Most people think that insider trading is trading on undisclosed material information. This is not legal advice, but such a view is not correct: you can trade on undisclosed material information. What you cannot do is trade on undisclosed material information while you are in a special relationship with the company that you have undisclosed material information about. So, if you're in possession of undisclosed material information about a company, a useful question to ask yourself is, Am I in a special relationship with that company?
To which I direct you to Section 76(5)(e) of the Securities Act (Ontario) where the term "special relationship" is defined in the Ontario Securities Act. Contrary to your hopes and dreams, it's defined broadly. Included in the definition of special relationship are: insiders, affiliates and associates of the company, persons engaged in business or professional activity with those insiders, affiliates and employees, or directors, officers or employees of any of those parties.
I am not one of those things, you may say. To which I respond: but did you learn of this fact from someone who is or someone who you reasonably ought to have known is? If so, you're in a special relationship and cannot trade.
In short, you can't shield yourself from insider trading liability through willful ignorance even if insider trading liability still requires that, somewhere down the line, there was a more concrete special relationship.
The Ontario Securities Commission's amended statement of allegations against Paul Azeff, Korin Bobrow, Mitchell Finkelstein, Howard Jeffrey Miller and Man Kin Chengargues there was a concrete special relationship. The OSC wants to go further than that, however: it wants to look down the special relationship rabbit hole not one but five levels. It is legal broken telephone, only the OSC has good reason to believe that the message was getting through loud and clear.
Mitchell Finkelstein, a former partner at the law firm Davies Ward Phillips and Vineberg, is accused of supplying Paul Azeff, his former University of Western Ontario fraternity brother and a former CIBC World Markets broker, with undisclosed material information about various transactions. The case has not yet been heard in front of the OSC, nor have the allegations been proven. The OSC alleges that Mr. Azeff would take that information and buy large volumes of shares. According to the statement of claim, Mr. Finkelstein would then deposit large numbers of hundred-dollar bills in his bank accounts. Obviously, Mr. Finkelstein was under a duty of strict confidentiality not to disclose material information about his clients and, equally as obviously, Mr. Azeff knew or should have known this. Under these facts, the OSC has made out a claim for insider trading against both Mr. Finkelstein and Mr. Azeff.
This is where the insider trading charge gets a bit more complicated. Despite Mr. Azeff not having a direct relationship with any of the companies he allegedly traded in, under section 76(5)(e) of the Securities Act, anyone who traded on information from Mr. Azeff, who knew or ought to have known that Mr. Azeff received information from Mr. Finkelstein, would have been in a special relationship with the company and therefore liable for insider trading.
In short, Mr. Finkelstein had become insider trading patient zero and, as in a viral outbreak , was capable of spreading his liability through Mr. Azeff's investment advice.
Indeed, the OSC charges that Mr. Azeff spread the liability promiscuously. So promiscuously that the complaint requires a flow chart detailing how the information moved between parties.
First, Mr. Azeff allegedly supplied his partner at CIBC World Markets Korin Bobrow with the information, which the OSC says caused Mr. Bobrow to trade on the information. Mr. Azeff is also said to have told the mysterious "Client A" (who is presumably one of the persons who is helping the OSC with the investigation) material undisclosed information.
Client A is then alleged to have fed information to Howard Jeffery Miller, an investment dealer at TD Waterhouse Canada Inc. The OSC charges that Mr. Miller himself proceeded to trade on this information and provided this information to clients.
Mr. Miller is then accused of passing this information along to Man Kin Cheng, a colleague of his at TD. And, you guessed it, Mr. Cheng allegedly proceeded to trade on that information and is now being charged with insider trading by the OSC.
To recap the allegations: Mr. Finkelstein told Mr. Azeff who told Mr. Bobrow and Client A (who is not being charged) who then told Mr. Miller who told Mr. Cheng. And yet, the only one of those persons who actually was doing business with any of the companies that were traded on was Mr. Finkelstein. At the very end of the chain, Mr. Cheng is being accused of liability because he knew or should have known that Mr. Miller knew or should have known that Client A knew or should have known that Mr. Azeff knew or should have known that Mr. Finkelstein was in a special relationship with each company! It's no wonder the complaint needed a flow chart.
One would think that five layers would be a shield for plausible deniability. And, in other cases, it might be.
Except, e-mail. With respect to one of the transactions, Mr. Miller wrote in an e-mail to a client "call me I have a tip … stock trades on TSX at around $34 – cash takeover of $40 Timing should be before xmas but you never know with lawyers." Oof. Not only does the e-mail allegedly show that Mr. Miller knew precise information about an unannounced deal, but there's an implication in the e-mail that he may have heard the information from a lawyer. If that is the case, that information can likely be traced all the way down. Mr. Miller not only wrote that he had material non-public information but that he knew the source of the information was a lawyer. It's not an unfair inference that the people who had the information before Mr. Miller also knew the information was coming from a lawyer. Double oof.
Similarly, Mr. Cheng wrote to a client that he was buying one of the stocks for clients and a "20% return is expected before Christmas" and the company is "a takeover target and I was told that it'll be done at Cdn. $40.00 before Christmas." At least he didn't mention that the information was coming from a lawyer.
The OSC says they traded stock quickly and in high volume. They deposited $100 bills into the bank. They expanded the web of people who knew the information. And, worst of all, one of them put it all down in an e-mail.
The lesson here is that our insider trading laws potentially allow the OSC to extend liability very far. Section 76(5)(e) is a potentially powerful weapon.