Canada: Outsiders On The Inside: A Cross-Border Insider Trading Case Study

It's not the typical insider trading story: a COO in the U.S. begins selling his retail company's sale and return reports of smartphones to an investment research analyst, but after one particular piece of information is released, a major smartphone manufacturer's stock drops more than seven percent in one day. That COO later ends up facing criminal fraud charges and incarceration for his actions. This is not what most people think of as insider trading, but what would happen if the COO had done the same thing on this side of the border? Is this a cautionary tale only applicable for U.S insiders and outsiders or should Canadians also be taking notice?

U.S. v Dunham: A Case Study

Dunham was the Chief Operating Officer of a Wireless Franchisor, which operates more than 400 franchise outlets that sell the services of a Major Wireless Provider. Along with the services of the Major Wireless Provider, the Wireless Franchisor also sold smartphones and other devices from multiple smartphone manufacturers, including a Major Smartphone Manufacturer. Both the Major Wireless Provider and the Major Smartphone Manufacturer are publicly traded companies. As a result of his position, Dunham had access to non-public material information about the Major Wireless Provider and the Major Smartphone Manufacturer, which included product sale and return reports. In May 2010, Dunham reached an agreement with an investment research analyst to provide real time information of the sales and returns that occurred in exchange for $2,000 a month. This non-public information was then circulated to various clients of the analyst's firm.

In April 2013 the Major Smartphone Manufacturer released its new smartphones which were largely considered to be crucial to the company's continuing financial success. When the analyst requested information about the smartphone's sale performance, Dunham informed him that some of the stores were seeing more returns than sales. The analyst then published this information and on that same day the share price of the Major Smartphone Manufacturer dropped more than seven percent.

Insider Trading Regimes: Canada And The United States

Insider trading has always been a focus for securities regulators in both Canada and the U.S. The use of material undisclosed or non-public information creates an informational advantage that flies in the face of securities regulators' emphasis on full disclosure and an informed market.

In the United States, there is not an express statutory prohibition on insider trading. Instead, actions are usually brought under the Securities Exchange Act of 1934's Rule 10b-5 general antifraud provisions. Due to the Rule 10b-5's fraud requirement, the emphasis in U.S. insider trading cases tends to be on misappropriation and fraudulent use of material non-public information, but with no clear context being given by regulators or the court on how far down the chain of information this fraud can extend.

In comparison, section 76(1) of the Securities Act of Ontario states that no person or company in a special relationship with an issuer shall purchase or sell securities with the knowledge of a material fact or change regarding that issuer that has not been generally disclosed. Section 76(2) of the Securities Act also stipulates that no issuer and no person or company in a special relationship with an issuer shall inform, other than in the necessary course of business, another person or company of a material fact or change with respect to an issuer that has not been generally disclosed (generally known as the "tipping" prohibition).

The definition of a person or company in a special relationship with the issuer has remained very broad. It includes not only people who are easily understood as insiders (i.e. directors and officers), but it also includes outsiders who are considered "insiders" for the purposes of the insider trading prohibitions (think of it as follows "special relationship" = (insiders) + (outsiders who are or become "insiders")). For example, even if a person receives material information as an insider, but then subsequently leaves that position, that person remains in a special relationship with the issuer or remains an "insider" essentially until the information has been generally disclosed or is no longer material. In addition, beyond directors and officers of the issuer itself, a person or company in a special relationship with an issuer includes an insider of a person or company who is considering making a take-over bid or considering becoming a party to a merger with the issuer (a "transaction person"); a person or company that is engaging or considering engaging in any business or professional activity with the issuer (a "business activity person"); a person who is a director, officer, or employee of a "transaction person" or a "business activity person"; and a person or company that learns a material fact or material change about an issuer from any other person described above who they knew or ought to have known were in a special relationship with the issuer.

Dunham In The Canadian Context

In the U.S., Dunham was eventually charged with criminal fraud by wire. Although the prosecution chose to pursue charges under the general U.S. wire fraud provision as opposed to Rule 10b-5's antifraud provisions in connection with the purchase and sale of securities, the prosecution still focused largely on the proprietary interest in the material information itself and how Dunham lacked the right to use that information. The prosecution referenced how Dunham "sold confidential business information, stolen from his employer" and how the information was "highly confidential to the Wireless Franchisor, as well as to the Wireless Franchisor's business partners".

Special Relationship

The approach to Dunham's entire case appears at first to contrast with the Canadian regime. The main focus for insider trading in Canada is the emphasis on defining the person's relationship to the issuer. Section 76 is designed to capture not only those persons who work for the issuer, but also those individuals who work for different companies that may gain material information with respect to the issuer through consideration of a transaction involving the issuer or during the course of a business or professional activity. Consequently, in Canada Dunham would likely have been considered to be in a special relationship with the issuer (i.e. the Major Smartphone Manufacturer) on the basis that he was an officer of a company that was engaged in a business activity with the issuer.


The second step of the analysis in Canada involves the application of the tipping prohibition. Under section 76(2), Dunham, as a person in a special relationship with the issuer would have been prohibited from informing, other than in the necessary course of business, another person or company of a material fact or change with respect to the issuer that has not been generally disclosed.

As polite and as accommodating as we Canadians may be, and as different as our insider trading regime may be, in this case at least the U.S. and Canadian regimes would likely both result in consequences for Dunham.

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