On August 1, 2013, the Alberta Securities Commission (ASC) announced that it had concluded a settlement with former Daylight Energy Ltd. (Daylight) President and CEO Anthony Lambert (Lambert) related to allegations of insider trading.
This prosecution and settlement agreement should cause insiders of Canadian reporting issuers to pause and reconsider their own trading practices in order to insulate themselves from investigation, prosecution and punishment by securities regulators.
The bottom line: Regardless of whether or not the position of the ASC in the Daylight case is accurate (and many in the legal community do not believe it is accurate), if there is any question as to whether or not the information you have constitutes a “material fact”, err on the side of caution and refrain from trading or risk the wrath of the securities regulators (which can be expensive and potentially damaging to your reputation even if you are not wrong).
The Law
Under Canadian securities law, it is illegal to purchase or sell securities of a reporting issuer with knowledge of a “material fact” regarding that reporting issuer that has not been generally disclosed. A “material fact” is defined as a fact that would reasonably be expected to have a significant effect on the market price or value of the securities of the reporting issuer.
The Practice
When management of a reporting issuer becomes aware of a material fact, it generally either (i) promptly publicly discloses that material fact (usually via the issuance of a news release) or (ii) institutes a trading blackout in the company’s securities on those with knowledge of the material fact until such time as the material fact is generally disclosed. However, regardless of whether or not the company formally imposes a trading blackout, persons with knowledge of a material fact that has not been generally disclosed are still prohibited from trading in the company’s securities until that material fact has been generally disclosed.
The Problem
For that reason, one of the most difficult questions that management and the board of a reporting issuer must answer on an almost daily basis is when does information within their possession become a “material fact”? For example, senior company officials are almost always engaged in discussions with one or more third parties regarding potential transactions that could be significant to the company. If they weren’t then they wouldn’t be doing a key component of their jobs. In the vast majority of these cases, the discussions lead nowhere. But every now and then they result in a material transaction for the company. An often asked question is “at what point during the course of discussions do the discussions themselves become a material fact?”. Unfortunately, case law on this point has rightfully told us that there is no bright line test and it depends on the facts and circumstances of each case and each reporting issuer. Further, the case law has rightfully told us that the determination of whether or not the discussions have reached the stage of being a material fact is not to be determined through the use of hindsight but rather is to be determined based on all relevant information existing at the particular point in time (i.e. a regulator can’t later conclude that the early discussions regarding a possible transaction were themselves a material fact at the time of the discussions simply because the discussions did in fact eventually lead to an agreement). Most industry participants have previously assumed that discussions regarding a potential transaction did not become material facts until such time as there were enough facts available for an investor with knowledge of the facts to make a reasoned and informed investment decision (i.e. discussions have progressed to the point where there is a degree of confidence that an agreement will be reached). However, the recent prosecution and eventual settlement by the ASC with Lambert over trades made by Lambert after he received “expressions of interest” from a third party for a potential take-over transaction of Daylight suggests that the ASC thinks that, in circumstances similar to those of Daylight, insiders should cease trading much sooner (i.e. at the time that Daylight first received an expression of interest from Sinopec Group (SIPC)).
The ASC may not be correct (and many in the legal community do not believe it is correct). But that is the position they seem to be putting forth in the Daylight case.
The Daylight Case
The facts and conclusion of the Daylight case are as follows:
1. In July, 2011 Canaccord (an investment bank) and SIPC had some very general discussions about the possibility of SIPC undertaking a transaction of some kind with Daylight, possibly even involving an acquisition of Daylight by SIPC. Canaccord informed Lambert of those discussions and Lambert indicated that he would be receptive to considering proposals that SIPC might put forward, if any.
2. On August 4, 2011, the day following the termination of a scheduled quarterly trading blackout, Lambert purchased securities of Daylight on the market because he considered that Daylight’s securities were undervalued. His intention was to purchase additional Daylight securities if those circumstances persisted. Note that he had also made purchases in June 2011, prior to the commencement of Daylight’s quarterly trading blackout and prior to the receipt of word of any interest from SIPC.
3. On the morning of August 5, 2011, Canaccord forwarded to Lambert’s attention an unsolicited letter from SIPC to Daylight which referred to the possibility of exploring “a major strategic investment transaction” between SIPC and Daylight (August 5 Letter). At that point in time, Canaccord had not been retained by Daylight to broker any transactions, solicit offers or provide any services in that respect.
4. An email from a Canaccord representative based in Asia (the Email) accompanying the August 5 Letter suggested that “SIPC is interested in discussion of acquiring the whole company”.
5. Lambert did not regard the August 5 Letter or the Email to be material information, but he forwarded them to Daylight’s Vice President and General Counsel (General Counsel) immediately upon receipt and enquired of him whether they raised any issues about further trading by Lambert. The General Counsel responded to Lambert that they did not.
6. Though he considered them immaterial and had advised Lambert accordingly, the General Counsel also sent the August 5 Letter and the Email to Daylight’s external legal counsel that day and discussed with them whether they contained material information. The external counsel advised the General Counsel that it was not necessary to impose a trading blackout of any kind.
7. The General Counsel also transmitted the August 5 Letter and the Email to the Chair of Daylight’s Governance Committee on August 5, 2011, and discussed with him whether they were material, merited the imposition of a blackout or whether the Board of Directors of Daylight (Board) should be notified. The Governance Chair expressed the view that the information was immaterial, a blackout was unnecessary and that it was not necessary to advise the Board.
8. The circumstances under which the General Counsel, the Governance Chair, external counsel and Lambert formed their views about the immateriality of the August 5 Letter and the Email included that:
(i) directly or through investment banks or agents, Daylight had previously received several other expressions of interest from various parties about possible business transactions of a potentially significant nature, none of which proceeded beyond preliminary or introductory stages;
(ii) the August 5 Letter from SIPC was unsolicited and contained no reference to any terms, price or the nature of a possible transaction; and
(iii) Daylight was not “in play” and had not retained Canaccord or other financial advisors to solicit or locate potential purchasers or partners.
9. On August 7, 2011, the General Counsel prepared a form of confidentiality agreement (Confidentiality Agreement) in respect of discussions with SIPC. On August 8, 2011, Lambert executed a letter on behalf of Daylight stating that Daylight was interested in exploring potential business opportunities with SIPC, which was forwarded to SIPC along with the draft form of Confidentiality Agreement.
10. On August 8, 2011, having enquired of the General Counsel as aforesaid in compliance with Daylight’s policies, Lambert purchased 60,000 Daylight shares at $7.70 per share for a total price of $462,000. This purchase was properly disclosed and reported on SEDI on August 8, 2011. When SIPC subsequently purchased those shares as part of the Daylight Acquisition on December 23, 2011, Lambert realized a profit of approximately $129,000 therefrom.
11. Subsequently, discussions between Daylight and SIPC ensued, eventually culminating in the completion of the Daylight Acquisition on December 23, 2011. The process included:
(i) On August 15, 2011, SIPC signed the Confidentiality Agreement;
(ii) On August 16, 2011, Daylight opened a data room for SIPC;
(iii) On August 23, 2011, Lambert and other senior officers of Daylight made a formal presentation to SIPC in Beijing, where the possibility of a corporate acquisition of Daylight was proposed by SIPC;
(iv) On August 26, 2011, Daylight imposed a trading blackout on those personnel with knowledge of a possible SIPC acquisition, including Lambert;
(v) On September 6, 2011, Daylight imposed a trading blackout on the Board;
(vi) On September 30, 2011, Daylight received a non-binding letter of intent from SIPC proposing an acquisition of Daylight’s shares for $10.08 per share, which represented a substantial premium above Daylight’s closing share price of $5.25 on September 29, 2011;
(vii) On October 9, 2011, Daylight and SIPC issued a joint news release announcing the execution of a binding agreement in respect of the Daylight Acquisition;
(viii) The Daylight Acquisition was completed on December 23, 2011.
12. In April 2013, the ASC filed charges against Mr. Lambert alleging insider trading with respect to his August 4 and August 8, 2011 trades.
13. On August 1, 2013, the ASC announced its Settlement Agreement with Mr. Lambert which states that:
(i) Lambert recognizes that as Daylight’s President and Chief Executive Officer he occupied a position of high responsibility and trust, and was obliged to be carefully attuned to trading issues and the possible materiality of information that came to his attention;
(ii) Notwithstanding that Lambert’s purchase of Daylight’s securities on August 8, 2011 was not motivated by the August 5 Letter or the Email, that he did not believe himself to be in possession of material undisclosed information and he made enquiries in that regard as aforesaid, he acknowledges that he made an error in judgment in purchasing Daylight securities at that time;
(iii) Lambert agrees that the prudent course of action as Daylight’s President and Chief Executive Officer would have been to err on the side of caution in the circumstances and refrain from any further trading in Daylight securities after the events described in paragraphs 1, 3 and 9 above; and
(iv) Lambert agrees that in those circumstances it is in the public interest that he make the payments and undertakings in paragraphs 14 and 15.
14. Lambert agreed to pay to the ASC:
(i) $129,000 representing the profit from the sale of the Daylight securities he purchased on August 8, 2011; and
(ii) $100,000 towards investigation and hearing costs; and
15. Further, Lambert undertook to the ASC:
(i) to refrain from becoming a director or officer of any reporting issuer for a period of 2 years; and
(ii) to refrain from trading or purchasing securities of any reporting issuer for 2 years.
16. In its announcement, the ASC also stated: “It is important that senior company officials – insiders – understand that insiders cannot trade while in possession of undisclosed material information; whether or not that material information must yet be disclosed under our continuous disclosure regime. Additionally, if in doubt, insiders should always err on the side of caution and not trade.”
The Lessons
This case is interesting for a variety of reasons including, but not limited to, the following:
1. First, the ASC alleged that Lambert traded with knowledge of a material fact that had not been generally disclosed even though the parties had just commenced discussions, had not even discussed terms yet and were not at the point where either party would have reasonably concluded that a binding agreement was either imminent or probable. While most industry participants do not agree with that interpretation of the law, it is interesting to note where the ASC wanted to draw the line in this case and that the ASC was willing to pursue charges against Lambert based on their position. It is also interesting to ponder whether or not the ASC would have considered the expression of interest to be a material fact, and therefore this case, had Daylight not actually eventually entered into an agreement with SIPC.
2. Because the case was settled before a hearing could be held and a decision made, the ASC did not in fact establish that the Daylight/SIPC discussions were at the point of being a material fact at the time Lambert made his trades. But again it is interesting to note that the ASC was suggesting that in putting forth charges in the first place and seems to be reaffirming their position with the statements they made at the time of announcing the settlement agreement with Lambert.
3. In the settlement agreement, Lambert did not admit to trading with knowledge of material information that had not been generally disclosed (perhaps to insulate himself from claims from other investors) and the ASC did not insist upon him doing so (perhaps because they knew that they would have a difficult time establishing that fact).
4. Regardless of the validity of the ASC position, Lambert agreed to settle rather than make the ASC prove its allegations against him (perhaps to save the time and cost of the hearing and the uncertainty with respect to whatever decision might be made).
5. Given its statements and those it required Lambert to make in the settlement agreement, the ASC may be asserting the position that there is a greater burden on directors and officers than others to simply refrain from trading when in knowledge of material facts that have not been generally disclosed but rather than they must, in the public interest, err on the side of caution when trading and the ASC will use its “public interest” powers to prosecute those that do not.
The bottom line: Regardless of whether or not the position of the ASC in the Daylight case is accurate, if there is any question as to whether or not the information you have constitutes a “material fact”, err on the side of caution and refrain from trading or risk the wrath of the securities regulators (which can be expensive even if you are not wrong).
Invitation for Discussion:
If you would like to discuss any aspect of the insider trading rules, or any other securities law related matter, please do not hesitate to contact one of the lawyers in the “Business Law” group at Linmac LLP.
Disclaimer:
Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.