The Canadian Securities Administrators recently took a trip down memory lane with CSA Staff Notice 51-366 Regulatory Concerns with Certain Asset or Business Acquisitions

It relates to “problematic acquisitions” that “typically have the following attributes:”

• Significant number of securities issued
• The reporting issuer distributes a significant number of securities that carry either no resale restrictions or a short hold period to acquire an asset or business having little or no actual value.
• An asset or business with little or no actual value or operating history acquired at what appears to be a significantly inflated price
• The reporting issuer ascribes a significant value to the asset or business to be acquired but then provides subsequent continuous disclosure that calls into question the reasonableness of the ascribed value, and that indicates that the acquired business or asset
  • has a minimal carrying value,
  • is at a very early stage of development, or
  • was recently acquired by a vendor from a third party with the vendor having made no significant expenditures to develop the asset or advance the business prior to selling it to the reporting issuer.

Key regulatory concerns with these types of transactions include:

• whether the reporting issuer’s continuous disclosure record is potentially misleading or contains a misrepresentation, which could lead to
  • information asymmetry as investors purchase securities at a potentially inflated price without benefit of appropriate disclosure regarding the value of the acquisition, and
  • a significant number of securities being re-sold in the secondary market before information about the actual value of the asset or business is publicly disclosed;
• whether there is a lack of a reasonable basis for the value initially ascribed to the asset or business being acquired giving rise to concerns about misleading disclosure or misrepresentations;
• whether the reporting issuer has
  • recorded all or a substantial portion of the consideration transferred as intangible assets or goodwill based on unreasonable and/or unsupportable assumptions; and
  • impaired substantially all of the value assigned to the intangible assets or goodwill in a short period of time after the acquisition;
• whether promotional campaigns about the acquisition are truthful and balanced; and
• whether the ascribed value is based on reasonable and supportable valuations.

After that build-up, there’s not actually much to the notice beyond reminding issuers to comply with IFRS, to make proper MD&A disclosure, and not to break the law (“we also remind audit committee members that they are responsible for reviewing the reporting issuer’s financial statements, MD&A, and annual and interim profit or loss press releases before the reporting issuer publicly discloses this information…”) It’s a mishmash of concerns, largely based, fundamentally, in how small and often thinly-traded (but not so thinly that their share price isn’t considered to be derived from an “active market”) companies find it all too easy to issue large numbers of shares, their derived aggregate fair value far in excess of what anyone would ever pay in cash (really, whether the assigned value ends up in intangible assets or goodwill hardly matters; it would all often be best labeled as “reckless overpayment”), a subsequent impairment all but inevitable. It seems to me that IFRS 13, having been designed with much bigger fish in mind, doesn’t work too well in such cases, to put it mildly.

As I mentioned, these concerns are hardly new. A report issued by the CSA in 2015 observed: “Upon acquisition of a business, issuers are reporting a significant portion of the purchase price in goodwill without separately identifying and assigning a value to other intangible assets, such as customer lists, intellectual property, etc.” and set out expectations for improved disclosure (that’s not the first time it came up; I’m quite sure it had been cited in various earlier documents, now rescinded and beyond my research capacities). As for the latest document, the term “problematic acquisitions” is perhaps a bit pejorative, considering that issuers in Canada’s venture markets often have no strategy other than to “swing for the fences” as the phrase goes: if any aspect of their activities and resulting reporting is problematic, the better solution might be to prevent such entities from going public until a later and more fully-formed stage. As that’s not going to happen, and noting again that accounting standards don’t help much in this case, this probably won’t the last time we hear about these issues. But in the meantime, many hope that accounting standards will move toward recognizing a wider range of intangible assets, acknowledging that the balance sheet captures an ever-decreasing portion of the market value of new technology entities; maybe ten years from now companies will be recognizing a greater range of internally-developed assets, or giving greater expression to environmental or other external impacts, all of which will require a substantial conceptual evolution, and enhanced ease with extreme measurement uncertainties. How “problematic” will that all be…?

The opinions expressed are solely those of the author.