The July 8 2014 acquittal of Rengam Rajaratnam in New York District Court ended a long streak of insider trading convictions in that jurisdiction. In Canada, such cases tend not to be brought in courts where the standard of proof is reasonable doubt, but before Securities Commission tribunals where the burden is the lesser standard of balance of probabilities. Despite the lesser burden of proof, respondents in Canada (Alberta in particular) have often enjoyed more successful outcomes than their American counterparts. For example, the recent decision Re Hagerty (2014 ABASC 237) marks the latest of several setbacks for the enforcement arm of the Alberta Securities Commission ("ASC") in insider trading and tipping cases. BLG represented both respondents in the below case involving Provident Energy trading and one of the respondents in the case involving Berens Energy.
A common thread emerging from these cases is that no matter how coincidental, odd or suspicious a trade may appear at first blush, ASC tribunals will scrutinize the evidence thoroughly to determine whether there is a plausible non-nefarious explanation for the trade. While the burden is only balance of probabilities ASC staff ("Staff") must still prove their allegations on clear and convincing evidence, not speculation.
ASC tribunals require Staff to clearly establish that the respondent's explanation of how they came to undertake the impugned trade is less plausible than the theory advanced by Staff. In the recent spate of Alberta cases, the trades in question understandably drew the attention of the Staff investigators (who routinely scrutinize all trading in the period leading up to important announcements) as can be seen below:
- In Hagerty, Mr. Gary Hagerty purchased $50,000 worth of Provident Energy stock very shortly after his wife Sherry – a senior employee of Pembina Pipeline Corp. – was informed by in-house counsel that Pembina might be acquiring Provident;
- In Re Keith, the wife of one senior employee of Berens Energy and the brother of another each purchased Berens stock shortly before a public announcement that Berens was being acquired by PetroBakken Energy (now, Lightstream Resources Ltd.). In the brother's case, the trade was particularly noteworthy in that he liquidated his portfolio in order to buy Berens;
- In Re Somji, the brother-in-law of Matrikon Inc.'s CEO bought Matrikon stock immediately after a phone call between his wife and the CEO (her brother), shortly before a takeover of Matrikon by Honeywell Corporation was publicly announced. The CEO was alleged to have tipped his sister during the call and the brother-in-law was alleged to have bought stock on the tipped information. The brother-in-law entered into a settlement agreement with ASC Staff acknowledging that it had been improper for him to have traded based on what he had learned from the call (although the agreement did not specify exactly what was said). Nonetheless at the CEO's hearing the tribunal concluded that Staff had failed to prove that he had illegally passed on inside information during the call;
- In Re Stan, various insiders and a spouse sold stock of Grand Cache Coal not long before unfavorable financial results were publicly announced.
In each of those cases, the circumstances were such that Staff decided to investigate the trades and, after having done so, make allegations of impropriety; but the ASC tribunals dismissed the allegations in each instance, begging the question of whether the allegations should have been pursued.
Undoubtedly, one factor behind the dismissals is that illegal insider trading findings carry an enormous stigma and therefore tribunals will scrutinize the evidence very thoroughly before making findings of impropriety. Findings of illegal trading will have not just a significant financial impact (investigation costs and repayment of about double the profit or avoided loss) but also cause loss of reputation, reduced or lost employment prospects and a prohibition from serving as a director or officer of companies. Mindful of that, tribunals weigh the evidence, including the respondents' explanations, vigilantly to determine if the allegations have been convincingly proved.
The law is very clear that illegal insider trading and tipping may be proved based only on circumstantial evidence, as long as it is sufficiently convincing. In tipping cases, seldom will the parties admit or will Staff be able to unequivocally prove that tipping occurred, since tips are normally verbal and both parties are liable to deny that one tipped the other. Similarly in cases where employees' trades of company stock seem suspiciously convenient, the employees may well say that they were not privy to the information and Staff may not be able to directly prove otherwise (for example, employees or others may learn hot news by overhearing it, seeing something on a desk or in the fax machine, reading someone else's email and any variety of other surreptitious means.) Therefore, if the timing of a trade by such an employee or an alleged tippee is simply too coincidental, or if the trade is implausibly out of character in terms of amount, sector or risk; or if they conduct themselves suspiciously beforehand or afterward; if they have no plausible explanation of why they decided to buy or sell the stock at that particular time; any or all of those things may enable a tribunal to conclude that the circumstantial evidence is sufficiently convincing to merit a finding of illegality.
The law requires that various elements be proved in insider trading and tipping cases. In particular, Section 147 of the Securities Act (Alberta) essentially declares it illegal to trade or tip with knowledge of a material undisclosed fact or change. Motivation is generally irrelevant to the legality of a trade: a person who, for example, sells a certain amount of their company stock every year on the same day (for example to pay taxes, pay down the mortgage or take an annual vacation) is nonetheless prohibited from trading if one year they happen to have undisclosed material information at the time of the intended trade. They cannot go through with the sell, notwithstanding that the trade was pre-planned and that the information was not the motivation for the sale. However, the key in every case is that, to be prohibited from trading or passing it on, the information has to rise to the level of a material fact or change that has not been generally disclosed. After all, every insider and employee of a public company knows things about their company that the public does not. However, they are only under a statutory prohibition if what they know is material, which means that if publicly known the information would be reasonably likely to have a significant effect on the stock price. So, knowledge that someone in accounting is quitting or some other minor news is not material, and one can trade with that knowledge. Conversely, knowledge of an upcoming merger or major contract is material, and no one who knew about it could trade or pass that news on to others until it was generally disclosed. (Paranthetically, this is why public companies typically have strict trading policies requiring that trades by employees be pre-approved.)
IN THAT CONTEXT, WHY WERE THE ALLEGATIONS DISMISSED IN THE KEITH, HAGERTY, STAN AND SOMJI CASES?
In Keith, Staff did not prove the two senior Berens employees who were alleged to have tipped the wife and brother respectively even knew themselves that Petrobakken was purchasing Berens. They were senior employees, but the transaction was kept closely under wraps inside Berens and Staff could not establish that they knew about the takeover prior to the public announcement. Obviously they could not have tipped anyone else to something they did not know. Nonetheless, it looked odd that the two relatives happened to buy Berens stock shortly prior to the announcement, one of whom made a very significant investment. Had the trades by the wife and brother been so implausible to allow for any other reasonable explanation but that they had to have been tipped, the tribunal could have concluded from that circumstantial evidence that the two senior employees had to have known in advance, and then passed the news on. However, both the wife and the brother testified at the Hearing and presented credible explanations as to why they happened to buy Berens shares at such a fortuitous time. Allan McCue had followed the company closely due to his brother being employed there, was quite familiar with the energy sector generally and was not averse to making sudden significant investments. The tribunal found his explanation to be more plausible than Staff's theory that his brother had learned about the transaction and then illegally passed that news to Allan.
In Hagerty, email evidence definitively showed that the husband had in fact decided to buy Provident stock shortly before his wife was informed of Pembina's possible acquisition of Provident. Staff theorized, though, that the trade was simply too fortuitous and that Mrs. Hagerty must have somehow learned about the transaction the day before she was officially informed, and then passed the news to her husband. However, there was no reasonable evidence that she learned about the transaction the day before, or how she could have; again the news was kept tightly under wraps and no indication as to how she may have found out about it. The Panel concluded that even if she had made some "perspicacious speculations" based on an accumulation of public and non-public information that may have come to her attention, that did not amount to knowledge of a material fact. It would be at most an abstract speculation, well short of the legal standard of materiality.
In Stan, the panel concluded that the financial, production and sales information that the Grand Cache insiders had at the time they sold their stock, while not positive, was not material given the vagaries of the industry and Grand Cache's particular business model and history. Therefore the insiders were entitled to trade with the information.
In Somji, it was clear that the CEO's brother-in-law bought Matrikon stock based on something the CEO told his sister during their phone call. The brother-in-law even acknowledged in his settlement agreement that it was improper for him to have traded based on what he learned from the call, whatever it was. In his testimony, however, the CEO steadfastly denied he had provided material information to his sister during the call and testified that he was very well aware that it would have been improper to do so. He was considered a plausible and honest witness. The tribunal concluded that while he may have conveyed to his sister a feeling that good things might be happening at the company, an "abstract expectation" of positive tidings was not the same as tipping a material fact and therefore not prohibited. Accordingly, the tipping allegation against the CEO was dismissed.
In each case the timing of the trades understandably aroused the concerns of the investigators, which underscores the fact that employees and their relatives should be exceedingly careful about buying or selling stock of the issuer. However, in each of the cases the respondents were able to refute the surface appearance of suspicious trading with a plausible non-nefarious explanation. These cases have provided valuable guidance to the public and to securities regulators about the level of proof required to constitute illegal trading and tipping.
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.
