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ALBERTA SECURITIES COMMISSION
DECISION
Citation: Flag Resources (1985) Limited, Re, 2010 ABASC 143 Date: 20100329
Flag Resources (1985) Limited, Golden Briar Mines Limited,
Murdo Campbell McLeod and Sidney Miszczuk
Panel: Glenda A. Campbell, QC
Allan L. Edgeworth, P. Eng.
Roderick J. McKay, FCA
Appearing: Robert Stack
for Commission Staff
Dennis A. McDermott, QC
for the Respondents
Dates of Hearing: 24-28 August and 10 November 2009; and
12 January 2010
Date of Decision: 29 March 2010
I. INTRODUCTION
[1] This proceeding commenced when staff ("Staff") of the Alberta Securities Commission (the
"Commission") issued a 14 July 2008 notice of hearing (the "Notice of Hearing"), alleging that two
corporate respondents (the "Corporate Respondents") – Flag Resources (1985) Limited ("Flag") and
Golden Briar Mines Limited ("Golden Briar") – contravened Alberta securities laws and engaged in
conduct contrary to the public interest by failing to file, or by filing deficient, continuous disclosure,
and further alleging that Murdo Campbell McLeod ("McLeod") was responsible for the Corporate
Respondents' contraventions and Sidney Miszczuk ("Miszczuk") was responsible for Flag's
contraventions and thus acted contrary to the public interest. The alleged continuous disclosure
failings pertained to Flag's fiscal years 2003 to 2005 and Golden Briar's fiscal years 2002 to 2004
(in each case, the "Relevant Period"). (Staff abandoned their allegations of failures to file insider
trade reports.)
[2] In December 2009 the panel was advised that Miszczuk had passed away. In the
circumstances, we decline to make any findings on the allegations against Miszczuk, and we make
findings only on the allegations against the remaining three respondents – Flag, Golden Briar and
McLeod (the "Respondents").
[3] The parties agreed that the hearing would be bifurcated, with the first part of the hearing
addressing the merits of the allegations against the Respondents (the "Merits Hearing") and a
second part, if necessary, addressing the issues of sanction and costs.
[4] The Merits Hearing began on 24 August 2009. (It was originally scheduled to begin on
2 February 2009; however, on 23 January 2009 another panel granted McLeod's and Miszczuk's
request for an adjournment to enable counsel recently retained by them to prepare.) The
Respondents were represented at the Merits Hearing by other counsel (apparently retained in the
preceding week). We received documentary evidence and heard testimony from a Staff
investigative accountant (formerly a senior securities analyst), Michael Mumby ("Mumby"), from
McLeod and Miszczuk, from the Corporate Respondents' bookkeeper and from two of the
Corporate Respondents' Alberta-resident shareholders. In September, October and November 2009,
the parties provided written and oral submissions.
[5] On 4 December 2009 the Respondents applied to have the Merits Hearing re-opened to
consider new evidence and additional submissions provided by them via a 25 November 2009 letter.
Staff opposed the application. In 21 December 2009 written reply submissions, the Respondents
asked that an additional document and, it appeared, associated submissions also be considered by
the panel. In a 12 January 2010 ruling (Re Flag Resources (1985) Ltd., 2010 ABASC 15), the panel
agreed to admit into evidence the new documents and consider the additional submissions proffered
by the Respondents, and to consider the related submissions made by Staff. The Merits Hearing
was then adjourned for decision on the merits of the allegations against the Respondents.
[6] This decision sets out our conclusions, and reasons, concerning the merits of the allegations
against the Respondents. Stated briefly, we find that:
the Corporate Respondents filed with the Commission annual audited financial
statements that were not prepared in accordance with generally accepted accounting
principles ("GAAP") as required by Alberta securities laws;
the Corporate Respondents filed with the Commission management's discussion &
analysis ("MD&A") that was not prepared as required by Alberta securities laws;
Flag filed a certification with the Commission that was not prepared as required by
Alberta securities laws and failed to file with the Commission other certifications so
required;
the Corporate Respondents thereby contravened Alberta securities laws and acted
contrary to the public interest; and
McLeod was responsible for the Corporate Respondents' contraventions of Alberta
securities laws and thus acted contrary to the public interest.
[7] We have yet to determine what, if any, orders for sanction or costs ought to be made against
the Respondents in light of these findings. The issues of sanction and costs will be addressed in the
second part of the hearing.
II. BACKGROUND
A. Respondents
1. Flag
[8] Flag is an Alberta corporation with its head office in Calgary. It is a junior resource issuer
engaged in the exploration and development of mineral properties in northern Ontario. McLeod and
Miszczuk were two of the four or five directors of Flag throughout the Relevant Period. Golden
Briar is a shareholder of Flag and was such during the Relevant Period.
[9] Flag is a reporting issuer in Alberta and British Columbia and was such during the Relevant
Period. Flag had its securities listed for trading on the TSX Venture Exchange ("TSXV") until its
securities were delisted from the TSXV in August 2005.
[10] Flag's fiscal year throughout the Relevant Period ended on 31 December of each year.
Flag's annual financial statements were audited for the Relevant Period by Lo Porter Hétu, Certified
General Accountants ("Lo Porter"). Flag's audit committee, when it had one during the Relevant
Period, consisted of McLeod and Miszczuk or McLeod, Miszczuk and Claude Giroux ("Giroux").
2. Golden Briar
[11] Golden Briar is an Alberta corporation with its head office in Calgary. It, like Flag, is in the
business of mining and mineral exploration. According to the Alberta Corporate Registration
System ("CORES"), two of the seven directors of Golden Briar during the Relevant Period were
McLeod and Miszczuk (misspelled "Misczuck"). Flag is a shareholder of Golden Briar and was
such during the Relevant Period.
[12] Golden Briar is a reporting issuer in Alberta, British Columbia, Ontario and Québec and was
such during the Relevant Period. Golden Briar had its securities listed for trading on the TSXV
until its securities were delisted from the TSXV in August 2005.
[13] Golden Briar's fiscal year throughout the Relevant Period ended on 31 December of each
year. Golden Briar's annual financial statements were audited for the Relevant Period by Lo Porter.
Golden Briar's audit committee, when it had one during the Relevant Period, consisted of McLeod,
Edwin Bauer ("Bauer") and Gerald Gereghty ("Gereghty").
3. McLeod
[14] McLeod resides in Calgary. He was 82 years old at the time of the Merits Hearing, has been
the president and a director of Flag since 1976 and was Flag's chief executive officer ("CEO")
throughout the Relevant Period. He has also been a director of Golden Briar since 1974 and was
Golden Briar's president and apparently its CEO throughout the Relevant Period. McLeod is the
only regular employee of the Corporate Respondents. He was responsible throughout the Relevant
Period for the day-to-day operations of the Corporate Respondents, including their mineral
exploration activities.
4. Miszczuk
[15] Miszczuk resided in Ontario and was, throughout the Relevant Period, a director of Flag and
the chair of the Flag board of directors. Miszczuk was also the president of Cooksville Steel
Limited ("Cooksville") and was a shareholder of the Corporate Respondents. Cooksville is a
shareholder and the major creditor of the Corporate Respondents.
[16] Although Miszczuk apparently signed at least two Golden Briar financial statements on
behalf of the Golden Briar board of directors and CORES identified him as a director of Golden
Briar during the Relevant Period, Miszczuk contended that he had not been a director of Golden
Briar. In the circumstances, we need not decide this issue.
B. Allegations
[17] The allegations of continuous disclosure failings by the Corporate Respondents, in
contravention of Alberta securities laws and contrary to the public interest, focused on three areas:
Annual audited Financial Statements
Flag's annual audited financial statements for its fiscal years ended 31 December
2003, 31 December 2004 and 31 December 2005 (the "2003 Flag Financial
Statements", "2004 Flag Financial Statements" and "2005 Flag Financial
Statements", respectively; collectively, the "Flag Financial Statements") filed with
the Commission were allegedly not prepared in accordance with GAAP as required
by Alberta securities laws; and
Golden Briar's annual audited financial statements for its fiscal years ended
31 December 2002, 31 December 2003 and 31 December 2004 (the "2002 Golden
Briar Financial Statements", "2003 Golden Briar Financial Statements" and "2004
Golden Briar Financial Statements", respectively; collectively, the "Golden Briar
Financial Statements") filed with the Commission were allegedly not prepared in
accordance with GAAP as required by Alberta securities laws
(we refer to the Flag Financial Statements and the Golden Briar Financial Statements
together as the "Financial Statements").
MD&A
Flag's MD&A for its three-month period ended 31 March 2004, six-month period
ended 30 June 2004, nine-month period ended 30 September 2004, three-month
period ended 31 March 2005, six-month period ended 30 June 2005 and nine-month
period ended 30 September 2005, and for its fiscal years ended 31 December 2004
and 31 December 2005 (collectively, the "Flag MD&A") was allegedly not prepared
in accordance with the requirements of National Instrument 51-102 Continuous
Disclosure Obligations ("NI 51-102"); and
Golden Briar's MD&A for its three-month period ended 31 March 2004, six-month
period ended 30 June 2004 and nine-month period ended 30 September 2004, and for
its fiscal year ended 31 December 2004 (collectively, the "Golden Briar MD&A")
was allegedly not prepared in accordance with the requirements of NI 51-102
(we refer to the Flag MD&A and the Golden Briar MD&A together as the "Impugned
MD&A").
Certification of Interim and Annual Filings
Flag's "Certification of Interim Filings" for its interim period ended 30 June 2005
(the "2005 Second Interim Certificate") filed with the Commission allegedly did not
contain the wording prescribed by Form 52-109F2 as required by Multilateral
Instrument 52-109 Certification of Disclosure in Issuers' Annual and Interim Filings
("MI 52-109"), and Flag allegedly failed to file with the Commission the
"Certification of Interim Filings" for its interim period ended 30 September 2005 (the
"2005 Third Interim Certificate") and the "Certification of Annual Filings" for its
fiscal year ended 31 December 2005 (the "2005 Annual Certificate") as required by
MI 52-109
(we refer to the 2005 Second Interim Certificate, the 2005 Third Interim Certificate and the
2005 Annual Certificate together as the "Certification").
[18] Staff further alleged that McLeod, as a director, officer and directing mind of the Corporate
Respondents, was responsible for the Corporate Respondents' contraventions of Alberta securities
laws and thus acted contrary to the public interest.
III. SUMMARY OF EVENTS
[19] Following is a summary of the relevant facts we find, more or less in chronological order.
A. Flag and Golden Briar Securities Cease-traded
[20] In May 2005 Staff agreed to the Corporate Respondents' requests to issue orders (the "May
2005 Orders") that would bar certain of their insiders from trading in their respective securities
rather than ordering that all trading in Flag and Golden Briar securities cease because Flag and
Golden Briar, respectively, had failed to file with the Commission the 2004 Flag Financial
Statements and 2004 Golden Briar Financial Statements. On 4 July 2005, when the Corporate
Respondents had yet to file those financial statements, Staff revoked the May 2005 Orders and
ordered that all trading in Flag and Golden Briar securities cease for 15 days. On 15 July 2005 Flag
and Golden Briar, respectively, filed with the Commission the 2004 Flag Financial Statements and
2004 Golden Briar Financial Statements. In the result, trading in Flag and Golden Briar securities
was permitted to resume.
[21] On 5 May 2006 Flag and Golden Briar securities were again cease-traded for 15 days
because Flag had failed to file with the Commission the 2005 Flag Financial Statements and Golden
Briar had failed to file with the Commission its annual audited financial statements for its fiscal
year ended 31 December 2005. On 19 May 2006 the Commission extended those trading bans,
ordering that all trading cease in Flag and Golden Briar securities "until further order of the
Commission" (the "2006 Cease Trade Orders"). The 2006 Cease Trade Orders remain in effect.
B. Staff Review of Corporate Respondents' Continuous Disclosure
[22] A 28 December 2006 application (the "Revocation Application") was made to the
Commission by Flag, or the Corporate Respondents, seeking revocation of one, or both, of the 2006
Cease Trade Orders. In considering the Revocation Application, Staff undertook a review of the
continuous disclosure record of the Corporate Respondents.
[23] A 24 January 2007 internal memorandum (the "January 2007 Staff Memo") from two Staff
securities analysts (one of whom was Mumby) to the Manager of Case Assessment summarized
what the analysts described as "significant omissions and deficiencies" in Flag's continuous
disclosure filings, including MD&A, financial statements and certification of annual and interim
filings. The January 2007 Staff Memo noted that a "brief review" of Golden Briar's continuous
disclosure filings revealed "similar deficiencies". The January 2007 Staff Memo noted that, as of
15 January 2007, Flag had not filed "all outstanding continuous disclosure materials" and, on that
basis alone, the Revocation Application was "premature".
[24] On 30 January 2007 Staff e-mailed counsel for Flag that: the Revocation Application was
under review; issues had been identified with Flag's continuous disclosure filings that "warrant
further consideration"; and Staff would "endeavour to provide a more detailed response within the
next 2 weeks". On 25 April 2007 Staff e-mailed counsel for Flag advising that, in considering the
Revocation Application, they had conducted "a selected review of [Flag's] continuous disclosure
record filed during the past three years" and that the Revocation Application would not proceed
until the deficiencies identified by that review had been resolved (the "April 2007 Deficiency
Letter"). Staff also requested that the April 2007 Deficiency Letter and Flag's response be sent to
each member of Flag's audit committee and to Flag's auditor, that Staff be copied on any
correspondence between Flag and its auditor and that Flag confirm to Staff that this had been done.
There is evidence before us that counsel for Flag sent the April 2007 Deficiency Letter to members
of Flag's audit committee and to Flag's auditor.
[25] Mumby was assigned to review continuous disclosure filings of the Corporate Respondents
to determine whether they complied with Alberta securities laws. Mumby told us that in carrying
out that task he did not rely on earlier work completed by another securities analyst but rather
conducted a fresh examination of continuous disclosure filed by Flag for the years 2003 to 2005 and
by Golden Briar for the years 2002 to 2004. Mumby recorded the deficiencies and omissions he
noted in the Corporate Respondents' continuous disclosure in two 23 November 2007 memoranda –
one for Flag and one for Golden Briar. Mumby then sent an 8 January 2008 memorandum to Staff
litigation counsel ("Mumby's January 2008 Memo") outlining the "most significant deficiencies" he
had identified in the continuous disclosure filings of the Corporate Respondents.
[26] It appears that Mumby's January 2008 Memo formed the basis of a 26-page 15 January 2008
letter that was sent by Staff litigation counsel to Flag (to the attention of McLeod and Miszczuk)
and Golden Briar (to the attention of McLeod) (the "January 2008 Deficiency Letter") advising that
Staff were considering the commencement of enforcement proceedings because of "significant
deficiencies" in continuous disclosure filed by Flag for its 2003 to 2005 fiscal years and by Golden
Briar for its 2002 to 2004 fiscal years. The January 2008 Deficiency Letter set out in detail the
deficiencies and omissions identified by Staff in the continuous disclosure filings of the Corporate
Respondents, including: alleged deficiencies in the disclosure contained in notes to the financial
statements, namely the notes discussing mineral interests, related party transactions, long-term debt,
accounting change and financial instruments; alleged failure to include required information in
annual and interim MD&A; and certifications which allegedly were not filed or did not comply with
the form requirements. The January 2008 Deficiency Letter concluded by stating:
You are offered the opportunity to provide any submissions you would like [S]taff to consider in
deciding whether or not to take enforcement proceedings against you. . . .
Your response is requested in writing and should be received by no later than February 28, 2008, as
[S]taff [intend] to proceed as we see fit without the benefit of your submissions if we have not
received them by that date.
[27] McLeod testified that he had spoken with Tenny Lo ("Lo") of Lo Porter about Staff's
concerns with the Financial Statements and that Lo had said it seemed Staff were more concerned
about other matters. In a 13 March 2008 letter (mistakenly dated 13 March 2007) to Flag (to the
attention of McLeod), Lo Porter (via Lo) stated:
We are in receipt of the letter from ASC dated January 15, 2008 with respect to the Continuous
Disclosure review that you have dropped off at our office on March 7, 2008. There were deficiencies
related to the financial statements prepared by us from fiscal years 2003 to 2005.
Subsequent to our meeting today, you have requested us to respond to the deficiencies listed on the
ASC letter by March 17th
. Please be advised that we are unable to provide a response to your
company on such a short notice, particularly when it involves files dating back to 2003.
We will need up to the end of March to provide you with a response.
[28] By a 13 March 2008 letter to Staff litigation counsel, then-counsel for the Corporate
Respondents, responding to advice that Staff were not prepared to agree to any further extensions,
advised that his clients were "unable to consider and prepare a response without the input from their
auditors, who prepared the material from which the alleged deficiencies arise" and that "Mr. Lo has
been out of the country until this past weekend and his office has confirmed that they will be unable
to prepare a report before the end of April".
[29] Next, new Staff litigation counsel requested that Mumby provide a summary of the Flag and
Golden Briar file. Mumby provided that summary in a 6 June 2008 memorandum, which suggested
that the Corporate Respondents had filed financial statements that were not prepared in accordance
with GAAP, had filed MD&A that did not comply with NI 51-102 and had filed or failed to file
certifications contrary to MI 52-109, and, in the result, had possibly contravened Alberta securities
laws.
[30] On 14 July 2008 the Director of Enforcement issued the Notice of Hearing.
C. Public Reporting at Flag and Golden Briar
1. Financial Reporting
(a) Preparation of Financial Statements
[31] Gentry Software Services Limited ("Gentry"), a sole proprietorship, was contracted to
provide bookkeeping services to the Corporate Respondents from October 2000. Gentry's principal,
David Milne ("Milne"), kept the Corporate Respondents' books of account. He testified that, on a
quarterly basis in each fiscal year, McLeod would provide him with the Corporate Respondents'
"source documents" such as supplier invoices, bank statements and cancelled cheques, from which
Milne would record the transactions in the companies' respective books of account. Milne
characterized Flag as "a pretty simple business", in that the company had no revenue, any money
received came from investors (primarily Cooksville) and money received was spent on minimal
expenses and mineral exploration; he said that Golden Briar "was really not an active company in
terms of the exploration like Flag was conducting". Milne believed that he received all the
documentation he needed to complete his bookkeeping. He also noted that McLeod answered any
questions Milne had about the documentation provided.
[32] Milne testified that he prepared the Corporate Respondents' quarterly financial statements,
which he provided to McLeod and filed on SEDAR (the Canadian Securities Administrators'
System for Electronic Data Analysis and Retrieval) on behalf of the Corporate Respondents. Milne
said that he did not prepare the Corporate Respondents' annual financial statements; rather, the
Corporate Respondents' auditor prepared them.
[33] Milne recommended Lo Porter to McLeod, who sought Milne's advice when Flag's previous
auditor resigned. According to Milne and McLeod, Lo Porter was engaged as the Corporate
Respondents' auditor, commencing apparently in 2002, and it was Lo Porter that prepared the
Financial Statements, including the notes to the Financial Statements. McLeod was adamant in his
testimony that he had nothing to do with the preparation of the Financial Statements or the
accompanying notes. McLeod told us that he simply accepted and agreed with the work done by Lo
Porter in formulating the Financial Statements.
[34] Milne testified that he provided to Lo Porter the general ledgers and all source documents
relating to the Corporate Respondents for each year in the following March or April, and this,
according to Milne and McLeod, was the information Lo Porter used in preparing the Financial
Statements. McLeod told us that Lo Porter also used news releases issued by the Corporate
Respondents in preparing the Financial Statements. Milne and McLeod said that they answered any
questions or requests for further information or documentation Lo Porter may have had as it
prepared the Financial Statements.
(b) Audit of Annual Financial Statements
[35] Lo Porter not only prepared the Financial Statements but also audited them. McLeod
testified that he had no concern about the independence of Lo Porter even though it was engaged to
audit and express opinions on the Financial Statements it had prepared. We note that Lo Porter
addressed the issue of its independence in an 18 June 2003 engagement letter to Golden Briar's
audit committee concerning the 2002 Golden Briar Financial Statements.
[36] Lo Porter issued unqualified auditor's reports on the Financial Statements, expressing its
opinion that the Financial Statements "present fairly, in all material respect [or respects], the
financial position of the Company . . . in accordance with Canadian generally accepted accounting
principles".
[37] Milne testified that he reviewed the Financial Statements to determine whether Lo Porter's
auditor's reports were unqualified and whether Lo Porter had made any "adjusting entries" that he
would be required to record in the Corporate Respondents' books of account. Milne said that he did
not review the Financial Statements to determine whether they complied with GAAP; when Lo
Porter – in Milne's view, a reputable accounting firm – issued unqualified auditor's reports on the
Financial Statements and the numbers corresponded with his numbers, then Milne accepted the
Financial Statements and had no need to concern himself with the notes to the Financial Statements.
(c) Approval of Audited Financial Statements
[38] McLeod thought that Flag had an audit committee until perhaps 2003, with him and
Miszczuk as its members. Miszczuk could not recall when Flag's audit committee was created but
he did recall that he and McLeod were its members. Flag's proxy statement and information
circular for 2004 and for 2006 each stated that McLeod, Miszczuk and Giroux were the members of
its audit committee. McLeod did not believe that Flag had an audit committee after 2003 because
"there was no need for an audit committee" – Flag was "a very junior mining company", "I spent a
great deal of time in the field simply trying to find something" and "it would have been a waste of
time". Golden Briar's proxy statement and information circular for 2002 stated that McLeod, Bauer
and Gereghty were the members of its audit committee. It was McLeod's testimony that at some
point Golden Briar did not have an audit committee because it too "would have been a waste of
time".
[39] The Balance Sheets in the Financial Statements included notations indicating that the
statements were approved by the Corporate Respondents' respective boards of directors, with all
signatures typewritten but for those in the 2002 Golden Briar Financial Statements. On the Balance
Sheets in the 2003 and 2004 Flag Financial Statements appeared the notation "Approved by the
Board", with McLeod and Miszczuk shown as signatories. The Balance Sheet in the 2005 Flag
Financial Statements included the same notation, with McLeod and Miszczuk signing as directors.
The Balance Sheet in the 2002 Golden Briar Financial Statements included a notation indicating
approval by the board and showed McLeod and Bauer signing as president and director,
respectively. The Balance Sheets in the 2003 and 2004 Golden Briar Financial Statements also
included a notation indicating approval by the board but showed McLeod and Miszczuk signing as
directors.
[40] McLeod testified that he signed his approval to the Financial Statements because Lo Porter
had issued unqualified auditor's reports stating that the Financial Statements were prepared in
accordance with GAAP and McLeod's review of the Financial Statements found nothing wrong or
requiring change. Miszczuk's testimony was similar in respect of his approval of the Flag Financial
Statements. McLeod testified that he relied on Lo Porter's statement in the auditor's reports that the
Financial Statements were prepared in accordance with GAAP.
[41] McLeod testified that it was a mistake in the 2003 and 2004 Golden Briar Financial
Statements that Miszczuk's name appeared as one of the Golden Briar directors approving those
statements – according to McLeod, Miszczuk was never a director of Golden Briar. McLeod said
that he should have caught the mistake that occurred over the two years but had not. McLeod
commented that he could not recall seeing Miszczuk's signature on any Golden Briar financial
statement. Miszczuk testified that he had never been a director of Golden Briar and that any
documentation indicating he was a director of Golden Briar or he signed as a director of Golden
Briar must have been a mistake.
[42] While the Financial Statements were apparently approved by the Corporate Respondents'
respective boards of directors, it appears that most, if not all, such approvals were accomplished via
telephone conference calls. There were apparently few, if any, in-person Flag or Golden Briar
board meetings; rather, according to McLeod and Miszczuk, such meetings were generally, if not
always, conducted over the telephone. McLeod testified that he sent the Flag Financial Statements
to Miszczuk but would not have requested specifically that Miszczuk review them because
"Miszczuk would not sign an agreement before reviewing it".
[43] There was no evidence that management letters were prepared by Lo Porter at the
conclusion of its engagements or were sent to or reviewed with either McLeod or the Corporate
Respondents' respective boards of directors. It appears that no representative of Lo Porter ever
attended a board meeting of either of the Corporate Respondents and that Lo Porter never met with
either of the Corporate Respondents' audit committees. It further appears that the Corporate
Respondents' respective boards of directors never reviewed any of the Financial Statements with Lo
Porter before approving the statements and that neither McLeod nor the Corporate Respondents'
respective boards of directors ever:
reviewed annually with Lo Porter or otherwise the accounting principles and
practices followed by the respective companies;
reviewed the constitution, mandate or responsibilities of the respective audit
committees;
reviewed estimates, judgments or accounting alternatives that may have been
material to the financial reporting of the respective companies; or
established or reviewed an audit plan to identify the most significant business,
control and financial reporting risks within the respective companies.
2. MD&A Reporting
[44] McLeod testified that he personally prepared the Impugned MD&A that was filed on
SEDAR and with the Commission. McLeod admitted that the Impugned MD&A was not
completed as required by Alberta securities laws.
[45] McLeod told us that the first MD&A he prepared for the Corporate Respondents was for
Flag for its three-month period ended 31 March 2004. He did so after learning from Milne that this
was a new filing requirement for public companies commencing in 2004. McLeod testified that, at
the time, he "might have been very involved" with Flag's exploration activities and had not taken
the time or paid "enough attention" to produce a "proper [MD&A]". According to McLeod,
although he knew there was a requirement to post on SEDAR quarterly updates on the Corporate
Respondents' activities, he was unaware of and unfamiliar with the national instrument requirements
for MD&A reporting when he prepared the Impugned MD&A. McLeod conceded that, with the
benefit of hindsight, he would have included more detail in the Impugned MD&A, as it would have
saved him "a lot of headaches".
[46] McLeod testified that he did not understand the MD&A requirements because they appeared
to require duplication of the information included in the Corporate Respondents' annual reports –
advising shareholders of the respective companies' achievements and future plans – and that, if he
had included every item of information that Mumby suggested Alberta securities laws required, the
MD&A for the Corporate Respondents would have been a document of 10 to 12 (or more) pages.
In McLeod's view, the length and detail of such a document would only confuse the Corporate
Respondents' shareholders, and he did not believe that was in their best interests when most of the
information was already in the Corporate Respondents' annual reports. According to McLeod, he
also provided MD&A-type information directly to shareholders of the Corporate Respondents when
he was asked to do so, which is consistent with the Corporate Respondents' shareholders' testimony.
McLeod further suggested that, had he addressed all items required to be addressed in MD&A, he
would have had no comments for many of the items.
[47] McLeod stated that he now understands the types of information required to be included in
MD&A, although he thought it "excessive" and "ridiculous" to require junior mining companies to
address some of the items – he cited working capital requirements and liquidity risks associated
with financial instruments as examples.
[48] McLeod said that no resolutions were passed by the Corporate Respondents' respective
boards of directors approving the Impugned MD&A. He testified that he faxed all MD&A to
Miszczuk "for him to look at", and Miszczuk confirmed that McLeod usually sent "these
statements" for Miszczuk's review. Otherwise, it appears that the Corporate Respondents'
respective directors did not review MD&A drafts before the MD&A was filed on SEDAR and with
the Commission, but McLeod said that he did discuss the content of the MD&A with the respective
board members over the telephone, in meetings or individually. Miszczuk testified that he did not
know whether the Flag board of directors had seen, discussed or approved the Flag MD&A before it
was filed.
3. Certification
[49] Flag filed its 2005 Second Interim Certificate, signed by McLeod as Flag's president, but
failed to file its 2005 Third Interim Certificate and its 2005 Annual Certificate.
[50] McLeod testified that he prepared the filed Certification. McLeod said he was not certain
why he prepared the filed Certification other than that someone, maybe a lawyer, had told him to do
so. McLeod testified that he was the president and CEO of Flag and that neither of the Corporate
Respondents had a chief financial officer ("CFO") – despite the references to himself as the
Corporate Respondents' CFO in MD&A he prepared. In his view, neither company needed a CFO
because they were junior mining companies.
IV. PARTIES' POSITIONS
A. Staff
[51] Staff called Mumby, a chartered accountant, as their sole witness. Mumby, formerly a
senior securities analyst in the Commission's corporate finance department, is an investigative
accountant in the Commission's enforcement department. In the latter capacity, he was assigned to
review continuous disclosure filings of the Corporate Respondents to determine whether they
complied with Alberta securities laws.
[52] Mumby was not qualified as an expert to give opinion evidence at the Merits Hearing but
rather testified as to facts and to his concerns that the Financial Statements, Impugned MD&A and
Certification filed or not filed by the Corporate Respondents did not comply with Alberta securities
laws. Mumby's January 2008 Memo elaborated on Mumby's concerns.
1. Financial Statements
[53] Mumby testified that, in general, his concerns about the Financial Statements centred on the
disclosure in the notes relating to mineral interests, related party transactions, long-term debt and
financial instruments.
(a) 2003 Flag Financial Statements
(i) Mineral Interests
[54] Mumby referred us to Note 5 "Mineral Interests" in the 2003 Flag Financial Statements
("Note 5 (2003)") and suggested that this note disclosure did not comply with GAAP. Note 5
(2003) read:
5. MINERAL INTERESTS
[Flag] has interests in mineral properties which it is in the process of exploring and determining
whether they contain reserves that are economically recoverable. The recoverability of expenditures
on mining interests is dependent upon the existence of economically recoverable ore, confirmation of
[Flag's] interest in the underlying mineral claims, the ability of [Flag] to obtain necessary financing to
complete the development and future profitable production.
Since [Flag] is writing off the costs of exploration in properties which [are] no longer being
developed, the book value of the assets approximates fair value. Although there is no reasonable
basis to determine if revenue will be sufficient to recover the capitalized costs, there [are] no other
conditions that exist at this time that would indicate the need to record further impairment of these
assets. Since 1994, a total of $5,498,135 of capitalized acquisitions, exploration and development
costs have been written down.
[55] Mumby suggested that, as Flag was "devoting most of its efforts to activities such as . . .
exploring for natural resources", paragraph 32 of Accounting Guideline 11 "Enterprises in the
Development Stage" applied. (Accounting Guideline 11 states that it "is to be read in conjunction
with the Introduction to Accounting Guidelines" contained in the Canadian Institute of Chartered
Accountants ("CICA") Handbook (the "Handbook").) Thus, according to Mumby, Note 5 (2003)
should have included – but did not include contrary to paragraph 32 of Accounting Guideline 11 –
disclosure about "each significant project under development, including those abandoned",
including: "identification and description of the project"; "amounts capitalized or deferred on the
project to date"; "amounts expensed on the project to date" and "revenue earned from the project".
Mumby observed that the amount of $5 498 135 identified as capitalized costs in Note 5 (2003)
represented 42% of Flag's total assets and was apparently associated with two separate properties in
fiscal year 2003. According to Mumby, without specific note disclosure as to the amounts
capitalized for each property and the related purpose (acquisition, exploration or development), the
progress made on each of Flag's properties was unclear. Mumby further contended that it was
incomplete disclosure simply to disclose that capitalized costs totalling $5 498 135 associated with
acquisitions, exploration and development of its properties had been written off since 1994 because
the effect of this cumulative amount could not be understood without a breakdown of these costs to
the related property, or to acquisition, exploration or development.
[56] Mumby also questioned why Flag did not write down any exploration expense for any of its
mineral interests in 2003 when Golden Briar, a related party to Flag which held a 50% working
interest on certain mineral claims of Flag, wrote down (or off) $259 999 as exploration expense in
the 2003 Golden Briar Financial Statements. Mumby noted that, if the Corporate Respondents had
been working a common property, then it was unclear why one company, Golden Briar, would
write down expenses when the other, Flag, would not. Mumby said that the disclosure about
specific properties in the 2003 Flag Financial Statements and 2003 Golden Briar Financial
Statements was so poor that it provided no clarification.
(ii) Related Party Transactions
[57] Mumby referred us to Note 9 "Related Party Transactions" in the 2003 Flag Financial
Statements ("Note 9 (2003)") and suggested that this note disclosure did not comply with GAAP.
Note 9 (2003) read:
9. RELATED PARTY TRANSACTIONS
[Flag] and [Golden Briar] are related through interlocking directorships and cross shareholdings.
[Flag] and Golden Briar share all operating expenses including office lease. [Flag] has billed Golden
Briar for its share of the operating expenses which are at fair market value.
[Flag] and Golden Briar have entered into an option agreement, whereby Golden Briar was required
to incur $400,000 of exploration expenditures on certain properties in return for a 50% interest of the
said properties.
[58] Note 13 "Economic Dependence" in the 2003 Flag Financial Statements ("Note 13 (2003)")
stated that Cooksville is a related party to Flag. As noted, Miszczuk was the president of Cooksville
and also a director of Flag and the chair of the Flag board of directors. Note 13 (2003) read:
13. ECONOMIC DEPENDENCE
[Flag] is economically dependent on [Cooksville]. Cooksville's financial support to [Flag] has
allowed Cooksville to exercise significant influence over the operations of [Flag] and as such, it is
considered to be a related party. Details of the transactions between [Flag] and Cooksville are more
fully disclosed in note 6 to these financial statements.
[59] Mumby concluded, as indicated in Notes 9 (2003) and 13 (2003), that the Corporate
Respondents, and Flag and Cooksville, were "related parties" for the purposes of financial reporting
in accordance with GAAP. Mumby referred us to section 3840 of the Handbook, which sets out
standards for the disclosure of related party transactions in financial statements. Paragraph 3840.03
provides that "[r]elated parties exist when one party has the ability to exercise, directly or indirectly,
control, joint control or significant influence over the other" or when they are subject to common or
joint control or common significant influence.
[60] Paragraphs 3840.43 and 3840.55 of the Handbook state:
.43
DISCLOSURE
An enterprise should disclose the following information about its transactions with related parties:
(a) a description of the relationship between the transacting parties;
(b) a description of the transaction(s), including those for which no amount has been
recognized;
(c) the recorded amount of the transactions classified by financial statement category;
(d) the measurement basis used;
(e) amounts due to or from related parties and the terms and conditions relating thereto;
(f) contractual obligations with related parties, separate from other contractual obligations;
and
(g) contingencies involving related parties, separate from other contingencies. [Italics in
original.]
.55
Representations about fair value
Representations that the exchange amount is equivalent to fair value (or an arm's length equivalent
value) are not made unless they can be substantiated. . . . When such disclosures are made, the basis
for determining fair value is disclosed.
[61] Mumby suggested that Note 9 (2003) failed to disclose, in accordance with
paragraphs 3840.43 and 3840.55 of the Handbook:
the amount charged to Golden Briar for operating expenses (thus the significance of
the transaction was unknown) and the basis for determining that amount was
equivalent to fair market value;
details of the contractual terms of the option agreement, including the effective date
of the agreement, the identity of the properties subject to the agreement, any deadline
for completion of the required exploration expenditures and the amount expended to
date by Golden Briar on exploration of the subject properties; and
the relationship between Flag and Cooksville resulting from Miszczuk's positions
with both companies.
(iii) Long-Term Debt
[62] Mumby referred us to Note 6 "Long Term Debt" in the 2003 Flag Financial Statements
("Note 6 (2003)") and suggested that this note disclosure did not comply with GAAP. Note 6
(2003) read:
6. LONG TERM DEBT
2003 2002
Convertible debenture held by Cooksville Steel Limited
bearing interest at 14% with up to $715,000 convertible at $0.40 per share secured by way of a first floating charge
on all assets.
$ 815,000
$ 815,000
Convertible debenture bearing interest at 15%,
convertible to common shares at $1.00 per share.
25,000
25,000
Note payable bearing interest at 15%. 42,699 42,699
Note payable bearing interest at 10%. 105,000 87,000
Accrued interest on debentures and interest bearing
notes payable
5,223,309
5,018,980
Advances from Cooksville Steel Limited, non-interest
bearing
1,247,803
1,174,303
Other advances, non-interest bearing. 21,423 21,423
$ 7,480,234 $ 7,184,405
These amounts, except as noted above, are unsecured and payable on demand. However, the creditors have indicated that
[they] will not demand payment in 2004. Therefore, they are classified as non-current.
Principal payment required for the next two fiscal years are as follow[s]:
2004 –
2005 7,480,234
[63] Mumby noted that only two of the seven transactions listed in Note 6 (2003) – those
involving Cooksville – were sufficiently described to allow them to be identified as related party
transactions. He suggested that Note 6 (2003) should have made clear which, if any, of the other
five transactions were also related party transactions.
[64] Mumby referred us to section 3860 of the Handbook, which establishes the standards for
presentation of financial instruments, as setting out the disclosure to be made in respect of the
convertible debenture held by Cooksville (the "Cooksville Convertible Debenture") identified in
Note 6 (2003). Specifically, paragraphs 3860.18 and 3860.24 state:
.18
The issuer of a financial instrument should classify the instrument, or its component parts, as a
liability or as equity in accordance with the substance of the contractual arrangement on initial
recognition and the definitions of a financial liability and an equity instrument. [Italics in original.]
.24
The issuer of a financial instrument that contains both a liability and an equity element should
classify the instrument's component parts separately in accordance with paragraph 3860.18. [Italics
in original.]
[65] Mumby therefore believed that GAAP would have required Flag, in reporting the Cooksville
Convertible Debenture, to have reported separately the amount owing under the debenture and the
amount of equity that would be issued on conversion of the debenture into Flag common shares.
Mumby observed that Note 7 "Share Capital" did not include any reference to the equity component
of the Cooksville Convertible Debenture.
[66] Mumby also pointed to Note 6 (2003)'s disclosure that the long-term debt amounts were
"unsecured and payable on demand" but that "the creditors have indicated that [they] will not
demand payment in 2004" and thus the long-term debt was classified as "non-current". Mumby
referred us to the CICA's Emerging Issues Committee ("EIC") Abstract of Issue Discussed Balance
Sheet Classification of Callable Debt Obligations and Debt Obligations Expected to be Refinanced
(EIC-122) which states that, if "the creditor has . . . or will have within one year . . . the unilateral
right to demand immediate repayment of any portion or all of the debt . . ., the obligation should be
classified as a current liability unless . . . [t]he creditor has waived or subsequently lost the right to
demand payment for more than one year . . . from the balance sheet date". Mumby suggested that
the reference to Flag's creditors' indicating they will not demand payment might not have been a
waiver or loss of right by the creditors. Therefore, he concluded that perhaps the amount of
$7 480 234 should have been classified as a current liability rather than as long-term debt.
(b) 2004 Flag Financial Statements
(i) Accounting Error
[67] Mumby referred us to Note 16 "Accounting Change" in the 2004 Flag Financial Statements
("Note 16") and suggested that this note disclosure did not comply with GAAP. Note 16 read:
16. ACCOUNTING CHANGE
Prior to 2003, [Flag] was assessed by Canada Revenue Agency (CRA) a penalty in the amount of
$150,000 for failure to remit under subsection[s] 224(1) and (4) of the Income Tax Act.
Correspondence from CRA indicated that the liability was wholly inapplicable to a director of [Flag]
and that the settled debt was that of [Flag]. The effect of the change is an increase in the 2003
opening deficit, and a decrease in amounts due from a director of $150,000.
[68] Mumby drew our attention to paragraph 1506.26 of the Handbook, which recognizes that it
may be necessary "to account for the correction of an error in the financial statements of a prior
period" in the financial statements of the current period. Mumby's position was that the adjustment
made in the 2004 Flag Financial Statements should have been attributed to the correction of an
accounting error, not to a change in Flag's accounting policies. In the result, Mumby contended that
the comparative information for fiscal year 2003 contained in the Statement of Operations and
Deficit and the Balance Sheet in the 2004 Flag Financial Statements should have been marked
"restated" to highlight that some of the comparative information had changed since the filing of the
2003 Flag Financial Statements.
(ii) Mineral Interests
[69] Mumby referred us to Note 5 in the 2004 Flag Financial Statements ("Note 5 (2004)"),
which wording was identical to that of Note 5 (2003). Mumby made the same points regarding
Note 5 (2004) as he did for Note 5 (2003) and thus suggested that the Note 5 (2004) disclosure also
failed to comply with GAAP.
[70] Mumby noted an additional purported defect in the Note 5 (2004) disclosure. The second
paragraph of Note 5 (2004) stated that, since Flag was "writing off the costs of exploration in
properties which [are] no longer being developed, the book value of the assets approximates fair
value". Mumby suggested that this disclosure did not comply with paragraph 3063.07 of the
Handbook (section 3063 is titled "Impairment of Long-lived Assets") because there was no
disclosure of what Flag used – whether, having regard to an Appendix referred to in
paragraph 3063.07, it was guided by quoted market prices or other valuation techniques – to
determine fair value.
(iii) Related Party Transactions
[71] Mumby referred us to Note 9 "Related Party Transactions" in the 2004 Flag Financial
Statements ("Note 9 (2004)"), which again disclosed how the Corporate Respondents were related
parties. Mumby made the same points regarding Note 9 (2004) as he did for Note 9 (2003) and thus
suggested that the Note 9 (2004) disclosure also failed to comply with GAAP.
[72] Mumby also suggested that Note 4 "Due from Related Party" in the 2004 Flag Financial
Statements ("Note 4 (2004)") did not comply with paragraphs 3025.03, 3025.34 and 3025.35 of the
Handbook. Note 4 (2004) read:
4. DUE FROM RELATED PARTY
The advances to [Golden Briar] are non-interest bearing and unsecured. The ultimate recoverability
of these advances is dependent on Golden Briar's ability to generate sufficient funds through future
operations or make alternative financing arrangements. Management does not feel that there has been
a permanent impairment in the value of these advances.
During 2003, the Board of Directors has accepted a proposal to retire total debt, in the amount of
$1,157,142, owed by [Golden Briar] as at December 31, 2002, [i]n exchange for 10,000,000 (ten
million) common shares of Golden Briar. The proposal was approved by the shareholders of [Golden
Briar] at the Annual General Meeting held July 29, 2004. As of the report date, approval from the
Exchange has not been granted.
[73] Mumby took issue with no impairment being recognized for the debt owing by Golden Briar
(the "Golden Briar Loan"). Mumby noted that, having regard to the 2004 Golden Briar Financial
Statements, he had some concern about Golden Briar's ability to pay back the Golden Briar Loan.
Mumby suggested that, in accordance with paragraph 3025.03 of the Handbook, Flag should have
recognized an impairment for the Golden Briar Loan because there was no reasonable assurance of
timely collection of it; therefore, the carrying amount of the Golden Briar Loan should have been
reduced and reflected as a charge in Flag's statement of income. Mumby further noted that
paragraph 3025.34 considers a loan to have been restructured when the lender grants a concession
to the borrower that it would not otherwise have considered. Mumby suggested the disclosure in
Note 4 (2004) that Flag had agreed to accept Golden Briar shares in exchange for retiring the
Golden Briar Loan was a concession as described in paragraph 3025.34. In the result, under
paragraph 3025.35, the Golden Briar Loan was impaired, requiring an allowance. Mumby
suggested that an amount of $584 245 lower than the book value of the Golden Briar Loan was
reasonable and would be a material amount in the 2004 Flag Financial Statements.
(iv) Long-Term Debt
[74] Mumby did not believe that Note 6 "Long Term Debt" in the 2004 Flag Financial
Statements ("Note 6 (2004)") complied with GAAP for the same reasons he expressed in connection
with Note 6 (2003).
(v) Financial Instruments and Credit Risk
[75] Mumby referred us to the discussion under "Risk management" in Note 14 "Financial
Instruments" in the 2004 Flag Financial Statements ("Note 14 (2004)"), in which Flag stated that it
had "no significant accounts receivable nor current debt that are subject to interest rate fluctuation"
and therefore it had "no credit risk nor interest rate risk". Mumby suggested that section 3860 of the
Handbook would have required Flag to discuss the credit risk associated with the Golden Briar
Loan (mentioned in Notes 14 (2004) and 4 (2004)), which was significant because it represented
48.9% of Flag's total assets and because of Golden Briar's poor financial condition. Mumby also
noted his earlier analysis that, as at 31 December 2004, the Golden Briar Loan was impaired.
Mumby suggested that lack of disclosure about this credit risk was a material item given the
significant amount of the Golden Briar Loan and the impact on Flag's financial condition in the
event of default.
(c) 2005 Flag Financial Statements
[76] Mumby noted that a review of the 2005 Flag Financial Statements revealed deficiencies and
failures to comply with the Handbook similar to those identified in the 2003 and 2004 Flag
Financial Statements:
Note 5 "Mineral Interests" ("Note 5 (2005)") did not include disclosure about "each
significant project under development" in accordance with paragraph 32 of
Accounting Guideline 11;
Note 9 "Related Party Transactions" ("Note 9 (2005)") did not adequately describe
the related parties and their transactions in accordance with section 3840 of the
Handbook;
Note 6 "Long Term Debt" did not properly classify the component parts of the
Cooksville Convertible Debenture in accordance with section 3860 (from April
2005, section 3861) of the Handbook; and
Note 13 "Financial Instruments" did not discuss any credit risk associated with the
Golden Briar Loan in accordance with section 3860 (from April 2005, section 3861)
of the Handbook.
(d) 2002 Golden Briar Financial Statements
(i) Mineral Interest
[77] Mumby referred us to Note 4 "Mineral Interest" in the 2002 Golden Briar Financial
Statements ("Note 4 (2002)") and suggested that this note disclosure did not comply with GAAP.
Note 4 (2002) read:
4. MINERAL INTEREST
[Golden Briar] has negotiated a 50% working interest on certain mineral claims of [Flag]. The
recoverability exploration and development costs [are] dependent upon the existence of economically
recoverable ore. Management is unable to determine whether economically recoverable reserves will
be found. Provision for impairment is recorded once exploration on a claim ceases.
In 1999, [Golden Briar] entered into [an] agreement whereby 100% of certain claims in Beauchastel
and Rouyn Townships have been sold to Globex Mining Enterprises Inc. The Agreement provides
that [Golden Briar] will retain a 1% net smelter return on all gold or base metal production from the
claims. Globex has the exclusive right to purchase the net smelter royalty at any time for $500,000.
2002 2001
Acquisition costs $ 1,351,242 $ 1,351,242
Exploration and development 1,145,406 1,138,487
Preproduction costs 253,565 253,565
2,750,213 2,743,294
Provision for impairment 1,976,202 1,976,202
$ 774,011 $ 767,092
[78] Mumby noted that the amount of $774 011, as shown on the Balance Sheet under "Mineral
Interest", represented 87.4% of the total assets of Golden Briar and referenced Note 4 (2002). Note
4 (2002) stated that Golden Briar had a "50% working interest on certain mineral claims of [Flag]"
but failed to provide details of the claims or identify the associated properties. There was also no
disclosure detailing amounts capitalized for each property, the related purpose (acquisition,
exploration or development) or progress made to date on any of these properties. Note 4 (2002)
also stated that total costs of $1 976 202 were written off for impairment. Mumby suggested that,
without a proper breakdown of the properties and the costs attributed to acquisition, exploration and
development, the impact of this cumulative amount could not be understood. Therefore, Mumby
suggested that, as was the case with the note disclosure of "Mineral Interests" in the Flag Financial
Statements, Note 4 (2002) did not provide disclosure about "each significant project under
development" in accordance with paragraph 32 of Accounting Guideline 11.
(ii) Related Party Transactions
[79] Mumby referred us to Note 6 "Due to Related Parties" in the 2002 Golden Briar Financial
Statements that disclosed amounts due to related parties having no fixed repayment terms. Mumby
suggested that, as there was no indication that Golden Briar had obtained waivers of repayment
from the related parties, these debts should have been classified as current debt and not as long-term
debt.
[80] Mumby noted the same concern he had with the Flag Financial Statements in that Note 7
"Related Party Transactions" in the 2002 Golden Briar Financial Statements ("Note 7 (2002")) did
not disclose the total amount of the operating expenses shared by the Corporate Respondents, how
the expenses were divided or how the fair market value of the expenses billed to Golden Briar by
Flag was determined. Mumby also noted that, as had Flag, Golden Briar failed to disclose in Note 7
(2002) details of the contractual terms of the option agreement whereby Golden Briar would earn a
50% interest in "certain properties" if it incurred "$400,000 of exploration expenditures" on the
properties. Mumby suggested that, in accordance with paragraphs 3840.43 and 3840.55 of the
Handbook, Golden Briar should have included these details in Note 7 (2002).
[81] Mumby further noted that, under "Investing Activities" in the Statement of Cash Flows in
the 2002 Golden Briar Financial Statements, Golden Briar during fiscal year 2002 sold (for
proceeds of $100 277) and purchased (at a cost of $75 000) shares of a "related company", but that
there was no disclosure in the notes about the details of this share sale and purchase. Mumby
suggested that there should have been disclosure of the details of these transactions – for example, if
the sale and purchase occurred on the open market, in a private placement or related to the
settlement of outstanding debts to related parties – in either the notes or MD&A.
[82] Mumby also observed that Note 5 "Convertible Debenture" in the 2002 Golden Briar
Financial Statements ("Note 5 (2002)") did not identify the party that was issued the convertible
debenture and whether that party was a related party to Golden Briar.
(e) 2003 and 2004 Golden Briar Financial Statements
[83] Mumby noted that a review of the 2003 and 2004 Golden Briar Financial Statements
revealed deficiencies and failures to comply with the Handbook similar to those identified in the
2002 Golden Briar Financial Statements:
Note 4 "Mineral Interest" did not include disclosure about "each significant project
under development" in accordance with paragraph 32 of Accounting Guideline 11;
and
Note 5 "Convertible Debenture", Note 6 "Due to Related Parties", Note 7 "Related
Party Transactions" and the Statement of Cash Flows did not adequately describe the
related parties and their transactions in accordance with section 3840 of the
Handbook.
(f) Summation on the Financial Statements
[84] Staff contended that the concerns noted above would have left readers of the Financial
Statements unable to determine the significance of or risks associated with certain transactions of
the Corporate Respondents or the direction the Corporate Respondents proposed to take. Staff
submitted that the deficiencies identified in the Financial Statements rendered them non-compliant
with GAAP, contrary to Alberta securities laws.
2. Impugned MD&A
[85] Mumby suggested that the Impugned MD&A did not comply with Alberta securities laws.
Comparing the form requirements set out in Part 2 of Form 51-102F1 Management's Discussion &
Analysis ("Form 51-102F1") with the Impugned MD&A, Mumby noted that the Impugned MD&A
was deficient – severely so – in that many of the requirements of Form 51-102F1 were either not or
inadequately addressed. Among the deficiencies identified by Mumby in the Impugned MD&A
were:
no date;
no or incomplete discussion of overall performance with reference to results of
operations and cash flows;
no or incomplete provision of financial data from the relevant financial statements
that discussed net income or loss (in total and on a per-share and diluted per-share
basis), total assets and total long-term financial liabilities;
no or inadequate analysis in relation to significant projects that had not yet generated
operating revenue, including plans for and the status of each project, expenditures
made, timing and costs of anticipated next stages;
no summary of quarterly results;
no discussion of liquidity, such as ability to generate cash flow and how the
Corporate Respondents proposed to deal with the working capital deficiency
identified in their respective financial statements;
no discussion of capital expenditure commitments and how the commitments would
be funded;
no discussion of transactions with related parties;
no disclosure that additional information relating to the Corporate Respondents was
available on SEDAR;
no breakdown of the material components of capitalized or expensed exploration and
development costs on a property-by-property basis and of administration expenses;
and
no analysis of the current interim period, interim comparisons or disclosure updates
of the annual MD&A.
[86] Mumby noted that the MD&A filed for Flag's nine-month period ended 30 September 2005
was actually for Golden Briar, not Flag. He also noted that it was handwritten, although the
SEDAR Filer Manual requires electronic filers to file MD&A in an electronic format, that is, a
computerized format of a document.
[87] Staff submitted that Mumby's evidence was clear that the Impugned MD&A was contrary to
Alberta securities laws in that it did not comply with regulatory requirements and was in many
respects "grossly deficient".
3. Certification
[88] Mumby said that, while Flag filed its 2005 Second Interim Certificate, that certification did
not comply with the form requirements of MI 52-109 in that it simply stated:
I hereby certify that, on behalf of [Flag], I have approved its second quarterly accounts, as of June 30,
2005.
[written signature]
Murdo Mc[L]eod
President
[89] Mumby noted that, among its deficiencies, the 2005 Second Interim Certificate failed to
state: that McLeod as signatory had reviewed the interim filing; that to his knowledge the interim
filing did not contain any untrue statements or omit to state a material fact necessary to make a
statement not misleading; and that, based on his knowledge, the filing fairly presented in all
material respects the financial condition, results of operations and cash flows of Flag.
[90] Mumby also identified Flag's failure to file with the Commission its 2005 Third Interim
Certificate and its 2005 Annual Certificate as contrary to MI 52-109.
[91] Staff submitted that the Certification did not comply with the requirements of MI 52-109.
4. Responsibility [92] Staff contended that McLeod was responsible for the Corporate Respondents' continuous
disclosure failings during the Relevant Period. During the Relevant Period, McLeod was a director
and the president and CEO of Flag, and he was a director and the president of Golden Briar. Staff
characterized McLeod as the guiding mind of the Corporate Respondents. McLeod signed the
Financial Statements. He also prepared the Impugned MD&A and the filed Certification.
[93] Staff submitted that, although Lo Porter prepared the Financial Statements, the Corporate
Respondents, their management and directors were responsible for the content of the Financial
Statements. Staff contended that the Respondents cannot avoid that responsibility because they did
not prove they performed reasonable due diligence in overseeing the preparation and auditing of the
Financial Statements. In support of their contention, Staff pointed to:
the failure of the Respondents to call anyone from Lo Porter to testify at the Merits
Hearing;
the failure of the Respondents to present any evidence as to measures they took to
ensure the independence of the auditor;
the failure of McLeod to fully engage in the audit process, including:
not informing himself as to the documents Lo Porter received from Milne;
and
not meeting with Lo Porter to discuss accounting policies, assumptions and
other matters relating to the audits;
the deficiency of the controls and governance of the Corporate Respondents such
that it was uncertain whether the right information reached Lo Porter;
the lack of formalized process for reviewing and approving financial statements;
the ineffective functioning of the audit committees (including that at some point
during the Relevant Period Flag's audit committee was apparently disbanded);
no evidence that McLeod had the requisite experience to review and approve
financial statements; and
the apparent disorder and confusion in relation to internal governance and financial
management and control within the Corporate Respondents.
[94] Staff also noted that, when Staff expressed their serious concerns about the Financial
Statements, McLeod failed to diligently investigate Staff's concerns and took few, if any, steps to
determine if a restatement of the financial disclosure was warranted.
[95] Staff's position was that directors and officers of reporting issuers, whose responsibilities
include approving or overseeing the issuers' financial reporting and disclosure practices, must be
held accountable for any deficiencies in the issuers' financial disclosure. Staff concluded that this is
not a case of an isolated failure to comply with a reporting requirement; rather, the Corporate
Respondents have demonstrated a general failure to adhere to financial and other disclosure
requirements over a span of several years. Thus, Staff submitted that it is in the public interest to
find McLeod responsible for the Corporate Respondents' continuous disclosure failings during the
Relevant Period.
B. Respondents
1. Financial Statements
[96] The Respondents contended that they relied on Milne to prepare the interim financial
statements, they relied on Lo Porter to prepare the Financial Statements and they relied on Lo Porter
as the auditor of the Financial Statements to review and opine on the Financial Statements. The
Respondents' primary position was that they hired individuals who were competent and met
professional standards to prepare the interim financial statements and Financial Statements – Milne
and Lo Porter, respectively – and that there were auditor's reports on the Financial Statements
opining that the Financial Statements "present fairly, in all material respect [or respects], the
financial position of the Company . . . in accordance with Canadian generally accepted accounting
principles", on which the Respondents were entitled to rely.
[97] The Respondents submitted that the management and directors of the Corporate
Respondents acted appropriately in being satisfied that they had complied with the requirements of
section 149 of the Act because the Corporate Respondents had filed comparative annual financial
statements for the years in question that were accompanied by auditor's reports. The Respondents
also submitted that a review of the applicable national instruments makes clear that the professional
accountants have the responsibility for a reporting issuer's financial statements, the notes to
financial statements and auditor's reports. They further contended that compliance with GAAP,
generally accepted auditing standards and the Handbook is the responsibility of the accredited
professional accountants and not of management, as is evident, they suggested, in the wording of
the auditor's reports signed by Lo Porter. Additional support for this contention, they suggested, is
evidenced by the magnitude of the fees charged by Lo Porter for the "Audit Engagement Services"
rendered to the Corporate Respondents during the Relevant Period.
[98] The Respondents argued that any GAAP deficiencies were "mere technicalities". The
Respondents also suggested that it was unreasonable for Staff to ask directors of a public company
to effectively audit the company's auditor.
[99] The Respondents observed that, while Staff criticized them for not calling "any expert in
GAAP requirements to indicate that the concerns of Staff were unfounded or misplaced", Staff also
did not call an accounting expert, preferring to rely on the evidence of Mumby with his relatively
recent chartered accountancy designation, no business experience and no apparent knowledge of the
mining industry. The Respondents submitted that Lo, who was McLeod's principal contact at Lo
Porter and who may have been of assistance to the Commission, was out of the country at the time
of the Merits Hearing and that another contact McLeod had at Lo Porter was also unavailable at that
time.
[100] The Respondents stated that there was no evidence of a complaint having been made by a
shareholder of either of the Corporate Respondents or other member of the public relating to the
Financial Statements. The Respondents also emphasized that there was no suggestion of fraudulent
conduct or breach of fiduciary obligation in this proceeding.
2. Impugned MD&A
[101] The Respondents submitted that the obligation to prepare and file MD&A is focused on
disclosure of material information and that "materiality" ought to be assessed in the context of
Milne's characterization of the business of the Corporate Respondents. The Respondents also
referred to the testimony of two of the Corporate Respondents' shareholders, who recognized the
Corporate Respondents' existence depended on the continued financial backing of Cooksville. The
Respondents submitted that this "prime material fact" – economic dependence on Cooksville – had
always been disclosed by the Corporate Respondents.
[102] The Respondents acknowledged that the Impugned MD&A "are what they are", but asked
the panel to bear in mind that the obligation to file MD&A was a new requirement in 2004, and that,
as was recognized by Mumby, "as time has passed, the level of input with respect to companies
filing an MD&A is getting more and more sophisticated".
[103] The Respondents argued that NI 51-102, which states an effective date of 30 March 2004,
did not have any legislative force until 30 March 2005 when section 152 of the Act was proclaimed
in force. Accordingly, they contended that the requirement to file MD&A did not encompass any
alleged failings by Golden Briar during the Relevant Period and was only effective for Flag for the
last nine months of the Relevant Period. The Respondents further argued that NI 51-102 "is
subordinate in ranking to the financial statement requirements".
[104] The Respondents suggested Mumby's contention that the Corporate Respondents should
have included discussions of forward planning or project planning in the Impugned MD&A was
inappropriate for junior mining companies because it would have been difficult to determine what
the companies' next exploration step might be, or, as counsel for the Respondents phrased it, there is
"many a slip between the cup and the lip in the world of mining exploration". The Respondents
also suggested that shareholders would have got lost in all the detail had the Corporate Respondents
included all required information in the Impugned MD&A.
[105] The Respondents contended that, while the contents of the Impugned MD&A may have
been deficient, they were not lacking in materiality if the whole of the information filed on SEDAR
and found on Canada Newswire and in the Corporate Respondents' annual reports for the Relevant
Period was considered. The Respondents emphasized that, because of McLeod's good
understanding of the Corporate Respondents' shareholders, no shareholder apparently lacked for
information about either of the Corporate Respondents.
[106] The Respondents also submitted that McLeod, the individual responsible for preparing the
Impugned MD&A, had been on a "learning curve" and "has learned that there is a requirement of
compliance".
3. Certification
[107] The Respondents contended that, while the filed Certification may have been defective,
other certifications filed on SEDAR on behalf of the Corporate Respondents during the Relevant
Period met the requirements of MI 52-109.
[108] The Respondents submitted that, as with MD&A requirements, the requirement to file
certifications under MI 52-109 was of lesser importance in the hierarchy of requirements to be met
by reporting issuers in that the requirement was contained in an instrument and not in the Act. The
Respondents also noted that, because MI 52-109 was a multilateral instrument and not a national
instrument, it appears not to have been universally accepted by all securities regulators in Canada
and thus had less weight.
[109] Finally, the Respondents argued that the evidence in the Merits Hearing made clear that,
during the Relevant Period, the Corporate Respondents had good financial controls, McLeod and
Miszczuk were aware of the financial condition of Flag, and McLeod was aware of the financial
condition of Golden Briar.
4. Responsibility
[110] The Respondents submitted that, as Staff's principal concerns seemed to relate to the
financial reporting in the Financial Statements, the party most knowledgeable about those
statements would have been the Corporate Respondents' auditor. The Respondents questioned why
Staff chose to approach Lo Porter indirectly about these concerns by issuing the Notice of Hearing
alleging that it was the Corporate Respondents who had filed deficient financial statements, when
those statements had been prepared by Lo Porter.
[111] The Respondents submitted that this proceeding could have been avoided had a more
diplomatic and helpful approach been taken by Staff towards the Corporate Respondents. The
Respondents argued that the Corporate Respondents' shareholders have not been harmed by, but
rather have benefited from, the actions of McLeod and Miszczuk. The Respondents further
contended that the Commission, being mindful of the public interest, should consider the interests
of the Corporate Respondents' shareholders, who have been unable to trade their Flag and Golden
Briar shares since the imposition of the 2006 Cease Trade Orders, as well as the interests of the
Corporate Respondents, who "have been cut off from the capital markets and their shareholders".
V. ANALYSIS AND CONCLUSIONS
A. Continuous Disclosure Regime
[112] The purposes of Alberta securities laws are to provide protection to Alberta investors from
unfair, improper or fraudulent practices and to foster a fair and efficient Alberta capital market and
confidence in that market. Disclosure is a cornerstone principle of securities regulation. Alberta
securities laws recognize that timely, complete, accurate and accessible disclosure of information
protects investors by giving them the information they need to weigh the benefits and risks
associated with a particular investment decision. This regulatory focus on disclosure of information
also promotes investor confidence and market integrity and efficiency.
[113] Continuous disclosure reporting obligations, aimed at fulfilling these regulatory objectives,
are important obligations placed on reporting issuers. The Corporate Respondents, as reporting
issuers in Alberta, are required to file with the Commission certain annual and periodic disclosure
(commonly referred to as continuous disclosure) as prescribed by Alberta securities laws. NI 51-
102 sets out the obligations of reporting issuers to file financial statements, MD&A and certain
other continuous disclosure-related documents. MI 52-109 set out, during the Relevant Period, the
obligations of reporting issuers to file certifications.
[114] The foundation of a reporting issuer's continuous disclosure record is its financial
statements. That foundation is supplemented by the issuer's interim and annual MD&A. MD&A
disclosure is intended to provide the issuer's shareholders and the capital market as a whole with a
greater understanding of the issuer's operations, results, business objectives and future prospects.
Management of a reporting issuer is responsible for developing a process to ensure compliance with
disclosure obligations – how the company will meet its financial reporting and disclosure filing
obligations. Individual senior members of management (the CEO and CFO) are responsible to
certify personally – annually and for each interim period – that the issuer's financial disclosure
presents fairly its financial position. We need not discuss other continuous disclosure required by
Alberta securities laws because those requirements are not the subject of the allegations in this
proceeding.
[115] The issues in the Merits Hearing are: whether, in filing or failing to file the Financial
Statements, Impugned MD&A and Certification, the Corporate Respondents contravened Alberta
securities laws and acted contrary to the public interest; and, if so, whether McLeod was responsible
for the Corporate Respondents' contraventions and thus acted contrary to the public interest. We
now consider the alleged continuous disclosure failings by the Corporate Respondents.
B. Financial Statements Not GAAP
1. Financial Statement Requirements
(a) Annual Financial Statements
[116] Section 149 of the Act (in force until 30 March 2005, at which time the requirement was set
out in a new section 149 to be read in conjunction with the regulations; the requirement is now
found in section 4.1 of NI 51-102) required a reporting issuer to file annually with the Executive
Director of the Commission comparative annual financial statements accompanied by an auditor's
report.
[117] Contrary to the Respondents' contention, it is well established that the responsibility for
financial statements rests with the reporting issuer, its management, its audit committee and its
board of directors (Re Workum and Hennig, 2008 ABASC 363 at para. 501). Management is
responsible for the accurate recording of transactions and for the preparation of its issuer's financial
statements. GAAP provides the framework for this financial disclosure.
[118] The annual financial statements of a reporting issuer must be audited by an independent
external auditor. This requirement is designed to provide reasonable assurance, based on an
independent examination of an entity's financial information, that the financial statements as a
whole are free from material misstatements, whether caused by fraud or error. The Handbook
provides that auditors of public company financial statements are required to assess their own
independence with a view to having an objective state of mind. The independence of the external
auditor is fundamental to an appropriate audit relationship between the external auditor and the
entity on whose financial statements that auditor will opine.
(b) GAAP
[119] As noted, financial statements form the foundation of a reporting issuer's continuous
disclosure record. A reporting issuer is obliged to ensure that the financial statements it files
pursuant to Alberta securities laws are prepared in accordance with GAAP. Section 144 of the
Alberta Securities Commission Rules (General) (the "Rules") (which was repealed on 1 December
2006; the requirement is now found in National Instrument 52-107 Acceptable Accounting
Principles, Auditing Standards and Reporting Currency) directed that all financial statements be
prepared in accordance with GAAP. The primary source of GAAP is the Handbook, which consists
of prescriptive declarations and explanation or guidance supplemented by "Abstracts" of the CICA's
EIC, all of which guide preparers of financial statements.
[120] When reviewing financial statements to determine their compliance with GAAP, we refer to
a number of overriding principles set out in the Handbook. Section 1000 of the Handbook, titled
"Financial Statement Concepts", sets out in paragraph 1000.15 that the "objective of financial
statements" (of which notes "are an integral part" – paragraph 1000.04) is:
. . . to communicate information that is useful to investors, members, contributors, creditors and other
users ("users") in making their resource allocation decisions and/or assessing management
stewardship. Consequently, financial statements provide information about:
(a) an entity's economic resources, obligations and equity/net assets;
(b) changes in an entity's economic resources, obligations and equity/net assets; and
(c) the economic performance of the entity.
[121] Paragraph 1000.17 discusses the Handbook concept of "materiality". This similarly focuses
on the users of financial statements in guiding the preparers' selection of the information to be
included in financial statements:
MATERIALITY
Users are interested in information that may affect their decision making. Materiality is the term used
to describe the significance of financial statement information to decision makers. An item of
information, or an aggregate of items, is material if it is probable that its omission or misstatement
would influence or change a decision. Materiality is a matter of professional judgment in the
particular circumstances.
[122] The Commission has commented that perfect accuracy in every detail of a financial
statement is not a requirement of either GAAP or Alberta securities laws. Rather, as set out in
Workum and Hennig at para. 499, what is demanded is:
. . . a fair depiction of the financial position and results of the entity being reported on, measured by
what would reasonably be considered, at the time, material to an investor or prospective investor.
This demands prudence, diligence, honesty and fairness on the part of those responsible for financial
statements.
2. GAAP Issues
(a) Review of Financial Statements
[123] We reviewed the Financial Statements for compliance with GAAP in the areas of concern
identified by Staff. We were provided with relevant extracts from the Handbook and Staff's
detailed exposition of their concerns. However, our determinations were somewhat hampered
because we did not have the benefit of reviewing the relevant company information and documents
that had been provided to Lo Porter for its preparation of the Financial Statements. Nor did we have
testimony from Lo Porter concerning the Financial Statements. Indeed, we were disconcerted that
neither Staff nor the Respondents saw fit to require the attendance of Lo Porter as a witness in this
proceeding, particularly given that the Merits Hearing had been scheduled many months in advance.
We also received little evidence as to the level of materiality that applied to the alleged use of
inappropriate accounting principles or wrong application of accounting principles.
[124] In the result, it was clear from the evidence provided that GAAP had not been complied with
in certain areas of concern identified by Staff, but there was insufficient evidence relating to other
areas of concern to allow us to reach determinations in those other areas.
[125] We now discuss our findings on the areas of concern that Staff identified in the Financial
Statements. (We refer to Note 5 (2003), Note 5 (2004) and Note 5 (2005) – the note disclosure of
"Mineral Interests" in the Flag Financial Statements – collectively as "Notes 5F"; and we refer to
the note disclosure of "Mineral Interest" in the Golden Briar Financial Statements, including Note 4
(2002), as "Notes 4". We refer to Note 6 (2003) and Note 6 (2004) – the note disclosure of "Long
Term Debt" in the 2003 and 2004 Flag Financial Statements – collectively as "Notes 6"; and we
refer to Note 9 (2003), Note 9 (2004) and Note 9 (2005) – the note disclosure of "Related Party
Transactions" in the Flag Financial Statements – collectively as "Notes 9". We refer to the note
disclosure of "Convertible Debenture" in the Golden Briar Financial Statements, including Note 5
(2002), as "Notes 5GB"; and we refer to the note disclosure of "Related Party Transactions" in the
Golden Briar Financial Statements, including Note 7 (2002), as "Notes 7".)
(i) Mineral Interests
[126] We agree with Staff that Accounting Guideline 11 applied to the Corporate Respondents as
both were (and are) clearly in the development stage, devoting substantially all of their efforts to
raising capital and exploring for natural resources, with any planned principal operations having yet
to commence.
[127] Accounting Guideline 11, at paragraph 31, notes that users of financial statements are
"interested in both past performance and expected future performance" as predictors of an
"enterprise's ability to earn income and generate cash flows in the future . . . to generate a return on
investment". However, because entities in the development stage have limited historical
performance, "users of financial statements of enterprises in the development stage are interested in
information regarding the significant projects being undertaken".
[128] In accordance with Accounting Guideline 11, the Corporate Respondents disclosed in their
Notes 2 to the Financial Statements that they were "in the exploratory stage of developing mineral
and resource interests". However, in their respective note disclosure of their mineral interests
(Notes 5F for Flag; Notes 4 for Golden Briar), the Corporate Respondents failed to disclose details
about "each significant project under development, including those abandoned", in accordance with
paragraph 32 of Accounting Guideline 11. According to McLeod's testimony, the Corporate
Respondents had mineral interests in more than one property. Indeed, each of the Corporate
Respondents had disclosed in other continuous disclosure their mineral interests or claims in
properties located near Sudbury, Ontario, including those described as Cobalt Hill, Wolf Lake, Jess
Lake, Laundry Lake, Mackelcan, Rathbun and Wanapitei Lake. However, the Financial Statements
did not make clear the nature and extent of the mineral interests of the Corporate Respondents,
which would have occurred had paragraph 32 been observed.
[129] Further, in the Flag Financial Statements, Flag disclosed that it had written off a significant
amount of capitalized costs – $5 498 135 or 42% of Flag's total assets – but failed to disclose the
detail necessary to indicate the impact of this cumulative amount. Similarly, in the Golden Briar
Financial Statements, Golden Briar disclosed that it had written off significant amounts for
impairment but failed to disclose the detail necessary to indicate the impact of these cumulative
amounts.
[130] In our view, users of the Financial Statements – such as shareholders, potential investors and
other capital market participants – would have been interested in learning the identity of the
respective Corporate Respondents' mining projects, amounts capitalized or deferred on the projects
to date, amounts expensed on the projects to date, revenues earned from the projects, details of any
contractual rights and obligations related to the projects and details of any abandoned projects. We
believe that the value and stage of exploration and development of the mineral interests of the
respective Corporate Respondents – whose business was (and is) mining and mineral exploration –
would have been highly relevant information not only for the respective Corporate Respondents'
shareholders but also for the Alberta capital market as a whole. We therefore find that Notes 5F in
the Flag Financial Statements and Notes 4 in the Golden Briar Financial Statements did not comply
with paragraph 32 of Accounting Guideline 11.
(ii) Related Party Transactions
[131] Section 3840 of the Handbook establishes disclosure and measurement standards for
transactions with related parties. To comply with section 3840 of the Handbook, issuers with
related party transactions should provide complete and transparent disclosure in their financial
statements about the identity of all related parties and the details of all related party transactions.
We are satisfied that there was sufficient – albeit not perfect – disclosure of the related party
relationship between Flag and Golden Briar, and between Flag and Cooksville, in the note
disclosure in the Flag Financial Statements (Notes 9 and the "Economic Dependence" note
disclosure) and in the note disclosure in the Golden Briar Financial Statements (Notes 7 and the
"Economic Dependence" note disclosure).
[132] However, we agree with Staff that there was insufficient detail provided in Notes 9 in the
Flag Financial Statements and in Notes 7 in the Golden Briar Financial Statements about the terms
and conditions of the disclosed option agreement between Flag and Golden Briar, contrary to
paragraph 3840.43 of the Handbook. According to the Balance Sheets in the Flag Financial
Statements, mineral interests represented approximately 42-52% of Flag's total assets. Although the
Corporate Respondents disclosed that, under the option agreement, Golden Briar could earn a 50%
interest in certain properties if it incurred $400 000 of exploration expenditures on those properties,
they failed to provide details of the contractual terms of the agreement, including the identity of the
properties subject to the agreement, any deadline for completion of the required expenditures
(except in the 2005 Flag Financial Statements) and the amount expended to date by Golden Briar.
In contrast, we note that, in Flag's annual audited financial statements for its fiscal year ended 31
December 2001, Flag did provide greater detail in its disclosure about option agreements with
Golden Briar.
[133] We agree with Staff that, while Notes 6 in the 2003 and 2004 Flag Financial Statements
identified some of the recorded debt as owing to a named related party, they should have made clear
which, if any, of the other recorded debt was also owing to related parties and, if so, their identities.
Notes 5GB in the Golden Briar Financial Statements similarly failed to indicate whether the
recorded convertible debenture had been issued to a related party and, if so, its identity. These
disclosure deficiencies made it impossible to assess accurately the impact on the respective
Corporate Respondents of the recorded debt and convertible debenture transactions.
[134] Further, while the Statements of Cash Flows in the Golden Briar Financial Statements fairly
disclosed the sale and purchase of shares of a "related company", the notes failed to disclose
sufficient detail about these transactions, including the identity of the related company, contrary to
paragraph 3840.43 of the Handbook.
[135] We view disclosure of related party transactions as significant. The details of such
transactions are critical in enabling users of financial statements to assess the impact on the
reporting issuer of its transactions with related parties. To this end, we expect considerable
disclosure of the existence, nature and amounts of all transactions with all identified related parties
in public company financial statements in accordance with section 3840 of the Handbook. The
Corporate Respondents did not meet this standard. Indeed, we find that the Financial Statements
overall did not clearly depict the extent or details of related party transactions. We therefore find
that the Financial Statements – particularly Notes 6 in the 2003 and 2004 Flag Financial Statements,
Notes 9 in the Flag Financial Statements and Notes 5GB and 7 in the Golden Briar Financial
Statements – did not comply with section 3840 of the Handbook.
(iii) Miscellaneous Items
[136] The other suggested deficiencies identified by Staff – such as no separate reporting of the
components of the Cooksville Convertible Debenture, classification of current liability or debt as
long-term debt and accounting error – were, in our view, appropriate issues for Staff to have raised
in the course of a continuous disclosure review. Further, any questions asked by Staff on these
issues should have been promptly and fully answered by the Corporate Respondents and their
auditor, which has not been done to date. However, the evidence received at the Merits Hearing
was insufficient for us to determine whether any of these other suggested deficiencies, about which
we have reservations, was material enough to move from the level of an unanswered concern raised
during a compliance review to a finding in an enforcement proceeding that the item was not
prepared in accordance with GAAP. We therefore make no findings on any of these other
suggested deficiencies.
(b) Conclusions
[137] The quality and usefulness of financial statements directly depend on the accounting
treatment used in their preparation. We believe that the Financial Statements, viewed as whole
units, disclosed to users the financial uncertainty of the Corporate Respondents' future viability as
going concerns – no historical or expected revenue, substantial deficit, substantial working capital
deficiency, the need for additional financing, historical and ongoing financial reliance on a related
party (Cooksville) and the associated uncertainty of their primary business activity of exploring and
developing potential mineral interests. However, we find that the disclosure of mineral interests
and related party transactions in the Financial Statements did not provide sufficiently clear and
understandable information about those interests and transactions to enable users of the Financial
Statements to understand the nature and effect of those interests and transactions when making
decisions in reliance on the Financial Statements.
[138] The significant assets of the Corporate Respondents were (and are) their mineral interests,
and there were transactions during the Relevant Period involving these significant assets with each
other as related parties and with Cooksville, another related party. While some attempt was made to
provide disclosure about the Corporate Respondents' mineral interests and related party transactions
in the Financial Statements, we believe that users of the Financial Statements would reasonably
have expected to be apprised of the specific details of the mineral interests under development or
abandoned and of any transactions involving related parties, particularly when these also involved
the mineral interests. Such information would undoubtedly have been of significance to users when
considering these mineral interests and transactions. This information could have influenced users'
interpretations of the Corporate Respondents' financial positions and prospects and, ultimately,
affected users' investment decisions. We find that the Corporate Respondents failed to disclose
their mineral interests and related party transactions in accordance with the relevant GAAP
provisions in the Handbook and that these mineral interests and related party transactions were
material items for the purposes of GAAP.
[139] For these reasons, we find that the Financial Statements filed by the Corporate Respondents
with the Commission were not prepared in accordance with GAAP as required by section 144 of the
Rules and therefore that the Corporate Respondents contravened Alberta securities laws.
C. Impugned MD&A Deficient
1. Legal Requirements
[140] MD&A is intended to provide capital market participants with management's analysis of the
reporting issuer's business and management's discussion of the issuer's current and prospective
financial position and operating results. MD&A should not merely repeat financial statement
information. It should supplement and build on financial statement information by giving investors
a fuller understanding of the issuer's business, operating results, future prospects, risks and
uncertainties as seen by its management.
[141] NI 51-102 sets out the filing and delivery requirements for MD&A, as well as the form and
content of MD&A. MD&A is to be prepared according to NI 51-102 and Form 51-102F1. National
and multilateral instruments are rules enacted by the Commission under the Commission's rule-
making power in section 224 of the Act. Section 224(4) of the Act states that "[a] rule made by the
Commission . . . has the same force and effect as a regulation made by the Lieutenant Governor in
Council under section 223". Sections 224(1) and 223(k) of the Act give the Commission the
authority to make rules governing continuous disclosure requirements in documents such as MD&A
and certifications by CEOs and CFOs. National and multilateral instruments are part of Alberta
securities laws, defined in section 1(b) to include the Act and the regulations. Thus, a breach of a
provision of the Act, the regulations or the rules (including a national or multilateral instrument) is a
breach of Alberta securities laws.
2. Review of Impugned MD&A
[142] It is clear from a review of the Impugned MD&A that it did not contain much of the
information that NI 51-102 and Form 51-102F1 require, as was admitted by McLeod. For example,
the Corporate Respondents were required – but failed – to provide:
an analysis of operating results and comparison to prior periods;
because the Corporate Respondents' operations were not producing any revenue, a
discussion of expenditures and business objectives, as well as details relating to
progress made or not made to achieve business objectives, milestones and
anticipated project timing;
a discussion of risk factors and uncertainties that might affect future performance;
a summary of financial data from the financial statements;
a discussion of working capital requirements, any working capital deficiency and the
ability to meet obligations as they became due and to remedy any deficiency;
the details of commitments for capital expenditures;
a discussion of the business purpose of related party transactions; and
a breakdown of capitalized or expensed exploration and development costs on a
property-by-property basis.
[143] We find that the Impugned MD&A contained significant material omissions and did not
provide capital market participants with clear and understandable information from management
about the Corporate Respondents' current and prospective financial positions and operating results.
In the result, we find that the Impugned MD&A filed by the Corporate Respondents with the
Commission was not prepared in accordance with NI 51-102 and Form 51-102F1 and therefore that
the Corporate Respondents contravened Alberta securities laws.
D. Certification Deficient
1. Legal Requirements and Recommendations
[144] On 30 March 2004 the Corporate Respondents became subject to the requirement to file
CEO and CFO certifications pursuant to MI 52-109 (which was repealed on 15 December 2008; the
requirement is now found in National Instrument 52-109 Certification of Disclosure in Issuers'
Annual and Interim Filings). MI 52-109 required an issuer's CEO and CFO (or the individuals
performing similar functions) to certify, among other things, that: the issuer's annual or interim
filings "do not contain any untrue statement of a material fact or omit to state a material fact
required to be stated or that is necessary to make a statement not misleading"; the issuer's annual or
interim filings "fairly present in all material respects the financial condition, results of operations
and cash flows of the issuer"; and the CEO and CFO are responsible for establishing and
maintaining, and have designed or caused to be designed, "disclosure controls and procedures and
internal control over financial reporting for the issuer" to provide "reasonable assurance that
material information relating to the issuer . . . is made known to [them]" and to provide "reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with the issuer's GAAP". In their certification of annual filings,
an issuer's CEO and CFO were also to certify as to their evaluation of, and their conclusions about,
"the effectiveness of the issuer's disclosure controls and procedures".
[145] Companion Policy 52-109CP to MI 52-109 ("MI 52-109CP") provided guidance to issuers,
their management and directors in complying with MI 52-109. As set out in Part 6 of MI 52-
109CP, securities regulators believed the "control" components of the certifications to be important
regulatory tools in maintaining market integrity and enhancing investor confidence. Part 8 of MI
52-109CP advised issuers that the "fair presentation" wording in the certifications differed from that
typically used by auditors in their reports because the intent was "to prevent management from
relying entirely upon compliance with the issuer's GAAP in this representation, particularly where
the issuer's GAAP financial statements may not reflect the financial condition of an issuer". MI 52-
109CP elaborated that, if an issuer's financial statements failed to portray an aspect of its financial
condition, the issuer should supplement its financial statements with additional disclosure in its
MD&A "to provide a materially accurate and complete picture of the issuer's financial condition,
results of operations and cash flows".
2. Certification
[146] A review of the Certification or lack thereof makes clear that the 2005 Second Interim
Certificate did not contain the representations McLeod, as Flag's certifying officer, was required to
make and certify and that Flag simply did not file either the 2005 Third Interim Certificate or the
2005 Annual Certificate.
[147] Moreover, the evidence revealed another critical concern – an apparent lack of adequate or
appropriate internal control over financial reporting and disclosure controls and procedures at either
of the Corporate Respondents. It was suggested that Miszczuk, whose Golden Briar directorship
was disputed, had approved the 2003 and 2004 Golden Briar Financial Statements in error, an error
that continued unchecked over two fiscal year ends. McLeod did not inform himself as to the
specific documents Lo Porter received from Milne that were used to prepare the Financial
Statements. As noted, it appears that Lo Porter never met with either of the Corporate Respondents'
audit committees and that neither McLeod nor the Corporate Respondents' respective boards of
directors ever reviewed the constitution, mandate or responsibilities of the respective audit
committees. Further, the evidence suggested that any audit committees appointed for the Corporate
Respondents did not carry out an effective function. Indeed, apparently at some point during the
Relevant Period an audit committee existed only on paper for Flag (and perhaps also for Golden
Briar). Also as noted, it appears that:
no representative of Lo Porter ever attended a board meeting of either of the
Corporate Respondents;
the Corporate Respondents' respective boards of directors never reviewed any of the
Financial Statements with Lo Porter before approving the statements; and
neither McLeod nor the Corporate Respondents' respective boards of directors ever:
reviewed annually with Lo Porter or otherwise the accounting principles and
practices followed by the respective companies;
reviewed estimates, judgments or accounting alternatives that may have been
material to the financial reporting of the respective companies; or
established or reviewed an audit plan to identify the most significant
business, control and financial reporting risks within the respective
companies.
[148] Indeed, the corporate culture at the Corporate Respondents appears to have fostered a
somewhat cavalier attitude towards the requirements for internal control over financial reporting
and disclosure controls and procedures. McLeod, as the directing mind of the Corporate
Respondents, clearly did not focus on this area – or, indeed, seem aware of these requirements or
their importance. In the circumstances, McLeod could not possibly have been in a position to
provide the certifications required of Flag by MI 52-109.
[149] Therefore, we conclude that there were few, if any, effective internal controls over financial
reporting or effective disclosure controls and procedures implemented within the Corporate
Respondents. McLeod's testimony revealed that he relied on his personal discretion when he made
decisions with respect to disclosing information to the public. While it appears that McLeod had
and has an in-depth understanding and knowledge of the mining business, his judgment as to what
information should be disclosed cannot supplant the disclosure obligations imposed by Alberta
securities laws.
[150] We are compelled to conclude that McLeod, in his capacity as the certifying officer for Flag,
failed to take reasonable steps in his review of the underlying MD&A and applicable Alberta
securities laws before completing the 2005 Second Interim Certificate required of Flag.
[151] We find that Flag failed to comply with MI 52-109 in respect of the Certification and
therefore was in contravention of Alberta securities laws.
E. Conclusions
[152] We found the Corporate Respondents' Financial Statements, Impugned MD&A and
Certification contravened Alberta securities laws. We reject the Respondents' contention that many
of the defects in the Corporate Respondents' continuous disclosure were merely "technical" defects.
We note that enforcing requirements for timely, complete, accurate and accessible disclosure is one
of the ways the Commission furthers the purposes of Alberta securities laws.
[153] We cannot overemphasize the importance we place on reporting issuers' scrupulous
compliance with all continuous disclosure reporting obligations. The regulatory focus on periodic,
thorough and truthful disclosure recognizes that most trading of securities in the Alberta capital
market occurs in the secondary market. Investors in the secondary market buy and sell securities in
reliance on the public disclosure record of the issuer. It follows that, for investors to be confident in
the integrity of our capital market and for the successful operation of that capital market, all issuers
must follow best disclosure practices. Only if that is done will an issuer's public record provide
investors – existing and potential – with disclosure that enables them to make informed investment
decisions.
[154] In this case, the Corporate Respondents' public disclosure record did not provide investors
with full and accurate disclosure. While we heard suggestions that existing shareholders were
provided with the information they wanted about the Corporate Respondents, selective disclosure to
certain investors – even to all current shareholders – does not equate to timely, complete, accurate
and accessible disclosure to the whole of the Alberta capital market. Without such disclosure,
uninformed and ill-advised investment decisions can be made, with resultant damage to investor
confidence and the capital market. All of this is contrary to the public interest.
[155] In conclusion, we find that, in filing or failing to file the Financial Statements, Impugned
MD&A and Certification in contravention of Alberta securities laws, the Corporate Respondents
engaged in conduct contrary to the public interest.
F. Responsibility of McLeod [156] We next consider whether McLeod was responsible for the Corporate Respondents'
contraventions of Alberta securities laws.
[157] The public has a reasonable expectation that, when a public company releases financial and
other disclosure information to the public, the directors and officers of the company will have met
certain standards of care in satisfying themselves as to the accuracy and completeness of the
disclosure. That reasonable expectation enables investors to rely on such information in making
investment decisions. The integrity of our continuous disclosure regime demands that all directors
and officers of reporting issuers exercise the care, diligence and skill of a reasonable person in
dealing with the issuer's disclosure obligations.
[158] McLeod, as the president and a director of the Corporate Respondents, occupied positions of
authority, responsibility and trust within the companies. We find that, apart from his responsibility
for disclosure reporting as a result of his being a senior officer and director, McLeod was directly
responsible for the Impugned MD&A and Certification in that he prepared the Impugned MD&A
for the Corporate Respondents and he was, or would have been, Flag's certifying officer for the
Certification. We further find that McLeod did not exercise reasonable diligence to ensure that
these public filings complied with Alberta securities laws and, in the result, caused the Corporate
Respondents to disregard the associated continuous disclosure obligations under Alberta securities
laws.
[159] As for the Financial Statements, McLeod argued that he relied on Lo Porter to prepare the
Financial Statements in accordance with GAAP and to audit those same Financial Statements. He
argued that he then relied on the auditor's reports opining that the Financial Statements had been
prepared in accordance with GAAP and "present[ed] fairly, in all material respect [or respects], the
financial position of the [Corporate Respondents]".
[160] Accounting requirements are complex. Accordingly, we appreciate that it is not uncommon
for junior companies without professional accounting personnel to rely on their auditors for
assistance, advice, direction and guidance in the preparation of financial statements to ensure they
comply with GAAP. While we have some sympathy for McLeod, who prudently sought
professional accounting advice, he must understand that ultimate responsibility for the preparation
of financial statements lies with the issuer and its management, audit committee and board of
directors. We find that, as the president and essentially CFO, as well as a director, of the Corporate
Respondents, McLeod was ultimately responsible for the Financial Statements and further that he
ought to have known of this ultimate responsibility, one that he could not simply delegate to the
auditor or bookkeeper. If assistance is sought from a professional advisor in the preparation of an
issuer's financial statements, reasonable steps ought to be taken to ensure that the advisor possesses
a current knowledge of GAAP. In that case also, the officers and directors should review the
financial statements and discuss and confirm with the issuer's auditor that all appropriate estimates,
judgments and accounting treatments have been applied to the issuer's financial statements.
[161] In the circumstances, we find that McLeod's reliance on the reports of the auditor, Lo Porter,
was neither reasonable nor sufficient to relieve him of responsibility for the Corporate Respondents'
filing of the non-GAAP-compliant Financial Statements. The evidence disclosed that neither
McLeod nor any other director conducted an appropriate review or consulted with the auditor to
ensure that the Financial Statements filed by the Corporate Respondents were GAAP-compliant.
Rather, as discussed above, the evidence brought into question the adequacy or appropriateness –
indeed the very existence – of internal financial reporting and disclosure controls within the
Corporate Respondents. We find that McLeod failed to exercise reasonable diligence in causing the
Corporate Respondents to file the Financial Statements that were not prepared in accordance with
GAAP as required by Alberta securities laws and, in the result, caused the Corporate Respondents
to disregard the associated continuous disclosure obligations under Alberta securities laws.
[162] We are also troubled by McLeod's conduct in relation to Staff during the continuous
disclosure review. This was not the behaviour we expect from someone who occupies a position of
senior officer or director with a reporting issuer. For example, Staff requested information from the
Corporate Respondents in relation to several accounting issues involving the Financial Statements.
We would have expected McLeod, as the senior officer of the Corporate Respondents, to cooperate
fully with Staff, and to review promptly Staff's concerns about the Financial Statements with the
Corporate Respondents' auditor with a view to assessing and responding to Staff's concerns.
Instead, McLeod took no effective steps to address Staff's concerns. Indeed, to date, Staff have
received no answers to the concerns they raised regarding the Financial Statements. In effect,
McLeod refused to cooperate with Staff and continues to do so.
[163] The Commission is charged with the statutory authority to ensure that those involved in the
securities industry provide full and accurate disclosure to maintain public confidence in the integrity
of the Alberta capital market. In order for the Commission to effectively monitor market
participants, those involved in the capital market are expected to provide timely, complete responses
to Staff's inquiries. It is difficult to conceive of anything more integral to the protection of the
integrity of, and the prevention of abuses in, the capital market than the full cooperation of market
participants when questioned by their regulator. We expect management and directors of a
reporting issuer to cooperate fully with Staff in Staff's review of the issuer's continuous disclosure,
to answer Staff's inquiries and to refile or restate financial or other disclosure if required.
[164] Clearly McLeod, as the senior officer and spokesperson for the Corporate Respondents, did
not fulfill his obligations as a participant in the capital market to provide timely, complete responses
to Staff's inquiries. This type of conduct is contrary to the public interest – it strikes at the heart of
the Commission's oversight responsibility.
[165] Although McLeod did not exercise reasonable diligence to ensure that the Corporate
Respondents' public filings during the Relevant Period complied with Alberta securities law, the
evidence did not suggest that he acted dishonestly, or misled or withheld information from Lo
Porter. However, McLeod's conduct did show a disregard for the public shareholders of the
Corporate Respondents and for the Alberta capital market as a whole. We can only conclude that, if
McLeod's conduct is left unchecked, it would undermine the continuous disclosure regime which is
fundamental to the well-being of our capital market. For these reasons, we find that McLeod was
responsible for the Corporate Respondents' filing of the Financial Statements that were not prepared
in accordance with GAAP, for improper or incomplete disclosure in the Impugned MD&A and for
the improper or unfiled Certification, all in contravention of Alberta securities laws, and thus acted
contrary to the public interest.
VI. CONCLUSIONS
[166] We found that:
the Corporate Respondents filed the Financial Statements that were not prepared in
accordance with GAAP;
the Corporate Respondents filed the Impugned MD&A that was not prepared in
accordance with NI 51-102 and Form 51-102F1;
Flag filed the 2005 Second Interim Certificate that was not prepared, and failed to
file the 2005 Third Interim Certificate and 2005 Annual Certificate, as required by
MI 52-109;
the Corporate Respondents thereby contravened Alberta securities laws and acted
contrary to the public interest; and
McLeod was responsible for the Corporate Respondents' contraventions of Alberta
securities laws and thus acted contrary to the public interest.
[167] This decision concludes the first part of the hearing. It remains to be decided what, if any,
orders for sanction or costs we should make against the Respondents. Staff are directed to provide
their written submissions to the panel (through the Registrar of the Commission) and to the
Respondents on the issues of sanction and costs by the close of business on 16 April 2010. If, in
turn, the Respondents wish to respond to Staff's submissions, those written submissions must be
sent to the panel (through the Registrar) and to Staff by the close of business on 7 May 2010. Staff
may then reply in writing to any such written submissions, that reply to be provided to the panel
(through the Registrar) and to the Respondents by the close of business on 14 May 2010.
[168] If any party wishes to make oral submissions concerning the issues of sanction and costs,
that party must so advise the Registrar by the close of business on 18 May 2010, with an indication
of whether that party proposes to call witnesses and the amount of hearing time expected to be
required. If such a request is made, the panel will set a date for oral submissions and advise the
parties accordingly. The panel of its own accord may also set a date for oral submissions, if it
considers that this would be of assistance to it.
29 March 2010
For the Commission:
"original signed by"
Glenda A. Campbell, QC
"original signed by"
Allan L. Edgeworth, P. Eng.
"original signed by"
Roderick J. McKay, FCA