Insider Trading and the Use of Evidence: Walton v Alberta
In Walton v Alberta (Securities Commission), 2014 ABCA 273, the Alberta Court of Appeal (“ABCA”) was asked to assess an Alberta Securities Commission (“ASC”) decision. The ABCA’s rejection of some of the ASC’s conclusions demonstrates the complications security regulators face when applying the law of insider trading and its related provisions.
The Facts and Law
The ASC determined that various parties breached at least one of the following three insider information prohibitions contained in the Securities Act, RSA 2000, c S-4 [Act]:
- “ … trading in the shares of the reporting issuer with knowledge of a material fact that has not been generally disclosed, sometimes called “insider trading”: s. 147(2);
- … disclosing the material fact to others, before the material fact has been generally disclosed, sometimes called “tipping”: s. 147(3); [and]
- … recommending or encouraging others to trade in securities of the reporting issuer before the material fact is generally disclosed: s. 147(3.1)” (para 14).
A material fact, according to the Act, “means a fact that would reasonably be expected to have a significant effect on the market price or value of the securities … ” (s. (1)(gg)). In this case, the alleged information involved a potential takeover of Eveready Inc. by Clean Harbors Inc.
While this case involved numerous appeals from different parties, this post focuses on the ABCA’s treatment of two particular issues:
- The appeal by Holtby, a director of Eveready, of the ASC’s decision that he encouraged Landsiedel to purchase Eveready shares; and
- The appeal by Shepert, a friend of Holtby’s brother, of the ASC’s decision that he committed insider trading by purchasing shares after being told about the takeover by Holtby’s brother, who allegedly learned of it from Holtby.
The Holtby Appeal
The ABCA found that part of the ASC’s treatment of Holtby was unreasonable. In their decision, the ASC started from the proposition that the three offences were “strict liability offences because there is no requirement to prove mens rea … Thus … there is no requirement that an alleged informer or recommender or encourager know or intend that the recipient will buy or sell the particular securities” (para 49).
The ABCA held that adherence to this proposition was a mistake. While the ASC’s interpretation of trading and tipping (offences 1. and 2.) was accurate, the third offence required more than mere knowledge. According to the ABCA, “[t]he ordinary meaning of ‘recommending or encouraging’ includes some intention to convey information with the expectation that it might be relied on” (para 50).
Therefore, the determination that Holtby had encouraged, but not tipped, Landsiedel was unreasonable. That conclusion relied too much on speculation (paras 67-68), incorrectly presumed motives (para 69), and other impermissible inferences (paras 70-71). Such evidence was too imprecise to satisfy the intent requirement of s. 147(3.1). As described by the ABCA:
The Commission Staff had to prove that Holtby said something that he knew or should have known would likely motivate Landsiedel to go out and purchase Eveready shares…The Commission never made a finding about Holtby’s state of mind, and indeed on this limited record it would have been impossible to find he had the requisite intention to “encourage or recommend”… The Commission was entitled to draw inferences about what the appellants said to each other, but only if there was evidence to support those inferences. Evidence that Holtby may have said generically positive things about Eveready cannot be turned into a finding that he told Landsiedel about the Clean Harbors takeover, nor that he recommended or encouraged the purchase of Eveready shares (paras 78-80).
The Shepert Appeal
The ABCA found that these allegations were also unfounded. The ASC felt that Shepert had been “tipped” by Holtby’s brother (Dale Holtby), and used this as the basis to determine he had committed insider trading. The determination that he had been tipped rested on two key findings:
- “The 50-year close and trusting personal relationship between Dale Holtby and Shepert and the substantial investment in Eveready made by Shepert [was, in the ASC’s] view, more consistent with Dale Holtby having informed Shepert of the non-public Proposed Acquisition than with recommending or encouraging Shepert to purchase Eveready Shares” (para 95); and
- Shepert’s defense of the accusation was not worthy of belief. The ASC thought it “reasonable and logical to infer that Shepert would have questioned, and did question, his long-time close friend Dale Holtby as to why he had decided to purchase Eveready Shares, and why through Shepert’s trading account” (para 104).
While the ABCA took issue with numerous aspects of the Shepert’s indictment, those two components were particularly problematic because they demonstrated an impermissible use of evidence. In particular, the ABCA felt that “evidence of a relationship … is at most evidence of opportunity, or perhaps motivation, and even then it is weak” (para 95). The mere existence of a friendship could not be used to make such a strong conclusion.
Further, the ABCA took issue with the ASC’s use of Shepert’s defense. Shepert, in defense of the accusation that he had been tipped by Dale, admitted to limited discussion with Dale about Eveready. The ASC used that interaction to infer that Shepert must have asked illicit questions, and then used that inference to ground the charge of insider trading. This reasoning was problematic because it “essentially turned Shepert’s disbelieved denial into positive proof … There was simply no evidence on the record to support the inference that any such questioning took place … [I]n the absence of any such evidence [the ASC’s conclusion] was bare speculation” (para 104).
Like Holtby’s charges, the ABCA found the evidentiary base of Shepert’s alleged culpability too limited to support the ASC’s conclusions.
This case is remarkable for several reasons. First, it is an appellate level court overturning part of a highly specialized tribunal’s interpretation and application of its constituting statute. For that reason alone it is noteworthy.
However, that is not the most striking component of these appeals. A more practical insight relates to the ABCA’s frustration of the ASC’s use of evidence. The fundamental problem with the ASC’s decision was, in essence, its interpretation of the facts. In the two instances, the ABCA found the ASC’s conclusions to not be a reasonable possibility.
In this way, these appeals exemplify the difficulty of proving insider information offences. No one disputed that “charges of illegal trading can be proven by circumstantial evidence” (para 25). The problem, in this instance, was the particular use of the particular evidence. The ASC simply stretched what they had too far. But what else was the ASC to do? The ABCA recognized that “it is often only possible to prove insider trading based on inferences drawn from the conduct, and particularly the trading activity, of those involved” (para 25). If the ASC’s expert analysis of such information is inadequate, how are they to enforce the law? If such provisions are not enforced, it is hard to argue that the protection afforded by the Act is not severely undermined.
To be clear, I do not criticize the ABCA’s decision. My intent, instead, is to draw attention to a potential shortcoming of the regulation of insider information: if the ASC’s analysis of the facts cannot be trusted, how are the relevant provisions to be enforced?