Rethinking the Scope of Insider Trading: A Closer Look at the SEC’s “Shadow Trading” Win

On April 5, 2024, a jury in the United States District Court for the Northern District of California found a corporate employee liable for insider trading under the SEC’s shadow trading theory. The employee was alleged to have leveraged his company’s material nonpublic information (MNPI) to trade another company’s securities. While this verdict is likely a gateway for broader SEC enforcement, its application may not be as extensive as the SEC and other commentators suggest.  

Background

The SEC’s evolved insider trading theory, termed “shadow trading,” extends insider trading liability beyond trading a company’s securities based on its MNPI to include trading the securities of another company impacted by the MNPI’s disclosure.

In SEC v. Panuwat, Matthew Panuwat, the former head of business development at Medivation Inc., was alleged to have received confidential information about Medivation’s impending acquisition by Pfizer Inc. via an email from the CEO. Shortly thereafter, according to the SEC, Panuwat used this information to trade call options of another public company, Incyte Corporation. Incyte’s share price increased by 7.7 percent after the market learned of the acquisition.

For the jury to find Panuwat liable for insider trading, the SEC had to prove:

1. That Panuwat owed a duty of trust, confidence, or confidentiality to Medivation;
2. That, as a result of his employment with Medivation, he possessed nonpublic information that was material to Incyte;
3. That he bought Incyte call options on the basis of that information and in a breach of duty owed to Medivation; and
4. That he, at the time he bought Incyte call options, knew that the information he received from Medivation was both nonpublic and material to Incyte or acted recklessly as to whether the information was both material and nonpublic, and knew that, or acted recklessly as to whether, he lacked consent from Medivation to use the information.

The key elements that could determine the scope of the SEC’s shadow trading theory include breach of duty and materiality. To demonstrate Panuwat’s breach of duty to Medivation, the SEC focused on three duties:

1. Panuwat’s duty under Medivation’s insider trading policy, which broadly prohibits trading “the securities of another publicly-traded company, including all significant collaborators, customers, partners, suppliers or competitors” based on MNPI about Medivation;
2. Panuwat’s duty under Medivation’s confidentiality agreement; and
3. Panuwat’s common law duty of trust and confidence that arose from being entrusted with confidential information during his employment.   

As for materiality, the jury had to determine whether, at the time of Panuwat’s call option trades, reasonable Incyte investors would believe the allegedly nonpublic Medivation information significantly altered the total mix of information available concerning Incyte. To establish this, the SEC proffered:

• Evidence showing that Medivation and Incyte were part of a niche section of the biopharmaceutical market.
• Evidence showing that Medivation's investment bankers considered Incyte a “comparable peer” to Medivation because they were both mid-sized, cancer-related drug companies with commercial product in a market where the scarcity of such companies played a large role in their value.
• Analyst reports and financial news articles that linked Medivation's acquisition to Incyte's future. For example, one such report, published in May 2016, stated “Medivation M&T Talk Makes [Incyte] Shares Look Very Appealing.” It reported that the “acquisition interest in [Medivation] highlights the attractiveness of [Incyte], yet [Incyte] shares have yet to benefit from the premiums being discussed for what is in our view a far inferior mid cap oncology company.” Another report predicted that given the small number of midsize biotech companies with “high-quality assets,” Incyte could “interest buyers” in the wake of Medivation's acquisition.
• Evidence suggesting that Medivation and Incyte’s stock performance are linked. The SEC’s expert, Chyhe Becker, testified that Medivation’s acquisition news had an expected “spillover effect” on Incyte’s stock price. Becker concluded that “market observers would expect Incyte’s stock price to increase when Medivation’s merger was announced.”
• Incyte’s share price increased 7.7% after the news broke, which, according to the SEC is “strong evidence” of how reasonable investors understand the significance of that information.

After an eight-day trial followed by less than three hours of deliberation, the jury sided with the SEC and found Panuwat liable for insider trading.

Implications

The Panuwat case raises questions about the reach of the SEC’s shadow trading theory. By labeling Incyte a “comparable” company to Medivation, the SEC implies it prohibits trading shares of such companies. Gurbir S. Grewal, Statement on Jury’s Verdict in Trial of Matthew Panuwat, U.S. Securities and Exchange Commission (Apr. 5, 2024), www.sec.gov/news/statement/grewal-statement-040524. Some commentators have suggested an even broader interpretation, positing a ban on trading shares of any competitor. However, the evidence indicates a more limited scope.  

Medivation and Incyte occupied a small pool of companies in a niche section of the biopharmaceutical industry, where their stock performances were linked and the information about Medivation’s acquisition directly affected Incyte’s valuation. This relationship does not universally apply across all industries or competitors. For instance, in industries with numerous competitors, such as the consumer packaged goods industry, the acquisition of a minor player by a leading company like The Coca-Cola Company is unlikely to affect the valuation of another major public competitor like PepsiCo, Inc. While such acquisitions assist in determining the valuation of similar private companies, they do not immediately affect larger public competitors’ valuations. Thus, the shadow trading theory, as applied to Panuwat, should not extend indiscriminately to all competitor companies—rather it more likely applies to those within narrow, unsaturated market segments where valuations are undeniably linked.

This verdict also emphasizes the importance of investors understanding their own company’s insider trading policies, confidentiality agreements, and common law duties of trust and confidence related to their employment status. Companies, too, must evaluate the scope of their policies, considering whether, like Medivation’s, they impose overly broad restrictions on trading any public company.  

Nevertheless, as this case progresses through the appellate courts, the scope of the shadow trading theory may receive further clarification.