FACTORS FOR S 76(5)(e)

Excerpts from Finkelstein v Ontario Securities Commission, 2018 ONCA 61

Facts Considers the definition of a “person in a special relationship with an
issuer” found in s. 76(5)(e) as it applies to successive tippees who possess
material, non-public information about an issuer.

• On November 16, 2004 Finkelstein (Partner at Davies; Mergers & Acquisitions

Lawyer in TO) learned KKR and Masonite had agreed to a takeover transaction and
passed the info along to Azeff (Montreal) who in turn told others who would trade
on his behalf prior to the mergers being announced.
• Flow of info: Finkelstein informed an investment adviser friend in Montreal,
Paul Azeff, of material facts about the bid. In turn, Azeff informed a Montreal
accountant, L.K., who passed the information on to the appellant, Howard Miller, an
investment advisor in Toronto, who then conveyed the information to his associate,
Francis Cheng, an investment advisor at the same firm. (Azeff also conveyed the
information to Kevin Bobrow, his close friend and fellow investment advisor at the
Canadian Imperial Bank of Commerce in Montreal).
• LK provided evidence to the administrative proceeding that Finkelstein tipped
Azeff (and Azeff tipped him)
CURRENT APPEAL:
• Appeal of a decision by the OSC in an administrative proceeding in which
sanctions were imposed on individual tippees for violating s 76 both by purchasing
securities with knowledge of undisclosed material facts or material changes and by
further tipping others.
• The tippees who had been sanctioned did not, in fact, know that the immediate
source of the undisclosed inside info about the reporting issuer was a person in a
special relationship with that issuer.  Thus, their liability turned on whether or
not, in the language of s 76(5)(e), they nevertheless “ought reasonably to have
known” that the source of info was a person in a special relationship with the
issuer.

ISSUE: At issue on this appeal is the Panel’s interpretation and application of s.

76(5)(e) to find that Miller and Cheng “ought reasonably to have known” that their
respective tippers stood in a special relationship with Masonite.
• On this appeal, there is no dispute Miller and Cheng received material, non-
public information about Masonite. But, didn’t have actual knowledge of the
immediate source of information.
• This was tipping, bc it was more than a rumour (recommending)  Miller was
told that Masonite was “in play,” and that alone wasn’t enough, but the info
provided was much more specific than this.
• A potential acquisition, while not yet a material change, is a material fact
[so subject to insider trading prohibition].
• ONUS OF PROOF: Was a balance of probabilities (rather than beyond a
reasonable doubt).
• Circumstantial evidence is usually what needs to be relied on in these cases:
The evidence was mostly in the form of phone records, but also based on timing of
Fink acquiring the MNPI and the timing of Azeff’s trades (but no direct evidence of
this).
• The standard of review applicable to the Panel’s interpretation of the Act is
the deferential standard of reasonableness.
Analysis BROWN JA
Chain of tippees: They first found that LK “knew or ought to have known” that the
source was a person in a special relationship [Therefore, LK in a “special
relationship” with the issuer].

THE REASONABLENESS OF THE PANEL’S FINDING OF LIABILITY AGAINST MILLER

Miller submits the Panel’s findings that he contravened ss. 76(1) and (2) of the
Act and acted contrary to the public interest were unreasonable because it failed
to find that L.K., the person from whom Miller received the Masonite MNPI, was in a
special relationship with Masonite.
 Applying the factors:
• LK and Miller knew each other well in 2004; spoke often by phone. Their
conversations revolved around their professional activities, LK speaking and asking
Miller about stocks and the market, and Miller asking for tax and accounting advice
(confidence and respect in each others’ advice)
• LK was a partner in a prominent Montreal accounting and auditing firm, a fact
known to Miller (knew of professional qualifications).
• Miller was a senior investment adviser, with a big book of business at TD. He
knew or is deemed to know the provisions of the Act and the prohibition on trading
on MNPI. A higher standard of vigilance and inquiry must be expected for both
registrants Higher obligation to uphold the integrity of the capital markets).
• The information that Miller received from LK was detailed and very specific.
• Within a very short time, Miller bought, for himself, a significant number of
shares of Masonite and then for his family and for 22 accounts of clients. No
evidence he did any further research.
Miller ought to have known that the MNPI LK gave him derived from a knowledgeable
person. (More probable than not that he ought reasonably to have known that LK was
in a special relationship with MHM and the MHM Material Facts originated from a
person in a special relationship).

THIRD ISSUE: THE REASONABLENESS OF THE PANEL’S FINDING OF LIABILITY AGAINST CHENG
Applying the factors:
• Cheng, too, relied on the same factual basis tipped to him by Miller, his
mentor and supervisor. Cheng’s email to SK underscores his reliance on the
reliability of the MNPI that Miller gave him. He would not have risked passing
speculative information, which may prove wrong, to an already complaining client.
• Miller and Cheng worked together.
• Cheng, too, as a registrant, failed to inquire of Miller the source of
Miller’s information. Cheng too did no due diligence on MHM and undertook no
research. He relied entirely on the MNPI given to him by Miller and precipitously
bought a large position for himself and family members of MHM, a stock neither he
nor they had owned previously.
On the basis of all the facts regarding Cheng, on a balance of probabilities, he
ought reasonably to have known that Miller was in a special relationship with MHM
and the MHM Material Facts originated from a knowledgeable person.
Rule Walton: A person who is tipped (gets MNPI) and knows or ought to know that
the source of the info is in a special relationship, also becomes a person in a
special relationship.

S 76(5)(e) “ought reasonably to have known:”

• S 76(5)(e) contains two requirements to establish liability: an “information
connection” and a “person connection.” To prove the tippee possesses knowledge of a
material fact or material change that has not been generally disclosed requires a
comparison of what information the tippee has knowledge of, contrasted with whether
that information is in the public domain. The statutory provision of “ought
reasonably to have known” (person connection) demands an objective test [It makes
sense to look at the tipper and the tippee in this analysis].
OBJECTIVE TEST: Should a person standing in the shoes of the tippee, reasonably
assume the info originated from a person in a special relationship? [The answer to
that question lies in a list of factors to be considered]:
FACTORS TO BE APPLIED IN DETERMINING, whether it could be said that a tippee “ought
reasonably to have known” that the source of undisclosed material info was a
“person or company in a special relationship” with a reporting issuer: [MNPI=
material non-public information]
(a) What is the relationship between the tipper and tippee? Are they close
friends? Do they also have a professional relationship? Does the tippee know of the
trading patterns of the tipper, successes and failures?
(b) What is the professional qualification and standing of the tipper? Is he a
lawyer, businessman, accountant, banker, investment adviser? Does the tipper have a
position which puts him in a milieu where transactions are discussed? [if you know
that someone is in the confidential loop of reporting issuers, then that factor is
going to tilt towards you knowing they are in a special relationship].
(c) What is the professional qualification of the tippee? Is he an investment
adviser, investment banker, lawyer, businessman, accountant, etc.? Does his
profession or position put him in a position to know he cannot take advantage of
confidential information and therefore a higher standard of alertness is expected
of him than from a member of the general public?  Need to uphold the capital
markets.
(d) How detailed and specific is the MNPI? Is it general such as X Co. is “in
play”? Or is it more detailed in that the MNPI includes information that a takeover
is occurring and/or information about price, structure and timing? [The greater the
detail of the info passed on to the tippee, the greater the availability of the
inference that the information came from a person with access to the issuer].
(e) How long after he receives the MNPI does he trade? Does a very short period of
time give rise to the inference that the MNPI is more likely to have originated
from a knowledgeable person? [The short lapse of time between the receipt of
information and the tippee’s start of trading using it could support an inference
that the tippee had confidence in the reliability of the information because it
came from a source “in the know” about the issuer’s affairs].
(f) What intermediate steps before trading does the tippee take, if any, to verify
the information received? Does the absence of any independent verification suggest
a belief on the part of the tippee that the MNPI originated with a knowledgeable
person? [Such an inference becomes even stronger in the case of tippees who are
market registrants. The OSC repeatedly has stated market registrants are well aware
of the seriousness with which Canadian securities regulators view illegal tipping
and illegal insider trading. “A higher standard of vigilance and inquiry must be
expected from a registrant than from someone who is a retail investor.”]
(g) Has the tippee ever owned the particular stock before? [Have they traded in
the stock previously?]
(h) Was the trade a significant one given the size of his portfolio? [The size of
the trade goes to the reliance on the info].
The weight to be accorded to each factor will vary. What is important is that the
overall weight given to the aggregate of all the factual criteria compels the
Commission to the conclusion that it is more probable than not that the tippee
ought reasonably to have known that the MNPI he received originated from a
knowledgeable person, i.e. one who was in a special relationship as enumerated in
section 76 of the Act.
• The Factors are not exhaustive and that the evidence must be considered in
its totality and assessed applying the objective test of “ought reasonably to have
known.”

The purpose of insider trading and tipping prohibitions

The securities regulation framework aims to protect the investor, promote capital
market efficiency, and ensure public confidence in the securities system: Pezim v.
British Columbia (Superintendent of Brokers).