Insider Tipping: Recent Ontario Capital Markets Tribunal Decision Provides Important Guidance for Public Companies and Insiders
It is generally well understood that securities laws prohibit “tipping,” the selective sharing of material non-public information (“MNPI”) about an issuer, except where such disclosure is in the “necessary course of business” (the “NCOB Exception”), a practice that is regularly relied upon by insiders of reporting issuers. Less well understood are the circumstances in which the NCOB Exception will be found to apply.
In a recent decision, Kraft (Re), 2023 ONCMT 36, (“Kraft”) the Ontario Capital Markets Tribunal (the “Tribunal”) directly addressed and applied the NCOB Exception under Section 76(2) of the Securities Act (Ontario) (the “OSA”) for the first time, providing important guidance to public companies and their insiders, alike.
In 2017, Michael Paul Kraft (“Kraft”) was the Chair of WeedMD Inc. (now known as Entourage Health Corp.) (“WeedMD”), a medical cannabis company listed on the TSX Venture Exchange. Staff of the Ontario Securities Commission’s Enforcement Branch (“Staff”) alleged that Kraft provided a close friend and business associate, Michael Brian Stein (“Stein”), with MNPI regarding WeedMD’s planned expansion at a property owned by Perfect Pick Farms Ltd. (“Perfect Pick”) located in Strathroy, Ontario. During the course of negotiations between WeedMD and Perfect Pick, Kraft sent Stein an email attaching draft documents, including substantially settled drafts of the lease and an option to purchase agreement, all without the knowledge or prior approval of management or the board of WeedMD. While Stein was a consultant to WeedMD a few years prior, such arrangement was no longer in place when the MNPI was shared; Kraft considered Stein a trusted advisor whose input was regularly sought, regardless of whether there was a formal relationship with WeedMD.
Stein, while possessing MNPI about the Perfect Pick expansion, later purchased shares of WeedMD and then sold those shares for a profit following WeedMD’s public announcement of the project.
The Tribunal held that Kraft had indeed supplied Stein with MNPI contrary to Section 76(2) of the OSA. In reaching its conclusion, the Tribunal rejected Kraft’s submission that his selective disclosure to Stein of draft documents relating to the Perfect Pick expansion was made within the parameters of the NCOB Exception.
The parties are expected to have a hearing in front of the Tribunal to address sanctions and costs by no later than December 1, 2023.
The Necessary Course of Business Exception
Tipping in contravention of Section 76(2) of the OSA is generally established if a person in a special relationship with a reporting issuer selectively discloses MNPI outside of the necessary course of business.
In assessing the application of the NCOB Exception in Kraft, the Tribunal held that the NCOB Exception is established on the basis of an objective standard and does not consider the subjective beliefs of the tipper, even if reasonably held. Rather, it asks whether the disclosure was objectively necessary, with the burden of proof landing with the respondent (i.e., the alleged tipper).
In this case, Stein provided comments to Kraft and certain senior officers at WeedMD on the draft lease but was not formally retained or compensated by WeedMD or Kraft to do so. While Stein and Kraft had a long-standing relationship which was at times a business relationship, Stein did not, during the relevant time, have any business, contractual or employment relationship with WeedMD. Rather, Stein was Kraft’s “go-to-guy” for real estate and financial matters.
However, the Tribunal ultimately rejected Kraft’s assertion that he sought Stein’s advice on the lease in the “necessary course of business.” While the Tribunal acknowledged that Kraft had made the disclosure for a business reason, the Tribunal held that this did not rise to the level of being in the “necessary course” of WeedMD’s business. In doing so, the Tribunal made the following key points:
- The analysis must give regard to the reasons for the prohibition against tipping. The Tribunal emphasized that the NCOB Exception must be interpreted and applied in a manner that gives regard to the reasons for the prohibition against tipping. That is, “to ensure that everyone in the market has equal access to and opportunity to act upon material information.” As a result, the Tribunal noted that the NCOB Exception must be interpreted and applied “reasonably narrowly” so that this purpose is not undermined.
- The word “business” is not necessarily limited to the issuer’s business. The Tribunal held that in the circumstances of the case, where MNPI was received by Kraft in his capacity as Chair of WeedMD, the NCOB Exception was to be applied with reference to WeedMD’s business specifically. However, the Tribunal noted that this will not necessarily be the case in all factual situations. It is therefore possible that a future decision may find the NCOB Exception to apply where the selective disclosure was made in the necessary course of the tipper’s business. Reporting issuers and insiders should exercise caution until the case law on this point develops further.
- The word “necessary” elevates the requirement beyond a mere business purpose or business rationale. The Tribunal noted that what is in the “ordinary” course of business may not necessarily be in the “necessary” course of business. The word “necessary” was held to import “a level of importance, including that something is ‘essential,’ ‘indispensable’ or ‘requisite.’” That is, the selective disclosure of MNPI must be “sufficiently important or necessary to the business to warrant an exception to the blanket prohibition against selective disclosure.”
- There is no universal or comprehensive set of factors relevant to establishing the NCOB Exception. The Tribunal noted that it would not be appropriate to seek to identify such an exhaustive list. However, it agreed with Staff that in appropriate circumstances, some or all of the following factors may be important considerations: (i) the business of the issuer; (ii) the relationship between the tipper and the issuer; (iii) the relationship between the tipper and the tippee; (iv) the nature of the MNPI that was disclosed; (v) the relevance of the MNPI to the relationship between the tippee and the issuer (i.e., whether the nature of the relationship requires the disclosure of the MNPI in question); (vi) the tipper’s reason for making selective disclosure to the tippee; and (vii) the credibility of the tipper seeking to establish the NCOB Exception.
- While non-binding and non-exhaustive, National Policy 51-201 – Disclosure Standards (“NP 51-201”) offers guidance. NP 51-201 contains a list of recipients with whom the NCOB Exception would generally cover communications: (i) vendors, suppliers or strategic partners on issues such as research and development, sales and marketing, and supply contracts; (ii) employees, officers and board members; (iii) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors; (iv) parties to negotiations; (v) labour unions and industry associations; (vi) governmental agencies and non-governmental regulators; and (vii) credit rating agencies (provided that the information is disclosed for the purpose of assisting the agency to formulate a credit rating and the agency’s ratings generally are or will be publicly available). However, the Tribunal emphasized that the NCOB Exception must always be established on the relevant facts, and the application of the categories listed in NP 51-201 will not be determinative.
The decision in Kraft serves as useful guidance and a cautionary note for executives and other insiders of reporting issuers for dealing with MNPI in the course of business. It is also a good reminder of the importance of establishing and maintaining appropriate disclosure controls, procedures and practices.
Given the significant consequences that can result from violations of insider tipping rules, it is important for organizations to take proactive steps in ensuring compliance. The Kraft decision highlights the importance of several key strategies:
- Establish clear processes for the handling of MNPI. In Kraft, the Tribunal noted that the MNPI was shared with Stein “hastily,” “with little instruction” and “without any prior discussion with management or the board.” While the Tribunal also acknowledged the reality that early stage companies in particular may not have stringent processes in place, it made clear that some level of process and care is expected when handling MNPI. Establishing clear and robust disclosure policies, for example, can improve efficiencies around public disclosure and reduce the opportunity for non-compliance. Written disclosure policies should also include guidance on how to maintain the confidentiality of MNPI.
- Utilize confidentiality and other agreements when dealing with MNPI. The Tribunal emphasized in Kraft that Stein had not entered into any agreements with respect to his review of the lease and was not asked to keep the information confidential. While confidentiality agreements are neither necessary nor a precondition to establishing the NCOB Exception, the Tribunal noted that doing so remains an advisable best practice that can be relevant to the analysis. Entering into written agreements outlining the reasons for disclosure, the accepted use of the MNPI and the expectations around confidentiality can therefore be a useful tool in mitigating disclosure risk.
- Maintain good record-keeping and communication practices. Associated risks can also be reduced by implementing strong record-keeping (including board minutes) and communication practices with respect to MNPI. Such practices are useful both in preventing and responding to instances of non-compliance. As indicated by the Tribunal in Kraft, establishing that one has considered whether selective disclosure is in the necessary course of business may be helpful in establishing, after the fact, the purpose for which selective disclosure was made. Utilize minutes, memorandums and other written communications where possible to ensure a detailed record is kept with respect to the purpose of selective disclosure. Maintaining insider lists can also be effective in controlling the flow of MNPI.
- Ensure proper oversight at the board level. It is important to ensure that the board of directors is engaged with the compliance efforts of the organization. As noted by the Tribunal, evidence of board discussions regarding the advisability or need for selective disclosure may be useful in establishing, after the fact, whether disclosure was made in the necessary course of business. Issuers should therefore be encouraged, where possible, to establish board committees dedicated to compliance and ethics.
The Capital Markets Group at Aird & Berlis LLP can assist issuers in navigating insider trading and tipping rules, and ensuring compliance across the organization. Please contact one of the authors, or another member of the group, if you have questions or require any assistance with respect to the matters discussed above.