Area of Law: Investments and Securities
Answer # 278
What is insider trading?Region: Ontario Answer # 278
The policy behind monitoring insider trading is to ensure that investors compete on a level playing field. Therefore, trading and informing others with respect to knowledge of important information about a public company, called ‘material information’ is only prohibited where that information has not been generally disclosed to the public.
Insider trading occurs in two circumstances. First, it is considered insider trading when a person buys or sells the securities of a public company while knowing undisclosed material information about that company. Second, it is considered insider trading when someone who knows undisclosed material information about a public company, informs other people about such information. This is called tipping.
Who is considered an insider?
A person is considered to be an insider of a public company in four situations.
First, every director or senior officer of a public company is an insider of that company.
Second, any person who beneficially owns, directly or indirectly, more than 10% of the voting rights of the public company, or exercises control or direction over more than 10% of the voting rights of the public company or a combination of both is also an insider of the public company.
Third, a subsidiary of the public company is considered an insider of the public company.
Fourth, if a company is considered an insider of the public company, the directors and senior officers of the insider company are also considered insiders of the public company.
When someone becomes an insider of a public company they are required to file an initial insider trading report with the appropriate provincial securities regulators. Insiders must also file insider trading reports with the appropriate provincial securities regulators within 10 days of the date of a trade of securities of that company.
What is a Special Relationship?
People in a “special relationship” with a public company are prohibited from purchasing or selling the securities of the company if they have knowledge of specific confidential information which, if disclosed, would likely materially affect the value of that company’s securities significantly.
The four classes of people who are considered to be in a “special relationship” with a public company include:
- Anyone who is a director, officer or employee of the public company and/or its affiliates;
- Anyone who is engaged in or proposing to engage in any business or professional activity with the public company;
- Anyone that obtained inside information while belonging to one of the classes of such persons; and
- Anyone that obtained material information from a person whom the recipient knew or ought reasonably to have known was in a special relationship with the company.
Any person in a “special relationship” with a public company who tips inside information to a third party may be liable to the person who sold or bought the securities from that third party.
There are substantial statutory penalties for persons and companies where there has been a breach of the law, including situations where required documents or notices contain misrepresentations about an insider’s trading activities. Under section 130 of the Canada Business Corporations Act, these penalties include fines up-to the greater of $1,000,000 or triple the amount of any profit made by such contravention. Penalties can also include prison terms for up-to six months.
There are also penalties that can be imposed under the Criminal Code. The Criminal Code is only meant to apply to the most egregious cases of illegal insider trading. If convicted, the maximum penalty is ten years in prison for each offence. For convictions relating to tipping, the maximum jail term is five years. In addition, under the Code it is also a crime to threaten or retaliate against employees who report, or blow the whistle on insider trading.
Who else may be held accountable?
Where a public company is found to be in breach of the law, the directors and officers who authorized, permitted or agreed to the events are also held to be guilty and may be liable to the same penalties as the public company.
Insiders and their affiliates and associates are also held accountable to the public company for any direct benefits or advantages received or receivable as a result of making use of inside information. Advantages include any gains from the purchase or sale of securities of the public company on the basis of such information or communication of such inside information.
A company is considered to be an affiliate of another company if one of them is a subsidiary of the other or if both are subsidiaries of the same company.
A person or company is an associate of a public company in any of the following six circumstances:
- The person or company beneficially owns more than 10% of the voting rights attached to all voting securities of the public company;
- Any partner of such person or company;
- Any trust or estate in which such a person or company has a substantial beneficial interest or as to which such person or company serves as trustee or in a similar capacity;
- Any relative of such person;
- Any person of the opposite sex to whom such person is married or has the same home, or with whom such person is living in a conjugal relationship outside marriage; and
- Any relative of a person mentioned above who has the same home as that person.
Insider trading is a very complicated area of law. If you require legal advice, you should consult an investments and securities lawyer.
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