Significant shareholders and activist investors in Canada may find themselves working closely with the issuer that they have invested in, whether that be through one or more seats on the issuer’s board of directors, extensive access to the issuer’s management and advisors, or through other meetings and/or access that may be made available to them. These interactions often put significant shareholders and activist investors in contact with non-public information, which in some cases may be “material.”
Generally, Canadian securities laws prohibit a person or company in a special relationship with an issuer from purchasing or selling securities with knowledge of material information that has not been generally disclosed to the public.[1] Further, Canadian securities laws also prohibit a person or company in a special relationship with an issuer from “tipping” or informing another person or company of material information that has not been generally disclosed, other than in the necessary course of business.[2] Securities laws classify those in a special relationship with an issuer broadly to include the issuer’s directors, officers, affiliated corporations and beneficial owners of voting securities carrying more than 10% of the voting rights attached to all voting securities of the issuer. Therefore, and as a result of access to material non-public information (MNPI), significant shareholders and activist investors may face an increased risk of violating, or being alleged to have violated, insider trading and tipping laws unless appropriate risk management policies and processes are established.
Establishing protocols and procedures protecting MNPI about an issuer may be particularly challenging for shareholders and investors that are not individuals but rather investment firms, private equity funds or other asset management companies with multiple overlapping lines of communication within their own organization, as well as across various issuers. This article will consider situations where this issue may arise, the need for potential policies and procedures to help prevent such issues from arising and how such policies and procedures may assist where trading prompts a securities regulatory investigation or related litigation.
Know more about what is asset management, and some of the governing laws of Canada on asset management.
Why is there a high risk of insider trading contraventions for significant
shareholders and activist investors?
Significant shareholders can be entities with uniquely vested interests in both the business of an issuer, as well as their own business and affairs. As such, they may have conflicting responsibilities and interests when acting in their different capacities, and in particular with respect to how they use an issuer’s MNPI. This conflict becomes increasingly complex when the best interests of the issuer and that of the significant shareholder are blurred. Thus, under these circumstances, there is a risk that insider trading or tipping may occur, whether intentionally or inadvertently.
Significant shareholders that have board nomination or board observer rights should be aware that their nominated representative is in a “special relationship” with the issuer and the representative may be considered an “insider” of the issuer if, for example, the significant shareholder holds more than 10% of the voting rights of the issuer.[3] Information and prospective changes of the issuer discussed in board meetings and internal correspondence may seem relevant for the significant shareholder’s obligations to report back to their organization; however, in many cases, reporting back such information to the significant shareholder’s organization must be carefully structured, otherwise it may support an allegation of prohibited “tipping” under securities laws that is not exempt as information conveyed in the necessary course of business.[4] Examples of disclosure in the necessary course of business include communications with vendors, suppliers, lenders, legal counsel, auditors, government agencies and non-governmental regulators, among others. These communications should be analyzed on a case-by-case basis based on the specific nature of the business to determine if it meets the definition of “in the necessary course of business.”
Determining when sharing material information is in contravention of securities laws can be challenging if left to the responsibility of the person acting as a director, officer or employee of the issuer without clear and structured policies to inform their judgment. In particular, it can be hard to navigate the line between prohibited insider tipping of material information that has generally not been disclosed and reasonable conveyance of information of an issuer to a significant shareholder in the necessary course of business, or conveyance of material information reasonably believed to have already been generally disclosed.[5] Accordingly, issuers should have policies and procedures in place to make it clear how directors, officers and employees should conduct themselves, including a disclosure policy, insider trading policy and a code of conduct policy.
Significant shareholders may also contravene securities laws when trading in the securities of an issuer if one or more of their nominated representatives are privy to MNPI about the issuer, as the significant shareholder could be deemed to possess the same knowledge as their nominated representatives.[6] Similarly, any nominated representative of a significant shareholder that holds a position or line of internal communication with an issuer must restrain from using any information learned through such avenues to encourage or discourage their company from making a trading decision.[7] Similar issues with respect to trading based on any MNPI would also apply to the individual employees within the significant shareholder’s organization.
Insider trading risks should also inform the advocacy and decision-making methods of activist investors who may be interested in building a block of shares in favour of a particular voting outcome regarding matters concerning the issuer. When reaching out to other shareholders, activist investors would need to be careful to avoid “tipping” concerns if they are in possession of MNPI about the issuer.
Failing to duly protect and properly manage the communication of MNPI or changes across shareholder companies may result in significant legal penalties as imposed by relevant securities regulators under securities laws and almost always will result in devastating reputational repercussions for a shareholder company. Even if an insider trading or tipping event involves a small number of individuals, such lack of corporate oversight will undermine other shareholders and the market’s faith in a company’s operational competency and trustworthiness.
For all of the above reasons, a significant shareholder with regular access to MNPI about an issuer must be both vigilant and forward thinking about how such information is communicated and stored within its own internal organization and by its corporate representatives involved with the issuer, and should have policies and procedures in place to help address and mitigate these risks.
Compliance policies and procedures for issuers, board members and investors
A significant shareholder or activist investor with access to MNPI should establish internal “walls” and other policies and procedures to ensure that such information is not shared with, or accessible by, other members of their organization. These internal policies can include restricted trading lists, reminders regarding insider trading prohibitions and a contact person to address any questions or concerns. Significant shareholder companies may also consider self-imposed blackout periods, including periods of time around an issuer’s board meetings and earnings releases. Further, to ensure a robust risk management program, the policies should be accompanied by training sessions and policy compliance monitoring.
Issuers can also ensure that any board observers from significant shareholders comply with the issuer’s corporate governance policies (including insider trading policies). This should be negotiated and discussed in the board observer agreement. Issuers may also institute blackout trading periods during certain times and around key events. However, issuers should be cautioned that if they are relying solely on blackout periods, a number of insider trading-type situations may arise or continue past a reasonable blackout period window.
Board nominees should be particularly careful regarding the duties owed to the issuer while on the board (and how they potentially conflict with the loyalties owed to the party that nominated them). In particular, board nominees should remember that they owe a fiduciary duty and a duty of confidentiality to the issuer under corporate law. A nominee director may be able to share confidential information with its nominating shareholder, if that is the expectation of the parties, but often the expectations are vague or unclear. Nominees should strongly consider getting the issuer’s consent before disclosure of such information to the nominating shareholder representative. Further, even when the information is disclosed, there should be adequate procedures at the shareholder representative’s organization to ensure disclosure is limited to those with a need to know, and with restrictions in place to restrict the organization or parts of the organization from acting on such information.
Strong policies, procedures and practices are important not only for compliance purposes, they serve as critical risk management tools for significant shareholders and activist investors in the event that one or more trades prompts a securities regulatory investigation. Robust written policies, procedures and practices may assist in preventing investigations from becoming enforcement proceedings, increasing settlement opportunities with the regulator, reducing any penalties imposed and protecting against reputational risks that may stem from findings made about a company’s culture of compliance and corporate hygiene. Beyond these regulatory and reputational risks, memorialized compliance with such policies and procedures narrows litigation risks for significant shareholders and activist investors, including those related to class actions for insider trading.
The authors would like to thank Bennett Wong, Partner, Brandon Barnes Trickett, Partner, Jason Roberts, Knowledge & Legal Operations Lawyer, Hannah Bourgeois, Articling Student, and Anthony Berlingieri, Articling Student, for their valuable research and contributions to this article.
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Eric Lung is a partner practicing in Dentons’ Vancouver office and is a member of the Securities and Corporate Finance group. Eric's practice is focused primarily on corporate, securities and transactional matters, with a particular emphasis on mergers & acquisitions, financings and corporate reorganizations. He has assisted public and private companies in various types of transactions, including acquisitions and divestitures, arrangements, public offerings, private placements and joint ventures. In addition, Eric has comprehensive experience advising clients on a variety of securities law, corporate governance and strategic matters, as well as general corporate and commercial matters. Eric’s industry experience includes mining, cannabis, manufacturing, health care and consumer products.
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Michael C. DeCosimo is a partner in the Corporate group at Dentons. Michael practices corporate and securities law with an emphasis on corporate finance, mergers & acquisitions, corporate governance, investment funds, private equity and venture capital. He has acted as issuer’s counsel on over 75 initial public offerings (including companies and structured products) and other public and private offerings, raising aggregate gross proceeds of over $8 billion. Michael also acts for underwriters and agents in connection with public and private financings. He offers significant experience advising companies ranging in size from start-ups to multinationals and serves as a trusted advisor to senior executives of public and private companies and investment funds, boards of directors and independent review committees on all aspects of transactions, corporate governance, disclosure and reporting requirements, risk management and compliance. Michael also has extensive expertise in drafting and negotiating agreements, policies and incentive plans for senior executives and directors.
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Kelly is co-leader of both the Litigation and Dispute Resolution group in Calgary and the Privacy and Cybersecurity subgroup, she is also a member of the Privacy and Cybersecurity group. An experienced commercial litigator, Kelly has particular expertise in class action defence, shareholder disputes, cyber breach coaching, cyber risk analysis, governance best practices, professional negligence, and regulatory investigations. Kelly represents a diverse group of clients in industries including finance, real estate, energy, cannabis, agribusiness, health care and consumer products. She has appeared before all levels of court in Alberta and British Columbia, as well as the Alberta Securities Commission, the Alberta Utilities Commission, IIROC and the Office of the Information and Privacy Commissioner.
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Raphael (He/Him/His) is counsel in Dentons’ Litigation and Dispute Resolution group. He specializes in capital markets regulatory investigations and proceedings. He provides clients and colleagues with advanced legal research, written advocacy, and tactical analysis and advice. Raphael specializes in complex regulatory and corporate/commercial matters with a focus on securities, banking, and shareholder disputes. Prior to joining Dentons, Raphael spent several years practicing at another leading Canadian law firm, and more recently has gained experience as a prosecutor in the Ontario Securities Commission's Enforcement Branch, and as Senior Litigation Counsel for a top tier bank. Raphael has appeared before courts and tribunals across Canada, including all levels of court in Ontario, the Ontario Securities Commission, the British Columbia Court of Appeal and the Supreme Court of Canada. Raphael is committed to improving diversity and inclusion within the legal profession and the broader community. He leads the Dentons Canada Black Professionals Network. He is also an active member of the Canadian Association of Black Lawyers’ Advocacy Committee.