On March 24, 2015, a panel (the “Panel“) of the Ontario Securities Commission (“OSC”) found that former Toronto securities lawyer, Mitchell Finkelstein, and four investment advisers breached the illegal insider trading and tipping provisions of the Securities Act (Ontario) (the “Act“). The decision is significant as it provides a framework for assessing circumstantial evidence in insider trading and tipping cases, including a test to determine whether or not the circumstantial evidence may be relied on by a panel to draw inferences from the facts of the case. The decision also relies on a two-part test for determining when a person who receives undisclosed material information ought to have known that the information originated from a person in a special relationship to the issuer, which is often a key element needed to establish an insider tipping offence. This test was applied to the facts of the case, which included successive tippees who did not know the original source of the information. The Panel also concluded that investment advisors and other registrants must make inquiries in an effort to determine the source of any material undisclosed information, even if it may be just a rumour.
Allegations and Decision
OSC staff alleged that between 2004 and 2007 Finkelstein was privy to certain material undisclosed information relating to proposed take-over bid transactions involving public companies. Finkelstein, while a lawyer at a large Bay Street firm, either learned of the undisclosed information in his communications with clients or by accessing documents prepared by other lawyers at his firm. OSC staff alleged that Finkelstein disclosed the details of the transactions to his long time friend Paul Azeff, a Montreal based investment advisor, who then further disclosed the details of the transactions to his associate Korin Bobrow, both of whom were advisers at CIBC. OSC staff alleged that Azeff and Bobrow acted on the material undisclosed information provided by Finkelstein and purchased shares worth millions of dollars. OSC staff further alleged that Azeff and Bobrow disclosed the information to some of their close friends and contacts who, in turn, tipped Toronto investment advisors Howard Miller and Man Kin Cheng, both of whom purchased a significant number of shares in the target companies.
The Panel found that with respect to three out of six alleged transactions, on a balance of probabilities and based on “clear, convincing and cogent” evidence, Finkelstein contravened the tipping prohibition in the Act. The Panel also found that Azeff and Bobrow engaged in illegal insider trading in one out of six alleged transactions and acted contrary to the public interest by recommending the purchase of shares of the target companies while possessing material undisclosed information in three out of six alleged transactions. Miller and Cheng were also found to have engaged in illegal insider trading in one out of six alleged transactions, and were found to have acted contrary to the public interest by recommending the purchase of shares of the target companies while possessing material undisclosed information in one out of six alleged transactions.
Reliance on Circumstantial Evidence
In rendering its decision, the Panel relied heavily on circumstantial evidence. The Panel noted that insider trading and tipping cases are typically established with circumstantial evidence that leads to an inference that it is more likely than not that the alleged breach occurred. The Panel confirmed that circumstantial evidence must be “firmly established” in order to draw proper inferences that flow “naturally and logically” from the established facts of the case and cannot be made where they are unreasonable or illogical. The Panel provided a non-exhaustive list of circumstantial evidence that can be used as indicia of insider trading and tipping: (i) unusual trading patterns; (ii) a timely transaction in a stock shortly before a significant public announcement; (iii) a first time purchase of the stock; (iv) an abnormal concentration of trading by one brokerage firm or with one or a few brokers; and (v) a trade that represents a very significant percentage of a particular portfolio.
The Panel had access to phone records, emails, trading data and details regarding the personal relationships of the respondents which did not directly reveal a “smoking gun” proving the allegations against them but were used to draw inferences to support the OSC staff’s allegations of illegal insider trading and tipping. OSC staff led evidence relating to when Finkelstein came into contact with the material undisclosed information, phone calls to Azeff on a regular basis, phone calls and emails from Azeff to Bobrow and other tippees, finally culminating in the purchase of shares in issuers that Finkelstein had initially tipped to Azeff. In examining the evidence, the Panel determined that, on a balance of probabilities, there was “no other reasonable explanation” than to conclude that Finkelstein had tipped Azeff who had, in turn, tipped others. The Panel’s considerable reliance on circumstantial evidence may create more favourable conditions and flexibility for OSC staff when compiling evidence for future insider trading and tipping proceedings before the OSC.
Lack of Motive
Part of Finkelstein’s defence centred on his lack of motive for committing the alleged breaches of securities laws. Finkelstein was a successful lawyer with significant income, and it was illogical to presume that he would put that all at risk in order to provide tips to his friend Azeff. The Panel concluded that “absence of motive is not a determinative factor in favour of no tipping having occurred.”
Interpretation of “Special Relationship”
In order to have breached the insider trading and tipping prohibitions under the Act, a tippee must have known or “ought to have known” that the undisclosed material information used to purchase securities originated (directly or indirectly) by someone in a special relationship to the issuer. The definition of “special relationship” is intentionally broad to cover the directors and officers of the issuer and also those engaged in a transaction or a professional service with the issuer, such as lawyers.
To determine if a tippee “ought to have known”, the Panel articulated a two part test. First, an “information connection” must be established. To do this, there must be confirmation that the tippee actually had possession of undisclosed material information by comparing what the tippee knew with the information available in the public domain. Second, a “person connection” must be established by examining whether the tippee would reasonably assume that the material undisclosed information was originated by someone in a special relationship with the issuer. To make this determination, the Panel considered the following factors:
- What is the relationship between the tipper and the tippee? Are they close friends? Do they have a professional relationship? Does the tippee know of the trading patterns of the tipper, successes and failures?
- What is the professional qualification and standing of the tipper? Is he/she a lawyer, businessperson, accountant, banker, investment advisor? Does the tipper have a position which puts him in a milieu where transactions are discussed?
- What is the professional qualification of the tippee? Is he/she an investment advisor, investment banker, lawyer, businessperson, accountant, etc.? Does his/her profession or position put him/her in a position to know he/she cannot take advantage of confidential information and therefore a higher standard of alertness is expected of him/her than from a member of the general public?
- How detailed and specific is the material undisclosed information? Is it general such as X Co. is “in play”? Or is it more detailed in that the information includes that a takeover is occurring and/or information about price, structure and timing?
- How long after he/she receives the information does he/she trade? Does a very short period of time give rise to the inference that the information is more likely to have originated from someone in a special relationship?
- What intermediate steps before trading does the tippee take, if any, to verify the information received? Does the absence of any independent verification suggest a belief on the part of the tippee that the information originated with someone in a special relationship?
- Has the tippee ever owned the particular stock before?
- Was the trade a significant one given the size of his/her portfolio?
The Panel found that some of the indirect successive tippees (who were informed by other tippees) did not know the original source of the undisclosed material information. In determining whether those tippees ought to reasonably have known that the information came from a special relationship person, the Panel considered, among other factors, that the information was detailed and very specific. If the information received was more general, such as the target company is “in play,” it could result from a rumour in the market, and a rumour is not a proscribed activity. The Panel concluded that even where a registrant receives information that could be a rumour, he/she should make inquiries as to the source of the information from the tipper.
It is also noteworthy that the Panel used the OSC’s public interest jurisdiction to find that a recommendation made by an investment advisor or dealer tippee to his/her clients is contrary to the public interest. Under the Act, making a recommendation is outside of the scope of the definition of the tipping offence which is limited to “informing” while in possession of material undisclosed information. However, it appears that the OSC can utilize its public interest jurisdiction to prosecute objectionable trading activity that does not neatly fit in a prescribed prohibition under the Act.