Canada: Securities Law, Social Media, And Disclosure

On July 3, 2012, the chief executive officer of Netflix Inc., Reed Hastings, did what many of us frequently do: He updated his Facebook account. However, he updated his account with a post stating that Netflix viewing ''exceeded 1 billion hours'' in the month of June 2012. This post was viewable by more than 200,000 Facebook users. Netflix Inc.'s shares rose 6.2 percent that day, the largest single-day gain in approximately six weeks.

Shortly thereafter, the U.S. Securities and Exchange Commission (''SEC'') sent Netflix Inc. and Hastings a ''Wells Notice'', a notice the SEC provides when it is of the opinion that sufficient wrongdoing has occurred to warrant civil claims. SEC regulation requires that material information must be made available to all investors simultaneously via an SEC filing, a press release, or other acceptable means. The SEC appears to be taking the position that the Facebook post provided material information, and that the Netflix Inc. CEO's Facebook account was not public.

It is evident that companies, directors, and officers are increasingly employing the use of social media as a means of communicating with investors, clients, and the public. While such a practice has the potential to create opportunities, those using social media for these purposes must be cognizant of a number of potential hazards imposed by securities regulation.

Among these is the potential to breach prospectus requirements while soliciting the sale of securities, the potential to ''tip'' individuals so that they trade with material undisclosed information, or the potential to breach timely disclosure obligations and restrictions. Breaching these obligations through social media is not only possible, but doing so can have significant consequences.

Advertising the Sale of Securities on Social Media

It is easy to imagine the opportunities created through using social media as a marketing tool. For companies considering raising small amounts of capital, it may represent a cost-effective method of advertising to a large number of people: Crowd funding through social media has become an increasingly used medium for aggregating funds in support of various initiatives. However, private companies should refrain from attempting to market securities through social media.

Consider the following cautionary tale of an attempt by a Canadian private company to use Facebook to sell securities without a prospectus. Kenneth Jakubowsky solicited investors through a Facebook advertisement to buy securities of Pumped Media Inc., of which he was the CEO and director. Specifically, Pumped Media Inc. advertised that it was offering up to 1 million common shares and suggested an anticipated return of 15 percent.

In front of the Alberta Securities Commission, Jakubowsky admitted to breaches of the Securities Act, RSA 2000 c. S-4. He breached Section 110 by advertising and soliciting investors to purchase securities without having filed a prospectus without an applicable prospectus exemption. He breached Section 92(4.1) by making statements that he knew or reasonably ought to have known were materially misleading or untrue and would reasonably be expected to have a significant effect on the market price or value of a security.

As a result of these breaches, the Alberta Securities Commission ordered Jakubowsky to cease trading in securities; to resign all positions he held as director and officer of any issuer; to refrain from acting in a management or consulting capacity with respect to the securities market for a period of three years; and to pay a fine of C$2,500 (U.S.$2,442) (Jakubowsky, Re, 2012 ABASC 540).

Jakubowsky's attempt to raise funds for his company resulted in disciplinary action that certainly harmed it.

Illegal Trading and Tipping

A further risk comes from the accidental dissemination of non-public material information. As evidenced by the CEO of Netflix and his short Facebook post, a small amount of very good (or very bad) information may have a significant effect on the share price of a publicly traded company.

How do we know what information is material? In Canada, materiality is determined objectively, based on the perspective of a reasonable investor. It must be substantially likely that the undisclosed fact would have been considered important by a reasonable investor making an investment decision. There must also be a substantial likelihood that the fact would have assumed actual significance in a reasonable investor's deliberations. Courts will balance these considerations in the facts and context that gives rise to the issue.

Who may possess material information? Securities legislation in Canada prohibits persons or companies in a ''special relationship'' with a reporting issuer from trading with material undisclosed information. This vast group includes insiders, affiliates, or associates of a reporting issuer, a person or company proposing a takeover bid with the reporting issuer or a person or company contemplating a material transaction with the reporting issuer. Notably, the definition includes any individual who has received or has access to information as to material facts or material changes before they are disclosed publicly.

''Illegal trading'' occurs when a person or a company in a special relationship with a corporation trades in shares of the corporation when that person or company is aware of material undisclosed information. ''Tipping'' occurs when a person who has received material undisclosed information provides that information to someone who then makes a trade based on that material information.

Consider the effect of these definitions on a scenario similar to that confronting the SEC described above. The CEO of Netflix Inc. is clearly in a special relationship with Netflix Inc. The information, being an indication of the rate of consumption of the company's product for the month of June 2012, had a material effect on the market. The primary issue appears to be whether the disclosure of this material information to 200,000 Facebook fans was public. If it is not, then the CEO of Netflix Inc. may have engaged in tipping.

Disclosure Standards

Canadian securities regulation provides guidance on the disclosure standards for information that may be material. When certain information is going to be disclosed, these standards often require the inclusion of certain statements and an explanation as to how the information was obtained. Some forms of disclosure may even be prohibited.

National Instrument 51-201: Disclosure Standards requires that someone in a special relationship considering disclosing forecast information is required to include forward looking statements, appropriate statements of risk and other cautionary language. This applies to the disclosure of expected revenues, net income, earnings per share, and research and development spending. As a result, a social media post disclosing net income, if it were public, would require the inclusion of a substantial amount of cautionary language — something not often at the top of one's mind when one is updating Facebook.

Certain oil and gas companies have heightened disclosure obligations under National Instrument 51 101: Standards of Disclosure for Oil and Gas Activities. The disclosure of material information relating to the oil and gas activities may allow disclosure only in a partial format or scope, or require the inclusion of cautionary statements. For example, disclosure concerning reserves must be made only in marketable quantities, and disclosure concerning natural gas must be made in respect of volumes that have been or are to be recovered prior to the point at which marketable gas is measured. If a reporting issuer makes a written disclosure of any reserves attributable to a particular property, a cautionary statement and further information is required to be included. Certain companies engaged in mineral projects also have heightened disclosure obligations under National Instrument 43-101: Standards of Disclosure for Mineral Projects. For example, an issuer is prohibited from disclosing the quantity, grade, or metal content of a deposit that has not been categorized. However, the potential quantity and grade may be disclosed in ranges if the disclosure includes statements regarding the conceptual nature of the disclosure and how the ranges were determined. An issuer is also prohibited from disclosing the result of an economic analysis that includes inferred mineral resources. A preliminary assessment that includes inferred mineral resources may be disclosed if the results are a material change or a material fact with respect to the issuer, a cautionary statement is included, and a statement indicating the basis for this assessment is included.

Tips for Businesses

The U.S. SEC has been much more proactive in managing the effect of new technologies on securities markets than have its Canadian counterparts. This is likely due, at least in part, to the size of the U.S. securities markets, which ensures the SEC is more frequently confronted with issues of technological innovation and disclosure.

As a result of the convergence in the policy rationale behind securities regulation between Canada and the United States, it is likely that the approach of Canadian securities regulators would mirror guidance provided by the SEC. As a result, it is prudent for Canadian companies to conduct themselves in a manner congruent with this SEC guidance while Canadian regulators remain silent.

In 2008, the SEC published Commission Guidance on the Use of Company Websites (Release Nos. 34-58288; IC–28351) (''Guidance''), which would likely apply to social media disclosure. This Guidance notes that ''[o]ngoing technological advances in electronic communications have increased both the markets' and investors' demand for more timely company disclosure and the ability of companies to capture, process and disseminate this information to market participants''.

The SEC clarifies that a company website could be considered public, stating:

Thus, in evaluating whether information is public for purposes of our guidance, companies must consider whether and when: (1) a company web site is a recognized channel of distribution, (2) posting of information on a company web site disseminates the information in a manner making it available to the securities marketplace in general, and (3) there has been a reasonable waiting period for investors and the market to react to the posted information.

It is likely that these criteria would be employed when determining whether social media is providing public information, which helps determine whether ''tipping'' is a potential issue. Knowing these principles helps guide measures Canadian companies can take to ensure they do not breach disclosure obligations.

The following list provides a number of tips businesses can follow to align themselves with the approach of the SEC:

  • Develop a social media policy that is cognizant of the disclosure obligations that apply to your company under securities regulation. Cross-reference this policy with any timely and continuous disclosure policy your company may already have. Ensure that individuals with access to material information are aware of these obligations.
  • Alert the market of any social media that may be used for disclosure purposes and invite investors and the market to use social media accounts as a means of staying abreast of your company's news. When determining whether information is disseminated to the public, the SEC will focus on the manner in which information is posted to social media and the timeliness and accessibility of such information to investors and the markets. Companies should consider doing the following:
    • let investors and markets know how the social media account works and how investors and markets should interpret social media information;
    • make investors and the markets aware that the business will or may post important information through social media. Ensure that this information is readily accessible; and
    • ensure that the social media is designed to lead investors and the market efficiently to information about the company, and ensure that the information is prominently disclosed in a format readily accessible to the public.

In determining whether the information is ''public'', securities regulators are likely to consider whether investors and the markets have been afforded a reasonable waiting period to react to the information. It may be prudent to:

  • make investors and the markets aware that the company uses social media as a source of important information; and
  • actively disseminate the information or the availability of the information posted through social media.

The Alberta Securities Commission's decision in Jakubowsky, Re, 2012 ABASC 540 can be accessed at http://www.albertasecurities.com/Enforcement/Enforcement%20Orders/JAKUBOWSKY%20Kenneth%20Edmund%20DEC%202012%2012%2021%204399369v1.pdf .

The U.S. SEC's Guidance on the Use of Company Websites is available at http://www.sec.gov/rules/interp/2007/34-58288fr.pdf .

Previously published in World Securities Law Report Vol. 19, No. 3, March 2013.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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