In the recently released decision in Finkelstein v. Ontario Securities Commission, the Ontario Court of Appeal (the Court) considered for the first time the definition of “person in a special relationship with an issuer” found in s. 76(5)(e) the Securities Act (the Act) as it applies to successive tippees who possess material, non-public information about an issuer.
The decision confirms that a person may be found to have contravened the insider trading or tipping provisions of the Act where he ought reasonably to have known that the source of the material non-public information about the issuer in his possession emanated from a “person in a special relationship” with the issuer. Subjective knowledge that his information source was in fact “in a special relationship with the issuer” is not required.
The Commission hearing panel (the Panel)’s identification and reliance upon certain factors or types of circumstantial evidence that could assist in drawing inferences as to whether it was more likely or not that insider trading or tipping had occurred, including the professional qualifications of the alleged tipper and tippee and their access to information about transactions, was upheld as reasonable.
The Ontario Securities Commission (the OSC) initiated proceedings under s. 127 of the Act against five individuals including Mitchell Finkelstein (Finkelstein), Howard Miller (Miller) and Francis Cheng (Cheng), alleging that they breached the Act’s insider trading and tipping provisions and acted contrary to the public interest by recommending to family and clients the purchase of shares in Masonite International Corporation (the Corporation). The OSC alleged that the material, non-public information (MNPI) flowed through a chain of five people, originating with Finkelstein, a mergers and acquisitions lawyer who was working on a take-over bid involving the Corporation. Finkelstein shared the MNPI with a friend who worked as an investment advisor, who in turn shared it with L.K., an accountant. L.K. shared the information with Miller who then conveyed it to Cheng.
At the conclusion of a contested hearing, the Panel found that all of the Respondents were in a special relationship with the Corporation, and had informed or “tipped” others of MNPI concerning the Corporation before that information had been generally disclosed, contrary to s. 76(2) of the Act. As well, the Panel determined that Miller and Cheng had contravened the prohibition against insider trading in s. 76(1) by purchasing the Corporation’s securities with knowledge of undisclosed material facts.
All five respondents appealed the Panel’s decision to the Divisional Court. All but Cheng’s appeal was dismissed. The Divisional Court held that the Panel made a number of factual errors in its analysis of the evidence concerning Cheng that undermined the foundation upon which the Panel concluded Cheng ought to have known he was receiving inside information.
Miller obtained leave to appeal to the Court of Appeal. The OSC appealed the Divisional Court’s decision to allow Cheng’s appeal from the decision of the Panel.
The primary issue on the appeal was the Panel’s interpretation and application of s. 76(5)(e) of the Act, in particular, whether it reasonably interpreted that section to find that Miller and Cheng ought reasonably to have known that their respective tippers stood in a special relationship with the Corporation. According to the Court, s. 76(5)(e) is intended to catch tippees “who, themselves, convey information they have received to others”, making a person who was ‘tipped” a person in a special relationship with the issuer.
Cheng and Miller did not challenge the Panel’s finding that the inquiry into successive tippees under section 76(5)(e) must ask “whether the tippee received material facts, which he reasonably knew or ought to have known came from someone who, in turn, knew or reasonably ought to have known came from a person in a special relationship”. Similarly, the parties did not dispute the Panel’s articulation of the objective knowledge test or the Panel’s determination that a tippee need not necessarily know the identity of the initial tipper. There was also no dispute that neither Cheng nor Miller had actual, subjective knowledge that the person who tipped each of them was in a special relationship with the Corporation.
Rather, the focus of the appeal was on how the Panel applied the objective test set out in s. 76(5)(e) to the specific facts. In particular, Miller and Cheng took issue with the factors (the Factors) used by the Panel to guide the application of the “ought reasonably to have known” element of s. 76(5)(e) of the Act:
- What is the relationship between the tipper and tippee? Are they close friends? Do they also have a professional relationship? Does the tippee know of the trading patterns, including successes and failures, of the tipper?
- What is the professional qualification and standing of the tipper? Is he a lawyer, businessman, accountant, banker, investment adviser? Does the tipper have a position which puts him in a milieu where transactions are discussed?
- What is the professional qualification of the tippee? Is he an investment adviser, investment banker, lawyer, businessman, accountant, etc.? Does his profession or position put him in a position to know he cannot take advantage of confidential information and therefore a higher standard of alertness is expected of him than from a member of the general public?
- How detailed and specific is the MNPI? Is it general such as X Co. is “in play”? Or is it more detailed in that the MNPI includes information that a takeover is occurring and/or information about price, structure and timing?
- How long after he receives the MNPI does he trade? Does a very short period of time give rise to the inference that the MNPI is more likely to have originated from a knowledgeable person?
- What intermediate steps before trading does the tippee take, if any, to verify the information received? Does the absence of any independent verification suggest a belief on the part of the tippee that the MNPI originated with a knowledgeable person?
- Has the tippee ever owned the particular stock before?
- Was the trade a significant one given the size of his portfolio?
Miller submitted that the Factors diverged from the plain language of the provision, and therefore constituted an unreasonable interpretation. Cheng argued that two of the Factors, 5 and 6 above, were not relevant.
The Court rejected these arguments, finding that the Factors constituted an appropriate guideline to use when applying the objective test of “ought reasonably to have known.” Given that circumstantial evidence usually forms the bulk of the evidence in insider trading cases, it was reasonable for the Panel to identify certain groups of circumstantial evidence, such as the Factors, to assist in drawing logical and reasonable deductions about the tippee’s “state of knowledge of the relationship between the tipper and the issuer or another person in a special relationship” with the Corporation. The probative value of such circumstantial evidence will be dependent upon the specific circumstances and the totality of the evidence.
The Court also rejected Miller’s argument that the Panel’s finding that he contravened the tipping and insider trading prohibitions was unreasonable because the Panel failed to determine that the person from whom Miller received the Corporation’s MNPI, L.K. (who was not named as a respondent in the OSC proceeding), was in a special relationship with the Corporation. The Court ruled that, in treating L.K. as a “knowledgeable person”, the Panel had implicitly found that he had a special relationship with the Corporation.
Finally, the Court granted the OSC’s appeal with respect to the Divisional Court’s decision to overturn the Panel’s finding that Cheng contravened the tipping and insider trading provisions, finding that the Divisional Court had impermissibly re-weighed the evidence, and substituted inferences it would have made had it been in the Panel’s position. The Court confirmed that the role of the reviewing court is to determine whether the tribunal’s decision “contains an analysis that moves from the evidence before the tribunal to the conclusion that it reached”, not whether the decision is the one that the reviewing court would have reached. The findings of fact and inferences drawn by the Panel were reasonably supported by the record.
The authors would like to thank Fahad Diwan, articling student, for his contribution to this article.