A friend of mine recently came to me with a hot stock tip that he was sure was going to make us both a lot of money. It seems that his employer, ABC Corp., was in the advanced stages of negotiations to sell itself to XYZ Corp. My friend was encouraging me to invest in ABC Corp. before the acquisition was publically announced on the expectation that ABC Corp.’s stock price would rise on the announcement of the sale to XYZ Corp. and I could make a quick buck.
While this may sound like a great opportunity, I unfortunately had to tell my friend that investing in ABC Corp. would be a breach of securities laws and that both he and I were prohibited from acting on the information of the impending sale. I also had to tell him that by sharing the information concerning the potential sale with me, he likely had already breached Canadian securities laws.
Securities legislation in Canada prohibits anyone in a “special relationship” with a reporting issuer (for purposes of this article, a reporting issuer is a company that has its shares listed for trading on a stock exchange) from purchasing or selling securities of the reporting issuer with knowledge of a material fact or material change about the company that has not been generally disclosed. This prohibited activity is known as “insider trading”.
Securities legislation also prohibits a reporting issuer and any person or company in a special relationship with a reporting issuer from informing, other than when it is necessary in the ordinary course of business, anyone of a material fact or a material change before that material information has been generally disclosed. This prohibited activity is commonly known as “tipping”. It is important to note that the definition of “special relationship” is broad and there is a potentially infinite chain of tippees who are caught by the prohibitions against tipping and insider trading. Because tippees are themselves considered to be in a special relationship with a reporting issuer, material information may be third or fourth hand and still be subject to the prohibitions under securities laws.
As a result of his employment with ABC Corp., my friend was in a special relationship with the company. The fact that ABC Corp. was pursuing a sale of the company to XYZ Corp. was material information that had not been generally disclosed. My friend’s decision to share that information with me was not only an infraction of securities laws, but also served to place me in a special relationship with ABC Corp. such that I could not purchase or sell shares of the company nor share the information of the impending sale with anyone else until the material information had been generally disclosed by ABC Corp.
The policy rational behind the insider trading and tipping rules is founded in the principle that it is fundamentally unfair for someone to use access to non-public information to improperly gain an edge on the market. So, the next time you receive a hot stock tip from a friend, you may wish to consider if acting on that tip will put you offside securities laws.
Throughout this article, I have used the terms “material fact” and “material change”. These terms are defined by applicable securities legislation as a fact or change relating to a company that significantly affects or would reasonably be expected to have a significant effect on the market price or value of any of the company’s securities.
I have also used the term “generally disclosed.” Securities legislation does not define the term “generally disclosed,” but court decisions indicate that information will generally be deemed to have been generally disclosed if: (i) the information has been disseminated in a manner calculated to effectively reach the marketplace; and (ii) the public investors have been given a reasonable amount of time to analyze the information.
Examples of Potentially Material Information:
The following is a non-exhaustive list of the types of events or information which could be material:
Changes in Corporate Structure:
- changes in share ownership that may affect control of the company
- major reorganizations, amalgamations, or mergers
- take-over bids, issuer bids, or insider bids
Changes in Capital Structure:
- the public or private sale of additional securities
- planned repurchases or redemptions of securities
- planned splits of common shares or offerings of warrants or rights to buy shares
- any share consolidation, share exchange, or stock dividend
- changes in a company’s dividend payments or policies
- the possible initiation of a proxy fight
- material modifications to rights of security holders
Changes in Financial Results:
- a significant increase or decrease in near-term earnings prospects
- unexpected changes in the financial results for any periods
- shifts in financial circumstances, such as cash flow reductions, major asset write-offs or write-downs
- changes in the value or composition of the company’s assets
- any material change in the company’s accounting policy
Changes in Business and Operations:
- any development that affects the company’s resources, technology, products or markets
- a significant change in capital investment plans or corporate objectives
- major labour disputes or disputes with major contractors or suppliers
- significant new contracts, products, patents, or services or significant losses of contracts or business
- significant discoveries by resource companies
- changes to the board of directors or executive management, including the departure of the company’s CEO, CFO, COO or president (or persons in equivalent positions)
- the commencement of, or developments in, material legal proceedings or regulatory matters
- waivers of corporate ethics and conduct rules for officers, directors, and other key employees
- any notice that reliance on a prior audit is no longer permissible
- de-listing of the company’s securities or their movement from one quotation system or exchange to another
Acquisitions and Dispositions:
- significant acquisitions or dispositions of assets, property or joint venture interests
- acquisitions of other companies, including a take-over bid for, or merger with, another company
Changes in Credit Arrangements:
- the borrowing or lending of a significant amount of money
- any mortgaging or encumbering of the company’s assets
- defaults under debt obligations, agreements to restructure debt, or planned enforcement procedures by a bank or any other creditors
- changes in rating agency decisions
- significant new credit arrangements
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Keith Inman is a securities and M&A lawyer with broad experience in the capital markets. Keith regularly advises individuals and companies with respect to securities reporting and compliance matters, purchases and sales of businesses and other corporate/commercial matters. You can reach Keith at 250-869-1195 or by email at [email protected]
