In a recent decision, Kraft (Re) (Kraft), the Ontario Capital Markets Tribunal (the Tribunal) articulated clear guidance with respect to the application of the necessary course of business (NCOB) exception to the prohibition against selective disclosure (or tipping) contained in the Ontario Securities Act (the OSA). This decision is significant insofar as it clarifies how rules surrounding tipping are to be interpreted and applied, and establishes a clearer framework as to how issuers and insiders should navigate their obligations with respect to material non-public information (MNPI).

Background

Tipping and insider trading are prohibited under Canadian securities laws. In Ontario, the offence of tipping is set out in section 76(2) of the OSA, which prohibits anyone in a “special relationship” with an issuer to inform another person of MNPI, other than in the necessary course of business. Insider trading is prohibited by section 76(1) of the OSA, which makes it an offence for anyone in a “special relationship” with an issuer to trade in securities of that issuer with knowledge of MNPI.

Facts of the Kraft Case

MPK was the chairman and director of WeedMD (now Entourage Health Corp.), a reporting issuer trading on the TSX Venture Exchange (TSXV). MS is a close personal friend and business associate of MPK. Staff of the Ontario Securities Commission (OSC) brought a proceeding against MPK and MS, alleging contraventions of the insider trading and tipping provisions of the OSA.

In October 2017, MPK sent an email to MS attaching draft documents relating to WeedMD’s proposed expansion at Perfect Pick Farms Ltd. (Perfect Pick). WeedMD’s board of directors later authorized management to execute the agreements and, in November 2017, WeedMD issued a news release announcing the transaction with Perfect Pick. The day before the transaction was announced, MS purchased 45,000 WeedMD shares, which he sold shortly thereafter for a 43 percent profit.

The Tribunal found that by providing the draft documents to MS for the planned transaction, MPK shared MNPI with MS in contravention of the tipping provision in section 76(2) of the OSA. The Tribunal also found that MS traded shares of WeedMD while in possession of MNPI, in breach of the insider trading provision in section 76(1) of the OSA.

The Meaning of the “Necessary Course of Business” Exception

The Tribunal, noting that there were no prior decisions directly considering or applying the “necessary course of business” provision, made the following significant findings:

• the “necessary course of business” language is an exception to the broad prohibition against tipping, which must be construed reasonably narrowly to ensure that the overarching rationale for the tipping prohibition is not undermined;¹
• the party seeking to rely on the NCOB exception (in this case, MPK) will bear the onus of proving that it applies;²
• the exception is to be established on an objective basis, and does not rest on any subjective belief of the tipper that the selective disclosure was necessary;³
• the word “necessary” elevates the requirement beyond a mere business purpose (what may be in the “ordinary” course of business does not necessarily equate to being in the “necessary” course of business).⁴

National Policy 51-201—Disclosure Standards contains a list of recipients of selective disclosure with whom communications would generally be covered by the NCOB exception; these include: “(a) vendors, suppliers, or strategic partners on issues such as research and development, sales and marketing, and supply contracts; (b) employees, officers, and board members; (c) lenders, legal counsel, auditors, underwriters, and financial and other professional advisors to the company; (d) parties to negotiations; (e) labour unions and industry associations; (f) government agencies and non-governmental regulators; and (g) credit rating agencies (provided that the information is disclosed for the purpose of assisting the agency to formulate a credit rating and the agency’s ratings generally are or will be publicly available).”⁵

However, the fact that a recipient falls within this list is not the end of the inquiry, and reliance on the NCOB exception must be established on the relevant facts.⁶ The Tribunal declined to articulate a concrete set of factors that would apply in all cases, but did identify the following non-exhaustive list of factors that may be relevant in determining whether the selective disclosure satisfies the NCOB exception:⁷

• the business of the issuer;
• the relationship between the tipper and the issuer;
• the relationship between the tipper and the tippee;
• the nature of the MNPI that was disclosed;
• the relevance of the MNPI to the relationship between the tippee and the issuer (that is, whether the nature of the relationship between the tippee and the issuer necessitates the disclosure of the MNPI in question);
• the tipper’s reason for making selective disclosure to the tippee; and
• the credibility of the tipper seeking to establish the NCOB exception.

The Decision

The Tribunal found that MPK did not provide the MNPI in the necessary course of business, and therefore the exception was not available to him.⁸ Although MPK’s decision to make selective disclosure to MS was made for a business reason—namely, his desire to have the benefit of his friend and colleague providing input as a second set of eyes—the Tribunal concluded that the selective disclosure to MS was not made in the necessary course of WeedMD’s business.⁹

MPK did not consult or notify management of WeedMD or the board of directors before making the selective disclosure.¹⁰ The Tribunal remarked that MPK’s selective disclosure was done “hastily, on the fly and was careless,” and the circumstances suggested that he did not actually turn his mind to the question of whether such disclosure was in the necessary course of WeedMD’s business before he made the disclosure.¹¹

MPK did not ask MS to enter into any confidentiality agreement, nor did he ask MS to keep the information confidential (though MPK testified that he had every expectation that MS would hold the information in confidence).¹² While entering into a confidentiality agreement is not a necessary precondition to establishing the NCOB exception, it is advisable as a best practice and is relevant to the question of whether the selective disclosure was made in the necessary course of business.¹³

Key Takeaways

The Kraft decision illustrates the risks associated with making selective disclosure of MNPI and provides new insight as to how the OSC views tipping and the legislative provisions that prohibit it. While confidentiality agreements are a best practice, they are not sufficient to establish the NCOB exception, which must be done on a case-by-case basis. The decision further underscores to issuers and insiders the importance of carefully considering how and with whom MNPI should be shared.

Some essential takeaways include the following:

1. Disclosure must actually be necessary. This is a higher standard than merely having a business purpose, and market participants should consider whether disclosure is sufficiently important to justify an exception to the blanket prohibition against selective disclosure.
2. Consider the process. If a party wishes to rely on the NCOB exception, it is prudent to be able to demonstrate that the relevant considerations were considered – this may include steps like engaging board and management members in a discussion about the advisability of the disclosure, being able to clearly articulate the purpose of the disclosure, and potentially entering into a confidentiality agreement that prohibits the tippee from trading on or disclosing MNPI.
3. Engage with legal counsel. The issues raised in this case are nuanced, and it is recommended that anyone with concerns about how to proceed in a given situation should engage with their legal counsel for guidance on how to navigate the situation in compliance with laws.