Bruce Carton’s Enforcement Action blog on Compliance Week is always interesting and informative. This week, he questioned whether someone who traded in securities based on information leaked through Twitter would be engaging in insider trading. He had three scenarios and analysed each (although he confessed it was “way tougher than I thought it would be”).
I thought it would be interesting to look at this from a Canadian perspective, given that our insider trading prohibition is more black and white, and got Mr. Carton’s consent to use his examples. But as the existing rules and guidelines were written well before the advent of social networking sites like Facebook and Twitter, I realized it was, well, way tougher than I thought it would be. As I thought it through, it occurred to me: this would make an excellent exam problem. And, as I have been watching the old Paper Chase TV series recently, I imagined a Socratic inquiry into the issue. You have to assume that Professor Charles Kingsfield teaches securities law in addition to contracts and that he teaches at the University of Toronto (where the movie version of The Paper Chase was filmed) and not Harvard (where it was set).
The biggest difference between Canadian and American law is that Canadian law is a blanket prohibition on trading on undisclosed material information, while American law requires a breach of a fiduciary duty, such that the person is misusing a confidence. In the recent SEC v. Cuban case,(1) six law professors filed an amici curiae brief (surprisingly short, given law professors wrote it!) arguing that the charges against Cuban should be dismissed. The SEC action alleged that Cuban breached Rule 10b-5 of the Securities Exchange Act of 1934 by selling shares of a company after he learned it was planning to issue shares at a discount to market, despite an agreement with the company that he would keep the information confidential. The professors argued (persuasively it seems, as the case was dismissed with leave for the SEC to refile) that breach of confidentiality alone is not sufficient. There must be some sort of family or other relationship that is betrayed when the confidential information is misused by the person receiving it. For example, someone giving confidential information to their spouse normally does so on the basis that the spouse will maintain the confidentiality and not trade on or otherwise unfairly profit from the information. In the Cuban case, there was no such relationship and no duty to refrain from trading absent an explicit agreement not to do so.
So are the Canadian rules clearer? Yes and no. Let’s see.
KINGSFIELD: Mr. Baikie, will you please give us the facts of Ontario Securities Commission v. Twaddle?
BAIKIE: Mr. Twaddle was a senior vice-president at ABC Corp. He knew that the company was in negotiations to be taken-over by XYZ Inc. at a premium to the current market price, and that they expected to come to final terms shortly. He made a posting on Twitter that said “I’m about to become a rich man. My company, ABC Corp., will be acquired next week at a 50% premium to the current stock price. Shhh!!!!” Several of his followers bought ABC stock on the Toronto Stock Exchange prior to the announcement of the merger, and the stock price jumped from $20 to $30 when the merger was announced. The OSC brought an enforcement action against Twaddle for violation of section 76 of the Ontario Securities Act.
KINGSFIELD: So, do you think Twaddle’s Twitter tweet was a violation?
BAIKIE: Clearly, sir. Subsection 76(2) of the Act prohibits any person or company in a special relationship with a reporting issuer from informing, or “tipping” any other person about a material fact or material change concerning the reporting issuer that has not been generally disclosed, or, in common parlance, “inside information.” As an insider, Mr. Twaddle was in a special relationship by virtue of the definition of “person in a special relationship” in subsection 76(5).
KINGSFIELD: Does it matter that Mr. Twaddle didn’t himself trade?
BAIKIE: No. Tipping is a violation in and of itself.
KINGSFIELD: Could Mr. Twaddle have argued that by tweeting the information he was “generally disclosing” it?
BAIKIE: I don’t think so. Both the Canadian Securities Administrators’ National Policy 51-201 Disclosure Standards and the TSX’s Timely Disclosure Policy (2) require broader dissemination than a tweet. The TSX policy requires the company to issue a news release with the broadest dissemination possible. NP 51-201 states that a conference call or press conference may be adequate if interested members of the public can attend or listen in and are given sufficient advance notice so they can decide whether to attend. NP 51-201 and the TSX’s Electronic Communications Disclosure Guidelines both state that posting information on a company’s website does not constitute general disclosure. If posting the information on ABC’s website would not be sufficient, it’s hard to see how posting it to a limited number of followers on Twitter would be.
KINGSFIELD: And what about Twaddle’s followers who bought the stock. Did they violate the Act?
BAIKIE: The OSC charged them separately, so this case doesn’t say what happened to them.
KINGSFIELD: I know, but I expect you to be able to analyse every aspect of the case. Come now, Mr. Baikie, we’re waiting. Fill this room with your intelligence!
BAIKIE: Any tippee, that is a person who receives inside information, violates subsection 76(1) of the Act if they trade in the subject security. The OSC does not have to prove that they used the information in their trading decision. Given that Mr. Twaddle’s tweet states “my company” and “Shhh,” I think it’s clear he was giving them inside information they could improperly use to their benefit. Furthermore, subsection 76(2), which I mentioned earlier, prohibits them from passing the inside information along to others.
KINGSFIELD: And that’s the end of the analysis?
BAIKIE: Yes, sir.
KINGSFIELD: I think not. Mr. Gagarian, could you enlighten us, please?
GAGARIAN: Sir, the answer to whether they violated the Act has to be “it depends.”
KINGSFIELD: And it depends on what?
GAGARIAN: Subsection 76(4) provides a defence if the person trading reasonably believed that the information had been generally disclosed. The key word is reasonable, and that depends on the circumstances.
Suppose Twaddle’s postings were extremely boring and his only followers were 5 family members and close friends. It is unlikely that the followers would believe that he was doing anything other than giving them inside information.
Now suppose he has 2,000 followers. An argument could be made that a follower could assume that the information had been generally disclosed. Although tweeting clearly doesn’t satisfy the requirements of NP 51-201, the inquiry doesn’t end there. First off, NP 51-201 is a policy, which by definition isn’t a binding rule. It notes that the Act doesn’t define what constitutes “generally disseminated,” but cites some insider trading cases as precedent. It was written when the Internet was in its infancy and social networking sites like Twitter and Facebook weren’t even contemplated. The precedents are even older.
One of Twaddle’s many followers might have a reasonable belief it wasn’t confidential because he had never posted confidential information before and because it would be read by so many other people. This is negated somewhat by the fact that he did say “Shhh,” and by the fact that if the information had been disclosed it should have already been reflected in the stock price, but I think there’s an argument there. If there was nothing in the tweet suggesting the information was confidential, they would have a much stronger argument.
Now what if he had only 5 followers, all of whom were strangers? They could construct an argument that they didn’t believe he was giving them confidential information because he had absolutely no motive to tip off people he didn’t know, but I think they are in a weaker position than the 2,000 followers.
KINGSFIELD: Are you suggesting that Mr. Baikie was incorrect when he stated that the tweet did not constitute general disclosure?
GAGARIAN: No, sir. Although “generally disseminated” isn’t defined, the Act clearly contemplates widespread awareness of the information before someone can trade. That would be thwarted if someone could “disclose” the information by posting it on the internet such that only a few people will become aware of it. And it would be unworkable if the test were a certain minimum number of people being aware, as the person posting would have no way of knowing how many people actually read it.
I’m suggesting that even though tweeting would not constitute “generally disclosing” the information, in certain circumstances, someone reading the tweet would reasonably conclude that it had been generally disclosed. Maybe 2,000 followers isn’t enough, but what if Ashton Kutcher told his 2.9 million followers (3)about the take-over?
KINGSFIELD: But aren’t you ignoring the fact that a tweet isn’t considered “general disclosure”?
GAGARIAN: This is a defence to an insider trading charge. The test isn’t whether the information was in fact generally disclosed. If the information had been, there wouldn’t have been a violation in the first place. The test is whether the tippee reasonably believed it had been. I think the standard should be the reasonable Twitter follower, not the reasonable securities lawyer who should be expected to know it hadn’t.
KINGSFIELD: Excellent, Mr. Gagarian. Now, did ABC breach the Act? Ms . . . . Logan?
LOGAN: Although subsection 75(1) of the Act requires prompt disclosure of a material change in a reporting issuer, which a take-over bid certainly is, subsection 75(3) allows a company to delay disclosure if premature disclosure would be unduly detrimental. If so, the company can make a confidential filing with the OSC. In this case, ABC could reasonably argue that disclosing details of the pending merger before all the terms were finalized could cause XYZ to walk away, which would be to the detriment of ABC’s shareholders.
However, subsection 75(5)requires ABC to make immediate disclosure of the information if it becomes aware that people are trading on the information. So if ABC knew about the tweet, or if there were unusual buying interest in the stock suggesting that the information had leaked, they would have to issue a news release.
KINGSFIELD: Thank you, Ms. Logan. I see we are out of time. Class dismissed.
KINGSFIELD gathers up his books and seating chart and leaves quickly by the back of the room.
(1) I was directed to this by Jim Hamilton’s World of Securities Regulation, another excellent blog.
(2) The timely disclosure policies of the other Canadian exchanges are virtually identical.
(3) Actually, it’s 2,895,067 followers as of July 23.