COR#95/172

Wade D. Nesmith and R.S. Fleming, for Commission staff. Bernard McGarva, for James Jonathan Hunter.

This is a hearing under section 144 of the Securities Act, S.B.C. 1985, c. 83. A notice of hearing was issued on June 11, 1993, and amended on June 23, 1993.

The original notice made allegations concerning the conduct of Anker Bank (formerly known as Handelskredit Bank AG), James Jonathan Hunter and John Murray Stirling in relation to trading in the shares of Cal Graphite Corporation in 1987 and 1988. Anker Bank entered into a Settlement agreement with Commission staff and was dropped as a respondent in the amended notice.

At the beginning of the hearing, the respondents presented several motions requesting that the hearing be discontinued. The motions were dismissed.

After the dismissal of the motions, Stirling entered into a Settlement agreement with Commission staff. As a result, Hunter is the only remaining respondent in these proceedings.

Commission staff allege that Hunter: traded in Cal shares with knowledge of material facts that had not been generally disclosed, contrary to section 68(1) of the Act; entered into a promotional agreement with Stirling that encouraged a misleading appearance of trading activity in Cal shares and performed the agreement in circumstances where his compensation and access to free trading shares were both undisclosed, contrary to the public interest; and arranged a private placement and option agreement with Handelskredit that improperly resulted in a distribution being made by Cal to Hunter without the imposition of the hold period that would otherwise have applied.

In its Settlement with staff, Handelskredit admitted that it had transferred to Hunter the Cal shares it purchased in the private placement and that this may have enabled Hunter to avoid a hold period. Handelskredit paid a penalty of $20,000, agreed to cooperate in the investigation and agreed to obtain advice of counsel in connection with any future private placements to better ensure compliance with the Act and Commission policies.

Stirling admitted that his promotional agreement with Hunter encouraged a misleading appearance of trading activity and was contrary to the public interest. Stirling paid a penalty of $5,000 and consented to orders removing his exemptions for one year and prohibiting him from being a director or officer of a reporting issuer for five years.

2.  BACKGROUND

During the period from April 1987 to March 1988, the relevant time period in this matter, Cal was a reporting issuer incorporated under the Company Act, R.S.B.C. 1979, c. 59, and its common shares were listed for trading on the Vancouver Stock Exchange. As of July 14, 1987, there were approximately 5,340,000 Cal shares issued and outstanding.

Stirling was a director and president of Cal from July 12, 1985, until March 12, 1992.

During the relevant period, Hunter published newsletters that recommended and promoted speculative investments.

During the relevant period, Handelskredit was a banking organization incorporated in Switzerland and was recognized as an exempt purchaser by an order made by the Superintendent under the Act. At that time, recognition as an exempt purchaser enabled Handelskredit to purchase securities of exchange issuers on a private placement without being subject to the one year hold period that applied to other purchasers. On February 18, 1987, as part of its application for exempt purchaser status, Handelskredit confirmed in writing to Commission staff that its purchases of securities under the exemption were made for investment purposes and were not incidental to a distribution to the public.

In the spring of 1987, Cal was developing an open pit mine in Ontario, where it had discovered an exceptionally high grade graphite deposit. Forty-five employees were working on the site, but Cal required immediate financing to continue the work and avoid a shut down of the project.

In April 1987, Stirling first met Hunter and discussed Cal's needs, including an immediate infusion of cash in the range of $5 million. Hunter offered to arrange a private placement and to promote Cal shares in exchange for a fee of $1 million and one million free trading shares of Cal. Stirling rejected these terms but continued discussions with Hunter. Ultimately they met on June 22, 1987, and reached an agreement, which was confirmed in a letter of the same date from Hunter to Stirling.

The key elements of the Hunter-Stirling agreement were that: Hunter would negotiate and arrange a private placement between Handelskredit and Cal; and Stirling would pay 300,000 free trading shares of Cal to Hunter upon the completion of the trade of the two millionth share of Cal through the Exchange since June 12, 1987. Although the agreement did not specifically say so, it was understood that one of Hunter's duties under the agreement was to promote trading in Cal shares. The agreement was not generally disclosed during the relevant period.

Hunter began publishing newsletters strongly recommending the purchase of Cal shares on approximately June 12, 1987, and continued to do so until late 1988. He also promoted Cal shares by publishing an advertisement in The Northern Miner newspaper and by renting and appearing in a booth at the gold show in New York City. Hunter claims to have spent $200,000 to $300,000 promoting Cal shares.

Hunter's newsletters contained a "boilerplate" notice in fine print on the bottom of the second page, which included the following statement: "Hunter and Associates, Inc. and/or its officers, directors and employees and members of their families may have a position in the securities mentioned in this publication and may make purchases and sales of these securities from time to time in the open marketplace or otherwise."

On or about July 14, 1987, Cal and Handelskredit entered into the private placement negotiated by Hunter. The terms of the private placement included the following:

-		Handelskredit would purchase 500,000 Cal shares at a price of $6.00 per share; and
-		Cal granted to Handelskredit non-transferable share purchase warrants entitling Handelskredit to purchase up to 500,000 more shares at a price of $9.00 per share at any time up to July 1, 1988.

The private placement was approved by the Exchange on July 29, 1987.

Handelskredit took delivery of the 500,000 private placement shares in four tranches: 100,000 shares on or about August 4, 1987; 100,000 shares on or about August 21, 1987; 200,000 shares on or about September 4, 1987; and 100,000 shares on or before January 6, 1988. In each case, the shares were purchased by and delivered to Hunter under his option within a few days. In early July 1988, Handelskredit took delivery under its share purchase warrant of a further 100,000 shares, which were not optioned to Hunter.

Hunter sold all 500,000 private placement shares in the market during the relevant period. Most or all of the shares were sold at prices substantially higher than $6.50.

In April, May and early June 1987, Cal shares declined in price from about $8 to $6 per share and traded an average of only a few thousand shares per day. Once Hunter began promoting Cal on June 12, trading volume increased sharply, on many days exceeding 30,000 shares. The price immediately jumped to $9 and reached about $13 by August. The price dropped sharply to $6 in October but it began to increase again in mid November and reached $12 by the end of December.

By March 1, 1988, two million shares of Cal had traded on the Exchange since June 12, 1987. However, Stirling resisted paying Hunter the 300,000 Cal shares contemplated in the Hunter-Stirling agreement. Hunter sued in the Ontario Court of Justice (General Division). He testified that he had two obligations to perform under the agreement -- arranging the private placement and trading two million shares -- and that he had completed both.

One of Stirling's defences was that the Hunter-Stirling agreement was unenforceable because it was illegal or contrary to public policy. This argument appears to have been based on the existence of Hunter's option agreement with Handelskredit. McRae J. of the Ontario Court of Justice (General Division) dealt with the argument as follows:

	The more difficult and complex defence argument is based on the admitted fact that the plaintiff had an arrangement with Handelskredit Bank wherein it verbally gave    him an option to buy the shares purchased by it through the private placement agreement at a 50 cent per share premium. The defendant says the plaintiff was the defendant's agent in arranging the private placement agreement, that he made a secret deal with the bank to get an option on the shares at the time when he had a fiduciary duty to the defendant not to do so, and that by negotiating this option, he received a secret benefit at no risk to himself since at the time the shares were trading between $8.00 and $12.00. It is alleged that this amounts to a secret commission and is unlawful or at least contrary to public policy, and since it is part of the consideration the plaintiff has received pursuant to the contract of June 22, 1987, the contract is unenforceable in law and equity.
	While this argument is imaginative and bears careful consideration, I have concluded that it is without merit. The evidence of whether or not a principal/agency relationship existed is equivocal. Overall, I am not satisfied on the evidence that such a relationship existed. Agency has been defined by Fridman's Law of Agency as:

"The relationship that exists between two persons when one, called the agent, is considered in law to represent the other, called the principal, in such a way as to be able to affect the principal's legal position in respect of strangers to the relationship by the making of contracts or the disposition of property."

	Mr. Hunter was not in a position to affect the defendant, Stirling's, legal position in respect of the bank or that of any other stranger to the relationship.
	In any event, even if such a relationship existed, I am satisfied that the arrangement the plaintiff made with Handelskredit Bank to buy the shares at a 50 cent premium was not a secret to the defendant. Mr. Stirling testified that he knew the plaintiff had an interest in the placement, but he didn't want to hear about it, that is, he didn't want to hear the details. The first letter of agreement between Cal Graphite and the Bank, Exhibit 1, Tab 3, contains, at Page 3 of the letter, the clause,

"The undersigned hereby declares that the shares to be purchased hereunder will be acquired for investment purposes and not with a view to resale or distribution."

	However, the agreement finally entered into was prepared by Mr. Kristoferson, solicitor for the defendant. It contains no such clause. This indicates, along with all of the other evidence, that the defendant knew that the plaintiff intended to take up at least some of the shares from the Bank. It is also significant that the defendant, after attending in Switzerland to sign the agreement and to receive payment for the first 100,000 shares, was given the 100,000 shares by the Bank in street form and asked to take them back to the plaintiff in Toronto. I am satisfied that the plaintiff made his verbal option agreement with the Bank with the knowledge and consent of the defendant. If I am mistaken in that, at least the defendant tacitly consented to the arrangement, but simply, to quote him, "didn't want to know the details."
	The arrangement the plaintiff had with the Bank to repurchase the shares at a 50 cent premium did not make the plaintiff the principal in the private placement. The Bank was obliged to purchase 500,000 shares at $6.00 per share whether the plaintiff exercised his option or not. The Bank was always the principal in the transaction. The Bank, as an exempt purchaser, was permitted to resell the shares immediately as it did to the plaintiff with respect to the first 500,000 shares. The 100,000 shares purchased by the Bank pursuant to its option at $9.00 per share were not resold, at least not to the plaintiff.
	Nothing the plaintiff did is illegal or contrary to public policy. At most, he used as a loop hole to obtain 500,000 free trading shares at $6.50 per share, and he did this with at least the tacit consent of the defendant.
	What happened here is the defendant made a bargain with the plaintiff when his company was in desperate need of funds. Later when the company was in better shape, he regretted making such an agreement. However, unfortunately, for him, he remains liable pursuant to the terms of the agreement.

3.  ANALYSIS AND FINDINGS

Commission staff make the following allegations in the amended notice of hearing:

-		The Hunter-Stirling agreement was an agreement that, in light of all the circumstances in which it was made, encouraged a misleading appearance of trading activity and was performed in circumstances where Hunter's compensation and access to free trading shares were both undisclosed.
-		In all the circumstances, the Hunter-Stirling agreement and its performance were both contrary to the public interest.
-		At all times material to this matter, Hunter was in a special relationship with Cal, and:

-		Hunter knew or ought reasonably to have known that the Hunter-Stirling agreement was a material fact in relation to Cal shares that had not been generally disclosed;
-		Hunter knew or ought reasonably to have known that his option agreement with Handelskredit was a material fact in relation to Cal shares that had not been generally disclosed;
-		Hunter sold the 500,000 private placement shares with knowledge of the agreement and the option, contrary to section 68(1) of the Act.

The various allegations relate to a series of activities that are, in our view, part of a single scheme related to trading in Cal shares.

Hunter was approached by Stirling, and agreed to arrange a private placement for Cal and to promote trading in its shares. The Hunter-Stirling agreement was clearly for the benefit of Cal and required Cal's cooperation, despite the fact that Cal was not a party. No one disclosed the agreement.

In carrying out the agreement, Hunter promoted Cal shares through newsletters, an advertisement and a booth at the New York gold show. The interest he generated through his promotion resulted in a sharp increase in the market price and trading volume of Cal shares.

Meanwhile, Hunter arranged a private placement with Handelskredit at $6 per share, which provided Cal with $3 million to carry on its mining project, and an option that permitted Hunter to obtain the private placement shares at $6.50 per share. The private placement was disclosed but the option was not. Hunter immediately exercised his option to obtain the private placement shares from Handelskredit and sold them into the market at prices well above $6.50 per share.

Before commenting on the broader implications of this scheme, we will turn to the specific allegations made by staff.

Insider Trading

Commission staff allege that Hunter was in a special relationship with Cal and engaged in illegal insider trading by selling Cal shares with knowledge of undisclosed material facts, namely the Hunter-Stirling agreement and the option.

Hunter admits that the agreement and the option were not disclosed and that he traded Cal shares. He argues, however, that these were not material facts and that he was not in a special relationship with Cal.

The relevant provisions of the Act at the time were as follows:

	1. (1) ...
	"material fact" means, where used in relation to securities issued or proposed to be issued, a fact that significantly affects, or could reasonably be expected to significantly affect, the market price or value of those securities;

3.

(1) For the purposes of sections 68 and 119, a person is in a special relationship with a reporting issuer, where he

...

(c)

has engaged, is engaging or proposes to engage in any business or professional activities with or on behalf of the reporting issuer and has, by that association, acquired knowledge of a material fact or material change in the affairs of the reporting issuer,

...

68.

(1) No person in a special relationship with a reporting issuer shall

(a)

purchase or sell securities of the reporting issuer with knowledge of a material fact or material change in the affairs of the reporting issuer that he knows or ought reasonably to know has not been generally disclosed,

	...
	(2) A purchaser or seller has not breached subsection (1)(a) if he proves that he did not make use of the material fact or material change in purchasing or selling the securities.

Hunter agreed to negotiate a substantial financing for Cal, which was in severe financial difficulty, and to promote Cal shares to generate more trading. For a junior resource exploration company like Cal, a promotional arrangement of this type can have a very significant effect on the market price of its shares. There certainly was a sharp increase in the trading volume and price of Cal shares after Hunter began promoting them and Hunter was clearly of the view that he had generated the active trading.  Furthermore, an investor's or analyst's assessment of the value (as opposed to the market price) of Cal shares would be significantly affected by the information that Hunter was actively promoting the shares under an agreement which tied his compensation to reaching a cumulative trading volume of two million shares. For example, if that fact had been generally disclosed, investors would likely have assumed that the promotion and the active trading of Cal shares would continue only until Hunter had received and disposed of his 300,000 shares of compensation.

On this basis, we find that the Hunter-Stirling Agreement was a fact that significantly affected, or could reasonably have been expected to significantly affect, the market price or value of Cal shares and therefore that it was a material fact.

The option was an arrangement under which Hunter obtained from Handelskredit 500,000 Cal shares that were (ostensibly) free trading. As far as the public was aware, these shares had been purchased by Handelskredit for investment purposes. It would certainly have affected the expectations of investors for the future price of Cal shares had they known that, instead, these shares were in the hands of the person promoting Cal shares and were to be sold into the market while he was recommending that others purchase Cal shares.

On this basis, we find that the option was a fact that significantly affected, or could reasonably have been expected to significantly affect, the market price or value of Cal shares and therefore that it was a material fact.

Hunter obviously knew of these material facts related to Cal shares and knew that they had not been generally disclosed.

The next question is whether Hunter was in a special relationship with Cal.

Hunter says he was not in a special relationship with Cal because his agreement was with Stirling, not Cal. He notes that the trial judge in the civil action found that Hunter was not an agent on behalf of Cal.

In our view the technical details of Hunter's arrangement with Stirling are not determinative of this question. The facts are that Hunter was negotiating a private placement to raise financing for Cal and he was promoting trading in the shares of Cal to help Cal develop its graphite mine. Although his agreement was with Stirling, Hunter clearly expected that Cal would cooperate with the agreement, as it ultimately did, by entering into the private placement with Handelskredit. He was, therefore, engaging in business or professional activities on behalf of Cal. In the course of those activities, he acquired knowledge of material facts, namely the Hunter-Stirling agreement and the option. We find that Hunter was in a special relationship with Cal.

During the relevant period, Hunter sold the 500,000 shares he acquired under the option. No evidence is presented to show that, in selling these shares, he did not make use of his knowledge of the Hunter-Stirling Agreement and the option.

Accordingly, we find that Hunter breached section 68(1) of the Act.

The Hunter-Stirling Agreement

Commission staff argue that the Hunter-Stirling agreement was contrary to the public interest in that it linked compensation to trading volume. They say that the structure of the agreement, whereby Hunter would be compensated only if a trading volume target was met, provided an incentive for him to artificially generate trading volume in Cal shares. They also say that Hunter saw his obligation as being to generate trading volume and that, in fact, he did so.

Hunter says that the agreement was in the public interest because it saved Cal by providing the financing needed to save its graphite mining project. He says that promotional contracts of this type are necessary for junior companies and are good for the market. He suggests that there is no problem providing compensation based on trading volume. However, he argues that this agreement did not provide compensation for more volume. He says the trading of the two millionth share would ultimately have happened at some time and merely served to determine the timing of payment under the agreement.

In our view, the agreement provided an incentive for Hunter to increase the trading volume in Cal shares. It was clearly in Hunter's interest to have the trading of the two millionth share occur sooner rather than later, so that he would get his 300,000 shares in compensation sooner and avoid the risks and uncertainties of delay. Furthermore, Hunter saw it as his obligation under the agreement to see that two million shares were traded.

Hunter also had an incentive to have the price of Cal shares as high as possible to maximize his profit on the 500,000 shares optioned from Handelskredit and the 300,000 shares he would receive under the Hunter-Stirling agreement.

The question then is whether an agreement of this type is contrary to the public interest.

Many reporting issuers, large and small, find that it is necessary to engage in some form of "investor relations" activities to broaden investor interest in the issuers' securities and thereby enhance their market price and liquidity. This is of particular importance to an issuer, like Cal, that expects to require financing and wishes to have a ready market for future public offerings or private placements.

At some point, however, investor relations activities can cross the line between legitimate efforts to generate interest in an issuer's securities and the abusive generation of trading activity in the securities.

Hunter was obviously successful in his promotional efforts at generating interest in and demand for Cal shares. His interest, however, was more than just seeing an active and liquid market in Cal shares. He saw his obligation to be to hit a numerical target of two million shares being traded and his compensation depended on it. He accomplished this objective not only by generating investor interest in Cal shares but also by obtaining 500,000 shares, through his option with Handelskredit, and selling them into the demand he had generated.

Purchasing 500,000 shares at $6.50 per share and selling them in the market at much higher prices was lucrative for Hunter in itself. It also represented 25 per cent of the volume he needed to fulfill the Hunter-Stirling agreement. When he was selling these shares, neither the agreement, which gave him the incentive to promote trading in Cal shares, nor the option, which gave him a large block of free trading Cal shares, had been generally disclosed. Although Hunter's newsletters disclosed that he might buy or sell Cal shares, investors were not told that he had acquired and was selling the 500,000 shares that had been purchased by Handelskredit, purportedly for investment purposes.

This type of activity, where a person is actively encouraging investors to buy a security while he is secretly selling a block of shares into the demand he has created, at a substantial premium, is detrimental to the fairness and efficiency of the market. In our view, Hunter's conduct in this case crossed well over the line and constituted abusive promotion and trading in Cal's shares. The agreement, which required Hunter to generate a specific volume of trading, led directly to this activity and was, in our view, prejudicial to the public interest.

The Option

Commission staff submit that Hunter's option with Handelskredit, in combination with Cal's private placement to Handelskredit, resulted in an illegal distribution of Cal shares to Hunter. They say that these linked transactions allowed Hunter to obtain shares without a hold period, which he could not otherwise obtain, and that the two transactions therefore constituted a distribution of Cal shares for which no exemption was available.

Hunter says that the private placement and the option were not linked transactions. He says that Handelskredit purchased the private placement shares as principal and that their subsequent sale to Hunter was simply the exercise by Hunter of an option.

Hunter says the fact that he chose not to exercise his option on the 100,000 warrant shares taken down by Handelskredit proves that his arrangement on the 500,000 shares was merely an option that he chose to exercise. However, the agreed facts and the documentary evidence indicated that Hunter had no option to acquire the warrant shares from Handelskredit. Hunter took down all the shares he was entitled to under his arrangement with Handelskredit.

Hunter also says that if there was an abuse of Handelskredit's exempt purchaser status (as admitted by Handelskredit in its Settlement agreement), that was Handelskredit's responsibility, not Hunter's.

It is useful here to step back and consider the true nature of this transaction. Hunter arranged on Cal's behalf the private placement with Handelskredit and, before the private placement was finalized, he arranged with Handelskredit an option to acquire the private placement shares. It was clearly Hunter's expectation that he would generate demand for Cal shares and sell into the market the shares he had arranged to purchase from Handelskredit. It is also clear, from the manner in which the private placement shares were taken down by Handelskredit in four tranches and then, in each case, immediately transferred to Hunter, that Handelskredit entered the private placement only on the understanding that Hunter would exercise the option.

This transaction, involving the private placement and the option, has several different aspects. First, it was an abuse by Handelskredit of its exempt purchaser status, in that Handelskredit purchased Cal shares on a private placement for $6 per share after granting Hunter an option to acquire them for $6.50 per share. The option was exercised and the shares were delivered almost immediately after the purchase. This clearly did not represent a purchase for investment purposes.

Second, as argued by staff, it was a sham transaction, arranged by Hunter to permit him to obtain free trading shares when he could otherwise only obtain shares subject to a hold period. It follows that there was really a distribution of shares from Cal to Hunter, through the intermediary of Handelskredit. Since no prospectus was filed, the distribution could legally be done only under an exemption, and under any available exemption the shares would have been subject to a hold period.  Under the Securities Regulation, any trade of the shares during the hold period would be deemed to be a distribution. As a result, the immediate resale of the shares by Hunter, in the absence of a prospectus or an available exemption, was an illegal distribution. (Furthermore, to the extent that Hunter's promotional efforts constituted an unusual effort to create a demand or prepare the market for the shares, any resale by him during the promotion was an illegal distribution.)

Third, the transaction was, in effect, a distribution to the public by Cal, through the intermediaries of Handelskredit and Hunter. Since no prospectus was filed and no exemption was available, this distribution was illegal.

However one views the transaction, it is clear that Hunter set up an arrangement in which Cal shares were issued from treasury and sold to the public through the Exchange with no prospectus disclosure concerning Cal and no disclosure that the shares were being sold. This constitutes a contravention of one of the most fundamental provisions of the Act, which requires that investors be provided with a prospectus containing full, true and plain disclosure of all material facts before they are invited to purchase securities being distributed by an issuer or security holder.

Summary

The scheme conducted by Hunter in relation to Cal shares involved several illegal and abusive elements, including illegal insider trading, an abusive promotional agreement and an illegal distribution. When viewed as whole, this scheme can be seen to have involved an undisclosed distribution to the public conducted by Hunter in the midst of his aggressive promotion of Cal shares under an undisclosed agreement. By arranging the private placement with Handelskredit and the undisclosed option agreement, Hunter concealed from investors the fact that he was selling the block of 500,000 shares while he was recommending that they buy. This is the abusive type of conduct that brings the securities market into disrepute and it is, in our view, highly prejudicial to the public interest.

4.  DECISION

This is a classic case of the type of abusive promotional activities that damage the integrity of the market and harm investor confidence. Hunter published investor newsletters praising the prospects of Cal's business while he had an undisclosed agreement committing him to generate more trading volume and an undisclosed block of shares that he was selling into the demand generated by his promotion.

Hunter says that his activities saved Cal and its project and argues that the survival of a "a solid Canadian junior resource company" was in the public interest. In our view this is merely an argument that "the end justifies the means". The fact that Cal was a real company with a real business prospect does not excuse abusive and illegal trading and promotional conduct in respect of its shares. Investors are entitled to fair treatment and a level playing field whatever the business prospects of the issuer.

The facts in this case are old. They were brought to the attention of Commission staff more than five years after the events and only a few months before the expiry of the limitation period. Hunter argues that, even if we find against him, as we have, any penalty assessed should be modest. He suggests a fine or costs in the order of $5,000.

We view his conduct more seriously. Hunter quietly and illegally sold over 500,000 Cal shares, with knowledge of undisclosed material facts, while he was actively promoting the shares to investors.  This type of conduct damages investor confidence in the fairness and efficiency of the market and generally brings the market into disrepute. We consider it to be in the public interest to remove Hunter from participating in the market for a significant period.

We order

1.		under section 144(1)(c) of the Act, that the exemptions described in sections 30 to 32, 55, 58, 80 and 81 of the Act do not apply to Hunter for a period of 10 years from the date of this order;
2.		under section 144(1)(d) of the Act, that Hunter is prohibited from becoming or acting as a director or an officer of any reporting issuer, or any issuer providing management, administrative, promotional or consulting services to a reporting issuer, for a period of 10 years from the date of this order;
3.		under section 154.2 of the Act, that Hunter pay -  $3,000 for the administrative costs of the three day hearing; and

-

costs of or related to the hearing incurred by the Superintendent, to be determined following further submissions from the parties.