David George-Cosh

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Canadian securities regulators are calling on companies in the cannabis industry to strengthen their governance and disclosure practices to ensure investors are aware of potential conflicts of interest for executives and directors relating to M&A activity.

The Canadian Securities Administrators, an umbrella organization for provincial securities regulators, issued a staff notice on Tuesday saying it will monitor developments in the cannabis industry after observing a “higher-than-usual crossover” of potential conflicts of interest, such as overlapping debt and equity, in the sector’s M&A transactions over the past several years.

Governance has emerged as a hot button issue for several Canadian cannabis companies, such as Aphria Inc., CannTrust Holdings Inc. and Cronos Group Inc., and eventually led to the departure of some executives or board members after potential conflicts were disclosed.   

BNN Bloomberg reported in August that beleaguered cannabis producer CannTrust’s board of directors is comprised of a number of family and other pre-existing relationships which raised the risk of governance failure. Meanwhile, Cronos Chief Executive Mike Gorenstein and Director Jason Adler had an indirect ownership in Redwood Holdings LLC, a company Cronos acquired for US$300 million in August, through a New York-based investment firm which was disclosed in a material change report but not included in a press release issued by the company.

Last year, the CSA issued a similar notice to the cannabis industry, highlighting that pot companies have several "deficiencies" in their disclosures to investors, such as insufficient information in their financial statements, following a review of 70 public companies.

"Investors need to understand the conflicts of interest that could arise when issuers have a crossover of financial interests because those conflicts could have implications for the possible M&A transaction," said Louis Morisset, the chair of the CSA, in a statement. "Strengthening governance disclosure is important to provide investors with information to make an informed decision."

The notice details how CSA staff have identified some deals where either the acquirer or acquiree had an undisclosed financial interest in the other entity, something that is deemed “material information” for investors and should be included in disclosure documents. Potential conflicts of interest could lead investors to re-examine other parts of the deal such as the purchase price, transaction timing or contingent payments, the notice said.

Additionally, the CSA said it has seen some instances when a cannabis company didn’t disclose how its “independent directors” may have potential conflicts of interest that include personal or business relationships with other directors that could compromise their independence.

“Independent directors must not have a direct or indirect ‘material relationship’ with the issuer. A material relationship is defined as a relationship which could, in the view of the board, be reasonably expected to interfere with the exercise of a director’s independent judgment,” the notice said.

The CSA added that it has also seen some examples where the chair of the board of a cannabis company also serves as its CEO. A previous notice issued by the CSA said a publicly-listed company should have an independent director appointed as the board chair or as lead director.

“Investors want to know that structures are in place to permit the board to operate independently,” the CSA said in its notice.

Cannabis Canada is BNN Bloomberg’s in-depth series exploring the stunning formation of the entirely new — and controversial — Canadian recreational marijuana industry. Read more from the special series here and subscribe to our Cannabis Canada newsletter to have the latest marijuana news delivered directly to your inbox every day.