Takeaways for In-House Counsel from the SEC’s “Shadow Insider Trading” Action

In January 2022, a federal district court denied a motion to dismiss a novel insider trading enforcement action brought by the U.S. Securities and Exchange Commission based upon a theory known as “shadow insider trading.” In SEC v. Panuwat, the SEC takes the position that the insider trading laws apply where an insider uses material nonpublic information about his or her own company to trade securities of another company, such as a competitor or peer company in the same industry.

The SEC brought an enforcement suit in the U.S. District Court for the Northern District of California against Matthew Panuwat, a former senior director of business development at Medivation, a publicly traded biopharmaceutical company, for insider trading.  The SEC alleged that Panuwat committed insider trading based upon his confidential knowledge that Medivation would soon be acquired. Panuwat, however, did not trade the securities of his own company, Medivation. Instead, Panuwat allegedly used the confidential information he learned about the acquisition to trade in the securities of Incyte, a different biopharmaceutical company that had no involvement in the acquisition. This trade violated Medivation’s insider trading policy, which prohibited using confidential Medivation information to trade securities of another company. The SEC took the position that confidential information about the acquisition of Medivation was material to Incyte because Medivation and Incyte were closely comparable mid-cap companies in an industry sector that was the subject of potential mergers and acquisitions.

Key Takeaways

• The court’s assessment of whether the SEC adequately alleged that Panuwat had breached his duty to Medivation turned entirely upon the expansive wording of Medivation’s insider trading policy. The court did not consider whether Panuwat’s conduct would have been unlawful absent a written insider trading policy prohibiting it. 
• Panuwat underscores the following important corporate governance considerations:
• A company should review its insider trading policy annually and modify it as appropriate in consideration of new regulations, case law, and corporate governance trends.
• Effective corporate training on insider trading liability is crucial, especially since companies are experiencing greater workforce transitions.
• 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.
• If a company has expansive prohibitions in its insider trading policy, it needs to establish proper processes to monitor potential violations and enforce the full scope of such policy.
• The SEC focused on an acquisition announcement in a concentrated industry sector whereby the news of a company’s acquisition is deemed material for purposes of trading in the securities of a competitor. This may suggest that 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 stock of other public companies under certain circumstances.
• The SEC’s case will still need to survive summary judgment and ultimately, the SEC will need to prove its case against Panuwat at trial. Among other things, the SEC will need to engage in a fact-intensive analysis of whether Medivation and Incyte were sufficiently similar so that a reasonable investor would consider news of the Medivation acquisition to be important when deciding whether to trade in Incyte. To prove materiality at trial, the SEC will likely need to (1) demonstrate the correlation between the stock prices and financial projections of the two companies, particularly where there was news of an acquisition of a peer company, and (2) call Incyte investors to testify that news of an acquisition of Medivation would have mattered in their decision whether to trade in Incyte.  
• Notably, no parallel criminal case has been filed against Panuwat to date. It is possible that criminal authorities, who bear a higher burden of proof than the SEC, are waiting to see how the case unfolds before bringing a criminal action based upon a similar theory.

Factual Background

As a Medivation employee, Panuwat agreed to comply with 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.

Panuwat’s role at Medivation included following the stock prices of peer companies, such as Incyte. Minutes after receiving an internal email stating that Medivation would be acquired, Panuwat bought short-term out-of-the-money Incyte stock options. Panuwat did not notify anyone at Medivation of his options purchases, and he had not previously traded in the securities of Incyte. Shortly after the Medivation acquisition, the stock price of Incyte increased, and Panuwat made more than $100,000 in profits from the Incyte options.

The Lawsuit and the Motion to Dismiss

The SEC sued Panuwat for insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Panuwat moved to dismiss, primarily on the grounds that (1) the information he possessed was not material and (2) he did not breach his duty to Medivation. The court denied his motion in an opinion dated January 14, 2022.

Materiality: Panuwat argued that the confidential information he obtained about the Medivation acquisition could not be material because it was not information about Incyte. Incyte, he argued, had no involvement in the acquisition, and Panuwat did not have any confidential information about Incyte’s business operations. 

The court rejected Panuwat’s argument based upon its reading of the plain language of Section 10(b) of the Securities Exchange Act and Rule 10b-5. Under the law, information is material “if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” The court rejected the defense’s contention that confidential information about an acquisition is material only to the parties of the acquisition. The court reasoned that the SEC’s complaint sufficiently alleged materiality and scienter in view of its allegations that Panuwat was aware that (1) Medivation and Incyte were closely comparable companies in a small industry sector (and he had discussed with bankers working on the acquisition that the two companies were comparable); (2) several companies had shown interest in acquiring Medivation; and (3) when Medivation was acquired, Incyte would become more attractive as one of the few remaining acquisition targets in the industry. 

Breach of duty: Panuwat did not dispute that he owed a duty of trust and confidence to Medivation, his employer. Panuwat nevertheless argued that the SEC’s complaint failed to allege that he breached that duty when he traded in the securities of a company other than Medivation. The court disagreed. It concluded that Medivation’s insider trading policy, which prohibited Medivation employees from using the company’s confidential information to trade in the securities of “another publicly traded company,” was broad enough to prohibit trading in the securities of any public company based upon Medivation’s confidential information.