PRB 99-38E
INSIDER TRADING
Prepared by:
Margaret Smith
Law and Government Division
22 December 1999
TABLE OF CONTENTS
INTRODUCTION
AND BACKGROUND
JURISDICTION TO ENACT
LAWS RELATING TO INSIDER TRADING
INSIDER TRADING
CANADA BUSINESS CORPORATIONS ACT
A. Requirement to File Reports
B. Prohibition against Speculative
Trading
C. Civil Liability
INSIDER TRADING DISCUSSION PAPER
A. Filing Reports
B. Speculative Trading
C. Civil Liability
D. Penal Liability
RECOMMENDATIONS
OF THE STANDING SENATE COMMITTEE
ON BANKING, TRADE AND COMMERCE
INSIDER TRADING
INTRODUCTION AND BACKGROUND
Insider trading has been described as the
purchase and sale of securities of a corporation by a person with access to confidential
information about the corporation that can materially affect the value of its securities
and that is not known by other shareholders or the general public.
Trading by insiders per se is not
illegal; most laws governing the issue allow insiders to trade in the securities of
corporations with which they have a connection, provided they do not possess material
confidential information about the corporation. Insider trading is proscribed, however,
when the insider possesses material confidential information or uses such information for
his or her benefit when trading in the securities of the corporation.
There are a number of reasons why improper
insider trading is regulated. Without regulation, insiders could use important inside
information to their own advantage and to the disadvantage of outside investors. This
could damage the corporations reputation and, more important, reduce confidence in
the securities market in general.
This note discusses the insider trading
provisions of the Canada Business Corporations Act (CBCA).
JURISDICTION TO ENACT LAWS
RELATING TO INSIDER TRADING
Both the federal and provincial
governments have jurisdiction to enact laws relating to insider trading. Provincial
jurisdiction is based on the authority to enact laws relating to property and civil
rights, while federal jurisdiction is based on the authority of the federal Parliament to
create and regulate federal corporations.
At the provincial level, insider trading
is regulated under provincial corporations laws and securities statutes. Companies
incorporated federally under the Canada Business Corporations Act (CBCA) are also
subject to the insider trading provisions found in that statute. The result is a certain
amount of overlap and duplication.
The overlap and duplication of the federal
and Ontario insider trading requirements were the subject of a Supreme Court of Canada
decision in the early 1980s. In Multiple Access Ltd. v. McCutcheon,(1) the provisions of the Ontario Securities Act
allowing compensation for loss suffered as a result of insider trading were held to apply
to a federally incorporated corporation, even though the corporation was subject to
similar insider trading requirements under federal law. The majority of the Court held
that the insider trading provisions of both the Canada Corporations Act(2) and the Ontario Securities Act were valid.
Writing for the majority, Dickson, J. concluded that the impugned provisions of the Canada
Corporations Act had a general corporate purpose and a rational, functional connection
with company law.
Providing safeguards against the
malfeasance of the managers is strictly within what might properly be called the
constitution of the company. The proper relationship between a company and its insiders is
central to the law of companies and, from the inception of companies, has been regulated
by the legislation sanctioning the companys incorporation.... [T]he impugned
provisions of the Canada Corporations Act are directed at preserving the integrity
of federal companies and protecting the shareholders of such companies; they aim at
practices, injurious to a company or to shareholders at large of a company, by persons
who, because they hold positions of trust or otherwise are privy to information not
available to all shareholders.(3)
The majority of the Court went on to find
that the relevant sections of the Ontario Securities Act were also a valid exercise
of provincial jurisdiction over property and civil rights and that these provisions did
not "sterilize the functions and activities of a federal company nor ... impair its
status or essential powers."(4)
Thus, the majority found that insider
trading provisions have both corporate law and securities law aspects. Because they
considered these aspects to be of roughly equal importance, the majority felt that one did
not have to prevail over the other.
The minority of the Court (three judges)
took a different view, however. They concluded that the provisions of the Ontario Securities
Act were constitutionally valid, being directed to regulating the holding and trading
of securities in Ontario. The central concern of securities legislation, they observed,
was not the constitution of the corporation but rather the regulation of trading in the
corporations securities.(5) On the other hand, they
held that the federal insider trading provisions were not essential to the constitution of
a federal corporation, or to its functional aspects and were therefore invalid.(6)
INSIDER TRADING
CANADA BUSINESS CORPORATIONS ACT
Insider trading provisions were first
introduced at the federal level in 1970 as part of the Canada Corporations Act and
subsequently carried over into the CBCA in 1975.
Found in Part XI of the Act, the insider
trading provision of the CBCA, for the most part, deal with insiders of "distributing
corporations." A "distributing corporation" is defined as a corporation
whose shares have been part of a distribution to the public, remain outstanding, and are
held by more than one person.
Under section 126(1), an
"insider" is defined as a director or officer of a distributing corporation, a
distributing corporation that purchases or otherwise acquires its own shares (except a
redemption of redeemable shares) or shares issued by an affiliate, or a person who
beneficially owns more than 10% of the shares of a distributing corporation or who
exercises control or direction over more than 10% of the votes attached to shares of such
a corporation.
There are three main components of the
provisions: requirement for insider reporting, speculative trading prohibitions, and civil
liability.
A.
Requirement to File Reports
A person is required to send a report to
the Director under the CBCA within 10 days after the end of the month in which he or she
becomes an insider of a distributing corporation. Additional insider reports are required
within 10 days following the end of the month in which there is any change in the
persons interest in the securities of a distributing corporation.
A person who, without reasonable cause,
fails to file an insider trading report is subject to a maximum fine of $5,000 and/or to
imprisonment for a term of up to six months (section 127).
B. Prohibition against Speculative
Trading
The CBCA prohibits insiders from selling
shares that they do not own or have a right to own (short selling) and from buying or
selling a call option or put option in respect of a share of a distributing corporation of
which they are insiders (section 130). Insiders can sell shares they do not own, however,
provided they own other shares that are convertible into the shares sold, or they own an
option or right to acquire the shares sold.
C. Civil Liability
Under subsection 131(4) of the CBCA,
insiders (as defined in section 131(1)) who make use of specific confidential information
for their own benefit in connection with a transaction in the securities of a corporation
(whether distributing or non-distributing) are liable to compensate anyone who suffers a
direct loss as a result. They are also accountable to the corporation for any direct
benefit or advantage they receive.
INSIDER
TRADING DISCUSSION PAPER
In February 1996, Industry Canada released
a Discussion Paper on insider trading.(7) The paper
looked at whether the CBCA insider trading provisions were still needed and, if so, what
changes could be made. It outlined the three following approaches:
At the outset, the Discussion Paper
considered the argument that, because of the similarity between provincial securities laws
and the CBCA insider trading provisions, the latter impose an unnecessary regulatory
burden and should therefore be repealed.
Proponents of maintaining the CBCA
provisions argue that these uphold a base level of regulation for CBCA corporations and
that their repeal would eliminate only a small amount of duplication.
Recommending that the CBCA provisions be
continued, the Discussion Paper went on to examine their three principal elements.
A. Filing Reports
The first element consists of the
reporting provisions. While making no recommendation as to whether these provisions should
be maintained, the Discussion Paper noted that duplicative filings could be eliminated if
the Director under the CBCA were to exempt those who reported trades under provincial laws
from having to file under the CBCA.
The Paper also examined a number of ways
in which the reporting requirements could be changed, such as decreasing the time within
which insiders must report trades or declare that they have become insiders and increasing
the penalties for violating the insider trading provisions.
As mentioned earlier, the CBCA reporting
provisions require that insider reports be filed within 10 days of the end of the month in
which the person becomes an insider or makes a trade. Some provinces provide for
disclosure to take place earlier, within 10 days of the personss becoming an insider
or making a trade. The Discussion Paper recommended that, if the CBCA insider reporting
requirements were to be maintained, the time allowed for insiders to report trades or
declare that they had become insiders should be decreased to within 10 days of the
persons becoming an insider or making the trade.(9)
B. Speculative Trading
The Discussion Paper also examined the
speculative trading provisions that prohibit insiders from short selling (selling shares
that they do not own or have a right to own), buying and selling certain call options, and
buying and selling a call option or a put option in respect of a share of the corporation
or any of its affiliates. Violations of these prohibitions are subject to a summary
conviction offence with a maximum fine of $5,000 and/or imprisonment for up to six months.
The Discussion Paper recommended that
these provisions be maintained and amended.
C. Civil Liability
The civil liability provision makes liable
those who, in connection with a transaction in a security of a corporation, and for their
own benefit or advantage, make use of confidential information that, if generally known,
might reasonably be expected to affect materially the value of the securities. This
provision applies to both public and private corporations. Two categories of persons can
assert a claim against an insider: any person who has suffered a direct loss and the
corporation itself.
Insider trading liability provisions are
also found in provincial securities legislation. While it can be argued that having civil
liability provisions in both the CBCA and provincial securities legislation may be
duplicative, the Discussion Paper pointed out the jurisdictional advantage of the CBCA
(investors across Canada can challenge the actions of an insider of any CBCA corporation)
and the statutes potential for a broader class of plaintiffs. The Discussion Paper
recommended that the civil liability provision be maintained and amended where necessary.
D. Penal Liability
Finally, the Discussion Paper examined
whether the CBCA should contain a penal liability provision for improper insider trading.
Noting that provincial securities legislation does contain such a provision, the paper
pointed out that its absence from the CBCA makes the trading provision of that law more
difficult to enforce. Moreover, it is argued that a penal provision would, in the event of
a successful prosecution, assist those undertaking a civil action.
The Discussion Paper recommended the
addition to the CBCA of a penal liability provision prohibiting improper insider trading
and wrongful communication of material confidential information. The provision would be
limited to securities of distributing corporations. The maximum penalty would be two years
in jail and/or $1,000,000 or three times the profit made, whichever was greater.(10)
RECOMMENDATIONS
OF THE STANDING SENATE COMMITTEE
ON BANKING, TRADE AND COMMERCE
The Standing Senate Committee on Banking,
Trade and Commerce examined the CBCA insider trading provisions in its 1996 report Corporate
Governance.(11)
The Committee did not see a need to repeal
these provisions but noted that, where duplication and overlap existed, the Director under
the CBCA should use individual and blanket exemptions to reduce the burden of duplicate
filings.
Of the Discussion Papers proposals
for modernizing the insider trading provisions, the one most widely discussed before the
Committee was that dealing with the time for filing insider trading reports. A number of
witnesses argued for earlier disclosure of insider trading, some even suggesting that
reports should be filed on the day a transaction was completed. Although favouring more
timely disclosure, others suggested that it might be difficult for some institutions to
report trades on a same-day basis.
The Committee supported earlier disclosure
of insider activities and recommended that the time given for insiders to report trades or
declare that they had become insiders should be decreased to within 10 days of the
persons becoming an insider or making a trade.(12)
The Committee also recommended that this time period be prescribed by regulation rather
than in the CBCA itself. This would allow for more timely updating of the provisions and
make it easier to harmonize time frames with provincial requirements.(13)
(1) Multiple Access Ltd. v. McCutcheon et al. (1982), 138
D.L.R. (3d) p. 18 (SCC).
(2)
The Canada Corporations Act was the predecessor to the Canada Business
Corporations Act.
(3)
Multiple Access Ltd. v. McCutcheon et al., p. 15.
(4)
Ibid., p. 19.
(5)
Ibid., p. 45.
(6)
Ibid., p. 48-49.
(7)
Industry Canada, Canada Business Corporations Act, Discussion Paper, Insider Trading,
February 1996.
(8)
Ibid., p. 6.
(9)
Ibid., p. 14.
(10)
Ibid., p. 52.
(11)
Senate of Canada, Standing Senate Committee on Banking, Trade and Commerce, Corporate
Governance, August 1996.
(12)
Ibid., p. 56.
(13)
Ibid.
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