There has been plenty of media coverage about the mystery of the identity of the businessman found guilty of insider trading over the sale of Pushpay Holdings shares and the basis of the conviction.
The purpose of this note is to make a few observations about the treatment of the legal test for ‘material information’.
But first, a little bit of background.
Background
In May, the Court of Appeal dismissed an appeal against the conviction by the High Court. In doing so, the Court of Appeal allowed the Crown’s [FMA’s] appeal against the sentence, doubling his fine from $100k to $200k. There was no change to the sentence of 6 months’ home detention, although it was observed by the Court of Appeal that this was made on compassionate grounds – when otherwise a custodial sentence may have been more appropriate.
Earlier this month, the Supreme Court dismissed an application for leave to appeal the Court of Appeal decision.
The back story is that:
- In April 2018, the Pushpay co-founder, who held about 9% of Pushpay’s shares, told the businessman that he was thinking of leaving Pushpay and selling his shares. He subsequently did so – and the shareholding was sold in June 2018 at $4.04 per share via a bookbuild process. (After that bookbuild/sale – when trading in Pushpay shares resumed, the closing market price on NZX on that trading day was $4.27.).
- Between the time that the co-founder told the businessman (who was a senior executive of Pushpay- and an alternate for one of its directors) of his intentions and before the co-founder’s departure and share sale, a trust that held Pushpay shares sold those shares on the NZX at an average price of $4.21 per share.
- The Crown alleged that on 3 May 2018, before the information about the co-founder’s intention to stand down and sell his shares was made public, the businessman advised or encouraged the trust to do so because he expected the sale of the co-founder’s shares would have an impact on the Pushpay share price. This was done via an email sent to the trustees and the principal beneficiary advising an immediate sale of the Trust’s Pushpay shares, telling them to set up a brokerage account with a share broker to process the sale.
- In his defence, the businessman said:
- he had not encouraged the trust’s principal beneficiary or the trustees of the trust to sell the shares but was just passing on the principal beneficiary’s instructions; and
- the co-founder’s departure and share sale was not ‘insider information’ because a reasonable investor would not expect this information to have a material effect on the share price.
- A High Court jury trial found the businessman guilty of insider trading – for which he was sentenced to 6 months’ home detention and a fine of $100k.
- That decision was appealed to the Court of Appeal, with the FMA appealing the sentence.
Materiality issues on appeal
There were a number of issues of appeal. In relation to the materiality issues, the defence submitted that the jury’s verdict was unreasonable on the basis that the FMA’s expert applied the wrong legal test for what would be a ‘material’ effect on Pushpay’s price.
However, the Court of Appeal pointed to the trial judge’s direction to the jury, that:
- the correct legal test is whether a reasonable person would expect a hypothetical public announcement on 3 May 2018 to have a material effect on the price of Pushpay shares on the NZX; and
- to the extent that not all of the expert’s evidence addressed the correct legal test (because, at times, the expert seemed to deny that a hypothetical public announcement on 3 May 2018 was the appropriate test of whether the inside information held by the businessman was material) the jury needed to consider his evidence in light of that correct legal test.
The full context in which the jury needed to consider that expert evidence – asked if a reasonable investor would expect the information [about the co-founder’s decision to leave and sell down their shareholding] to have a material effect on the price of Pushpay’s shares. The expert said that a bookbuild at a discount of around 7% could be anticipated – and this was material. Confidentiality was critical.
To the extent there was confusion, because the expert thought he was being asked to say what immediate price impact there would be on 3 May 2018 in anticipation of the upcoming bookbuild that would be expected to occur at a discount – and with this impact having been experienced, what price impact would then occur at the time of the bookbuild. He did not regard this as the right approach. There was, the expert said, one source of information and this one source drove its materiality (an anticipated discount of around 7% – 7.5% when the anticipated bookbuild occurred) meant that the information was material as at 3 May 2018.
Supreme Court outcome
The basis of the further appeal was a submission about questions of when and how the materiality of information is assessed – for an insider trading claim, and that materiality questions must be met daily by directors (and by extension insiders). And this underpinned submissions that the Court of Appeal decision erred in three respects (i) it should have found that the expected price effect of the transaction was to be measured as at 3 May 2018, rather than when the transaction was expected to occur; (ii) a bookbuild discount should not be used to judge the materiality of the information because that discount does not reflect a market price set when the information is “generally available” to the investing public; and (iii)the Court should have concluded the jury reached an unreasonable verdict as there were several plausible alternatives consistent with innocence.
The Supreme Court dismissed the appeal saying that it was not sufficiently persuaded that the Court of Appeal erred in its approach to evaluating the materiality of information. The jury found the information was material in fact and that the applicant knew it was material. The Court of Appeal also closely assessed the evidence on materiality and any plausible alternatives, such as the possibility that the co-founder might not leave or that the shares would not be sold via bookbuild. And the Supreme Court agreed with the Court of Appeal’s conclusion that the jury could accept the [FMA’s expert] evidence that the anticipated bookbuild discount when it occurred in June 2018 meant the information was material as at 3 May 2018.
Materiality in the context of insider trading
Liability for insider conduct under the FMC Act requires proof that ‘material information’ was used to tip or trade in [listed] securities at a time when that information was not generally available to the market.
Information is “material information” if:
| … a reasonable person would expect, if it were generally available to the market, to have a material effect on the price of quoted financial products of the listed issuer. |
The test for materiality looks at the likely [hypothetical] movement in share prices had the non-public information been released at the time the insider tipped or traded.
In the High Court, the FMA’s expert gave evidence about [listed] securities market behaviour to news of the departure of a co-founder with sale of a substantial shareholding that depresses market prices; requiring sale at a discount to clear the increased volume of shares offered for sale. That expert evidence included that general movements in market prices subsequent to improper use of inside information are of no direct relevance in determining ‘materiality’ at time the insider tips or trades.
The jury’s verdict was that the businessman knew the fact of the co-founder’s proposed departure was ‘material information’ – and that the businessman acted on that, non-public material information, when advising [tipping] the family trust to sell.
More about material information
The FMC Act does not set out the characteristics of a ‘reasonable person’ – but guidance is available in the form of the NZX Guidance Note on Continuous Disclosure – which refers to a person who commonly invests in [listed] securities, and holds them for a period of time, based on their view of inherent value. The test is forward-looking – i.e. what the reasonable person would expect, if [the non-public, price sensitive] information was generally available to the market.
Whilst the Court of Appeal judgment in Pushpay said that there is no a statutory requirement that a counterfactual of a hypothetical public announcement be used to consider whether the inside information is material – that is essentially the decision-making process required to decide the key question (how would the reasonable person who routinely invests in shares … assess the market reaction if everyone had the same information as the insider?).
The statutory (FMC Act) test for inside information requires that the reasonable person would expect the information to have a material effect on the price (of the [listed] securities in question). Material effect is context specific. The NZX Guidance Note provides guidance on material effect.
In this case, the FMA’s expert evidence was that a reasonable investor would regard the information (that the co-founder intended to resign and sell his shares) as material because they would expect the large parcel of shares to sell at a discount in a bookbuild at a level that would be material. This triggered a technical issue at trial, as to whether the expected discount at the time of the bookbuild was relevant – on the basis that the price effect was the price on NZX and should excluded the bookbuild (because it was off-market). Here, the Court of Appeal agreed with the trial judge that an anticipated bookbuild discount is not excluded from the ‘material information’ test. A bookbuild is a sale of the [listed] securities. The trade (bookbuild) is quoted on NZX once completed. Therefore, an anticipated discount in a bookbuild can be “material”. The jury decided it was material based on the inside information held by the businessman as at 3 May 2018; and a reasonable investor’s expectations as at 3 May 2018 of the likely impact on the price of Pushpay’s shares if that inside information was generally available.
Concluding comments
Clearly, there were some difficult elements arising out of the manner in which the jury trial unfolded. There was a lot of focus, on appeal, about the FMA’s expert witness evidence and the claim that, in giving evidence, the expert appeared (mostly during cross–examination) not to have understood that the ‘material information test’ was assessed on the basis of the counterfactual of a hypothetical public announcement (of the co-founder standing down and embarking on a process to sell his shares). However, the higher courts were satisfied that, when armed with all of the evidence, the prosecution submissions on the evidence and the Judge’s directions about the (correct) legal test, the jury were satisfied that the information was material.
Importantly, the decision underlines the significance of NZX guidance on materiality (for the purposes of compliance with a listed company’s continuous disclosure obligations). The NZX guidance underlines the point that materiality (the material information test) is based on what a reasonable person would expect to happen upon the release of information.
The test is not applied with the 20/20 vision of hindsight, based on the price movement which actually occurs upon release of information. Instead, it is an assessment of all available evidence of the expected [price] impact of information at a snapshot in time. This forward-looking test is based on the available information prior to release. The NZX guidance that issuers are expected to consider what they expect to happen to the price of the securities when material information is released – is an application of the hypothetical public announcement counterfactual.
Also, in the context of continuous disclosure, the suggestion in that NZX guidance that it may assist to document the issuer’s reasoning (why the information is / is not material) as part of the decision-making process – just in case this needs to be considered in future, is now even more likely to be seen as a ‘must have’.
For more information, please do not hesitate to contact me.