The Ontario Capital Markets Tribunal (the Tribunal) recently released a decision where it considered the meaning of the “necessary course of business” exception to the general prohibition against the selective disclosure of material non-public information (MNPI). The decision of the Tribunal in Kraft (Re) (the Kraft Decision) provides long-awaited guidance about disclosing MNPI and the “necessary course of business” exemption.
Though the Kraft Decision was rendered in Ontario, the guidance provided by the Tribunal is relevant in all provinces and territories in Canada.
General Securities Law Matters
Canadian securities laws generally prohibit publicly-traded entities and those persons who are in a “special relationship” with those entities (including, among others, directors, officers, employees, insiders, potential bidders, professional service providers and anyone who receives MNPI from any of the foregoing) from: trading in securities with knowledge of MNPI (referred to as insider trading); and disclosing MNPI about the issuer to any person, other than in the “necessary course of business” (referred to as illegal tipping).
Insider trading and tipping prohibitions are designed to ensure that anyone who has access to MNPI does not trade or assist others in trading to the disadvantage of investors generally. Accordingly, when MNPI is disclosed to another person (either within or outside their organization) the disclosure must be made in the “necessary course of business”.
Before the Kraft Decision, neither Canadian courts nor securities regulators had defined the scope of the “necessary course of business” exception, other than limited guidance that included a list of recipients whom the “necessary course of business” exception would generally cover. The Kraft Decision makes clear there are a number of important considerations beyond the identity of the recipient of MNPI.
The Kraft Decision
WeedMD Inc. (WeedMD) was negotiating a transaction to expand its production capacity (the “Transaction”) in 2017. Before the Transaction was announced, Michael Kraft (the then-current Chair and a director of WeedMD) informed his friend and advisor, Michael Stein, of the Transaction and provided him with near final drafts of documents relating to the Transaction. On the day before the Transaction was announced, Mr. Stein acquired shares of WeedMD, which he then sold shortly following the announcement of the Transaction, realizing a profit of approximately $30,000.
The Tribunal concluded that Mr. Stein had engaged in illegal insider trading. The Tribunal also concluded that Mr. Kraft’s disclosure of the Transaction to Mr. Stein amounted to illegal tipping as the documents provided to Mr. Stein were MNPI and the disclosure was not made in the “necessary course of business”. In concluding that disclosure was not made in the “necessary course of business”, the Tribunal held:
Mr. Stein was not formally engaged by WeedMD in any official capacity at the time the disclosure was made.
The disclosure was made because of Mr. Kraft’s own personal desire to have Mr. Stein provide thoughts and input as a second set of eyes.
The disclosure took place hastily, without any prior discussion with the board of directors or management of WeedMD or consideration of whether the disclosure was being made in the necessary course of WeedMD’s business.
Mr. Stein was not asked to keep the information confidential and was not given any specific direction about the use that could be made of the information.
There was no evidence Mr. Stein possessed any specialized expertise that was not already available to WeedMD.
Key Takeaways
Burden of Proof: The Tribunal held that, once the elements of the tipping offence are established, the onus of establishing that the disclosure was made in the “necessary course of business” shifts to the disclosing party. Those disclosing MNPI should therefore ensure they can demonstrate (through evidence) the reasons for disclosing MNPI.
Necessity of Disclosure: The Tribunal placed significant weight on the word “necessary” and concluded the “necessary course of business” exception was intended to be a narrow exception that permits disclosure that is “essential”, “indispensable” or “requisite” to the business. It requires more than a mere “business purpose” or “business rationale” and is a higher bar than “ordinary course of business”.
Fact-Specific Inquiry: The Tribunal held that the question of whether disclosure was made in the “necessary course of business” is determined on an objective standard. A subjective belief by the disclosing party that disclosure was in the necessary course of is insufficient to invoke the availability of the exception. While the Tribunal noted that it would not be appropriate to identify a comprehensive set of factors relevant to establishing the “normal course of business” exception in all cases, it did agree that all or some of the following factors may be important considerations:
the business of the issuer;
the relationship between the disclosing party and the issuer;
the relationship between the disclosing party and the recipient;
the nature of the MNPI that was disclosed;
the relevance of the MNPI to the relationship between the recipient and the issuer (that is, whether the nature of the relationship between the recipient and the issuer necessitates the disclosure of the MNPI in question);
the disclosing party’s reason for making selective disclosure to the recipient; and
the credibility of the disclosing party seeking to establish the necessary course of business exception.
Practical Considerations
Given the significant consequences that can result from violations of insider tipping rules, it is important for those in possession of MNPI to take proactive steps in ensuring compliance when disclosing such information. The Kraft Decision highlights certain steps that should taken prior to disclosing such information to third parties, including:
discussing disclosure of MNPI at the board or management level and specifically considering the following: (i) the scope of information to be disclosed; (ii) the purpose of disclosing that information to the relevant person; and (iii) the prohibition against tipping and the reasons why the disclosure is in the necessary course of business;
considering whether the issuer can achieve the desired outcome of the disclosure in another reasonable way that limits the disclosure of MNPI;
instructing the recipient of the MNPI as to the permissible uses of the information and the recipient’s confidentiality obligations; and
entering into a legal agreement with the relevant person that documents the foregoing matters.
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DISCLAIMER: This post is intended to convey general information about legal issues and developments as of the date above. It does not constitute legal advice and must not be treated or relied on as such.