Recent decisions of securities regulators and amendments to Canadian securities laws demonstrate regulators’ lowered tolerance for insiders who trade with information regarding a potential M&A transaction – and increased risk to insiders who engage in such trading:

• Questionable Conduct Threshold. Canadian securities regulators will seek to prosecute in circumstances considered questionable and where it is believed an insider had material information not available to the market at the time of trading. They have been using their discretionary powers to sanction trading on the basis it is contrary to the public interest – even if it is not contrary to securities laws.

• Don’t Rely on Blackout Periods. Directors and officers of a reporting issuer should not rely solely on their company’s trading blackout periods. Companies should review their insider trading and blackout policies and consider imposing blackout periods early in the M&A process.

• Disclosure: A Risky Solution. Directors and officers must be cautious about trading after obtaining information about a potential M&A transaction. Disclosure is a solution – but carries the risk of prejudicing the company’s ability to pursue the transaction.

Insiders must take a cautious approach to trading when they have information about a potential M&A transaction. The bottom line?  When in doubt … don’t trade.

LOWER TOLERANCE – AND INCREASED RISK

 

Two recent securities commission decisions and an amendment to Ontario’s securities legislation indicate regulators have a lower tolerance for insider trading when there is a potential merger and acquisition transaction in the works – resulting in increased risk for directors and officers who engage in trading when they have information about potential M&A transactions.

 

Err on the Side of Caution: Re Lambert. In Re Lambert, the Alberta Securities Commission investigated allegations that a senior officer breached Alberta securities laws or acted contrary to the public interest by purchasing securities of a company with knowledge of an undisclosed material fact.

Daylight Energy Ltd. received an unsolicited letter of interest from a third party inquiring about the possibility of acquiring Daylight.  Lambert, a former Daylight officer, subsequently purchased Daylight shares. Daylight’s general and external legal counsel advised Lambert that the letter of interest did not raise any issues regarding insider trading in Daylight’s shares, and that it was not necessary to impose a trading blackout of any kind. Counsel based its determination on the facts that:

• Daylight had previously received several other expressions of interest – none of which proceeded beyond preliminary or introductory stages;
• The letter was unsolicited and contained no reference to any terms, price or the nature of a possible transaction; and
• Daylight was not “in play” and had not retained financial advisors to solicit or locate potential purchasers or partners.

A few months after Daylight received the letter of interest, the third party acquired Daylight and the Alberta Securities Commission investigated Lambert’s trades.  The Commission and Lambert ultimately settled.  Lambert admitted he “made an error of judgment” when he purchased Daylight’s shares with knowledge of the letter of interest, and  acknowledged it would have been prudent to “err on the side of caution” and “refrain from any further trading in Daylight securities”.  In a news release of the Alberta Securities Commission’s Chair and CEO issued following the Settlement Agreement, he stressed that senior company officials must understand that insiders cannot trade while in possession of undisclosed material information – whether or not that material information must be disclosed under the province’s continuous disclosure regime. He also emphasized that if there is any doubt, insiders should err on the side of caution and not trade.

Public Interest Trumps Legality: Re Donald. In Re Donald, the Ontario Securities Commission found an officer who traded securities of a reporting issuer with knowledge of a potential acquisition of that issuer did not violate securities laws – but did act contrary to the public interest.

Donald was an officer of Research in Motion (RIM) when he had information that RIM was considering an acquisition. He learned RIM had been, but was no longer, in confidential discussions with the target; that RIM had an ongoing interest in acquiring the target; and that the target’s shares were undervalued. The next day, Donald acquired shares of the target company. A few months later, RIM acquired the target – and Donald nearly doubled his investment. The Ontario Securities Commission concluded the facts that Donald learned were material undisclosed facts about the target. However, his conduct was not insider trading: at the time of trading, RIM’s consideration of the acquisition had not yet risen to a proposal bid and Donald’s conduct did not violate the Ontario Securities Act. Despite this, the Commission concluded Donald’s acquisition of the target’s shares while knowing the undisclosed material facts was contrary to public interest and “abusive of capital markets and to confidence in the capital markets”.

Expanded Scope for Prosecution: Ontario Securities Act. Shortly after Re Donald, amendments to the Ontario Securities Act expanded the Ontario Securities Commission’s ability to prosecute and sanction insider trading violations. The insider trading provisions have been amended by expanding the definition of a person or company in a “special relationship” with a reporting issuer beyond situations where a person or company is “proposing to make a take-over bid” to include situations where the person or company is “considering or evaluating” a take-over bid or other change-of-control transaction in the target company.

WHEN IN DOUBT… DON’T TRADE

 

These recent decisions and legislative amendments demonstrate that regulators have a lowered tolerance for insiders who trade with information regarding a potential M&A transaction – and an increased risk to insiders who engage in such trading: 

 

• Questionable Conduct Threshold. These recent developments demonstrate that Canadian securities regulators are willing to impose sanctions on insiders who trade in circumstances beyond those expressly prohibited in the legislation. Recent cases indicate that regulators will seek to prosecute in circumstances considered questionable and where it is believed that an insider traded in securities while in possession of material information not available to the market.

• Don’t Rely on Blackout Periods. Directors and officers of a reporting issuer should be wary of relying solely on their company’s trading blackout periods as to when they should refrain from trading in the company’s securities. In both Re Lambert and Re Donald, the trading occurred when the respective companies were not in a blackout period. Securities regulators have the benefit of looking at the facts in hindsight and imposing sanctions on insiders who trade in a period when a blackout should have been imposed. Companies should review their insider trading and blackout policies and impose blackout periods early in the M&A process.

• Disclosure: A Risky Solution. To avoid potential liability, directors and officers must be cautious about trading after obtaining information about a potential M&A transaction. Disclosure of the information is a solution to the risk of insider trading – but premature disclosure could also prejudice the company’s ability to pursue the transaction, and thus raises new risks.

Directors and officers must take a cautious approach to trading when exposed to information about potential M&A transactions. The bottom line? It may be advisable to err on the side of caution –  and restrict trading altogether.

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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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