Due to the difficulty in obtaining direct evidence, insider trading and “tipping” cases are relatively rare. As a result, the high-profile decision of Finkelstein v Ontario (Securities Commission) (2016) is significant. Writing for the Ontario Divisional Court, Justice Nordheimer set out and affirmed a number of governing principles in insider trading and tipping cases. These include the importance of circumstantial evidence, and clarity on the test used in tipping chains.
The Commission’s findings
On March 24, 2015, the Ontario Securities Commission found that several individuals contravened the insider trading and “tipping” provisions under s 76 of the Securities Act. The Commission found the following:
- All of them shared material non-public information, other than in the necessary course of business, contrary to s 76(2) of the Act; and
- Apart from Finkelstein, the remaining individuals were also found to have engaged in insider trading and to have acted against the public interest, in breach of s 76(1).
Some of these individuals appealed these findings to the Divisional Court, as well as the Commission’s later decision imposing sanctions and costs. With deference to the Commission’s factual findings, the court upheld the offences and sanctions against every appellant but one.
Breaking down the tipping chain
Since this case involved multiple offenders who are linked to one another, a summary of events will help to contextualize the court’s analysis.
Mitchell Finkelstein, a former corporate lawyer, set off the chain of events when he tipped off Paul Azeff by giving him material non-public information regarding three separate acquisitions. Azeff, a longtime friend of Finkelstein’s, tipped off Korin Bobrow. Azeff also tipped off L.K ., who did not appeal the Commission’s decision. L.K. passed the information to Howard Miller, who, in turn, passed it to Man Kin (Francis) Cheng. Apart from Finkelstein, the appellants were all investment advisors.
Figure A summarizes the tipping chain, below. Appellants whom the court found guilty of offences are marked in red. Cheng’s name is in black because the court did not find sufficient evidence to uphold the Commission’s findings against him.
In its analysis, the court drew a distinction between Miller’s and Cheng’s roles as downstream tippees. As the court explained, downstream tippees, or those who were informed by Azeff rather than by Finkelstein directly, are only guilty of an offence if they fall within the ambit of section 76(5)(e) of the Act. Using an objective test, this paragraph requires that each tippee knew or reasonably ought to have known that the information came from a person with a “special relationship” with the company (i.e., an insider).
As the court explained, regulators need not prove that downstream tippees knew the original tipper’s identity and his or her relationship to the issuer. Nor do they need to show that downstream tippees knew the identities of those links preceding them in the chain. Instead, the court clarified that regulators need only show knowledge or constructive knowledge one link up the chain. For instance, it was only necessary to show that Miller reasonably ought to have known that the information he received from L.K. came from a person in a “special relationship.”
To help decide whether these downstream tippees “reasonably ought to have known” that the information came from a person in a special relationship, the Commission set out a number of factors to consider. These include:
- the relationship between the tipper and tippee and their professional qualifications – note that lawyers, bankers and other professionals are held to a higher standard, since they are more likely to possess material non-public information and they should be more alert about receiving it;
- the level of detail and specifics of the material non-public information;
- the tippee’s trading behaviour with respect to the information, such as:
- how much time passes between he or she receives the information and trades,
- whether the tippee took intermediate steps to verify the information before trading,
- whether he or she previously owned the stock, and
- the size of the trade relative to the portfolio.
Applying this test, the court concluded that Cheng was the only appellant who did not breach s 76 of the Act. Cheng’s situation was factually different: he had a more distant relationship with Miller, he took additional measures to verify the target stock before buying, and his purchases were less significant, relative to his portfolio and buying history.
The court found that the remaining appellants, unlike Cheng, ought to have known that they were receiving inside information. For example, Finkelstein and Azeff were close friends. Shortly after Finkelstein shared detailed takeover information with Azeff, Azeff and Bobrow bought significant amounts (i.e., over 293,000 shares) of a buyout company in more than 100 accounts belonging to them, their families, friends and clients. The court deferred to the Commission’s findings that these purchases were sudden, significant, and not based on prior research.
The Finkelstein decision also affirmed that the Commission may properly rely on circumstantial evidence in bringing in insider trading and tipping cases. Circumstantial evidence fills evidentiary gaps where certain events cannot be directly proven. After confirming that the standard of review was reasonableness in these appeals, the court then found that the Commission’s findings against Finkelstein, Azeff, Bobrow, and Miller were reasonable.
Amending recommendations provisions after Finkelstein
Under the Act, the Commission may also make orders in the public interest in the absence of actual securities law breaches. In Finkelstein, the Commission used this discretion to find against every appellant, other than Finkelstein, for recommending that their clients purchase shares in the companies being acquired.
At the time of the Finkelstein decision, those in special relationships with an issuer and who had information about the companies could, legally, recommend the trade to another without informing them of the illicit knowledge. Subsection 76(2) only limited the sharing of the information.
Following Finkelstein, recent amendments to the Act now prohibit those in special relationships with the issuers from recommending or encouraging others to trade the stock.
Implications of Finkelstein
There are two main implications of the Finkelstein decision. The first concerns the Commission’s use of its public interest power in this case. Because the Commission exercised its jurisdiction by choice in Finkelstein, it remained uncertain whether and how the Commission would deal with recommendations in later cases. By amending the recommendations provision, the Act has added certainty to insider trading cases, specifically, and securities law, more generally. This codification removes the need for the Commission’s discretion in these matters.
Secondly, the Finkelstein decision aligns with those in other recent insider trading and tipping cases. In both Re Agueci and Fiorillo v Ontario (Securities Commission), the court was also heavily influenced by deference to the Commission’s findings of fact and decisions. Taken together, these three cases demonstrate the overall reluctance of Ontario courts to interfere with the Commission’s factual findings in insider trading and tipping cases. Likely, if one loses before the Commission, one will lose before the court.
Kseniya Kudischeva is a student representative on the CBA National Business Law Section Executive