Insider trading settlement agreement calls to attention consequences of unsolicited expressions of interest

Maïté Murray -

Last July, the former CEO and President of Daylight Energy Ltd. (now Sinopec Daylight Energy Ltd.) entered into a settlement agreement with the Alberta Securities Commission (ASC). The agreement settled claims that he had breached Alberta securities laws and acted contrary to the public interest by purchasing securities of Daylight with knowledge of undisclosed material facts about the company, namely that a potential acquirer was interested in a “major strategic investment transaction”.

Background

In 2011, Daylight, an Alberta corporation engaged in the oil and gas industry with headquarters in Calgary, was acquired by Sinopec International Petroleum Exploration and Production Corporation (SIPC), a wholly-owned subsidiary of the state-owned China Petrochemical Group. The acquisition was carried out by way of a plan of arrangement that was completed in December 2011. Anthony Lambert, the respondent in this matter, had purchased securities of Daylight at various occasions before the transaction was publicly announced in October 2011. He subsequently made a significant profit on the sale of those securities when, pursuant to the plan of arrangement, SIPC acquired all of Daylight’s securities at a substantial premium.

In an initial Notice of Hearing issued in April 2013, the ASC alleged, among other things, that the respondent had purchased securities of Daylight in August and September 2011 with full knowledge of certain material facts about Daylight that were then generally undisclosed, thereby contravening the insider trading restriction under section 147(2) of Alberta’s Securities Act (ASA), and that he had acted contrary to the public interest.

Although the settlement agreement contains no legal analysis on this point, the notice identified the “facts and information regarding the anticipated acquisition of Daylight by SIPC” as being all separately and collectively “material facts” as defined in the ASA. What is notable about the allegations and ensuing settlement agreement is that the process of acquisition by SIPC was, arguably, at an exceptionally early stage at the time at least one of the impugned trades took place. Specifically, at that point in time, the information regarding a possible acquisition was limited to indications of potential interest, which were evidenced primarily by a letter sent to Daylight on August 5, 2011 regarding the possibilities of exploring “a major strategic investment transaction” between SIPC and Daylight.

The letter of interest was unsolicited and contained no reference to any terms, price or the nature of a possible transaction. For this and other reasons, including that Daylight was not “in play”, had not retained any financial advisors in view of a sale transaction, and had previously received several other expressions of interest from various parties about possible transactions that never proceeded beyond preliminary or introductory stages, the respondent formed the view that SIPC’s indications of interest were immaterial and therefore did not raise any insider trading issues. This view was corroborated upon further enquiry to Daylight’s General Counsel, Governance Chair and outside counsel.

One of the trades identified in the notice, however, took place on August 8, the same day a letter (executed by Lambert) was sent to SIPC confirming Daylight’s interest in exploring a potential business opportunity, which was accompanied by a draft form of confidentiality agreement. The settlement agreement provides specifically that it would have been prudent for the respondent to confirm with Daylight’s General Counsel that it remained permissible for him to trade on that day.

Legal Framework

The ASA provides that no person in a special relationship with a reporting issuer shall purchase or sell securities of the reporting issuer with knowledge of a material fact or material change with respect to that reporting issuer which has not been disclosed to the public. The term “material fact” is defined in the ASA (and under the securities laws of Canadian provinces and territories generally), in relation to securities issued or proposed to be issued, as a fact that would reasonably be expected to have a significant effect on the price or market value of the securities. In contrast, a “material change” is defined, in relation to an issuer, as a change in the business, operations or capital of the issuer that would reasonably be expected to have a significant effect on the market price or value of the issuer’s securities.

The settlement agreement, though not explicitly, draws our attention to the distinction between the criteria that trigger insider trading restrictions for those persons in a special relationship with a reporting issuer, and those that trigger material change disclosure obligations for a reporting issuer under securities laws. If a material fact constitutes a material change for the issuer, it must be disclosed immediately via press release. Meanwhile, a material fact will trigger the insider trading restrictions notwithstanding that it does not amount to a material change. (Note that the rules and policies of the Toronto Stock Exchange, which are not covered here, require disclosure of “material information”.) This distinction was echoed in the comments of Bill Rice, the ASC’s CEO, who stated in the press release announcing the settlement that “it is important that senior company officials – insiders – understand that insiders cannot trade while in possession of undisclosed material information; whether or not that material information must yet be disclosed under our continuous disclosure regime.”

In Re Coventree Inc., which we discussed in an earlier post, the Ontario Securities Commission (OSC) confirmed that the definition of “material fact” under Ontario’s Securities Act (OSA) is broader than that of “material change”, as the former will not necessarily arise from a change in an issuer’s business, operations or capital. Coventree also made clear that the standard of materiality for both concepts is the same and is based on an objective standard, and that assessments of materiality are not to be made with the benefit of hindsight, as had been previously established by the OSC in its 2008 decision In the Matter of AiT Advanced Technologies Corporation and as was reiterated by the British Columbia Securities Commission in its recent ruling in respect of Canaco Resources Inc. and four of its directors. AiT remains the key decision with respect to disclosure obligations in the context of a strategic transaction. (In that decision, the panel held that the obligation to disclose a potential merger as a “material change” under section 75 of the OSA does not apply to proposed mergers and acquisitions until the board believes that the parties are committed to the transaction and that completion is substantially likely.)

A different standard, unrelated to the notion of materiality, is observable, however, when, on the basis of their public interest jurisdiction, securities commissions intervene to determine whether an individual’s conduct is contrary to public interest, a determination which can, and often does, occur concurrently with the assessment of insider trading allegations.

In the recent decision of Re Donald, the OSC found that, while the respondent was not technically in breach of the OSA’s insider trading restriction, since he was not in a special relationship with the issuer, his conduct had failed to meet the high standard of behavior expected of market participants and officers of public companies. The OSC levied sanctions against him for that reason. (Also see the subsequent amendments to the OSA, which expanded the scope of what it means to be in a special relationship with an issuer.)

The decision on the merits in Donald offers a clear description of the law relating to the OSC’s public interest jurisdiction. It points to the Supreme Court of Canada’s decision in Committee for the Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission), which addressed the scope of the public interest power, and to other decisions where securities commissions found that a respondent’s conduct was contrary to the public interest even though not in breach of securities laws. The Ontario Superior Court of Justice (Divisional Court), in reviewing and ultimately upholding the OSC’s decision in Coventree, also made clear that the OSC could exercise its public interest jurisdiction irrespective of whether the conduct under review was willful or deceitful.

The fact that conduct in this context is evaluated beyond its compliance with the “letter of the law” is evidence that commissions, pursuant to their public interest jurisdiction, are applying a high standard of scrutiny when reviewing the conduct of insiders, persons in a “special relationship” with the issuer, and even others, as was the case in Donald. Yet, this is not to be equated to evidence that commissions are applying a lower threshold of materiality to assessments of insider trading.

The Supreme Court confirmed in Asbestos that the protection of investors and the efficiency of, and public confidence in, capital markets generally should be considered in the OSC’s application of its public interest jurisdiction. It also held that deterrence may inform the choice of sanctions the OSC can apply pursuant to its public interest power. The open-ended and forward-looking aspect of those considerations raises some uncertainty as to the elements that commissions will take into account when ascertaining whether certain conduct is contrary to the public interest and the appropriate sanctions.

Takeaways

The challenge when interpreting or attempting to derive recommendations as to best practices from a settlement agreement is that a large part of the regulator’s reasoning is typically excluded and we are left to fill in the gaps. Even so, the settlement agreement between Lambert and the ASC makes clear that early stage discussions or negotiations towards a possible change of control transaction should be carefully scrutinized to determine the appropriate stages at which a trading blackout and disclosure are required. Most significantly, it cautions that the receipt of unsolicited expressions of interest should always be viewed in light of the relevant circumstances at hand to determine whether, and when, such measures are required.

The author wishes to thank Ramandeep Grewal and Alex Colangelo for their helpful comments.

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