Good old-fashioned insider trading
By Jerome Veldsman
Finkelstein and others v Ontario Securities Commission, a judgment of the Court of Appeal for Ontario on 25 January 2018, dealt with insider trading under the Canadian Securities Act. The relevant provisions in the South African Financial Markets Act are substantially similar.
Prohibitions against insider trading affect both an “insider” (a director, employee, shareholder, professional advisor, and the like, of the relevant company) and a “tippee” (a person who knowingly receives the information directly or indirectly from an insider).
Masonite was a company listed on the Toronto Stock Exchange, and at the time trading at CAD 34 per share. A private equity firm was interested in acquiring all of Masonite’s shares, and Finkelstein was Masonite’s lead lawyer on the takeover. The parties agreed on an all-cash deal at CAD 40 per share, to be implemented immediately. This was obviously “inside information” (information that if it was made public would be likely to have a material effect on the price or value of a listed security).
Finkelstein promptly informed his good friend Azeff, an investment advisor. Azeff promptly informed his good friends Mr X, an accountant, and Bobrow, an investment advisor. Mr X promptly informed his good friend Miller, a senior investment advisor. Miller promptly informed a work colleague, Cheng, an investment advisor. All the tippees started to buy Masonite shares, for themselves, family, and clients.
The Ontario Securities Commission brought proceedings against Finkelstein, Azeff, Bobrow, Miller, and Cheng, but not Mr X. Perhaps Mr X cut a deal. All five were found guilty of insider trading and received substantial administrative penalties and trading bans.
All five appealed. Only Cheng’s appeal was successful. Only Miller appealed to the Court of Appeal, and the Ontario Securities Commission did likewise against Cheng’s successful initial appeal.
“The core of this appeal concerns …: were Miller and Cheng persons who learned of a material fact with respect to … Masonite, from any other person who was [an insider] and ought they reasonably to have known that the other person was a person in such a relationship?“
Simplified, Miller and Cheng argued that they were too far removed from the original source to be guilty. The argument failed:
‘A person who is “tipped”, and knows or ought to know that the source of the information is in a special relationship, also becomes a person in a special relationship … The same consequences apply down a chain of tipping to everyone who ought to know that the source of the information was a person in a special relationship.‘
A South African Court may well come to the same conclusion with regard to similar facts.
The Court of Appeal also explained the main reasons for the prohibition against insider trading:
|●||An important premise of securities law is that all investors and prospective investors ought to be given access to material information about securities so that prospective purchasers can value them accurately and make informed investment decisions.|
|●||Insider trading will undermine investor confidence in the capital markets. If prospective investors have reason to fear insiders will be free to trade on the basis of undisclosed information, they might refuse to purchase securities.|