On October 20, 2023, the Capital Markets Tribunal of Ontario (the "Tribunal") released a decision ‎‎ analyzing, for the first time, the "necessary course of business" exception (the "NCOB ‎Exception") to ‎the prohibition on selective disclosure contained in section 76(2) of the Securities Act ‎‎(Ontario) (the "Act"). Market participants should ‎consider the takeaways from this decision prior to relying ‎on the NCOB Exception regarding disclosure of material non-public information ("MNPI"). ‎

Background

WeedMD Inc. ("WeedMD", now named Entourage Health ‎Corp.) is a producer and distributor of cannabis ‎that is listed on the TSX Venture Exchange. In 2017, WeedMD planned to enter into a material lease ‎agreement and associated option to purchase with Perfect Pick Farm's Ltd., which would significantly ‎expand its production capabilities (the "Transaction"). Prior to finalizing the Transaction, Michael Kraft, ‎chairman and director of WeedMD, sent his long-time friend, Michael Stein, an e-mail containing MNPI ‎relating to the Transaction for the purposes of seeking Mr. Stein's input. At all relevant times, Mr. Stein ‎had no business, contractual, or employment relationship with WeedMD. After receiving the MNPI, Mr. ‎Stein purchased 45,000 WeedMD shares, which he then sold ‎after the Transaction was announced, ‎realizing a 43 percent return.‎

Enforcement staff of the OSC alleged the following breaches of Ontario securities law and conduct ‎contrary to the public interest:‎

  • Mr. Kraft, while in a special relationship with an issuer, informed another person outside of the ‎necessary course of business of a material fact or material change with respect to the issuer, ‎before the material fact or material change had been generally disclosed, contrary to subsection ‎‎76(2) of the Act); and‎
  • Mr. Stein, while in a special relationship with an issuer, purchased or sold securities of the issuer with ‎the knowledge of a material fact or material change with respect to the issuer that had not been ‎generally disclosed, contrary to subsection 76(1) of the Act.‎

A central issue that the Tribunal considered was whether Mr. Kraft provided Mr. ‎Stein with MNPI in ‎accordance with the NCOB Exception, and therefore not in breach of the Act. ‎

Prohibition on tipping and insider trading ‎

The Act prohibits an issuer, and any person or company in a special relationship with an issuer, from ‎informing, other than in the necessary course of business, another person or company of a material ‎fact or material change with respect to the issuer before the material fact or material change has been ‎generally disclosed (also known as "tipping").‎

The Act also prohibits a person or company in a special relationship with an issuer from purchasing or ‎selling securities of the issuer with the knowledge of a material fact or material change that has not been ‎generally disclosed (also known as "insider trading").‎

Findings

The Tribunal found that Mr. Stein engaged in insider trading when he traded shares in WeedMD while in ‎possession of MNPI, and that Mr. Kraft engaged in tipping when he provided Mr. Stein with MNPI. ‎Further, the Tribunal determined that Mr. Kraft's selective disclosure to Mr. Stein was not made in reliance ‎on the NCOB Exception.‎

The "Necessary Course of Business" Exception

‎"Necessary" information‎

Not all selective disclosure that is tied to a business purpose or rationale is "necessary."‎ ‎ Rather, ‎‎"necessary" selective disclosure must go beyond a mere business purpose or rationale, and must be ‎‎"essential", "indispensable", ‎or "requisite".‎ ‎ Moreover, the purpose of the selective disclosure must be ‎sufficiently important to the business to warrant an exception to the prohibition against selective ‎‎disclosure.‎

The Tribunal also found that the word "business" in the phrase "the necessary course of business" does ‎not necessarily mean in the issuer's business. The Tribunal determined that while "business" did mean ‎WeedMD's business in this case, in other factual circumstances, the exception could apply to selective ‎disclosure that is necessary to the recipient's business.‎

Onus of proof

The Tribunal determined that the NCOB Exception is to be applied as an exception to the prohibition on ‎tipping, meaning that the respondent (in this case, Mr. Kraft), bears the onus of proving its availability. ‎

Test to establish the NCOB Exception

To determine whether selective disclosure was made in reliance on the NCOB Exception, the Tribunal ‎ruled that an objective test is to be applied. As a result, the tipper's subjective beliefs as to whether the ‎selective disclosure was necessary is not determinative. ‎

The Tribunal also clarified that the NCOB Exception is to be interpreted and applied narrowly, so as to ‎ensure that everyone in the market has equal access to, and opportunity to act upon, material ‎information.‎ ‎ ‎

Factors to consider ‎

The Act does not define "necessary course of business", and does not provide guidance as to which ‎factors are relevant in establishing the NCOB Exception. However, the Tribunal provided the following ‎non-exhaustive list of relevant factors when determining whether selective disclosure satisfies the NCOB ‎Exception:‎ ‎ ‎

  • 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.‎

Additionally, National Policy 51-201 – Continuous Disclosure Obligations ("NP 51-201") provides some ‎guidance on the types of recipients and categories of communication which may indicate it was made in ‎reliance on the NCOB Exception. However, these factors are not determinative, and complying with them ‎does not guarantee that the NCOB Exception will apply.‎ ‎ ‎

Application to Mr. Kraft's conduct

In applying these principles to Mr. Kraft's conduct, the Tribunal found Mr. Kraft's selective disclosure ‎was not made in reliance on the NCOB Exception, but rather arose out of his personal preferences and ‎habit. Mr. Kraft's desire to have someone that he trusted provide input on the documents was not ‎equivalent to providing selective disclosure in the necessary course of WeedMD's business.‎ ‎ ‎

In coming to this conclusion, the Tribunal outlined the following: ‎

  • Mr. Kraft did not turn his mind to whether the selective disclosure was in the necessary course of ‎business prior to disclosing the MNPI. Mr. Kraft hastily forwarded the e-mail to Mr. Stein out of ‎habit;‎
  • Mr. Stein had no business, contractual, or employment relationship with WeedMD‎ at any time ‎between when he received the MNPI, and when he sold his shares in WeedMD;‎
  • Mr. Kraft did not ask Mr. Stein to act as an advisor or consultant to WeedMD, to enter into any ‎agreements with WeedMD, or to keep the information he provided to Mr. Stein confidential;‎
  • Mr. Stein reviewed the draft lease as a favour to Mr. Kraft, and was not compensated for his ‎review;‎ ‎ and
  • Mr. Kraft did not consult with or advise WeedMD's management or directors regarding his desire ‎to receive a second opinion, nor that he had reached out to Mr. Stein for this opinion. No other ‎member of WeedMD's management or directors asked Mr. Stein to review draft documents ‎related to the expansion.‎

Key takeaways ‎

This decision provides important guidance on how the NCOB Exception will be applied. Reporting ‎issuers and those in special relationships with reporting issuers should therefore consider the following ‎prior to relying on the NCOB Exception for selective disclosure: ‎

  • Disclosure must be "necessary": The use of the term "necessary" (as opposed to "ordinary") in the ‎language of the NCOB Exception elevates the requirement beyond a mere business purpose or ‎business rationale. Accordingly, the purpose of the disclosure must be sufficiently important or ‎necessary to warrant an exception;‎
  • Burden of proof on the tipper: Once the elements of tipping are established, the onus shifts to the ‎persons intending to rely on the NCOB Exception to prove its applicability and to show that the ‎communication was in the necessary course of business. If the tipper does not succeed in ‎proving that, the contravention is established. Anyone disclosing MNPI should ensure they can ‎sufficiently demonstrate the basis for such disclosure in compliance with the NCOB Exception;‎
  • An objective standard will apply: The NCOB Exception is to be established on an objective basis;‎
  • Interpretation of "business": The Tribunal noted that the word "business" in the phrase "in the ‎necessary course of business" is not qualified by the phrase "the issuer's". Accordingly, the ‎Tribunal left open the possibility that it may be interpreted as applying to not only the business ‎of the issuer. Persons intending to rely on the NCOB Exception should consider whether ‎‎"business" will be deemed to refer to the issuer's business, or the tippee's business. There ‎remains uncertainty as to the interpretation and application of the term "business" and the ‎statement should not be taken as definitive guidance of the application of the exemption to ‎extend to the business of the business of the tipper or tippee;‎
  • Consider NCOB Exception prior to disclosure: The Tribunal notes that establishing that one has ‎turned one's mind in advance to the question of whether the purpose of making selective ‎disclosure is in the necessary course of business is not a precondition to availing oneself of the ‎NCOB Exception, although it does note that it may help to establish after the fact the purpose ‎for which the selective disclosure was made and that such purpose was in the necessary course ‎of business. Accordingly, evidence of the tipper turning their mind to whether the disclosure is ‎in the NCOB prior to making the disclosure is relevant; and
  • Relevant factors: The Tribunal did not outline any bright line test for determining whether disclosure ‎was made in reliance on the NCOB Exception, although they provided non-exhaustive factors ‎‎(summarized above) to consider when determining whether the NCOB Exception is available, ‎along with guidance contained in NP 51-201.‎

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.