Securities regulators pursuing allegations of insider trading typically allege not only that respondents have violated the statute but also that their conduct is contrary to the public interest. When a regulator fails to demonstrate a violation of the statute, what are the limits on using the public interest to punish conduct otherwise found to have been lawful? The decision of the Ontario Securities Commission (OSC) in Waheed^[1] may signal the OSC’s appetite to exercise more restraint than was seen in other recent cases in determining when the public interest standard has been satisfied.

 

The Waheed decision also brings home the resources that must be marshalled to seek vindication in a long, contested multi-party enforcement proceeding based on complex facts that are subject to conflicting interpretations. Even complete success on the merits does not entitle successful parties to be made whole for defence costs.

 

Summary of Facts

 

The facts and issues in this proceeding led to a 43-day contested hearing.

 

Baffinland Iron Mines Corporation (Baffinland) was a publicly traded junior mining company. Between February 18 and April 30, 2010, Jowdat Waheed was a consultant to Baffinland’s board and CEO regarding potential transactions to develop its mining property. In this role, Mr. Waheed had significant access to confidential information. He learned, among other things, that Baffinland was negotiating a potential strategic partnership with ArcelorMittal S.A. (ArcelorMittal) and that the negotiations were not progressing well.

 

Mr. Waheed was subject to a confidentiality agreement with Baffinland. In early July 2010, after his consulting assignment had ended, Mr. Waheed approached his friend Bruce Walter, an experienced dealmaker, about a potential acquisition involving Baffinland. They ultimately incorporated Nunavut Iron Ore Acquisition Inc. (Nunavut), with Mr. Waheed as its president and CEO, and Mr. Walter as its chairman. Nunavut acquired a toehold position in Baffinland in advance of launching a takeover bid on September 9, 2010.

 

Baffinland was eventually acquired in a joint bid by ArcelorMittal and Nunavut.

 

OSC Staff alleged that Messrs. Waheed and Walter^[2] (the Respondents) engaged in insider trading and tipping contrary to the Securities Act (Ontario) and conduct contrary to the public interest in connection with the purchase of Baffinland shares by Nunavut as a toehold position in advance of its takeover bid.

 

No Insider Trading and Tipping

 

The OSC dismissed the allegations of insider trading and tipping, and determined the following:

1. Although Mr. Waheed might have been aware of material facts in relation to the status and terms of the ArcelorMittal negotiations when he was Baffinland’s consultant, the circumstances had changed significantly and these facts were stale and therefore not material as of September 9 when Nunavut started its toehold purchases.
2. After his engagement as a consultant had ended, Mr. Waheed did not learn of any material facts in relation to the ArcelorMittal negotiations from Baffinland’s insiders. These negotiations were long, contentious and, for much of the period, inconclusive. The facts that Mr. Waheed gleaned were from external sources and represented inferences based on his experience in the mining industry and his understanding of the capital markets. He was acting as a broker trying to weave together from various sources an understanding of the circumstances that would translate into a professional assignment.

 

The OSC confirmed that the “market impact” test (i.e., would the facts be reasonably expected to significantly affect the market price of the securities?) governs the OSC’s assessment of the materiality of a contingent event. It rejected Staff’s argument that the “probability/magnitude” test (i.e.,balancing the probability of an event occurring with the magnitude of its impact on the issuer) should apply. Staff had argued that the Baffinland/ArcelorMittal negotiation was a material fact because even though the negotiations were not progressing well, if an agreement was reached, it would have had a material impact on Baffinland’s operations. The OSC held that, while the probability/magnitude test can be an aid to the assessment of materiality, the market impact test still governs.

 

No Contravention of the Public Interest

 

The OSC also dismissed allegations that the public interest was breached. These allegations were not based on breaches of the insider trading and tipping law in the Securities Act but rather on alleged breaches of confidentiality obligations that Mr. Waheed owed to Baffinland under the consulting agreement between them.

 

Staff had alleged that Mr. Waheed contravened the public interest by not acting in Baffinland’s best interests when, while still a consultant, he advised Baffinland’s major shareholder regarding a potential proxy contest against the incumbent board. In other decisions not involving insider trading or tipping issues, the OSC has accepted that breaches of analogous statutory duties can support public interest violations.^[3]

 

In Waheed, the OSC considered Mr. Waheed’s non-statutory obligations. The OSC determined that it was “beyond the scope of the [OSC’s] jurisdiction” to make any findings with respect to allegations that Mr. Waheed did not act in Baffinland’s best interest while acting as a consultant. As Baffinland’s board did not take any legal action against Mr. Waheed, the OSC concluded that there were no grounds to make a finding against Mr. Waheed for the purposes of investor protection or fostering fair and efficient capital markets and confidence in the capital markets.

 

Staff also alleged that the Respondents contravened the public interest because Mr. Waheed breached his duty of confidentiality to Baffinland when the Respondents used Baffinland’s material and non-material confidential information as a springboard to launch Nunavut’s takeover bid. Staff was, in effect, using Mr. Waheed’s confidentiality obligations^[4] to expand the insider trading and tipping statutory prohibitions, which apply only to material facts. In rejecting these allegations, the OSC determined the following:

1. The Respondents did not trade with knowledge of any material facts.
2. There is no statutory prohibition on trading on the basis of non-material confidential information, rumours, speculation and suppositions.
3. It was not prepared to adjudicate the breach of confidentiality allegations when Baffinland’s board, after careful consideration, decided against seeking any remedies. The OSC held that private law disputes should properly be left to the courts.
4. There was “no evidence of any harm suffered by investors or harm to the capital markets”. To the contrary, the price of the joint bid by Nunavut and ArcelorMittal represented a 87% premium over the price initially offered by Nunavut, and was near the high end of values that Baffinland’s banker estimated that the ArcelorMittal joint venture proposal represented.

 

Key Lessons

 

In recent years, securities regulators have increasingly expanded their reach under the public interest jurisdiction. In cases where Staff had failed to prove insider trading, the public interest power was arguably used to propound standards of behaviour that are not specifically mandated by the legislative scheme.

 

The outcome in Waheed represents a more restrained application of the OSC’s public interest jurisdiction in the context of insider trading allegations. It is likely to influence the way Staff proceeds in future cases. The following are some key lessons:

1. Respondents contesting insider trading and public interest allegations face serious reputational and financial costs even if they ultimately prevail after a contested hearing to settle disputed facts and legal theories. In Waheed, the Respondents needed to contest potentially career-ending allegations over a 43-day hearing with the benefit of legal representation. Similarly, in Stan,^[5], an Alberta case, the respondents’ “vindication” occurred four years after the relevant facts and only after the respondents’ “non-suit” motion failed, thereby forcing them to endure a costly 14-day contested proceeding in which the respondents, various officers of the issuer and three experts testified.
2. The power to prohibit conduct contrary to the public interest should not be used to restrain trading on non-material confidential information. In Waheed, the OSC determined that because the alleged conduct was not insider trading or tipping, the public interest would not be engaged to restrain trading on non-material confidential information, rumours and speculation. Contrast this outcome with the OSC’s approval of a settlement agreement in Moore.^[6] Mr. Moore, an investment banker, purchased securities of a company that he deduced was likely to be acquired. He never received any material, generally undisclosed information. Nevertheless, Mr. Moore agreed to breaching the public interest, and the OSC determined that his conduct fell “below the standard of behaviour expected from someone in [his] position and given his extensive experience in the capital markets industry”.
3. The broad application of the public interest power in cases like Donald^[7]continues to apply to market participants who trade on undisclosed material information. In Waheed, the OSC exercised restraint on two grounds in recognition of the unusual facts of this case. First, the OSC attached significance to the fact the Respondents were not “market participants” (a statutorily defined term that includes directors, officers and registrants) at the relevant time. Second, the OSC recognized that the capital markets and investors were not harmed by the Respondents’ conduct. The Respondents did not use undisclosed material information to exploit investors who, in fact, were not financially disadvantaged by Nunavut’s bid.
4. The OSC will generally decline to intervene in private law disputes in which other parties have remedies that they can enforce. In keeping with the OSC’s general policy, the OSC was not prepared to decide private claims using its public interest powers.

 

Although the OSC showed some restraint in applying its public interest power in Waheed, critical questions remains unanswered: when OSC Staff fails to demonstrate a violation of the statute, what are the limits on the use of the public interest to punish conduct otherwise found to have been lawful? If the detailed rules governing inside trading and tipping are not broken, is it right for a public interest case to be pursued? Notwithstanding Waheed, market participants should not discount the OSC’s willingness to flexibly apply the public interest power to establish liability in the absence of a statutory breach.

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^[1] McCarthy Tétrault LLP successfully represented Jowdat Waheed in this matter.
^[2]There was no insider tipping allegation against Mr. Walter.
^[3] For instance, see Canadian Tire Corp. (Re), 1987 LNONOSC 47 at 38, in which the OSC noted that although it was not the proper forum to determine breach of fiduciary duty allegations, the “showing of such a breach can be useful evidence to support facts which otherwise call for [public interest] intervention by the Commission.” Recently, in Crown Hill Capital Corp. (Re), 2013 LNONOSC 656, the OSC found that an investment fund manager and its CEO breached their fiduciary obligations to the fund under s. 116 of the Securities Act (Ontario).
^[4] The confidentiality provisions of the consulting agreement stated that Mr. Waheed would not use for his own account or disclose to anyone else any confidential or proprietary information or material relating to Baffinland’s operations or business to which he had access by virtue of his position with Baffinland or obtained from Baffinland or its directors, officers, employees, agents, suppliers or customers.
^[5] Stan (Re), 2013 ABASC 148.
^[6] Re Richard Bruce Moore, (2013), 36 OSCB 4455.
^[7]Re Paul Donald, (2012), 35 OSCB 7383. Mr. Donald traded on the basis of material information but was not in a “special relationship” with the issuer whose shares he purchased. The OSC nevertheless determined that his conduct was contrary to the public interest because he had failed to adhere to the “high standard of behaviour” expected of officers of public companies and did so in a manner that “impugns the integrity of Ontario’s capital markets.”