In its recent decision regarding allegations of insider trading against Kwok Yuen Ho, the former Chairman and CEO of ATI Technologies Inc. ("ATI") and his wife, Betty Ho, the Ontario Securities Commission ruled on several important issues in the context of an insider trading case. Mr. Ho was represented by a team of lawyers from FMC, led by J.L. McDougall, Q.C., and both he and Mrs. Ho were exonerated by the Commission of any wrongdoing.1
Issues Before The Commission
The Commission, in its Reasons, addressed four critical issues:
1. the standard of proof to be applied in the context of an insider trading case before the Commission;
2. the extent to which hearsay evidence will be relied upon by the Commission in reaching a decision on the merits of a case;
3. whether, at the time Mr. Ho and Mrs. Ho disposed of their shares, it was a material fact that ATI would suffer a shortfall in forecasted revenue and earnings and whether they had knowledge of that fact when they disposed of their shares; and
4. whether a charitable donation is a "sale" falling within the ambit of subsection 76(1) of the Securities Act.
Background And The Allegations Against Mr. And Mrs. Ho
On May 24, 2000, ATI issued a press release announcing that it would not meet its forecasted revenue and earnings in its third quarter of 2000. Shortly thereafter, the price of ATI shares fell more than 50%.
Almost a full month prior to the issuance of the press release, between April 26 and April 28, 2000, Mr. Ho donated a number of ATI shares to charitable institutions. Between April 24 and May 2, 2000, Mrs. Ho sold a number of her own ATI shares. OSC Staff ("Staff") alleged that, in contravention of subsection 76(1) of the Securities Act2, Mr. and Mrs. Ho "traded" their ATI shares while they were in a special relationship with ATI and while they had knowledge of a material fact about ATI that had not been generally disclosed. Subsection 76(1) reads as follows:
No person or company in a special relationship with a reporting issuer shall purchase or sell securities of the reporting issuer with the knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed.
Staff alleged that the material fact was that "ATI would fall short of its forecasted revenue and earnings for Q3 2000." In addition, Staff formulated the allegations so as to link the donations of Mr. Ho with the sales of Mrs. Ho, alleging that they both traded the total amount of shares gifted and sold.
1. The Standard Of Proof
In reaching its decision, the Commission applied a standard of "clear and convincing proof based on cogent evidence" in considering whether a breach had occurred. This approach is consistent with prior case law which has held that where a respondent’s ability to carry on professional practice or continue as a registrant under the Securities Act is in jeopardy as a result of the allegations made against him or her, there is a heightened burden within the civil standard of the balance of probabilities that must be met in order to find that an administrative offence has been committed.
In its decision, the Commission emphasized that in the context of a "serious complaint" against a person, the appropriate standard of proof to be applied, and the nature of the evidence required to meet that standard, are integral to the duty of an administrative tribunal to provide a fair hearing. The Commission went on to state that where adverse findings will have "serious consequences" for a respondent, reliable and persuasive evidence is required as a matter of fundamental fairness in order for Staff to discharge its burden of proof.
2. Hearsay Evidence
In the course of presenting its case, Staff chose to introduce a number of documents, primarily emails sent and received by executives at ATI in the course of ATI’s fiscal year 2000. These documents were introduced into evidence through Staff’s principal investigator in the case. Staff did not call as witnesses the authors and recipients of those documents with the result that Staff’s case was based almost entirely on documentary hearsay evidence. Staff asked the Commission to draw inferences from the documents.
While the Commission accepted that an administrative tribunal may exercise its discretion and admit hearsay evidence, pursuant to section 15 of the Statutory Powers Procedure Act3, the exercise of that discretion must take into account the nature of the complaint and the rights of the respondent, especially where the allegations are serious and contentious. In doing so, the Commission recognized that the "mere allegation of insider trading can have significant adverse repercussions for a respondent" and that the admission of hearsay evidence might, in some cases, give rise to a denial of natural justice and fundamental fairness. The Commission concluded that the hearsay evidence adduced by Staff merited little weight given Staff’s failure to call the authors of the documents to explain the content of the documents and the facts they relied upon in preparing them. The Commission found that Staff’s failure to do so compromised the ability of the respondents to test the evidence through cross-examination.
3. At The Time Of The Disposition Of Shares, Did A Material Fact Exist?
Staff alleged that the material fact known to Mr. and Mrs. Ho was that ATI "would" fall short of forecasted revenue and earnings for Q3 2000. This material fact was made public with the issuance of the press release by ATI on May 24, 2000. The issue under consideration, therefore, was whether, during the period from April 24 to May 2, 2000 when Mr. Ho gifted his shares to charity and Mrs. Ho sold a portion of her ATI holdings, it was an established fact that ATI would fall short of its forecasted revenue and earnings.
To prove its case that ATI "would" fall short of its forecasted revenue and earnings, Staff relied primarily upon the emails of ATI executives that expressed a pessimistic outlook of ATI’s ability to meet its forecasts. In response to this evidence, witnesses were called on behalf of Mr. Ho, some of whom had authored the emails, to provide context and evidence as to the nature of the industry in which ATI operated and the factors that affected ATI’s operations and sales. The direct evidence of these witnesses, and of Mr. Ho, was found to be credible by the Commission. In the result, the Commission concluded that at the time Mr. and Mrs. Ho disposed of their shares, the material fact in issue did not yet exist.
Knowledge Of The Material Fact
Notwithstanding the finding by the Commission that the alleged material fact did not exist during the period in which the respondents disposed of their shares, the Commission considered whether Mr. and Mrs. Ho had "actual knowledge" of that fact. The Commission emphasized that a contravention of subsection 76(1) of the Securities Act requires that the respondents have actual or "subjective" knowledge of a material fact.
This finding was significant in the context of the hearing where Staff had submitted that actual knowledge of a material fact was not a prerequisite to a finding that subsection 76(1) had been contravened. Rather, Staff argued that a violation of subsection 76(1) occurred where a person conducts a trade and "ought to have known" of the existence of a material fact, or was reckless or wilfully blind to the existence of a material fact. Staff went further in its closing written submissions, arguing that Mr. Ho "would have known" that there was "some probability" that ATI would fall short of its forecasted revenue and earnings. With respect to Mrs. Ho, Staff alleged that the Commission should draw the inference that she traded her shares on the advice of her husband with the intention of applying the tax credit received from his donations and avoiding the capital gains tax incurred on the sale of her shares.
The Commission noted that Staff’s allegations were "significantly at variance" with the original allegations levied against the respondents and that Staff is prohibited from changing the allegations without first seeking an order of the Commission permitting such an amendment. The Commission further found that Staff failed to demonstrate that Mrs. Ho sold her shares on the advice of Mr. Ho, or that Mrs. Ho was in a special relationship with ATI, a required element of section 76(1). In doing so, the Commission implicitly rejected the attempt by Staff to link the donations of Mr. Ho to the trades of Mrs. Ho. The Commission concluded that Staff failed to establish that the respondents knew of a material fact at the time they disposed of their shares.
4. Whether A Gift Constitutes A Trade
The Commission also considered whether the gifting of shares to a charity constituted a sale of securities within the meaning of subsection 76(1) of the Act which prohibits a person or company in a special relationship with reporting issuers from selling securities with knowledge of an undisclosed material fact or change.
Staff asserted that the tax savings received by the donor in such circumstances make the donation of shares a sale for the purposes of subsection 76(1). However, the Commission noted that Staff failed to adduce any direct evidence that Mr. Ho realized any tax savings. The Commission determined that where a gift is made "in good faith and without pretence or subterfuge" it will not be considered a sale for the purposes of an insider trading offence. In addition, the Commission referred to OSC Policy 57-602, which applies where there is an application to vary a cease trade order to permit a party to establish a tax loss. The Policy provides that if the disposition of shares is by way of gift, the Commission will take the view that it is not a trade within the meaning of the Securities Act. Ultimately, the Commission found that the gifts were made in good faith as each gift was made to a significant charity and had been the subject of prior planning by Mr. Ho.
The decision of the Commission is likely to have more general application beyond the limited scope of insider trading offences. In particular, where serious allegations are made against a respondent which, if accepted, may result in severe sanctions, Staff will be expected to satisfy the heightened evidentiary standard of clear and convincing proof based on cogent evidence. This standard, in most cases, would not be met through hearsay evidence alone. Direct, reliable and persuasive evidence proving the allegations will be required. Further, given the fundamental principle of fairness in the administrative law context, Staff is likely to be limited in attempts to deviate during the course of a hearing from allegations made against a respondent at the outset of a hearing. The stricter evidentiary standard to which Staff was held in this case appropriately reflected the seriousness of the allegations against the respondents and the severity of the consequences of an adverse decision by the Commission.
1 Mr. Ho was also represented by Mr. Randall Bennett, a partner with Reuter Scargall Bennett LLP.
2 R.S.O. 1990, c. S.5.
3 R.S.O. 1990, c. S.22.
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