A recent decision of the Alberta Securities Commission addresses allegations of insider trading (and in the case of one respondent, tipping) against several senior officers of a public company and a spouse of an executive. In that decision, market participants were reminded that context is “all-important” in the determination of materiality. While the decision expressly dealt with allegations of insider trading, it also provided broader guidance on issues of materiality.
In Re Stan, 2013 ABASC 148,1 the Alberta Securities Commission considered allegations that five senior employees of Grade Cache Coal Corporation and the spouse of one respondent engaged in illegal insider trading, and that one employee engaged in tipping. The basis for these allegations was that they had engaged in transactions involving the company’s shares using alleged undisclosed material facts.2 The case centred on whether the company’s expected failure to meet a quarterly sales target and the magnitude of the actual difference were undisclosed material facts, rendering company executives and one of their spouses liable for insider trading in respect of their pre-disclosure trading. After carefully considering and weighing the evidence led during the 14-day hearing, the Commission concluded that, given all the circumstances, more specific disclosure of the company’s missed quarterly sales target would not have had a significant impact on the company’s share price and, therefore, the prospect of missing the sales and production targets did not constitute undisclosed material facts. In reaching its decision, the Commission reaffirmed the proper application of the materiality test and highlighted the importance of context in assessing materiality.
Grande Cache Coal Corporation was an Alberta reporting issuer in the metallurgical coal mining and sale business. The company sold coal under annual fixed price and fixed volume contracts (as did its industry peers). In the metallurgical coal industry, it was not uncommon for the company to experience variations in sales from quarter to quarter because (i) the price of coal was fixed for the year; and (ii) the timing of sales was often dictated by customer demands; therefore, sales not completed in a quarter were considered delayed sales, not lost sales.
On April 21, 2008, the company issued a news release in which it disclosed an annual sales target of 1.8 to 2.0 million tonnes for the 12-month period ending March 31, 2009, and a quarterly sales target of 0.4 million tonnes for the 3-month period ending June 30, 2008. The news release also included a standard forward-looking statement advisory warning and identified specific risks associated with the company’s operations. Due to unexpected issues at its mines, the company’s coal production in April and May 2008 was lower than anticipated. Nonetheless, management remained confident that the annual sales target would be achieved. On both May 28, 2008 and June 30, 2008, the company released interim news releases in which it indicated that its then-current quarterly coal production was “below plan,” but that its annual sales target remained the same as previously indicated. On August 14, 2008, the company released its quarterly results and announced that its lower-than-planned quarterly coal production had resulted in quarterly sales of 0.25 million tonnes (compared with the 0.4 million tonnes noted in the April 21, 2008 news release), but that annual sales were still projected to meet target.
In the period between late May 2008 when the company came out of a scheduled black-out period and mid-July 2008 when the company went into a scheduled black-out period, the employee respondents and the one spouse exercised options and/or sold shares into the market. Notably, the company’s share price had risen from approximately $1 at the commencement of calendar 2008 to $10 by mid-June 2008, reflecting the record-high annual metallurgical coal prices prevailing at the time.
The five employee respondents conceded that they were insiders within the meaning of the applicable securities legislation and that they had engaged in transactions involving the company’s shares during the period May 2008 through July 2008, which was prior to the release of the company’s quarterly results.
The Commission’s decision focused on whether more specific disclosure of the company’s missed quarterly sales target was an undisclosed material fact. As a starting point, the Commission reviewed the concept of, and the proper test for, materiality. The Commission determined that “materiality is a market-focused concept” that should be “assessed objectively from the perspective of an investor and prospectively through the lens of expected market impact.”3 The Commission reaffirmed that a materiality assessment is “directed at not what eventually transpired but rather at what would have been expected to transpire” and cautioned against relying on hindsight. The Commission accepted that “assessments of materiality are not to be judged against the standard of perfection.”4 Most importantly, the Commission determined that “a materiality assessment is a contextual assessment – an assessment to be made in light of all relevant circumstances.”5 As support for the importance of context, the Commission cited National Policy 51-201, which provides as follows:
In making materiality judgments, it is necessary to take account a number of factors that cannot be captured in a simple bright-line standard or test. These include the nature of the information itself, the volatility of the company’s securities and prevailing market conditions. The materiality of a particular event or piece of information may vary between companies according to their size, the nature of their operations and many other factors.6
In applying the materiality test to the evidence, the Commission reiterated that “context is all-important.”7 In addressing the central disclosure issue, the Commission determined that the significance of quarterly results to market participants is a fact-specific exercise that must be assessed in the context of the surrounding circumstances. Notably, the Commission adopted the reasoning in R v. Landen, 2008 ONCJ 561 (in the context of a gold mining company) expressing the view that the market impact of a coal production company achieving its sales volume forecast within any given quarter may not be significant as an isolated event.8
The Commission concluded that more specific disclosure by the company regarding production and sales volumes would not have had a significant effect on its share price. In reaching its conclusion, the Commission relied heavily on evidence regarding the coal industry generally and the securities market for shares of coal producers and found, among other things, that (i) the timing of coal sales during the fiscal year was more significant than the timing of sales in a particular quarter; (ii) the probability that the quarterly production and sales would not be met was, at the time, insignificant compared with the probability that the company would meet its annual production and sales; (iii) the company continued to reaffirm its annual sales projection (which the Commission found was a reasonable reaffirmation at the time); and (iv) the company disclosed lower quarterly production.9
This decision is important to capital market participants for several reasons. First, it reaffirms that assessments of materiality involve the exercise of judgment and common sense, and are to be viewed within the proper context – the determination of materiality is heavily dependent upon the specific facts and the surrounding circumstances. Quarterly forecasts and results taken in isolation are not invariably material. Second, it emphasizes the importance of avoiding hindsight and “confusing outcome with expectation” in assessing materiality. Third, although market participants will not be held to a standard of perfection in making materiality assessments, they should err on the side of caution to avoid facing serious allegations from securities regulators. Fourth, to succeed in these cases, regulators will have to provide clear, convincing and cogent evidence of their case – it is not sufficient to rely on isolated facts without regard to all of the facts and the surrounding circumstances.