This article, the result of an interview with Olivier Lecat, Chairman of the Canadian Council and Luc Lavoie, Executive Director/Directeur général, the Institute of Internal Auditors-Canada is an interesting development as it is, to our knowledge, the first time that Canadian representatives of the IIA are interviewed by a reporter of this well known, respected US-based magazine.

In Canada, A Different Approach To SOX
By Kathrine Schmidt — May 8, 2007

Canada, America’s largest trading partner, is finally trying to answer the question of how much it wants to embrace U.S.-style corporate governance.

Securities regulators in that country are seeking comment on two proposals: a proposal on the effectiveness of internal controls over financial reporting and a proposal to increase disclosure of executive compensation. Both were released March 30 and are open for further comment until June 28.

While Canada has many of the same corporate governance concepts used in the United States, so far it has avoided any firm decision on how much its laws will mimic Sarbanes-Oxley—in no small part, because Canadian regulators have seen the protracted compliance difficulties and regulatory reforms still gripping American businesses.

But the proposal from the Canadian Securities Administrators, formally called National Instrument 52-109, would update, refine, and clarify the existing limited internal controls apparatus. Currently, most provinces only require certification of accuracy in reporting and limited discussion of compensation processes (except for British Columbia, which opted out of the last agreement).

“Until now, the executive certifications have dealt almost exclusively with the design of internal controls rather than their effectiveness,” says David Brown, executive director of Brown Governance, a consulting firm based in Ottawa.

“I think there’s a sense that even in the U.S., there’s the possibility that regulators are going to back away from some of the more onerous requirements,” Brown says. “I think what Canada’s trying to do is come down fairly close to where we think the U.S. is eventually going to settle out.”

U.S. companies with Canadian operations will not need to worry about the rule, Canadian securities experts say, since compliance with SOX is deemed to meet the corporate governance obligations in Canada as well.

The proposed regulations echo the SEC’s recent mantra of using a “top-down, risk-based approach” to audit internal controls. But lawyers and auditing experts say the proposals don't require the same level of detail that the Securities and Exchange Commission does.

“They don’t propose to follow the SEC’s approach, that’s for sure,” says Peter Villani, of the law firm Fasken Martineau DuMoulin in Quebec. “It’s a less prescriptive and more judgment-based approach.” Instead, Villani says, the rules address “big-picture items” such as codes of ethics and whistleblower hotlines.

Critically, the rules would not require an external audit of a company's internal controls. That requirement in Sarbanes-Oxley is widely seen as the cause of companies' sky-high compliance costs in the United States, and even the SEC now wants to reform that part of SOX to make compliance less difficult.

Lecat 

While an external audit requirement was included in initial forms of the Canadian proposal, regulators decided against it given the country’s larger proportion of small enterprises, according to Olivier Lecat, head of internal audit at the National Bank of Canada and chairman of the Institute for Internal Auditors’ Canadian Council.

“In Canada you have a lot more small issuers,” Lecat says. “The implication of attaining that certification had a large bearing on provincial securities regulators.”

How To Manage Compliance

Another significant difference between the Canadian rules and SOX: The proposed regulations do not require nor recommend any particular framework for internal controls, although companies must disclose and identify one if they use one or state that they don’t.

The SEC encourages companies to use a 1992-era framework for internal controls published by COSO. COSO has since updated its framework and published a scaled-down version more suitable to small companies.

Lavoie 

The lack of any prescribed framework does not mean that companies can be sloppy about their work. Rather, says Luc Lavoie, executive director of IIA Canada, the proposals merely rid the compliance process of steps many deem redundant.

The rules “still require management to report on the effectiveness of internal controls through the management discussion and analysis section,” Lavoie says. “It doesn't mean you don't do any less work.”

As for company guidance—the lack of which is another sore point for American companies unhappy with SOX—the proposal also includes a Companion Policy, which Lavoie describes as “guidance on how the authorities will interpret the various regulations. There’s quite a bit of detail.”

So far, Lecat says, companies have been pleased with the ongoing changes. “It’s still early to provide a general stance of what the reaction is,” he says. “We certainly feel that the new draft is a substantial improvement over what existed before.”

Likewise, Brown says investors have largely been content. “[For] the vast majority, as long as they have clarity and they have transparent disclosure, they’ll be happy,” he says. “What was uncertain was where [Canada] would come down with regard to SEC changes. Investors appreciate the clarity. They have a clearer idea now what’s going to be shared.”

Canadian Compensation Disclosure

In addition, Canada is pursuing its own version of compensation discussion and analysis, in reforms that would update the 1994 National Instrument 51-102, which requires companies in all provinces to divulge executive pay. The updates would require additional detail in the compensation disclosure and explanation of the rationale for compensation.

“[Companies] could avoid reporting large amounts of senior executive compensation depending how you paid it,” Brown explains. “It did happen quite a lot.”

Much like Canada’s approach to internal controls, its proposed disclosures for executive pay are similar in concept to the SEC’s new disclosure rules, but are not as exacting. For example, the SEC requires disclosure of all perks valued at $10,000 or more; Canada's threshold is $50,000.

“Our new tables require less detail,” Villani says. “We really want to know generally what’s going on, as opposed to having all this minutiae of detail. We really haven’t gone to the extreme disclosure [requirements] that the SEC has.”

“Major companies are starting to be much more transparent about this,” and have begun incorporating executive compensation disclosure as best practices, Villani says.

Related Documents:

 Proposed National Instrument 

 Canada Compensation

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