SEC Secures Groundbreaking Win in Shadow Trading Insider Trading Case

The Securities and Exchange Commission (SEC) has a new insider trading theory that all issuers and corporate insiders should have on their radar. While the agency claims the “shadow trading” theory is not “novel,” a recent federal verdict marks the first time that the SEC has successfully held a corporate official liable for insider trading for purchasing the securities of a company based on material nonpublic information (MNPI) about a different company.

What is Shadow Trading?

“Shadow trading” involves the misappropriation of confidential information about one company to trade in securities of a second company where there is a sufficient “market connection” between the two companies. According to the SEC, the theory is not novel; rather, it just hasn’t been previously enforced.

As discussed in prior articles, Section 10(b) of the Exchange Act and Exchange Act Rule 10b-5 prohibit the “use or employ” of any “manipulative or deceptive device” in connection with the purchase or sale of securities. Pursuant to the Exchange Act, a person commits fraud “in connection with” a securities transaction, and violates § 10(b) and Rule 10b-5, “when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. The so-called misappropriate theory of insider trading premises liability on a trader’s deception of those who entrusted him with access to confidential information. 

The SEC’s Insider Trading Allegations in SEC v. Panuwat

The SEC’s complaint alleged that Matthew Panuwat, then-head of business development at Medivation, Inc., used highly confidential information about an impending announcement of Pfizer Inc.’s acquisition of Medivation, to trade ahead of the news for his enrichment. While the market was aware that Medivation was interested in being acquired, the negotiations were confidential, including the anticipated sales price and timing of the transaction.

Rather than buying the securities of Medivation, Panuwat used the confidential information he received in an email from the Medivation CEO to purchase short-term, out-of-the-money call options of another comparable public company, Incyte Corporation. The SEC’s complaint alleged that Panuwat purchased the options within seven minutes of receiving the confidential information concerning the acquisition via email. The complaint further maintained that following the public announcement of Medivation’s acquisition just a few days after Panuwat purchased his stock options, Incyte’s stock price increased by approximately 8%, which generated illicit profits for Panuwat of over $100,000.

Both Judge and Jury Side With SEC on Shadow Trading Theory

The SEC’s case against Panuwat is groundbreaking in that both the court and the jury accepted the SEC’s shadow trading theory. On January 14, 2022, District Court Judge William H. Orrick denied Panuwat’s motion to dismiss. In refusing to dismiss the SEC’s enforcement action, Judge Orrick found that information may be material to more than one company and that information does not need to come from the issuer of the security to be material. While Judge Orrick acknowledged that the case was the first of its kind, he found that the SEC’s theory of liability “falls within the general framework of insider trading, as well as the expansive language of Section 10(b) and corresponding regulations.”

On November 20, 2023, the court similarly denied a motion for summary judgment filed by Panuwat that challenged the key elements of the SEC’s case — materiality, non-public information, legal duty, and scienter. With regard to materiality, Judge Orrick found that the evidence supported the SEC’s theory that “a reasonable investor such as Panuwat—who paid careful attention to the biopharmaceutical market, and specifically to Incyte—could have perceived Medivation and Incyte to be connected in the market such that pertinent information about one was material to the other.” The court further found that a reasonable investor could find the CEO’s email to be material to Incyte. In support, Judge Orrick cited the significant uptick in Incyte’s share price after the acquisition became public knowledge.

The court also rejected Panuwat’s argument that the information in the Medivation CEO’s email was not non-public information because the market was well aware that Medivation was involved in acquisition negotiations. According to Judge Orrick, because the details contained in the email, including that the company wanted to close the acquisition over the weekend and the anticipated price of the deal, were not publicly known, the information constituted MNPI.

With regard to whether Panuwat breached a duty of trust and confidence to Medivation, the SEC’s case was bolstered by the fact that Medivation’s insider trading policy specifically prohibited employees from using MNPI to trade not only in its own securities but in “the securities of another publicly traded company.” Panuwat also signed a “Confidential Information and Invention Assignment Agreement,” under which he agreed to “hold in strictest confidence, and not use, except for the benefit of [Medivation]… confidential knowledge, data, or other proprietary information relating to…any business of [Medivation]. Notably, the court further found that a jury could also find that Panuwat breached his duty to maintain his employer’s confidential information simply because he was entrusted with Medivation’s confidential information and used it for his personal benefit.

On April 5, 2024, following an eight-day jury trial, the jury delivered a verdict finding Panuwat liable for insider trading. In a statement regarding the verdict, SEC Division of Enforcement Director Gurbir S. Grewal sought to downplay the novelty of the case, stating:

As we’ve said all along, there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple. Defendant used highly confidential information about an impending announcement of the acquisition of biopharmaceutical company Medivation, Inc., the company where he worked, by Pfizer Inc. to trade ahead of the news for his own enrichment. Rather than buying the securities of Medivation, however, Panuwat used his employer’s confidential information to acquire a large stake in call options of another comparable public company, Incyte Corporation, whose share price increased materially on the important news.

New Compliance Considerations for Insiders and Issuers

Despite what the SEC says, the case is significant in that both the court and the jury accepted the SEC’s shadow trading theory of insider trading. At a minimum, the case highlights that the SEC can be successful when asserting a broad view of materiality in insider trading cases and will likely encourage the SEC to bring similar cases in the future.

With this in mind, directors, corporate executives, and others privy to MNPI should consider treating shadow trading as another form of prohibited insider trading even in the absence of express prohibitions. Companies should also evaluate their insider trading policies and other compliance procedures to address the risk of shadow trading.