Edited by David Di Paolo
The offences of illegal insider trading and tipping are established in provincial securities legislation. The subject is an increasing focus of enforcement in all Canadian jurisdictions. The area is important to brokers in connection with both their personal trading and their gatekeeper duties. As an example, IIROC recently scheduled a hearing for November 9, 2009 in Vancouver alleging that an RR should not have accepted orders when he knew his client was likely in possession of material undisclosed information.
There are several recent decisions or settlements that do not fit the classic mold of an insider who has traded with a deliberate intent to benefit from inside knowledge.
An intent to benefit from inside knowledge is not a required element of the offence. The offence of illegal insider trading is committed when a person in a special relationship (which includes a business relationship) trades with knowledge of a material fact or change that has not yet been generally disclosed. In other words, as long as one has knowledge of undisclosed material information at the time of trading, the offence is committed, even if that knowledge is not what motivated the trade.
In a recent Alberta Securities Commission (ASC) settlement, an officer of an issuer sold securities in accordance with a pre-existing, pre-disclosed financial plan to generate funds to pay down debt. In accordance with his standing intention, he sold some of his securities shortly after a blackout was lifted. He and some other senior management had by then become aware that product sales under a new corporate initiative were less than hoped. Since the officer had traded with knowledge of what was later considered by the ASC to have been material information, this was insider trading even though the officer had sold his shares without understanding he had done anything of an objectionable nature. His awareness of the disappointing sales played no role in his decision to sell the stock. The ASC acknowledged in the settlement agreement that the offence had been purely unintentional but nonetheless the officer agreed to pay a penalty and investigative costs as it was an offence nonetheless.
In another recent ASC settlement, an oil and gas research analyst acknowledged that he had disclosed material information of an issuer before it had been generally disclosed. He did not personally trade the stock or benefit personally and never had any intention to benefit from the information. The analyst had learned from a telephone conversation with the issuer's CEO that first quarter production would be lower, and debt higher, than expected. The analyst did not think this was material at the time. He incorporated this information into a spreadsheet, which in turn was sent to the trading desk and then to a client of the firm. He too agreed in his settlement that he had contravened the Securities Act.
In both instances, the individuals lacked any culpable intent and did not appreciate that the information in their possession was material. The lesson is that insiders-and those who obtain information from insiders – must be extremely careful about disclosing information or trading stock. The most prudent approach for insiders is not to trade (even if there is no blackout) if they are in any doubt whatsoever about whether or not they might have material undisclosed information or, at the very least, to be extremely diligent about confirming that the information they possess is not material, for example checking with the disclosure committee, legal counsel or a senior officer.
Liability Of Firm For Unauthorized Acts Of Brokers
It is hard to quibble with the long-established legal principle that employers are liable for the mistakes and misdeeds of employees who are acting in the course and scope of their employment. If a crane operator dumps a load of concrete on a passerby, it is only fair that the victim can pursue the operator's employer, not just the operator himself. This doctrine of "vicarious liability" is commonly applied in the brokerage industry as well, so that firms are liable to clients for the negligence of its brokers for unsuitable or unauthorized trading or other breaches of duty.
It is also hard to quibble with the notion that employers should not be liable for the acts of employees if the acts are totally unconnected with the employment. If our crane operator ran over a pedestrian on his way home from work, then obviously the employer would not be liable (assuming the operator was not driving the crane!).
There is a gray area, however, when an employee's actions are outside the scope of his duties, but are nonetheless somewhat connected to his or her employment. In the brokerage context, two recent Alberta cases attributed vicarious liability to the brokerage for investor losses that occurred outside of the usual scope of the broker-client relationship. In neither case was the investor even a client of the brokerage, but the courts found a sufficient connection with the brokerage to justify a finding of vicarious liability in both instances.
In Northey-Taylor v. Casey & Wolverton Securities Ltd., the court imposed liability on the brokerage for acts of the broker that were "unauthorized, but so connected with authorized acts but they may be regarded as modes of doing an authorized act". The Alberta Court of Appeal recently upheld the trial judgment. Although the transaction was an unbrokered private placement, the investor claimed he thought the placement was being brokered through Wolverton because some meetings and discussions relating to the investment occurred at Wolverton's office and the investor dealt to some extent with Wolverton's broker, Casey. Casey himself thought Wolverton was sponsoring the placement although in fact it was not. Wolverton defended on the basis that Casey was acting as an agent of the issuer, not as an employee of Wolverton. The subscription agreement was directly with the issuer, not through Wolverton, and the investor even pursued the issuer to a court judgment before turning to Casey and Wolverton for relief. The investor was a financial planner and considered himself to be a sophisticated investor, but nonetheless the court determined that both the broker and the brokerage were liable for the entirety of the investment after it failed.
In MacLise v. Union Securities Ltd., et al, the investor - an astute real estate investor – was, similarly, introduced to an unbrokered private placement by her broker, who knew almost nothing about either the issuer or the placement. Union had nothing whatsoever to do with the financing, but a presentation by the issuer to the investor occurred in its offices and was attended by both the broker and a representative of Union's corporate finance department.
The investor testified that she had thought she was dealing with Union, even though the subscription agreement was directly with the issuer, her cheque was made directly to the issuer and she was told that her deal was with the issuer. In addition, she dealt extensively directly with the issuer in undertaking her own due diligence. Again, the Alberta Court of Queens Bench found both the broker and the corporate finance representative responsible for the loss of the failed investment due to the extent of their participation. The Court also found that Union was vicariously liable for the acts of its two employees because, even though this was an unauthorized off-book private placement, the transaction was connected to Union due to the involvement of its employees, the use of its offices and the fact that private placements are the sort of business that brokerages do. This case is currently under appeal.
If a broker or brokerage is for some reason making an introduction to an unbrokered private placement, then, at the very least, they should have the potential investor sign a written acknowledgment to the effect that it is an unbrokered transaction and that the brokerage accepts no responsibility for the transaction or anything associated with it. Such a document would alert the investor to the true relationship between the parties. Brokerages should also be very alert concerning the use of their premises and the involvement of their brokers in non-firm matters since invariably the sympathy will go to the injured investor when investments go sour.
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.