Defences to Insider Trading / Tipping – Securities Regulation

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  1. “Make Use of Defence – no longer applicable
  • Used to be a defence in Canada saying that you had info, but didn’t MAKE USE OF IT (I would have bought it anyways)

o E.g. Martha Stewart ^ knew it, but made decision to trade before I knew this (found guilty of lying about insider trading, not guilty OF Insider trading)

  • Made it impossible to convict anyone or find them liable for insider trading (to prove that they USED that knowledge to buy the securities, not just that they bought it)

o People in securities market not happy ^ can’t have an efficient market if you have such severe consequences and a broad rule

o In response to that: created another defence under OSA- now only requires that person “has knowledge” of a material fact that has not been disclosed (although Crim Code insider trading provision, s.182.1, requires that accused sold sec “knowingly using insider info” – therefore, may hamper effectiveness of provision)

  1. “Protecting Integrity of the Info” (s.175 of Regs)

If you take all reasonable precautions to protect integrity of info and someone else trades, not guilty (only if reckless)

  • Under agency law: partner is deemed to know what partners now (when in reality, you don’t)

o Thus, if you take all reasonable precautions to protect integrity of that information and someone else trades, not guilty, but if you’re reckless and they’re still not sure, rather take $ from you than investor

o Policy considerations to protect shareholders

Rule:

  • If you’re a person in a special relationship, you buy/sell securities with knowledge of material change/fact that hasn’t been generally disclosed, you’re NOT guilty of insider trading if ALL of the following conditions are met:

o (a) only reason you’re deemed to have knowledge is bc info was known to one of your officers, directors, partners or employees

o (b) decision to buy/sell was made by someone who did not have ACTUAL knowledge of the information

o (c) no advice was given by person who had actual knowledge to person who made decision to trade

o (d) appropriate mechanism (wall) was in place to prevent flow of information from person who had actual knowledge to person who made decision to trade o firm or business took reasonable precautions to protect the integrity of that information

REGULATIONS, s.175

  • s. 175(1) A person or company that purchases or sells securities of a reporting issuer with knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed is exempt from subsection 76 (1) of the Act and from liability under section 134 of the Act, where the person or company proves that,

o (a) no director, officer, partner, employee or agent of the person or company who made or participated in making the decision to purchase or sell the securities of the reporting issuer had actual knowledge of the material fact or material change; and o (b) no advice was given with respect to the purchase or sale of the securities to the director,

officer, partner, employee or agent of the person or company who made or participated in making the decision to purchase or sell the securities by a director, partner, officer, employee or agent of the person or company who had actual knowledge of the material fact or the material change, o but this exemption is not available to an individual who had actual knowledge of the material fact or change.

  • (2) AGENTS/INVESTMENT PLANS/FULFILLING CONTRACTS: A person or company that purchases or sells securities of a reporting issuer with knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed is exempt from subsection 76 (1) of the Act and from liability under section 134 of the Act, where the person or company proves that,

o (a) the purchase or sale was entered into as agent of another person or company pursuant to a specific unsolicited order from that other person or company to purchase or sell;

o (b) the purchase or sale was made pursuant to participation in an automatic dividend

reinvestment plan, share purchase plan or other similar automatic plan that was entered into by the person or company prior to the acquisition of knowledge of the material fact or material change; or

o (c) the purchase or sale was made to fulfil a legally binding obligation entered into by the person or company prior to the acquisition of knowledge of the material fact or material change.

  • (3) In determining whether a person or company has sustained the burden of proof under subsection (1), it shall be relevant whether and to what extent the person or company has implemented and maintained reasonable policies and procedures to prevent contraventions of subsection 76 (1) of the Act by persons making or influencing investment decisions on its behalf and to prevent transmission of information concerning a material fact or material change contrary to subsection 76 (2) or (3) of the Act.
  • (4) A person or company who purchases or sells a security of a reporting issuer as agent or trustee for a person or company who is exempt from subsection 76 (1) of the Act and from liability under section 134 of the Act by reason of clause (2) (b) or (c), is also exempt from subsection 76 (1) of the Act and from liability under section 134 of the Act.
  • (5) A person or company is exempt from subsections 76 (1), (2) and (3) of the Act where the person or company proves that such person or company reasonably believed that,

o (a) the other party to a purchase or sale of securities; or o (b) the person or company informed of the material fact or material change, o as the case may be, had knowledge of the material fact or material change.

  1. Defence in Practice – Law Firms
  • Protect themselves against inadvertent trade – they all have rules on insider trading.

o Restricted List: Some say, every time you have transaction involving public company that is material, you have an obligation to phone a designated person and put that company on a restricted list so that someone in the law firm knows that people in that law firm cannot buy/sell shares b/c “we have knowledge of..

o Either way, trying to stop inadvertent/unintended insider trading claim. Integrity of information is protected (so you can use the defence) o In investment banks: Geographic separation b/w traders/investment bankers doing the deal, so bankers can’t get access to broker’s information (doesn’t work in law firm)

  1. Trading as an agent & you ’ve given no advice (s.172((a) of Regs)

If you trade as AGENT for another person pursuant to unsolicited order, and you gave NO advice, you’re not guilty of insider trading

• I phone my broker, say buy apple. My broker knows that apple is about to make a massive announcement. What should my broker do?

o Not say anything. If broker tells me I can’t do that trade, I’ve learned something. In absence of defence, if my broker executes that trade, he’s guilty of insider trading. He shouldn’t be. So there’s a defence.

    1. .5.5 Automatic Investment Plan (175(2)(b) of Regs)

If automatic dividend reinvestment plan, not guilty of insider trading, even if you knew

• Example: Disney: automatic dividend reinvestment plan: don’t want to send you cheques every quarter for .05 if you own 1 share ^ accumulate dividends for you, when it reaches price of a share, we buy you one

If you know someone is going to bid for Disney and they automatically buy you a share pursuant to Automatic Dividend Reinvestment Plan, you ’re not guilty of insider trading, even if you knew. They’re doing it for you w/o you asking

  1. To fulfill legally binding agreement that happened before material info was known (s.175(2)(c) of regs)

Defence b/c entered into legally binding contract BEFORE You had knowledge, then you subsequently get

knowledge, don’t have to breach contract (Policy rationale dno uneven playing field I- not making decisions

w/ knowledge)

  • E.g. Enter into legally binding agreement that on Halloween, you’ll buy 100 shares of apple from me, we both know nothing. Then I get insider info that stock is going down. Halloween comes, what should law be? dOKAY
  • What if I have an option, then I learn information? No, b/c option not a legally binding contract.
  1. Trades between 2 People Who Both Know the Info (s.175(5) of Regs)

Fine b/c both have same info, no one has advantage over someone else. Playing field still level.

  • NOTE: insider trading isn’t designed to create equal opportunities or be fair in every circumstanced can’t do everything
  1. Actions, Sanctions & Penalties for Insider Trading
  2. Penal sanctions – CRIMINAL

Under s. 382.1 Criminal Code prohibits trading on basis of material info concerning an issuer that has not been generally disclosed (similar to OSA s.76)

Conviction for insider trading: Prosecution must prove:

  1. Accused was in a “special relationship”
  2. Accused purchased or sold securities of the reporting issuer
  3. Accused made the purchase or sale with knowledge of a “material fact” or “material change” concerning the affairs of the reporting issuer; AND
  4. That the material fact or material change had not been generally disclosed.

Conviction for tipping/informing:

  1. Accused person was in a special relationship with reporting issuer
  2. Accused informed another person of a material fact or material change with respect to the reporting issuer.
  3. Accused informed another person of the material fact or material change before it was generally disclosed.

*also note: that unlike OSA, Crim Code does not cover tippees of tippees

*also makes no distinction between reporting issuers and non-reporting issuers (who would not have to disclose insider trading under OSA)

4.6.6.2 Civil Actions

Defencedinformation was given in the necessary course of business of the reporting issuer; a defence where the giving of the information is necessary to effect the takeover, business combination or acquisition; finally where the person reasonably believed the information had been generally disclosed.

The Act provides for an action for damages against a person trading on inside information by the person with whom the trade was made.

P must show:

  1. D was in “special relationship” with RI
  2. D purchased or sold securities of RI
  3. D made purchase or sale with knowledge of a material fact or change
  4. Material fact or change had not been generally disclosed.

Tipping: The Act also provides for an action for damages against a person who informed another of the inside information.

P must prove:

  1. D is RI was in “special relationship” with issuer
  2. D informed another person of material information
  3. Information was given before material information generally disclosed.

You can grab notes on other topic from here.


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