The province's administrative tribunal dismissed allegations filed last year by l'Autorite des marches financiers that the toy maker's CEO and three other executives profited by selling thousands of shares after learning about the child's death.
The three-member panel concluded that the regulator "didn't meet its burden of establishing that the information in the possession of the insiders was privileged according to the law."
The bureau de decision et du revision found that Mega Brands investors didn't seem to be influenced by news of the death as the company's share price remained high for months after reports surfaced about the death.
The regulator was claiming nearly $6.5 million for allegedly trading company stock based on non-disclosed information that 22-month-old Kenny Sweet of Redmond, Wash., died Nov. 24, 2005 after swallowing a magnetic part that became detached from one of the toys purchased for his 10-year-old brother.
The allegations of insider trading were originally part of a complaint filed in Ontario by the former owners of Rose Art, who sold their business to the Montreal-based company in 2005. An AMF official testified that it launched its investigation following a September 2008 news release by Mega Brands in which it refused to take action against the allegations made by Rose Art founder Larry Rosen.
Sylvain Theberge, spokesman for the regulator, said it was surprised by the conclusions of the tribunal's decision and will study it carefully before deciding whether to appeal to the Quebec Superior Court.
Named in the allegations were Mega Brands (TSX:MB) chief executive Marc Bertrand, his brother Vic and two former executives Alain Tanguay and Brahm Segal.
The regulator originally sought the reimbursement of $5.2 million of option proceeds, along with $1.3 million in fines. It later amended its claim to increase the amounts of reimbursement sought.
Marc and Vic Bertrand each sold 100,000 shares at $27 per share on Dec. 14, two days after U.S. retailer Fred Meyer informed the company about the boy's death. Tanguay and Segal sold 30,000 shares.
Bertrand last year denied the accusations and said he was confident of a favourable outcome when all the facts are disclosed. He couldn't be reached for comment Thursday.
"The judgment is pretty strong from what I've read," said Mark Girgis, vice-president legal affairs, who added the allegations doesn't involve the company itself.
The toy maker is slowly recovering from near bankruptcy caused by several recalls of magnetic toys that were part of the Rose Art acquisition. Mega Brands faced several lawsuits over allegations that the toy caused injuries to several children.
Gerrick Johnson of BMO Capital Markets said the tribunal's decision is positive for Mega Brands.
"Each step closer to a final resolution is obviously a step in the right direction for these guys because the last thing you want from a management team is for a distraction," he said from New York.
Johnson said the Rosen situation and the Magnetix fiasco is pretty much behind the company as overall sales are picking up.
"The (construction toy) category is still strong, they're showing nice sales growth and nice shelf space gains, so it seems like those distractions are behind them."
Sweet died after he suffered cardiac arrest when two of the pill-sized magnets he ingested got lodged in his intestine. He was one of seven children in the Sweet family.
The magnets broke away from their plastic casings after the older children dropped a spacecraft they built onto the floor from various heights. The family later launched a lawsuit against Rose Art and Mega Brands.
After chief innovation officer Vic Bertrand spoke to the deceased child's parents, a Mega Brands legal adviser told the other executives that the incident looked like "a fluke accident," according to the tribunal's decision.
"The circumstances appear to be such that this fatality is the result of a unique set of facts and not necessarily a defect in the product or the warning themselves."
Several analysts maintained their positive outlook for the company even after news reports about the "freak accident" surfaced days before Christmas 2005 and the company told them weeks later that it didn't believe a recall was likely.
The company's stock price remained high for several months after the incident was disclosed. The regulator argued, however, that it was only after the family announced its lawsuit in March 2006 that the public became fully aware of the incident and the stocks began to fall.
On the Toronto Stock Exchange, Mega Brands shares fell 10 cents at $8.90 in afternoon trading.