Canada: Selective Disclosure In The "Necessary Course Of Business": New Guidance From Ontario's Capital Markets Tribunal

In Kraft (Re), 2023 ONCMT 36 ("Kraft"), a recent decision of Ontario's Capital Markets Tribunal (the "Tribunal"), the panel considered the meaning of the "necessary course of business" ("NCOB") exception to the general prohibition against the selective disclosure of material non-public information ("MNPI"). As such, Kraft provides significant and long-awaited guidance on the circumstances in which disclosure may be made under this tipping exception.

Prohibition against Tipping

Subsection 76(2) of the Securities Act (Ontario) (the "Act") provides 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 material change with respect to the issuer before the material fact or material change has been generally disclosed.

The Act does not define "NCOB", and the only source of interpretive guidance has been National Policy 51-201 Disclosure Standards ("NP 51-201"), which was first published in 2002. NP 51-201 suggests that the NCOB exception exists to ensure that a company's ordinary business activities are not unduly interfered with. It also lists the types of recipients to whom communications might be viewed as having been made in the NCOB.

Insights from Kraft

Background

WeedMD Inc., now named Entourage Health Corp. ("WeedMD"), is a reporting issuer on the TSX Venture Exchange that produces and distributes cannabis and cannabis extracts. In 2017, it sought to expand its business in connection with the Canadian government's proposal to legalize the recreational use of cannabis products. WeedMD's plans included a lease to rent space in Perfect Pick Farms Ltd.'s ("Perfect Pick's") greenhouse and an option to purchase Perfect Pick's property, greenhouse and infrastructure (collectively, the "Perfect Pick Transaction"). WeedMD believed that the Perfect Pick Transaction would increase its annual production of cannabis from 1,200 kg to more than 21,000 kg, initially, and to more than 50,000 kg, following its exercise of the option.

On October 23, 2017, the Chairman and a director of WeedMD at the time ("MK") provided a long-time friend and business associate ("MS") with draft documents relating to the Perfect Pick Transaction. While MS provided comments on the draft lease, he was neither formally retained nor compensated to review the documents. MK claimed that he had sought MS's advice on the draft lease as MS was his "go-to advisor" for real estate and financial matters.

On November 21, 2017, the day before the Perfect Pick Transaction was announced, MS purchased 45,000 shares of WeedMD for C$68,525. MS proceeded to sell his shares over the following two days for C$97,870, representing a return of approximately 43% on his investment.

While there were several issues for determination, a submission central to MK's argument before the Tribunal was that his selective disclosure to MS had been made in the NCOB. Applying the principles discussed below, the Tribunal found that MK had provided MS with MNPI in breach of the prohibition against tipping and that MS had traded shares of WeedMD while in possession of MNPI in breach of the prohibition against insider trading.

Key findings

The Tribunal emphasized that a primary purpose of the prohibition against tipping is to ensure that everyone in the market has equal access to and opportunity to act upon material information. In the Tribunal's view, the NCOB exception to the prohibition must be interpreted and applied reasonably narrowly such that the purposes of the Act and rationale for the prohibition are not undermined. To this end, Kraft offers the following guidance:

• Focus on "necessary": the inclusion of the word "necessary" in the language of the exception elevates the requirement beyond a mere business purpose or rationale and imports a level of importance, including that something is "essential", "indispensable" or "requisite." The Tribunal observed that the purpose of the selective disclosure must be sufficiently important or necessary to the business to warrant an exception to the blanket prohibition against selective disclosure;
• Meaning of "business": the word "business" in the language of the exception is not qualified by the phrase "the issuer's." While this was not explored as a result of the facts in Kraft, the Tribunal indicated that the exception may not be limited to a consideration of what may be in the necessary course of the issuer's business in all factual situations;
• Objective standard: the exception is to be established on an objective basis and does not rest on any subjective belief of a tipper;
• Burden of proof: the person seeking to rely on the exception bears the burden of establishing that the communication was made in the NCOB; and
• Evidence of forethought: evidence of the tipping prohibition and the exception being considered prior to the selective disclosure of MNPI may prove helpful in establishing the purpose for which the disclosure was made after the fact. Such evidence may include but is not limited to: (i) discussions at the board or management level considering the advisability or need for the disclosure; (ii) documents such as retainer agreements, minutes, memoranda or other communications specifying the purpose of the disclosure; and (iii) confidentiality agreements with or confidentiality instructions provided to the intended recipient of the disclosure.

Kraft also clarifies that, although NP 51-201 provides helpful guidance, the NCOB exception must be established on the relevant facts. Demonstrating that selective disclosure was made to a recipient contemplated in NP 51-201 is not the end of the enquiry.

As part of its analysis, the Tribunal acknowledged certain other non-exhaustive factors that may also be important to a consideration of whether selective disclosure satisfies the NCOB exception. These include the:

• business of the issuer;
• relationship between the tipper and the issuer;
• relationship between the tipper and the tippee;
• nature of the MNPI that was disclosed;
• relevance of the MNPI to the relationship between the tippee and the issuer;
• tipper's reason for making selective disclosure to the tippee; and
• credibility of the tipper seeking to establish the NCOB exception.

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.