A Practical Analysis of “Material Fact”

In its April 2013 decision in Re Stan, the Alberta Securities Commission provides issuers with a practical approach to the assessment of both a “material fact” and general disclosure to the public:

• Contextual Analysis. Materiality assessments are fact specific and heavily dependent on context.
• No Benefit From Hindsight. It is impossible to assess materiality with the benefit of hindsight.
• Public Disclosure Record. An issuer’s public disclosure record is key; insiders must use “care and scrutiny” and err on the side of caution in assessing disclosure of material facts.
• Evidentiary Burden. Regulators will be required to provide clear, convincing and cogent evidence of their case; reliance on isolated facts, without regard to the surrounding circumstances, is insufficient.

BACKGROUND

Staff of the Alberta Securities Commission alleged that six insiders participated in insider trading of the shares of Grande Cache Coal Corporation, a publicly traded coal mining and production company in violation of section 147(2) of the Alberta Securities Act. The Staff further alleged one of the accused also violated sections 147(3) and (3.1) of the Act by disclosing non-disclosed information to his wife (also accused of insider trading) and encouraging her to sell Grande Cache shares.

The Staff had to establish the following facts to prove the insider trading allegation:

• Grande Cache was a reporting issuer in Alberta at all relevant times;
• the accused was in a special relationship with Grande Cache at all relevant times;
• the accused sold Grande Cache shares;
• the accused had knowledge of a material fact with respect to Grande Cache when he /   she sold the shares; and
• the accused did not generally disclose the material fact when he/she sold the shares.

The Commission focussed on the question of whether the “alleged material facts” were material facts that were not generally disclosed. The Act defines materiality as, “a fact that would reasonably be expected to have a significant effect on the market price or value of”.

The Staff argued that:

• Grande Cache’s reduced coal production and its failure to meet its first quarter sales projects by almost 40% was a material fact that would significantly affect share price; and
• the decrease in Grande Cache’s share price on August 14 to15, 2008 following its August 14th news release about its first quarter results was evidence that Grande Cache’s reduced coal production was a “material fact” which it had not disclosed until the August 14th news release.

The Staff argued that the accuseds’ failure to disclose this material fact, coupled with their trading activity, amounted to insider trading.

COMMISSION’S DECISION

The Commission applied the test of what would reasonably have been expected to transpire and cautioned against using hindsight in the assessment of materiality, and disagreed with the Staff on all accounts:

• Sufficient Facts Disclosed: The Commission decided the probability of not meeting quarterly projections was less significant than the probability of meeting annual projections met. Grande Cache did disclose other important details – such as lower production levels in the first quarter, higher cost of sales, reaffirmation of annual sales projections and information regarding sales contracts – through quarterly reports. The Commission found Grande Cache’s was not required to provide more specific disclosure.

• The Coal Industry. The Commission found that the market decline on share price for the coal industry made mid-August – when Grande Cache issued the August 14th news release – a “considerably different” environment than that which existed in late May 2008 – when a prior Grande Cache news release reflected the upward trend in share prices in the coal industry. The volatility of Grande Cache’s share price was within the normal range, and the decline was similar to the pattern in the Mining Index. TheCommission found the market analysis evidence unconvincing, and the mixed reactions of market analysts did not help prove that the alleged facts were material.

• 2008 Recession. The Commission found the accused shareholders could not have predicted the 2008 collapse of the global economy, and this financial context affected Grande Cache’s actual 2008 financial and operational results.

The Commission concluded the accused disclosed the alleged material facts when the trading activity occurred, and dismissed all of the allegations.

Click here to read the Alberta Securities Commission’s decision in Re Stan.

A PRACTICAL “MATERIALITY” TEST

Re Stan provides market participants with a practical approach to assessing and determining “materiality”:

• Contextual Analysis. In addition to the exercise of judgment and common sense, materiality assessments depend heavily on the specific facts and surrounding circumstances; for example, quarterly forecasts and results taken in isolation are not always “material”. It is impossible to determine material facts in isolation from the context.

• No Benefit From Hindsight. Similarly, it is impossible to do so with the benefit of hindsight: it is important to avoid hindsight and “confusing outcome with expectation” in assessing materiality.

• Public Disclosure Record. The Commission noted its focus on examining Grand Cache’s public disclosure record – a reminder to issuers of the importance of good public disclosure. The Commission specifically reminded insiders to exercise “care and scrutiny” in determining whether all material information that they are aware of, due to their close position with the company, has been generally disclosed before they complete any trading activity with securities. Securities regulators will not hold market participants to a standard of perfection in making materiality assessments, but they should err on the side of caution to avoid facing serious allegations from securities regulators.

• Evidentiary Burden. Regulators will be required to provide clear, convincing and cogent evidence of their case; reliance on isolated facts, without regard to the surrounding circumstances, is insufficient.

Please contact your McInnes Cooper lawyer or any member of our McInnes Cooper Corporate Finance and Securities Team to discuss this topic or any other legal issue.

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