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Alexandra Murray is currently a JD student at Osgoode Hall Law School. Prior to law school, she earned a degree in economics and worked in the mutual fund industry. Alexandra will be completing her articles at a firm in Toronto with an interest in corporate and securities law.
On January 25th, the Ontario Court of Appeal (“ONCA”) released its decision in the case of Finkelstein v Ontario Securities Commission, 2018 ONCA 61 [Finkelstein], in which it considered for the first time the interpretation and application of provisions of the insider trading and tipping scheme of the Ontario Securities Act,?RSO 1990, c S.5?[Securities Act]. The ONCA affirmed the decision made by a panel (the “Panel”) of the Ontario Securities Commission (“OSC”) and demonstrated support for the Panel’s interpretation and application of the relevant Ontario Securities Act provisions.
In this post, I will first provide an overview of the law on illegal insider trading and tipping in the Securities Act. Next, I will summarize the facts in Finkelstein and the decision of the OSC Panel before discussing the ONCA decision. Finally, I will offer what I believe to be the implications of Finkelstein for the interpretation of the insider trading and tipping provisions of the Securities Act moving forward.
Insider Trading and Tipping
Section 76(1) of the Securities Act?states that:
“No person or company in a special relationship with an issuer shall purchase or sell securities of the issuer with the knowledge of a material fact or material change with respect to the issuer that has not been generally disclosed.”
Section 76(2) further states that:
“No issuer and no person or company in a special relationship with an issuer shall inform, other than in the necessary course of business, another person or company of a material fact or material change with respect to the issuer before the material fact or material change has been generally disclosed.”
In other words, in order to conclude that a person has engaged in tipping, it must be established that the person facing allegations must have, at the relevant time, been in a “special relationship” with the issuer in question and that they possessed “material” non-public information that had not been publicly disclosed. To conclude that a person has engaged in insider trading, the additional fact that must be established is, of course, that they traded in securities during the relevant time period.
Section 76(5) of the Securities Act provides a definition of “person or company in a special relationship with an issuer.” This definition includes:
- a person or company that is an insider, affiliate or associate of the issuer or a person or company that is considering or evaluating whether to enter into a transaction with the issuer
- a person or company that learns of a material fact or material change with respect to the issuer from any other person or company [in a special relationship as per this subsection], and knows or ought reasonably to have known that the other person or company is a person or company in such a relationship.
Mitchell Finkelstein was an M&A lawyer at a Toronto firm. Finkelstein came into possession of material non-public information with respect to pending transactions by virtue of being a lawyer directly involved in those transactions and having access to other information in the firm’s system. Through a series of communications, Finkelstein gave his friend (and investment advisor at CIBC), Paul Azeff, this material non-public information. Azeff subsequently passed the information about the imminent transactions to Korin Bobrow who was also an investment advisor. Both Azeff and Bobrow purchased shares of the issuers for themselves and others. They also gave the information in their possession to friends who then tipped investment advisors, Howard Miller and Francis Cheng. Both Miller and Cheng also purchased shares of the issuers for themselves, family, friends and clients. The statement of allegations brought by the OSC did not implicate the individual(s) in the chain between Bobrow and Azeff and Miller and Cheng for reasons that the Panel did not make explicitly clear. Nevertheless, the evidence enabled the OSC to make formal allegations against Miller and Cheng.
The Panel found that, with respect to three out of six transactions, Finkelstein engaged in insider tipping in breach of section 76(2) of the Securities Act upon concluding that he was (1) in a special relationship with the issuers because of his role as a lawyer at the firm involved in the transactions, and (2) that he was in possession of material non-public information and provided this information to Azeff before the material facts were generally disclosed.
The Panel also found that, with respect to one out of six transactions, Azeff, Bobrow, Miller and Cheng engaged in insider trading in contravention of section 76(1) of the Securities Act. The Panel concluded through the evidence that each of the individuals “ought reasonably to have known” that their tippers were in a special relationship with the issuer pursuant to section 76(5)(e) of the Securities Act. ?
Additionally, the Panel used their public interest power under Section 127 of the Securities Act, to find that Azeff, Bobrow, Miller and Cheng acted contrary to the public interest by recommending the purchase of shares of issuers involved in transactions while in possession of material non-public information.
All five individuals appealed to the Divisional Court in Finkelstein v Ontario (Securities Commission), 2016 ONSC 7508. The Divisional Court dismissed the appeals made by Finkelstein, Azeff, Bobrow and Miller but allowed Cheng’s appeal. At the ONCA, Miller’s appeal was dismissed while the OSC’s appeal with respect to Cheng was allowed.
On appeal, there was no dispute as to whether Miller and Cheng had received material non-public information about the issuer. Also, it was agreed that neither party had actual knowledge that the person, through whom they came into possession of that information, stood in a special relationship with the issuer. At issue was the Panel’s interpretation and application of section 76(5)(e) of the Securities Act, in finding that Miller and Cheng “ought reasonably to have known” that their tippers were in a special relationship with the issuer.
The ONCA agreed with the Panel that the reality of most insider trading cases is that circumstantial evidence “usually forms the bulk of the evidence in cases where insider trading and tipping is alleged” (Finkelstein, para 58). The ONCA went on to say that, “In such circumstances, it was reasonable for the Panel to identify certain factors, or groups of circumstantial evidence, that could assist in drawing permissible inferences as to whether it was more likely than not that insider trading and tipping has occurred” (Finkelstein, para 58).
The ONCA also agreed that the factors used by the Panel to establish whether a person “ought reasonably to have known” that the tipper was in a special relationship with the issuer are a “reasonable guideline that can be applied in the vast majority of situations” (Finkelstein, para 73). These factors include:
- What is the relationship between the tipper and the tippee?
- What is the professional qualification and standing of the tipper?
- What is the professional qualification of the tippee?
- How detailed and specific is the material non-public information?
- How long after he or she receives the material non-public information does the tippee trade?
- What intermediate steps before trading does the tippee take, if any, to verify the information received?
- Has the tippee ever owned the particular stock before?
- Was the trade a significant one given the size of his or her portfolio? (Finkelstein, para 48)
The Court then provided a helpful and practical explanation of the relevance of these factors to the determination of whether a person “ought reasonably to have known” that the tipper was in a special relationship with the issuer. With respect to the first three factors, they made it clear that certain professionals—particularly those who are more likely to come into possession of material non-public information by virtue of their position—such as lawyers and investment advisors, will be held to a higher standard. In other words, these individuals are more likely to possess such information and be in a better position to assess the source and nature of that information than would others.
With respect to the specificity of the material, the Court said that more detailed information may lead to a stronger inference that the information came from a person with access to the issuer. A short amount of time between a person receiving the material non-public information and trading as well as a lack of intermediate steps taken to verify the information, may support an inference that the tippee is confident in the reliability of the information because of its source (i.e. a person in a special relationship with the issuer).
Ultimately, the ONCA dismissed Miller’s appeal and accepted the OSC’s appeal with respect to Cheng to restore the finding that both had engaged in tipping pursuant to section 76(2) of the Securities Act.
Implications of Finkelstein
The endorsement by the ONCA with respect to the use of circumstantial evidence to draw reasonable inferences based on the facts of each circumstance raises interesting questions about the type of inferences that may be made in the future. For instance, how many of the above factors should be present in order to make an inference that a person “ought reasonably to have known” that their tipper was in a special relationship? It appears that neither the OSC or ONCA gave any one factor more weight than another. Rather, the factors operate as a “non-exhaustive” list with which to analyze the activity of the person (Finkelstein, para 73). Although the ONCA’s explanation with respect to the general application of each factor is helpful, there remains uncertainty as to how these factors may be applied in future circumstances. For example, it is unclear as to what constitutes a “short amount of time” between receiving material non-public information and placing a trade. Critically, however, the ONCA made it clear that individuals in certain positions or with certain professional qualifications—such as lawyers and investment advisors—will be held to a higher standard because of their industry knowledge and proximity to material non-public information.
Undoubtedly, it is often, if not always, difficult to obtain direct evidence that a person has engaged in illegal insider trading or tipping. Unlike in the United States, where wiretapping is heavily used to obtain evidence of illegal insider trading and tipping activity, Canadian securities authorities rely on facts such as the frequency and timing of communications between potential tippers and tippees and the timing and magnitude of trades. It appears that the OSC is expanding the scope within which it decides cases like Finkelstein in order to sanction individuals who they believe contribute to erosion of public confidence in the market through this kind of illegal conduct.
The OSC’s National Policy 51-201, OSC NP 51-201 (12 July 2002) [Disclosure Standards] states that the “special relationship” definition under section 76(5) is broad and that “there is a potentially infinite chain of tippees who are caught by the prohibitions against tipping and insider trading.” (Disclosure Standards, s 3.2) It further warns that material non-public information “may be third or fourth hand and still be subject to the prohibitions.” Certainly, this commentary together with the support for the use of circumstantial evidence by the OSC and ONCA with respect to insider trading and tipping, offers a warning to potential investors who are uncertain as to whether they possess material non-public information of an issuer—it may be best to err on the side of caution and temporarily step back from trading in the issuer’s shares.