Insider Trading and Tipping: Ontario Court of Appeal Helps Set Limits

On January 25, the Ontario Court of Appeal released its decision in Finkelstein v. Ontario Securities Commission, which considered—for the first time—the definition of "person in a special relationship with an issuer" as it applies to persons who receive material non-public information (MNPI) about an issuer from an insider, and then become subject to the securities law prohibitions against insider trading and tipping. The decision warns anyone trading in securities to make reasonable inquiries before using a tip or sharing MNPI.

The Prohibitions Against Insider Trading and Tipping

The Securities Act prohibits persons in a "special relationship" with an issuer from trading in the issuer's securities when they possess MNPI, and prohibits those persons from disclosing MNPI, or tipping. Certain categories of persons—like an issuer's officers, directors and advisors—are automatically captured by the insider trading and tipping prohibitions. The prohibitions also capture individuals who learn MNPI from someone that the individual knows or "ought reasonably to know" is in a special relationship with an issuer. This can capture not only those who get a tip directly from an insider, but also those who get a tip from a tippee. As National Policy 51-201 puts it, "[t]here is a potentially infinite chain of tippees", and MNPI "may be third or fourth hand and still be subject to the prohibitions" against insider trading and tipping. The Finkelstein decision establishes an approach to finding the outer limits to the chain of tippees.

Procedural History

In 2014, the Ontario Securities Commission (OSC) initiated proceedings against five individuals alleging breaches of the prohibition against insider trading and tipping. The OSC alleged the MNPI about the company had flowed through a chain of five people, starting with a lawyer (Finkelstein), who advised an investment advisor (Azeff), who in turn advised an accountant (L.K.), who then conveyed the information to another investment advisor (Miller), who passed the information to his associate (Cheng). Azeff had also conveyed the information separately to another investment advisor (Bobrow). The OSC commenced proceedings against each individual other than L.K., the accountant.

The OSC hearing panel found, among other things, each of the five individuals were in a special relationship with the company and had breached the prohibitions against insider tipping and trading. All five of the individuals appealed the OSC decisions. The Divisional Court only allowed Cheng's appeal, which was significant in that it suggested someone distance from the original source of the tip—in this case, four removed from the source—should be granted some benefit of the doubt. The OSC appealed the Divisional Court's reversal of its decision regarding Cheng, and Miller appealed the decision dismissing his appeal.

The Court of Appeal Decision

The issue for the Court of Appeal was how to assess whether an individual who has learned MNPI from another person "ought reasonably to know" the other individual is in a special relationship with the issuer. That is, when does the chain of tippees end?

The Court of Appeal endorsed the analysis applied by the OSC, which considered whether "a person standing in the shoes of the tippee would reasonably assume that the MNPI passed on to him originated with a knowledgeable person", based on consideration of, among other things:

• the relationship between the tipper and tippee;
• the professional qualifications of the tipper;
• the professional qualifications of the tippee (and, in particular, whether the tippee's profession puts the tippee in a position to know he or she cannot take advantage of confidential information, such that a higher standard is expected);
• the nature of the MNPI;
• the time between receipt of the MNPI and the trade;
• any intermediate steps taken by the tippee to verify the information prior to trading (including whether the absence of independent verification suggests a belief that the MNPI originated with a knowledgeable person);
• the trading history of the tippee in the particular issuer; and
• the significance of the trade at issue, considering the tippee's overall portfolio.

Takeaways from the Court of Appeal's Decision

Aside from clarifying the analysis applicable to the definition of a "person in a special relationship" as it relates to successive tippees, the Court of Appeal's decision serves as a warning to make reasonable inquiries before trading on a tip. If there is any doubt as to whether the information at issue is MNPI and originated from a person in a special relationship with the issuer, no use should be made of the information and it should be kept confidential.