On January 25, 2018, the Ontario Court of Appeal released its decision in the high-profile Finkelstein v Ontario Securities Commission case, upholding the earlier OSC hearing panel (the “Panel”) decision and confirming the appropriate test for determining insider trading/tipping liability for individuals further downstream the tipping “chain”.

The Court of Appeal heard appeals relating to two individuals who were found liable for insider trading/tipping by the Panel in 2015. The court upheld the Panel’s finding of liability against one individual and reinstated the Panel’s finding of liability against the other. In its reasons, the Court of Appeal emphasized the substantial deference owed to securities commissions and reaffirmed the reasonableness of finding insider trading/tipping liability based on circumstantial evidence.

Background

The Finkelstein case involved a “chain” of five individuals who disclosed and traded on material, non-public information (“MNPI”) about a pending corporate transaction, in contravention of the Securities Act’s insider trading prohibitions. The insider trading/tipping chain began with Finkelstein, a partner at a Bay Street law firm, who disclosed the MNPI to a friend, who then passed the information down the tipper/tippee chain to the other respondents. The Panel (whose decision we previously discussed) found that all five respondents were liable for insider trading/tipping. The respondents appealed to the Divisional Court (whose decision we also previously discussed), which overturned the ruling against the furthest downstream tippee (Cheng), but upheld the findings against the other four respondents.

Both Miller (one of the respondents whose finding of liability was upheld by the Divisional Court) and OSC Staff appealed the Divisional Court’s ruling. Miller appealed the finding of liability against him, while OSC Staff appealed the Divisional Court’s decision to overturn the finding of liability against Cheng.

Court of Appeal affirms the acceptable use of circumstantial evidence in insider trading/tipping cases

The Securities Act (the “Act”) prohibits both insider trading (when a “person in a special relationship with an issuer” trades in securities of that issuer while in possession of MNPI) and tipping (disclosing MNPI to others).

In Finkelstein, the Court of Appeal for the first time considered the definition of “person in a special relationship with an issuer” found in section 76(5)(e) of the Act. This section provides that a person who knows or “ought reasonably to have known” that they received MNPI from a person in a special relationship with an issuer (i.e., a director, officer, insider or other person falling under s. 76(5)(e)) becomes a person in a special relationship with that issuer as well. No subjective knowledge that the source of the MNPI was a “person in a special relationship” is required. The court noted that this section extends the chain of liability for insider trading/tipping beyond direct insiders to those who trade or tip on information received from insiders – and that the chain can extend endlessly.

At first instance, both Miller and Cheng were found to be in a “special relationship” with the relevant company based on s. 76(5)(e). At the Court of Appeal, Miller and Cheng took issue with the Panel’s reliance on certain factors in making this determination.

The Panel relied on the following factors in making its finding:

  • The relationship between the tipper and tippee;
  • The professional qualification and standing of the tipper;
  • The professional qualification of the tippee;
  • The level of detail and specificity of the MNPI;
  • The length of time a tippee waits to make a trade after receiving MNPI;
  • The intermediate steps a tippee takes, if any, to verify the information received;
  • The tippee’s past ownership, or lack thereof, of the particular stock; and
  • The significance of the trade given the size of a tippee’s portfolio

Miller and Cheng disputed how the Panel applied the objective knowledge test to the specific facts of the case. Miller argued that all of the factors fundamentally diverge from s. 76(5)(e)’s plain language, and therefore amount to an unreasonable interpretation of that section. Cheng disagreed on more narrow grounds, arguing that two of the factors (the length of time between receiving MNPI and making a trade, and the immediate steps taken to verify the MNPI before trading) are not relevant.

The Court of Appeal disagreed, ruling that because there is often a lack of direct evidence about a tippee’s knowledge in insider trading cases (the offence is by nature clandestine), it is reasonable for a Panel to use such factors to help identify “groups of circumstantial evidence” which support inferences about a tippee’s knowledge.

Court of Appeal emphasizes deference owed to securities commissions

The Court of Appeal overturned the Divisional Court’s findings with respect to Cheng, and reinstated the Panel’s original finding of liability against him. In doing so, the Court of Appeal found that the Divisional Court had improperly re-weighed the evidence before the Panel, and emphasized the deference owed to decisions made by securities commissions:

[101] The function of a reviewing court, such as the Divisional Court, is to determine whether the tribunal’s decision contains an analysis that moves from the evidence before it to the conclusion that it reached, not whether the decision is the one the reviewing court would have reached: Ottawa Police Services, at para. 66. With due respect to the Divisional Court, it failed to do so in the case of the Panel’s decision about Cheng. Instead, it impermissibly re-weighed the evidence and substituted inferences it would make for those reasonably available to the Panel. That was an error. The findings of fact made and inferences drawn by the Panel in respect of Cheng were reasonably supported by the record.

Implications

The Court of Appeal’s decision demonstrates that successive tippees further downstream the tipping chain can be held liable for insider trading/tipping, and confirms the factors that will be considered by securities commissions in making a determination of liability. Based on those factors, liability can attach to an individual who lacks subjective knowledge about the origins of the MNPI if they “ought reasonably to have known” that it came from an insider.

As in the Divisional Court’s decision in Fiorillo v Ontario Securities Commission, the Court of Appeal’s decision in Finkelstein confirms the deference that appellate courts show to findings by and decisions of securities commissions (and the reasonableness standard to be applied to those findings), including findings of liability for insider trading/tipping based predominantly on circumstantial evidence.

The Court of Appeal’s decision in Finkelstein affirms OSC Staff’s approach to prosecuting insider trading/tipping cases. OSC Staff will likely seek to capitalize on the ruling in future cases, such as the allegations surrounding Hutchinson.