Insider trading: An insider on the outs

Mitchell Finkelstein was a rising star, but insider tipping allegations have made him the man that Bay Street wants to forget.

Once, corporate lawyer Mitch Finkelstein was celebrated as one of Bay Street’s most marketable assets. In November 2007, he was toasted with freeflowing champagne at Toronto’s Acadian Court ballroom, where the legal community held its annual Rising Stars Awards gala. Described as ‘ Vanity Fair for lawyers’ by one Toronto litigator, the annual event is organized by Lexpert magazine to recognize 40 legal hot shots under 40. At the time, Lexpert quoted a Davies client stating: ‘There is not a deal where we wouldn’t want him acting on our behalf.’

Three years later, Finkelstein was no longer being praised. As Canadian astronaut Dave Williams, this year’s keynote speaker, compared the careers of Lexpert‘s 2010 up-and-comers to his experience reaching the stars, nobody spoke of Finkelstein’s equally spectacular downward trajectory.

On Nov. 11, the Ontario Securities Commission accused the 41-year-old of participating in what it dubbed an ‘illegal insider tipping and trading scheme.’ Finkelstein allegedly passed confidential information about corporate transactions Davies worked on to a Montreal-based CIBC investment adviser, Paul Azeff. From there, it allegedly spread through a network of family, friends and clients who made a potential profit of about $2.5 million across more than 100 trading accounts.

These allegations have not been tested before any court or tribunal. Nevertheless, insiders say Finkelstein wasn’t long gone when his firm officially cut ties with its former poster boy. Suddenly, the firm could not bring itself even to utter his name. ‘Davies has recently been informed of the allegations against a former member of our firm and has co-operated fully with the OSC,’ said a statement issued by a crisis communications specialist on behalf of Davies managing partner Shawn McReynolds. The statement added: ‘Our firm’s policies concerning the duty to keep client matters confidential are very clear, and are well understood by our people. We will tolerate no breach.’ Davies wasn’t merely looking to distance itself from what it called isolated actions ‘allegedly taken years ago by one individual.’ It attempted to erase all traces of Finkelstein’s very existence, at least on its website, where the 2007 press release announcing Finkelstein’s rising-star status has been rewritten. References to his involvement in various deals have been systematically deleted. In the faint trail that remains, there is little to explain why Finkelstein would have risked so much for so little gain.

On average, 17 months elapse between the day the OSC’s enforcement branch commences an investigation and the day litigation commences. Exactly when Davies learned Finkelstein was the target of a regulatory investigation remains unclear, but it took the legal community by surprise. Says one former Davies co-worker: ‘I thought it was one of those, you know, really bad jokes, when someone puts together something that looks like, you know, a news article or something like that and then fires it around. It’s unimaginable. ‘

Inside Davies, Finkelstein wasn’t known for rubbing people the wrong way. ‘Davies,’ says one former co-worker, ‘is not a warm and fuzzy kind of place where everyone goes for coffee. It’s a pretty serious culture. Mitch had been identified as a superstar a long time ago, and he was very focused on his work and earning power, but people generally liked working with him.’ When there was time for chit-chat, another co-worker says, Finkelstein often talked about his son and daughter. ‘Pictures of them were everywhere in his office,’ outnumbered only ‘by his numerous deal toys [corporate trophies issued to transaction participants after deals are closed].’ One source noted Finkelstein isn’t overly materialistic, ‘not a Rolex guy.’ His home in Toronto’s prestigious Forest Hill neighbourhood is among the more modest on the street.

Lawyers who know Finkelstein call him an extremely hard-working individual who worries about his health and loves his kids. Last year, he publicly complained about shortages of H1N1 flu vaccine. ‘Quite frankly, I think this kind of proves socialized health care doesn’t work,’ he told a national newspaper last November, after his family used an expensive private-clinic membership — provided by his employer — to avoid waiting for inoculation shots like the general public. Sources say he had a seizure while on a family trip about a year ago. He reportedly fell down, hurt his back and was off work for weeks. ‘There never was any explanation given,’ says a lawyer who now wonders if stress related to an OSC investigation was a factor.

Fellow graduates of Lower Canada College’s Class of ’86 in Montreal, where Finkelstein grew up, are also floored by the allegations. Finkelstein was raised by wealthy, but divorced, parents. A fellow jock remembers him as a calm, contained, confident, straight-up and clever student, one who performed well in the classroom and on the basketball court. Finkelstein dated, but didn’t brag ‘about how many chicks he smooched.’ He wasn’t known for ‘rocking the boat’ or ‘thumbing his nose at authority.’ He didn’t cheat and wasn’t considered ‘a schemer at all.’

Non-jocks found the stocky lawyer somewhat intimidating. They called him ‘Noneck Finkelstein.’ One classmate recalls being berated by the lawyer for listening to the Rolling Stones instead of Tears for Fears. Finkelstein completed undergraduate studies at the University of Western Ontario, where he met Azeff, then studied law at the University of Ottawa. A fellow student from the 1994 graduating class perceived Finkelstein as intelligent and outgoing. ‘I think things came to him fairly easily,’ that lawyer recalls. ‘I don’t think he was killing himself to get good marks.’

Finkelstein articled at Davies and quickly earned a partnership. During his years there, he participated in various takeovers, equity offerings, and bank and mortgage financings, with a particular focus on work involving real estate investment trusts. He’d chosen the right firm for such work: last year the firm played a significant role in three of the Top 10 Canadian deals. Observers said a commercial lawyer of Finkelstein’s stature might earn $500,000 a year. ‘Do a cost-benefit analysis,’ says a lawyer who worked with him, ‘and none of this makes sense.’

‘Special relationship’: this regulatory term appears often in insider trading cases, including this one. Under provincial securities rules, anyone possessing material information about a reporting issuer unavailable to the broader public automatically enters a special relationship with that issuer. They’re prohibited from trading the issuer’s securities until the information becomes publicly available. It can happen to just about anybody — an investment banker’s gardener, a person overhearing a conversation while riding an elevator. Used less formally, ‘special relationship’ invokes something else: the lifelong friendships, and occasionally marriages, around which so many insider trading cases revolve.

Finkelstein’s special relationships allegedly first became a problem in 2003, when famed American leveraged-buyout firm Kohlberg Kravis Roberts & Co. began making overtures to buy Masonite International, a Mississauga-based door manufacturer. Well into the following year, the two parties discussed possible business combinations but made little progress. Negotiations began in earnest only during the summer of 2004, after KKR hinted it might be willing to pay between $40 and $42 for each outstanding Masonite share.

Seeking advice, Masonite drew numerous professionals into its orbit. The choice of law firms was obvious. Earlier that year, Davies represented Masonite when it acquired a residential doors manufacturer based in Connecticut. Two years earlier, it helped Masonite amend a US$700-million credit facility. Finkelstein, who’d worked both previous deals, was a shoo-in. The OSC says he was among the lawyers who met with Masonite’s management on Nov. 16 to discuss the transaction.

The deal’s esoteric code name, ‘Project Balboa,’ was just one sign Masonite craved secrecy: the company also decided against shopping itself around to other possible bidders, citing the ‘risk of leaks.’ Rumours of an impending sale could disrupt the company’s relationships with its customers and suppliers, distract employees, and send the price of its shares soaring, potentially killing the deal. Professional standards aim to plug those leaks: the Law Society of Upper Canada’s Rules of Professional Conduct state that lawyers cannot divulge any information regarding a client’s business and affairs without permission, even to spouses. ‘Client confidentiality is fundamental to the profession of law,’ says the society’s CEO, Malcolm Heins.

But with so many service providers involved, loose lips were nevertheless possible. ‘You try to keep information confidential,’ says one senior partner at a prestigious Bay Street law firm. ‘But people end up talking to other people within a firm about what they are working on.’

Somehow, information escaped. According to the OSC, in late November 2004 a trading officer at TD Waterhouse Canada named Howard Miller told clients to buy Masonite. To one, he sent an e-mail that read:

Call me I have a tip … stock trades on TSX at around $34 — cash takeover of $40 Timing should be before xmas but you never know with lawyers … I’m long.

‘Long’ meant he was holding shares. Indeed, the OSC claims that before and after sending that message, Miller bought thousands of Masonite shares on behalf of his wife and himself. He also allegedly told his friend and associate, Man Kin Cheng, also employed at TD. Cheng passed the information along to his own clients and family, including a brother living in Hong Kong. They bought shares, too.

KKR made its final offer on the morning of Dec. 22: $40.20 per share. After markets closed, the two parties signed a combination agreement and announced it via a press release. Masonite shares spiked the following day. According to the OSC, over the following months Miller, Cheng, and their friends, clients and families sold shares, ringing up thousands of dollars in profit.

In major financial centres — New York, London, Toronto — the perception is nearly universal: insider trading goes on all the time. For decades, economists and academics have studied trading patterns during takeovers in North America and Europe. Much of the research reached the same conclusion: that share prices and trading often surge prior to a takeover being announced, suggesting some market participants know in advance. Abroad, spectacular insider trading crackdowns reinforce that impression. Earlier this year, British authorities raided London’s so-called Square Mile and led employees from venerable institutions like BNP Paribas and Deutsche Bank in handcuffs. And the FBI descended on U.S. hedge funds in late November. They also arrested Don Chu, a research firm executive, on allegations he provided hedge funds with improperly obtained information.

Easy though it may be to detect, securities lawyers say tipping and insider trading cases are difficult to prosecute. In the decades leading up to the KKR-Masonite deal, provincial securities commissions netted fewer than one insider trading conviction per year. Penalties, when imposed, were often dwarfed by the ill-gotten gains.

Yet amid the strange trading around KKR-Masonite, change was afoot. Canadian regulators convened an Insider Trading Task Force in 2002 to examine ways to improve their batting average. They began co-operating more with international partners. The federal government passed new legislation in 2004 adding insider trading to the Criminal Code. Although they occasionally receive tips and complaints, regulators most often learn about suspicious trading through electronic market surveillance. The Investment Industry Regulatory Organization of Canada’s surveillance team conducts real-time assessments of market activity looking for suspicious or unusual patterns. This is likely how unusual trading around the KKR-Masonite deal came to light.

In September, the OSC launched an insider trading action against Miller and Cheng, the TD traders. The OSC’s allegations against these men do not reveal how they purportedly acquired their information. The explanation, which arrived when the commission amended its allegations on Nov. 11, suggested a convoluted chain. Miller allegedly learned about KKR-Masonite from one of his clients, who happened also to be a client of an investment adviser at CIBC World Markets in Montreal named Paul Azeff. Azeff and his CIBC colleague and high-school pal Korin Bobrow (a director of the National Capital Commission) allegedly conducted their own insider trading using the information. The crucial link: Azeff allegedly learned about the looming deal from Finkelstein.

Azeff met Finkelstein in Toronto in late January 2005. Over the following two days, Finkelstein deposited $50 and $100 bills into two of his bank accounts. (The OSC did not reveal the amount.) KKR-Masonite was the first of four deals Finkelstein allegedly tipped Azeff about. Until May 2007, Finkelstein ‘sought out and acquired material, non-public information concerning pending corporate transactions that he would communicate to Azeff,’ the OSC claims. Sometimes he wasn’t even working on the transaction: Finkelstein learned of other colleagues’ deals by conducting searches on Davies’ internal document management system.

Illegal insider trading schemes sometimes involve offshore brokerage accounts and clandestine communications via payphone, but the OSC makes no mention of such tactics. And strikingly, the alleged profits from Azeff’s trades — $51,500 on KKR-Masonite, for instance — seem relatively small. If Finkelstein really did tip Azeff, the payoff seems surprisingly low.

Finkelstein did not respond to requests for comment for this story. But as one of his next-door neighbours noted, there are two sides to any story — ‘especially when it comes to OSC allegations.’ On Jan. 11, the OSC will hold a hearing that among other things will consider whether Finkelstein and other respondents should be banned from trading securities, and whether they should pay administrative penalties of up to $1 million each for violating securities laws. The process is likely to drag on for months or years, and will ensure that efforts to erase traces of Finkelstein’s time at Davies will come to naught. The great violence such proceedings do to lives and careers serves as a stark reminder of the ravages of insider trading — but will not likely eradicate the practice. In the words of one high-profile securities lawyer: ‘My gut says every time there is one of these OSC cases, people who might be tempted to misuse information [for profit] think twice. But it will happen again.’