Readers of this publication will undoubtedly be aware that the Ontario Court of Justice acquitted John Felderhof of Bre-X fame of four insider trading charges on July 31, 2007. The charges had been brought by the Ontario Securities Commission under Ontario’s Securities Act. Most of the post-trial publicity has lamented on Canada’s supposed inability to prosecute serious securities violations as opposed to addressing the actual rationale of the decision. In our view, that approach is unfair to each of Mr. Felderhof, the Commission and the legal system. For those interested in the basis of the decision, a brief analysis follows.
It was significant that the OSC decided to prosecute its case in the courts instead of before a commission panel. Panels are empowered to make findings of guilt merely if they conclude that the prosecution case has been proven on a “balance of probabilities”. Courts, on the other hand, must be satisfied of guilt beyond a reasonable doubt in order to convict. Courts can impose harsher sentences than tribunals, including imprisonment or restitution, but the trade-off is that it is more difficult to obtain a conviction due to the higher standard of proof.
The case underscored an often misunderstood tenet of insider trading: namely, it is not necessary for the prosecution to establish (on either standard) that the accused traded based on inside information. It is enough to show merely that the accused traded while having inside knowledge, whether or not they used it as the reasons for the trade. Proving that a person traded using the knowledge would be unreasonably difficult, and as a consequence the legislation is drafted so that trading with knowledge of material facts is all that is required to be proven.
Since brokers have a gatekeeper duty, it is important that they understand that a client who trades while in possession of material undisclosed facts may be engaging in prohibited insider trading. As the Court stated in Felderhof, “the offence is in essence not a question of using insider information but of buying or selling securities of a company while possessed of insider information”.
On all four insider trading charges the Court considered first whether the “facts” that Mr. Felderhof supposedly had knowledge of were “material”. It is a requirement of insider knowledge that it be material, which means information that would reasonably be expected to have a significant effect on the market price or value of the shares. The OSC called a market expert to testify that the facts in question were material in that sense. However, the Court concluded that there was a reasonable doubt about whether the knowledge was material and acquitted Mr. Felderhof on that basis. The Court also decided that the OSC had not proven beyond a reasonable doubt that Mr. Felderhof had knowledge of some of the facts even if they had been material.