Cannabis and Beyond

Capital Markets Update: Cannabis and Beyond

October 24, 2018 Patricia Olasker, Rob Murphy, David Wilson, Robin Upshall and Chantelle Cseh

1 Cannabis Update 5 Non-GAAP and Other Financial Measures Disclosure

2 Cross-Border Developments 6 The Evolving Standard for Assessing Materiality

3 Securities Laws and Blockchain Update 7 Elon Musk and the Importance of Careful Tweeting

4 TSX Update

– Illicit: ~ $5.0 – $6.2 Billion – Expected: ~ $4.9 - $8.7 Billion

TSX Listed Issuers (as at October 23) Other Issuers

Market Cap: Market Cap: Market Cap: Market Cap: Market Cap: $11.74 Billion $9.38 Billion $3.65 Billion $10.18 Billion $696 Million (TSX & NYSE) (TSX & NYSE) (NASDAQ) (TSX-V)

Market Cap: Market Cap: Market Cap: Market Cap: Market Cap: $1.93 Billion $1.02 Billion $1.04 Billion $440 Million $412 Million (TSX & NASDAQ) (TSX-V) (TSX-V)

Market Cap: Market Cap: Market Cap: $983 Million $728 Million $529 Million (TSX-V) (TSX-V) 5

Regulatory History

October 17, 2012 2018 MMPR Cannabis Act 1999 Harper government Legalization of Exemptions regulations creating cannabis for issued by commercial recreational Health Minister cannabis industry purposes

2001 2016 MMAR ACMPR Allows individuals Foundation for with medical need current medical to grow their own cannabis cannabis regime

Federal Cannabis Act Provincial Regulation – Comprehensive scheme governing the licencing, - Provinces are given the ability to regulate on, among other things, the retail sale of cannabis production, distribution and sale of cannabis and under s. 69(1) of the Cannabis Act related products - The provinces have generally adopted one of – Replaces Access to Cannabis for Medical three retails methodologies: Purposes Regulations  Public – New medical regime substantially similar to  Private ACMPR  Hybrid – What’s legal: fresh, dried, oils, plants and seeds - Ontario – What’s not legal: edibles and concentrates  Current: Cannabis sold exclusively online  April 2019: Private retail

Aurora Cannabis Inc. Acquired: Canopy Growth Corporation Aphria Inc. Acquired: – CanniMed Therapeutics $1.1 Acquired: – Broken Coast Cannabis Inc. - billion (May 2018) – Mettrum Health Corp. - $430 $230 million (February 2018) – MedReleaf Corp - $3.2 billion million (January 2017) – Nuuvera Inc. - $425 million (July 2018) – Hiku Brands Ltd. - (March 2018) – ICC Labs Inc. - $290 million $299.4million (September (pending) 2018)

Alcohol/CPG Retail – Constellation Brands Inc. acquisition of equity stake – Aurora Cannabis and Liquor Stores N.A. Announce in Canopy Growth Corporation Investment to Develop Retail Cannabis Business – Molson Coors Canada and Hexo Joint Venture – Billion-Dollar Cannabis Brand MedMen Coming To Focused on Non-Alcoholic, Cannabis-Infused Canada Via Cronos Beverages – NAC and Second Cup Establish Strategic Alliance – Coca-Cola? to Operate Recreational Cannabis Dispensaries Pharmaceutical – Shoppers Drug Mart gets medical pot licence from – Tilray and Sandoz Announce Pharmaceutical Health Canada Partnership Technology – CannTrust and Apotex Accelerate Partnership to Fuel – Cronos Group and Ginkgo Bioworks Announce a Global Expansion in Medical Cannabis Market Partnership to Produce Cultured Cannabinoids Tobacco? – Emerald Health Announces Blockchain based – Altria investment in Aphria? Supply Chain Management solution

U.S. Cannabis Industry Risk

Use and sale – Cannabis is Schedule I narcotic under U.S. Controlled Substances Act > Medical sales permitted in 31 states; Recreational sales permitted in 9 states – Cole Memorandum > Never de-criminalized cannabis offences, just de-prioritized U.S. federally regulated banks – Any money derived from cannabis operations in the U.S.  proceeds of crime > Size of the investment does not matter – BUT any profits from legal Canadian operations are not proceeds of crime > Key is that the cannabis company be operates solely within Canada, or another jurisdiction where cannabis is legal

TSX Staff Notice – Delisting of Cannabis Companies

– (i) direct or indirect ownership of, or investment in, an entity engaging in the cultivation, distribution or possession of marijuana in the U.S. (“Subject Entities”)

– (ii) commercial interests or arrangements with Subject Entities that are similar in substance to ownership of, or investment in, Subject Entities

– (iii) providing services or products that are specifically designed for, or targeted at, Subject Entities

– (iv) commercial interests or arrangements with entities engaging in the business activities described in (iii)

CSA Staff Notice 51-352 Issuers with U.S. Marijuana-Related Activities – Focus on disclosure BUT deference to stock exchanges > nature of the issuer's involvement in the cannabis industry, > cannabis remains illegal under U.S. federal law > whether and how the issuer's U.S. cannabis related activities are conducted in a manner consistent with U.S. federal enforcement priorities > ability to access both public and private capital and what financing options are or are not available in order to support continuing obligations. – CSA revised Staff Notice in 2018 in response to rescission of Cole Memo – Quantification of exposure, receipt of legal advice, exposure arising from U.S. federal law

Securities Regulation (continued)

– Issuers' response: – Aphria sold its shares in Liberty Health > Divest/spin-out assets Sciences, a cannabis producer with operations in Florida for $59.1 M > Buyback options contingent upon cannabis becoming federally legal in the U.S. – CannTrust assigned certain US IP to a non- related party for nominal consideration

– Aurora spun-out its subsidiary, Australis, to pursue investment opportunities in the U.S.

– Canopy Rivers restructured its investment in TerrAscend to allow TerrAscend to pursue strategic transactions in the U.S.

Equity Financing Reverse Take Overs Streaming Agreements – Primary source of capital – Preferred method of going – What is streaming? – Big banks slow to enter public > Essentially a loan, to be repaid in cannabis at agreed – BMO – Recent RTOs: upon rates > $100 million bought deal for > Canopy Rivers (September > Often accompanied by equity Cronos 2018) stake > $200 million bought deal for > Flowr Corporation Canopy (September 2018) – Auxly > $90 million bought deal for – IPOs – Canopy Rivers Supreme Cannabis > The Green Organic – CIBC Dutchman > Canopy Rivers RTO > Tilray (NASDAQ)

Bank Financing What are the Assets? – Cannabis companies can borrow from Schedule I - Real Property Banks, but how will a bank take and enforce its - Equipment security? - Intellectual Property – Asset Forfeiture/Seizure - Goodwill – Considerations when taking Security - Securities or Other Interests > What are the assets > Challenges when enforcing security - Inventory - Receivables - Production and/or Sales License(s)

– Generally, any non-U.S. citizen who has been convicted of, admits having committed or admits committing acts that violate any law or regulation of a state in the U.S. or the U.S. itself will be inadmissible to the U.S. – September directive: “As Canada prepares to legalize recreational marijuana starting Oct. 17, 2018, U.S. Customs and Border Protection (CBP) would like to remind travelers that marijuana is a controlled substance under United States federal law. The sale, possession, production, distribution or the facilitation of the aforementioned of both medical and recreational marijuana remains illegal under U.S. federal law…Determinations about admissibility and whether any regulatory or criminal enforcement is appropriate are made by a CBP officer based on the facts and circumstances known to the officer at the time.” – October update: “A Canadian citizen working in or facilitating the proliferation of the legal marijuana industry in Canada, coming to the U.S. for reasons unrelated to the marijuana industry will generally be admissible to the U.S. however, if a traveler is found to be coming to the U.S. for reason related to the marijuana industry, they may be deemed inadmissible.”

Employment Issues Workplace Safety Issues – Benefits Plans Coverage – Concern that increased use of cannabis, led by > Manulife and Shoppers offering coverage social normalization, will result in higher incidences of impairment in the workplace

– Drug Testing for Cannabis Use – Challenge: identifying impairment and

responding accordingly – Accommodating Cannabis Use

What are they? • Ontario's new rule (72-503) provides a prospectus exemption for any: i. public offering in the U.S. or specified foreign jurisdiction; ii. foreign offering concurrent with a Canadian public offering; iii. foreign offering of a Canadian reporting issuer; or iv. foreign offering of a non-reporting issuer • Acquired securities are freely tradeable except under exemption (iv) • Exemptions (iii) and (iv) require brief trade report (no confidential purchaser info) Equivalent rules implemented in British Columbia and Alberta • B.C. first to implement (Oct 2017) but modelled on Ontario's initial rule proposal • Later Alberta rule (Aug 2018) is substantially same as Ontario's final rule

Why are they important? Finally, we can give you a clear answer … • Provide clear exemptions from local Canadian prospectus requirements • Without them there is legal uncertainty due to broad 'distribution' trigger (which does not expressly except trades outside a local jurisdiction) • Critical in AB and BC, where offshore trades are deemed a 'distribution' from the jurisdiction by any issuer with substantial connection (regardless of flowback risk) • Prior AB and BC offshore offering exemptions were outdated & impractical Do they work? • The Ontario and Alberta rules work in practice but the B.C. rule is flawed • Ontario also adopted new policy on its general approach to offshore sales • Replaced outdated Ontario guidance • Unfortunately, BC and Alta failed to revisit their 'distribution from' approach

(Fun) Fact: No hold period on offshore private placement by reporting issuer • Foreign purchaser can freely resell back into Canada day one • No limitations on their volume or manner of resale • In contrast with 4 month hold on same securities privately placed in Canada Potential to apply same approach to Canadian private placements? Unclear • CSA has said they are conducting a broader review of resale regime • Could new exemptions signal a change in their view on restricted periods? • That available disclosure is sufficient to address investor protection? • It is possible but … • New exemptions were local and provided no rationale for absence of hold period • Regulators seem focused on a national (not local) approach to resale regime • Investor protection concerns if results in diminished underwriter participation

Alternative exemption for offshore resale of non-reporting “foreign” issuer securities • Issuer does not qualify as 'foreign' if: • organized or has head office in Canada or • a majority of its directors or executive officers are resident in Canada Why is this new exemption important? • Removes impediment to Canadian participation in treasury issue of foreign issuer • Existing exemption not available if Canadian residents own more than 10% of issuer • Impractical to confirm ownership; Canadian investors may have indefinite hold Does it work? Yes, for the most part, but still imperfect • Availability is a function of domestic connections that aren't a good proxy for risk that securities flowback into Canada • Not available to Canadian company listed exclusively on foreign exchange • CSA is considering whether to address in its broader review of resale regime

The Objective: To meaningfully reduce regulatory burden on reporting issuers without compromising investor protection • Began with April 2017 CSA consultation • Similar to the SEC's Disclosure Effectiveness Initiative (started in 2012/13) • In March 2018, the CSA identified six 'options' as policy projects in the near term: i. Streamlined, alternative prospectus offering model ii. Facilitate at-the-market offerings iii. Clarify the 'primary business' financial statement requirement for IPOs iv. Remove / modify the criteria to file a business acquisition report v. Review current continuous disclosure requirements with a view to … • reducing the disclosure burden on issuers • while enhancing usefulness and understandability vi. Facilitate / expand the use of electronic delivery

Are there further details? Not yet • As the CSA noted, these are just 'options' as policy projects in the near term • In true lawyerly fashion, they've disclaimed any assurance of changes • While some changes are obvious, hard to guess direction they'll take on others • Not even clear on initiatives that they chose not to pursue at this time … • as some are being considered in the context of another CSA policy initiative When will we hear more? Don't hold your breath … • Per the CSA, any regulatory change involves a number of steps • Some of these initiatives could involve significant changes • Likely the CSA will first deal with low-hanging fruit • Disclosure rationalization to be in stages with majority requiring longer timeframe • Experience to date with U.S. disclosure rationalization initiative may be instructive • A few years before first proposals; started with redundant & outdated disclosure

– ICO Statistics – Adopted (and broadened) by SCC in Pacific > 2015 - $6 million raised Coast Coin Exchange > 2016 - $99 million raised > investment of money > 2017 - $6.5 billion raised > common enterprise > 2018 - $21.4 billion raised (so far) ○ fortunes interwoven with investee > expectation of profit > from sole, primary or significant efforts of others – Refresher

> definition of “securities” very broad ○ includes an “investment contract” – Capital raising > law on investment contracts originates in U.S. > key hallmark of a security token Supreme Court decision in Howey ○ orange grove case

– Summer 2017 – February 2018 > DAO: SEC Report of Investigation > SEC chairman: “Every ICO I’ve seen is a > CSA Notice 46-307 security” ○ Very limited guidance – May 2018 – November 2017 > Operation Cryptosweep > SEC chairman: “I have yet to see an ICO that ○ U.S. and Canadian regulators – 70 inquiries doesn’t have a sufficient number of hallmarks of a security” and investigations; 35 pending or completed enforcement actions – December 2017 > SEC files fraud charges against Quebec-based – June 2018 PlexCorp > CSA Notice 46-308 > SEC halts ICO of Munchee tokens ○ Utility not determinative ○ Emphasis on investor’s expectation

– Issuers responded by acknowledging the capital- – U.S. pathway raising nature of their activities or other measures > hope is that Regulation A+ will open the door to > SAFT: more crypto issuers ○ Simple Agreement for Future Tokens (aka ○ broader scope of potential purchaser DDATs, SAFEs) • not just accredited investors • limited financial reporting, in some cases > jurisdiction shopping no audit necessary ○ leave for a more crypto-friendly jurisdiction • immediately freely tradable – Canadian pathway? > Patience/compliance > “closed system” means that no free tradability ○ waiting for relevant hold periods on the unless a reporting issuer “security” tokens to expire ○ tokens generally require free tradability to be ○ offering under a prospectus functional

Securities Law and Blockchain: The Next Hurdles

– Investment funds – Exchanges/Marketplaces > emergence delayed due to concerns with > only exchanges currently established trade in ○ custody the main cryptocurrencies ○ valuation > avoids risk of trading in securities and requiring > initially only “crypto-adjacent” funds registration > now IFMs registered and custodians approved ○ Canadian regulators have sent inquiry letters to crypto-participants asking whether they > some crypto funds have emerged operate marketplaces, clearing agencies ○ limited to main cryptocurrencies > some participants intend to start a regulated • bitcoin, ether, litecoin marketplace ○ need regulatory approval to expand holdings > limited ability to trade where custodian is not registered dealer

• TSX Staff Notice 2018-003 • Builds on TSX Staff Notice 2016-006 • Discourages pricing of offerings with material undisclosed information • When pricing public offerings and private placements, the TSX compares the offering price to the market price • TSX will require security holder approval of offerings that: • Exceed the permissible pricing discount • Result in dilution in excess of 25% and are priced at a discount to the market price • Materially affect control (create a new 20% shareholder) • Exceed the10% threshold for placements to insiders

• What is the market price? • Generally, the five-day VWAP • What if the five-day VWAP is not appropriate? • Includes period before and after disclosure of a material event • TSX view is that pricing should occur five clear trading days following dissemination of material information • TSX may permit market price calculation using VWAP of less than five days • Issuers proposing to use an abbreviated period to determine market price should contact the TSX in advance

• TSX Staff Notice 2018-0005 • Applies if security holder approval required in connection with the issuance of securities • Mandates disclosure required to be provided to the issuer’s security holders • Commonly implicated where more than 25% of an issuer's securities are to be issued in connection with the acquisition of a public company • Requirement to approve a maximum number of shares issuable is unchanged

• Can issue up to an additional 25% of the number of shares approved for issuance by security holders • Exclusively for an increase in consideration payable to target shareholders • Circular must state: “TSX will generally not require further security holder approval for the issuance of up to an additional [x] [securities], such number being 25% of the number of securities approved by security holders for the transaction.”

– Proposed rule, if adopted, will have the force of law – New provisions relate to use of > Current policy is a CSA staff notice, which > forward-looking non-GAAP measures stated staff’s views on where use of non-GAAP > ratios information might be a misrepresentation > segment measures > Rule will provide CSA staff with stronger tool for enforcement > supplementary financial measures > capital management measures – When adopted, will apply to > disaggregated line items > all issuers other than “SEC foreign issuers” > investment funds > public documents > social media

– Regulators’ concerns about non-GAAP Financial – Regulators have found that disclosure practices measures surrounding non-GAAP financial measures vary – Provide CSA with stronger tool for enforcement > lack standardized meanings under financial – Have identified that the 52-302 definition of non- reporting framework used in an issuer’s GAAP financial could be equally problematic financial statements without additional disclosure > lack context when disclosure outside the issuer’s financial statements – Reaction to some confusion in marketplace about non-authoritative guidance provided by industry > lack transparency in their calculation groups and professional bodies > vary significantly by issuer and industry – other stakeholders (particularly investors) also interested

– New definition: – Some common examples of non-GAAP financial > non-GAAP financial measure means: information ○ a financial measure of financial performance, > adjusted earnings financial positions or cash flow > adjusted EBITDA • not disclosed or presented in the financial > free cash flow statements; and > pro forma earnings • not a “disaggregation” (calculated in > cash earnings accordance with the accounting policies > distributable cash used to prepare the financial statements) of > cost per ounce a line item presented in the primary financial statements; or > adjusted funds from operations ○ a financial outlook for which no equivalent > earnings before non-recurring items financial measure is presented in the primary financial statements

– A non-GAAP financial measure must be – First time non-GAAP financial measure disclosed > labelled appropriately given its composition and > identify measure as non-GAAP in way that distinguishes it from financial > state that it is a non-GAAP measure statement measures ○ does not have a standardized meaning and > no more prominent than most directly ○ may not be comparable to other issuers comparable GAAP financial measure > explain how the non-GAAP measure > document must present same measure for ○ provides useful information; and comparative period ○ additional purposes, if any, for which – Rule addresses the disclosure of ratios a little bit management uses the measure differently > provide a quantitative reconciliation to most directly comparable GAAP measure > explain reason for any change to label, composition or calculation of measure

– How to reconcile – Reconciliations that are forward-looking have > must be disaggregated in a way that gives a separate rules reasonable person an understanding of each > must present the equivalent historical non- reconciling item GAAP measure > explained in a way that provides a reasonable > must describe either person an understanding of each reconciling ○ each of the material differences between item • the financial outlook; and – Reconciliation may be located in another section • the most directly comparable financial of the document outlook for which an equivalent historical financial measure is presented in the financial statements; or ○ each of the significant components of financial outlook used in its calculation

– A segment measure is a financial measure that is – Supplementary financial measures are disclosed in the notes to the financial statements > not in financial statements and are a – Regulators are concerned about aggregations of “disaggregation” of a line item in financial segment measures statements; and – If not a total, subtotal or line item in financials > disclosed on a periodic basis (or intended to be) to present an aspect of financial performance, > first-time disclosure must provide a quantitative financial position or cash flow reconciliation to the most directly comparable financial measure in the financial statements – First time disclosed in document, must > present the total of segment measures with no > describe how calculated more prominence that the comparable measure > explain any reason for change in label, > include the total of segment measures for the composition or calculation of measure comparative period if the total has been – Include measure for comparative period if it has previously disclosed been previously disclosed

Non-GAAP Measures: Capital Management Measures

– Capital management measures are – May not present capital management measure > measures disclosed in the notes with greater prominence than > most directly comparable financial measure in > enable users of financial statements to evaluate financial statements, or issuer’s objectives, policies and processes for > if ratio, similar financial measures presented in managing capital financial statements – Rule applies to measures that are not a total, – First-time disclosure requires subtotal or line item in financial statements or a > description of how measure calculated disaggregation of a line item presented in the > statement that calculation is not prescribed financial statements > explanation of how measure provides useful information and how management uses > quantitative reconciliation – Include measure for comparable period if previously disclosed

The Evolving Standard for Assessing Materiality

WONG V. PRETIUM RESOURCES, 2017 ONSC 3361 PANICCIA V. MDC PARTNERS INC., 2018 ONSC 3470

1 2 3 2011-2012: Pretium November 2012: May 2013: Pretium conducts mineral Snowden produces announces the start exploration program its Mineral of its Bulk Sample at Brucejack. Resource Estimate. Program.

4 5 July-October 2013: October 7-9, 22 Strathcona 2013: Strathcona expresses concerns resigns from the with the sample Bulk Sample tower results. Program and Pretium issues press release.

Plaintiff Defendants • Strathcona's concerns with the sample tower • Strathcona's concerns were discussed both results were material facts that were required to internally and with Snowden and the decision be disclosed at the time they were raised by was made not to disclose those concerns Strathcona during the period from July 23 to because they were deemed premature and October 21, 2013. unreliable, and accordingly were not material. • The only accurate and reliable test method was • There was no reason why Pretium could not milling the entire sample. have disclosed Strathcona's concerns from the • As it turns out, Pretium was right and mill results outset together with an explanation of the supported the Mineral Resources Estimate. Company's view as to why those concerns were • Relied on the reasonable investigation defence. unfounded.

• Misrepresentation: a) an untrue statement of material fact; or b) an omission to state a material fact that is necessary to make a statement not misleading in light of the circumstances in which it is made. • Material Fact: a fact that would “reasonably be expected to have a significant effect on the market price or value of securities.” o Known as the “market impact” test for assessing materiality – impact of the alleged misrepresentation on the market price or value of a company's securities. o Compare with the “reasonable investor” test – information that a reasonable investor would consider important in making an investment decision. o “Reasonable investor” sets a lower threshold for materiality than “market impact” – a reasonable investor might want to know information that would not have an impact on the market price or value of securities.

Belobaba J. asked the wrong question: “Even if Pretium genuinely believed that Strathcona's findings and concerns were based on unreliable (sample tower) data, how can it be that the findings and concerns of an experienced and respected mining consultant is not information that a reasonable investor would consider important?”

No mention anywhere in the decision as to whether the “findings and concerns” of Strathcona would be expected to have an impact on the market price or value of Pretuim's securities.

• Primary goal of the OSA is investor protection. o Decision should be viewed through this lens. Focus on investor protection likely drove articulation and application of the law on materiality. • Pretium could easily have satisfied its disclosure obligations at many points along the way while including language that made express the Company's views about the unreliability of Strathcona's findings. • Materiality is not to be assessed with the benefit of hindsight. o The fact that Pretium ultimately turned out to be right is not relevant to assessing the materiality of the information at the relevant time.

• Five separate claims for misrepresentation advanced, including failures by MDC to disclose:  Subpoena received from the SEC  Formation of a Special Committee to conduct an internal investigation  Amounts reimbursed to the company's CEO

• Leave to appeal was denied, so the decision is out there to contend with in future cases. The case has not received any subsequent judicial consideration. • How are we to assess materiality – market impact or reasonable investor? o Prevailing standard appears to be “market impact” in light of the language of the relevant provisions of the OSA. o However, courts are still supposed to assess materiality “from the perspective of a reasonable investor”. o There are multiple decisions out there from both the OSC and the courts relying on the lower, reasonable investor standard. o Bottom line: companies should be cautious in assessing materiality, and need to understand that regulators and the courts will not defer to executives’ “business judgment” in assessing materiality, even if the business judgment of those executives ultimately turns out to be correct.

– Musk and Tesla charged with securities violations in the U.S. over an ill-advised tweet about privatizing Tesla > Musk forced to resign as Tesla Chairman > Personally and professionally embarrassing – Stock price still down ~ 24% over “pre-tweet” price – Private action ongoing

SEC treats tweets as disclosure/press releases – make sure you do the same

Draft carefully and subject tweets to due diligence

Apply disclosure protocols to social media posts

Internally coordinate timing of posts to avoid surprises

Empower independent directors to oversee communications

Separate corporate and employee online personas when possible – use social media managers

Patricia L. David Chantelle Olasker Wilson Cseh Partner Partner Partner

Toronto Toronto Toronto 416.863.5551 416.863.5517 416.367.7552 [email protected] [email protected] [email protected]

Robert S. Robin Murphy Upshall Partner Partner

Toronto Toronto 416.863.5537 416.367.6981 [email protected] [email protected]