Case places onus of proof on the issuer, not the regulator
Businesses run on the exchange of information – non-material and material information – and a recent Capital Markets Tribunal decision involving insider trading has delivered some additional clarity about what information can and can’t be shared.
“There have been a whole bunch of cases about what constitutes material information…The idea on the tipping side, never mind the trading side, that somebody who is in a special relationship with a reporting issuer can’t communicate [information] to a third party is also something that has received some attention because, in an insider trading cases, the inside traders are not always insiders, but are people who get information from insiders,” says Neill May, a partner at Goodmans specializing in securities law.
“What has not received attention is one very important element of the tipping prohibition – [where] tipping is the act of communicating non-public information – that is the prohibition that says you cannot communicate material information other than in the necessary course of business…
“People speak to their lawyers. They speak to their accountants. They speak to their lenders. They speak to their sources of equity capital. They speak to ratings agencies. They speak to all kinds of people as a part of the necessary course of business (NCOB). That exception is relied on every minute of every day. That exception has never, in my awareness, been considered by the regulator. And [this case] is a decision of the Ontario Securities Commission that considers in some detail that exception, which is critical to the way business is conducted for publicly traded issuers every minute of every day.”
In Kraft (Re), 2023 ONCMT 36, Michael Paul Kraft was the chair and a director of the cannabis company WeedMD Inc. Michael Brian Stein was Kraft’s long-time friend and business associate. Kraft gave Stein material non-public information (MNPI) regarding WeedMD’s expansion plans on two separate occasions, contravening s. 76(2) of The Securities Act. After receiving the MNPI from Kraft, Stein purchased 45,000 WeedMD shares, contravening s. 76(1). Stein sold those shares after the public announcement of a deal related to the expansion plans, resulting in a profit of $29,345.
Kraft argued that the disclosure to Stein was made in the necessary course of business, but the tribunal disagreed and said Kraft couldn’t rely on that rule in part because the tribunal was able to prove three conditions:
- the tipper informed the other party of a material fact or material change about an issuer;
- at the time the material information was communicated, the material fact or material change had not been generally disclosed, and
- the tipper was in a special relationship with the issuer.
The tribunal’s decision explains: “Subsection 76(2) also requires that for there to be a contravention, the impugned communication must have been [other than in the necessary course of business’….[W]e conclude that if Staff proves the three elements listed above, the onus shifts to the respondent to show that the communication was in the necessary course of business. If the respondent does not succeed in proving that, the contravention is established.”
According to May, this decision has several significant takeaways, and one of the key ones is about the onus of proof. As is stated in the decision, “Staff and Kraft agreed that there do not appear to be any prior decisions directly considering or applying the ‘necessary course of business’ provision.” Kraft and Stein were friends. They didn’t have a formal business agreement, let alone a non-disclosure agreement.
“This case establishes – and this is important – that the onus of proving that the exception, that the necessary course of business exception is available – is on the party, not on the regulator… That is something that was not settled,” explains May.
Another critical element of this decision involves how an NCOB exception is determined – whether it is an objective test rather than a subjective/objective test, which is how Kraft viewed it.
“[Kraft’s legal counsel] argued that an executive in the position of Mr. Kraft is making decisions all the time and can’t be at legal risk for a subjective determination that he makes in the discharge of his obligations – a subjective determination that is reasonable in the circumstances. But the regulator did not accept that and concluded that the standard is objective – that not only is the burden of proof on the party, but the party needs to demonstrate that on objective terms, that the communication was in the necessary course of business,” says May emphasizing that the regulator said, “necessary doesn’t mean ordinary.”
While this is an Ontario tribunal, the ruling will likely influence the law across the country. Noting that provincial insider trading prohibitions are “virtually identical,” May points to National Policy: NP - 51- 201 - Disclosure Standards and says that they are non-binding standards but that since the principles apply nationally, “it’s reasonable to expect that the implications of this decision will extend beyond Ontario’s borders.”
May believes this decision should assist lawyers in advising their clients and says that corporate securities lawyers can “point to a decision and say, ‘See, all this stuff about which I’ve been cautioning you to formalize and regularize your sharing of information is serious. Here’s a guide on how to do it. And here’s a decision where the principals show you how to properly do this. When to do it or when not to do it has now been determined,’” he explains.
“It's a process. There are hurdles to overcome, but they are manageable hurdles that are handled every day.”