In the Finkelstein v. Ontario Securities Commission insider trading case, the Ontario Court of Appeal provided guidance on the interpretation of a “person in a special relationship with an issuer” as it applies to successive tippees who possess material, non-public information (MNPI) about an issuer.
OSC’s 2015 Findings
For a detailed summary of the 2015 decision of the Ontario Securities Commission (OSC), please see here. In brief, the OSC Panel found that, in connection with three separate M&A transactions between 2004 to 2007, a lawyer tipped his friend (Azeff), an investment advisor, and Azeff’s partner Bobrow about MNPI, and that Azeff and Bobrow engaged in insider trading and tipping. Two other investment advisors, Miller and his associate Cheng, learned of MNPI from LK, a friend and client of Azeff and Bobrow. The OSC determined that Miller and Cheng also engaged in insider trading in one stock, Masonite.
The elements that constitute insider trading under the Securities Act (Ontario) require (i) a special relationship with the issuer on the part of the party purchasing or selling securities; (ii) the purchase or sale of a security of the issuer; and (iii) knowledge of MNPI by the special relationship party. An insider trading violation can only be established if all the elements are proven.
If the recipient of MNPI “ought reasonably to have known” that the person who provided the information was in a special relationship with the issuer, they are themselves deemed to have a special relationship with the issuer under s. 76(5)(e) of the Securities Act (Ontario).
The 2018 Appeal Decision
The Court of Appeal’s decision concerned the OSC’s findings against Miller and Cheng only. There was no dispute that Miller and Cheng (a) received MNPI about Masonite, (b) traded on that information, and (c) did not have actual knowledge that LK, their informant / tipper, was in a special relationship with Masonite, as LK had himself received MNPI from Azeff. At the OSC hearing, Miller and Cheng argued that they were trading on rumours in the marketplace. Trading on a rumour does not contravene the Securities Act (Ontario).
The key issue on appeal was the interpretation and application of s. 76(5)(e) of the Securities Act (Ontario) and whether Miller and Cheng as recipients of MNPI “ought reasonably to have known” that the person who provided the information was in a special relationship with the issuer. Under s. 76(5)(e), an objective knowledge test must be applied: should a person standing in the shoes of the tippee reasonably assume that the MNPI passed on to the tippee originated with a knowledgeable person? Answering this question becomes increasingly difficult in cases involving a chain of successive tippees.
The Court of Appeal agreed with the OSC Panel that because most insider trading cases involve circumstantial evidence, the OSC could rely on the following non-exhaustive list of factors to determine whether a person ought reasonably to have known that the information originated from someone in a special relationship with an issuer:
- What is the relationship between the tipper and 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 MNPI?
- How long after he or she receives the MNPI 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?
The OSC’s reliance on circumstantial evidence may be viewed as lowering Staff’s evidentiary onus to prove insider trading and tipping allegations. However, the Court of Appeal cautioned that any deduction from circumstantial evidence about the tippee’s state of knowledge must be drawn “in a logical and reasonable fashion” based on the “the totality of the evidence.” This guidance accords with the OSC Panel’s comments that circumstantial evidence must be “firmly established”, speculation cannot be used to fill in the gaps, and circumstantial evidence should flow “naturally and logically”.