A number of our previous posts have commented on the difficulties faced by regulators and law enforcers when trying to prove insider trading, and particularly “tipping”, in Canada and the United States. With the close of the OSC’s hearing in the matter of Paul Azeff, Korin Bobrow, Mitchell Finkelstein, Howard Jeffrey Miller and Man Kin Cheng (a.k.a. Francis Cheng)(“Finkelstein”). Market participants await what some have called, “one of the most important insider trading decisions in Canadian history.”
The OSC alleged that Finkelstein, a partner at a prominent Bay Street law firm, “sought out and acquired material, non-public information concerning pending corporate transactions”, handled by his firm. It is alleged that he then communicated this message to his friend Paul Azeff, who in turn, improperly tipped other respondents, one of whom, it is alleged, then passed information to another accused, who is alleged to have informed yet another accused.
OSC Staff were tasked with proving not only the information received was material and non-public, but also that those who had or received the information, knew or reasonably ought to have known that the person who gave them the information was a person with a special relationship to the issuer. Establishing an alleged ‘tippee’s’ level of knowledge regarding the source of the information he receives, is an onerous burden, especially where purported tip recipients are several people within a chain of persons, and therefore removed from the source of the information. The task in Finkelstein is made more difficult by the fact that allegations relate to alleged trading activity that took place 7 – 10 years ago.
The US Court of Appeals’ December 10, 2014 decision in United States v. Newman (“Newman”), vacating the convictions of two former hedge fund managers, on insider trading charges, highlights the difficulties associated with proving improper ‘tipping’.
As in Finkelstein, the facts in Newman involved an alleged tip that made its way from insiders to two hedge fund managers through the intervention of 3 or 4 other intermediaries. The American Government chose to prosecute only the hedge fund managers because, “as sophisticated traders, they must have known that information was disclosed by insiders in breach of a fiduciary duty, and not for any legitimate corporate purpose.”
This case will be examined in greater detail in a future post, but for now it is notable that, the trial decision in Newman was overturned by the appeal court for two main reasons:
- there was insufficient evidence that the alleged insiders received a personal benefit; and,
- there was no evidence that the defendants knew they were trading on information disclosed by insiders in violation of their fiduciary duties.
Unlike Finkelstein, an administrative case that is likely to apply civil standards of proof, Newmanwas a criminal case wherein the standard of proof was explicitly stated as ‘beyond a reasonable doubt’. The Appeal Court’s discussion of the requisite mens rea is particularly instructive: “under the common law, mens rea, which requires that the defendant know the facts that make his conduct illegal, is a necessary element in every crime.” The onus is on the Government to establish that the tippee knew of the tipper’s breach, that is, he knew the information was confidential and divulged for personal benefit. As has been mentioned in an earlier post, the degree of proof required in Canadian regulatory matters of this kind is the subject of the Walton v Alberta (Securities Commission) decision, leave to appeal having been sought to the Supreme Court of Canada.
As a matter of prosecutorial strategy, in contrast to the focused prosecution in Newman, the OSC inFinkelstein pursued a more factually comprehensive approach, naming each party to the chain. While this perhaps tells a fuller narrative, it also required the OSC to launch an ever more complicated fact pattern to prove its allegations.
The Alberta Court of Appeal’s decision in Walton v Alberta (Securities Commission), and the Ontario Securities Commission’s decision in Baffinland show that proving insider trading allegations is a real challenge for Canadian securities regulators. How cases are framed factually by securities regulators may also be a factor in their ease of prosecution and outcome. With this in mind, watchful eyes await the decision in this case.