Canada: The Scope Of Improper Trading

Last Updated: August 21 2012
Article by David Surat and Andrew McLean

In Re Donald 1, the Ontario Securities Commission ("OSC") found that a former Research in Motion Ltd. ("RIM") employee acted in a manner "contrary to the public interest" by trading in securities with knowledge of a potential take-over of the Issuer, despite the fact that there was no violation of the insider trading prohibition. The decision is indicative of the OSC's willingness to find public interest violations where there is no technical breach of the insider trading provisions of the Ontario Securities Act (the "Act").

Background

Paul Donald ("Donald"), a former Vice-President of RIM, was attending a dinner party after a golf event, when he became aware of information pertaining to RIM's ongoing interest in acquiring Certicom Corp. The following day, Donald instructed his broker to purchase approximately $300,000 worth of Certicom shares. Certicom subsequently entered into an arrangement agreement with RIM, which valued the Certicom shares at approximately twice the price paid by Donald.

The Insider Trading Prohibition

Securities legislation prohibits any person or company in a special relationship with a reporting issuer from buying or selling securities of the issuer while in possession of knowledge of a material fact or material change regarding the issuer that has not been generally disclosed.

Who is in a "special relationship" with a reporting issuer?

The definition of a person or company in a special relationship with a reporting issuer is expansive and includes the reporting issuer or another person or company proposing a business combination with the reporting issuer; any insiders, affiliates or associates of those issuers; and anyone who learns of a material fact or material change with respect to the reporting issuer from the foregoing and who ought reasonably to have known that the person or company is in such a relationship. It also includes a company that is engaging in or proposes to engage in any business or professional activity with the reporting issuer.

In the Donald case, OSC staff alleged that RIM was in a special relationship with Certicom because of its business relationship with Certicom and its interest in acquiring Certicom.

The OSC concluded that RIM was not in a special relationship with Certicom because, at the relevant time, RIM was not "proposing" to make a take-over bid for, or enter into a merger or similar business combination with, Certicom, despite internal interest to this effect. The OSC held that there must be some significant level of involvement and approval of the process at the highest corporate levels for a special relationship to be found. As there was only one officer with meaningful involvement in the process, and his involvement was periodic and supervisory in nature, the OSC held that notwithstanding the considerable due diligence conducted by RIM, its interest in acquiring Certicom had not evolved into a proposal to do so.

The OSC also found that while RIM had a business relationship with Certicom due to licensing agreements, this was insufficient to establish a special relationship with Certicom. The OSC held that there must be a more clear connection between the business engaged in or proposed to be engaged in and the alleged material facts in order for their to be a special relationship.

What constitutes a material fact?

The determination of materiality for the purpose of insider trading is not a bright-line test, but a "common sense judgment" that must take into account the specific circumstances of each case. The OSC will apply an objective market impact test to determine materiality. Factors that might be considered in conducting this test include the nature of the information communicated, the volatility of the securities (the more volatile the securities, the more likely a fact will be held to be material), the size of the issuer and the nature of the issuer's operations. The OSC has determined that specifics with respect to a merger transaction may be material for the purposes of insider trading before disclosure of a material change is required.

In the Donald case, the OSC looked to whether Donald was in possession of a fact that, at the time he placed his order to purchase Certicom shares, would reasonably be expected to have had a significant effect on the market price or value of Certicom securities. Applying the factors above, the OSC held that if generally disclosed on the day following the dinner, the information that Donald learned would reasonably be expected to have a significant effect on the market price of Certicom securities and therefore constituted material facts.

The OSC also suggested that the importance placed on information may be important in determining materiality. That Donald purchased $300,000 worth of securities within hours of becoming aware of the facts is indicative of the facts' materiality.

Has the material fact been generally disclosed? A material fact will be considered generally disclosed if the information has been disseminated in a manner calculated to effectively reach the marketplace and public investors have been given a reasonable amount of time to analyze the information.

The facts communicated to Donald at the RIM golf event had not been generally disclosed and were based in part on confidential information provided to RIM by Certicom. The fact that some of the information disclosed was publically available was not sufficient for the facts to be considered generally disclosed.

The Public Interest Jurisdiction

The OSC has a broad based power to make orders in the public interest without necessarily finding contravention of the Act. In dealing with cases involving allegations of trading while in possession of undisclosed information, the OSC may find that the conduct was contrary to the public interest without finding there was a breach of a particular provision of Ontario securities law.

Donald was found to have engaged in conduct contrary to the public interest as he purchased shares of Certicom with knowledge of material facts that had not yet been generally disclosed. The OSC stated that market participants and the officers of public companies, such as Donald, are expected to adhere to a higher standard of behaviour. By purchasing securities with knowledge of material facts which had not been generally disclosed, Donald clearly failed to meet that standard and did so in a manner that impugned the integrity of Ontario's capital markets.

The Donald case is not the only recent instance of the OSC making an order pursuant to its public interest jurisdiction to extend the insider trading prohibition in response to insider trading allegations. In Re Suman 2, a decision released March 19, 2012, the OSC held that an employee of MDS Sciex acted in a manner contrary to the public interest when he purchased shares of Molecular Inc., a company MDS Sciex was planning to acquire, after learning of the planned acquisition through his employment as an IT technician. The employee did not breach the insider trading provisions of the Act as the company in question was not a "reporting issuer" under the definition in the Act. The OSC determined that the employee's trades were contrary to the public interest as they would have been illegal insider trades had Molecular been a reporting issuer.

Conclusion

The decision is a clear indication of the OSC's willingness to act against improper trading activities and its capacity to do so even when there has been no breach of the Act. This is especially true for market participants, who are expected to adhere to a higher standard of behaviour and should act with prudence and caution when in possession of undisclosed material facts. We encourage you to contact with any member of our Securities & Capital Markets Group for further information.

Footnotes

1 http://www.osc.gov.on.ca/documents/en/Proceedings-RAD/rad_20120801_donaldp.pdf

2 http://www.osc.gov.on.ca/documents/en/Proceedings-RAD/rad_20120319_suman_rahman.pdf

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