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Legal Update
by Chris Koressis

Recent changes to securities law in Canada coupled with changes to the Criminal Code bring Canada one step closer to comparable laws in the United States such as Sarbanes-Oxley. These laws apply to any company doing business in Canada.

All companies doing business in Canada must take steps to ensure that their business practices do not lead to violation of the Criminal Code. In the area of health and safety obligations, the criminal code will be amended to broadly define who is responsible for the safety of persons in the workplace and to allow for prosecution under charges of "criminal negligence" when those responsibilities are recklessly or willfully disregarded.

Public companies and "reporting issuers" doing business in Canada must also comply with the changes in securties law. The new laws are similar to Sarbanes-Oxley, but compliance with Sarbanes-Oxley is not necessarily enough to comply with the new laws. The new laws are relevant not just to CEOs and CFOs but also to CIOs.

The Canadian Criminal Code was amended on March 31, 2004 to modernize the law with respect to the criminal liability of corporations. Before these changes, a corporation was guilty of a crime if its "directing mind" committed the prohibited act. To be a "directing mind" of a corporation, a person must have authority to set policy rather than simply having authority to manage. As well, the directing mind has to be intending, at least in part, to benefit the corporation by the crime.

Under the new law, the definition of "senior officer" goes beyond looking for the directing mind of the corporation. The definition of senior officer includes everyone who has an important role in setting corporate policy and everyone responsible for managing an important part of the organization's activities (which is new). The definition focuses on the function of the individual, rather than on any particular title. On the other hand, the new definition makes it clear that the directors, the chief executive officer and the chief financial officer of a corporation are, by virtue of the position they hold, automatically "senior officers". A corporation doing business in Canada that is charged with an offence cannot argue that the individuals occupying these positions actually had no real role in setting policy or managing the organization.

The law is clear that if a senior officer misrepresents the financial reports and records of a corporation, leading others to provide funds to the organization or otherwise act to their detriment, both the organization and the CEO will be guilty of fraud. And if a senior officer directs others to commit wrongful acts, the organization will be found guilty. For example, a senior officer may instruct employees to procure products from a supplier known to be dealing in stolen products and thus offering the lowest price. The employees themselves have no criminal intent but the senior officer and the organization could be found guilty.

In addition, an organization doing business in Canada would be guilty of a crime if a senior officer knows employees are going to commit an offence but does not stop them because he wants the organization to benefit from the crime. Using the stolen goods example, the senior officer may become aware that an employee is going to get a kickback from a supplier for getting the organization to buy its stolen goods. The senior officer has done nothing to set up the transaction. But, if he does nothing to stop it because the organization will benefit from the lower price, the organization would be responsible.

In the area of health and safety obligations, the Criminal Code broadly defines who is responsible for the safety of persons in the workplace and allows for prosecution under charges of "criminal negligence" when those responsibilities are recklessly or willfully disregarded.

The Criminal Code states that: " Every one who undertakes, or has the authority, to direct how another person does work or performs a task is under a legal duty to take reasonable steps to prevent bodily harm to that person, or any other person, arising from that work or task." All organizations can be held responsible for the actions or omissions of any of their employees that assume the role defined in the above section. This includes executive officers, operations managers, plant managers, production managers, and so on.

Under the Occupational Health and Safety Act, an individual found guilty of a contravention may be fined up to a maximum of $25,000 and/or sentenced to up to one year in jail, per offence. The fine for a corporation can be up to $500,000. Fines under the criminal code in an indictable offense have no predetermined limit. The maximum sentence for an individual convicted of "criminal negligence causing death" is life imprisonment.

Organizations need to review their existing policies and procedures, training requirements and so on to protect themselves from prosecution under these amendments.

Also at the end of March 2004, new corporate governance rules that are similar to Sarbanes-Oxley came into force in Canada. The CEO and CFO of any public company or reporting issuer doing business in Canada is personally required to certify six representations regarding the financial statements and corporate governance of the company.

For example, Multilateral Instrument 52-109: Certification of Disclosure in Issuers' Annual and Interim Filings will require Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) of reporting issuers to each personally certify six representations, using the exact language prescribed in the various forms, to declare that:

1. The annual filings financial statements, management discussion and analysis (MD&A) and annual information form (AIF) and interim filings financial statements and management discussion and analysis do not contain any untrue statement of material fact or omit to state any material facts.

2. The financial statements and other financial information in the annual and interim filings fairly present in all material respects the financial condition, results of operations and cash flows for the relevant time period.

3. The CEO and CFO have designed effective disclosure controls and procedures (or caused them to be designed under their supervision) to provide reasonable assurance that material issuer information is made known to them.

4. The CEO and CFO have designed effective internal control over financial reporting (or caused them to be designed under their supervision) to provide reasonable assurance regarding the reliability of the financial reporting and the preparation of financial statements for external purposes, in accordance with the issuer's GAAP.

5. The CEO and CFO have evaluated the effectiveness of disclosure controls and procedures and disclosed their conclusions regarding their evaluation in the annual MD&A.

6. The CEO and CFO have disclosed in the annual and interim MD&A any material changes in internal control over financial reporting.

The CEO and CFO of a corporation doing business in Canada will be required to certify that their issuer's financial statements and other financial information (e.g., the MD&A) fairly present the issuer's financial condition, results of operations and cash flows for the relevant time period. The certification of fair presentation is not limited to a representation that the financial information disclosed in the interim and annual filings have been presented in accordance with the issuer's generally accepted accounting principles (GAAP). Instead, this certification is intended to provide assurance that the financial information disclosed in the interim and annual filings, when viewed in their entirety, meets a standard of overall material accuracy and completeness that is broader than financial reporting under the requirements of GAAP, but not defined in the instrument.

The CEO and CFO certification requires a representation on financial condition rather than on financial position, as used in the auditors' report. The concept of financial condition is broader than that of financial position, and further guidance can be found in the CICA MD&A.

In essence, the fairly presents assessment consists of answering three fundamental questions for companies doing business in Canada:

1. Are the financial statements, including note disclosure, prepared in accordance with GAAP?

2. Are the MD&A and the AIF in annual filings (including all documents incorporated by reference), prepared in accordance with the relevant regulations (e.g., OSC, SEC) and guidance (e.g., CICA guidance, reports by regulators on deficiencies etc.)?

3. Do the financial statements and the MD&A (and AIF in annual filings), taken together, meet an overall standard of material accuracy and fair presentation?

The rules apply to "reporting issuers" - not just public companies that are doing business in Canada. Reporting issuers include a person or company who has outstanding, issues or proposes to issue a security. Currently, there are about 8,000 reporting issuers and 3,600 public companies doing business in Canada that must comply. Any company that wants to raise capital by private placement, prospectus or by debt would be well-advised to comply with the rules. This will improve their marketability to providers of venture capital, bankers and other stakeholders. I made a similar point in October 2002 in an article that has been reprinted at Corporate Policies.

The new rules are similar to Sarbanes-Oxley in the USA, but compliance with Sarbanes-Oxley is not necessarily enough to comply with the new rules. The new rules are known as Multilateral Instruments and were made by the National Securities Administrators. They complement the National Instruments on Continuous Disclosure and Acceptable Accounting Principles, as well as the new independence standards for auditors issued by the Canadian Institute of Chartered Accountants. All of these rules and guidance are intended to help maintain investor confidence in Canadian financial reporting.

Chris Koressis, a Toronto business lawyer, has served as in-house counsel to Royal Bank of Canada, Canadian Imperial Bank of Commerce, and GEAC. He can be reached at 416.720.1624 or by email at Chris.Koressis@Koressis.com

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