Illegal Insider Trading in the Information Age

Transcription

1 Insider Trading in the Information Age: Not Just a Public Company Issue FM Panelist: David Hausman Guest Panelist: Geoff Clarke, President, Byron Capital Markets Ltd. Toronto Fasken Martineau Symposium Wednesday, April 27, 2011 Stan Grmovsek This insider-trading scheme was a rare but high profile example of how greed can override good sense and the law for a couple of corporate lawyers (Stan Grmovsek & Gil Cornblum). Canada s 1st criminal conviction for illegal insider trading occurred on November 6, 2009 when Stan Grmovsek plead guilty to insider trading in violation of the Criminal Code. On January 7, 2010, he was sentenced to 39 months imprisonment. Section of the Criminal Code creates the offences of insider trading and tipping, punishable by a maximum prison term of 10 years. The distinction between the Criminal Code and the Securities Act (Ontario) offence of illegal insider trading is that the criminal offence imports a mens rea requirement that the individual knowingly used inside information, whereas in the Securities Act (Ontario) context the Crown or OSC is only required to prove that the person was in possession of inside information.

2 Illegal Insider Trading Securities Act (Ontario) Insider Trading: 76 (1) 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. (5) A person or company in a special relationship with a reporting issuer means [ ]: (a) a person [ ] that is an insider [ ] of [ ] the reporting issuer, [or is] a person or company that is proposing to make a take-over bid for the [...] securities of the reporting issuer [ ]; Illegal Insider Trading (b) a person or company that is engaging in or proposes to engage in any business or professional activity with or on behalf of the reporting issuer[...] (c) a person who is a director, officer or employee of[ ]a person or company described in[...]clause (b); or (d) a person or company that learned of the material fact or material change with respect to the reporting issuer while the person or company was a person or company described in the clause[...](c);

3 Definitions material fact means a fact that would reasonably be expected to have a significant effect on the market price or value of the securities material change means: (i) a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of any of the securities of the issuer, or (ii) a decision to implement a change referred to in subclause (i) made by the board of directors or other persons acting in a similar capacity or by senior management of the issuer who believe that confirmation of the decision by the board of directors or such other persons acting in a similar capacity is probable Definitions generally disclosed has been interpreted to mean that: (i) the information has been disseminated in a manner calculated to effectively reach the marketplace; and (ii) public investors have been given a reasonable amount of time to analyze the information

4 Definitions material facts material changes material information and if undisclosed, it s colloquially referred to as inside information Material Facts: - are required to be included in any prospectus Material Changes: - require the issuer to issue a press release and file a material change report Observations Regarding Illegal Insider Trading: inside information has to be both material and non-public the restrictions apply to any person or company in a special relationship with a reporting issuer and not just an insider liability for insider trading attaches when securities are purchased or sold (rather than traded, which is defined much more broadly) although a change is defined to mean a change in the business, operations or capital of the issuer, a fact, in and of itself, is not defined in the legislation

5 Observations Regarding Illegal Insider Trading: the test for the materiality of information is objective and is a market impact test, that is, information is considered to be material it significantly affects the market price or value of the securities or would reasonably be expected to do so it is not necessary to establish that the person or company in a special relationship with a reporting issuer actually made use of the information For the purpose of the illegal insider trading prohibition, a security of the reporting issuer shall be deemed to include: a put, call, option or other right or obligation to purchase or sell securities of the reporting issuer; or a security, the market price of which varies materially with the market price of the securities of the issuer. Observations Regarding Illegal Insider Trading: In a nutshell, a court must find that four constituent parts are present for a person to be found guilty of illegal insider trading under the Securities Act (Ontario) A court must find that: 1) the accused person is in a special relationship with the reporting issuer; 2) that such person purchased or sold securities of that reporting issuer; 3) while such person had knowledge of material information about the reporting issuer; and 4) where such material information has not been generally disclosed. (Farley J. in R. v. Plastic Engine Technology Corp. (1994), 88 C.C.C. (3d) 287 (Ont. Gen. Div.))

6 The Tipping Prohibition Securities Act (Ontario): 76(2) No reporting issuer and no person or company in a special relationship with a reporting 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 reporting issuer before the material fact or material change has been generally disclosed. The prohibition against tipping prohibits a person or company from disclosing non-public material information to anyone (other than in the necessary course of business ) before the information becomes generally disclosed The provision also catches tippees who further convey information they have received to others, therefore there is a potentially infinite chain of tippees who are caught by the prohibitions against tipping and insider trading. The Tipping Prohibition in the necessary course of business : Subsection 3.3(2) of NP provides that the necessary course of business exception would generally cover communications with: a) vendors, suppliers, or strategic partners on issues such as research and development, sales and marketing, and supply contracts; b) employees, officers, and board members; c) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors to the company; d) parties to negotiations; e) labour unions industry associations, government agencies and other regulators; and f) credit rating agencies (provided that the information is disclosed for the purpose of assisting the agency to formulate a credit rating and the agency's ratings generally are or will be publicly available).

7 The Tipping Prohibition Subsection 3.3(3) of NP provides that selective disclosure in connection with a private placement may be in the necessary course of business. However, the necessary course of business exception would not generally permit a company to make a selective disclosure of material information to a research analyst, institutional adviser or other market professional Exemptions To The Prohibition Against Illegal Insider Trading Exemptions are available when: 1) (a) the employee(s) of an investment dealer who participate in making the decision to purchase or sell the securities of the reporting issuer do not have actual knowledge of the undisclosed material fact or material change; and (b) no advice was given by any person or company who had actual knowledge of the undisclosed material fact or the material change; or 2) the purchase or sale was entered into as agent of another person or company pursuant to a either (a) a specific unsolicited order from that other person or company to purchase or sell or (b) a plan such as an automatic dividend reinvestment plan

8 Exemptions To The Prohibition Against Illegal Insider Trading In determining whether the exemptions are available, it is relevant whether and to what extent the investment dealer has implemented and maintained reasonable policies and procedures to prevent contraventions of the prohibition against insider trading by persons making or influencing investment decisions on its behalf and to prevent the transmission of undisclosed material facts or material changes contrary prohibition against tipping. Problems with Insider Trading Regime The statutory regime does not address all forms of problematic trading Special Relationship definition does not capture every person with an informational advantage In certain circumstances it can create liability for arguably non-problematic trading The OSC s public interest jurisdiction can be engaged to address circumstances where there is a mismatch between statutory liability and regulatory objectives

9 Blackout Policies Public issuers ought to adopt blackout policies to address improper trading These policies should establish safe margins to avoid the appearance of improper conduct Boards of Directors need to be prepared to address violations of blackout policies through independent investigation Inconvenience and cost of perpetual blackout periods can be addressed through Automatic Share Disposition Plans Chinese Walls Chinese Walls What are they? Components of a Chinese Wall Grey List Restricted List

10 Chinese Walls What are they? Also sometimes referred to as Ethical Walls Purpose: prevent prohibited insider trading and tipping How: education of employees policies and procedures to contain information policies and procedures to restrict transactions compliance monitoring and supervision Reasonable Policies And Procedures Chinese Walls = reasonable policies and procedures to prevent prohibited insider trading and tipping Chinese Walls include: education and training of employees policies and procedures to contain information separate office space (controlled access) separate files (hard and soft) separate fax and computer server space use of code names appropriate internal reporting

11 Reasonable Policies And Procedures policies and procedures to restrict transactions Grey List and Restricted List Compliance monitoring and supervision The Grey List A confidential list of names of issuers indicating that an individual at the dealer, who is within the Chinese Wall, has inside information regarding the issuer The Grey List is disseminated only to persons within the Chinese Wall infrastructure The Grey List is typically maintained and distributed by the Corporate Finance Department and the Compliance Department. It is the responsibility of those individuals within the Chinese Wall to self report the names of issuers who should be added or removed from the Grey List Trading activity is monitored by the Compliance Department Generally, no Research Dept., Trading Dept., or Sales Dept. restrictions will occur when an issuer s name is included on the Grey List

12 The Restricted List A list of names of issuers indicating either (i) that an individual at the dealer, who is NOT within the Chinese Wall, has inside information regarding the issuer; or (ii) that the investment dealer is closely involved with the issuer and the firm desires to restrict activities to ensure that there is the perception of a fair capital market (e.g. after an issue s prospectus has been filed but before the offering is fully completed) The Restricted List is disseminated to all staff The Restricted List is typically maintained and distributed by the Corporate Finance Department, Syndication Department and Compliance Department. It is the responsibility of all professionals at the investment dealer to report the names of issuers who should be added or removed from the Restricted List The Restricted List Trading activity is monitored by the Compliance Department Generally, all Research Dept. publications, Trading Dept. activities, or Sales Dept. activities (other than unsolicited orders) regarding the relevant issuer will cease when that issuer s name is included on the Restricted List

13 IIROC Member Regulation Notice MR0377 Guidelines for Confidential Information Containment IIROC s guidelines were prepared in 2005 by the IDA s Compliance and Legal Section and Market Regulation Services Inc. They are provided to assist IIROC Members in implementing, revising or reviewing the effectiveness of their procedures. IIROC recognizes that such procedures will vary from firm to firm depending on factors such as the nature of the firm s business, its size, clientele and the markets in which it conducts business. IIROC Member Regulation Notice MR0377 Guidelines for Confidential Information Containment The notice contains a list of red flags indicating possible insider trading for supervisors and compliance personnel to consider when reviewing account activity. IIROC Members should ensure that all their traders and IAs are aware of their Gatekeeper obligations (as per UMIR requirements) to report suspected insider trading violations to their respective compliance departments.

14 The Donnini Case In the OSC s 2002 Donnini case, lawyers for Piergiorgio Donnini (a trader at Yorkton Securities Inc.) argued that it was perfectly legitimate for a member of his firm s corporate finance department to say to Mr. Donnini: Look, I ve had some discussion with [the issuer], we re talking perhaps about another deal, what do you think the market would do? Would the market take it? Mr. Donnini s lawyer argued that that type of conversation goes on every day and suggested that the OSC should not prohibit that type of conversation because, he suggested, there was no other way for the investment banker to know how to proceed with a deal. The OSC rejected the suggestion that it is necessary for the efficient operation of the market to allow, without consequences which result in a limitation on the firm s trading ability (e.g. adding the issuer s name to the Restricted List), conversations about potential deals as depicted by Mr. Donnini s legal counsel. The Donnini Case The OSC recognized that it is quite often that people in corporate finance departments of investment dealers will talk to people in the trading department to ascertain market tone with respect to an issuer. However, the OSC stated that reputable firms have Chinese or Ethical Walls and other procedures and take steps to prevent confidential inside information from flowing to those who trade. The OSC also noted that, in some cases, the necessity for obtaining market information may require an investment firm to bring someone over the wall so that the firm can obtain key market advice on the receptivity of a proposed transaction. When that happens, the person brought over the wall obtains confidential inside information and is thereby precluded from trading in the issuer s securities until public disclosure and other procedures have been satisfied.

15 The Donnini Case Investment dealers have Chinese Wall policies and procedures to prevent information flowing to traders, salesmen and others for at least two reasons. First, the law requires it. The second reason is one of legitimate selfinterest. Investment dealers do not want their staff to be frozen out of normal trading activity by being contaminated with insider knowledge, because, under the law and especially the regulation that applies to insider trading, the investment dealer itself will be deemed to have the knowledge that its employees have and the exemption provided by the regulation would not be available. For these reasons, investment dealers should strictly follow and maintain its policies and procedures regarding its Chinese Walls and the use of the Grey List and the Restricted List. Questions & Answers