On August 26, 2014, a panel of the Ontario Securities Commission (the “panel”) released its highly anticipated decision involving allegations of insider trading, tipping and conduct contrary to the public interest in connection with the hostile takeover bid of Baffinland Iron Mines Corporation by Nunavut Iron Ore Acquisition Inc. in 2010. The decision dismissed all allegations against the respondents, once again demonstrating the difficulties in prosecuting such cases.
The facts of the case are relatively straightforward. Between February and April 2010, Baffinland engaged the services of a consultant to provide strategic advice to the Board and CEO. During the consultancy period and after, certain confidential information was imparted to the consultant by the company, including information relating to Baffinland’s negotiations with ArcelorMittal regarding a potential joint venture. In early September 2010, the consultant, together with the co-respondent, purchased a significant block of shares in Baffinland (called a toehold purchase) and then subsequently launched a takeover bid for the company.
Staff of the Ontario Securities Commission (“Staff”) alleged that the consultant, together with the co-respondent, used the confidential information that was disclosed to him in order to make the toehold purchase and then launch the takeover bid.
In order to prove that both individuals contravened s. 76(1) of the Securities Act (the “Act”), Staff had to establish that the respondents commenced the takeover bid while they were persons in a special relationship with Baffinland and had knowledge of material facts with respect to Baffinland that had not been generally disclosed. Staff also alleged with respect to the consultant that he contravened s. 76(2) of the Act by informing third parties, including the co-respondent, of material facts about Baffinland before the material facts were generally disclosed. Additionally, Staff alleged that the respondents acted contrary to the public interest by using the confidential information in this manner, and that the consultant in particular acted contrary to the public interest by not always acting in Baffinland’s best interests while he was a consultant and afterwards.
The Decision and Findings
After over 40 days of evidence and submissions, in which over 2,600 documents were filed, the panel dismissed the allegations against both respondents. It found that at the time of the toehold purchase, the consultant did not have knowledge of material facts about Baffinland that were not generally disclosed. It followed therefore that the consultant did not convey any such material, non-disclosed facts to the co-respondent. Neither the insider trading allegations nor the tipping allegations could be substantiated.
What Amounts to a Material Fact?
In arriving at its conclusion, the panel considered whether confidential information regarding status and terms of negotiations with ArcelorMittal amounted to a “material fact” within the meaning of s. 76(1) of the Act. The panel confirmed that the status and terms of negotiations regarding a potential joint venture between two public companies may, in certain circumstances, constitute material facts. However, the panel provided an important clarification to the significance of the U.S. “probability/magnitude test”, which states that whether a contingent fact is material is a function of the significance of the contingent fact and the probability that it may occur. In previous cases, panels of the Ontario Securities Commission had applied the probability/magnitude test, holding that the possibility of a highly significant event may be material, even if the likelihood that it will occur is low. In Baffinland, the panel clarified that while the probability/magnitude test can be an aid to the assessment of materiality, the key question remains whether disclosure of the undisclosed contingency could reasonably be expected to have a significant effect on the market price. In this case, the negotiations that were alleged to be a material fact were not at an advanced stage and the proposed transaction was neither imminent nor even likely. Accordingly, the panel did not accept that disclosure of the negotiations would be expected to have a significant effect on the market price.
The panel also found that although out-of-date information regarding negotiations may have been material at an earlier date, if intervening events and/or the passage of time negate or diminish the importance of that information, such information can no longer be considered to be “material”. In this case, the confidential information imparted to the consultant while acting in that role ceased to be correct or relevant by the date on which the toehold purchase was made.
When is a Material Fact “Generally Disclosed”?
The panel also provided an important clarification with respect to the meaning of the term “generally disclosed”. Information relating to the existence of negotiations between Baffinland and ArcelorMittal had been “fairly broadly disseminated” to the steel industry and to sophisticated investors in junior exploration companies in Canada. It had been the subject of commentary in industry and investing publications and was known, to varying degrees, by a number of industry participants including potential strategic partners, financial advisors and analysts. The panel held that the information had been effectively disclosed to a specialized audience. However, the information had not been disseminated in a way that was calculated to reach the investing public generally, and even if it had, the public had not had a reasonable opportunity to digest the information. Accordingly, it had not been “generally disclosed”.
What Constitutes a Special Relationship?
Even though it was not necessary, the panel also considered whether the respondents would have been in a special relationship with Baffinland had it found that the respondents had knowledge of material facts. The panel held that, if that had been the case, it would have concluded that the consultant was in a special relationship with Baffinland under subsections 76(5)(d) and (e) of the Act because:
- The consultant obtained knowledge about Baffinland during the term of his consultancy while he was a person engaged in a business or professional activity with or on behalf of Baffinland; and
- The consultant obtained knowledge about Baffinland during both the term of his consultancy and post-consultancy from the directors and officers of Baffinland, who were themselves persons in a special relationship with Baffinland.
Additionally, the panel would have concluded that the co-respondent (or “alleged tippee”) was in a special relationship with Baffinland by virtue of the fact that he acquired all of his information about Baffinland from the consultant in circumstances where he knew or ought to have known that the consultant was in a special relationship with Baffinland.
Public Interest Jurisdiction
One of the most relevant aspects of the decision is the panel’s approach to the Ontario Securities Commission’s “public interest” jurisdiction. Having concluded that there was no violation of “securities law”, the panel nonetheless considered whether it had jurisdiction to make an order under its public interest jurisdiction (s. 127) in relation to (i) trading while in possession of confidential, non-material, information; or (ii) failing to act in the best interests of the issuer while in a special relationship with the issuer.
The panel held that s. 76 of the Act does not prohibit trading on the basis of non-material confidential information or rumours, speculation or suppositions, and that therefore it was not appropriate to find the respondents acted contrary to the public interest when they were found not to have knowledge of the material facts. Similarly, the panel found that it was beyond the scope of the panel’s jurisdiction to make findings with respect to allegations that the consultant did not always act in Baffinland’s best interest while he was a consultant and afterwards. The panel found no grounds upon which to make a finding against him for the purposes of investor protection or fostering fair and efficient capital markets and confidence in the capital markets.
At first blush, Baffinland can be seen as another setback for securities regulators in their pursuit of alleged insider trading. As discussed in previous posts on Osler’s Risk Management & Crisis Response Blog, regulators both north and south of the border continue to face multiple challenges in proving allegations of trading and tipping, including limited financial resources, perceived insufficiently effective investigative and enforcement tools, and an inadequate national structure to coordinate oversight of enforcement activity.
This panel seems to have set a high bar for what constitutes a “material fact” within the context of insider trading allegations. Nevertheless, the Baffinland decision highlights that capital market participants must continue to exercise caution in using and disclosing sensitive, confidential information which has been obtained while in a special relationship with a reporting issuer.