Determining whether something is material can be a perplexing and challenging task for clients and lawyers, even at the best of times – all the more so when you consider that whether you get it right or not can have some serious legal consequences. The concept of “materiality” is a cornerstone of securities laws and it is the foundation on which the integrity of the capital markets is based. It is the basis for determining what needs to be disclosed
- in offering and disclosure documents such as prospectuses and offering memoranda,
- in information circulars sent to shareholders to enable them to make informed decisions on matters affecting a corporation,
- to meet a reporting issuer’s continuous disclosure obligations, and
- for the integrity of the market place not to be compromised, to ensure that no participant in the market place be in possession of a material fact that has not been generally disclosed.
It is a conundrum, therefore, why something as important as “materiality” is in securities law can, most times, be so difficult to determine. The difficulty stems from the requirement that in order for something to have constituted either a “material change” or a “material fact”, there has to be an assessment by the client of whether the fact or the event would reasonably be expected to have a significant effect on the market price or value of a security of the issuer . Lawyers are not particularly adept in assisting on that, not having been taught the subject in law school, and the law on this matter is unclear and not particularly helpful to lawyers when they are asked to provide advice to clients on the matter, as each situation must be judged on its own merits.
The difficulty of advising a client on whether a material fact has occurred in the context of merger discussions may, however, have become easier for lawyers if we are to take the situation encountered by Mr. Tony Lambert, who at the time was the President and CEO of Daylight Energy Ltd. (Daylight), as setting something of a “bright line”. Assessing when a material fact arises in the context of potential merger discussions has been particularly difficult because of the inherent uncertainty that underlies the analysis, namely, whether a transaction will occur, having regard to the many steps that may occur in the evolution of these discussions. Put another way, can the event be reasonably be expected to result in a merger being completed? If the answer to the question is yes, then the second question becomes easier, as a merger usually has an effect on the trading price of a corporation’s shares. Such was the case in 2011 when Mr. Lambert received a call one day informing him that another company was interested in pursuing merger discussions with Daylight. If the events which subsequently unfolded did not actually establish a bright line for when a material fact has occurred in the context of merger discussions, it has certainly illustrated the difficulties clients and lawyers face in determining if one has occurred, and why clients and lawyers would be well advised to take a cautious approach when doing so. The events which occurred in 2011 ultimately came to the attention of the Alberta Securities Commission (ASC), which took the position that in the course of the merger discussions Mr. Lambert had purchased shares of Daylight in the secondary market at a time when he was in possession of an undisclosed material fact, contrary to section 147(2) of the Securities Act (Alberta) (Act). The matter was ultimately settled when Mr. Lambert and the ASC entered into a Settlement Agreement and Undertaking (Re Lambert, 2013 ABASC 338).
A recitation of the facts, taken from the Settlement Agreement and Undertaking, is helpful to have an understanding and appreciation of the issue that was faced by Mr. Lambert and his advisors.
- In July 2011 Canaccord Genuity Asia (Canaccord) and China Petrochemical Group (Sinopec) had very general discussions about the possibility of Sinopec acquiring Daylight. Canaccord informed Mr. Lambert of those discussions and he indicated that he would be receptive to receiving a proposal from Sinopec.
- On August 4, 2011, the day following the termination of a scheduled quarterly trading blackout, Mr. Lambert purchased some shares of Daylight, believing that they were undervalued in the market.
- On August 5, 2011, Mr. Lambert received from Canaccord a letter from Sinopec addressed to Daylight expressing an interest in exploring “a major strategic investment transaction” between the two. On the same day, Mr. Lambert received an email from Canaccord which suggested that Sinopec “is interested in discussion of acquiring the whole of the company”.
- In the Settlement Agreement and Undertaking, Mr. Lambert stated that he did not consider either the letter or the email as being material (for the reasons stated below), but on August 5, 2011 nevertheless inquired of Daylight’s Vice President and General Counsel (General Counsel) if they raised any issues about his further trading in Daylight shares. The General Counsel said they did not.
- Despite the advice given by him to Mr. Lambert, the General Counsel also asked Daylight’s external counsel, as well as the Chair of Daylight’s Governance Committee (an ex-corporate lawyer), if the events of that day constituted material information and, therefore, merited any kind of trading blackout being imposed. Both replied that they did not.
- On August 7, 2011, the General Counsel prepared a form of confidentiality agreement (CA) with respect to the contemplated discussions with Sinopec.
- On August 8, 2011, Mr. Lambert sent Sinopec a letter stating that Daylight was interested in exploring potential business opportunities with Sinopec and forwarded along with it the draft CA.
- On August 8, 2011, Mr. Lambert purchased more shares of Daylight in the market (August 8 Purchases).
- Thereafter, the events unfolded as follows:
- August 15 – CA was signed;
- August 16 – Daylight data room was opened;
- August 23 – Mr. Lambert and other senior officers made a formal presentation to Sinopec in Beijing;
- August 26 – trading blackout imposed by Daylight on its personnel who had knowledge of the possible Sinopec transaction;
- September 6 – trading blackout imposed by Daylight on its board of directors;
- September 30 – Daylight receives non-binding letter of intent from Sinopec;
- October 9 – Daylight and Sinopec issue press release announcing the entering into of a formal binding agreement;
- December 23 – acquisition of Daylight by Sinopec completed.
Section 147(2) of the Act provides that no person in a special relationship with a reporting issuer (which includes a director or officer) shall purchase or sell securities of the reporting issuer with the knowledge of a material fact or material change with respect to the reporting issuer that has not been generally disclosed. The ASC took the view that at the time Mr. Lambert made the August 8 Purchases, he was then in possession of a material fact, namely, that he knew that Sinopec was interested in pursuing discussions with him with a view to possibly acquiring Daylight. The Settlement Agreement and Undertaking stated that the reasons on which Mr. Lambert, the General Counsel, the Governance Chair and external counsel formed their views that the August 5 communications were not material were:
- Daylight had previously received several similar expressions of interest, none of which proceeded beyond the preliminary or introductory stages;
- The August 5 communications were unsolicited and contained no reference to any terms, price or the nature of a possible transaction; and
- Daylight was not then “in play” and had not retained financial advisors to locate potential buyers.
In his defence, Mr. Lambert said that while he believed he was not in possession of a material fact at the time of the August 8 Purchases, he acknowledged that he made an error in judgement in doing so and that it would have been the prudent course of action as Daylight’s President and CEO to err on the side of caution and to have refrained from making any trades in Daylight shares from and after being first notified in July of Sinopec’s interest in Daylight. Nevertheless, the ASC did not accept Mr. Lambert’s arguments and in the end Mr. Lambert agreed to settle the matter by paying a fine ($129,000, representing the profit he made from the sale of the shares he acquired by the August 8 Purchases), reimbursing the ASC’s investigation and hearing costs of $100,000, agreeing to not be a director or officer of a reporting issuer for a period of two years, and agreeing to other trading restrictions.
In conclusion, given the view of the ASC in Re Lambert of when a material fact may arise in the course of merger discussions, the imposition of trading blackouts should now be imposed earlier than perhaps has been done in the past. As for precedent value, while Re Lambert may be restricted to situations involving merger discussions, if it is any indication of the general attitude of the securities commissions on when a material fact comes into existence, the potential gains of purchasing or selling shares in the market are hardly worth the risk of being found to have violated the laws concerning insider trading, let alone having to deal with a hearing to prove you were not in the wrong. It would, therefore, be better to take an even-more cautious approach when considering whether trading blackouts should be imposed.
 While securities laws only require immediate disclosure of “material changes” (being material facts constituting a change in the business, operations or capital of the issuer), readers need to be mindful of the requirements of the Toronto Stock Exchange that all “material information”, which includes any “material fact”, must be immediately disclosed (although, the Exchange is more flexible in allowing circumstances where disclosure can be delayed for confidentiality reasons).