID-19 may have caused some shareholders that might otherwise have remained silent to make their demands public.
FIGURE 4-3: Public Demands to Canadian Issuers by Activist Focus (2013 H1–2020 H1)
50%
40%
30%
20%
10%
0% 2013 H1 2014 H1 2015 H1 2016 H1 2017 H1 2018 H1 2019 H1 2020 H1 Demand Year
Primary/Partial Focus Occasional Engagement Concerned Shareholder
Source: Activist Insight
Governance Insights 2020 54 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
One such example was the push by a shareholder group of Australis Capital Inc., an issuer listed on the Canadian Securities Exchange (CSE), which was spun out from Aurora Cannabis Inc. in September 2018 as its U.S. investment vehicle. The shareholder group, which owns a combined 8% of Australis’ common shares, is being led by Duke Fu and Roger Sykes, and includes Terry Booth, the former CEO of Aurora Cannabis. The shareholder group launched a campaign to have its candidates stand for election at Australis’ September 22, 2020 annual shareholders’ meeting, which has been postponed by Australis. We expect that the trend toward a larger number of one-off activist events against Canadian-listed issuers will continue, with the pandemic and the ensuing recovery acting as accelerants.
SHAREHOLDER RIGHTS PLANS AND THE U.S. “ANTI-CORONAVIRUS PILL”
One notable development in response to the with 10 years for most plans enacted in response to the uncertainty brought on by COVID-19 was the prevalence 2008 financial crisis. Second, these pills were adopted of U.S. public companies adopting “anti-coronavirus” by the most vulnerable issuers, with consumer cyclicals shareholder rights plans. These poison pills were accounting for one quarter of such plans and most generally adopted in the absence of a threat of a issuers’ market capitalizations falling under US$1 billion. hostile takeover; instead, they were directed at a Lastly, these plans also have lower triggering thresholds, perceived threat that opportunistic investors would take with about half having a 10% trigger (instead of the more advantage of depressed share prices and accumulate traditional 20% trigger). And some plans have different a sizable equity stake. According to data collected triggering thresholds for activists (13D filers) and for by Activist Insight, as of April 21, 2020, just over one passive investors (13G filers). month after the global pandemic was declared, 40 such anti-coronavirus pills were announced by Russell 3000 We have not seen the emergence of anti-coronavirus- index issuers in the United States, with 17 of those styled pills in Canada, largely due to differences in introduced in March 2020 alone. This is in contrast to Canada’s takeover bid regime and the style of rights the total of 18 poison pills introduced there during the plans that have developed here. Instead, most Canadian whole of 2019; with 20 pills adopted in 2017 constituting rights plans continue to be “new generation plans” with the highest number in the previous five years.86 By early fairly consistent and relatively non-controversial features, September 2020, a total of 52 poison pills had been including a 20% triggering threshold and no distinction adopted by Russell 3000 index issuers in 2020. between the types of acquirers that can trigger the plan. In fact, there has been no notable increase in the Similar plans were adopted in the midst of the 2008 number of shareholder rights plans filed in Canada since financial crisis, but the anti-coronavirus pills differ from the start of the COVID-19 pandemic compared with the their 2008 counterparts in a number of ways. First, the same period in 2019. anti-coronavirus pills are shorter in duration – most were adopted for a period of less than one year, compared
55 Davies | dwpv.com In Focus: M&A Activism – Practical Guidance for Issuers and Shareholders
Despite the decline in activism involving Canadian- listed issuers in the wake of COVID-19, Canadian public M&A activity has remained healthy, particularly in the resource sector. Issuers undertaking a change of control transaction should remain mindful of potential criticism when conducting a sale, especially in the midst of continued economic uncertainty. Even though markets have recovered from their early 2020 lows, some shareholders may feel that their shares have been undervalued in a transaction. Even in less volatile economic times, shareholders are willing to challenge a transaction for other reasons as well, including due to perceptions that target boards have undertaken inadequate processes or in cases where value appears to have been transferred to management or other insiders at the expense of shareholders. Below we offer some practical guidance to issuers wishing to protect their deals from shareholder challenges. We also offer similar guidance to shareholders that may wish to mount a challenge to a proposed transaction.
Governance Insights 2020 56 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
In Focus (Cont'd)
ISSUER CONSIDERATIONS: BULLET- inevitably come to their own conclusions regarding PROOFING THE DEAL value, a robust review process (accompanied by equally robust public disclosure of that process) An issuer pursuing a change of control transaction by a special committee of independent directors often faces criticism, deserved or not, whether it be would help mitigate the risk that a shareholder could that it is selling at the wrong time in the company’s successfully challenge or delay the transaction in development, it is selling at a depressed price court or before a securities regulator. Our discussion compared with its potential long-term value, or in Chapter 1, Special Committees: Governance that a better deal would have been available with a Safeguards for Conflict of Interest Transactions more robust sale process. The risks of criticism are and High-Stakes Situations provides further best heightened when the issuer is seeking to execute practices for issuers setting up special committees in a sale in the midst of continuing and substantial a variety of contexts, including M&A. economic uncertainty. Issuers can consider the following steps to maximize the likelihood that the Consider transaction structures in light transaction passes muster in the eyes of both courts of potential activist interventions. Many and regulatory authorities, as well as in the court of 2 factors will drive the appropriate transaction public opinion. structure, including tax and approval considerations; however, some transaction structures provide more Assess the vulnerabilities of your transaction. opportunities for shareholder intervention. For Almost any public M&A transaction has example, a plan of arrangement provides activists with 1 potential areas of vulnerability. Shareholders a ready-made forum for challenging the transaction will, without fail, analyze the consideration offered through the court fairness hearing. Of course, this under the deal and can be expected to uncover factor alone should not necessarily be determinative; any issues that might suggest value is being however, if a transaction has a high proportion of transferred to others at the shareholders’ expense. vulnerabilities, an issuer would be well-advised to Executive compensation in the form of golden enhance its process as necessary, recognizing that parachutes, option payouts and other transfers of the deal could be subject to heightened scrutiny by value to management may also come under scrutiny. a court. Transactions involving related party acquirers also attract special attention. Although shareholders will
57 Davies | dwpv.com Establish a robust communications in Davies Governance Insights 2019,87 institutional plan. Although price and transaction investors are becoming more vocal in contentious 3 structure are focal points in any M&A- situations, publicly throwing their support behind related activist campaign, having a robust process an issuer or an activist in M&A activism and other and communications plan are paramount in a activist situations and, in some cases, becoming successful defence. An issuer should proactively the activist themselves. Securing the endorsement address perceived weaknesses in the lead-up to of a transaction by proxy advisory firms is also the announcement of its transaction and build a increasingly essential, particularly if the shareholder disclosure record that can withstand the scrutiny of base includes a number of institutional, rather an activist, the public and any regulator or court that than retail, shareholders. Finally, to the extent that may be called upon to evaluate the transaction. the shareholder base is widely dispersed, a proxy solicitation agent is critical to both increase turnout In many cases, issuers will be well-advised to engage and drive a higher positive vote outcome. public relations firms and, in some cases, government relations advisers, as well as proxy solicitation agents. Monitor trading activity and changes in Issuers should develop, in advance, a communications your shareholder base. In the context of any plan with their advisers to convey a clear and 5 potential activism, including M&A activism, consistent message concerning the process issuers should implement a stock watch program undertaken and the benefits of the transaction. A to monitor trading activity and regulatory filings, transaction’s success may very well depend on the including Canadian early warning reports and record created through press releases, circulars, alternative monthly reporting system filings, and U.S. announcements and media coverage. 13F, 13G and 13D filings. Doing so will help an issuer identify potential allies or dissenting voices that may Build public support. Issuers should seek emerge during the course of a transaction. Real-time support from major shareholders to the extent review of public filings can also reveal under-the-radar 4 practicable, ideally through lock-up or voting market accumulations and suspicious trading activity. support agreements. In many cases, institutional Knowing in real time any significant changes in the shareholders may be unwilling to commit their shares issuer’s shareholder base will often help the issuer by contract; however, it can be equally important to with the timing and substance of its announcement of ensure that key shareholders are willing to endorse the transaction. the transaction if asked or, at a minimum, not to make any public criticism. For example, as we discussed
Governance Insights 2020 58 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
In Focus (Cont'd)
SHAREHOLDER CONSIDERATIONS: target’s shareholders, providing further opportunity KNOW YOUR OBJECTIVE AND for skeptical shareholders to try to scuttle a deal. TRANSACTION TIMING As most shareholders are unlikely to hold sufficient shares to block a transaction, gaining allies among Given the continuing economic uncertainty and other investors is critical. Knowing the makeup of the market turbulence, shareholders can be expected shareholder base, including the presence of large to evaluate M&A transactions more carefully with blocks and the distribution between institutional an eye on value and, in some cases, may be more and retail shareholders, is key to developing a inclined to raise challenges, especially if the deal communications and solicitation strategy to build appears to be opportunistic. Public M&A activity also that support. Reports published by Institutional often attracts event-driven traders into the stock and, Shareholder Services Inc. (ISS) and Glass, Lewis & while their motives may be different, their objectives Co. (Glass Lewis), as well as historical voting records, could align with those of long-term shareholders. may also reveal whether the shareholder base Whether a shareholder’s view is long or short term, includes other investors that have been at odds the shareholder needs to consider a number of key with management or may be receptive to the factors when assessing whether, when and how to activist’s thesis. challenge a transaction.
Evaluate the best means to achieve your Know the shareholder base and the vote objective. A shareholder has a number of threshold. The voting threshold required by a 2 options, depending on the challenge it wishes target’s shareholders to approve a change of 1 to mount. At one end of the spectrum, a shareholder control transaction is often two-thirds of the votes may be content to air its grievances in a press release cast “for” – meaning a dissident must secure one-third in the hope that other like-minded shareholders will of the votes cast “against” to defeat the transaction. take up the mantle of challenging the transaction. In some cases, the acquirer may also require two- A shareholder might also engage formally with the thirds or majority approval by its shareholders for board or special committee to achieve its objective. the deal. In addition, in cases involving material At the other end of the spectrum, a skeptical conflicts of interest, Multilateral Instrument 61-101 – shareholder may seek redress in the courts or before Protection of Security Holders in Special Transactions a securities regulator or launch a proxy contest. A and related guidance88 may require an additional shareholder may also build up its equity stake in “majority of the minority” shareholder approval by the the target or the acquirer to bolster its leverage,
59 Davies | dwpv.com including through a so-called mini-tender, which is Going public. If a shareholder wishes to discussed below under “Mini-Tenders as a New Tool make its concerns public, it may do so short of in M&A Activism?” Finally, rather than try to derail the 4 a formal proxy solicitation campaign by relying transaction, a shareholder may instead exercise its on various exemptions from the proxy solicitation dissent rights under applicable corporate law and requirements. Unlike the issuer, a shareholder can claim “fair value” for its shares after the transaction rely on the “public broadcast” exemption allowing is completed. it to solicit proxies and support for its campaign without preparing and filing a proxy circular to Understand transaction timing. Public shareholders (subject to complying with certain M&A transactions often play out in tight prescribed disclosure requirements). This strategy 3 time frames, leaving shareholders little allows an activist to engage in a solicitation without time to react, especially to launch a formal proxy incurring the additional costs and burdens associated solicitation campaign or seek redress in the courts with preparing and mailing a dissident information or before a securities regulator. In some cases, the circular. Alternatively, or in combination with the shareholders’ meeting to approve the deal may be public broadcast exemption, a shareholder may rely as few as seven weeks after the transaction is first on an exemption allowing it to solicit proxies from no announced. Engaged shareholders should prepare more than 15 shareholders, which can be particularly a detailed calendar plotting key transaction dates, effective if ownership in the issuer is concentrated including the record date, proxy deposit deadline (e.g., if the top 15 shareholders represent a sizable and deadline to file a note of dissent, to ensure that proportion of the issuer’s outstanding voting they meet deadlines for any particular action. The securities). Finally, a press release that merely overall timeline and key dates within it will very much states how the shareholder intends to vote and influence shareholders’ strategies, often dictating the reasons for its vote is not subject to the proxy what is and is not feasible, irrespective of what might solicitation rules. be optimally desired.
Governance Insights 2020 60 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
Spotlight: Mini-Tenders as a New Tool in M&A Activism?
It should come as no surprise that the leverage of Air Canada’s acquisition of TSX-listed Transat A.T. a shareholder seeking to challenge a transaction Inc. In each case, the activist opposed the proposed increases with the size of its stake in the issuer. transaction, with the activist in HBC seeking a better Unfortunately, it can prove quite challenging and costly deal and the activist in Transat hoping to launch a to increase one’s stake meaningfully, particularly competing bid. after a deal has been announced. However, in some circumstances, a motivated activist may be inclined to In the face of the going-private insider buyout led deploy a “mini-tender” to increase its stake and win by HBC’s executive chair, Richard Baker, who was a seat at the bargaining table. In the M&A context, supported by a group of locked-up shareholders a shareholder making a mini-tender seeks to build representing approximately 57% of HBC shares, The a stake of up to 19.9% (therefore, staying below the Catalyst Capital Group Inc. launched a mini-tender to 20% threshold at which Canada’s takeover bid regime acquire up to 10.75% of HBC common shares at a price and associated requirements would be triggered) by of $10.11 per share, a 7% premium to the Baker group’s offering to acquire shares from other shareholders at a offer. Catalyst also used the public broadcast proxy small premium to the applicable transaction price and solicitation exemption to garner support from other within a very short time frame. The offer may also be shareholders. In total, 28.24% of HBC shares, including coupled with a solicitation of proxies with respect to Catalyst’s shares, were opposed to the Baker offer. shares tendered. While not frequently used in Canada Catalyst’s strategy included a complaint to the Ontario (especially relative to the practice in the United States), Securities Commission (OSC) and the announcement of the mini-tender may be an effective means for a minority a competing offer for HBC at $11.00 per common share. shareholder to build its equity stake while also securing Catalyst was successful in its mini-tender and ultimately, proxies to vote the tendered shares; this, in turn, can through its strategy, achieved an increase in the Baker help a minority shareholder block (or influence changes group offer to $11.00 per share. in the terms of) a deal. In the case of Transat, Group Mach Acquisition Inc. This strategy was most recently implemented in two employed a similar strategy when it offered to acquire separate transactions – one involving an insider bid for up to 19.5% of the outstanding Class B voting shares Hudson’s Bay Company (HBC), formerly listed on the of Transat for an 8% premium to Air Canada’s $13.00 Toronto Stock Exchange (TSX), and the other involving per share offer. As a condition of the Group Mach offer, the depositing shareholders also had to give a proxy to
61 Davies | dwpv.com Investors wishing to employ the strategy in the future will need to structure their bids carefully to minimize the risk of a mini-tender being successfully challenged or defeated.
Group Mach with respect to all of the Transat shares held by such depositing shareholder, regardless of whether the shares were actually taken up under the mini-tender. As a result, Group Mach would have been entitled to vote more shares than what it ultimately acquired in the mini-tender. In response to a public interest application brought by Transat, the Tribunal administratif des marchés financiers (Québec) ultimately cease-traded Group Mach’s offer on the basis that it was abusive and contrary to the public interest; however, Transat shareholders later benefited from Air Canada’s increasing the consideration under its offer to $18.00 per share.
Both examples demonstrate how a mini-tender can pressure a potential purchaser to increase its offer, even if the mini-tender itself is unsuccessful, as was the case with Group Mach’s bid for Transat. In the case of HBC, Catalyst was able to strengthen its hand at the bargaining table. The Group Mach mini- tender also serves as a reminder that mini-tenders can attract harsh regulatory scrutiny, particularly if structured in a manner that a regulator views as heavy- handed and coercive, or if it is accompanied by aggressive marketing efforts or disclosure deficiencies – and with a tight time frame in which shareholders are required to make a decision.
To date, mini-tenders in Canada remain relatively unregulated with the exception of historical CSA Staff Notice 61-301 – Staff Guidance on the Practice of Mini- Tenders, which contains guidance by the Canadian Securities Administrators (CSA) concerning mini-tenders made at a discount to the market price. The recent Catalyst/HBC and Group Mach/Transat situations have renewed regulatory interest in mini-tenders. However, it remains to be seen whether Canadian regulatory authorities will wade into the arena with more concrete guidance, including as to the acceptable timelines, terms and required disclosure associated with mini-tenders. Investors wishing to employ the strategy in the future will need to structure their bids carefully to minimize the risk of a mini-tender being successfully challenged or defeated.
Governance Insights 2020 62 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
Our Take: When to Settle? There Is No One-Size-Fits-All Solution
Settlements have become more common in recent consider settling a contest to the extent practicable years and, generally, are also happening earlier given the substantial time and costs associated with in the process. According to data collected by pursuing a proxy contest all the way to a shareholder Activist Insight, approximately 63% of board-related vote. However, there is no one-size-fits-all template demands in 2020 H1 were resolved through a for evaluating settlement terms. The majority of publicly announced settlement before reaching the settlement agreements contain similar clusters of shareholders’ meeting, compared with 50% in 2019 rights and obligations, which we discuss below, but H1. And of course, many more board renewals are the achieving the optimal outcome will vary in every result of constructive behind-the-scenes engagement situation. In the end, issuers and investors alike need between shareholders and boards that are not to be wary of “buying peace” (which can sometimes accounted for in publicly available data. The rise in prove to be illusory or short-lived at best) at too great settlements, especially in board-related activism, is a price. not surprising. It is consistent with the maturation of the activist market and reflects an acknowledgment, Branding the settlement. Parties wishing to on both sides, of the costs associated with lengthy achieve a mutually agreeable outcome are contests. In addition, the rise in board-related activist 1 increasingly using more descriptive titles for settlements is likely due to the fact that board-related their settlement agreements, as well as different activism better lends itself to settlement because it terms within them, to better signal and achieve provides a path forward that is based on cooperation. their objectives. For example, while naming an In contrast, balance sheet activism and event-related agreement “settlement agreement” may seem activism, such as M&A activism or one-off situations, simple and be unlikely to garner attention, it can may not be as amendable to settlement as the connote the parties’ laying down their arms and contest may revolve around two different and wholly compromising on an outcome. In some cases, irreconcilable visions for the future of the target. referring to the agreement as a “board refreshment agreement” may better indicate that the agreement Regardless of the type of activism faced by issuers was the result of constructive discussions aimed and undertaken by activists, where there may be at enhancing a board’s existing complement of some middle ground, both sides are well-advised to skills and experiences, rather than in response to
63 Davies | dwpv.com activist demands. In other contexts, titles such Nomination of directors. Perhaps the most as “cooperation agreement” or “stewardship common feature of any settlement agreement agreement” may suggest that the parties’ interests 3 is the right granted to the shareholder to are aligned with a view toward the long-term nominate an agreed number of directors to the issuer’s interests of all shareholders, eliminating the focus on board. This is of course not surprising since board- a presumed fight or assumed short-term demands related change is still the most common objective of often (and sometimes inappropriately) associated an activist campaign. The nomination right typically with activist campaigns. With the universe of requires the issuer to appoint the shareholder’s director activists and their objectives expanding, finding the nominees to the board immediately and to nominate right way to convey the parties’ intentions can be such directors for election at the upcoming (and critical to achieving a settlement in the first place sometimes subsequent) annual shareholders’ meeting. and appropriately signalling those objectives to the Importantly, however, gaining board representation market. Even in this context, words matter. is often a means to the investor achieving some other objective, not an end itself; therefore, having Term and duration. Settlement agreements an agreement that solely entitles the shareholder to typically terminate after a finite period of board representation may not be sufficient. As such, 2 time. The termination date is often tied to the this right is typically accompanied by a variety of other date of the issuer’s upcoming annual shareholders’ investor rights, such as a requirement that the issuer meeting, whether immediately following the meeting appoint the shareholder’s director nominees to certain or upon a related deadline such as the nomination board committees and/or the creation of new board deadline under the issuer’s advance notice bylaws. committees (such as a strategic review committee). The agreement, or certain terms, may also terminate once the engaged shareholder’s director nominee A settlement agreement may also include a provision no longer serves on the issuer’s board or once the barring the issuer from expanding the board beyond a shareholder’s ownership in the issuer falls below a certain size to ensure that the influence afforded to the threshold level. shareholder’s director nominees is not diluted at a later date. Conversely, if the maximum number of directors Many settlements include standstill provisions, permitted under the issuer’s articles already serve on as discussed below, which may have their own the board, and no incumbent directors intend to resign, termination date. While the duration of an agreement the agreement may include a requirement that the or its standstill provision will depend on the issuer increase the board’s size to accommodate the surrounding context, it is generally advisable for the appointment of the shareholder’s nominees. agreement’s rights and restrictions to overlap and expire at the same time. Additionally, it is important An activist with a larger stake in the issuer will generally to ensure that the timeframes selected provide the have more leverage to negotiate for the appointment issuer with sufficient opportunity to execute its long- of a greater number of director nominees under a term strategy and for the activist to implement its settlement agreement. If the parties cannot agree on objectives, since the agreement (and any standstill) the number of director nominees to be appointed to will provide for peace only while it is in force. the board, a reasonable compromise may be to agree to appoint an independent director who is mutually acceptable to the issuer and the shareholder.
Governance Insights 2020 64 CHAPTER 04 Shareholder Activism Abates, but Not for Long: Significant Activity and Developments in 2020
Our Take (Cont'd)
Standstill provision. One of the most as adding the shareholder’s director nominees to important concessions an activist shareholder the issuer’s board or making other changes to the 4 can make is agreeing to a standstill. A board’s composition. The issuer may also agree to standstill provision specifies a period during which take certain corporate or operational actions, such the shareholder agrees to refrain from certain as replacing the CEO, commencing a share buyback activities designed to influence the control or program, paying out dividends or striking a committee policies of the issuer. And while standstills are more to explore the sale of the issuer or a portion of the common than not in settlement agreements, we issuer’s assets. have seen several cases in recent years involving “brand name” activists with a record of success, A standstill may also include share ownership where a negotiated outcome was achieved by the restrictions that prohibit a dissident shareholder from parties without any standstill. Standstill provisions trading in the issuer’s securities. These restrictions often include prohibitions on (i) soliciting proxies can be structured creatively in order to align the or seeking to influence or control the issuer or its dissident’s interests with the issuer and its broader policies; (ii) seeking to elect candidates to the issuer’s shareholder base. For example, a standstill may board; (iii) acting jointly or in concert with another require the shareholder to own at least 5% of the shareholder with respect to the issuer’s securities; issuer’s securities in order to maintain its nomination (iv) commencing a takeover bid or effecting or right. It may also prohibit the shareholder from participating in an extraordinary transaction involving acquiring more than 9.9% of the issuer’s securities, the issuer; (v) putting forward a shareholder proposal; thereby preventing the shareholder from obtaining too (vi) requisitioning a shareholders’ meeting of the large and influential an equity stake. issuer; or (vii) making public statements concerning any of the foregoing. They also typically release the Voting obligations. A settlement agreement investor from its obligations upon the occurrence of that contemplates the appointment of a certain events – known as a “spring,” such as upon 5 shareholder’s director nominees typically the issuer approving or announcing a change of includes a provision requiring the issuer to support control transaction. the election of those nominees at the issuer’s annual shareholders’ meetings in a manner no less In exchange for the standstill, the issuer may agree rigorous and favourable than the manner in which to take certain steps that would align the governance the issuer supports its other nominees. In exchange, of the issuer with the shareholder’s objectives, such the shareholder will typically agree to also support
65 Davies | dwpv.com Importantly, while a shareholder’s initial inclination is to seek reimbursement of its expenses, other considerations, including any adverse impact it may have on the independence of the shareholder or its director nominees, must be carefully evaluated.
the issuer’s director nominees. Depending on the Expense reimbursement. A settlement circumstances, this provision may also require the agreement may include an expense shareholder to support other business items in line 7 reimbursement provision stipulating that with the issuer board’s recommendations. the shareholder will be reimbursed for all or part of its contest-related expenses. An issuer will often Non-disparagement. Settlement agreements attempt to negotiate a cap on the reimbursement often, but not always, include a mutual non- amount. Conversely, a shareholder may resist a cap 6 disparagement clause requiring both the and instead propose to accept “reasonable” fees issuer and the shareholder not to make or release and expenses as a compromise. Importantly, while any disclosure or statement that would reasonably be a shareholder’s initial inclination may be to seek expected to undermine, disparage or reflect adversely reimbursement of its expenses, other considerations, on the other party. A non-disparagement provision including any adverse impact it may have on the typically includes a carve-out allowing either party to independence of the shareholder or its director make disclosure that it determines, after consulting nominees, must be carefully evaluated. In some cases with legal counsel, is legally required to be made. And it may be preferable to forgo expense reimbursement as with all other settlement agreement terms, the in exchange for other, more beneficial rights. language and scope of the non-disparagement clause matter, as does its duration. Typically, the length of While settlement agreements cover a lot of the same the non-disparagement obligations will dovetail with ground, as noted above, there is no one-size-fits-all the time periods associated with the standstill. Doing approach. Deciding whether or not (and when) to so is important to ensure that, once the shareholder settle, and on what terms, will depend on a variety of is sprung from the restrictions on its actions, the non- factors. Increasingly, we see greater variation in the disparagement restrictions do not indirectly prevent terms of settlements. And those terms should in all it from doing what it may directly wish to do, such as cases be customized to reflect the parties’ principal solicit proxies. The non-disparagement obligations will objectives. also typically fall away in the event of a breach of the agreement by a party, so that the non-breaching party is not hamstrung in its ability to take action in the face of a breach.
Governance Insights 2020 66 CHAPTER 05
Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
67 Davies | dwpv.com In Canada, virtual shareholders’ meetings began growing in popularity in 2019. A year later, they have become the new normal in a period devoid of normalcy. In this chapter, we explore how the COVID-19 pandemic has changed the landscape of annual shareholders’ meetings, and discuss key considerations for issuers evaluating whether and how to hold a virtual meeting in the current and post-pandemic eras. We expect the number of virtual-only meetings in 2021 to be significantly higher than that in 2019, particularly in the absence of a vaccine prior to the start of the 2021 proxy season; however, in the medium to long term, we predict a substantial portion of Canadian reporting issuers will revert to in-person meetings supplemented by a virtual component (i.e., hybrid- virtual meetings).
Governance Insights 2020 68 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
Virtual Shareholders’ Meetings Prior to COVID-19 Recognizing the need for pragmatism, corporate and securities regulators, As discussed in Davies Governance Insights 2018,89 virtual shareholders’ meetings can facilitate shareholder stock exchanges and proxy advisory participation by enabling shareholders to attend firms reacted swiftly to craft workable meetings, listen to discussions, ask questions and vote their shares, all through the means of secure technology solutions to help safeguard the and without the cost and time of participating in person. health of all stakeholders without
There are two principal types of virtual shareholders’ disenfranchising shareholders. meetings:
– Hybrid-virtual meetings. These are traditional contemporaneously – whether because of technical in-person meetings that are supplemented by an constraints or the particular virtual format made electronic component whereby shareholders not available by the issuer. We discussed these and other physically attending the meeting can hear, and pros and cons of virtual shareholders’ meetings in Davies sometimes view, the meeting proceedings in real Governance Insights 2018.90 time, as well as ask questions and vote online contemporaneously. Changing Rules and Policies in – Virtual-only meetings. These meetings cannot be attended in person by shareholders. Accessing an Response to COVID-19 online portal is the sole means available to attend, ask The 2020 proxy season had already commenced when questions and vote at the meeting. the World Health Organization declared COVID-19 a global pandemic on March 11, 2020. The unfortunate Prior to COVID-19, the primary advantage of virtual timing left hundreds of issuers with upcoming annual shareholders’ meetings relative to traditional in- general (or general and special) shareholders’ meetings person meetings was increasing access to meetings (AGMs) scrambling to navigate corporate and securities for a greater number of shareholders, largely due laws, stock exchange requirements and leading proxy to the elimination of travel costs and reduced time advisory firms’ voting guidelines. These requirements commitments. Conversely, the primary disadvantage and guidelines presumed the feasibility of large in- of virtual meetings compared to traditional in-person person gatherings and provided little flexibility regarding meetings was, and still is, the potential to disenfranchise how and when AGMs could be held. Recognizing shareholders; this may be caused by limitations on the need for pragmatism, corporate and securities asking questions, meeting and speaking with the regulators, stock exchanges and proxy advisory issuer’s leadership in person and/or voting firms reacted swiftly to craft workable solutions to help safeguard the health of all stakeholders without disenfranchising shareholders.
69 Davies | dwpv.com TABLE 5-1: Relief and Guidance for AGMs During COVID-19
Date of Relief Organization or Guidance Summary of Relief or Guidance (2020)
– A corporation governed by the Business Corporations Act (Ontario) (OBCA) that was otherwise required to hold its AGM between March March 31 17 and July 24 , 2020, is instead permitted to hold its AGM by October Ontario (amended April 22, 2020. An OBCA corporation that was otherwise required to hold Government 24 and May 12 ) its AGM between July 25 and August 24 , 2020, can hold its AGM by November 23, 2020. An OBCA corporation can hold a virtual meeting even if virtual meetings are prohibited by its articles or bylaws.91
– The requirement for a corporation governed by the Business Corporations Act (Alberta) (ABCA) to convene an in-person shareholders’ meeting was suspended between March 17 and August Alberta April 9 14, 2020. Although an ABCA corporation is not prevented from holding Government a virtual shareholders’ meeting, the relief did not modify the provision of the ABCA requiring that the corporation’s bylaws specifically allow for virtual meetings.92
– A corporation governed by the Business Corporations Act (British Columbia) (BCBCA) that wanted to delay its AGM is granted a six- British month extension. A BCBCA corporation is permitted to hold a virtual- Columbia April 21 only meeting if the notice of meeting sent to shareholders explains Government how they can attend and vote, and as long as meeting participants can communicate with each other and vote.93
– A corporation governed by the Business Corporations Act (Québec ) (QBCA) is permitted to hold a virtual shareholders’ meeting even if a Québec April 26 virtual meeting is otherwise prohibited by its bylaws. In order to be valid, Government the technology must allow “all members to communicate with each other immediately.”94
– A corporation governed by the Canada Business Corporations Act (CBCA) that otherwise had to hold its AGM within 15 months of its previous AGM and within six months of its financial year-end is granted an extension until the earlier of (i) 21 months after its previous AGM and Federal July 31 no later than 12 months after its financial year-end; and (ii) December Government 31, 2020. A CBCA corporation can also present its financial statements to shareholders at the corporation’s AGM no later than 12 months after its last financial year-end, which extended the usual requirement by six months.95
Governance Insights 2020 70 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
TABLE 5-1: Relief and Guidance for AGMs During COVID-19 (Cont'd)
Date of Relief Organization or Guidance Summary of Relief or Guidance (2020)
– A reporting issuer converting its AGM to a virtual format is expected to notify securityholders, intermediaries and other market participants in a timely manner and disclose clear directions on the logistical details March 20 of the meeting. A reporting issuer involved in a proxy contest, holding a Canadian special meeting for an M&A transaction or seeking approval for a conflict Securities of interest transaction is expected to contact its principal regulator to Administrators discuss the appropriate steps in those circumstances.96
– A reporting issuer can avail itself of blanket relief from the requirements May 1 to file its executive compensation disclosure and send its annual financial statements and MD&A by the relevant deadlines.97
– A registrant can avail itself of a 45-day extension to file certain reports that would otherwise have been due between March 1 and July 1, March 4 2020. A registrant can also take advantage of an exemption from the (amended requirement to furnish proxy statements, annual reports and other March 25) soliciting materials to securityholders when mail delivery is not possible.98
U.S. Securities – An issuer that conducts a virtual meeting is expected to notify and Exchange shareholders, intermediaries and other market participants in a Commission timely manner and disclose clear directions on the logistical details of the meeting. An issuer is encouraged to allow shareholders or March 13 their representatives to present shareholder proposals through (amended alternative means (e.g., by phone). When printing and mailing delays April 7) are unavoidable, an issuer can use a “notice-only” delivery option if it provides shareholders with proxy materials sufficiently in advance of the meeting and allows them to exercise their voting rights in an informed manner.99
– An issuer listed on the Toronto Stock Exchange (TSX) or the TSX TSX and TSXV March 23 Venture Exchange (TSXV) is permitted to hold its AGM on any date in 2020.100
– Both Institutional Shareholder Services, Inc. (ISS) and Glass, Lewis & Co. Proxy March 19 and (Glass Lewis) have relaxed their views regarding virtual-only meetings Advisory April 8 as long as shareholders are able to participate meaningfully and Firms COVID-19 is disclosed as the reason for holding the meeting virtually.101
71 Davies | dwpv.com As represented in Figure 5-1, the number of AGMs with an in-person component (i.e., both in-person meetings and hybrid-virtual meetings) decreased significantly owing to the impracticability of large gatherings, particularly The number of AGMs between March and July 2020. With respect to issuers listed on the TSX with an in-person Composite and SmallCap indices, the number of in-person meetings plummeted from 268 (72.04%) in the 2019 proxy season to just 94 (27.89%) in the 2020 component (i.e., both proxy season. And the number of hybrid-virtual meetings hosted by those in-person meetings issuers decreased from 103 (27.69%) in the 2019 proxy season to 62 (18.40%) in the 2020 proxy season. Those decreases were offset by a spike in virtual- and hybrid-virtual only AGMs, which increased from one (0.27%) to a whopping 180 (53.71%) for meetings) decreased the corresponding periods. significantly owing to the impracticability of large gatherings, particularly between
FIGURE 5-1: Number and Type of Issuers’ AGMs on the TSX Composite March and July 2020. and SmallCap Indices (2019–2020)
2019 Proxy Season 2020 Proxy Season
0.27% In-Person Hybrid-Virtual Virtual-Only 27.69% 4% 27.89% 53.71%
72.04% 18.40%
Note: The data presented in the figure “2019 Proxy Season” include AGMs for which a management information circular was filed on SEDAR between August 1, 2018 and July 31, 2019; the data presented in the figure “2020 Proxy Season” include AGMs for which a management information circular was filed on SEDAR between August 1, 2019 and July 31, 2020.
Governance Insights 2020 72 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
Considerations for Future Virtual Shareholders’ Meetings An issuer’s ability to hold a virtual shareholders’ meeting depends on GOVERNING LEGISLATION AND its governing corporate legislation, its CONSTATING DOCUMENTS articles and its bylaws. An issuer’s ability to hold a virtual shareholders’ meeting depends on its governing corporate legislation, its articles and its bylaws. Some statutes, such as the OBCA, allow a shareholders’ meeting to be held by OTHER TOP CONSIDERATIONS electronic means unless the corporation’s articles or The decision whether to hold some form of virtual bylaws provide otherwise. Other statutes, such as AGM in the 2021 proxy season and beyond will be the CBCA, allow a meeting to be held by electronic influenced in large part by COVID-19 and the prevailing means only if the corporation’s bylaws expressly state of affairs from both health and legal perspectives. permit it. Corporate statutes also differ in whether and For example, ISS and Glass Lewis have taken a how quorum for a virtual meeting is established. The pragmatic approach to 2020 virtual-only AGMs in provisions of an issuer’s applicable corporate statute response to COVID-19; however, as the health crisis and its bylaws also determine the means by which dissipates (as we hope), proxy advisory firms could electronic voting is permitted and the degree to which revert to their traditional anti-virtual-only meeting shareholders must be able to communicate with each stances, rendering the holding of a virtual-only AGM other at a virtual meeting. too risky for some issuers.
Some statutes are so restrictive that an issuer may need The health and safety of an issuer’s stakeholders to obtain a court order to hold a virtual-only meeting. will also continue to be of paramount importance. As For example, certain major Canadian banks and life discussed in Chapter 8, ESG and Climate Change insurance companies issued a joint statement in March in the Shadow of COVID-19: “E,” “S” & G Are Here to 2020 announcing that they had obtained a court order Stay, environmental, social and governance (ESG) allowing them to hold their respective AGMs through issues continue to attract increased attention, making electronic means and authorizing alternative delivery it more important than ever for each issuer to evaluate methods for their proxy materials, which was not its particular circumstances in determining whether otherwise permitted by their governing legislation. to hold a virtual-only or hybrid-virtual AGM in 2021. This decision will be informed by a variety of factors, Issuers that are considering switching to a virtual format including the associated costs, the relative composition in the future and that have not already done so will want of its retail and institutional shareholder base, the past to start reviewing their governing legislation, articles and and expected impact of a virtual format on shareholder bylaws to determine what, if any, amendments may be turnout and participation, its peer group’s practices, the necessary or desirable to facilitate virtual participation potential impacts of an in-person meeting on the health and/or voting at their 2021 and future AGMs. and safety of its shareholders and other stakeholders, any continuing restrictions on travel and in-person gatherings and the nature and expected controversy of the business to be considered at the AGM.
73 Davies | dwpv.com Spotlight: 10 Practical Considerations When Holding a Virtual AGM
As a general proposition, issuers holding any shareholders’ meetings, whether in person or virtually, should strive to enfranchise shareholders and promote the exercise of their fundamental shareholder rights, including their right to elect directors. An issuer’s board and management should keep this overarching principle in mind when determining the format and/or location of the meeting, those entitled to attend, the facilities available for shareholders and proxyholders to speak and vote, and the information to be provided at the meeting. The following are 10 practical considerations that management and boards should address in determining whether, and how best, to host a virtual- only or hybrid-virtual shareholders’ meeting.
1. EARLY PLANNING Transitioning to a virtual AGM is a significant undertaking for many issuers. It requires assistance and input from various parties, including virtual-meeting platform providers, scrutineers and external legal counsel. During the 2020 proxy season, service providers were overwhelmed with requests as a wave of issuers looked to transition to virtual AGMs in response to COVID-19. While this level of unexpected and unprecedented demand is not likely to repeat itself, issuers would nevertheless be wise to begin planning their 2021 AGMs as early as possible to enable them to meet their desired or required timelines.
2. CHOOSING A PLATFORM One gating decision for any issuer planning to hold a virtual AGM is choosing the right platform on which to hold it. The primary criteria to consider include whether the platform allows for the authentication of attendees and facilitates voting and asking questions.It is preferable to use a platform that is designed for the purpose of hosting virtual AGMs, such as those offered by LUMI Global or Broadridge Financial Services, Inc., as opposed to traditional video-conference or dial-in services.
Governance Insights 2020 74 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
Spotlight (Cont'd)
3. PROXY MATERIALS 5. ACCESSING THE MEETING
Issuers should consider what information is material Issuers must decide whether to permit persons other and should be included in their public disclosure than shareholders and proxyholders (such as analysts, documents regarding holding or switching to a virtual employees or media representatives) to attend their meeting format (especially when moving to a virtual- virtual AGMs. A large majority of Canadian public only format). Issuers should consult the policies and companies allowed non-shareholders to attend their guidelines of influential corporate governance advisers virtual AGMs as guests in 2020, but implemented and institutional investors regarding recommended controls that prevented them from voting or asking best practices. As many of the participation features questions. Issuers must also determine whether to and voting mechanics of virtual AGMs can differ from publish the audio or webcast recording of the meeting traditional in-person AGMs, blind reliance on prior on their websites following the AGM. Doing so is a best years’ proxy disclosures is fraught with risk. Materials practice because it affords shareholders that were should be customized to ensure that they accurately unable to attend the meeting the opportunity to listen to and completely reflect the processes to be followed to and/or view it at their convenience. maximize shareholder participation.
6. SHAREHOLDER PROPOSALS 4. SHAREHOLDER AUTHENTICATION Consideration must be given to the way in which AND VOTING shareholders will be permitted to present shareholder Issuers must be able to verify that each participant proposals, be it in real time through a dial-in number or remotely accessing a virtual AGM is a legitimate by pre-recording an audio or video statement. Currently, shareholder or a duly appointed proxyholder. This task the most common method is an operator-assisted phone is usually delegated to a third-party service provider, and line that shareholders putting forward a proposal can verification is most frequently accomplished through call during the meeting. Whatever method is chosen, the unique code inserted in each shareholder’s proxy every effort should be made to ensure that shareholders materials that is used to access the meeting’s online have the ability to participate to the same extent that portal. Capable scrutineers and vote tabulators are key they otherwise would at an in-person meeting. to ensuring a fair, reliable and verifiable voting process; this is particularly important given the complexities inherent in the proxy voting system – complexities that can be magnified when voting via webcast or telephone is permitted in addition to voting in person and by proxy.
75 Davies | dwpv.com Issuers should consider what information is material and should be included in their public disclosure documents regarding holding or switching to a virtual meeting format.
7. GUARDING AGAINST TECHNICAL 9. AUDIO, SLIDESHOWS AND VIDEO COMPLICATIONS Although audio-only virtual meetings can typically Issuers should consider offering a technical support line satisfy Canadian legal requirements for holding a virtual through which shareholders may obtain assistance and meeting, some issuers choose to use slides and/or instructions when using virtual-meeting software. Issuers stream their AGMs by way of webcast. Some should also have contingency procedures in place in governance organizations and shareholders prefer the event of technological problems, such as a power or a visual element and the increased transparency network outage. To mitigate such issues, we recommend it provides. However, setting up the technology to that issuers structure their meeting agendas to conclude accommodate a visual component entails increased all voting and formal business as early as possible during costs and complexity, particularly if the visual the AGM. In large part due to potential IT issues, many component is more elaborate than a simple slideshow. issuers that held virtual AGMs in 2020 skipped their Some issuers are also concerned about the possibility of usual management presentations following the formal embarrassing moments being captured on camera. business; instead they opted to conduct these via more traditional investor calls, accompanied by presentations 10. DRAFTING SCRIPTS made available on their websites, immediately prior to their AGMs. It would also be prudent to have individuals When preparing the meeting script, issuers should on standby to fulfill the roles of chair, secretary, mover carefully consider the practicalities of running a virtual and seconder in case any of the individuals intended to meeting to ensure that the AGM runs smoothly and act in these capacities experience technical difficulties anticipates various contingencies. For example, it is that prevent them from participating. important that the script addresses the information that shareholders will need to vote and ask questions during the meeting. In addition, the script should contemplate 8. SHAREHOLDER QUESTIONS all speakers stating their names before speaking – How will shareholders be permitted to ask questions particularly if there is no live video component – and during a virtual meeting? For example, must questions muting their microphones at all other times. be submitted in advance? Will questions be allowed via text messaging in real time or can they be asked live through a dial-in number managed by an operator? See “Responding to Virtual Questions and Comments,” below, for further guidance on best practices for responding to questions and comments.
Governance Insights 2020 76 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
RESPONDING TO VIRTUAL QUESTIONS AND COMMENTS
Shareholders and duly appointed proxyholders have a fundamental right Regardless of the to speak and be heard at an AGM, subject to certain limited exceptions. means by which Regardless of the means by which questions are submitted, as a best practice, all proper questions relating to an issuer’s business should be read aloud and questions are answered at the meeting. Although this could create an awkward dynamic in certain situations, including when the comments are critical of the issuer or submitted, as a members of its leadership team, it is imperative that all proper questions and best practice, all comments be addressed as they would be at an in-person meeting. proper questions As Q&A sessions can be quite time-consuming, we recommend that issuers relating to an employ the following techniques to ensure that questions are dealt with both appropriately and efficiently: issuer’s business should be read – It is advisable to provide a means by which shareholders and duly appointed proxyholders can submit questions prior to the AGM. This will provide an aloud and issuer with the opportunity to consolidate the questions, as appropriate, answered at the and answer them at the relevant time during the AGM. It can also facilitate planning for the meeting by ensuring that the issuer’s representatives are well meeting. prepared to respond to the concerns that are most important to the issuer’s shareholders.
– At the outset of the AGM, when describing the meeting procedures, the chair should clearly outline the protocol for shareholders and proxyholders to speak at the meeting. Typically, this will require speakers to wait to be recognized by the chair and then to identify themselves as registered shareholders or proxyholders. The chair of the meeting should consistently follow the articulated protocol throughout the meeting to promote the fair and equitable treatment of those entitled to speak and to preserve the integrity of the meeting.
– When the same or similar questions are asked by several shareholders and proxyholders, it is acceptable to respond to those questions together as long as the substance of each proper question is addressed. It is common practice to have a representative of the issuer (such as its general counsel or secretary) marshal the questions, although in some cases it may be appropriate to appoint an independent moderator to fulfill this role. In either case, it is crucial that the individual managing the questions does so in good faith to avoid potential criticism.
77 Davies | dwpv.com Virtual Shareholders’ Meetings on Significant or Contentious Matters
The above considerations are relevant for all virtual AGMs. However, additional factors come into play if an issuer intends to hold a virtual meeting at which significant or contentious matters will be considered and voted upon by shareholders. For these purposes, significant or contentious matters include mergers and going-private transactions, related party transactions, substantial share issuances, contested director elections, shareholder proposals and material amendments to articles and bylaws. They typically do not include relatively routine business, such as the approval of stock option plans or advisory votes on executive compensation.
The 2020 proxy season demonstrated that it is possible, albeit more challenging, for issuers to hold virtual-only meetings for significant or contentious matters. Twenty-eight issuers (8.31%) listed on the TSX Composite and SmallCap indices held virtual-only meetings at which such matters (broken out in Figure 5-2) were put to shareholders. However, almost all of these meetings were held in the midst of the COVID-19 pandemic. Accordingly, issuers should be wary about relying on these meetings as precedents in the absence of similarly exceptional circumstances. Even in extenuating circumstances, it may not be feasible or advisable to hold a virtual meeting (especially a virtual-only meeting) to consider significant or contentious matters, whether due to technological limitations, an unwillingness of virtual meeting service providers to accept liability in the event of a malfunction or an elevated risk of litigation or regulatory intervention.
Governance Insights 2020 78 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
FIGURE 5-2: Issuers on the TSX Composite and SmallCap Indices that Held Virtual-Only Meetings for Significant or Contentious Matters, by Type of Matter Considered (2020)
0% 3.57% 0% Amendments to Articles or Bylaws Mergers or Going Private Transactions 7.14% Shareholder Proposals 4% 17.86% Substantial Share Issuances Related Party Transactions Contested Director Elections
71.43%
CONTESTED VIRTUAL-ONLY MEETINGS IN THE UNITED STATES
Although virtual-only proxy contests were non- – First United Corporation defeated Driver Opportunity existent in Canada during the 2020 proxy season, Partners I LP, which sought to elect three directors to five reached a vote in the United States: First United’s board.
– Saba Capital Management, LP succeeded in – Privet Fund LP and UPG Enterprises LLC managed having three directors appointed to the 11-person to have three of their nominees elected to the eight- board of trustees of Eaton Vance Floating Rate person board of directors of Synalloy Corporation. Income Plus Fund. Although shareholders were able to vote by electronic – TEGNA Inc. fended off Standard General LP, ballot at the Eaton Vance, First United and Synalloy which sought to replace five of the 12 directors on shareholders’ meetings, shareholders of TEGNA and TEGNA’s board. GCP Applied Technologies were required to download, print, execute and email a ballot to the inspector of – Starboard Value LP successfully replaced eight election before the polls closed. of the nine incumbent directors of GCP Applied Technologies Inc.
79 Davies | dwpv.com Spotlight: Guidelines for Virtual Meetings on Significant or Contentious Matters
1. OBTAIN THE CONSENT OF PARTIES THAT MAY OBJECT TO A VIRTUAL MEETING
Shareholders and proxyholders log in to a virtual AGM with a unique code often referred to as a “control number.” However, it is possible for that control number to be given to, or stolen by, someone who does not have legal authority to vote the associated shares. Unlike a traditional in-person meeting where the scrutineer verifies the identity of each attendee, verification is impossible in a virtual context and could lead to the validity of the voting results being called into question. Although this is an issue for every virtual- only and hybrid-virtual AGM, meetings involving contested director elections or the approval of a transaction for which there is significant shareholder opposition can exacerbate litigation risk.
It would be prudent for issuers to address this problem before it arises, if possible. For a contested director election, the issuer might explore whether a dissident shareholder would be willing to enter into a negotiated meeting protocol agreement that provides that the inability of the scrutineer to verify voters’ identities will not constitute a basis on which to dispute the meeting results. In a transactional context, similar comfort may be obtained via a court order, particularly if the transaction is a plan of arrangement for which court approval is already required.
Governance Insights 2020 80 CHAPTER 05 Let’s Take This Online: Virtual Shareholders’ Meetings in 2020 and Beyond
Spotlight (Cont'd)
2. CONSULT THE ISSUER’S PRINCIPAL 4. MAXIMIZE COMMUNICATION AMONG SECURITIES REGULATOR SHAREHOLDERS AT THE MEETING
A reporting issuer should consult its principal securities Some corporate statutes require that all meeting regulator prior to proceeding with a virtual-only meeting participants be able to communicate “adequately” at which significant or contentious business will be with each other during the meeting. However, exactly considered. Securities regulators’ primary concern is to what constitutes adequate communication is unclear. ensure that all shareholders have the right to participate Most virtual meeting platforms allow issuers to control at the meeting. Regulators have broad public interest whether questions or comments submitted during the powers that they can use if they believe that an issuer is meeting are visible only to the issuer or can be seen holding a virtual-only meeting for tactical reasons or in by the other attendees. When putting special business a manner that otherwise disenfranchises shareholders. to shareholders, issuers should err on the side of Candour and transparency prior to any public maximizing disclosure to pre-empt any disgruntled announcement that a meeting will be virtual-only can go shareholders’ challenges after the meeting that could a long way to avoid costly and potentially embarrassing allege it was not held in compliance with applicable law. issues down the road.
3. CONSIDER POTENTIAL ISSUES WITH DEMONSTRATING FAIRNESS FOR A PLAN OF ARRANGEMENT
A transaction that proceeds by way of a plan of arrangement requires court approval, which in turn requires an issuer to demonstrate that the arrangement is “fair and reasonable.” This is achieved in part through various procedural protections that an interim court order sets out for the meeting at which shareholders will be asked to approve the transaction. A common provision in such orders is that shareholders and proxyholders will be entitled to attend and speak at the meeting. A court may have concerns if shareholders are unable to ask questions or question the transaction to the same extent that they otherwise could if the meeting were held in person. An issuer’s proxy materials should invite shareholders to submit questions and comments in advance of a virtual-only meeting, and these should be read at the meeting. To the extent possible, an issuer should work with its virtual meeting service provider to give shareholders or proxyholders wishing to speak the means to do so.
81 Davies | dwpv.com Our Take: Brave New (Virtual) World
Assuming COVID-19 no longer poses a significant health and safety concern in Canada in 2021 and beyond, the number of virtual AGMs held in 2020 is likely to represent the high-water mark for the next several years. Nevertheless, we expect the total number of virtual AGMs in 2021 to dwarf the total in 2019, given many issuers’ newfound experience with the futuristic format and shareholders’ newly minted expectations that virtual attendance should always be an option. Both ISS and Glass Lewis are likely to address the issue of virtual meetings in their respective 2021 guidelines (typically issued late fall), which will largely depend on the global health situation.
We expect that hybrid-virtual meetings will be viewed by many as the gold standard since they enable more shareholders to access meetings, while affording those who wish to attend in person the option to do so. Virtual-only meetings, however, will likely continue to be met with opposition out of concern that the format impedes shareholder engagement and communication. Issuers need to be particularly mindful of the risks associated with holding virtual-only meetings at which significant or contentious business will be considered.
Governance Insights 2020 82 CHAPTER 06
Executive Decisions: Compensation Trends In and Outside of Times of Crisis
83 Davies | dwpv.com The reasonableness of executive compensation arrangements has long been a contentious issue. The COVID-19 pandemic has accelerated pre-existing trends and introduced new challenges, including increased concerns about the widening pay gap between executives and the average Canadian employee, as well as demands for greater proportionality of outcomes for issuers’ various stakeholders. In this chapter, we explore the ways public issuers in Canada and the United States have adjusted their compensation structures in response to unanticipated disruptions. We also provide guidance for boards and compensation committees considering recalibrating their compensation plans. Finally, we discuss the pandemic’s impact on both current year and future say-on-pay votes and some renewed calls for mandatory pay ratio disclosure in Canada.
Governance Insights 2020 84 CHAPTER 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis
COVID-19’s Immediate Impact: Director and Senior Executive Among those Russell 3000 index issuers that implemented reductions Salary Reductions and Freezes in executive compensation in 2020, As the COVID-19 pandemic spread to North America, resulting in widespread lockdowns and significant the extent of the reductions varied economic disruption, many issuers in Canada and widely, both among issuers and the United States faced little choice but to suspend dividends, lay off staff and implement wage reductions. internally between the CEO and other A significant number of these issuers determined that executive officers. it was important that management show solidarity with both shareholders and employees. Issuers that found themselves appealing for government support also faced market and political pressure for their senior Similarly, in the United States, data released by The executives to share the economic pain associated with Conference Board, Inc., in collaboration with Semler the health crisis. Brossy and ESGAUGE Analytics, indicate that, as of August 14, 2020, only 636 issuers (representing just As a result, between late March and early May 2020, 21.2%) on the Russell 3000 index had announced many issuers announced reductions to, or deferrals of, executive pay reductions or deferrals.104 executive and/or director pay.
A QUESTION OF DEGREE: THE VARIED MANY REDUCTIONS DO NOT A MAGNITUDE OF PAY REDUCTIONS TREND MAKE Among those Russell 3000 index issuers that It has been said that the plural of “anecdote” is not implemented reductions in executive compensation “data.” Despite the stream of announcements of in 2020, the extent of the reductions varied widely, executive pay cuts, which might have led the average both among issuers and internally between the CEO news consumer to conclude that executive pay and other executive officers. Studies show that the reductions in the face of COVID-19 were the norm, the majority of CEOs among those issuers that reduced data suggest that these measures were not particularly compensation temporarily cut their salaries between widespread among North American issuers. 20% and 50% (see Figure 6-2).105 The time frames for those reductions ranged from an indefinite period to As of June 20, 2020, studies found that only 51 (3.1%) of a fixed period with the potential for extension. Some over 1,600 issuers listed on the Toronto Stock Exchange CEOs, particularly in industries that were significantly (TSX) had publicly announced changes to their pay adversely affected by COVID-19, such as airlines and practices in response to COVID-19 (see Figure 6-1),102 hospitality, forwent their salaries entirely. with only 18% of those being constituents of the TSX 60.103
85 Davies | dwpv.com FIGURE 6-1: Publicly Disclosed CEO Base Salary Reductions by TSX-Listed Issuers (as of July 20, 2020) As of June 20, 2020, studies found that Percent of Total Base Salary
25 only 51 of over 1,600 22% 20% issuers listed on the 20 18% 18% TSX had publicly
15 14% announced changes to their pay practices 10 8%
Percent of Issuers of Percent in response to
Percent of Issuers of Percent 5 COVID-19. Studies 2% 0 show that the 0-20% 20% 20-50% 50% 50-100% 100% % Not disclosed majority of CEOs Source: Hugessen Consulting102 among those issuers that reduced compensation FIGURE 6-2: Publicly Disclosed CEO Base Salary Reductions by temporarily cut their Russell 3000 Index Issuers (as of August 14, 2020) salaries between 20% and 50%. Percent of Total Base Salary
25 23% 22%
20 17%
14% 15 13%
10 8% Percent of Issuers of Percent
5 Percent of Issuers of Percent 3%
0 0-20% 20% 20-50% 50% 50-100% 100% % TBD
Source: The Conference Board, Inc.104
Governance Insights 2020 86 CHAPTER 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis
Spotlight: The Walt Disney Company under Scrutiny
Of the issuers facing heightened scrutiny surrounding CEO Bob Chapek’s pay packages in comparison executive compensation in light of the effects of with those of their peers, as well as the lack of COVID-19, The Walt Disney Company, which is listed on rigour in performance metrics. These factors, they the New York Stock Exchange (NYSE), has been among concluded, resulted in outsized rewards for median the most heavily scrutinized for its approach to performance or even significant underperformance.107 executive compensation. The spread and effects of COVID-19 compounded the Prior to the pandemic, Disney had already faced adverse optics of Disney’s executive compensation controversy relating to its executive compensation practices. In response to the pandemic, Disney arrangements. Both institutional shareholders and announced on March 30, 2020 that certain named proxy advisory firms have for many years expressed executive officers, including Messrs. Iger and Chapek, dissatisfaction with the pay package of former CEO and had agreed to temporary reductions in their base current executive chair, Bob Iger. According to its public salaries, with Mr. Iger forgoing nearly 100% of his base disclosure, Disney engaged shareholders in its executive salary through the end of 2020 and Mr. Chapek forgoing compensation decision-making process in fiscal 2019, 50%. However, Disney stated that all provisions under consulting with approximately 74% of its largest 50 the executives’ employment agreements would continue shareholders. As a result of this outreach and in an to be based on their full base salary.108 According to effort to assuage investor concerns, Disney reportedly CGLytics, Mr. Iger’s temporary salary reduction amounts reduced Mr. Iger’s compensation for fiscal 2019 on three to US$2.25 million, which represents only 3.3% of his separate occasions.106 total realized 2019 compensation of US$47.5 million.109
Nevertheless, in early March 2020, Disney’s say-on-pay These reductions were perceived to be little more than vote was approved by only a slim majority – 53%, down token gestures, particularly in the context of Disney’s from 57% in 2019. Proxy advisory firms Institutional announcement that it would furlough (U.S. terminology Shareholder Services Inc. (ISS) and Glass, Lewis & Co. for “lay off”) more than 100,000 workers owing to (Glass Lewis) recommended that shareholders vote the pandemic. Since then, there have been continued against the compensation resolution owing to their widespread calls for Disney to recalibrate its executive concerns with the size of both Mr. Iger’s and the current pay structures.110
87 Davies | dwpv.com INDUSTRY BREAKDOWN
Initially, those issuers announcing temporary reductions or freezes in salary While initially were in the heaviest-hit sectors, including travel, hospitality and what some lauded by some, might call “non-essential” retail. However, several issuers in other industries quickly paralleled these measures in response to COVID-19, with the result that the executive pay we saw temporary reductions or freezes in salary across several industries, including information technology, media, energy, industrial machinery, real cuts in response to estate, healthcare and financial services (see Figure 6-3).111 COVID-19 quickly
In the oil sector, the pandemic coincided with a significant drop in the price of drew criticism crude (with the former exacerbating the effects of the latter); however, no data from a number are currently available to indicate what portion of issuers’ pay measures in 2020 were attributable to one cause versus the other. of institutional investors, proxy FIGURE 6-3: Industry Breakdown of Executive Base Salary Reductions by advisory firms, the TSX-Listed Issuers (as of July 20, 2020) media and large U.S. labour unions. Energy (23) 4% 4% Industrials (9) 8% 18% Consumer Discretionary (9) Communication Services (4)
4% 17% Materials (2) Information Technology (2) Health Care (2)
45%
Source: Hugessen Consulting102
ANNOUNCED EXECUTIVE PAY CUTS DRAW CRITICISM
While initially lauded by some, the executive pay cuts in response to COVID-19 quickly drew criticism from a number of institutional investors, proxy advisory firms, the media and large U.S. labour unions. Their main argument was that the reductions were largely symbolic and did not represent a meaningful sacrifice
Governance Insights 2020 88 CHAPTER 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis
on executives’ part, given that most of the announced reductions or freezes related solely to base salary and not the more lucrative bonus, incentive plan, equity and Boards and compensation pension entitlements that typically constitute the major committees will need to consider portion of an executive’s total compensation. how, if at all, existing metrics should In fact, the results of a July 2020 survey by CGLytics be adjusted to take this new reality of approximately 3,000 U.S. public issuers suggests that cuts to executive pay were, overall, “minimal,” with into account. two-thirds of CEOs’ reductions being only 10% or less of their total compensation for fiscal 2019.112 ADJUSTMENTS TO EXISTING Given the widespread use of relative rather than PERFORMANCE METRICS AND absolute shareholder returns as a metric for CONSIDERATIONS FOR FUTURE METRICS performance, many executives will likely remain eligible for payouts at least in-line with historical levels, ISS and Glass Lewis are relatively open to issuers despite depressed share performance. Boards and adjusting annual incentives, provided those adjustments compensation committees will need to consider the are made in accordance with their established 113 potential reputational risks and the risks to investor guidelines. However, both firms have expressed and employee relations that may arise as a result of increased reservations with adjustments to long-term increased scrutiny at bonus time, particularly at issuers incentives. Moreover, executive compensation advisers that temporarily laid off employees, consolidated and and consultants are warning issuers against drastic or rationalized worksites and workforces, or suspended or overly formalistic mid-year changes to existing goals 114 cut dividends. and targets in the midst of significant uncertainty. Put simply, interim action for the sake of activity may be frowned upon until the COVID-19 dust has settled Performance Metrics in a and issuers have a more holistic view of where they Time of Crisis have landed. For boards and compensation committees considering Given the volatility and uncertainty caused by adjustments, ISS and Glass Lewis, as well as executive COVID-19, many issuers may find themselves with compensation consulting firms like Semler Brossy executive performance metrics, goals and targets and Hugessen Consulting,115 recommend the following that have become unrealistic and unattainable in the guiding principles: current economic climate. Boards and compensation committees will therefore need to consider how, if at Balance and proportionality. Boards and all, existing metrics should be adjusted to take this compensation committees should balance the new reality into account. In doing so, directors should 1 priorities of management, shareholders and issuers’ consider the upside and downside implications of any broader group of stakeholders, such as employees, move to more discretionary compensation awards. business partners and customers, in order to ensure a greater proportionality of outcomes.
89 Davies | dwpv.com A holistic approach. Boards and compensation committees should take a 2 holistic approach to compensation arrangements, putting a greater emphasis on long-term incentives. Doing so will ideally reduce the need to Boards and adjust incentives on a short-term (e.g., annual) basis. compensation
Transparency and communication. Boards and compensation committees committees 3 should increase communication and transparency at every level. This should take a can be accomplished by maintaining an ongoing dialogue between the board and management regarding executive performance and providing robust holistic approach and, if possible, contemporaneous public disclosure of the rationale for any to compensation adjustments to performance metrics, goals or targets. arrangements, Alignment of awards and results. There are various ways in which putting a greater 4 issuers can ensure that executive incentive awards are aligned with results. These include recalibrating the definition of “good performance” and adjusting emphasis on long- performance metrics to take into account shifting priorities due to COVID-19, term incentives. separating annual incentive plans for the second half of the year or for the fourth quarter, and/or even allowing the board to have discretion in making such awards.
Consider long-term effects. In adjusting or setting performance metrics 5 for short-term awards, boards and compensation committees should consider the longer-term perceptions and expectations any adjustments could create among executives for the future.
EQUITY-BASED AWARDS AND THE POTENTIAL FOR WINDFALLS
Many executives’ recently granted equity-based compensation awards may undergo fluctuations in value that, prior to COVID-19, could not have been reasonably expected (although far from all issuers have experienced stock price declines in the COVID-19 era, and some issuers’ businesses have benefited significantly).
The shifting of stock options to underwater status may have ramifications for long-term retention or, at least, morale of executives and other key employees.
Perhaps as expected, consultants and proxy advisory firms have warned against making any changes to formulaic approaches to equity awards. For example, both ISS and Glass Lewis are firmly opposed to issuers repricing, replacing, exchanging or regranting underwater options unless timely shareholder approval is obtained.116
Governance Insights 2020 90 CHAPTER 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis
LESSONS LEARNED FROM MANDATORY PAY When boards and compensation committees RATIO DISCLOSURE IN THE UNITED STATES provide new equity grants at current depressed AND THE UNITED KINGDOM prices, which may be seen as an attractive way to make up for forgone salaries or share As discussed in Davies Governance Insights 2018, drops in the longer-term, they should heed both the U.S. and the U.K. have mandated pay ratio the lessons learned after the Great Recession disclosure. In the years since those disclosure and be cautious to avoid windfalls – or the requirements were adopted, Canadian investors and perception of windfalls – that could negatively stakeholders have had the opportunity to scrutinize the affect issuers’ reputations among shareholders effects of disclosure in those countries. and other stakeholders. Long-term incentive grants should be tested for dilution and The flexibility permitted within the U.S. disclosure potential gains upon recovery of the stock regime has, to some extent, undermined the usefulness market. It might also be prudent when of the disclosure, as it continues to result in significant establishing grant formulas to leave room for variance between the disclosed ratios, even among discretion or to fix caps on payouts. issuers in the same industry.
To date, it appears that no U.S. company has won or lost AN INCREASED ROLE FOR vote support on the basis of its pay ratio disclosure.117 In (MEASURED) BOARD DISCRETION 2019, both ISS and Glass Lewis stated that they would The discretion of boards and compensation include CEO pay ratio disclosure in their proxy papers, committees can be a useful tool in times of but the ratio would not be considered in future voting crisis. However, the exercise of discretion in recommendations. According to researchers at Equilar, making compensation decisions is likely to be Inc., data from the first three years of mandatory CEO scrutinized in the current climate. pay ratio disclosure in the United States show a general trend of higher median pay ratios among issuers with Some recommendations for discretionary low levels of say-on-pay support. However, the data is decision-making that have arisen in recent inconclusive with respect to whether or not lower CEO literature include the following:120 pay ratios helped to improve say-on-pay support among shareholders.118 – Establish ongoing communication between the board or compensation committee and The U.K. regime provides less flexibility. It requires management with respect to performance, issuers to choose among three concrete methodologies potential variances and the resulting pay in to calculate the CEO pay ratio. High Pay Centre, a U.K. order to maintain transparency and avoid corporate governance think tank, has identified that the surprises at year-end. median ratio between the CEO and the lower quartile – Make decisions in-line with the issuer’s threshold of the pay distribution was 78:1 in the FTSE broader compensation philosophy. 350 issuer size category, and 109:1 among the more capitalized FTSE 100 companies.119
91 Davies | dwpv.com – Implement objective measures to govern the exercise of discretion (e.g., materiality thresholds for variances or caps on payouts) and ensure discretion is applied Worldwide, just 9% of FTSE All consistently. World companies have incorporated – Consider public perception. ESG criteria into their incentive – Publicly disclose the rationales for the amounts paid, scorecards and, as in Canada, those as well as the need to depart from the company’s pre- established incentive formulas (if applicable). criteria focus on occupational health and safety concerns. ENVIRONMENTAL, SOCIAL AND GOVERNANCE METRICS
There is increasing pressure in some quarters, which See Chapter 8, ESG and Climate Change in the predated the COVID-19 outbreak, for boards and Shadow of COVID-19: “E,” “S” & G Are Here to Stay compensation committees to consider the addition for our discussion of ESG trends and developments of environmental, social and governance (ESG) more generally. benchmarks for incentive awards, particularly criteria relating to the “social” prong of ESG. The Future of Say-on-Pay Reports show that 65% of TSX 60 issuers have in some way linked executive pay to ESG criteria, the UPDATED PROXY VOTING GUIDELINES majority of which are related to occupational health Prior to the spread of COVID-19 in Canada, Glass Lewis 121 and safety in the oil and gas sector. Worldwide, just modified its proxy voting guidelines relating to say-on- 9% of FTSE All World companies have incorporated pay in ways that are increasingly relevant in the context ESG criteria into their incentive scorecards and, as in of any significant disruption, including COVID-19. The Canada, those criteria focus on occupational health two main changes were:124 and safety concerns.122 – the inclusion of the following three additional We have begun to see heightened scrutiny from problematic pay practices: institutional investors that are demanding a greater > targeting – without adequate justification – overall focus on ESG as it relates to executive compensation, levels of compensation at higher than the median including short- and long-term incentives. We expect level relative to the issuer’s peer group; that COVID-19 will accelerate this trend, given the > payment of discretionary bonuses when short- or confluence of layoffs, government-driven or other long-term incentive plan targets were not met; and publicly backed support packages for businesses, and the general disruption and increased risks in many > insufficient response to low shareholder support; and employees’ day-to-day working environment.123 – a requirement that boards demonstrate engagement and responsiveness to concerns of shareholders in the event that a say-on-pay vote receives at least 20% of shareholder opposition.
Governance Insights 2020 92 CHAPTER 06 Executive Decisions: Compensation Trends In and Outside of Times of Crisis
SAY-ON-PAY IN 2020 AND BEYOND
The COVID-19 pandemic and resulting heightened scrutiny of executive The COVID-19 compensation does not seem to have had any significant impact on say-on- pandemic pay votes in Canada in 2020. This year’s say-on-pay vote results are largely in keeping with those in previous years. We note a slight decrease in the and resulting percentage of Composite Index and SmallCap Index issuers that had a say- heightened scrutiny on-pay shareholder approval level greater than 85% (from 91% in 2019 to 86% in 2020) but, on the other hand, a marked increase in the percentage that of executive received approval levels greater than 95% (from 38% in 2019 to 60% in 2020). compensation does Among the 186 Composite Index and SmallCap Index issuers that put forward not seem to have say-on-pay resolutions in the 2020 proxy season, the average shareholder support was 93%, and there were no failed say-on-pay proposals. Nevertheless, had any significant as discussed above, as the economy recovers, issuers can expect an even impact on say- higher level of scrutiny than usual for compensation proposals. on-pay votes in Calls for Pay Ratio Disclosure in Canada Canada in 2020.
In 2019, median CEO total direct compensation increased by 12% among TSX 60 issuers.125 In 2020, the COVID-19 crisis arrived and created or exacerbated economic hardship across the country for many Canadians, with two million fewer jobs in Canada in July 2020 than at the start of the pandemic.126 Layoffs and pay cuts have revived demands for wage transparency, including some calls for mandatory disclosure of the ratio of CEO compensation to that of a median employee (pay ratio or vertical compensation ratio).
Elevated pay ratios have been a source of criticism in Canada for some time. In a 2017 policy paper, the Institute for Governance of Private and Public Organizations (IGOPP) drew attention to the increase in compensation of executives compared with that of the average Canadian private sector worker at the time. IGOPP’s paper noted that the ratio between the median compensation of a Canadian CEO and the average salary of employees had grown from 62:1 in 1998 to 140.1:1 in 2016.127 The ratios in Canada’s banking industry are even higher, at 184:1 in 2016.
93 Davies | dwpv.com Other activist organizations have also weighed in. The Shareholder Association of Research and Education (SHARE) has urged Canadian securities regulators to mandate pay ratio disclosures.128 In addition, Le Mouvement d’éducation et de défense des actionnaires (MÉDAC) has in recent years repeatedly called for Canada’s big six banks129 to voluntarily disclose pay ratios (see “Canadian Big Banks’ Diverging Approaches to Voluntary Pay Ratio Disclosure,” below).
That said, the majority of large Canadian shareholders have not been vocal in their support for pay ratio disclosure, and the proxy voting guidelines of several major shareholders (including Caisse de dépôt et placement du Québec, Ontario Teachers’ Pension Plan and British Columbia Investment Management Corporation) do not make any references to pay ratio disclosure.
There is no current evidence that Canadian regulators are considering introducing mandatory pay ratio disclosures in any sector. Without clear regulatory guidance or widespread sustained investor pressure, we do not expect voluntary disclosure to become more prevalent among issuers, especially in North America where priority is being placed on burden reduction for public issuers and, in some jurisdictions, modernizing and improving the competitiveness of the capital markets. Further background and details about pay ratio disclosure, including in the United States and the United Kingdom, is available in Davies Governance Insights 2018.130
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Spotlight: Canadian Big Banks’ Diverging Approaches to Voluntary Pay Ratio Disclosure
Despite calls for voluntary pay ratio disclosure, each of particular organization; therefore, the ratio was not a Canada’s big six banks has opposed such disclosure, meaningful tool that could contribute to decision-making citing concerns over the variance in methodology that or shareholders’ ability to assess the bank’s would ultimately render the ratios meaningless for approach to compensation.131 CIBC’s board provided shareholders. In 2020, voluntary pay ratio disclosure similar reasons in its April 2020 management proposals were rejected by shareholders at each of the information circular.132 However, CIBC noted that following major Canadian banks: vertical pay ratios were already internally disclosed to the board for review and consideration. – Scotiabank: 92.98% of shareholders voted against. In a stark departure from the rest of the major Canadian – TD: 93.7% of shareholders voted against. banks, Desjardins Group, Canada’s seventh largest – CIBC: 92.06% of shareholders voted against. financial institution, has been voluntarily disclosing pay – NBC: 91.53% of shareholders voted against. ratios since 2012. Desjardins is joined in this approach by Vancouver City Savings Credit Union, which publishes – Laurentian: 89.44% of shareholders voted against. compensation ratios, including CEO compensation compared with that for the lowest-paid entry level And while neither BMO nor RBC faced pay ratio employee and CEO compensation compared with the disclosure proposals in 2020, similar proposals put median annual compensation for all employees.133 forward to those banks in 2019 were rejected by 93.61% and 94.59% of their shareholders voting at their 2019 In contrast with the calls to the largest banks, we have meetings, respectively. In recommending against pay not witnessed significant external pressure for pay ratio ratio disclosure at TD, its board stated that ratio results disclosure by smaller Canadian lenders or other financial can vary significantly according to the business mix, institutions, and most do not disclose pay ratios. employee base and geographies of operations of a
95 Davies | dwpv.com Our Take: COVID-19 Has Amplified Existing Trends, Which Show No Sign of Slowing Down in the Near Future
The degree to which a particular industry or issuer – ESG factors and how these should be defined has been affected by the current health and economic with reference to the issuer, including “social” and crises can and should play a role in the way boards and “sustainability” factors; and compensation committees make compensation-related – the potential for criticism from key stakeholders and decisions. However, more broadly, regardless of industry for reputational harm. or degree of impact from COVID-19, issuers should expect to continue to face increased scrutiny relating to Most important, and as noted by Glass Lewis in a pay decisions in the future. document outlining its approach to governance in the context of COVID-19, companies should avoid putting In these uncertain times and in response to still further, in place any pay practices that make – or even keep – as yet unforeseeable, future crises, boards executives whole at the expense of shareholders and and compensation committees will need to consider employees.134 Doing so is likely to lead to less support and balance: for say-on-pay resolutions and director elections and, potentially, to greater shareholder activism. – executive retention and morale; – disclosure requirements and best practices; Finally, in any decision-making relating to executive compensation, directors should prioritize dialogue, – the views of major investors and proxy advisers, as transparency and clarity, both in the issuer’s public well as other key stakeholders (including government disclosure and in communications with the issuer’s and regulatory authorities, employees, creditors and management and key stakeholders. And all decisions, pensioners); importantly, should be made within the context of an issuer’s broader long-term strategy and objectives, including its human capital and resources priorities.
Governance Insights 2020 96 CHAPTER 07
Beyond Gender: Diversity and Inclusiveness Now and Going Forward
97 Davies | dwpv.com Over the past five years, Canadian public companies have been largely focused on improving gender diversity. Some progress has been made, including in increasing the number of women holding director and senior executive positions. Recent events, however, have taken the discussion beyond gender, and Canadian public companies are now facing greater pressure to improve the overall diversity of their organizations. Systemic racism and discrimination have become issues of particular importance for stakeholders. In this chapter, we discuss the most significant diversity-related developments over the past year and the evolving expectations being placed on Canadian issuers. We also consider the current regulatory framework and potential for changes in the future. We conclude with recommendations for boards and executive teams to consider in order to foster diversity and inclusion, and keep pace with the ever-changing landscape.
Governance Insights 2020 98 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
Current State of Diversity in Canada CBCA issuers’ disclosure regarding diversity and their OVERVIEW OF REGULATORY FRAMEWORK associated initiatives or targets to As a result of the amendments to the Canada Business increase diversity still primarily Corporations Act (CBCA) that came into effect on January 1, 2020, all CBCA public companies are required focus on gender. to annually disclose information on their policies, practices and metrics related to the diversity of their boards and senior management teams, subject to CURRENT IMPACT OF THE CBCA limited exceptions. In Davies Governance Insights 2019,135 AMENDMENTS we outlined the evolving legal framework for diversity disclosure in Canada. With 2020 being the first year for the expanded disclosure requirements for CBCA public companies, The CBCA amendments specifically expanded the we reviewed data based on the proxy circulars from diversity disclosure requirements for CBCA public the 2020 proxy season for 338 issuers on the TSX companies relative to other issuers listed on the Toronto Composite and SmallCap indices (192 of which are Stock Exchange (TSX) that are incorporated under CBCA public companies). Our review indicates that other corporate statutes. CBCA public companies CBCA issuers have generally satisfied their enhanced are now required to provide disclosure regarding four disclosure obligations under the CBCA. However, “designated groups” (which takes its meaning from the CBCA issuers’ disclosure regarding diversity and their federal Employment Equity Act) – namely, “women,” associated initiatives or targets to increase diversity still “Aboriginal peoples,” “persons with disabilities” and primarily focus on gender. “members of visible minorities.” From a disclosure perspective, both CBCA and non- All other Canadian public companies, however, are CBCA issuers on the Composite and SmallCap indices currently required only to comply with Canadian typically include fairly general statements regarding securities laws – namely, National Instrument 58-101 – their diversity and associated initiatives or targets, Disclosure of Corporate Governance Practices while referencing specific diversity characteristics (NI 58-101) – which limits disclosure to an issuer’s that they consider as part of their diversity practices. approach to gender diversity, including data regarding Issuers that do not have diversity policies or targets in the representation of women on boards and in executive place commonly cite the principles of meritocracy and positions. NI 58-101 follows a “comply or explain” regime the negative implications of arbitrary targets as their (like the CBCA amendments) and does not mandate any justification for not having these measures. We found specific diversity practices or require disclosure beyond that a similar disclosure approach was followed by gender diversity; nor does it require issuers to adopt CBCA issuers on those indices with correspondingly any specific gender diversity policies and practices or broad references to the consideration (or lack thereof) targets or quotas. However, current trends and debate of the four designated groups. over the lack of diversity among companies’ leadership may lead to significant changes.
99 Davies | dwpv.com FIGURE 7-1: Diversity Targets and Written Policies for Directors of TSX Composite and SmallCap Index Issuers (2020) These figures highlight the contrast 71% 78% 80% Women between issuers’ 70% Other Designated focus on gender 60% Groups 50% 43% representation and 41% 39% 40% 33% their approach 30% regarding diversity 20%
10% more broadly. They 1% 1.6% 0% also suggest that the Targets Targets Written Written Policies (of All Issuers) (of CBCA Policies (of CBCA CBCA amendments Issuers) (of All Issuers) Issuers) have yet to have a meaningful impact 90As shown in Figure 7-1, of the 338 Composite and SmallCap index issuers in on the actual 80our study universe, 41% disclosed targets for the representation of women on diversity policies or 70their respective boards; meanwhile, only 1% of those issuers disclosed board 60representation targets for the other designated groups. Of the CBCA issuers initiatives of CBCA on those indices, these percentages are 43% and 1.6%, respectively. In addition, 50whereas 77% of Composite and SmallCap index issuers have disclosed written public companies at 40policies regarding the representation of women on their respective boards, this early stage. 30only 33% have disclosed written policies regarding the representation of other 20designated groups. These percentages are 78% and 39%, respectively, for 10CBCA issuers on these indices. Similar trends were revealed when reviewing comparable data for executive officers among the same issuers, although 0a smaller proportion of issuers disclosed having targets or written policies regarding the representation of women and the other designated groups in executive positions.
These figures highlight the contrast between issuers’ focus on gender representation and their approach regarding diversity more broadly. They also suggest that the CBCA amendments have yet to have a meaningful impact on the actual diversity policies or initiatives of CBCA public companies at this early stage; it should be acknowledged, however, that the CBCA amendments are only in the first year of being in force, and COVID-19 has undoubtedly affected the immediate priorities of many issuers.
Governance Insights 2020 100 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
DIVERSITY TRENDS FOR MINORITY GROUPS
As discussed in Davies Governance Insights 2019,136 some meaningful progress has been made with respect to the representation of women among the leadership of Canadian public companies, including in senior executive and director positions. However, the same cannot yet be said with respect to diversity among other under-represented groups.
FIGURE 7-2: CBCA Designated Groups – Percentage of Canada’s Population (2016) vs Percentage of CBCA Public Company Directors (2020)
60%
50% Canada’s 50% Population (2016) 40% CBCA 31% DIrectors 30& 22.3% 22% 20%
10% 5.5% 4.9% 0.78% 1.18% 0% Women Visible Persons with Indigeneous Minorities Disabilities Peoples
Note: The population data is based on Canada’s most recent census in 2016 and the data on CBCA public company directors is from The Financial Post.137 90 80For example, The Financial Post recently completed a review of 23 CBCA public companies that had 70filed proxy circulars in 2020. Of the 23 boards and 255 director positions that were reviewed, only 14 60(5.5%) directors were identified as visible minorities, and there were only three Indigenous directors and 50two directors with disabilities. Fourteen of the 23 issuers reported that they did not have a director who identified as a visible minority, and 11 of the 23 issuers reported that they had no directors from any of 40the four designated groups aside from women. All 23 issuers reported that they had at least one female 30director, with 31% of all directors being women. The Financial Post also indicated that these data points 20were not significantly better for senior executive positions at the 23 issuers.137 10 0As shown in Figure 7-2, based on The Financial Post’s data, board composition is not yet representative of Canada’s population at large. For context, Canada’s most recent census in 2016 indicates that 22.3% of Canada’s overall population identifies as a visible minority and 4.9% identify as Indigenous peoples.
101 Davies | dwpv.com As of 2017, 22% of the Canadian population aged 15 and over had one or more disabilities according to Statistics Canada.
Furthermore, a report released by Ryerson University’s Diversity Institute in August 2020, titled Diverse Representation in Leadership: A Review of Eight Canadian Cities, analyzed the diversity of companies in 2019 across a range of sectors in Calgary, Halifax, Hamilton, London, Montréal, Ottawa, Toronto and Vancouver. The report indicates that women continue to make slow progress in terms of their overall representation on boards but that there has not been much progress, if any, for other minority groups.138
That report (which advanced similar research by the Diversity Institute over the past decade) marked the first time that Black representation on Canadian boards was specifically analyzed by the Diversity Institute, and its findings on the lack of Black representation on corporate boards are particularly notable. The report analyzed 178 Canadian private and public companies in the corporate sector and a total of 1,639 directors. Of these directors, only 13 (0.79%) were Black and 61 (3.72%) were from other visible minority groups. For context, Canada’s 2016 census indicates that Black people make up approximately 3.5% of Canada’s overall population. The report also noted that Black representation on boards across all sectors was disproportionately lower than all other visible minority groups.139
Finally, Corporate Knights Magazine completed a recent analysis of TSX 60 issuers and found that only six of the 799 senior executives and only four of the 686 directors were Black. When reached for comment by Corporate Several TSX 60 issuers indicated Knights Magazine, several TSX 60 issuers indicated that that change was necessary and that change was necessary and that more gender and racial diversity was required within their board and senior more gender and racial diversity executive teams. Some also indicated had established was required within their board and diversity and inclusion councils and that they were reviewing or enhancing their diversity and inclusion senior executive teams. policies, initiatives and reporting.
Governance Insights 2020 102 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
In Focus: Systemic Racism and Discrimination
MAJOR DEVELOPMENTS IN 2020 – Canadian Council of Business Leaders Against Anti-Black Systemic Racism. This new organization The tragic death of George Floyd and ensuing protests was launched in June 2020 by a group of high-profile for racial justice have brought issues of diversity, Bay Street executives and is committed to removing systemic racism and discrimination to the forefront of anti-Black systemic barriers affecting the lives of Black discussions in the corporate world. Prominent business Canadians. It hopes to increase the representation of leaders in Canada have become particularly active in Black people in Canadian boardrooms and executive trying to build on the growing momentum with respect offices, while also ensuring that companies follow to diversity issues. In recent months, many companies through on their statements and take active steps to have responded with statements decrying the current support Black employees and the Black community state of affairs and have announced significant financial more broadly.141 See “Canadian Council of Business commitments to diversity initiatives. Large institutional Leaders Against Anti-Black Systemic Racism and the investors have been speaking out and considering BlackNorth Initiative,” below, for further discussion. action relating to their portfolio companies. In the United States, we are starting to witness diversity-related – Goldman Sachs’ updated IPO policy. Effective July lawsuits, including lawsuits against Oracle Corporation, 1, 2020, Goldman Sachs implemented a new policy Facebook, Inc. and certain of their directors and officers. stipulating that it will not take a company public in the These lawsuits are based on their alleged failure to United States or Europe unless the company has at uphold commitments to diversity, the lack of racial least one diverse director from an under-represented diversity on their boards and misrepresentations about group. Individuals affected by gender identity, sexual their commitments to diversity in light of their public orientation, race or ethnicity are considered diverse. disclosure regarding the overall level of diversity of their Starting in 2021, Goldman Sachs will raise the workforces, boards and executive teams. Some directors requirement to two diverse directors. Goldman Sachs and officers at Oracle and Facebook are also alleged noted that the decision was driven by two main factors: to have violated their fiduciary duties by their inaction (1) U.S. issuers that have gone public with at least one on diversity issues and their acceptance of racially female director outperformed those without any female discriminatory practices in the workforce.140 directors; and (2) changing the stereotypes associated with corporate decision-making will have many positive The following other notable examples of business- effects for society. Goldman Sachs’ policy is expected related diversity initiatives and actions in recent months to be impactful, given that it is one of the pre-eminent suggest that diversity based on a broader range of underwriters of IPOs globally.142 criteria will continue to remain under focus in the coming years.
103 Davies | dwpv.com – Apple’s Racial Equity and Justice Initiative. Apple has resignation by noting that “resignation can actually be committed US$100 million to a new initiative known an act of leadership from people in power right now. To as the Apple Racial Equity and Justice Initiative. The everyone fighting to fix our broken nation: do not stop.”145 initiative is based on the principles of representation, inclusion and accountability. Apple will, among other – Resignation of Stockwell Day from TELUS board things, use the initiative to launch a new entrepreneurial and Bay Street law firm. Stockwell Day resigned camp for Black developers, enhance the representation as a director of TSX-listed TELUS Corporation and of under-represented groups across the companies that as a strategic adviser to McMillan LLP following his Apple does business with and commit to hiring from, and comments claiming that systemic racism was not an supporting, under-represented groups. When discussing issue in Canada. Mr. Day also compared the experience the initiative, Apple CEO Tim Cook stated, “Whether it’s of people facing racial discrimination to his experience at Apple or anywhere in society, the burden of change of being mocked for wearing glasses as a child. Aside must not fall on those who are underrepresented. It falls from the significant reputational harm that companies heaviest on those in positions of power, leadership, and can face from such comments or similar situations, influence to change structures for the greater good.”143 the statements from Mr. Day also fuelled demands for greater diversity in Canadian boardrooms and executive – Resignation of Alexis Ohanian from Reddit board. offices and underscored the need for training and Alexis Ohanian, founder of U.S.-based social media education regarding systemic racism, discrimination and aggregator and web-rating company Reddit, resigned as unconscious bias.146 a director of Reddit in June 2020 and publicly requested that his position be filled by a Black individual, which it While the long-term impact of all of these recent events ultimately was. When making his announcement over remains uncertain, a profound business shift appears to Twitter, Mr. Ohanian stated, “It is long overdue to do the be underway, with Canadian businesses facing significant right thing. I’m doing this for me, for my family, and for pressure to increase their commitment to diversity, to my country. I’m saying this as a father who needs to be disclose their diversity data and to improve diversity more able to answer his black daughter when she asks: ‘What broadly. Companies are expected to move beyond verbal did you do?"144 Mr. Ohanian also noted that he will use and financial commitments. It is clear that diversity will future gains on his Reddit shares to support the Black and should continue to play a large role in board community. He started with a US$1-million donation to composition practices and issuers’ overall corporate Colin Kaepernick’s Know Your Rights Camp initiative. governance framework. Mr. Ohanian ended his series of tweets regarding his
Governance Insights 2020 104 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
Spotlight: Canadian Council of Business Leaders Against Anti-Black Systemic Racism and The BlackNorth Initiative
“For too long too many have said, ‘this is not above, the Council is committed to dismantling anti- my problem’; that anti-Black systemic racism Black systemic barriers affecting the lives of Black and hate are somehow distant from the lives Canadians. It hopes to increase the representation of we live here in Canada. I am pleased to join Black people in Canadian boardrooms and executive offices while also ensuring that companies actually with Mr. Dodig, Mr. Watsa, and Ms. Dagher to follow through on their diversity statements and take say enough is enough, it’s time for anti-Black concrete action to support Black employees and the systemic racism to end. As a first step, the Black community more broadly.148 BlackNorth Initiative will ask corporate leaders across Canada to pledge their organizations On July 20, 2020, the Council held its virtual inaugural to policies and specific targets to end BlackNorth Initiative Summit, to which it invited senior systemic anti-Black systemic racism. For leaders from the top 250 TSX-listed issuers, over 100 of companies who consider themselves diverse, the largest private businesses in Canada, major banks, insurance companies, international companies with a hold that statement up against your board significant presence in Canada, and the largest asset and your executive team – how many Blacks managers and institutional investors in Canada. At the do you see?” summit, organizations were asked to sign a CEO Pledge and to deliver a statement regarding what they will do – Wes Hall147 to combat the issue of systemic racism and to make society free from anti-Black systemic racism.149 The Canadian Council of Business Leaders Against Anti- Black Systemic Racism (Council) and the BlackNorth Signatories to the CEO Pledge commit, among other Initiative have been gaining widespread support and things, to the following seven goals in an effort to end recognition since their on page launch in June 2020. anti-Black systemic racism in Canada and to create 150 The Council and the BlackNorth Initiative are being opportunities for under-represented groups: led by prominent Canadian business leaders Wes Hall (executive chairman & founder, Kingsdale Advisors); Rola Increase their efforts to make workplaces trusting Dagher (president & CEO, Cisco Canada); Victor Dodig 1 places to have complex, and sometimes difficult, (president & CEO, CIBC); and Prem Watsa (chairman & conversations about anti-Black systemic racism and CEO, Fairfax Financial Holdings Limited). As discussed ensure that no barriers exist to prevent Black employees from advancing within the company.
105 Davies | dwpv.com As of the end of August 2020, approximatelyCallout 290 to Come organizations had signed the CEO Pledge, with 30% of TSX 60 issuers being signatories.
Implement or expand education regarding Create the conditions for success, which includes 2 unconscious bias and anti-racism. 7 collecting data on race and ethnicity, including from Black employees, to understand where there are gaps Share best and unsuccessful diversity and inclusion and when progress is made. Signatories will work to 3 practices with other companies. attract and retain talent from the Black community and commit to developing and advancing Black people within Create and share strategic inclusion and diversity the company. 4 plans with the company board and establish at least one diversity leadership council that will develop and As of the end of August 2020, approximately 290 evaluate concrete and strategic action plans to prioritize organizations had signed the CEO Pledge, with 30% and drive accountability regarding diversity and inclusion, of TSX 60 issuers being signatories. The total market including as it relates to Black employees. capitalization of all committed organizations exceeds $1 trillion, representing almost one-third of the TSX’s Use resources to work with members of the Black total market capitalization.151 5 community and to ensure that Black communities across Canada are aware of opportunities of As we move forward, we expect the BlackNorth Initiative employment within the company and that employment will be one of many driving forces behind progressive opportunities are set aside for Black people. Signatories change to the diversity landscape in the Canadian commit to hiring at least 5% of their student workforce business community. While commitments, pledges and from the Black community and will invest at least 3% deadlines for change are not the complete answer, they of corporate donations and sponsorships to promote are important steps in building an ecosystem of diverse investment and to create economic opportunities in the workplaces and diverse companies in Canada. As noted Black community, both by 2025. by Mr. Hall, “Doing nothing now is akin to telling George Floyd to get up when he was powerless. Inaction is what Review their corporate governance framework has happened every other time the Black community 6 in order to ensure representation from the Black has cried out. A system that oppresses Blacks is not community on their boards and executive teams. a problem for Blacks to fix, it’s for the gatekeepers of Signatories will ensure that a minimum of 3.5% of the system. Those gatekeepers who fail to act must be executive and board roles based in Canada will be held moved aside. It’s time for a new and truly inclusive era.”152 by Black leaders by 2025.
Governance Insights 2020 106 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
What’s Next in Canada? Expect Greater Emphasis The CMMT consultation report proposes an overhaul of the “comply on Diversity Characteristics or explain” disclosure regime under Beyond Gender NI 58-101, with a focus on extending In light of recent events, we expect that the conversation the obligations of TSX-listed issuers will continue to expand and grow louder with respect to diversity characteristics beyond gender identity. We beyond gender to also include Black also expect that corporate and securities regulators in people, Indigenous people and people Canada and abroad will increasingly focus on potential regulatory changes aimed at promoting greater diversity of colour (BIPOC). among corporate leadership, on the basis of a broader range of diverse characteristics. Several prominent Black leaders in the Canadian business community are now – TSX-listed companies should be required to set emphasizing that it is time to put the same level of focus targets and to annually provide data in relation to the on other under-represented groups as was previously representation of women and BIPOC, both on boards done for gender. and in executive positions. Although the consultation report does not provide a precise recommendation on “Corporate Canada was bold enough to take the appropriate targets, it does reference potential up the challenge to add gender diversity to targets of 40% for women and 20% for BIPOC. The Canadian boardrooms and executive suites by consultation report notes that TSX-listed companies declaring policies, setting specific targets, and should also be required to review and assess the holding itself accountable and is now well on the appropriateness of their targets on an annual basis. way to reforming the system. Now it is time to do – TSX-listed companies should be required to adopt a the same thing for Blacks.” written policy regarding the director nomination process that expressly addresses the identification – BlackNorth Initiative of candidates who are women and BIPOC during the nomination process. The July 2020 consultation report released by the Capital Markets Modernization Taskforce (CMMT), – A 10-year maximum tenure limit for directors should be which was established by the Ontario government in mandated, with an allowance for 10% of the board to February 2020 to review and modernize Ontario’s capital exceed the 10-year maximum for up to two years. This markets, is one example of a push for regulatory change. proposed change is intended to encourage board renewal The consultation report proposes an overhaul of the and lead to greater levels of diversity on boards. “comply or explain” disclosure regime under NI 58-101, with a focus on extending the obligations of TSX-listed The CMMT is aiming to deliver a final report to the Minister issuers beyond gender to also include Black people, of Finance by the end of 2020. The final report is expected Indigenous people and people of colour (BIPOC). In to include a broader set of prescriptive recommendations, particular, the consultation report proposes the following and a decision should then follow on whether any changes amendments to Canadian securities laws:153 will be made to the regulatory framework in Ontario.154
107 Davies | dwpv.com The above recommendations go further than the recent CBCA amendments by proposing targets in relation to the representation of women and BIPOC on boards Having a more diverse board and and in executive positions. In Davies Governance executive team is only part of the Insights 2019,155 we outlined that one concern with the CBCA amendments was the creation of inconsistent solution. The real work for Canadian disclosure standards among Canadian reporting companies is to pay more than issuers. Although changes to securities laws may create further inconsistencies in disclosure standards among lip-service to diversity. Canadian reporting issuers, we expect that change may be forthcoming in the future, especially in light of While potential regulatory amendments and the recent the growing demands to address systemic racism and responses from companies regarding diversity are discrimination in the Canadian business community. means that may effect meaningful change, it will also be Inconsistent disclosure standards, which can in turn important for companies to truly embrace diversity if real compromise confidence in and the competitiveness of progress is to be made. Having a more diverse board our capital markets, may not suffice to preclude changes and executive team is only part of the solution. The real to Canadian securities laws. work for Canadian companies is to pay more than lip- service to diversity. Doing so may require companies to The “comply or explain” regime under NI 58-101 has consider implementing a range of new diversity initiatives resulted in a notable increase in both the nature and the throughout their organizations – for example, committing extent of public disclosure on gender diversity and in the to specific employment goals, changing recruitment number of women holding director and senior executive practices and establishing more diverse director, positions. There has also been a significant decline in executive and employee teams. As recently stated by the number of boards without female directors. These Meryl Afrika, president of the Canadian Association and other related developments are discussed in detail of Urban Financial Professionals, “You need to have in Davies Governance Insights 2019. However, there regulations to get people to comply, but there also has is still significant progress to be made, and both the to be that buy-in.”156 current legislative framework and the level of disclosure with respect to diversity are far from perfect from the The latest diversity initiatives announced by Royal perspective of many market participants. Bank of Canada (RBC) are but one example of a public company that is trying to improve its diversity In particular, the concept of mandating targets for and eliminate systemic racism issues. Notably, RBC women, Black people and other under-represented announced the following company changes in groups is gaining momentum. There is a wealth of July 2020:157 empirical data that suggest that companies with formal diversity targets are generally doing better at enhancing – voluntarily increasing its target for visible minorities in the overall diversity of their boards and executive teams, executive positions to 30%; and doing so faster. This was certainly the case for – requiring anti-racism and anti-bias training for all staff; women – in 2019, issuers that adopted board targets had – making $100 million in loans available to Black an average of 27% of their board seats held by women, entrepreneurs over the course of the next five years; compared with issuers without targets, which had an average of 22%.
Governance Insights 2020 108 CHAPTER 07 Beyond Gender: Diversity and Inclusiveness Now and Going Forward
– increasing the recruiting goal for summer internships implementing its inclusivity vision, strategies and goals; (ii) so that 40% of spaces are filled with BIPOC candidates, providing support to, and actively listening to the concerns an increase from the previous goal of 30%; and of, management and employees; and (iii) ensuring – adding diversity and inclusion objectives to its adequate training and education regarding systemic performance management process and expanding its racism, discrimination and unconscious bias. public disclosure on diversity efforts starting in 2021 to include racial and ethnic data in pay equity reporting. Consider whether diversity committees or officers 2 would be appropriate. Several issuers are beginning to establish diversity and inclusion board committees Immediate Steps to Promote and/or hiring chief diversity, equity and inclusion officers. These committees and officers can help bring focus to Diversity diversity programs and initiatives and provide strategic advice and direction to advance diversity, equity and In Davies Governance Insights 2019,158 we outlined inclusion. They can also facilitate regular monitoring five practical tips to help move the diversity needle: and reporting of a company’s progress with respect to (1) consider adopting a target; (2) consider whether diversity. However, a committee does not relieve the board to expand your board size; (3) consider more diverse of its overall responsibility for oversight and, if established, board criteria; (4) ensure your culture supports diversity a committee should provide reports and updates to the and inclusiveness; and (5) move past the business board. case approach and begin to execute on your diversity goals. While these tips were provided in the context Consider whether company resources should of navigating gender diversity, they apply equally to be allocated to diversity initiatives. Boards and diversity more broadly. 3 senior management should consider allocating company resources to both internal and external diversity programs In addition, issuers should consider the following and initiatives. If an issuer decides to allocate resources, recommendations in order to be more progressive and a formal plan should be developed with respect to the forward-looking in embracing and promoting diversity: amount of resources to be allocated and how and where those resources are to be allocated. Re-evaluate the board’s role in integrating inclusion into the organization’s strategy. Boards 1 Determine how to best engage with stakeholders and senior management should thoroughly review about diversity. Communicating the company’s overall and evaluate their overall corporate governance 4 commitment to diversity and inclusion to shareholders, the framework, including board and committee mandates, general public and the company’s other key stakeholders governance guidelines and diversity policies, to ensure is an important consideration for boards and senior that they adequately (and coherently) promote diversity management. Establishing formal communication throughout the organization. Boards should set a vision guidelines may be helpful, with many issuers relying on for diversity and inclusion and work with management to their CEO to deliver messaging. Boards should also define these concepts within the organization. Boards consider how to measure and meaningfully compensate should also play an active role in overseeing diversity the CEO and other senior officers on diversity and and inclusion initiatives, including by (i) establishing inclusion performance goals. goals and evaluating the organization’s progress on
109 Davies | dwpv.com Our Take: Expect Diversity to Stay in the Spotlight
Recent events have spurred calls for greater diversity Although no changes have (yet) been implemented to across leadership positions in the corporate world, within the existing legal diversity framework for the 2021 proxy government and in the not-for-profit space. We expect season, expectations by shareholders, employees, these societal shifts will increasingly demand that issuers customers and other stakeholders with respect to go beyond compliance with the strict legal requirements. diversity disclosure, policies and initiatives of public Stakeholders, proxy advisory firms and institutional companies are quickly evolving. Issuers that wish to shareholders have tended to be the drivers of change on enhance their diversity should consider the desired governance issues, with changes to the legal framework outcomes of their entity-specific diversity initiatives and generally trailing behind. Now, business leaders across policies, especially within the context of their long-term sectors are also becoming more active and vocal change strategies and objectives. Each issuer’s board should ask agents. Organizations that fail to be forward-thinking risk itself: Do our programs and policies create a framework being unable to adapt to the constantly changing legal that gets us to a level of diversity that will meet our human and social landscape. The need to be forward-thinking capital strategy and needs five to 10 years from now? becomes even more important in light of the many Now more than ever, boards and senior management other forms of discrimination that are not contemplated should be thinking about their overall frameworks, with in legislation or as apparent to the eye, including for greater emphasis on gender, race and ethnicity, as well example discrimination based on sexual orientation, as other diversity criteria. All forms of diversity are – gender identity, classism, religion, mental health, and are expected to remain – in the spotlight in 2020 disability and ageism. and beyond.
Governance Insights 2020 110 CHAPTER 08
ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay
111 Davies | dwpv.com In this chapter, we outline the significant developments that have taken place over the last year regarding the alignment and harmonization of the leading climate disclosure frameworks with the recommendations of the Task Force on Climate- related Financial Disclosures (TCFD). We discuss the major environmental, social and governance (ESG) trends and initiatives that have unfolded in parallel with, and in some cases in response to, the COVID-19 global pandemic and consider their market implications. In our view, the short-term focus on economic survival in the wake of COVID-19 will not quiet the increasing demands for greater efforts to be made by companies to prepare and implement strategies to facilitate responsible and sustainable business practices, particularly with respect to material environmental and social issues within the broader ESG space; nor will such focus slow the recent progress already made.
Governance Insights 2020 112 CHAPTER 08 ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay
Growing Acceptance and Importance of ESG ESG attracted heightened Consistent with the past four years’ of Davies Governance Insights reports, this year we again have tracked and discuss Canadian public companies’ growing scrutiny in 2020, acceptance of the importance of environmental, social and governance (ESG) signalling the issues. In addition, we look at the trend toward more robust reporting of ESG issues, particularly climate-related financial disclosure. Over the next year, we pronounced expect that these trends will continue.159 The varied and often significant effects and sustained of COVID-19 on companies have demanded urgent responses from boards and management to minimize these impacts. Nonetheless, ESG attracted attention that heightened scrutiny in 2020, signalling the pronounced and sustained attention ESG, especially its that ESG, especially its environmental and social components, will require of issuers in Canada and globally in the decade to come. environmental and social components, Convergence of Climate Disclosure will require of Frameworks Towards TCFD issuers in Canada
The 2017 Final Report: Recommendations of the Task Force on Climate-related and globally in the Financial Disclosure of the Financial Stability Board’s Task Force on Climate- decade to come. related Disclosures (TCFD) has emerged as the leading industry standard owing to its widespread support by government,160 international organizations,161 and the recent alignment efforts of other leading frameworks. As discussed in Davies Governance Insights 2019,162 the TCFD framework encourages disclosure of material information within four key areas: governance, strategy, risk management, and metrics and targets.163 The TCFD also advocates for the use of scenario analysis to assess the resilience of an issuer’s business and risk-mitigation strategies under different climate-related scenarios. The TCFD recommends that disclosures with respect to strategy and metrics and targets be assessed for their materiality, as determined in a manner consistent with other risks in a company’s regulatory filings; however, it recommends that information in respect of governance and risk management processes be disclosed irrespective of its materiality, as shown in Figure 8-1.
113 Davies | dwpv.com FIGURE 8-1: TCFD Recommendations and Disclosures
Governance: Strategy: Risk Metrics & Disclose the Management: Disclose the actual Targets: organization’s and potential impacts Disclose how the Disclose the metrics and governance around of climate-related risks organization identifies, targets used to assess climate-related risks and opportunities on the assesses and manages and manage relevant and opportunities. organization’s business climate-related risks. climate-related risks strategy and financial and opportunities where planning where such such information is information is material. material.
While a variety of major climate-related financial – The TCFD recommendations have also been disclosure (Climate Disclosure) frameworks are being incorporated into the draft Net Zero Investment used by issuers, each of those frameworks have, to Framework, released for consultation in August 2020 a greater or lesser degree, now been aligned with, or by the Institutional Investors Group on Climate Change continue to move toward, the TCFD framework and (IIGCC), an association of institutional investors aiming recommendations.164 In particular, through participation to mobilize capital for the transition to a low-carbon in the Corporate Reporting Dialogue’s Better Alignment economy.169 The IIGCC’s draft investment framework, Project, significant progress has been made toward developed with input from 70 investors who manage harmonizing the recommendations of the Global over $16 trillion in assets globally, outlines specific Reporting Initiative (GRI),165 the CDP (formerly the actions, metrics and methodologies that can be used Carbon Disclosure Project), the International Integrated by investors to align their portfolios with the goals of Reporting Council (IIRC) and the Climate Disclosure the 2015 Paris Agreement. Standards Board (CDSB).166 – Tiff Macklem chaired Canada’s Expert Panel on The following are some recent examples of convergence Sustainable Finance, which released its Final Report on the TCFD framework: – Mobilizing Finance for Sustainable Growth in 2019 recommending a number of measures aimed at – The Canadian federal government incorporated “spurring the essential market activities, behaviours Climate Disclosure into the Large Employer and structures needed to bring sustainable finance Emergency Financing Facility (LEEF). This program, into the mainstream.”170 According to the panel, “If announced on May 11, 2020, aims to provide bridge Canada is to meet its long-term objectives, sustainable financing to large Canadian employers that have been finance must become, simply, finance. In other words, 167 affected by COVID-19. A condition of participation climate change opportunity and risk management need in the LEEF program requires recipient companies to to become business-as-usual in financial services, commit to publishing annual Climate Disclosure reports and embedded in everyday business decisions, consistent with the recommendations made by the products and services.”171 The Final Report includes TCFD.168
Governance Insights 2020 114 CHAPTER 08 ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay
15 recommendations for achieving this, grouped into three pillars: (1) opportunity (put forward a renewed long-term vision for transition, with focused policies to The importance of integrating ESG help businesses and investors of all sizes effectively into issuers’ models and disclosure respond to the economic opportunity); (2) foundations for market scale (public and private sectors should practices is not expected to abate, invest in the essential building blocks needed to even in the wake of unanticipated scale the Canadian market for sustainable finance to mainstream status); and (3) financial products and crises such as COVID-19. markets for sustainable growth (develop and scale up market structures and financial products that would have particular impact in facilitating Canada’s transition and adaptation). Mr. Macklem’s subsequent to embrace and provide more transparent disclosure appointment in 2020 as Governor of the Bank of concerning a variety of ESG issues, particularly social Canada has raised expectations of an increased focus issues involving issuers’ human capital and human by Canada’s federal government on ESG matters and resources-related policies and practices. Climate Disclosure, consistent with developments witnessed globally.172 ESG Trends and Market – The updated Equator Principles (EP4, to be Implications implemented by October 1, 2020) support the application of TCFD in worldwide project finance. As ESG disclosure is effective in addressing risk only if anticipated, EP4 underscored climate change as a investors make decisions on the basis of the information crucial element of project due diligence by affirming disclosed (or on the basis of an issuer’s failure to support for the objectives of the Paris Agreement and disclose). Several recent developments signal that requiring climate change risk assessments (including ESG disclosure will increasingly be required of issuers physical risks) for most projects.173 In June 2020, the by their key stakeholders. And those demands are not Equator Principles Association released guidance likely to be limited to climate change, which has attained aimed at assisting both Equator Principle Financial prominence within the ESG debate in recent years. Institutions (EPFIs) and borrowers implement EP4 in Rather, increasingly we see stakeholders looking to the midst of the COVID-19 pandemic.174 issuers to do the following:
The above non-exhaustive list of recent developments – Create equities. Put in place effective policies and highlights the sustained importance ESG and climate practices to promote social and financial equities change have had, and will continue to have, in the public (including diversity, pay equity and the protection of and private markets and business practices of many human rights) within their organizations. issuers. The importance of integrating ESG into issuers’ models and disclosure practices is not expected to – Implement ESG policies. Implement enterprise- abate, even in the wake of unanticipated crises such as wide ESG policies and practices with respect to their COVID-19. In fact, in 2020, in the midst of the COVID-19 key stakeholders, including employees, customers, pandemic, we witnessed an increase in calls for issuers suppliers and other partners core to their businesses.
115 Davies | dwpv.com – Provide robust disclosure. Provide more robust entity-specific disclosure concerning their ESG practices, including issuers’ corporate and social purpose and specific risks to achieving those long- term objectives and goals (including foreseeable crises that could undermine those plans).
– Promote long-term viability. Develop and implement (and articulate to stakeholders) sustainability strategies to maximize the long-term continuity, resilience and viability of their businesses, including with regard to issuers’ corporate purpose. Investors Sharpen Focus on ESG
In January 2020, BlackRock, Inc. announced that: (1) in recognition of the impact that climate- related risks can have on a company’s profitability, sustainability will become BlackRock’s new investment standard; (2) BlackRock will continue to remove from its discretionary active investment portfolios the public securities of companies that generate more than 25% of their revenues from thermal coal production; and (3) BlackRock intends to make no future direct investments in those companies.175 In July 2020, BlackRock confirmed that thus far in 2020 it had identified 244 companies that were not making sufficient progress to adequately address climate risk,176 and that it has consequently taken voting action against 53 of those companies, with the remainder being placed on a watch list.
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Shortly after BlackRock’s January 2020 announcement, State Street Global Advisors followed suit, reiterating its focus on financially material ESG issues, Shortly after and confirming its intention to go beyond engagement and deploy its voting power in director elections to accelerate corporate action on ESG matters.177 BlackRock’s State Street disclosed in its CEO letter, “[h]aving already engaged with companies on a number of governance matters for many years, we see that January 2020 shareholder value is increasingly being driven by issues such as climate change, announcement, labor practices, and consumer product safety. We believe that addressing material ESG issues is good business practice and essential to a company’s State Street Global long-term financial performance – a matter of value, not values” [emphasis Advisors followed added]. State Street intends to leverage its endorsement of the Sustainability Accounting Standards Board (SASB) materiality framework through the use suit, reiterating of its new proprietary R-Factor ESG scoring methodology (“R” stands for its focus on “responsibility”) to benchmark over 6,000 companies globally against their peers. State Street describes its R-Factor as a transparent scoring system that financially material measures the performance of a company’s business operations and governance ESG issues, as it relates to financially material and sector-specific ESG issues. The resulting R-Factor score is then used to determine whether to vote against “laggards” and confirming that cannot properly articulate a plan to improve the company’s score. State its intention Street disclosed that in 2022 this voting strategy would be expanded to include all companies that have consistently underperformed in comparison with their to go beyond peers for multiple years. engagement
In Canada, the Ontario Municipal Employees Retirement System (OMERS) and deploy its has committed in its proxy voting guidelines to generally support proposals voting power in that request the reasonable disclosure of information or development of policies related to ESG factors.178 OMERS indicates that it supports the view director elections that companies should publish and update their policies and procedures with to accelerate respect to ESG issues that materially affect long-term shareholder value. And these policies should be an integral part of the overall management of corporate action companies. OMERS encourages the companies in which it invests to develop on ESG matters. policies and practices that address issues of social and environmental responsibility, including with respect to:
– the environmental impact of a corporation’s products and operations; – the impact of a corporation’s strategies and decisions on the communities and constituencies directly affected by its products and operations; and – human rights and work standards in a corporation’s operations.
117 Davies | dwpv.com With respect to Climate Disclosure specifically, CDP DEVELOPS TEMPERATURE OMERS recommends the use of the TCFD RATINGS framework and recommendations, and says that In an effort to guide investors toward decisions that it will generally support proposals that request that will facilitate the transition to a net-zero disclosure of information on the impact of climate economy, the CDP has developed a new change on a company’s operations, as well as “Temperature Ratings” service aimed at providing associated policies and procedures to address investors with data that can be incorporated into risks and/or opportunities. OMERS will consider climate-related risk analysis.183 CDP’s temperature withholding votes from the chair of the relevant ratings are designed to help investors committee if, in its assessment, a company is not benchmark, communicate and reduce the taking the appropriate steps to mitigate the risks impact of their portfolios and products on global stemming from climate change. temperatures. The ratings provide a temperature pathway for over 2,850 global companies, based Consistent approaches to ESG generally, and on emissions-reduction targets covering all Climate Disclosure specifically, are also being taken relevant emissions in a company’s value chain. by other large Canadian institutional investors, The temperature ratings are intended to reflect such as the Canada Pension Plan Investment the long-term global warming potential if global Board,179 the Alberta Investment Management GHG emissions were to be reduced at the same Corporation,180 and the Ontario Teachers’ Pension pace as the company’s emissions. Plan (Teachers’).181 And as discussed above, those approaches are not limited to Climate Disclosure, More specifically, the service leverages the CDP’s but are rather aimed more broadly at a wide range vast collection of climate-related disclosure of ESG issues. For example, Teachers’ states to produce a temperature rating, either for in its proxy voting guidelines, “We encourage companies individually or as part of an investment companies to demonstrate leading practices in portfolio that analyzes the emissions-reduction human capital management to support a healthy targets of a company and projects those targets work environment and culture. […] We typically into long-term temperature outcomes. This, in support proposals requesting a company to report turn, is intended to enable investors to better on, or develop policies related to: antidiscrimination, understand how ambitious a given emissions- freedom of association, improving diversity and reduction target actually is. The temperature inclusion, pay practices, and employee health pathways used in CDP temperature ratings are 182 and safety.” derived from the UN Intergovernmental Panel on Climate Change 1.5°C report and the Integrated Assessment Modelling Consortium database of climate scenarios.184
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Spotlight: Global Carbon Premium Confirmed
In March 2020, the results of the first empirical study aimed at considering whether and how investors are incorporating climate change risk into their investment decisions were released.185 The study explored how a so-called “carbon premium” varies around the world, by estimating the stock return premium associated with carbon emissions in a cross-section of over 14,400 organizations in 77 countries. A carbon premium exists when higher stock returns are associated with higher greenhouse gas (GHG) emissions – the idea being that a higher return is demanded by investors to offset the risk associated with elevated GHG emissions.
The study revealed that a positive and significant carbon premium exists in North America, Europe and Asia,186 and that the premium has generally been rising in recent years. The study also indicates that although the carbon premium is related to the level, and changes in levels, of a company’s emissions (both direct and indirect), it has no relation to a company’s emission intensity – the ratio of a company’s total emissions to sales.187 The study also confirmed that institutional investors are following through on measures they have been threatening to implement for a number of years now as part of their transition to investing in more environmentally sound and sustainable organizations – namely, widespread divestment based on carbon emissions, particularly with respect to their foreign investees.
119 Davies | dwpv.com On June 26, 2020, HESTA (a $52-billion Australian superannuation fund for the health and community services industries) announced the development of a Climate Change Transition Plan under which it will seek a 30% reduction of In the long term, carbon emissions in its investment portfolio by 2030, with the aim of achieving issuers will need to 188 net zero emissions by 2050. shift their practices We expect investors, having regard to a wide range of ESG metrics and factors, and disclosures, to make these demands on an increasingly larger scale as they continue to shift the composition of their portfolios toward more sustainable companies. for practical (if not And in the long term, issuers will need to shift their practices and disclosures, legal) reasons, to for practical (if not legal) reasons, to better align them with evolving ESG expectations if they are to promote their long-term viability, including their ability better align them to raise capital in the public and private markets. with evolving ESG expectations if they NORGES BANK INVESTMENT MANAGEMENT AND DEUTSCHE BANK STEP BACK FROM CANADIAN OIL SANDS are to promote
Norway’s Norges Bank Investment Management (NBIM) is one of the world’s their long-term largest investment funds, managing revenues from Norway’s oil and gas viability, including resources. It has investments in more than 9,000 companies worldwide. In May 2020, NBIM announced its divestment from four Canadian oil sands their ability to companies – Suncor Energy Inc., Canadian Natural Resources Ltd., Imperial raise capital in the Oil Ltd. and Cenovus Energy Inc. – citing concerns over unacceptable GHG emissions as the rationale for its decision.189 That decision marked the first time public and private that NBIM had used GHG emissions as the reason for excluding companies markets. from its portfolio on ethical grounds. NBIM also withdrew its investments from Swiss-based Glencore Plc., U.K.-based Anglo American Plc, Germany’s RWE AG, South Africa’s petrochemicals firm Sasol and Dutch company AGL Energy. Egypt’s Elsewedy Electric Co. and Brazilian companies Vale SA and Eletrobras were also excluded from NBIM’s portfolio, for causing environmental damage.190
Similarly, in July 2020 Deutsche Bank announced that it had committed not to back any further oil sands projects, and that by 2025 it would no longer participate in any financing or capital market transactions involving coal mining.191
Governance Insights 2020 120 CHAPTER 08 ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay
BHP CLARIFIES EXPECTATIONS FOR RESOURCE SECTOR LOBBY GROUPS Vanguard’s support On August 14, 2020, Australian-based BHP Group Limited announced that it for climate-related intends to hold industry associations that engage in advocacy activities relating to the resources sector to the same standards to which BHP adheres.192 More resolutions is specifically, BHP released its “Global Climate Policy Standards,” which outline further evidence its approach to climate change in its own advocacy activities, as well as in the advocacy activities of the industry associations to which BHP belongs globally. that institutional That approach includes support for the Paris Agreement and for policies aimed investors are at fostering the development of low-emission technologies and the transition to a net-zero economy.193 increasingly willing to “walk the talk” VANGUARD GROUP BACKS SHAREHOLDER GHG RESOLUTIONS (and not just “talk On June 18, 2020, Vanguard Group, one of the world’s largest investment the talk”) on ESG management firms with approximately $6 trillion in assets under management, announced that it had backed climate-related shareholder resolutions for United and climate-related Parcel Service Inc. (UPS) (listed on the New York Stock Exchange (NYSE)), issues. J.B. Hunt Transport Services Inc. (listed on the Nasdaq), and Ovintiv Inc. (listed on both the Toronto Stock Exchange and NYSE). Vanguard cited the fact that businesses have an obligation to take into account the risks of operating on a warmer planet.194 More specifically, Vanguard voted in favour of individual shareholder proposals calling for UPS and J.B. Hunt to issue board reports describing whether and how the companies plan to reduce their contributions to climate change and align their operations with the goals of the Paris Agreement. Vanguard also supported a shareholder proposal calling on Ovintiv’s board to disclose the company’s Paris Agreement–aligned targets, addressing medium- and long-term climate-related risks and opportunities, and to provide annual reports on the company’s progress toward meeting those targets.
Vanguard’s support for these resolutions is further evidence that institutional investors are increasingly willing to “walk the talk” (and not just “talk the talk”) on ESG and climate-related issues. We expect issuers will increasingly face similar ESG proposals and growing investor support for those proposals. This will be the case especially for those issuers that resist taking proactive steps to implement entity-specific policies and practices with respect to ESG-related risks and opportunities and fail to communicate to the market the concrete steps being taken to support the long-term sustainability of their organizations.
121 Davies | dwpv.com CERES CALLS ON FINANCIAL ISS Launches Sustainable REGULATORS TO TACKLE CLIMATE Development Goals Impact CHANGE On July 1, 2020, an association of over 70 Ratings investors, businesses, former regulators and On May 5, 2020, the responsible investment arm politicians sent a letter to the U.S. Federal of Institutional Shareholder Services Inc. (ISS) Reserve chairman and several other financial announced a new Sustainable Development Goals regulatory agencies, emphasizing the (SDG) Impact Rating service.195 The service will significant systematic threat posed by climate measure an issuer’s impact with reference to change to financial markets, and the economy the United Nations’ SDG framework in order to more generally. The letter called on financial identify how the issuer is managing the negative regulators to consider the recommendations externalities in its operations across the entire made in a recent report by the Ceres value chain, as well as how the company is Accelerator for Sustainable Capital Markets, capitalizing on existing and emerging opportunities which proposed a requirement for financial to contribute toward the achievement of the SDGs. institutions to conduct climate stress tests and to explore potential means to address climate The new rating is designed to support investors risks through monetary policy.196 seeking to align their investments with the SDGs, to measure and report on the alignment of their portfolios to the SDGs and to develop their own investment solutions based on specific themes such as biodiversity, climate, gender equality and health. The ISS rating system is the first of two new solutions ISS is launching in 2020 to support SDG investment strategies. The second, a new SDG Impact Index, is expected to be launched by ISS later this year.
ISS has stated that the new services will initially be available in respect of over 6,500 issuers, with that coverage expected to expand in the future.
Governance Insights 2020 122 CHAPTER 08 ESG and Climate Change in the Shadow of COVID-19: “E,” “S” & G Are Here to Stay
Our Take: Lessons Learned from COVID-19 and What to Expect in the 2020s
Perhaps one of the key lessons learned from the Despite the immediate focus on economic survival impact of COVID-19 is the speed at which seemingly in the wake of COVID-19, the pandemic has not remote risks can turn into existential threats for abated shareholder or stakeholder expectations businesses. The main difference between COVID-19 relating to ESG and Climate Disclosure; nor has it and many ESG factors, like climate change, is that muted calls to prepare for and implement plans and the latter is foreseeable, and opportunities exist to strategies that facilitate responsible and sustainable respond to and mitigate the impact of a wide range of business practices for the long term. In this context, ESG-related risks. companies should consider taking the following steps to position themselves to meet and exceed COVID-19 has also reinforced and brought new stakeholder expectations regarding ESG factors: prominence to the importance, both to shareholders and stakeholders, of the “S” in ESG. The crucial role Focus on the TCFD. The TCFD framework that is played by traditional social issues – such as is emerging as the current leading industry human capital management and labour relations – 1 standard for Climate Disclosure and is has now been expanded by a broader concern over recommended as a guide for issuers in preparing for the indirect impacts of an issuer’s operations (such future disclosure.197 While some issuers are already as those taking place further up in the supply chain), utilizing aspects of the framework, others may find it and by concerns over the manner in which the issuer prudent, if not essential, to begin their shift to align is, and is perceived to be, satisfying both economic with the TCFD recommendations.198 and ethical expectations. In fact, more than ever, considering the 2020 ESG-related themes that appear to dominate the public debate and having in place solid ESG policies and practices are widely accepted as being core to issuers’ long-term sustainability, resilience and financial viability.
123 Davies | dwpv.com COVID-19 has also reinforced and brought new prominence to the importance, both to shareholders and stakeholders, of the “S” in ESG.
Use what you already know. While Address social factors. Beyond climate-related risks most reporting frameworks are and disclosures, as well as the focus on the host of 2 converging on the TCFD framework, 4 governance issues over the past decade, issuers issuers can still make use of the guidance must carefully consider the social factors relevant to their provided by the GRI, CDP and the Corporate businesses, if they have not yet done so, having regard to the Reporting Dialogue’s Better Alignment Project key risks and opportunities, and their long-term strategies in order to identify information and data already and plans. These factors include, but are not limited to, human in their possession that may be used to make capital and human resources, ethical practices, and diversity TCFD-aligned Climate Disclosure.199 and inclusion. Issuers should also be prepared to be able to clearly articulate their broader corporate or social purpose, and Two heads are better than one. how their policies and practices promote those long-term goals. In considering how to strengthen 3 and implement issuers’ ESG and Provide transparent disclosure. As we discussed in climate change strategies, consider retaining past Davies Governance Insights reports, significant experienced advisers who can assist with cost- 5 improvements can be made by many issuers to improve efficient ESG assessments, including the often the clarity and transparency of their disclosure on ESG issues, complex modelling needed for climate-related as well as the entity-specific risks facing them. Rather than scenario analysis. Even issuers with several 15-page lists of generic risk factors contained within annual years of Climate Disclosure under their belts information forms or annual reports, consider the core ESG- can benefit from a fresh set of eyes. Having related risks and opportunities facing the issuer, applying expert advice can provide much-needed clarity existing securities law materiality standards for these purposes. on an issuer’s materiality assessment of a Where possible, aim to quantify the risks and potential wide range of ESG-related risks, including the outcomes for investors, particularly with respect to climate- process used to prioritize such risks. related risks.
Governance Insights 2020 124 CHAPTER 09
Governance in a Nascent Industry: Lessons from Canada’s “Green Rush”
125 Davies | dwpv.com In the two years that have passed since Canada became the first industrialized country to legalize recreational cannabis use, the industry has experienced unprecedented levels of growth and interest, a phenomenon widely referred to as Canada’s “Green Rush.” Such rapid development, however, has not occurred without significant challenges – particularly in the realm of corporate governance. In this chapter, we draw upon core lessons learned from Canada’s burgeoning cannabis industry to examine three key governance practices that should be considered by junior issuers or those operating in other nascent industries. In our view, proactive actions, such as installing an independent and experienced board at the outset that oversees key operations, establishing robust internal controls and risk management frameworks, combined with transparent and timely disclosure practices, will best position issuers for future success.
Governance Insights 2020 126 CHAPTER 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush”
Canada’s Green Rush: Growing Pains Many cannabis In July 2018, Aurora Cannabis Inc., a company listed on the Toronto Stock Exchange (TSX), acquired the then TSX-listed MedReleaf Corp. in a $3.2-billion issuers have deal, the largest cannabis transaction at the time. In the months that followed, struggled to cannabis issuers and investors poured billions of dollars into the industry through substantial M&A and investment activities. More recently, however, comply with many cannabis issuers have faltered. Demand for cannabis and derivative disclosure products has proven to be lower than anticipated, and many issuers have not been able to generate a profit. obligations and have faced In addition, many cannabis issuers have struggled to comply with disclosure obligations and have faced increasing stakeholder demands for improved increasing governance structures and greater accountability. Many of the founders of stakeholder Canada’s largest issuers in the industry have been ousted. At the time of writing this report, at least 14 cannabis issuers had filed for creditor protection or demands entered into receivership proceedings in 2020, and more filings are expected. In the following sections, we discuss three key governance lessons learned for improved from Canada’s cannabis experience and offer recommendations for boards and governance management of issuers in any nascent industry. structures Board Composition: The Cannabis and greater accountability. Industry Learns from Common Pitfalls of Nascent Issuers
BOARD COMPOSITION IS OFTEN NOT A TOP CONCERN FOR NASCENT ISSUERS
The explosion of the cannabis industry seemingly happened overnight. Though many of its major players had been operating in the medical cannabis space for some time, the tabling of draft legislation for a recreational-use cannabis regime in April 2017 (targeted to become effective on July 1, 2018) ignited a groundswell of public and investor excitement over an industry expected to rival Canada’s beer and wine sectors. The ensuing 18 months saw a flurry of M&A and capital-raising activity in the cannabis space, as producers jockeyed to increase production capacity and establish themselves as industry leaders in anticipation of recreational legalization.
127 Davies | dwpv.com For many issuers operating in emerging industries, as has generally been the case in the cannabis space, management’s focus is often on rapid growth, Director independence is establishing market position and executing its strategic considered critical to aligning vision. These issuers are often founder-led and may have executive teams and boards of directors that lack public directors’ interests with those of company experience. the issuer’s shareholders and to
Good corporate governance practices are not always maximizing directors’ objectivity – top of mind during this growth phase. However, it is and thus effectiveness – in their critical for junior issuers to cultivate independent boards with a diverse array of relevant industry and public decision-making. company experience, particularly when the executive team has limited experience leading a public issuer. Management may be tempted to preserve a board of CSA Staff observed instances in which the chair of directors composed of familiar candidates who support 2 the board and the chief executive officer (CEO) of the founder’s vision; however, recent developments in the cannabis issuer were the same individual. the cannabis industry illustrate the heightened potential for regulatory and investor scrutiny of board composition As discussed in detail in last year’s Davies Governance and effectiveness of early-stage companies, as Insights 2019,201 the need for independent directors on discussed below. public company boards is a well-established principle. Securities regulators and stock exchanges have specific regulations, and proxy advisory firms offer additional CSA REMINDS CANNABIS ISSUERS OF guidelines that influence their voting recommendations. CORPORATE GOVERNANCE EXPECTATIONS Director independence is considered critical to On November 12, 2019, just over one year after aligning directors’ interests with those of the issuer’s recreational legalization, the securities regulatory shareholders and to maximizing directors’ objectivity – authorities of Ontario, British Columbia, Québec, New and thus effectiveness – in their decision-making. It is Brunswick, Saskatchewan, Manitoba and Nova Scotia generally recommended that boards comprise a majority (CSA Staff) issued CSA Multilateral Staff Notice 51- of independent directors, subject to certain exceptions. 359 – Corporate Governance Related Disclosure Expectations for Reporting Issuers in the Cannabis Although the TSX, Canadian securities regulators and Industry (CSA Notice 51-359).200 CSA Notice 51-359 proxy advisory firms’ definitions of independence vary, specifically targeted issuers in the cannabis sector and they are all concerned with relationships that could in other emerging growth industries, and highlighted two reasonably be expected to interfere with a director’s principal concerns regarding the independence of board ability to act objectively and without bias in fulfilling his members of cannabis issuers: or her fiduciary duty to act in the best interests of the corporation. CSA Notice 51-359 specifically noted that Many issuers identified board members as being independent directors must not have a direct or indirect 1 independent without giving adequate consideration “material relationship” with the issuer. This refers to to potential conflicts of interest or other factors that may any relationship that could be reasonably expected to compromise their independence.
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interfere with the exercise of a director’s independent judgment. Factors that may compromise independence include personal or business relationships with other directors and executive officers of the issuer. Boards lacking in independence CSA Notice 51-359 also identified best practices with respect to the separation of the roles of CEO and board chair, consistent with National Policy 58-201 – risk undermining Corporate Governance Guidelines (NP 58-201). NP 58-201 and most industry not only their experts and proxy advisory firms support separating the roles of board chair and CEO, in light of their different responsibilities and objectives. Not separating effectiveness and these roles can jeopardize the proper checks and balances on management. the performance of This may in turn lead to less internal scrutiny on company performance, unless the issuer appoints an independent lead director of the board to mitigate the their duties but also risks associated with having the same individual serve as chair and CEO. investor and market
Boards lacking in independence risk undermining not only their effectiveness confidence. This is and the performance of their duties but also investor and market confidence. the case whether This is the case whether the relationships are between directors or between the directors and management, or whether the directors lack the requisite skills and the relationships are experiences necessary to oversee the management of the day-to-day affairs between directors of public companies – especially those operating in nascent industries. In that context, such deficiencies in board composition can become particularly acute or between the and attract heightened scrutiny, which may ultimately thwart the success of a directors and proposed corporate transaction that lacks appropriate board oversight or that has been influenced by conflicts of interest. management, or whether the CANNABIS ISSUERS NOW TRENDING TOWARD BEST directors lack the GOVERNANCE PRACTICES requisite skills Many cannabis issuers appear to be heeding the guidance of CSA Notice 51-359 and the broader governance community and are working to implement and experiences improved governance practices, at least as they pertain to independence. Our necessary to June 2020 review of the available public disclosure of 20 prominent Canadian licensed producers of cannabis (LPs)202 indicated that as at the later of the oversee the date of recreational legalization (October 17, 2018) and the date the issuer management of the first became publicly listed, 40% of those LPs had the same individual acting as CEO and board chair. Of those LPs, 65% had a board chair who was not day-to-day affairs of independent for purposes of NP 58-201. As of September 15, 2020 only 20% of public companies. those LPs had the same individual who was both CEO and board chair, and only 30% had a non-independent board chair.
129 Davies | dwpv.com FIGURE 9-1: Percentage of Cannabis Issuers with Same Individual Acting as CEO and Board Chair and with Non-Independent Board Chair 40% of 20 prominent Canadian LPs had 80 Same Individual the same individual Non-Independent 70 65% acting as CEO and 60 board chair. Of those 50 40% 40 LPs, 65% had a 30% 30 board chair who 20% 20 was not independent 10 for purposes of 0 2018 2020 NP 58-201. (As of September 15)
SIGNIFICANT EXECUTIVE AND BOARD TURNOVER IN THE CANNABIS INDUSTRY
Since the flurry of financing and M&A activity that took For example, since Constellation Brands Inc., listed place in 2017 and 2018, the cannabis industry has seen on the New York Stock Exchange (NYSE), invested significant turnover at the executive and board levels. approximately $5 billion in exchange for a 38% Of the 20 LPs reviewed, roughly 55% have a different ownership stake in TSX- and NYSE-listed Canopy CEO today than they did as at the later of the date of Growth Corporation, Canopy has experienced a recreational legalization (October 17, 2018) and the date complete overhaul of its board and the termination of its the issuer first became publicly listed.203 founder and long-time CEO, Bruce Linton. Similarly, on the heels of disappointing financial performance, Terry While some of that turnover has been proactive and Booth, founder of Aurora Cannabis, stepped down as aimed at improving corporate governance by bringing CEO in February 2020 after having brokered some of in a more experienced leadership team or improving the most high-profile transactions in the sector – namely, skills and competencies at the board level, some high- acquiring MedReleaf for $3.2 billion and CanniMed profile board and executive shakeups have resulted Therapeutics Inc. for $1.1 billion. from significant shareholder action or have occurred in response to poor financial performance. Other cannabis issuers have also been forced to replace executives and directors in light of public controversies stemming from poor corporate governance practices.
Governance Insights 2020 130 CHAPTER 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush”
Board Oversight: A Critical Board Function in Regulated Boards of regulated issuers should be regularly meeting with Industries management and receiving and
INTERNAL CONTROL AND REPORTING probing operational reports from PROTOCOLS AND PROCEDURES ARE KEYS management, rather than deferring TO SUCCESS compliance matters to annual Although it is important to have the right people around the boardroom table to guide a nascent issuer, strategy sessions. establishing effective management oversight and internal controls is crucial for a board to carry out its duties.
It is also critical that issuers establish and implement Board members should also be aware that a line of robust policies and procedures for reporting to the board case law is developing in the United States that requires on key operational developments, risks and milestones, boards to make good faith efforts to implement oversight including a mechanism for timely communication of controls relating to the corporation’s principal risks and significant issues by management to the board. While to actively monitor (not solely defer to management to the content of those policies will depend on, among execute) operations, failing which directors risk facing other factors, the nature of the company’s industry, personal liability. See Chapter 2, Risky Business: The the board should ensure that it has oversight over Board’s Role in Enterprise Risk Management for further internal controls as they relate to the issuer’s principal discussion about these so-called Caremark duties and operations and risks. how they can inform best practices for directors in carrying out their duties. Particularly in highly regulated industries, such as the cannabis sector, it may be prudent for the board to As previously noted in this chapter, amid the fervour have a more active monitoring role with respect to of the Green Rush, certain cannabis issuers exhibited compliance. Boards of regulated issuers should be less than ideal corporate governance practices. Next regularly meeting with management and receiving we consider the adequacy of the board’s response to and probing operational reports from management, the most publicized scandal in the cannabis space from rather than deferring compliance matters to annual 2019, which arose in part from a lack of board oversight strategy sessions. For any issuer in the growth phase in critical risk areas. or operating in a monoline industry, the board should closely monitor and implement robust controls over critical activities or projects. In these circumstances, THE CANNTRUST SAGA it may be advisable to establish new (or delegate The following is a timeline of events that led to TSX- and responsibility to existing) board committees to oversee NYSE-listed CannTrust Holdings Inc. having its licence particular segments of the company’s strategies, major suspended by Health Canada and ultimately filing for projects or operations. creditor protection.
131 Davies | dwpv.com FIGURE 9-2: CannTrust Timeline of Key Events (2019–2020)
June 15, 2019 A former employee and whistleblower reports that CannTrust has been growing cannabis illegally in July 8, 2019 unlicensed rooms and actively concealing those activities Health Canada issues a notice of non-compliance from Health Canada, leading to a Health Canada audit. relating to cannabis grown in five unlicensed rooms between October 2018 and March 2019. July 11, 2019 CannTrust strikes a special committee of independent July 22, 2019 directors to investigate the non-compliance. CannTrust announces that it has filed a response with Health Canada regarding its notice of non-compliance July 24, 2019 and reiterates its commitment to identifying the root The Globe and Mail publishes an article alleging, cause of all non-compliance issues. according to email evidence, that CEO Peter Aceto and board chair Eric Paul had been aware of illegal cannabis production since as early as November July 25, 2019 2018. Mr. Paul was the founder and former CEO of CannTrust’s board terminates Peter Aceto CannTrust and, therefore, not an independent director. with cause and Eric Paul is forced to resign.
August 12, 2019 CannTrust discloses another non-compliance notice from August 15, 2019 Health Canada in respect of a second production facility. CannTrust discloses that it is preparing a remediation plan under the supervision of its special committee. September 17, 2019 CannTrust’s licence is officially suspended by October 14, 2019 Health Canada. CannTrust’s board determines to destroy $12 million of unlicensed biological assets and $65 million worth October 24, 2019 of unlicensed inventory. On the special committee’s recommendations, CannTrust commits to an expanded training December 5, 2019 program, a strengthened governance and operations framework, improved infrastructure, and prescribed CannTrust announces it has been served or accountabilities and timelines for specified tasks. become aware of class action lawsuits in both Canada and the United States regarding the drop in its share price after July 8, 2019. February 13, 2020 CannTrust announces it has appointed a new CEO and that the special committee’s focus would be on March 31, 2020 pursuing strategic alternatives for the issuer. CannTrust obtains creditor protection under the Companies’ Creditors Arrangement Act (CCAA).
Governance Insights 2020 132 CHAPTER 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush”
The CannTrust story underscores the importance of board independence and the extent to which a material relationship with the issuer can impair independent The CannTrust story underscores judgment. In this case, the chair’s material relationship the importance of board with the company he founded may have impaired his judgment in not raising potential regulatory risk to the independence and the extent to independent members of the board. which a material relationship with
It also appears the CannTrust board did not have the issuer can impair independent effective controls in place to alert it to material risks judgment. In this case, the chair’s affecting critical aspects of the business – namely, compliance with the very licences required to produce material relationship with the cannabis. Although active efforts were allegedly made company he founded may have by management to conceal illicit activities, the August 12 non-compliance notice regarding CannTrust’s second impaired his judgment in not raising facility detailed several non-compliant practices, such as potential regulatory risk to the unauthorized construction, insufficient security controls and operating procedures that did not comply with independent members of the board. statutory requirements. Especially in a heavily regulated industry, a board should take an active role in overseeing operational compliance and not rely exclusively on EXPERT ADVISORY BOARDS MAY BE management to do so. USEFUL IN SOME CIRCUMSTANCES A common practice in the cannabis industry that may Although CannTrust’s response in striking an be instructive to issuers in nascent industries or those independent special committee to investigate the with executive teams or boards that have limited wrongdoing and oversee its remediation was a public company experience is the formation of an positive step, this cautionary tale suggests that sound advisory board. An advisory board is typically a small governance practices must be established from the group of third-party experts struck to advise the CEO, outset, and that the risks of not doing so may be management and/or the board on a specific aspect of irreparable. And those risks are not limited to regulatory the company’s business or a particular transaction or action alone – even in less regulated industries, course of action. The recommendations of an advisory reputational damage and loss of market share, board are not binding on the issuer, and its members significant stock price declines, short-selling activism, do not have a fiduciary obligation to the corporation. litigation and, ultimately, financial distress are common Nonetheless, advisory boards can serve to complement consequences. CannTrust has since been delisted the skills and competencies that an issuer has in- from both the TSX and the NYSE and, at the time of house or to enhance the expertise, skills and objectivity writing this report, is awaiting the outcome of its of an issuer’s leadership in areas where it may lack CCAA proceedings. bench strength. Of the 20 prominent cannabis LPs we examined, 50% have some form of advisory board, most often advising on the medical aspects of the cannabis plant and/or scientific research of the issuer.
133 Davies | dwpv.com Many of the same considerations regarding board composition should be given to the composition of an advisory board. In short, an advisory board should not be used as a tool to circumvent best practices on board composition and As will be apparent independence. to readers of our past 10 years’ of Davies OVERSIGHT PRACTICES SHOULD EVOLVE OVER TIME Governance Insights As will be apparent to readers of our past 10 years’ of Davies Governance Insights reports and followers of governance trends and practices generally, reports and followers good governance practices are not static. As a young company grows and of governance evolves, so too should its governance policies and procedures in order to adapt to the changing nature of the issuer and the industry in which it trends and practices operates. The ramifications of COVID-19 have resulted in many issuers re- generally, good evaluating established practices and identifying vulnerabilities that had previously gone undetected. On the flip side, sudden disruption can also governance present unidentified opportunities to streamline operations and facilitate practices are not increased shareholder returns. Boards should continually seek to challenge and pressure-test key assumptions. static. As a young company grows In addition to implementing oversight practices, keeping a written record of the deliberative oversight process at both board and committee levels is and evolves, so vital. Corporate minutes should reflect the careful process that was followed, too should its including the time spent by the board or the committee on a given topic, the scope of the discussion, any external advice obtained, documents and governance policies agreements reviewed, the disclosure of any conflicts of interest and any and procedures in in camera sessions. Effective record-keeping is not only critical in helping directors discharge their fiduciary obligations but also serves to discipline order to adapt to the directors and ensure that they adhere to the corporation’s governance changing nature of policies and procedures. the company and the industry in which it operates.
Governance Insights 2020 134 CHAPTER 09 Governance in a Nascent Industry: Lessons from Canada’s “Green Rush”
Disclosure Practices: Lack of Transparency Undermines Investor Confidence Although Aphria’s trading price did THE APHRIA SHORT-SELLER REPORT (temporarily) In December 2018, Hindenburg Research and Quintessential Capital recover, the event Management released a report204 alleging that then TSX- and NYSE-listed brought into focus Aphria Inc. had entered into a number of non-arm’s length transactions allegedly designed to funnel funds into companies controlled by Aphria insiders and the perceived advisers. The report claimed that Aphria had acquired assets in Latin America and Jamaica from related companies at significantly inflated valuations and deficient disclosure failed to disclose conflicts of interest. The allegations sent shockwaves through practices of issuers the industry, and Aphria’s share price fell by over 50% within four days of the release of the report. Although Aphria’s trading price did (temporarily) recover, in the cannabis the event brought into focus the perceived deficient disclosure practices of industry generally. issuers in the cannabis industry generally.
Although Aphria defended its valuation of the acquired assets, shortly after the allegations were made, Aphria’s CEO and board chair, Vic Neufeld, resigned from his position as CEO, and the corporation became the subject of an unsolicited (ultimately unsuccessful) takeover bid.
CSA STAFF TAKE NOTICE OF DISCLOSURE DEFICIENCIES
As discussed above, nearly one year after the Aphria report was released, CSA Staff issued CSA Notice 51-359. CSA Staff had identified “instances of inadequate transparency relating to the cross-ownership of financial interests” by cannabis issuers or their directors and executive officers in corporate transactions – transactions in which either the acquirer or the target, or a director or executive officer of either entity, had an undisclosed financial interest in the other entity. A “financial interest” may include business relationships or ownership, control or direction of equity, debt or other investments related to the transaction counterparty.
135 Davies | dwpv.com According to CSA Staff, detailed disclosure of cross- ownership is necessary to allow investors to make informed decisions. Cross-ownership “results in conflicts of interest that may lead investors to re- examine other variables such as purchase price, transaction timing or contingent payments,” which investors may not consider in the same manner if the cross-ownership is undisclosed. In addition, non- disclosure of cross-ownership may cause investors to question whether the transaction achieves a legitimate business purpose, whereas transparency allows investors to evaluate the transaction on its merits.
CSA Staff regards the existence of cross-ownership to be material information for investors and their investment and/or voting decisions that should be disclosed in the applicable disclosure document (whether a material change report, a takeover bid circular, a listing or filing statement or an information circular). CSA Staff is also of the view that the disclosure should be made even if the applicable threshold (whether quantitative or qualitative) under the rules governing the disclosure document is not met.
Although CSA Notice 51-359 is directed toward cannabis industry participants, the content is equally relevant to other issuers, including those operating in emerging growth industries.
CSA Staff regards the existence of cross-ownership to be material information for investors and their investment and/or voting decisions that should be disclosed in the applicable disclosure document.
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Our Take: Strong Governance, Oversight and Transparency Are Keys to Success
While it is impossible to predict with any degree 1. ESTABLISH AN INDEPENDENT AND of certainty which new industries will emerge EXPERIENCED BOARD OF DIRECTORS in the decade ahead, history has taught us – Promote a majority-independent board with that change and disruption are inevitable, and relevant industry and public company experience, and consider establishing an advisory board to the lessons learned from Canada’s Green complement director experience where appropriate Rush provide instructive guidance for issuers (such as to advise on complex issues). operating in emerging growth industries. Junior issuers and issuers in nascent industries should – Appoint an independent board chair or an independent lead director. be proactive and prioritize establishing robust corporate governance practices from inception, – Adopt and adhere to a robust written board mandate, rather than in response to issues as they emerge. governance guidelines and a code of business conduct and ethics to ensure ethical conduct and In our view, the following are three core areas maintain integrity throughout the organization. in which these issuers can better position themselves for future success.
137 Davies | dwpv.com Junior issuers and issuers in nascent industries should be proactive and prioritize establishing robust corporate governance practices from inception, rather than in response to issues as they emerge.
2. MAINTAIN BOARD OVERSIGHT OF 3. PROVIDE TRANSPARENT AND TIMELY CRITICAL OPERATIONS, CONTROLS DISCLOSURE TO KEY STAKEHOLDERS AND RISKS – Ensure that disclosure to investors and other key – Establish and implement robust internal controls stakeholders is clear and easy to understand, balanced and written policies and procedures for timely and provided on a timely basis. reporting to the board, particularly with respect to key operations, risks and compliance matters. – Make disclosure entity-specific and related to the transaction or development in question; avoid – Seek external advice in cases where expertise or boilerplate language. in-house resources are not available to develop appropriate policies and procedures. – Prominently disclose any relationships or circumstances that may, or may appear to, give rise to – Be cognizant of industry or product factors that conflicts of interest (including due to cross-ownership may present unique risks. or other financial interests).
– Do not be complacent – continually probe – Boards (or special committees, discussed further management and re-evaluate governance in Chapter 1, Special Committees: Governance practices. Safeguards for Conflict of Interest Transactions and High-Stakes Situations) charged with evaluating a – Document discussions on material operations, transaction should establish robust processes to fulfill risks and developments, including relevant their mandates and anticipate the need to provide corporate governance considerations, and keep detailed disclosure of the background and role of the the documentation up to date. board/committee throughout the process, including how any conflicts were managed.
Governance Insights 2020 138 Database and Methodology
The quantitative analysis in this report, except when – TSX 60: The S&P/TSX 60 Index (referred to as the otherwise noted, is based on data provided by TSX 60) is a subset of the Composite Index and ISS Corporate Solutions, Inc., and drawn from the represents Canada’s 60 largest issuers by market management information circulars of 338 issuers on capitalization. (Our analysis includes only 58 of the the Toronto Stock Exchange (TSX) issued between issuers on the TSX 60 because, as noted above, two August 1, 2019 and July 31, 2020, which are included in issuers on the TSX 60 did not issue a proxy circular one (or both) of the S&P/TSX Composite Index and the during the period covered.) S&P/TSX SmallCap Index as at May 31, 2020. A total of 1,604 issuers are listed on the TSX. Although the 338 – Completion Index: The S&P/TSX Completion Index Composite Index and SmallCap Index issuers included (referred to as the Completion Index) is the Composite in our study make up only 21% of all TSX-listed issuers, Index excluding the TSX 60 issuers. It comprises 169 they represent approximately 85% of the total market issuers. (Our analysis includes only 153 of the issuers capitalization on the TSX.205 on the Completion Index because, as noted above, 16 issuers on the Completion Index did not issue proxy Descriptions of the relevant indices discussed in this circulars during the period covered.) report are set out below. SmallCap Index: The S&P/TSX SmallCap Index Composite Index: The S&P/TSX Composite Index (referred to as the SmallCap Index) includes 199 issuers, (referred to as the Composite Index) comprises 229 55 of which also meet the market capitalization eligibility issuers. It is the “headline index” and the principal broad criteria and are part of the Composite Index.206 (Our market measure for the Canadian equity markets. It analysis includes only 177 of the issuers on the SmallCap includes common stock and income trust units. Eighteen Index because 22 issuers did not issue a circular for the of the 229 Composite Index issuers did not issue proxy period covered.) circulars for the relevant period discussed; accordingly, our analysis is based on 211 Composite Index issuers. The number and specific constituents of the two indices covered in our study universe change periodically. In Two components of the Composite Index are referred addition, relative to past years, a larger proportion of to in this report: issuers in our study universe had not yet issued their management information circulars by July 31, 2020, largely due to delays caused by the COVID-19 pandemic in holding annual shareholders’ meetings. These factors may in some cases affect comparisons of data points year over year.
139 Davies | dwpv.com Notes
Chapter 1 – Special Committees: Governance Safeguards for 9 Davies (June 5, 2020), online: https://www.dwpv.com/en/ Conflict of Interest Transactions and High-Stakes Situations Insights/Publications/2020/Canadian-Directors-Should- Heed-US-Caremark-Litigation. 1 Peoples Department Stores (Trustee of) v Wise, 2004 SCC 68 (SCC) [People’s]; BCE Inc. v 1976 Debentureholders, 10 See In the Matter of Cartaway Resources Corporation (Re), 2008 SCC 69 (SCC) [BCE]. 2000 LNABASC 375, 9 ASCS 3092 (ASC) [Cartaway]. In that case, the Alberta Securities Commission (ASC) 2 Davies Governance Insights 2019, online: https://www.dwpv. brought proceedings against the chief executive officer and com/en/Insights/Publications/2019/Davies-Governance- a director of Cartaway in connection with misleading press Insights-2019, chapter 1. releases that inflated the stock price. In considering what, 3 See Multilateral CSA Staff Notice 61-302 – Staff Review and if any, liability should be attributed to the director in such Commentary on Multilateral Instrument 61-101 Protection circumstances, the ASC referred to a number of U.S. and of Minority Security Holders in Special Transactions (July 27, Canadian cases regarding liability for a director’s “failure 2017); The Catalyst Capital Group Inc. (Re), 2020 ONSEC 6 to monitor.” The ASC noted that there appear to be two (OSC) [Catalyst]. standards that are applicable to directors to assess liability. 4 Davies (December 20, 2019), online: https://www.dwpv.com/ The first is the well-known Standard Trustco standard (the en/Insights/Publications/2019/Expectations-of-Special- “regulatory test”), which involves an objective evaluation of Committees. whether a director exercised appropriate prudence and due diligence, having regard to the particular circumstances, the 5 Davies (February 27, 2020), online: https://www.dwpv.com/ information available and the systems in place to deal with en/Insights/Publications/2020/HBC-Privatization-Part-II. such information. The second is the Caremark standard 6 Magna International Inc., Re, 2010 ONSEC 13 (OSC) (the “negligence test”), which imposes a lesser standard [Magna]. on a director in that it does not involve an evaluation of the impugned behaviour through an objective lens; rather 7 Our dataset of fees paid to special committee members it considers factors such as good faith and reliance on a by Canadian public companies does not represent an rational process to assess liability. In Cartaway, the ASC exhaustive or complete list of all transactions in which special applied the regulatory test since the securities disclosure committees have been used or paid a fee. Rather, the data standards imposed on directors were codified in legislation rely exclusively on the publicly available information disclosed and related instruments and therefore warranted the higher by Canadian public companies during the noted period in standard. their management proxy circulars and other continuous disclosure documents. 11 India Today, “94% Companies Think COVID-19 Pandemic Can Boost Their Risk Management Techniques: Global Survey” (May 9, 2020), online: https://www. Chapter 2 – Risky Business: The Board’s Role in Enterprise indiatoday.in/education-today/latest-studies/story/94- Risk Management companies-think-covid-19-pandemic-can-boost-risk- 8 Paul J. Sobel and Kurt F. Reding, “Aligning Corporate management-1676236-2020-05-09. Governance with Enterprise Risk Management: Melding 12 Vanguard Group, Investment Stewardship 2020 Enterprise Risk Management with Governance Means Semiannual Report (2020), online: https://about.vanguard. Directors, Senior Management, Internal and External com/investment-stewardship/perspectives-and- Auditors, and Risk Owners Must Work Interdependently” commentary/2020_investment_stewardship_semiannual_ (2004) 5(2) Management Accounting Quarterly, 29. report.pdf, at 4. Gale Academic OneFile, online: https://go.gale.com/ps/ anonymous?id=GALE%7CA118890702&sid=googleScholar 13 Glass Lewis, 2020 Proxy Paper Guidelines: An Overview &v=2.1&it=r&linkaccess=abs&issn=15285359&p=AONE of the Glass Lewis Approach to Proxy Advice (Canada) &sw=w, citing Thomas L. Barton, William G. Shenkir and Paul (2020), online: https://www.glasslewis.com/wp-content/ L. Walker, Enterprise Risk Management: Pulling it All Together uploads/2016/11/Guidelines_Canada.pdf, at 10, 16; ISS, (Altamonte Springs: Institution of Internal Auditors Research Canada: Proxy Voting Guidelines for TSX-Listed Companies: Foundation, 2002), at xi. Benchmark Policy Recommendations (November 18, 2019), online: https://www.issgovernance.com/file/policy/active/ americas/Canada-TSX-Voting-Guidelines.pdf, at 16.
Governance Insights 2020 140 Notes (Cont'd)
14 The number of dedicated risk committees is an approximate Chapter 3 – Navigating Financial Distress: Key Considerations number determined with reference to committee titles and for Directors is not based on a review of committee mandates confirming 24 Canada Business Corporations Act (CBCA), RSC 1985, c that risk was solely delegated to the risk committee. This C-44, sections 102(1), 122(1). number does not include audit committees with risk oversight responsibility (e.g., an audit and risk committee). 25 People’s, supra note 1, at para 67.
15 Serious Fraud Office, “SFO enters into €991 Deferred 26 See Tara Deschamps, “Companies Weigh Dividend Cuts, Prosecution Agreement with Airbus as part of a €3.6bn Suspensions Ahead of Earnings Amid Pandemic,” The Globe global resolution” (January 31, 2020), online: https://www. and Mail (April 21, 2020), online: www.theglobeandmail. sfo.gov.uk/2020/01/31/sfo-enters-into-e991m-deferred- com/investing/investment-ideas/article-companies-weigh- prosecution-agreement-with-airbus-as-part-of-a-e3-6bn- dividend-cuts-suspensions-ahead-of-earnings-amid/; global-resolution/; Serious Fraud Office, “R v Airbus SE Lawrence C. Strauss and Andrew Bary, “Coronavirus Is –Deferred Prosecution Agreement,” online: https://www.sfo. Forcing Companies to Suspend Dividends and Cancel Stock gov.uk/download/airbus-se-deferred-prosecution-agreement- Buybacks,” Nasdaq (March 23, 2020), online: www.nasdaq. statement-of-facts/. com/articles/coronavirus-is-forcing-companies-to-suspend- dividends-and-cancel-stock-buybacks-2020-03-23. 16 CSA Staff Notice 51-358 – Reporting of Climate Change- related Risks (August 1, 2019), at 5; CSA Staff Notice 51- 27 See, for example, CBCA, sections 34(2), 35(3), 36(2), 42; 333 – Environmental Reporting Guidance (October 27, 2010), Business Corporations Act (Ontario), RSO 1990, c B16, at 8. sections 30(2) 31(2) 32(2), 38(3); Companies’ Creditors Arrangement Act (CCAA), RSC 1985 c C-36, section 6(8); 17 CSA, “COVID-19: Continuous Disclosure Obligations and Bankruptcy and Insolvency Act (BIA), RSC 1985, c B-3, Considerations for Issuers” (May 6, 2020), online: https:// section 101. www.securities-administrators.ca/uploadedFiles/General/ pdfs/COVID-19_Continuous_Disclosure_Obligations_and_ 28 Coronavirus Aid, Relief, and Economic Security (CARES) Act, Considerations_for_Issuers.pdf, at 16, 17. 15 USC Ch. 116 § 4003(c)(2)(F), § 4003(c)(3)(A)(ii)(II).
18 Canadian Coalition for Good Governance, 2019 Best 29 See National Instrument 51-102 – Continuous Disclosure Practices for Proxy Circular Disclosure (2019), online: Obligations. https://ccgg.ca/wp-content/uploads/2019/12/2019-Best- 30 CBCA, section 123(4). Practices-March-2020-update.pdf, at 30. 31 People’s, supra note 1, at paras 35, 57. 19 Davies Governance Insights 2018, online: https://www. dwpv.com/en/Insights/Publications/2018/Governance- 32 BCE, supra note 1, at paras 37–39. Insights-2018, chapter 8. 33 Ibid, at paras 44–45.
20 Davies Governance Insights 2019, online: https://www.dwpv. 34 Davies Governance Insights 2019, online: https://www.dwpv. com/en/Insights/Publications/2019/Davies-Governance- com/en/Insights/Publications/2019/Davies-Governance- Insights-2019, chapter 9. Insights-2019, chapter 1.
21 CSA, “CSA Business Plan | 2016-2019: Achievement 35 People’s, supra note 1, at para 47. Highlights” (2019), online: https://www.securities- 36 administrators.ca/uploadedFiles/General/pdfs/Achievements_ CBCA, section 119(1). CSA_Business_Plan_2016-2019.pdf, at 12. 37 Income Tax Act, RSC 1985, c 1 (5th Supp), section 227.1.
22 Protiviti, “Executive Perspectives on Top Risks 2020” (2020), 38 Canada Pension Plan, RSC 1985, c C-8, section 21.1. online: https://www.protiviti.com/sites/default/files/nc-state- 39 Employment Insurance Act, SC 1966, c 23, section 83(1). protiviti-survey-top-risks-2020-executive-summary.pdf. 40 Excise Tax Act, RSC 1985, c E-15, sections 323, 329, 330. 23 Keith Laing, “Despite New NAFTA, Trump Slaps Canada with 10% Aluminum Tariff,” The Detroit News (August 6, 41 BIA, sections 198, 204. 2020), online: https://www.detroitnews.com/story/news/ 42 BIA, section 101(1); CCAA, section 36.1(1). politics/2020/08/06/despite-new-nafta-trump-slaps- canada-aluminum-tariff-usa/3313739001/. 43 Environmental Protection Act, RSO 1990, c E19, section 194(1).
141 Davies | dwpv.com 44 Canada Labour Code, RSC 1985, c L-2. 68 Supra note 64, at 506, 670, 682.
45 Securities Act (Ontario), RSO 1990, C S.5, section 122. 69 CBCA, section 192(3): Where it is not practicable for a corporation that is not insolvent to effect a fundamental 46 Ibid, sections 129.2, 134. change in the nature of an arrangement under any other 47 CBCA, sections 124(1)–(3). provision of this Act, the corporation may apply to a court 48 CCAA, section 11.51(1); BIA, section 64.1(1); Re Northstar for an order approving an arrangement proposed by the Aerospace Inc, 2013 ONSC 1780 (ON SCJ), at para 29. corporation.
49 BIA, section 95(1); CCAA, section 36.1. 70 CBCA, section 192(7): The Director’s role extends to the issuance of a certificate of arrangement once the court has 50 CBCA, sections 238–241; First Edmonton Place Ltd v granted an order approving the arrangement and the Director 315888 Alberta Ltd (1988), 40 BLR 28; 1988 CarswellAlta has received articles in the proper form. 103 (AB QB); Olympia & York Developments (Trustee of) v Olympia & York Realty Corp (2001), 16 BLR (3d) 74, 2001 71 CCAA, section 5.1(1); BIA, section 50(13); Re Fraser Papers CarswellOnt 2954 (ON SCJ). Inc, 2012 ONSC 4882 (ON SCJ).
51 BCE, supra note 1, at paras 70–94. 72 Metcalfe & Mansfield Alternative Investments II Corp, (Re), 2008 ONCA 587 (ON CA), at para 70. 52 Ibid, at para 72. 73 CCAA, section 5.1(2); BIA, section 50(14). 53 Wilson v Alharayeri, 2017 SCC 39 (SCC), at paras 50–51, 61. 74 FTI Consulting, “Canwest Global Communications Corp. 54 BCE, supra note 1, at para 40; UPM-Kymmene Corp v UPM- and the Other Applicants Listed on Schedule ‘A’: Pre- Kymmene Miramichi Inc (2004), 42 BLR (3d) 34, 2004 filing Report of the Proposed Monitor” (October 5, 2009), CarswellOnt 691 (ON CA). online: cfcanada.fticonsulting.com/cmi/docs/Prefiling%20 55 Rea v Wildeboer, 2015 ONCA 373 (ON CA), at paras 15, 18, Report%20of%20the%20proposed%20Monitor%20-%20 36. Oct%205%202009.pdf.
56 Ernst & Young v Essar Global Fund Limited, 2017 ONCA 75 EY Canada, Nortel, online: https://documentcentre.ey.com/#/ 1014 (ON CA). detail-engmt?eid=66; see particularly “Fifth Amended and Restated Initial Order” (February 25, 2011). 57 Ibid, at paras 49–53. 76 FTI Consulting, “Sino-Forest Corporation: Pre-filing Report of 58 Ibid, at para 128. the Proposed Monitor” (March 30, 2012) at 6, online: http:// 59 Ibid, at para 133. cfcanada.fticonsulting.com/sfc/docs/SFCPre-Filing%20 Report.pdf, at 6; FTI Consulting, “Sino-Forest Corporation: 60 Stelco Inc Re, 48 CBR (4th) 299 at para 26, 2004 Sixth Report of the Monitor” (August 10, 2012), online: http:// CarswellOnt 1211 (ON SCJ); See BIA, section 2 for the cfcanada.fticonsulting.com/sfc/docs/Sixth%20Report%20 definition of “insolvent.” of%20the%20Monitor.pdf, at 12. 61 CCAA, section 3(1). 77 FTI Consulting, “The Cash Store Financial Services Inc. and 62 CBCA, section 192. Related Applicants,” First Report of the Monitor, EY Canada 63 9354-9186 Québec inc v Callidus Capital Corp, 2020 SCC (15 April 2014), online: http://cfcanada.fticonsulting.com/ 10 (SCC), at paras 42–43. cashstorefinancial/docs/First%20Report%20of%20the%20 Monitor.pdf, at 13. 64 Stephanie Ben-Ishai & Thomas GW Telfer, eds, Bankruptcy and Insolvency Law in Canada: Cases, Materials, and Problems 78 EY Canada, U.S. Steel Canada Inc, online: https:// (Toronto: Irwin Law, 2019) at 510. documentcentre.ey.com/#/detail-engmt?eid=220; see particularly “Pre-Filing Report of the Monitor” 65 Ibid at 506. (September 16, 2014).
66 Janis P Sarra, Rescue! The Companies’ Creditors 79 EY Canada, CannTrust Holdings Inc, online: https:// Arrangement Act, 2nd ed (Toronto: Thomson Carswell, 2013), documentcentre.ey.com/#/detail-engmt?eid=370; see at 346 [Sarra]; Re Nortel Networks Corp, [2009] OJ No particularly “Report of the Proposed Monitor” 1044, 2009 CarswellOnt 1330 (ON SCJ). (March 31, 2020), at 4. 67 Sarra, ibid.
Governance Insights 2020 142 Notes (Cont'd)
80 Alvarez & Marshal Canada Inc., “Third Report of the maintaining for their portfolio companies best-in-class ESG Monitor Alvarez & Marsal Canada Inc.” (March 10, characteristics. Engagement focus activists are typically, 2020), online: https://www.alvarezandmarsal.com/sites/ but not exclusively, mutual fund managers who often default/files/canada/monitor_s_third_report_to_the_court_ operate through the submission of shareholder proposals. march_10_2020_0.pdf. – Concerned shareholders are individual shareholders, 81 EY Canada, Essar Steel Algoma Inc, online: https:// or groups of shareholders, who attempt to enforce documentcentre.ey.com/#/detail-engmt?eid=244; see change typically at a single company in response to particularly “Sixteenth Report of the Monitor” (September 9, poor performance or other grievances. Typically, these 2016), at 13–14. one-off situations are advanced by former directors or management, or related parties. Chapter 4 – Shareholder Activism Abates, but Not for Long: 86 Activist Insight, “COVID-19: The Impact on Shareholder Significant Activity and Developments in 2020 Activism,” online: https://www.activistinsight.com/research/ 82 Except where otherwise noted, activism data have been COVID19_ActivistInsight.pdf. provided by Activist Insight and are current to June 30, 2020. 87 Davies Governance Insights 2019, online: https://www.dwpv. H1 data relate to periods between January 1 and June 30 of com/en/Insights/Publications/2019/Davies-Governance- the applicable year. Insights-2019, chapter 3. 83 Ibid. 88 See CSA Multilateral Staff Notice 61-302 – Staff Review and 84 Ibid. Commentary on Multilateral Instrument 61-101 Protection of 85 Activist Insight defines “activist focus” as follows: Minority Security Holders in Special Transactions (July 27, 2017); see also the decision and reasons of the – Primary focus activists are investors that proactively OSC in Catalyst, supra note 3. and systematically identify and target underperforming companies, attempting to enhance shareholder value Chapter 5 – Let’s Take This Online: Virtual Shareholders’ through the execution of shareholder activism. For these investors, activist investments typically form a significant Meetings in 2020 and Beyond majority of their investment portfolios. Primary focus 89 Davies Governance Insights 2018, online: https://www. activists are typically, but not exclusively, hedge funds. dwpv.com/en/Insights/Publications/2018/Governance- Insights-2018, chapter 3. – Partial focus activists also proactively and systematically target underperforming companies as part of an established 90 Ibid. activist investment strategy. However, they differ from 91 COVID-19 Response and Reforms to Modernize Ontario Act, primary focus activists in that activist investments will tend 2020, SO 2020, c 7, Schedule 2, online: https://www.ontario. to constitute only a portion of their investment portfolios ca/laws/statute/s20007. alongside assets acquired through the employment of other investment strategies. 92 Ministerial Order No SA:009/2020, OIC 080/2020, Public Health Act, RSA 2000, c P-37, online: https://www.qp.alberta. – Occasional focus activists are investors for which activist ca/Documents/MinOrders/2020/Service_Alberta/2020_ investing is not typically a frequently used strategy within SA009_Service_Alberta.pdf. their broader investment philosophies. Rather than proactively targeting underperforming companies with 93 Ministerial Order No 73/2020, OIC 173/2020, Emergency the goal of improving shareholder value, these otherwise Program Act, RSBC 1996, c 111, online: http://www.bclaws. typically passive shareholders often react instead with ca/civix/document/id/mo/mo/2020_m116. demands for change to the underperformance of portfolio 94 Ministerial Order No 2020-029, OIC 177/2020, Public Health companies, in a bid to protect their existing investments. Act, CQLR c S-2.2, online: https://cdn-contenu.quebec.ca/ – Engagement focus activists are investors that have cdn-contenu/adm/min/sante-services-sociaux/publications- escalated their otherwise typical investment stewardship adm/lois-reglements/AM_numero_2020-029-anglais. responsibilities in order to protect and enhance shareholder pdf?1588008772. value. These activists adopt or otherwise publicly support activist strategies with the objective of achieving or
143 Davies | dwpv.com 95 Order Respecting Time Limits and Other Periods Established 103 Hugessen Consulting, 2020 Proxy Season Overview: By or Under Certain Acts and Regulations for which the Highlights from the TSX60 and Commentary on the Impacts Minister of Industry Is Responsible (COVID-19), online: https:// of Covid-19, online: https://www.hugessen.com/sites/default/ www.ic.gc.ca/eic/site/693.nsf/eng/h_00184.html; Time files/news/20%2006%2018%20TSX-60-draft-rev3.pdf, at 3 Limits and Other Periods Act (COVID-19), SC 2020, c 11, [Hugessen]. section 11, online: https://www.canlii.org/en/ca/laws/astat/ 104 Mark Emanuel, Kathryn Neel, Todd Sirras and Matteo Tonello, sc-2020-c-11/latest/sc-2020-c-11.html. Executive and Director Compensation Reductions in the 96 Canadian Securities Administrators, “Canadian Securities COVID-19 Era, online: https://conferenceboard.esgauge.org/ Regulators Provide Guidance on Conducting Annual General covid-19/payreductions. Meetings During COVID-19 Outbreak” (March 20, 2020), 105 Ibid. online: https://www.securities-administrators.ca/aboutcsa. aspx?id=1879. 106 The Walt Disney Company, Notice of 2020 Annual Meeting and Proxy Statement (January 17, 2020), online: https:// 97 Canadian Securities Administrators, “Canadian Securities thewaltdisneycompany.com/app/uploads/2020/01/2020- Regulators Provide Temporary Relief to Public Companies Proxy-Statement.pdf, at 19-20. with Delayed Annual Meetings Due To COVID-19” (May 1, 2020), online: https://www.securities-administrators.ca/ 107 Christopher Palmeri and Anders Melin, “Disney’s Bob Iger aboutcsa.aspx?id=1897. Faces Criticism of Pay, Even After Leaving CEO Job,” Bloomberg (March 5, 2020), online: https://www.bloomberg. 98 U.S. Securities and Exchange Commission, Release No. 34- com/news/articles/2020-03-05/disney-s-iger-faces- 88465 (March 25, 2020), online: https://www.sec.gov/rules/ criticism-of-pay-even-after-leaving-ceo-job. exorders/2020/34-88465.pdf. 108 United States Securities and Exchange Commission, 99 U.S. Securities and Exchange Commission, “Staff Guidance Form 8-K Walt Disney Co (March 30, 2020), online: for Conducting Shareholder Meetings in Light of COVID-19 https://sec.report/Document/0001744489-20- Concerns” (April 7, 2020), online: https://www.sec.gov/ocr/ 000072/#dis-20200330.htm. staff-guidance-conducting-annual-meetings-light-covid-19- concerns. 109 Supra note 107.
100 Toronto Stock Exchange, “Staff Notice 2020-0002” (March 110 “Mickey’s on furlough: Disney’s Wholesome Family Image 23, 2020), online: https://decisia.lexum.com/tsx/sn/en/ Takes a Hit as It Lays Off Workers but Maintains Executive item/466093/index.do; TSX Venture Exchange, “Extension of Bonuses,” Financial Times (April 27, 2020), online: https:// Deadlines for AGM and Stock Option Plan Approval” (March financialpost.com/financial-times/mickeys-on-furlough- 23, 2020), online: https://www.tsx.com/resource/en/2230. disneys-wholesome-family-image-takes-a-hit-as-it-lays-off- workers-but-maintains-executive-bonuses. 101 Glass, Lewis & Co., “Immediate Glass Lewis Guidelines Update on Virtual-Only Meetings due to COVID-19 111 Hugessen, supra note 102. (Coronavirus)” (March 19, 2020), online: https://www. 112 Peter Eavis, “As the Pandemic Forced Layoffs, C.E.O.s Gave glasslewis.com/immediate-glass-lewis-guidelines-update- Up Little,” The New York Times (July 29, 2020), online: on-virtual-only-meetings-due-to-covid-19-coronavirus/; https://www.nytimes.com/2020/07/29/business/economy/ Institutional Shareholder Services Inc., “Impacts of the ceo-pay-pandemic-layoffs.html. COVID-19 Pandemic – ISS Policy Guidance” (April 8, 2020), online: https://www.issgovernance.com/file/policy/ 113 Greg Arnold and Blair Jones, “Principles for Paying Incentives active/americas/ISS-Policy-Guidance-for-Impacts-of-the- in the Midst of Covid-19,” Semler Brossy (July 17, 2020), Coronavirus-Pandemic.pdf. online: https://www.semlerbrossy.com/insights/principles-for- paying-incentives-in-the-midst-of-covid-19/ [Semler Brossy]; Hugessen, supra note 103, at 7; ISS Global Policy Board, Chapter 6 – Executive Decisions: Compensation Trends In and Impacts of the COVID-19 Pandemic: ISS Policy Guidance Outside of Times of Crisis (April 8, 2020), online: https://www.issgovernance.com/file/ 102 Hugessen Consulting, Canadian Pay Cut Summary policy/active/americas/ISS-Policy-Guidance-for-Impacts-of- (June 20, 2020), online: https://www.hugessen.com/sites/ the-Coronavirus-Pandemic.pdf, at 7. default/files/inline-files/Canadian%20Pay%20Cut%20 Summary%20%28as%20of%20July%2020%202020%29. pdf [Hugessen].
Governance Insights 2020 144 Notes (Cont'd)
114 Camille Jovanovic, “Executive Compensation in 124 Glass Lewis, supra note 116, at 26. Unprecedented Times,” Hugessen Consulting (March 20, 125 Hugessen, supra note 103, at 3. 2020), online: https://www.hugessen.com/sites/default/ files/news/Hugessen%20Consulting%20%28March%20 126 Pete Evans, “Canada Added Almost 1 Million Jobs in June 20%2C%202020%29%20-%20Executive%20 but Still Almost 2 Million Down from Pre-COVID-19 Level,” Compensation%20in%20Unprecedented%20Times.pdf. CBC News (July 10, 2020), online: https://www.cbc.ca/news/ business/canada-jobs-june-1.5644672. 115 Semler Brossy, supra note 113; ISS, supra note 113; Hugessen, supra note 103; infra note 116. 127 IGOPP, Executive Compensation: Cutting the Gordian Knot, Policy Paper No. 9 (November 2017), online: https://igopp. 116 Glass Lewis, 2020 Proxy Paper Guidelines: An Overview org/en/executive-compensation-cutting-the-gordian-knot/. of the Glass Lewis Approach to Proxy Advice (Canada) (2019), online: https://www.glasslewis.com/wp-content/ 128 Rita Trichur, “Why Canada Should Adopt Pay Ratio uploads/2016/11/Guidelines_Canada.pdf, at 33; ISS, supra Disclosures,” The Globe and Mail (April 19, 2020), online: note 113, at 7. https://www.theglobeandmail.com/business/commentary/ article-why-canada-should-adopt-pay-ratio-disclosures/. 117 Kevin Wells, David J. Moore and Nicole Bondi, “As Pay Ratio Enters Its Third Year, Here’s What We Know So Far,” Aon plc 129 The referenced “Canadian big banks” are: National Bank (September 2019), online: https://rewards.aon.com/en-us/ of Canada (NBC), Royal Bank of Canada (RBC), Bank of insights/articles/2019/as-pay-ratio-enters-its-third-year- Montreal (BMO), Canadian Imperial Bank of Commerce heres-what-we-know-so-far. (CIBC), Bank of Nova Scotia (Scotiabank) and Toronto Dominion Bank (TD). 118 Amit Batish and Courtney Yu, “Say on Pay and the Effects of the CEO Pay Ratio: Key Findings from the 2020 130 Davies Governance Insights 2018, online: https://www. Proxy Season,” Harvard Law School Forum on Corporate dwpv.com/en/Insights/Publications/2018/Governance- Governance (June 24, 2020), online: https://corpgov.law. Insights-2018, chapter 7. harvard.edu/2020/06/24/say-on-pay-and-the-effects-of-the- 131 The Toronto-Dominion Bank, “Notice of Annual Meeting of ceo-pay-ratio-key-findings-from-the-2020-proxy-season/. Common Shareholders and Management Proxy Circular” 119 Rachel Kay and Luke Hildyard, “Rethinking Reward – Analysis (April 2, 2020), online: https://www.td.com/document/PDF/ of 2020 Pay Ratio Disclosures (Interim Report),” High Pay investor/2019/E-2019-Proxy-Circular.pdf, at 67. Centre (April 2020), at 2, 7, 22, 31. 132 CIBC, “Notice of Annual Meeting of Shareholders and 120 Greg Arnold and Mark Emanuel, “A Thoughtful Approach in Management Proxy Circular” (April 8, 2020), online: https:// Uncertain Times,” Harvard Law School Forum on Corporate www.cibc.com/content/dam/about_cibc/investor_relations/ Governance (July 22, 2020), online: https://corpgov.law. pdfs/quarterly_results/2020/management-proxy-circular- harvard.edu/2020/07/22/a-thoughtful-approach-in- 2020-en.pdf, at 6. uncertain-times/; Semler Brossy, supra note 113; Glass 133 Vancity, “2019 Annual Report Accountability Statements” Lewis, supra note 116, at 28. (2019).
121 Hugessen, supra note 103, at 8. 134 Aaron Bertinetti, “Everything in Governance Is Affected by the 122 Martin Vezér and Martin Wennerström, “The State of Pay: Coronavirus Pandemic. This is Glass Lewis’ Approach,” Glass Executive Remuneration & ESG Metrics,” ESG Spotlight Lewis (March 26, 2020), online: https://www.glasslewis.com/ No. 26, Sustainalytics Thematic Research (April 30, 2020), everything-in-governance-is-affected-by-the-coronavirus- online: https://www.sustainalytics.com/esg-research/ pandemic/. issue-spotlights/esg-spotlight-the-state-of-pay-executive- remuneration-esg-metrics/. Chapter 7 – Beyond Gender: Diversity and Inclusiveness Now 123 Alastair Marsh, “‘Tone Deaf’ Executive Pay Is Virus Focal and Going Forward Point for ESG Investors,” Bloomberg (April 28, 2020), online: 135 Davies Governance Insights 2019, online: https://www.dwpv. https://news.bloomberglaw.com/coronavirus/tone-deaf- com/en/Insights/Publications/2019/Davies-Governance- executive-pay-is-virus-focal-point-for-esg-investors. Insights-2019, chapter 6.
136 Ibid.
145 Davies | dwpv.com 137 Geoff Zochodne, “Visible Minorities Vastly Underrepresented 145 Catherine Thorbecke, “Reddit Replaces Alexis Ohanian’s in the Boardroom, New Disclosures Suggest,” The Financial Board Seat Wth Black Tech Entrepreneur Michael Seibel,” Post (June 12, 2020), online: https://financialpost.com/news/ ABC News (June 10, 2020), online: https://abcnews.go.com/ fp-street/the-lifting-of-all-boats-is-clearly-not-happening- Business/reddit-replaces-alexis-ohanians-board-seat-black- boardrooms-of-big-canadian-companies-still-mostly-white- tech/story?id=71175108#:~:text=Seibel%20has%20a%20 and-still-mostly-male. long%20history%20of%20promoting%20inclusion%20 and%20diversity%20in%20tech.&text=Days%20after%20 138 Ryerson University’s Diversity Institute, “Black Leaders Are Reddit%20co%2Dfounder,be%20filled%20by%20 Nearly Non-Existent on Canadian Boards According to Michael%20Seibel. Ryerson’s Diversity Institute’s New Study of Canadian Board Diversity” (August 6, 2020), online: https://www.ryerson.ca/ 146 Alexandra Posadzki, “Stockwell Day Steps Down from Telus diversity/news-events/2020/08/black-leaders-are-nearly- Board After Remarks on Systemic Racism in Canada,” non-existent-on-canadian-boards-according-to-ryerson-s- The Globe and Mail (June 3, 2020), online: https://www. diversity-institute-s-new-study-of-canadian-board-diversity/. theglobeandmail.com/business/article-stockwell-day-steps- down-as-telus-director-after-remarks-on-systemic/. 139 Ryerson University’s Diversity Institute, Diversity Leads – Diverse Representation in Leadership: A Review of Eight 147 Business Wire, “Canadian Council of Business Leaders Canadian Cities (August 2020), online: https://www.ryerson. Against Anti-Black Systemic Racism Announces ca/diversity/reports/DiversityLeads_2020_Canada.pdf, Formation; Launch of BlackNorth Initiative” (June 10, at 14; Uhanthaen Ravilojan, “New Study Finds Less Than 2020), online: https://www.businesswire.com/news/ 1 Per Cent of Canadian Corporate Leaders Are Black,” home/20200610005399/en/Canadian-Council-Business- Toronto Star (July 4, 2020), online: https://www.thestar.com/ Leaders-Anti-Black-Systemic-Racism. business/2020/07/04/less-than-one-per-cent-of-corporate- 148 Ibid. leaders-at-tsx-60-companies-are-black-researchers-find. html. 149 The BlackNorth Initiative, supra note 141; supra note 147.
140 Kevin LaCroix, “Facebook Board Hit with Derivative Lawsuit 150 The BlackNorth Initiative, “The Pledge,” online: https://www. on Board Diversity and Other Race-Related Issues,” blacknorth.ca/The-Pledge. LexBlog (July 16, 2020), online: https://www.lexblog. 151 The BlackNorth Initiative, “Canadian CEOs Commemorate com/2020/07/16/facebook-board-hit-with-derivative- Launch of the BlackNorth Initiative” (July 21, 2020), online: lawsuit-on-board-diversity-and-other-race-related-issues/. https://blacknorth.ca/canadian-ceos-commemorate-launch- 141 Mark Rendell, “CEOs Launch Initiative to Boost Black of-the-blacknorth-initiative/. See also the BlackNorth Initiative Representation on Boards,” The Globe and Mail (June 10, website, online: https://blacknorth.ca/signatories. 2020), online: https://www.theglobeandmail.com/business/ 152 Supra note 147. article-bay-street-executives-announce-new-council-to- combat-systemic-racism/. See also The BlackNorth Initiative, 153 Capital Markets Modernization Taskforce, Capital Markets online: https://www.blacknorth.ca/Home. Modernization Taskforce – Consultation Report (July 2020), online: https://files.ontario.ca/books/mof-capital-markets- 142 Goldman Sachs, “Goldman Sachs’ Commitment to modernization-taskforce-report-en-2020-07-09.pdf, at 23. Board Diversity” (February 4, 2020), online: https://www. goldmansachs.com/what-we-do/investing-and-lending/ 154 Ibid, at 5, 47. launch-with-gs/pages/commitment-to-diversity.html. 155 Supra note 135, chapter 1 at 11-12.
143 Lisa Eadicicco, “Apple Is Launching a $100 Million Initiative 156 Mark Rendell, “Ontario Task Force Recommends TSX to Fight Racial Injustice and Promote Diversity Both Inside Companies Be Required to Set Diversity Targets for and Outside the Company,” Business Insider (June 11, 2020), Leadership,” The Globe and Mail (July 9, 2020), online: online: https://www.businessinsider.com/apple-launches-100- https://www.theglobeandmail.com/business/article-ontario- million-racial-equity-justice-initiative-2020-6. task-force-recommends-tsx-companies-be-required-to-set/.
144 Lesley Messer, “Alexis Ohanian Resigns From Reddit Board, 157 James Bradshaw, “RBC Boosts Target for Visible Minorities in Wants a Black Candidate to Replace Him,” ABC News Executive Roles to 30 Per Cent,” The Globe and Mail (June 5, 2020), online: https://abcnews.go.com/GMA/Culture/ (July 6, 2020), online: https://www.theglobeandmail.com/ alexis-ohanian-resigns-reddit-board-black-candidate-replace/ business/article-rbc-boosts-target-for-visible-minorities-in- story?id=71092749. executive-roles-to-30-per/.
158 Supra note 135, at 95-96.
Governance Insights 2020 146 Notes (Cont'd)
Chapter 8 – ESG and Climate Change in the Shadow of CPA, “Summary Report: Study of Climate-related Disclosures COVID-19: “E,” “S” & G Are Here to Stay by Canadian Public Companies” (January 2020), online: https://www.cpacanada.ca/en/business-and-accounting- 159 For example, a March 2020 Bloomberg study, which found resources/financial-and-non-financial-reporting/mdanda- that discussions about climate change during first-quarter and-other-financial-reporting/publications/climate-related- earnings calls by Standard & Poor’s 500 companies dropped disclosure-study-2019-summary, at 2. 50% compared with the previous quarter. Olivia Raimonde and Hailey Waller, “CEOs Drop Climate Change Talk to Focus 164 Emerging disclosure frameworks are increasingly using on Surviving Covid-19,” Bloomberg (July 1, 2020), online: the TCFD as their foundation. For example, on January https://www.bloomberg.com/news/articles/2020-07-01/ 22, 2020, a task force sponsored by the International ceos-drop-climate-change-talk-to-focus-on-surviving- Business Council of the World Economic Forum released covid-19. for stakeholder consultation a white paper titled “Toward Common Metrics and Consistent Reporting of Sustainable 160 For example, the United Kingdom’s Financial Conduct Value Creation,” which outlines a core set of material Authority (FCA) issued a consultation paper in March metrics and recommended disclosure already present 2020, proposing that all firms with a U.K. premium listing be in existing standards and frameworks: notably, those of obligated to include in their annual reports: (i) confirmation as the GRI (Global Reporting Initiative), SASB (Sustainability to whether they had made TCFD-consistent disclosures; (ii) Accounting Standards Board), CDP (formerly the Carbon identification of instances where they had not adhered to the Disclosure Project) and TCFD. More details concerning TCFD’s recommendations (along with an explanation for such the various Climate Disclosure frameworks are available in departures from the framework); (iii) identification of climate Davies Governance Insights 2019, online: https://www.dwpv. disclosure made in documents other than their annual reports com/en/Insights/Publications/2019/Davies-Governance- (along with the rationale for doing so); and (iv) identification of Insights-2019, chapter 2. precisely where in the annual report, or any other document, the issuer’s climate disclosure may be found. In Canada, the 165 Global Reporting Initiative, “How to Report the TCFD consultation report issued in July 2020 by Ontario’s Capital Recommendations Using the GRI Standards” (September 30, Markets Modernization Taskforce recommended mandatory 2019). disclosure of material ESG information that is compliant 166 CDSB and CDP, “The Building Blocks: Connecting CDP Data with either the TCFD or the SASB frameworks. See Capital with the CDSB Framework to Successfully Fulfil the TCFD Markets Modernization Taskforce, supra note 153, at 27. Recommendations” (May 2020), online: https://www.cdsb. 161 The TCFD reports that as of February 2020, over 1,027 net/sites/default/files/the_building_blocks_guidance_web_ public and private organizations, in multiple sectors version.pdf. and jurisdictions, have expressed support for the TCFD 167 Canada, “Prime Minister Announces Additional Support for framework. See TCFD News Release, “More than 1,000 Businesses to Help Save Canadian Jobs” (May 11, 2020), Global Organizations Declare Support for the Task online: https://pm.gc.ca/en/news/news- Force on Climate-related Financial Disclosures and its releases/2020/05/11/prime-minister-announces-additional- Recommendations” (February 12, 2020), online: https://www. support-businesses-help-save. fsb-tcfd.org/wp-content/uploads/2020/02/PR-TCFD-1000- Supporters_FINAL.pdf. 168 Ibid. On July 16, 2020, the Canadian federal government continued to advance action on climate change as a priority 162 Davies Governance Insights 2019, online: https://www.dwpv. when it released its “Strategic Assessment of Climate com/en/Insights/Publications/2019/Davies-Governance- Change,” intended to provide guidance to proponents of Insights-2019, chapter 2. projects to which the federal Impact Assessment Act (IAA) 163 A recent study by the Chartered Professional Accountants applies regarding the greenhouse gas and climate change of Canada (CPA) analyzing the carbon disclosure made by information required for assessments under the IAA. leading Canadian public companies in their regulatory filings 169 IIGCC, “Consultation: Net Zero Investment Framework” found that nearly all companies had made disclosures in (August 5, 2020), online: https://www.iigcc.org/resource/net- at least one of the TCFD’s recommended categories, while zero-investment-framework-for-consultation/. only one company made disclosure in every recommended category and sub-category.
147 Davies | dwpv.com 170 Canada, “Final Report of the Expert Panel on Sustainable 179 CPP Investment Board, “Proxy Voting Principles and Finance: Mobilizing Finance for Sustainable Growth” (June Guidelines” (February 13, 2020), online: https://www. 14, 2019), online: https://www.canada.ca/en/environment- cppinvestments.com/the-fund/sustainable-investing/proxy- climate-change/services/climate-change/expert-panel- voting. sustainable-finance.html. 180 Alberta Investment Management Corporation, “Proxy Voting 171 Ibid. Guidelines & Corporate Governance Principles” (January 2020), online: https://assets.ctfassets.net/ 172 On May 19, 2020, the Bank of Canada also released a staff lyt4cjmefjno/1Xc2BDu3jejmzIBKVjXh82/316ecc27d1ae98a discussion paper titled “Scenario Analysis and the Economic 25343d88d3e2e19d9/AIMCo_-_Proxy_Voting_Guidelines_-_ and Financial Risks from Climate Change,” providing further January_2020.pdf, at 14-15. confirmation that climate-related risks are being carefully considered by the Bank of Canada. The discussion paper is 181 Ontario Teachers’ Pension Plan, “2020 Corporate available online: https://www.bankofcanada.ca/wp-content/ Governance Principles and Proxy Voting Guidelines,” online: uploads/2020/05/SDP-2020-3.pdf. https://www.otpp.com/documents/10179/20940/-/ bf03be90-a413-433f-bc4a-24a266ae17bb/2020%20 173 Transition risk assessments and alternatives analyses are Corporate%20Governance%20Principles%20and%20 required for projects with total annual emissions of at least Proxy%20Voting%20Guidelines.pdf. 100,000 tonnes of carbon dioxide equivalent. 182 Ibid, at 50. 174 Canadian EPFI’s include Bank of Montreal, Bank of Nova Scotia, Canadian Imperial Bank of Commerce, Export 183 CDP, “CDP Temperature Ratings,” online: https://www.cdp.net/ Development Canada, Manulife, Royal Bank of Canada and en/investor/temperature-ratings. TD Bank Financial Group. Equator Principles, “The Equator 184 Ibid. Principles: Guidance on Implementation of the Equator Principles During the Covid-19 Pandemic” 185 Patrick Bolton and Marcin T. Kacperczyk, “Carbon Premium (June 2020), online: https://equator-principles.com/wp- Around the World” (March 13, 2020), online: https://dx.doi. content/uploads/2020/06/Guidance_on_the_imlementation_ org/10.2139/ssrn.3550233. of_the_EP_during_the_covid19_pandemic.pdf. 186 But not in Africa, Australia or South America.
175 The value of disclosure to BlackRock’s decision-making 187 Supra note 185. Conversely, Bolton and Kacperczyk reported process was made explicit through BlackRock’s commitment that institutional investors’ divestment policies are focused to use proxy voting to hold accountable those companies that primarily on a company’s emission intensity levels, suggesting are not adequately disclosing and managing sustainability- that such policies are failing to minimize exposure to climate related risks. BlackRock’s co-founder and CEO Larry Fink change risk, and are instead simply filtering companies by the went so far as to describe climate change as the “defining efficiency of their fossil fuel use. This disconnect between factor” in a company’s long-term prospects, and pushed the climate disclosure metrics that correlate to the carbon companies to make climate disclosure in line with TCFD and premium and those on which divestment decisions are based SASB guidelines, warning that BlackRock would vote against highlights the need for companies to increase efforts to management and board directors who fail to discharge this educate the public on the significance of each element of obligation. climate disclosure.
176 BlackRock, Inc., “Our Approach to Sustainability” (July 2020), 188 HESTA, “HESTA Announces Net Zero by 2050 Aim as Part online: https://www.blackrock.com/corporate/literature/ of Ambitious Climate Change Plan” (June 26, 2020), online: publication/our-commitment-to-sustainability-exec-summary- https://www.hesta.com.au/about-us/media-centre/HESTA- en.pdf. announces-net-zero-by-2050-aim-climate-change-plan.html.
177 State Street Global Advisors, “CEO’s Letter on our 2020 189 Norges Bank Investment Management, “Exclusion Decisions Proxy Voting Agenda” (January 28, 2020), online: https:// and Decisions to Revoke Exclusion” (May 13, 2020), online: www.ssga.com/library-content/pdfs/insights/CEOs-letter-on- https://www.nbim.no/en/the-fund/news-list/2020/exclusion- SSGA-2020-proxy-voting-agenda.pdf. decisions-and-decisions-to-revoke-exclusion/. 178 OMERS, “Proxy Voting Guidelines” (April 1, 2020), online: https://assets.ctfassets.net/ iifcbkds7nke/76hZIwR6HOvjFxMWpODjgC/ eab3221c3068048e8b6efd1902b1b91d/OMERS-Proxy- Voting-Guidelines-April-2020-FINAL.pdf, at 28-29.
Governance Insights 2020 148 Notes (Cont'd)
190 Geoffrey Morgan, , “Why Norway Fund’s Divestment from Chapter 9 – Governance in a Nascent Industry: Lessons from the Oilsands Could Trigger a Bigger Fund Exodus,” The Canada’s “Green Rush” Financial Post (May 13, 2020), online: https://financialpost. 200 CSA Multilateral Staff Notice 51-359 – Corporate com/commodities/energy/why-the-worlds-largest-sovereign- Governance Related Disclosure Expectations for Reporting wealth-funds-divestment-from-the-oilsands-could-trigger-a- Issuers in the Cannabis Industry (November 12, 2019). bigger-fund-exodus. 201 Davies Governance Insights 2019, online: https://www.dwpv. 191 CBC, “Deutsche Bank Says It Won’t Back Any New Oilsands com/en/Insights/Publications/2019/Davies-Governance- or Coal Projects” (July 27, 2020), online: https://www.cbc.ca/ Insights-2019, chapter 5 at 75. news/canada/calgary/deutsche-bank-coal-oilsands-invest- carbon-energy-fracking-1.5664632. 202 On the basis of market capitalization as of June 15, 2020, we selected a sample of 20 Canadian cannabis issuers holding 192 BHP, “Industry Associations – BHP’s Approach” (2020), licences issued under the Cannabis Act. online: https://www.bhp.com/our-approach/operating-with- integrity/industry-associations-bhps-approach/. 203 Ibid.
193 Ibid. 204 Hindenburg Research, “Aphria: A Shell Game with a Cannabis Business on the Side” (December 3, 2018), online: https:// 194 Ross Kerber and Sinead Cruise, “Vanguard Names and Backs hindenburgresearch.com/aphria-a-shell-game-with-a- Some Calls for Climate Steps,” Reuters (June 18, 2020), cannabis-business-on-the-side/. online: https://www.reuters.com/article/us-climatechange- vanguard-exclusive/exclusive-vanguardnames-names-and- backs-some-calls-for-climate-steps-idUSKBN23P1T1. Database and Methodology
195 ISS ESG, “ISS ESG Launches New SDG Impact Rating” (May 205 As at May 31, 2020, based on data provided by Market 5, 2020), online: https://www.issgovernance.com/iss-esg- Intelligence Group. launches-new-sdg-impact-rating/. 206 To qualify for the Composite Index, an issuer must, at the time 196 Ceres Accelerator for Sustainable Capital Markets, of determining eligibility, (i) represent a minimum weight of “Addressing Climate as a Systematic Risk: A Call to Action for 0.05% of the index and (ii) have a minimum volume-weighted U.S. Financial Regulators” (June 1, 2020), online: https://www. average share price of at least $1.00. To qualify for the ceres.org/resources/reports/addressing-climate-systemic- SmallCap Index, an issuer must have a market capitalization risk. that is at least $100 million, but not more than $1.5 billion.
197 The TCFD has created a Knowledge Hub, aimed at providing guidance to organizations interested in implementing the TCFD’s recommendations, online: https://www.tcfdhub.org/. Useful guidance that is available through the Knowledge Hub includes the “TCFD Implementation Guide” and the “TCFD Good Practice Handbook.”
198 For example, based on our recent review of the climate- related disclosures by 19 leading public mining issuers in Canada, 15 expressly endorsed the TCFD recommendations in their 2019 disclosures.
199 PwC has also published guidance recently with the aim of bridging the gap between current ESG disclosure practices and growing investor expectations for useful information concerning ESG-related risks. PwC, “Mind the Gap: The Continued Divide Between Investors and Corporates on ESG” (June 2020), online: https://www.pwc.com/us/en/services/ assets/pwc-esg-divide-investors-corporates.pdf.
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