Illegal insider trading is hard to prove in Canada. Despite its apparent ubiquity – a 2010 study finds that 63 per cent of target companies show aberrant trading patterns in their shares prior to the announcement of a takeover – insider trading convictions are hard to come by in Canada. Even adjusting for market size, the U.S. prosecutes 17 times more insider trading cases than Canada.
Just this summer, securities regulators have failed in a number of high profile prosecutions, including the prosecution of Jowdat Waheed and Bruce Walter with respect to the takeover of Baffinland Iron Mines Corp (an acquittal I supported). If this summer wasn't bad enough for securities regulators trying to prosecute illegal insider trading, the Alberta Court of Appeals (ACA), in Walton v. Alberta (Securities Commission), may have just made illegal insider trading much more difficult to prosecute. Indeed, it's almost a shame that this case came down so late in the year. It seems to greatly expand the scope of the conversations you can have with your financially connected relatives at family barbecues or on the golf course.
The story of illegal insider trading in the shares of Eveready Income Fund Inc. revolves around one John Herbert "Bert" Holtby, a director of Eveready. During the winter and spring of 2009, the Alberta Securities Commission's staff alleged that Mr. Holtby told a small circle of friends, family and acquaintances that Eveready was going to be taken over by Clean Harbors Inc. causing them to trade in Eveready's securities. If proven, this would straightforwardly meet the definition of insider trading, which requires that a person in a special relationship (like a director) with a company passes on a material fact (like a pending takeover) to a third party, about a company that has not been generally disclosed (like a pending takeover). In Alberta, there is a provision that allows for a person in a "special relationship" who encourages someone to buy their company's shares to face liability, but the liability does not extend to the person they "encourage."
The charges read like a greatest hits of insider trading charges. Mr. Holtby was charged with telling his golfing buddy about the deal on a golf course. He was charged with tipping his downtrodden brother, who had recently received an inheritance and therefore investment capital for the first time, who was then charged with giving his friend the information at a barbecue so that the friend could help him invest. Mr. Holtby was also charged with tipping his financial advisor and accountant, and the accountant was charged with passing along the information internally. On the strength of a plea deal, the ASC's staff was able to get the financial advisor to admit that he was tipped by Mr. Holtby.
This admission, combined with circumstantial evidence against the others, was enough for the ASC panel to find that Mr. Holtby did tip the others, that he "encouraged" his golf buddy to trade, and that the other parties involved traded on the information. Any champagne bottles popped came too early, however. The ACA overturned nearly every finding it could and, where it couldn't – due to the financial advisor's admission that he was tipped – it set aside the sanctions and remitted the issue, including a $1.7-million administrative penalty against Mr. Holtby, back to the ASC for further consideration.
On a first pass, this is very surprising. Canadian administrative law requires that courts give securities commissions a high degree of deference in their rulings. While administrative tribunals are sometimes reviewed on a "correctness" standard, specialized tribunals interpreting the statute they were created to interpret, like a securities commission interpreting a securities act, who provide written reasons when making a ruling, will be reviewed under a standard of "reasonableness."
for a court to overrule the ASC's decision, it must find that it was not reasonable for the court to find that it was more likely than not that Mr. Holtby was engaged in illegal insider trading. But that's what the ACA did.
In its analysis, the ACA suggests that insider trading accusations are particularly serious, and need to be reviewed "on the balance of probabilities by clear and cogent evidence." While clear and cogent evidence is always necessary for a conviction, the ACA seems to use the requirement to raise the ASC's burden of proof to something beyond the typical civil standard.
Using this as an analytical fulcrum, the ACA goes on to find that the ASC staff failed to provide such evidence for why the parties involved happened to coincidentally buy Eveready stock during the relevant period. For example, where the ASC found that Bert Holtby likely tipped his brother to the merger during a visit to his brother in California, prompting the brother to request that a more financially savvy friend by the shares for him, the ACA found that the timing of this purchase was more likely a fortuitous coincidence. This, despite the friend also buying shares on his own account and paying back the brother the amount invested on his behalf through a series of small payments.
While this doesn't seem to me to be an unreasonable conclusion for the ACA to reach, the contrary conclusion doesn't seem to be an unreasonable one for the ASC to have reached, either.
Since most provincial securities acts don't contain an "encouragement" provision like Alberta, a knowing wink on the golf course likely won't trip insider trading laws. Winks and nods are not "material facts," and frankly, it's amazing that anyone ever discloses a material fact through any means other than quick taps of the nose.
While the ACA's decision in Eveready doesn't articulate a new burden of proof, it does appear to fortify the ASC's burden with stronger evidentiary requirements, and it does appear to subject to ASC's decision to more a more searching analysis than a mere reasonableness standard. This is fine if you think that insider trading prosecutions should be very hard to prove. It's less fine if you think that illegal insider trading is harmful to our capital markets.
Either way, the ACA's decision has likely made it a lot easier to swap stock tips during long summer days. I expect Canada's golf courses to be crowded earlier than ever next year.