Prosecuting illegal insider trading requires a certain amount of finesse. Illegal insider trading law gives prosecutors a number of buttons they have to press in just the right way to get a conviction. There isn't just one way to push a button, however, if they're creative about it. In particular, the "material fact" element of illegal insider trading may be able to reward a prosecutor who is willing to make more creative, but legally sound, arguments.
That's one lesson from a three judge panel of the Alberta Securities Commission's recent decision in In Re: Hagerty, a decision absolving a husband and wife of illegal insider trading allegations. It seems that a more finessed argument about the "material fact" in the case could have resulted in a conviction. Whether that conviction would have been fair, of course, is an entirely different question.
The facts of the Hagerty decision look complex but are really fairly simple. Sherry Hagerty and her husband Gary both worked at Pembina Pipeline Corporation. Pembina transports crude oil and natural gas. In 2012, Pembina completed an acquisition of Provident Energy Ltd, a publically traded midstream oil and natural gas firm that managed infrastructure and logistics for other midstream companies such as Pembina.
The case alleged that Mr. Hagerty bought a bunch of Provident shares right around the time Mrs. Hagerty had acquired knowledge of the Provident transaction. ASC staff thought that this was because Mrs. Hagerty had told Mr. Hagerty of the Provident transaction before he had made the trade or had encouraged him to make the trade with knowledge of the Provident transaction.
The panel disagreed, finding that Mrs. Hagerty lacked the requisite knowledge to insider trade.
To show illegal insider trading, ASC staff had to prove that Mrs. Hagerty was in a special relationship with Provident, she knew material non-public information about Provident, and that she supplied Mr. Hagerty with that information or encouraged him to trade in Provident. Also, for one version of the claim, ASC staff would have to show that he actually traded.
Much of this was not in dispute. Mr. Hagerty traded, and Mrs. Hagerty was in a special relationship with Provident as an employee of a company that was planning to merge with Provident. Mrs. Hagerty had also encouraged Mr. Hagerty to trade in Provident's securities. The only question was whether Mrs. Hagerty knew the material fact that Pembina was going to acquire Provident.
In its decision, the panel makes it clear that Mrs. Hagerty knew a lot. She knew that there was consolidation taking place in the midstream oil and natural gas market. She knew that Pembina was considering expanding its role in Provident's area of the market. She knew that Pembina had explored other transactions and that Provident was a likely target. Mrs. Hagerty also knew from an e-mail exchange with one of Pembina's in-house lawyers that Pembina was looking for contracts that would typically be provided as part of a transaction, not a standard end of year review, and that the lawyer's search for these contracts meant that Pembina was putting together a "virtual data room" – a secure internal website where lawyers and financial advisors can log in to conduct due diligence. Indeed, she said as much in an e-mail (which she characterized at trial as "a joke").
The ASC panel found that this level of knowledge didn't amount to "concrete knowledge" of the Pembina-Provident combination. And this seems broadly correct. While a review of the case reveals some sketchy action by the Hagertys, it's hard to conclude from the facts that it's more likely than not that they had concrete knowledge of the combination.
OK. Good. But the legal standard is not "concrete knowledge of a material transaction"; it's knowledge of "a material fact [about a public company] that has not been generally disclosed." And – according to the ASC in paragraph 124 – a "material fact" is "'a fact that would reasonably be expected to have a significant effect on the market price or value of' a security."
So, if Mrs. Hagerty knew such a material fact that would reasonably be expected to have a significant effect on Provident's share price and she provided Mr. Hagerty with such a fact, in violation of her special relationship with Provident (remember, the special relationship merely requires that she's employed by PPC who is acquiring Provident, not that she was both employed and knew of the material fact) she would have illegally insider traded. The big question is then, Was there such a fact?
Of course there was: the existence of the data room! I exaggerate, but only slightly. The critical question – which goes unexamined by the panel – is whether public knowledge of the existence of the data room at Pembina being populated with out of the ordinary contracts would have moved the market price of Provident. If it would have, then the Hagertys insider traded.
This is, of course, an empirical question and it's one the ASC staff could have pushed. Provident didn't have a large number of competitors and was a likely takeover candidate. There's a great argument that information that a likely acquirer of Provident was getting ready to make an acquisition would have moved Provident's market price. And price movement is all we need for materiality. If the ASC's staff really wanted the conviction, it should have forced the panel to grapple with the consequences of the market definition of materiality.
Of course, this argument may strike you as a bit unfair. It strikes me as a bit unfair. It's creative and fun and, yeah, technically accurate, but it seems a bit nasty to convict someone of illegal insider trading because she knew about a data room. As a matter of equity then, it seems to me that the ASC panel was pretty much right.
As a matter of law, however, neither ASC staff nor the panel attempted to fully use our legal definition of materiality. While the panel may not have found that knowledge of the data room wouldn't have moved the market price of Provident, there's a pretty good chance it would have. And that may have made illegal insider trading convictions much easier to get in the future.
In that case, maybe the ASC staff wasn't being uncreative; maybe it was just showing a bit of providence in not opening up the Pandora's box of materiality.