When investment tips seem too good to be true

Easier access to market information helps you do your job. But there are rules that govern what kind of information you can use, and how.

Section 76 of Ontario’s Securities Act is clear on the rules around insider trading: investors who are insiders can’t trade on information about market-moving material changes that haven’t been announced by a publicly traded company, also known as a reporting issuer.

“If investors feel others have more information than they do, they’ll lose faith in markets,” says Jonathan Heymann, director of compliance and regulation at Wychcrest Compliance Services in Toronto.

Following a July 2016 amendment to the Act, insiders are considered tippers if they “recommend or encourage” others to trade on or leverage sensitive information, whether or not they’ve done so themselves. Acting on the information makes those other people insiders, and liable.

Prior to the change, the only ones liable were those who had a “special relationship” with companies and who traded on material, non-public information (MNPI — see definition) they had obtained.

Recent case law

A Court of Appeal for Ontario ruling earlier this year has made it easier to gather evidence and establish liability in insider trading cases in Ontario.

Finkelstein v Ontario Securities Commission (2018, ONCA 61) started with the OSC investigating and sanctioning five people (one mergers and acquisitions lawyer, Mitchell Finkelstein, and two pairs of bank advisors) whom the commission identified as being part of a chain that passed and traded on non-public information about multiple takeover transactions between 2004 and 2007.

Finkelstein didn’t make trades, but the OSC found he had tipped one advisor who spread the information to others, and so on. The commission said in its August 2015 Reasons and Decision on Sanctions and Costs document that, without Finkelstein’s misconduct, no insider trading would have occurred. He “was the instigator of significant consequences to market integrity and must bear responsibility,” it said.

All four advisors involved recommended the purchase of shares to “friends, family and/or clients,” the OSC found, and three made a combined profit of more than $80,000. In its March 2015 Reasons for Decision, the commission said that all four advisors acted contrary to the public interest, despite their claims that they did not receive MNPI.

The OSC’s sanctions included fines of between $200,000 and $750,000; bans on trading, registration and becoming officers or directors; and disgorgement of all profits. They were also ordered to pay administrative costs of $500,000 between them.

In 2016, all five respondents appealed the OSC’s decision. Only one, the junior investment advisor at the end of the chain, was successful. In January 2018, after further appeals on both sides in 2017, the Court of Appeal for Ontario upheld the OSC’s original 2015 findings, saying those findings “were reasonably supported by the record.”

The OSC had used circumstantial evidence—including email and phone records that linked the respondents, and related data that showed trading volumes and times. Still, the Court of Appeal for Ontario found the commission was reasonable in drawing “permissible inferences as to whether it was more likely than not that insider trading and tipping had occurred.”

The OSC has noted that a major hurdle for insider trading cases has been a lack of strong, direct evidence, leading to dependence on circumstantial evidence. The Finkelstein decision “strengthens our ability to bring actions against all involved in tipping cases,” the commission said in an emailed statement.

“Each time [regulators] have a court case, it sets more precedent and defines regulations in more detail,” says Heymann. “A big win [is] something they can use and point to; it gets a message out to markets and investors,” and can pave the way for more enforcement.

The OSC added in its email that it plans to “dedicate significant enforcement resources to uncover instances of illegal insider trading and tipping,” and “aggressively prosecute.”

How to protect yourself

If you receive information about a public company that seems like market-moving MNPI, be diligent—even if it’s from a trusted or unexpected source whom you wouldn’t expect to be an insider, says Gillian Dingle, a partner at Torys LLP in Toronto. If the information is available publicly, “then it’s not MNPI and you’re OK,” she says. However, you should also determine where the information came from by asking and researching your source.

Part of what sets the final Finkelstein verdict apart is the OSC was able to prove that Finkelstein and his advisor friend weren’t the only ones liable for sharing and using MNPI; people Finkelstein didn’t tip himself, and whom he didn’t know, were also liable because they were trading on his insider information.

As the commission said in 2015: “In a situation involving a successive tippee, it is quite probable that the tippee will not know the identity of the original tippee.” If the tippee is someone who should know market rules, like a financial advisor, they’re expected to analyze the information, how specific it is and how they received it.

If doubts remain, Dingle says, “The point for advisors is: Do you want to take that risk?”

If a client starts talking about a company out of the blue, especially if they’re typically uninterested in stock picking, “You have to ask questions,” Heymann says. You should also review and, if needed, update the client’s KYC forms to note their changed interest. Ensure you’re aware of where they work, their responsibilities, and to which companies they’re connected—and whether that’s changed.

Dingle notes that while KYC documents cover whether clients are officers or directors of companies whose shares are publicly traded, “there isn’t a requirement to capture that information about people the client may know.” As a result, contacting compliance or your legal department if you’re worried is “consistent with the advisor’s obligation to act as a gatekeeper,” she says, adding that many large dealers have anonymous code of conduct hotlines for those anxious about naming colleagues or clients.

Heymann says that doing so is a way for advisors “to protect themselves in case of any blowback.”

Firms must “have processes in place” to educate advisors on current rules and relevant case law, he says. “Regulators don’t always go into detail, so firms have to come up with communications and examples to illustrate the rules.”

Definitions

Material non-public information (MNPI): Defined as a fact “that would reasonably be expected to have a significant effect on the market price or value of the securities” in the Ontario Securities Act, and referred to as material non-public information (MNPI) in OSC’s 2015 decision documents against Finkelstein and the tipping chain he started. National Policy 51-201 on Disclosure Standards (NI 51-102), which is not law, says examples of such information can relate to the corporate or capital structure of a company, or its financial results, which have not been generally disclosed. Also, such facts can relate to acquisitions and dispositions.

A special relationship with an issuer: The act says that such a relationship exists when a person or company is “an insider, affiliate or associate of” an issuer, a person or company that’s entering into business with an issuer or offering any business or professional activities, or a high-level employee of an issuer. People can be deemed an insider if they:

• have learned of MNPI from someone with a special relationship, and
• “know or ought reasonably to have known” that the facts weren’t public.

Insider trading and tipping: Sharing sensitive, non-public information outside of the necessary course of business is tipping, says the act, while NI 51-102 says that insider trading happens when those in special relationships buy or sell securities in an issuer based on MNPI.