ENVIRONMENTAL COMPANY DISCLOSURE: A LAWYER’S PERSPECTIVE

ENVIRONMENTAL COMPANY DISCLOSURE: A LAWYER’S PERSPECTIVE Environmental Finance January 20, 2005Toronto, Ontario Gray E. Taylorgtaylor@dwpv.com1 First Canadian Place, 44th Floor Toronto, ON M5X 1B1 Ph: 416 863 5533 C: 416 529 5533 Fax: 416 863 0871 www.dwpv.com

THEORIES SUPPORTING ENVIRONMENTAL DISCLOSURE REQUIREMENTS • Consider Company A and Company B • have identical businesses, financial performance and future (using traditional analysis) • difference: Company B has undisclosed environmental liability (contamination, reputation, regulatory requirement approaching) • Company A inherently worth more • but absence of disclosure means investors cannot distinguish between Company A and Company B • therefore Company A is a good investment as it will ultimately have lower costs, a greater market value and, if publicly traded, a lower cost of capital

THEORIES SUPPORTING ENVIRONMENTAL DISCLOSURE REQUIREMENTS • Consider Company C and Company D • Company C and Company D have identical businesses, financial performance and future (using traditional analysis) • Company C and Company D also have identical environmental issues (liabilities and opportunities) • Company C has undisclosed fully functioning environmental management system and Company D does not • Assume environmental "performance" is proxy for management expertise (Innovest and others) • Absence of disclosure means investors cannot distinguish Company C from Company D • Disclosure of Company C's EMS should permit investors to establish value differential

THEORIES SUPPORTING ENVIRONMENTAL DISCLOSURE REQUIREMENTS • Company G and Company H • Company G and Company H have identical businesses, financial performance and future using traditional analysis • Company G and Company H have identical environmental management systems • Company G's business involves exposure of humans to electromagnetic radiation which might cause cancer • Absence of disclosure means cannot tell Company G from Company H • Assume electromagnetic radiation is irrelevant to causing cancer (i.e. benign) • Is anyone harmed? • Investors may prefer no electromagnetic radiation exposure but may also prefer companies that paint buildings blue • What disclosure should be required?

CANADIAN PROSPECTUS DISCLOSURE OBLIGATIONS • Prospectus disclosure requirements when securities are issued • “full, true and plain disclosure of all material facts…” • “material fact” is a “fact that would reasonably be expected to have a significant effect on the market price or value of the securities” • Prospectus Disclosure Form Requirements • Item 6.1(1) 4 (h) – requires a narrative description of the business of the issuer which includes: “the financial and operational effects of environmental protection requirements on the capital expenditures, earnings and competitive position of the issuer in the current financial year and the expected effect, on future years”. (emphasis added) • Item 20.1 – requires issuers to: “Describe the risk factors material to the issuer that a reasonable investor would consider relevant to an investment in the securities being distributed such as [ … ] the general risks inherent in the business carried on by the issuer, environmental and health risks…” (emphasis added)

CANADIAN PROSPECTUS DISCLOSURE OBLIGATIONS • Prospectus Disclosure Form Requirements (cont’d) • Item 6.3, 1(d) – requires issuers with “mineral projects” to disclose “all environmental liabilities to which the property is subject”. (emphasis added)

CANADIAN PROSPECTUS DISCLOSURE OBLIGATIONS Prospectus Disclosure Form Requirements (cont’d) • Item 5.3 – requires issuers to “disclose any trend, commitment, event or uncertainty that is both presently known to management and reasonably expected to have a material effect on the issuer’s business, financial condition or results of operation…" • Item 22 – requires the description of “any legal proceedings material to the issuer to which the issuer or a subsidiary of the issuer is a party or which any of the their respective property is the subject matter”(cf U.S. requirement to disclose all government legal proceedings with “sanctions” greater than U.S. $100,000)

NEW ENVIRONMENTAL DISCLOSURE REQUIREMENTS National Instrument 51-102 entitled “Continuous Disclosure Obligations” in force as of 2005 • Annual Information Form (AIF) • Item 5.1(4) – If your company has implemented social or environmental policies that are fundamental to your operations, such as your company’s relationship with the environment or with the communities in which it does business, or human rights policies, described them and the steps your company has taken to implement them. (emphasis added) • Item 5.2 – Disclosure risk factors relating to your company and its business … the general inherent risks in the business carried on by your company, environmental and health risks … regulatory constraints … economic or political conditions … and any other matters that would be most likely to influence an investor’s decision to purchase securities of your company. (emphasis added) • Item 12.1 – Describe any legal proceedings to which your company is a party or of which any of its property is the subject and any such proceedings known to your company to be contemplated.

NEW ENVIRONMENTAL DISCLOSURE REQUIREMENTS National Instrument 51-102 entitled "Continuous Disclosure Obligations" in force as of 2005 (cont’d) • Management’s Discussion and Analysis (MD&A) • Part 1.4(d) – Discuss your analysis of your company’s operations … including … (d) for issuers that have significant projects that have not yet generated operating revenue, describe each project, including your company’s plan for the project and the status of the project relative to the plan, and expenditures made and how these relate to anticipated timing and cost to take the project to the next stage of the project plan • The instruction to Part 1.4(d) states that company’s disclosure under Part 1.4(d) should include “any factors that have affected the value of the project(s) such as change in commodity prices, land use or political or environmental issues” (emphasis added)

NEW ENVIRONMENTAL DISCLOSURE REQUIREMENTS • MD&A (cont’d) • Part 1(a) – Discuss material information that may not be fully reflected in the financial statements, such as contingent liabilities … discuss important trends and risks that have affected the financial statements, and trends and risks that are reasonably likely to affect them in the future. • Part 1.2 – Discuss any known trends, demands, commitments, events or uncertainties that are reasonably likely to have an effect on your company’s business • Part 1.4 – requires the issuer to “discuss your analysis of your company's operations for the most recently completed financial year, including…(g) commitments, events, risks or uncertainties that you reasonably believe will materially affect your company's future performance…(j) any unusual events or transactions”

NEW ENVIRONMENTAL DISCLOSURE REQUIREMENTS • MD&A (cont’d) • Part 1.12 – provide an analysis of your company's critical accounting estimates • An accounting estimate is a critical accounting estimate only if • It requires your company to make assumptions about matters that are highly uncertain at the time the accounting estimate is made and, • Different estimates that your company could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on your company’s financial condition, changes in financial condition or results of operations.

NEW ENVIRONMENTAL DISCLOSURE REQUIREMENTS • MD&A (cont’d) • MD&A requires disclosing • The methodology used in determining the critical accounting estimate; • The assumptions underlying the accounting estimate that relate to matters highly uncertain at the time the estimate was made; • Any known trends, commitments, events or uncertainties that you reasonably believe will materially affect the methodology of the assumptions described; • If applicable, why the accounting estimate is reasonably likely to change from period to period and have a material impact on the financial presentation; • The significance of the accounting estimate to your company’s financial condition, changes in financial condition and results of operations • Quantification of the changes in overall financial performance and financial statement line items if you assume that the accounting estimate was to change using either • reasonably likely changes in the material assumptions; or •the upper and lower ends of the range of estimates from which the recorded estimate was selected.

CANADIAN SARBANES-OXLEY EQUIVALENT REQUIREMENTS Multilateral Instrument 52-109 in force for 2005 and after • CEOs and CFOS must annually certify that the financial statements and information in the company’s filings: "fairly present all material respects the financial condition, results of operations and cash flows of the issuer …" • Annually and quarterly, CEOs and CFOs must certify that their 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 …" • CFOs and CEOs must certify that • they are responsible for establishing and maintaining disclosure controls and procedures to ensure that information required to be disclosed is accumulated and communicated to management • they are responsible for establishing and maintaining internal controls over financial reporting • They have evaluated the effectiveness of the disclosure control and procedures and internal financial controls and disclosed their conclusions; and

CANADIAN SARBANES-OXLEY EQUIVALENT REQUIREMENTS • They have caused the issuer to disclose in the MD&A any important changes to disclosure controls and procedures and internal financial controls • Significant penalties attach to misstatements by CEOs and CFOs

"MATERIALITY" • Securities Act (Ontario) definition of materiality • "material change"…means…a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer, … • US definition • a fact is material if there is – a substantial likelihood that a reasonable investor would attach importance in determining to buy or sell the securities…or the…fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available. • SEC Staff Bulletin 99 on “Materiality” quotes US Financial Accounting Standards Board to indicate consideration of potential market reaction to disclosure of a misstatement is by itself ‘too blunt an instrument to be depended on’ in considering whether a fact is material”. • Canadian AIF and MD&A Part 1(d) and Part 1(e) respectively – "You do not need to disclose information that is not material"

MATERIAL CHANGE DISCLOSURE • issuers must promptly disclose to the public most material changes • “material change” means … a change in the business, operations or capital of the reporting issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the reporting issuer … • Note that changes in material facts may not be sufficient to be a material change • Only changes in business, operations or capital • Only if change would be expected to have a significant effect on the market price or value of securities

CASE LAW • In the matter of J. Patrick Sheridan • OSC decision in 1993 • Appears to be only significant decision on environmental disclosure in Canada • Allegation of failure to disclose material change and of filing financial statements that did not comply with GAAP • Ministry of Environment (MOE) asked for an injunction to prevent Sheridan’s mining company, Madeleine, from carrying on mining activity at its principal mine • Mine in “tune-up” (i.e. pre-operation) phase • Had requested MOE approval and no response had been provided by MOE when injunction sought • MOE had not inspected mine site when injunction sought • Madeleine share price fell after disclosure but “not too significantly” and had been falling earlier, perhaps from declining gold and platinum prices

CASE LAW • OSC said “our view is that in determining whether there was a material change in respect of Madeleine in these circumstances it was appropriate to consider the effect that the mere fact of environmental proceedings by the MOE would have on Madeleine’s shares, the likelihood of success of the injunction application and the impact that an injunction, if granted, would have on the operations of Madeleine. While there may have been a material change, given the evidence before us in the case on those matters, we do not feel that we have sufficient facts on which to properly make that assessment ourselves”. • OSC similarly couldn’t decide if the injunction proceeding were required to be disclosed by GAAP as a “subsequent event” that might have a “significant effect on the future operations of the enterprise”. • Weak decision

LIABILITY FOR SECONDARY MARKET TRADING • Ontario intends to make issues, directors, officers, promotions and other insiders and controlling persons liable for misrepresentations in publicly filed or distributed documents and oral statements and for failure to make material change disclosure. • Liability will be to investors who purchase or sell during the post-failure and pre-correction period • If a core document (prospectus, AIF, MD&A, financial statements), no need to prove knowledge • If a non-core document (including environmental and other CSR reports), must prove knowledge • Due diligence defence (and other defences) • Damages based on market prices but subject to liability limit • Issuer – greater of 5% of market capitalization and $1.0 million • Directors and officers – greater of $25,000 and 50% of compensation from issuer and affiliates in previous 12 months

LIABILITY FOR SECONDARY MARKET TRADING • Experts – greater of $1 million and revenue from issuer and affiliates in previous 12 months

VOLUNTARY DISCLOSURE Risks and Rewards • Market driven? • Reputation? • Liability if incorrect? • Expanding in Canada but slow growth of standards • Potential for liability • Securities Act • Competition Act (false and misleading advertising - see OPG precedent) • tort

FUTURE • Greater Disclosure? • “Materiality” exceptions a problem • Enforcement an issue • Lack of agency guidance a concern • But improvements • Disclosure of fundamental environmental policies and steps to implement in AIF • Disclosure of environmental and health risks in AIF • Discussion in MD&A of contingent liabilities and trends and risks that are reasonably likely to affect financial statement • Analysis of critical accounting estimates in MD&A • CEO & CFO certification re: disclosure controls and procedures and internal financial controls • Liability for secondary trades, including failure to disclose material change.

Thank you.

ENVIRONMENTAL COMPANY DISCLOSURE: A LAWYER’S PERSPECTIVE