The Finkelstein Case Demystified

This article first appeared in French as a blog-post on the website Conseiller.ca, and has been modified to account for the adjournment of the May 21, 2015 hearing. 

Further to an adjournment on May 21, 2015, former lawyer Mitchell Finkelstein and four investment advisors have been summoned to a June 17, 2015 sentencing hearing before the Ontario Securities Commission (the “OSC”). 

The summons is further to the decision rendered by the OSC last March, by which these individuals were found to have violated Ontario’s Securities Act for having engaged in illegal insider trading or “tipping” with respect to three reporting issuers. 

This decision is the most recent in Canada relating to insider trading. It reflects the overall strategy of North American securities regulators to proactively target individuals illegally using insider information regarding an issuer, either by engaging in insider trading or by “tipping” someone else for that purpose. 

While the terminology and evidentiary criteria may vary from one province or state to the next, the overall aim of securities regulation remains largely the same: to prevent insiders – and individuals with confidential relationships with insiders – from using “privileged” information, “material facts” or “material changes” unknown to the public at large to their benefit, or to communicate such information to others for that same purpose. 

Profitable Word-of-Mouth 

Mr. Finkelstein was a prominent mergers & acquisitions attorney practicing in Toronto. Given his area of specialization, he had access to information on impending major transactions involving public companies (including the likelihood of such potential transactions being consummated and their probable impact on the price of the issuer’s shares). 

Mr. Finkelstein was accused before the OSC of having disclosed information in connection with potential transactions to a close friend, an investment advisor in Montreal associated with a Canadian bank, before such information was rendered public. 

The investment advisor, in turn, shared this information with fellow investment advisors, who then proceeded to trade the securities, both personally and on behalf of others – before the information in question became public – and realized substantial gains. 

North America Securities regulators have always actively pursued individuals suspected of being involved in illegal insider trading or tipping, with the goal of punishing wrongdoers and dissuading others from doing the same. In the past, regulators systematically filed criminal charges against such suspects, though without an admission or direct evidence of illegal activity, it was often difficult to obtain convictions. 

In criminal matters, regulators must prove “beyond a reasonable doubt” that the accused had illegally traded the securities of a reporting issuer, based on insider information not available to the public, or had tipped a third party for that same purpose. 

In recent years, those targeted by such accusations were primarily members of issuers’ boards of directors, but also investment advisors, lawyers (like Mr. Finkelstein) and accountants. 

A lesser burden of proof 

Given the rarity of admissions or direct evidence establishing illegal insider dealings “beyond a reasonable doubt”, regulators began instituting proceedings before administrative tribunals such as the OSC and, in Quebec, the Bureau de décision et de révision, rather than giving up on certain files. 

The burden of proof is lower before such administrative tribunals. Indeed, in the context of administrative proceedings relating to illegal insider trading, the burden is to prove, on a balance of probabilities, that the alleged activity took place. For this purpose, circumstantial evidence can be sufficient, which is not the case in a criminal trial. 

The Finkelstein decision illustrates the new strategy of securities regulatory authorities in both Canada and the United States, which consists in instituting proceedings before administrative bodies to seek monetary sanctions against targeted persons where the regulator considers that it does not have evidence “beyond a reasonable doubt”. Although prison sentences cannot be imposed by such tribunals, sanctions can nevertheless be very severe. 

The importance of indirect evidence 

The hearing in the Finkelstein case lasted 22 days. Mr. Finkelstein and the four investment advisors denied the allegations filed against them, and the OSC had no direct evidence to prove these allegations. 

The evidence put forward by the regulatory authority was exclusively circumstantial, and notably consisted in: 

• the lawyer’s time sheets, to establish when he worked on the transactions in question;
• the recommendations he had made to the board of directors, to establish his knowledge of the material non-public information;
• the frequency, duration and date of telephone calls, text messages and emails between Finkelstein and his investment-advisor friend, in order to demonstrate the connection between such communications and the market transactions;
• the pattern of the  trades;
• the date of the trades;
• the fact that the trades were first-time purchases of the securities in question;
• the concentration of the trading. 

On the basis of this indirect evidence, the OSC concluded that Finkelstein, his investment-advisor friend and the other investment advisors had – on the balance of probabilities – engaged in illegal insider trading or tipping with respect to the stock of Masonite, Dynatec and/or Legacy Hotels REIT. 

The Finkelstein decision illustrates the important contrast between the standard of proof that must be met by securities regulators in order to prevail before an administrative body as compared to that in criminal proceedings. 

Regulators nevertheless continue to file criminal charges in cases where they believe that they can prove illegal insider trading “beyond a reasonable doubt”. In fact, just recently in the United States, Mathew Martoma, a former portfolio manager at SAC Capital, was sentenced to nine years in prison based on evidence that he traded in the shares of two pharmaceutical companies while in possession of insider information. That insider trading netted had SAC Capital a profit of US$ 276 million and allowed it to avoid significant losses.