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Thursday December 24, 5:50 pm Eastern Time
TORONTO, ONTARIO--The Ontario Securities Commission has been responding to various news media inquiries regarding YBM Magnex International, Inc. and the OSC's role in relation to YBM.
In the interests of providing a complete public record to all interested media, the Commission is providing a list of the questions which have arisen to date and its responses.
QUESTIONS AND ANSWERS REGARDING YBM MAGNEX INTERNATIONAL, INC. AND THE OSC
The OSC's Jurisdiction with respect to YBM
Q. What is the OSC's role in the YBM Magnex matter?
A. YBM Magnex International, Inc. is a reporting issuer of
securities in Ontario, and as such is required to comply with the requirements of the Ontario Securities Act. The OSC is responsible for the administration and enforcement of the Securities Act.
Until recently, YBM was a company listed on the Toronto Stock Exchange and therefore was obliged to comply with the requirements imposed on such companies by the TSE. The OSC has oversight responsibility for the TSE.
On May 31, 1997 YBM filed with the OSC a preliminary short form prospectus relating to a proposed public offering of securities. On November 17, 1997 the OSC issued a receipt for a final prospectus involving 3,200,000 common shares and gross proceeds of $52,800,000.
The Prospectus Review
Q. What are the information requirements that a company has to satisfy in order to receive a receipt for its prospectus?
A. The prospectus is a disclosure document and the guiding
principle behind its content requirements is full, true, and plain disclosure.
In the context of a prospectus, disclosure must include information relating to the business of the issuer, its management, its operations, financial condition and operating results. The Act and Regulation prescribe extensive disclosure requirements including specific financial statement requirements.
Q. On what basis would or could the OSC refuse to issue a receipt for a prospectus?
A. The Act provides a general condition that a receipt shall not
issue if it appears to the OSC Director that it is not in the public interest to issue a receipt.
Without limiting the above, the Act provides specific criteria where a receipt shall not issue. These criteria include circumstances where:
- it appears to the Director that there is non-compliance with the Act,
- the prospectus contains false, misleading, or deceptive information, or
- the past conduct of an officer, director, promoter, or controlling shareholder affords reasonable belief that the business will not be conducted with integrity and in the best interests of the security holders.
Q. What is a company's remedy if the Director refuses to issue a receipt for a prospectus?
A. If the Director refuses to issue a receipt for a prospectus,
the company is entitled to a hearing and review of the Director's decision by the Commission which can make such other decision as it considers proper.
The existence of an ongoing Enforcement investigation will not, per se, result in a refusal to issue a receipt for a prospectus. In this respect, an OSC Staff Notice was issued in February 1990 (copy attached) outlining the considerations which are given by staff reviewing a prospectus where there is an ongoing Enforcement investigation.
Q. How did staff address concerns identified during the course of the YBM prospectus review?
A. Clearly, certain information was viewed very seriously by staff
in their review of the prospectus.
As a consequence of concerns identified by staff respecting the disclosure of YBM's sales, staff required YBM to take the extraordinary step of retaining a ``Big Six'' accounting firm to perform a re-audit of the company's financial statements for fiscal 1996 and provide new comfort on its interim financial statements for the 9 months period ending September 30, 1997. YBM retained Deloitte and Touche, LLP. Staff further required that the company provide Deloitte and Touche with a copy of all relevant correspondence between YBM and staff of the OSC which set out the concerns which had been identified by OSC staff. In addition, upon completion of the audit, Deloitte and Touche was required to meet with OSC staff to respond to its questions.
At that meeting with Deloitte and Touche, there was no indication given of the kinds of problems subsequently identified by Deloitte in the Spring of 1998 in the course of its audit of YBM's 1997 financial statements. In fact, at no time was staff given reason to believe that it could not rely on Deloitte and Touche's work on the 1996 and 1997 balance sheets.
Furthermore, notwithstanding Deloitte issuing a clean audit opinion, staff insisted that YBM disclose in the prospectus the extensive review OSC staff carried out during the course of the prospectus review and further, the existence of a continuing regulatory review. (copy attached)
Q. Was there a difference of opinion amongst OSC staff regarding the issuing of the receipt for the prospectus or regarding a staff review of Deloitte and Touche's audit papers before issuing the receipt?
A. The issues around the prospectus review were viewed very
seriously by OSC staff and considerable attention was focussed on this matter. As would be expected, in any matter where professional judgement and discretion are involved regarding the process to be followed in arriving at a decision, different approaches were extensively discussed and analyzed by staff.
It is, however, important to emphasize that the issuance of a clean audit opinion by Deloitte and Touche, LLP following a high-risk audit conducted with full knowledge of the concerns of staff of the OSC was instrumental in staff's decision to issue the receipt. In the absence of any reason to believe it could not rely on the work of Deloitte and Touche, it would not have been reasonable, in these circumstances, for staff to have, in effect, audited the auditor.
Q. Why didn't the OSC go ahead with the hearing originally scheduled in August of this year?
A. The purpose of the hearing was to deal with the failure by YBM
to file financial statements. The result of such a hearing would have been the issuance of a cease trade order. Such an order was obtained on consent and is continuing.
The OSC Investigation
Q. Is the OSC conducting an investigation into YBM?
A. The OSC has an ongoing investigation.
Generally, the purpose of such investigations is to gather information to enable Commission staff to assess whether there is sufficient evidence upon which to base formal proceedings in front of the Commission.
Q. What if any action has the OSC taken against YBM, its officers, directors, underwriters or auditors? What action is contemplated?
A. The OSC imposed a Cease Trade Order against YBM. It would not
be appropriate to comment on any other regulatory action which may be contemplated.
Q. Are you considering any changes to securities regulation because of this case?
A. The OSC will work together with the TSE and the other
provincial regulators and Canadian stock exchanges to determine whether the YBM situation highlights any gaps in securities regulation which need to be addressed. However, at present, the OSC does not see how greater regulation would have served to avoid recent developments in the YBM matter.
Q. Did this situation develop because of the inadequacy of resources available to the OSC at the time?
A. No. In fact, significant, senior staff resources as well as
external consultants were involved in the prospectus review.
Q. Is the OSC concerned about how the YBM case will affect investor confidence in our markets?
A. Obviously the OSC is concerned about the impact which cases
such as this have on investor confidence. It is important that all parties learn from experiences such as this to reduce the likelihood of their recurrence. It remains very important for investors to carefully review the information contained in prospectuses to ensure they have a full understanding of what they are buying into.
Q. When will the OSC's investigation be completed?
A. It is not possible to predict, at this point, when the
investigation will be completed, but every effort is being made to complete it expeditiously.
Q. What is the status of the police investigations into this matter?
A. The OSC will not comment on any investigative activities of
other enforcement bodies.
ONTARIO SECURITIES COMMISSION NOTICES 18
----------------------------------------------------------------
......... 15. Security Checks ....complete or undertaking
...........16. Ontario Principal: ....all jurisdictions
clear before issuing
final receipt
....Quebec clearance required
before issuing receipt
under NP 1 Receipt System
For further information, contact: Corporate Finance Branch
18 -- Disclosure of Investigations
13 O.S.C.B. 598 1990/02/16
In the past, situations have arisen where a preliminary prospectus is filed and Corporate Finance staff becomes aware of an ongoing or recently concluded investigation by the Enforcement Branch relating to certain persons and/or companies who are involved in the proposed prospectus offering. The investigation may relate to the issuer, promoter, underwriter or other person or company involved in the prospectus offering (the ``Participants'').
Subsection 60(1) (61(1)) of the Act provides that, subject to subsections 60(2) (61(2)) and 62(4) (63(4)), the Director shall issue a receipt for a prospectus unless it appears that it would not be in the public interest to do so. The existence of an ongoing or recently concluded investigation relating to any Participant may or may not, in the circumstances, afford sufficient grounds for the Directo r to refuse to issue a receipt for the prospectus. That decision will be made on a case by case basis and will depend upon the facts known at the time.
Where the facts do not justify the denial of a final receipt for the prospectus, the Act nonetheless imposes a statutory obligation to provide full, true and plain disclosure of all material facts relating to the securities issued or proposed to be issued by prospectus. Commission staff is of the view that disclosure of an investigation relating to a Participant in a proposed public offering may be necessary to meet the standard. The circumstances in which such disclosure will be required and the nature and extent of the disclosure (i.e. faced page, prospectus summary, notes to financial statements or any combination thereof) will also be determined on a case by case basis. In making this determination, Commission staff will consider all relevant facts including, but not limited to, the allegations which gave rise to the investigation, the status of the investigation, the seriousness of the alleged breaches of the Act which are the subject of the investigation and the degree of involvement in the proposed prospectus offering of the Participant(s) under investigation.
The decision to require disclosure and the form of the disclosure will be determined by the staff of the Corporate Finance Branch. If necessary, the matter may be referred to the Commission on a formal or informal basis, for its consideration and determination.
The matters discussed above are equally applicable in the context of offering memoranda provided to prospective purchasers in connection with various prospectus exempt trades under the Act and the Regulation thereto. Given the self-policing nature of private placements and the fact that offering memoranda are not routinely reviewed by Commission staff, the decision relating to the appropriate disclosure in an offering memorandum rests with the issuer and/or vendor(s) and their advisor(s). If Commission staff becomes aware of an offering memorandum that fails to disclose material information regarding an investigation pertaining to parties involved in the transaction, it may seek to intervene to effect remedial action.
REGULATORY REVIEW
In the context of their review of this prospectus, staff of the Ontario Securities Commission (the ``OSC'') raised concerns with respect to certain aspects of the Corporation's 1996 audited financial statements, including the audit procedures relating to reported amounts of sales as well as the identity and ultimate location of the Corporation's customers. In order to address these concerns and at the request of OSC staff, the Corporation engaged a major international account ing firm (the ``Confirming Auditor'') to perform an audit of its financial statements for the year ended December 31, 1996.
In rendering its unqualified opinion, the Confirming Auditor determined that, in its professional opinion, certain non-cash restatements and reclassifications to the Corporation's existing 1996 financial statements would be appropriate. These matters may be summarized as follows:
- an accounting accrual for income taxes of approximately (U.S.)$6.3 million to account for the potential for increased tax liability as a result of the Corporation's international business operations and corporate structure;
- an adjustment to record consigned inventory of (U.S.)$5.2 million, relating to an inadvertent error on the part of management to accurately record inventory relating to an isolated delivery of diesel oil on a consignment basis, thereby understating its operating income for the year; and
- a reclassification of certain geographic sales information in order to reflect the ultimate end user of the Corporation's products, which reclassification reflected an increase in the level of sales attributable to Eastern Europe and a decrease in the sales attributable to North America for the year (prior to the acquisition by the Corporation of the business of Crucible Magnetics in the United States).
The combined impact of these non-cash adjustments on the Corporation's financial position at December 31, 1996 was as follows:
- total assets were increased by (U.S.)$5.2 million;
- total liabilities were increased by (U.S.)$6.3 million;
- shareholders' equity was reduced by (U.S.)$1.1 million;
- cost of sales was reduced by (U.S.)$5.2 million; and
- income tax expense was increased by (U.S.)$6.3 million.
As as result of the foregoing, fully-diluted earnings per share were reduced by (U.S.)$0.03 per share or 6.2 percent. A copy of the opinion of the Confirming Auditor as well as supplemental management's discussion and analysis disclosure explaining these adjustments and reclassifications in greater detail and their impact upon the Corporation's financial position is contained in the material change report dated November 13, 1997, a copy of which is incorporated herein by reference.
As part of its continuing review, staff of the OSC has requested certain source documentation underlying the Corporation's disclosure record in connection with its 1996 financial statements. Management believes that the various steps being taken to improve the Corporation's controls, monitoring, reporting and other information systems will ensure that its financial information is and will continue to be accurate and complete. See ``Business of YBM.''
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