Canada: The Challenge With Determining When The Writing Is On The Wall: Insider Trading Case Considers Materiality Of Confidentiality Agreement And Expired Unsolicited Offer

The British Columbia Securities Commission (BCSC) recently considered whether a consultant for a law firm had committed insider trading and breached the public interest when she traded a client's shares with knowledge of undisclosed facts.

In Weiqing Jane Jin, 2014 BCSECCOM 194, there was no question that the consultant was in a special relationship with the issuer client and had traded while in possession of facts that had not been disclosed.  The materiality of these facts was contested.

Confidentiality Agreement Was Not a Material Fact

The BCSC determined that it was not a material fact that the client had entered into a Confidentiality Agreement with a Chinese company interested in acquiring the client and/or its main asset. In other words, a reasonable investor would not expect this fact to have a significant effect on the market price or value of the client's shares. The BCSC accepted fact evidence (from the lawyer who had been supervising the consultant) that entering into confidentiality agreements is a "normal course" event for companies in the client's circumstances (a junior mining company), and found it compelling that the Confidentiality Agreement did not bind the parties to transact.

The BCSC determined that it was not a material fact that the Confidentiality Agreement had been amended to include a no shop provision and to allow the Chinese company the opportunity to respond to a binding third party offer. The BCSC found that these exclusivity rights were "very limited". The client remained "free to consider, negotiate, and enter into transactions relating to unsolicited offers," and the right granted to the Chinese company to make a competing offer conveyed rights that it already had.

Unsolicited Offer Was a Material Fact

The BCSC determined that the consultant had committed insider trading by trading with knowledge of an unsolicited take-over offer that the client had received.

The BCSC rejected the argument that the unsolicited offer was not a material fact because it was not binding. The BCSC found that "it was clear" from the offer that the bidder "was ready, willing, and able to acquire" the client company because:

  • Pricing and transaction structure were specified;
  • The offer was not conditional on securing financing;
  • Confirmatory due diligence was not required; and
  • The bidder was prepared to invest considerable resources in any negotiations and analysis required to complete a transaction as soon as possible.

The BCSC also rejected the argument that the unsolicited offer was not a material fact because it had expired before the consultant traded in the client's shares. The BCSC determined that the offer was "highly indicative" of the bidder's intention to go hostile if its offer was not accepted. Since the consultant believed this when she traded, the unsolicited offer did not cease being a material fact after its expiry.

Takeaways

  1. The materiality of commercial negotiations will often turn on how advanced the negotiations are. In Weiqing, "it was clear" from the offer that the bidder was "ready, willing, and able to acquire" the client company. Contrast this with Agrium Inc. v. Hamilton, [2005] A.J. No. 83 (Q.B.), a civil case where insider trading was not found because the defendant was only aware that potential acquirors had expressed interest in the target, but was not aware of the price being offered. Determining when the writing is on the wall is a matter of subjective judgment, which is not easy to apply as illustrated by the number of contested hearings dealing with material disclosure issues.
  2. Enforcement Staff may aggressively pursue a novel theory of materiality that is ultimately rejected at a contested hearing. In AIT Advanced Information Technologies Corp., Re (2008) 31 O.S.C.B. 712, it was alleged that a non-binding Letter of Intent for a potential acquisition was a material change even though the price therein was subject to due diligence (unlike the offer in Weiqing), and the potential acquiror's approval of the proposed transaction was subject to significant internal review (unlike in Weiqing , where the bidder wanted to complete a transaction "as soon as possible"). Although these allegations were dismissed by the Ontario Securities Commission (OSC), cases like AiT demonstrate Staff's willingness to commence enforcement proceedings in circumstances where the materiality of the fact is less certain than it was in Weiqing.
  3. For expediency and certainty, respondents facing insider trading allegations may contemplate settling allegations that could be contested. The AiT proceedings demonstrate the false pragmatism of respondents who settle too early. In AiT, two respondents — the issuer and its CEO — agreed to contravening securities laws, and paid legal costs and fines. The third respondent, the  company's lawyer, successfully contested the allegations. The OSC subsequently revoked its order approving the settlement agreements for the company and its CEO, acknowledging that the CEO "has suffered personal and financial consequences" and that "[i]t is one of those things that happens".
  4. Regulators are continuing to rely on the public interest jurisdiction as a failsafe when prosecuting insider trading allegations. Although the BCSC dismissed the public interest allegations in Weiqing because they were not sufficiently particularized, we previously discussed how the OSC has been relying on its discretionary public interest power to make enforcement orders in circumstances where no actual breach of securities laws has been proven and no egregious violation of recognized conduct standards is necessarily involved. A securities regulator could find that facts analogous to Weiqing amount to a breach of the public interest if the allegations were more specific.
  5. Insider trading allegations, by themselves, can be career-ending. Respondents contesting such allegations face serious reputational and financial costs even if they ultimately prevail after a contested hearing. For instance, in Stan (RE), 2013 ABASC 148, the respondents' "vindication" occurred 4 years after the relevant facts, and only after the respondents' "non-suit" motion failed, thereby forcing them to endure a costly 14-day contested proceeding where the respondents, various officers of the issuer, and 3 experts testified.

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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