trading by insider contrary to the public interest, but not in breach of securities legislation – analysis of whether a person is in a "special relationship" – Re Donald decision
In August 2008, Mr. Paul Donald ("Donald"), who was then an officer of Research In Motion Limited ("RIM"), bought $305,000 in common shares of Certicom Corp. ("Certicom"), a company that RIM had an ongoing interest in acquiring. The Ontario Securities Commission (the "OSC"), in one of the few decisions to analyze the insider trading provisions of the Securities Act (Ontario) (the "Act") in the context of an M&A transaction, held that Donald had not breached such provisions.1 However, the OSC held that Donald's actions had called into question the integrity of the capital markets and that such conduct was contrary to the public interest.
The decision in Re Donald is one of the very few decisions of securities regulators that have considered in detail whether a person is in a "special relationship" with a reporting issuer, which is the cornerstone for the determination of whether a person has breached insider trading provisions. In addition, the fact that Donald was held to have acted contrary to the public interest may cause public companies to examine whether blackout periods should be imposed earlier in an M&A process.
On August 20, 2008, Donald attended a golf tournament and dinner hosted by RIM for its executives. At the dinner, Donald discussed with Chris Wormald ("Wormald"), RIM's Vice President and head of the Strategic Alliances Group, RIM's relationship with Certicom. RIM's Strategic Alliances Group undertook corporate development work, including investigating companies that were potential targets for acquisitions.
While the witnesses gave varying testimonies of what exactly was said, the OSC, upon examining the evidence, held that Donald learned of three facts from Wormald over dinner: RIM had been, but was not currently, engaged in confidential discussions with Certicom regarding a potential acquisition; RIM had an ongoing interest in acquiring Certicom; and Certicom's share price was undervalued based on its licensing agreements (the "Three Facts").
RIM's executives returned to RIM's offices that night at 11:30 p.m., and the next day Donald called his broker at 9 a.m. and placed an order for $300,000 worth of Certicom shares at a price not to exceed $1.55 per share. The Certicom share price, on August 21, 2008, was around $1.50 per share. Donald testified that on the morning of August 21, before calling his broker, he had researched Certicom's trading history, press releases, and financial reports online and came to the conclusion that Certicom was extremely undervalued. However, in examination by OSC Staff during their investigation, Donald had stated that "it looked like a good investment based on a discussion I had with a gentleman, Chris Wormald."2
Between August 21, 2008, and September 15, 2008, Donald acquired 200,000 shares of Certicom at a cost of $305,000, or $1.525 per share on average. On December 3, 2008, RIM announced that it would commence a hostile bid for Certicom at $1.50 per share. Following court hearings and a white knight bid, on March 23, 2009, a plan of arrangement between RIM and Certicom was implemented, under which RIM acquired Certicom for $3.00 per share. Donald therefore made a profit of $295,000.
the relationship between RIM and Certicom
Since 2000, RIM had been licensing Certicom's elliptical curve cryptography ("ECC") technology. The security provided by Certicom's ECC technology was extremely valuable to RIM's BlackBerry phones.
In 2007, Jim Balsillie ("Balsillie"), RIM's Co-CEO, had met with Certicom executives to propose that RIM purchase Certicom. In 2007 and 2008, Certicom provided RIM with several documents which were specifically deemed to be confidential, pursuant to non-disclosure agreements signed by both companies.
The negotiations stalled due to changes in Certicom's management. In March 2008, Balsillie emailed Certicom's new CEO, Karna Gupta ("Gupta"), to express interest in recommencing acquisition negotiations. Gupta replied that he had other priorities at the time and would contact Wormald regarding the acquisition after a few quarters.
Wormald was instructed by Balsillie to conduct research and due diligence on Certicom as a potential acquisition target. In July and August 2008, although acquisition negotiations between RIM and Certicom were no longer active, the Strategic Alliances Group of RIM continued to gather information on Certicom and assess the value and functionality of Certicom's patents and license agreements. It developed a slide deck with information on Certicom, entitled the Pitch Book, which was prepared for submission to RIM's senior management to brief them on a potential take-over bid for Certicom. However, as of August 20, the day of the golf tournament and dinner, no member of senior management had yet seen or reviewed the Pitch Book. Wormald characterized the status of the acquisition negotiations at that point in time as "frustrated," as Certicom was not prepared to continue negotiations in spite of RIM's interest.
After August 20, 2008, the Strategic Alliances Group continued its work on preparing for the potential acquisition. In September, Gupta advised RIM that it wished to restart discussions about a proposed strategic transaction. In October, Balsillie informed Gupta that RIM's board of directors had agreed to proceed with a negotiated transaction. In November, RIM's board of directors passed a resolution authorizing RIM to make a bid.
insider trading (section 76 of the Act)
Section 76(1) of the Act prohibits any person or company in a "special relationship" with a reporting issuer from trading in its securities with knowledge of a material fact or material change that has not been generally disclosed. Section 76(5) defines a person in a "special relationship" to include an officer of a "company that is proposing to make a take-over bid" for the shares of a reporting issuer, or an officer of a "company that is proposing to become a party to a reorganization, amalgamation, merger or arrangement or similar business combination" with the reporting issuer, or an officer of a company that is "engaging in or proposes to engage in any business" with the reporting issuer.
Accordingly, for the OSC to hold that Donald was in breach of the insider trading provisions of the Act, it had to conclude that Donald was in a special relationship with Certicom and had knowledge of an undisclosed material fact at the time of the trade.
The OSC reviewed prior decisions on the requirements for materiality, and applied the objective market impact test, which in this instance asks whether the Three Facts would reasonably be expected to significantly affect the market price or value of Certicom's securities.3 The OSC held that the Three Facts were collectively a material fact. Consistent with prior decisions,4 the OSC held that materiality is an issue to be determined by the OSC and it gave no weight to the opinion, as to the materiality of the facts, of an expert retained by Donald.
The OSC also rejected the application of the probability/magnitude test from U.S. jurisprudence;5 holding that the panel was not required to conclude whether at August 20, 2008, there was a substantial likelihood that RIM would acquire Certicom. The OSC however applied, by analogy, the "American reasonable investor test,"6 holding that a reasonable investor, understanding the importance of Certicom's security technology to RIM and the wireless industry and understanding that the information was being received from the person overseeing the analysis of whether Certicom should be acquired who in turn believed Certicom to be undervalued, would likely consider the Three Facts to be important in making investment decisions with respect to Certicom shares.
In deciding whether Donald was in a "special relationship" with Certicom, the OSC found the reasoning in Basic v Levinson7 and Re Donnini8 helpful. The US Supreme Court decision of Basic v Levinson held that, in assessing the materiality of merger negotiations, a fact finder will generally need to look to indicia of interest in the transaction at the highest corporate levels. In Re Donnini, the Ontario Divisional Court held that whether contingent or speculative events constitute material facts or material changes depends on the particular circumstances and facts. In that case, the Court upheld the OSC's holding that the respondent's knowledge about a potential transaction constituted knowledge of material information, because although Donnini was not aware of all the specifics of the proposed transaction, he knew that negotiations were being conducted at the highest levels of the parties and that the negotiations "were actual and serious". The discussions about the transaction were well beyond expressions of mutual interest and had reached the stage of negotiating the finest of points. While these cases were in the context of materiality, the OSC found it informative to the analysis of whether or not RIM fell under section 76(5) because it was "proposing" to make a take-over bid or other business combination for Certicom. The OSC held that, in order for the "proposing" requirement to be met, "there must have been some significant level of involvement and approval of the process at the highest corporate levels at RIM."9 In other words, "RIM must have made a decision to propose a take-over bid or business combination with Certicom for subsection 76(5)(a)(iii) to apply."10
Although Balsillie had previously been engaged in acquisition negotiations with Certicom, his direct communications with Certicom stopped following Gupta's email of March 26, 2008. As of August 20, Balsillie and other senior executives had never reviewed the Pitch Book or the other work prepared by the Strategic Alliances Group regarding Certicom. Although the Strategic Alliances Group was evaluating the merits of a take-over bid for Certicom, Wormald was the only officer involved in the process, and his involvement was only periodic and supervisory. Prior to August 20, Balsillie never advised Wormald as to whether or not RIM should acquire Certicom.
Considering all these circumstances, the OSC held that, as of August 20, RIM's interest in Certicom had not yet evolved into a "proposal" to acquire Certicom. Therefore, the requirement for "proposing" a take-over bid or a reorganization, merger, or other similar business combination was not met.
OSC staff also argued that Donald was in a "special relationship" with Certicom by reason of section 76(5)(b) of the Act since RIM was "engaging in" or proposing to "engage in" business with Certicom. OSC Staff argued that this provision was applicable because RIM had an ongoing business relationship with Certicom through licensing agreements and there was no "requirement that the business activity … relate directly to a potential transaction."11 The OSC rejected Staff's argument and held that "there must be a more clear connection than exists in this case between the business engaged in or proposed to be engaged in and the alleged material facts"12 in order to find a person to be in a special relationship.
As a result of the OSC holding that RIM was not in a special relationship with Certicom, neither Wormald nor Donald could be found to be in a special relationship with Certicom, either as officers of RIM or, in Donald's case, through learning of a material fact from another officer of RIM. Therefore, Donald was held to not have contravened the insider trading provisions of the Act.
conduct contrary to the public interest (section 127 of the Act)
The OSC reviewed case law holding that the public interest jurisdiction under section 127 serves the purposes of protecting investors from unfair, improper or fraudulent practices, and to foster fair and efficient capital markets and confidence in capital markets. Even if there is not a technical breach of the provisions of the Act, the OSC may still hold that the conduct of a respondent is contrary to the public interest where the purposes of securities law are undermined.13
The OSC cited, with approval, Re Seto,14 where the Alberta Securities Commission (the "ASC") held that conduct contrary to the public interest could be established even though the accused was not liable under insider trading provisions. In that case, the issuance of options to insiders of an issuer at a time when the issuer had been notified that it would be subject to a take-over bid was not technically in breach of the legislation.15 Nonetheless, the ASC exercised its public interest jurisdiction to find the respondent CEO liable for profiting from material information that was not generally disclosed. The OSC adopted the ASC's holding that not addressing trades based on undisclosed material information obtained through an officer's position would undermine the integrity of the capital markets.
The OSC concluded that Donald knew that the information he learned from Wormald was confidential and had not been generally disclosed, and if the information had been generally disclosed, it would have significantly impacted the price or value of Certicom's shares. The OSC found that Donald must also have known that the information was provided to him from Wormald confidentially with the expectation that Donald would not use it for personal profit.
The OSC held that by purchasing Certicom shares with knowledge of material facts that were not generally disclosed, Donald clearly failed to meet the high standard of behaviour that is expected of market participants and officers of public companies. The OSC noted that the facts in this case were highly unusual: although RIM was not, on August 20, proposing to make a take-over bid, it had an ongoing interest in Certicom as a potential acquisition target and was actively analyzing confidentially obtained information about Certicom.
In being one of the few decisions of the OSC to analyze whether a person is in a special relationship with a reporting issuer, the decision in Re Donald is important.
With respect to interpreting the word "propose" in section 76(5) of the Act, the OSC held that there must be a significant level of involvement and approval at the senior management or board level. The OSC, however, did not conclude that such involvement and approval had to be expressed to the other party to a prospective transaction. Accordingly, if senior management or a board of an issuer proposes to make a takeover bid for another company, regardless of whether this intent is disclosed to another party, an insider of the issuer may be considered to be in a special relationship with the target.
The decision of the OSC is helpful with respect to whether one is "engaging in" a business for purposes of section 76(5)(b) of the Act. Staff of the OSC had asked for a literal reading of that provision. The OSC, however, rejected that proposition and held that there must be a "clear connection" between the business being engaged in and the material information. While the OSC did not give guidance on what a "clear connection" is, the decision is nonetheless helpful for practitioners and public companies.
The conclusion that the Three Facts collectively constituted a material fact may be considered troubling even if one was to agree that the exercise of the public interest discretionary power of the OSC was warranted. Although the OSC was presented with unique facts, it appears to have set a low threshold for the determination of a material fact.
It is also important to note that RIM had not, as of August 20, imposed a blackout period under its insider trading policies and the OSC made no comment on this matter.16 In embarking upon an M&A process, issuers must be cognisant of the Re Donald decision. In order to protect public companies and their insiders, senior officers and boards must now consider whether it is prudent to impose blackout periods very early on in an M&A process.
1 Re Paul Donald (2012), 35 OSCB 7383 [Re Donald].
2 Ibid at para 56.
3 Re YBM Magnex International Inc (2003), 26 OSCB 5285 at para 91 [YBM]; Re Coventree Inc, Geoffrey Cornish and Dean Tai (2011), 34 OSCB 11374 at para 149 [Coventree].
4 Re Biovail Corp (2010), 33 OSCB 8914 at para 213 [Biovail]; Coventree, supra note 3 at para 157.
5 Re Donnini (2002), 25 OSCB 6225 at para 131 [Donnini], citing Securities and Exchange Commission v Texas Gulf Sulphur Co, 401 F 2d 833 (2d Cir 1968). The probability/magnitude test determines whether a fact relating to a speculative event is material by balancing the probability that the event will occur and the anticipated magnitude of the event. Even if there is a low probability of the speculative event occurring, the fact may still be material if the potential magnitude of the event is sufficiently large.
6 YBM, supra note 3 at para 92, citing TSC Industries Inc v Northway Inc, 426 US 438 (1976).
7 Basic Inc v Levinson (1988), 485 US 224, 108 S Ct 978 (US Ohio).
8 Re Donnini (2003), 177 OAC 59 (Div Ct) [Donnini (Div Ct)].
9 Re Donald, supra note 1 at para 214.
10 Ibid at para 234.
11 Ibid at para 239.
13 Committee for Equal Treatment of Asbestos Minority Shareholders v Ontario (Securities Commission),  2 SCR 132 at para 41; Biovail, supra note 4 at para 382.
14 Re Seto, 2003 LNABASC 81.
15 Ibid at para 40. The respondent Richard Seto, as a director of the issuer Inter-Tech Drilling Solutions Ltd., was issued options to purchase shares of Inter-Tech through a share option plan. Section 147(b)(i) of the Securities Act (Alberta) provides that the insider trading provisions do not apply where the purchaser reasonably believed that the other party to the sale of the securities had prior knowledge of the material facts. The ASC held that section 147(b)(i) applied, because Seto and Inter-Tech were both aware of the material facts at issue. However, the ASC characterized the situation as a technical gap in the legislation, because the legislation addresses the harmless situation of trading between two investors who each know of the undisclosed material information, but overlooks the harmful possibility where the "other party" is the issuer itself and the purchaser is actually a director causing the issuance of securities to be made.
16 In fact, RIM had not yet retained outside counsel.
by Paul D. Davis and Gideon Ng, summer law student
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a cautionary note
The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.
© McMillan LLP 2012