One of the more fun legal stories making the rounds is about the alleged insider trading at Capital One Financial Corp. Well, fun to think about and write about if you're someone like me, probably not so fun if you're, you know, Bonan Huang and Nan Huang who were actually charged by the Securities and Exchange Commission with the offense.
And what, exactly, does the SEC's lawsuit allege that Mr. Huang and Mr. Huang did? Bloomberg View's Matt Levine does a typically excellent job of describing and analyzing what they did from an American perspective, but the details are essentially this:
The suit alleges that the two defendants, both of whom are based in Virginia, were employees of Capital One who would use their spare time to search Capital One's internal databases to see how many people were using their Capital One cards at various businesses (the complaint centres around trading shares in Chipotle Mexican Grill Inc.). If they discovered that lots of people were using the Capital One cards at a particular business, they would buy options in that company's shares; if they discovered that purchases were declining, they would short sell the shares.
The end result? An approximate three-year return of 1,819 per cent. Not bad at all.
As I said, there's lots of interesting stuff in here. Mr. Levine points out that two Capital One employees were basically running the world's most successful research driven hedge fund out of their customer support desks. That's crazy, and you can read about that elsewhere (like in the linked Bloomberg article). What's interesting from our perspective is that this is a great example of how Canadian and American insider trading rules approach the same problem in two different ways and yet reach the same result.
The kind of conduct that the defendants engaged in is not insider trading in the classic sense. It didn't involve a hot tip from someone in Chipotle's upper management who slipped them a note in their burritos. Instead, the SEC is relying on what's known as the misappropriation theory of insider information. The misappropriation theory requires that the trades took place in breach of a duty owed to the source of the information. In this case, the defendants owed a duty of trust and confidence to Capital One not to use Capital One's information about credit cards to, you know, buy stock on their own account. And they breached that duty by trading on the information. This is textbook misappropriation theory; easy marks on your first year corporations exam.
But what if the impugned conduct had taken place in Canada? In Canada, we don't have a misappropriation theory – our insider trading rules are based upon the concept of a "special relationship" which is defined in our securities acts. And this is why a conviction against the defendants would be a step more complicated in Canada (to my good friend who works in legal at Capital One – don't get any ideas).
That's because neither of the defendants had a special relationship with Chipotle.
Neither defendant is an insider or affiliate of Chipotle; neither is engaging in business or professional activity with Chipotle; and neither of them learned of Chipotle's sales data from Chipotle – the information came from Capital One's database, and Capital One likely got the data from a payment processor. and it's the payment processors have the relationship with Chipotle. Therefore, the only way to find that the defendants engaged in insider trading under Canadian law is to find someone in a special relationship with Chipotle who supplied the information to the defendants, who the defendants knew was in a special relationship with Chipotle.
In this case, there is a special relationship between Chipotle and the credit card payment processors, who supply each other with confidential information as part of their business. Capital One has a contract with those payment processors and knows that Chipotle and the processors are in a special relationship with each other. And, most likely, the defendants know or should know about that relationship between the processors and Chipotle, and they got the data from Capital One, who also know about the duty.
We've seen this kind of argument before; there is a long chain of liability in the soon-to-be-decided Mitchell Finkelstein insider trading case, far away from the initial tip. But the Capital One circumstance is different: it's not brokers tipping brokers, it's information being conveyed between organizations through contracts and intranets. In a sense, this is an easier case to prove – it's simple to show that the defendants accessed permitted data and then traded on it – but it's also a more abstract one.
Although we haven't seen many, if any, situations in Canada where individuals accused of insider trading did so by breaching a series of special relationships between companies created out of contracts. And yet, despite different theories of insider trading, Canadian and American laws end up coming to the same conclusion.
American law, however, reaches its conclusion more directly through the misappropriation theory. Canadian law requires a number of steps to get to the same place. In other words, even where legal regimes reach the same result, the way to get there can be very different. The conduct doesn't change, but the description of the conduct does, and description determines how the law evaluates conduct.
This is an important thing – law is description, and legal compliance is about navigating description, and two laws describing the same thing can describe the same thing in two different ways. But if you're reading this article to find out whether you can copy the defendants' trading strategy in Canada and get away with it, here's some legal advice I'm comfortable giving: don't.
Adrian Myers is a lawyer at Torkin Manes LLP.