On August 29, 2014, the Alberta Court of Appeal released its decision in Walton v Alberta(Securities Commission), 2014 ABCA 723 (“Walton”). The decision is significant as it is extremely rare for an appellate court to overturn a decision of a securities commission, since the latter are recognized as having particular expertise in their field and are accorded considerable deference by courts. In Alberta, only once previously had the Alberta Court of Appeal overturned a decision of an Alberta Securities Commission (ASC) tribunal. The Court of Appeal in Walton identified a number of conclusions made by the ASC Panel and was particularly scathing of the conclusions as, despite its relative expertise, the ASC Panel: (i) improperly interpreted the provisions of the Securities Act related to “recommending or encouraging” a trade; (ii) relied on speculation and conjecture rather than drawing reasonable inferences in making its decisions; and (iii) imposed excessive sanctions without justification or transparency.

Background

As background, in late 2008 Eveready Inc.’s unit price was depressed, parallel with the global economic downturn and it became a potential takeover target. Eveready eventually attracted the attention of Clean Harbours Inc. The prospect of a takeover by Clean Harbors became sufficiently realistic to meet the threshold of being a “material fact” by late January 2009. The Staff of the ASC (Staff) alleged that nine respondents (Respondents) had obtained knowledge of the proposed takeover and then traded in shares of Eveready, making improper use of the information prior to the press release in April 2009. The linchpin of the factual matrix was John Herbert Holtby, one of the directors of Eveready, who admittedly knew about the Clean Harbors takeover discussion and improperly passed on knowledge about that material fact to others as well as trading himself.

In its decision, the ASC Panel found that Holtby  had engaged in insider trading and improperly disclosed the material fact to others. In addition, the Panel found that Holtby and a number of the other Respondents had engaged in informing (tipping) and recommending or encouraging others to purchase Eveready shares before the acquisition was publicly disclosed. Under section 147 of the Alberta Securities Act tipping and recommending/ encouraging are different offences, one being passing on the fact and the other pushing a person to trade but without disclosing the fact. The Panel ultimately ordered sanctions against Holtby and the other Respondents which included significant administrative penalties, the disgorgement of profits, the payment of costs for the investigations and bans from trading in securities and acting as directors  and officers. The severe monetary sanctions imposed against the Respondents amounted to $2.8 million including a $1.75 million administrative penalty against Holtby alone.

The Court Of Appeal Decision

The Respondents appealed the decision of the Panel, including the sanctions, to the Alberta Court of Appeal. As noted, it is extremely rare for a reviewing court to overturn the decision of a securities commission. Courts have less expertise than securities commissions in determining what is in the public interest in the regulation of financial markets. The courts also have less expertise in interpreting securities statutes given the broad policy context within which securities commissions operate. Despite this, the Court of Appeal in Walton overturned the decisions against Kenneth Burdeynet, Gayle Walton and John Shepert, and overturned all of the sanctions that the Panel had imposed. The Court of Appeal recognized that the ASC is an expert tribunal, charged with the administration and interpretation of the Securities Act and its interpretation was entitled to deference. In this case however, the decisions made by the Panel were found to be unreasonable as it had improperly interpreted the provisions of the Securities Act related to the rarely used “recommending or encouraging provision”, it had made determinations based on bare speculation rather than drawing them from reasonable inferences and it had imposed unreasonable sanctions without justification and transparency.

(I) Interpretation Of The Securities Act

While the interpretation of the Securities Act by the Panel is entitled to deference, it can be disturbed on appeal if it is unreasonable. In this case, the Court of Appeal held that the Panel’s interpretation of “insider trading” and “tipping” was reasonable and supported by the case law. However its interpretation of “recommending or encouraging” was unreasonable and could not be sustained. The Panel had concluded that there was no requirement for the recommender or encourager to know or intend that the recipient would buy or sell the particular securities, thus making use of the recommendation or encouragement.

The recommending or encouraging provision (s. 147(3.1)) of the Securities Act requires “knowledge of a material fact” and also an act of recommending or encouraging. The Court of Appeal held that the ordinary meaning of “recommending or encouraging” includes some intention to convey information with the expectation that it may be relied on. Just because a person in a special relationship with the issuer says something positive about the issuer does not necessarily amount to recommending or encouraging even if the comment piqued the interest of the recipient of the information, or caused him to make further inquiries, or even to purchase the security. As the Panel had incorrectly interpreted the provisions of the Act related to recommending or encouraging the decisions made by the Panel had to be examined having regard to the appropriate legal standard.

(II) Speculation and Drawing Inferences

While findings of fact made by the Panel are also entitled to deference, they can be overruled if they demonstrate palpable and overriding error. In this case, the Court reviewed the findings of fact made by the Panel that were based on circumstantial evidence. As we have noted in previous bulletins, it is only possible to prove insider trading cases based on circumstantial evidence and inferences drawn from the conduct of those involved. There is however, a legal distinction between speculation and drawing inferences. Speculation can be described as the drawing of an inference in the absence of any evidence to support that inference or in situations where there is no “air of reality” to the inference.

In Walton, the Court of Appeal overturned many of the decisions made by the Panel as they were made on “bare speculation” and conjecture and the Panel had not drawn proper inferences. Holtby, for example, had been found culpable for encouraging an acquaintance to purchase Eveready shares based on a conversation at a golf course and a telephone conversation. The Panel had concluded that based on the conversations with Holtby and the acquaintance’s subsequent purchase of Eveready shares, an inference could be drawn. The Court held that the fact that the individuals may have been encouraged by Holtby’s general attitude, that he said generically positive things or his statements that Eveready was “busy making money” could not be turned into a finding that he told the individuals about the takeover, nor that he recommended or encouraged the purchase of Eveready shares. A finding that anything more than this was speculation, not inference and there was nothing on the record that could support an inference that Holtby did anything amounting to encouraging. Similarly, the Court overturned a number of the other decisions for recommending or encouraging against the other Respondents as the factors relied upon by the Panel amounted to nothing more than evidence of opportunity, and could only support speculation and not justifiable inferences. The Court noted that the reasoning of the Panel was “too tenuous to support the findings it made” and the Panel’s reasoning “included a number of presumptions that had no basis in the evidence.” The finding of the Court confirms that there does come a time when the facts may be so remote that there are just too many steps or leaps in the chain of reasoning to say that an inference can be reasonably drawn. The Court also noted the unlikelihood of Holtby being inclined to tip or make recommendations to someone he barely knew.

(III) Sanctions

The appropriateness of remedial orders or sanctions is also within the expertise of the Panel and will not be overturned on appeal unless they are demonstrably unfit or are otherwise unreasonable. In this case, all of the Respondents opposed the sanctions that had been imposed by the Panel, arguing that they were demonstrably unfit in the circumstances. Generally, sanctions are not intended to be directly punitive but rather are exercised prospectively to the public interest to protect capital markets. Nevertheless, individual and general deterrence is a legitimate consideration in formulating the appropriate sanction.

In this case, the penalties imposed against Holtby and Kowalchuk (the only two whose decisions were not overturned) were severe. The Panel had declined to determine the administrative penalties by any formula and did not indicate how it arrived at these amounts. The Court of Appeal, in reviewing the decision of the Panel, held that the sanction must be proportionate and reasonable for each appellant. The pursuit of a general deterrence does not warrant imposing a crushing or unfit sanction on an individual. The Court noted that based on the record it was impossible to determine whether the sanctions imposed were reasonable. The severity  of the sanctions left cause for concern as it lacked the justification and transparency that a proper decision making process requires. As such, the sanctions imposed against Holtby and Kowalchuk were set aside and remitted back to the Panel for reconsideration.

Conclusion

Recently John Blair from BLG, wrote an article on Alberta Insider Trading Cases (found here), in which he identified the difficulty the ASC has had recently in prosecuting insider trading and tipping. The decision in Walton is significant and underscores the difficulties that securities commissions may face in proving insider trading cases. Further, while it is rare for appellate courts to question decisions made by securities commission, they will do so where the law is improperly interpreted or where determinations are made that are unsupportable on the record.