CSA calls for better risk disclosure

When times get tough, regulators pay closer attention. And while advisors may be squirming under increased SRO scrutiny, they’d be gratified to know the watchdogs are keeping close tabs not just on them, but also the companies their clients are invested in.

The Canadian Securities Administrators (CSA) just released the results of its continuous disclosure (CD) review program for the fiscal year ended March 31, 2009. Over that period, regulators undertook 1,094 reviews, an increase of 28% over the prior fiscal year.

“In response to current market conditions, CSA members are conducting more continuous disclosure and issue-oriented reviews. We’re focusing on financial services sector issuers and highly leveraged issuers at risk of liquidity problems,” said Jean St-Gelais, CSA Chair and president and CEO of the Autorité des marchés financiers. “These reviews are vital in promoting confidence in our marketplace and we’ll continue to place high emphasis on the quality, transparency and completeness of disclosure to investors.”

During periods of extreme market turmoil, the regulators were most keenly interested in issues surrounding asset-backed commercial paper (ABCP), disclosure in the defined benefit pension space and the use of financial instruments.

The freezing of the ABCP markets two years ago has gradually thawed, but over the course of fiscal 2009, many issuers were still struggling to place a fair valuation on their short-term paper holdings.

“During the last six months of fiscal 2009, we focused our resources on issues related to the market turmoil and credit crisis,” the CSA report says. “We conducted over 250 reviews of issuers to assess the transparency and completeness of disclosures. Areas of particular focus included financial services sector issuers and highly leveraged issuers at risk of liquidity problems.”

Regulators requested that future filings include disclosure on a wide array of issues, including:

• specific exposures to credit risk; • methodology used to determine the allowance for credit losses; • policies for managing capital in the current environment; • assumptions used to determine fair value for financial instruments, including the process for assessing impairment; • additional disclosures of risks and exposures to loss related to off-balance sheet entities; and • additional discussion related to liquidity and sources of cash.

Of the nearly 1,100 reviews completed, there were 465 full reviews and 629 “issue-oriented” reviews. Nearly half (48%) were later classified as “prospective changes” required largely as a result of a renewed focus on accounting and disclosure requirements.

Twenty percent of the reviews required no action, while 14% were contacted and alerted to specific areas where disclosure enhancements should be considered.

Another 13% were required to amend or re-file certain continuous disclosure documents, and 5% were either cease traded, placed on a default list or referred to regulatory enforcement.

The most common deficiencies were found in Management Discussion and Analysis (MD&A) documents, where data from the financial statements were repeated without significant explanation.

The regulators also found inadequate disclosure of liquidity and capital resources, ranging from insufficient disclosure of working capital requirements to explanations of circumstances that could affect an issuer’s financing sources.

Reporting issuers also frequently failed to discuss the risks they faced as a result of the economic downturn, or failed to explain the assumptions made in accounting estimates.

With the markets in turmoil and equity valuations commonly slashed by 40%, many issuers were forced into under-funding positions on the defined benefit pension plans they provide to their employees.

These temporary shortfalls should be corrected by an eventual upturn in the stock market, but in the meantime, the employer is on the hook for making up the difference. This is often a multi-million dollar risk on the company’s financial statements. Reporting and discussion of this specific risk was another key deficiency cited by the CSA.

Financial statements themselves were another area of concern, with common deficiencies found in fair value accounting of financial instruments, and the failure to disclose the credit, liquidity and market risks associated with these financial instruments.

Aside from investment funds, there are 4,300 reporting issuers in Canada that are subject to regular full and issue-oriented reviews as part of the CSA continuous disclosure review program.

(07/24/09)