(1) The “tipping” provision allows a company to make a selective disclosure if doing so is in the “necessary course of business”. The question of whether a particular disclosure is being made in the necessary course of business is a mixed question of law and fact that must be determined in each case and in light of the policy reasons for the tipping provisions. Tipping is prohibited so that everyone in the market has equal access to, and opportunity to act upon, material information. Insider trading and tipping prohibitions are designed to ensure that anyone who has access to material undisclosed information does not trade or assist others in trading to the disadvantage of investors generally.
(2) Different interpretations are being applied, in practice, to the phrase “necessary course of business”.[FN 13] As a result, we believe interpretive guidance in this regard is necessary. The “necessary course of business” exception exists so as not to unduly interfere with a company’s ordinary business activities. For example, the “necessary course of business” exception would generally cover communications with:
(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).
(3) Securities legislation prohibits any person or company that is proposing to make a take-over bid, become a party to a reorganization, amalgamation, merger, arrangement or similar business combination or acquire a substantial portion of a company’s property from informing anyone of material information that has not been generally disclosed. An exception to this prohibition is provided where the material information is given in the “necessary course of business” to effect the take-over bid, business combination or acquisition.
(4) Disclosures by a company in connection with a private placement may be in the “necessary course of business” for companies to raise financing. The ability to raise financing is important. We recognize that select communications between the parties to a private placement of material information may be necessary to effect the private placement. [FN 14] Communications to controlling shareholders may also, in certain circumstances, be considered in the “necessary course of business.” [FN 15] Nevertheless, we believe that in these situations, material information that is provided to private placees and controlling shareholders should be generally disclosed at the earliest opportunity.
(5) The “necessary course of business” exception would not generally permit a company to make a selective disclosure of material corporate information to an analyst, institutional investor or other market professional. [FN 16]
(6) There may be situations where an analyst will be “brought over the wall” to act as an advisor in a specific transaction involving a reporting issuer they would normally issue research about. In these situations, the analyst becomes a “person in a special relationship” with the reporting issuer and is subject to the prohibitions against tipping and insider trading. This means that the analyst is prohibited from further informing anyone of material undisclosed information they learn in this advisory capacity, including issuing any research recommendations or reports. [FN 17]
(7) We draw a distinction between disclosures to credit rating agencies, which would generally be regarded as being in the “necessary course of business,” and disclosures to analysts, which would not be. This distinction is based on differences in the nature of the business they are engaged in and in how they use the information. The credit ratings generated by rating agencies are either confidential (disclosed only to the company seeking the rating) or directed at a wide public audience. Generally, the objective of the rating process is a widely available publication of the rating. [FN 18] The reports generated by analysts are targeted, first and foremost, to an analyst’s firm’s clients. Also, rating agencies are not in the business of trading in the securities they rate. Sell-side analysts are typically employed by investment dealers that are in the business of buying and selling, underwriting, and advising with respect to securities. Further, securities legislation requires specified ratings from designated rating organizations in certain circumstances. [FN 19] Consequently, ratings form part of the statutory framework of provincial securities legislation in a way that analysts’ reports do not.
(8) When companies communicate with the media, they should be mindful not to selectively disclose material information that has not been generally disclosed. The “necessary course of business” exception would not generally permit a company to make a selective disclosure of material undisclosed information to the media. However, we are not suggesting that companies should stop speaking to the media. We recognize that the media can play an important role in informing and educating the marketplace.
FN 13 See Re Royal Trustco Ltd. et al. and Ontario Securities Commission (1983), 42 O.R. (2d) 147 (Div. Ct.) affirming (1981), 2 O.S.C.B. 322C. In Royal Trustco, it was alleged that two officers had revealed to a major shareholder, other than in the “necessary course of business” certain material facts in relation to the affairs of Royal Trustco that had not been generally disclosed including: (i) that approximately 60% of the shares of Royal Trustco were owned by persons or companies who the officers knew or had reason to believe would not tender pursuant to a bid; and (ii) that Royal Trustco management was considering recommending to the board that the dividends payable on the Royal Trustco shares be increased. The Court held that the information disclosed fell within the category of material facts and that such material facts had been made available to such shareholder not “in the necessary course of business” from Royal Trustco’s perspective.
FN 14 Securities legislation provides an exemption from the insider trading and selective disclosure prohibition where the person or company who trades with material undisclosed information or tips it proves that they reasonably believed that the other party to the trade or the tippee had knowledge of the information. Under the Québec Securities Act, the person or company must be justified in believing that the information is known to the other party.
FN 15 For example, a company may need to share sensitive strategic information with a controlling shareholder when preparing consolidated financial statements.
FN 16 See In the Matter of Gary George (1999), 22 OSCB 717, where the Ontario Securities Commission addressed in obiter the issue of a selective disclosure made by an issuer’s chief executive officer to an analyst and the subsequent disclosure by the analyst to other members of his firm. We agree with the principles expressed by the Ontario Securities Commission:
It would appear that some corporate officers see the maintenance of good relations with analysts as being more important than ensuring equality of material information among shareholders. The fact that it was thought that [the analyst] was about to come out with a report as to [the issuer] which would overvalue its shares would in no way justify [the President] giving the information to [the analyst] rather than publicly disseminating it. If the information was material enough to cause [the analyst] to change his projections, it should have been publicly disseminated. In general, we view one-on-one discussions between an officer of a reporting issuer and an analyst as being fraught with difficulties.
Also see In the Matter of Air Canada, where employees of the company disclosed information about third quarter earnings per share results and a revised forecast for the next quarter to 13 analysts who covered the company but not to the marketplace generally. In the Excerpt from the Settlement Hearing Containing the Oral Reasons for Decision, the Ontario Securities Commission said:
Communication by a corporation with analysts is not covered under some exception; so what is disclosed to analysts, if it is material and will significantly affect the market price, or reasonably may be expected to significantly affect the market price of the shares of the issuer, should not be selectively disclosed.
FN 17 Parties to a transaction in which an analyst is “brought over the wall” should be mindful that bringing an analyst over the wall can be a risky practice and may in itself be a signal to others of a significant development involving a reporting issuer.
FN 18 This is consistent with the reasoning of the SEC in excluding ratings organizations from Regulation FD. As the SEC indicated in paragraph II.B.1.a., of the implementing release, “[r]atings organizations…have a mission of public disclosure; the objective and result of the ratings process is a widely available publication of the rating when it is completed.”
FN 19 For example, under National Instrument 44-101 – Short Form Prospectus Distributions, alternative eligibility requirements allow companies without the requisite public float to issue “designated rating” non-convertible debt, preferred shares or cash-settled derivatives under a short form prospectus.