What the SEC’s “Shadow Insider Trading” Trial Means for In-House Counsel

On April 5, 2024, a jury in California federal court found a former corporate executive liable for insider trading in SEC v. Panuwat, a novel enforcement action involving a theory known as “shadow trading.” In Panuwat, the U.S. Securities and Exchange Commission (SEC) takes the position that the insider trading laws apply where an insider uses material non-public information about his or her own company to trade securities of another company, such as a competitor or peer company in the same industry.

Key Takeaways

  • The jury’s finding that the Panuwat defendant had breached his duty of trust and confidence to his employer, a public company, turned upon the wording of his employer’s insider trading policy, which prohibited trading the securities of any public company based on material non-public information.
  • Panuwat, an important test case for the SEC, underscores the following corporate governance considerations:
    • A company should review its insider trading policy annually and modify it as appropriate in consideration of new regulations, recent enforcement actions, and corporate governance trends. The SEC now requires annual disclosure of an issuer’s insider trading policies and procedures.
    • Vague or overbroad language in an insider trading policy could broaden the scope of potential liability for employees or insiders who are subject to the policy.
    • A company must establish processes to enforce the full scope of its insider trading policy, monitor potential violations, and train employees and agents on compliance.
    • Though future application of the SEC’s theory is not yet known, the SEC focused on an acquisition announcement that was deemed important to investors in a closely competitive company in a concentrated industry sector. A company should take into consideration the competitive landscape of its industry in drafting its insider trading policy, especially if the policy prohibits trading in securities of other public companies in certain circumstances.
    • A financial institution should consider the potential reach of the SEC’s theory in other scenarios, including the propriety of trading securities of competitor companies when it possesses material non-public information about a particular company in the same industry.
  • SEC leadership has taken the position that Panuwat does not involve a novel theory and is instead a straightforward application of the elements of the misappropriation theory of insider trading.
  • No criminal case has been brought to date based on a theory of “shadow trading.” The Panuwat verdict could cause criminal authorities to consider pursuing a similar theory.

The SEC’s Allegations and Factual Background

The SEC alleged that Matthew Panuwat, a former senior director of business development at Medivation, a publicly traded biopharmaceutical company, committed insider trading based on his confidential knowledge that Medivation would soon be acquired. Panuwat, however, did not trade the securities of Medivation. Instead, Panuwat allegedly purchased short-term out-of-the-money call options of Incyte, a biopharmaceutical company that was not involved in the acquisition, seven minutes after he received an email from Medivation’s chief executive officer stating that Medivation would be acquired.

This purchase allegedly violated Medivation’s insider trading policy, which provided:

During the course of your employment you may receive important information that is not yet publicly disseminated about the Company. Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company. For anyone to use such information to gain personal benefit is illegal.

The SEC alleged that confidential information about the acquisition of Medivation was material to Incyte investors because Medivation and Incyte were comparable companies in a mid-cap industry sector that was the subject of potential acquisitions.

Shortly after the Medivation acquisition, the stock price of Incyte increased, and Panuwat made more than $100,000 in profits from the Incyte options. Panuwat had not previously traded Incyte securities.

The SEC Action and the Trial

The SEC sued Panuwat in the U.S. District Court for the Northern District of California for insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. The court denied Panuwat’s motions to dismiss and for summary judgment. Prior to trial, the court precluded Panuwat from arguing to the jury that the case was “unique,” “novel,” or “unexpected.”

At trial, the SEC argued that Panuwat intended to commit insider trading based on documentary evidence that he purchased out-of-the-money Incyte call options minutes after he was informed by email that Medivation would be acquired. It further argued that Panuwat had breached his duty of trust and confidence to Medivation based on (1) Medivation’s insider trading policy, (2) a confidentiality undertaking requiring Panuwat to keep information learned during his employment confidential, and (3) common-law agency principles.

The SEC and Panuwat sparred over whether Medivation and Incyte were market competitors, a factual issue central to the jury’s determination of whether non-public information about the Medivation acquisition was material to Incyte investors. The SEC offered expert testimony that news of the acquisition would have a spillover effect on Incyte and cause its stock price to increase. Panuwat countered by calling a co-worker as a defense witness, who testified that Incyte and Medivation were not competitors and there was no connection between their stock prices.

Panuwat took the stand in his own defense. He testified that he purchased Incyte options based on an analyst report that he had read a month earlier and that his purchase was unrelated to his knowledge of the Medivation acquisition. On cross-examination, the SEC confronted Panuwat with his deposition testimony, in which he testified that he could not recall why he had purchased the Incyte options

Following an eight-day trial and three hours of deliberations, the jury found Panuwat liable

Panuwat is likely to appeal the verdict. He may seek to appeal the court’s jury instructions defining the duty of trust and confidence and non-public information. No appellate court has yet reviewed a theory of “shadow trading.”

This post comes to us from Morrison & Foerster LLP. It is based on the firm’s memorandum, “Takeaways for In-House Counsel from the SEC’s ‘Shadow Insider Trading’ Trial,” dated April 5, 2024, and available here. 

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