In August 2021, the SEC filed a complaint in the U.S. District Court charging Matthew Panuwat, a former employee of Medivation Inc., an oncology-focused biopharma, with insider trading in advance of Medivation’s announcement that it would be acquired by a big pharma company.  But it wasn’t your average run-of-the-mill insider trading case. Panuwat didn’t trade in shares of Medivation or shares of the acquiror, nor did he tip anyone about the transaction.  No, according to the SEC, he engaged in what has been referred to as “shadow trading”; he used the information about his employer’s acquisition to purchase call options on another biopharma, which the SEC claimed was comparable to Medivation.  (See this PubCo post.)  Since then, we’ve seen the usual moves on the chess board (discussed briefly below). But what’s particularly interesting, as Alison Frankel pointed out in Reuters, is the amicus brief filed by the Investor Choice Advocates Network, a self-described “nonprofit, public interest organization focused on expanding access to markets by underrepresented investors and entrepreneurs.”  In its brief, ICAN contended that the SEC’s invocation of the novel “shadow-trading” theory made this a “major questions” case—a judicial torpedo that we might begin to see fired with some regularity.  

Background. According to the SEC, Panuwat used information he learned about the acquisition of his employer, Medivation, to purchase call options on a separate biopharma company, Incyte Corporation, which the SEC claimed was comparable to Medivation.  He made that purchase, the SEC claimed, based on an assumption that the acquisition of Medivation at a healthy premium would probably boost the share price of Incyte. And, Incyte’s stock price did increase after the sale of Medivation was announced.  The SEC charged, under the “misappropriation theory,” that Panuwat committed fraud against Medivation in connection with the purchase or sale of securities, with scienter, in violation of Rule 10b-5; he had, the SEC charged, breached his “duty to refrain from using Medivation’s proprietary information for his own personal gain” and traded ahead of the announcement. The SEC sought an injunction and civil penalties.

In December 2021, Panuwat  filed a motion to dismiss the complaint under Rule 12(b)(6), calling it “an unprecedented expansion” of the Exchange Act, but the court denied the motion. (See this PubCo post.)  Just this past September, Panuwat moved for summary judgment, claiming that this was the wrong case to test out the novel shadow-trading theory:  “Incyte  and  Medivation  were  fundamentally  different  companies  with  no  economic or business  connection, Medivation’s policies did not prohibit Mr. Panuwat’s investment, and Mr. Panuwat’s reasons for making the investment were entirely separate from the Medivation sale process and consistent with his prior investment  practices.”  The SEC responded that Panuwat’s “actions fit squarely within the misappropriation theory of insider trading” and that his “actions provide strong evidence of his scienter.” That motion is expected to be heard this week.

Amicus brief.  On October 27, ICAN moved for leave to file its amicus brief. The SEC opposed the motion on the basis that the request was “untimely and proffers legal arguments neither party has raised.” The Court granted the motion for leave to file the amicus brief.

In its brief, ICAN contended first that the SEC’s position on shadow trading “will have enormous impact, not just in this case and against the individual defendant, but more broadly on many other market participants nationwide,” harming the very retail investors and market integrity that the SEC claims to protect.  That’s because, in amicus’s view, trading on the basis of material nonpublic information contributes to price accuracy, and “prohibiting all or too much trading on nonpublic information in other circumstances might undermine the integrity of the markets if the investing public believes prices do not reflect all relevant information, whether publicly available or not.”  The question is “how much ‘correctional’ trading by people with nonpublic information should be tolerated”?  Trading on the basis of MNPI is not prohibited in every circumstance, they argued. According to ICAN, “[a]llowing a publicly traded company to restrict trading in its competitors’ stock unless it benefits the company and anchoring civil and possibly criminal liability to such facially self-serving prohibitions, would lead to perverse results harmful to retail investors and the integrity of the market…That cannot be what Congress intended.”

And speaking of what Congress intended, amicus pointed out that there have been calls for Congress to pass more explicit legislation on insider trading, but nothing has been enacted. And certainly, they suggested, nothing has been enacted authorizing the SEC to take on shadow trading. In the absence of a clear Congressional delegation of authority to the SEC, ICAN contended, the SEC has gone too far, and the court should not impose shadow trading liability.  That would fly in the face of the “major questions” doctrine, ICAN argues, which holds that “when an agency seeks to use its delegated authority to regulate an issue of major national significance, that agency’s authority to do so must be supported by clear, and not vague or ambiguous, statutory authorization.”   

SCOTUS first gave its imprimatur to the “major questions” doctrine in West Virginia v EPA. That case came to the Supreme Court as the attorney generals of West Virginia and other states and entities sued EPA, questioning its authority under the 1970 Clean Air Act to issue broad systemic regulations governing GHG emissions from power plants. In the majority opinion, SCOTUS declared that this case was “a major questions case,” referring to a judicially created doctrine holding that courts must be “skeptical” of agency efforts to assert broad authority to regulate matters of “vast economic and political significance”; in those instances, the doctrine required, the agency must “point to ‘clear congressional authorization’ to regulate.’” In West Virginia, EPA’s decision would have involved “billions of dollars of impact”  and “represent[ed] a ‘transformative expansion in [its] regulatory authority’ . . . that Congress had conspicuously and repeatedly declined to enact itself.” SCOTUS concluded that the Clean Air Act did not give EPA that authority. Rather, the Court said, a “decision of such magnitude and consequence rests with Congress itself, or an agency acting pursuant to a clear delegation from that representative body.” (See this PubCo post.) 

“In describing the EPA’s regulatory decision,” amicus argued, “the Supreme Court could just as easily have been describing the SEC’s attempt to expand its authority over ‘shadow trading’ despite the vast economic and political significance such a decision would have and in the absence of Congressional delegation to do so.” Without that clear authority, amicus advocated, the SEC should “subject its ‘shadow trading’ theory to the rigors and public scrutiny of the rulemaking process.” Instead, the SEC was seeking to impose shadow trading liability through litigation, where the public and investors are denied “the opportunity to evaluate and weigh in on whether the SEC’s proposed expansion of insider trading liability…is consistent with both its stated mission to protect investors and market integrity, as well as its statutory authority.”

In her column, Frankel observed “there’s no guarantee that [the judge] will address ICAN’s argument,” but the judge’s willingness to permit the filing of the amicus brief, the SEC’s objection notwithstanding, might imply that the judge “is interested in ICAN’s invocation of the major questions doctrine.” Or, it could just be a “blip.” 

As she noted, some potentially positive news for the SEC may be the recent decision of the Fifth Circuit in Alliance for Fair Board Recruitment, National Center for Public Policy Research v. SEC, denying petitions for review of the SEC’s approval of the Nasdaq board diversity rule. (See this PubCo post.) In that case, the court rejected a “major questions” argument under West Virginia v. EPA, explaining that “the ‘major questions doctrine’ applies in ‘extraordinary cases’ where the ‘history and the breadth of the authority that the agency has asserted, and the economic and political significance of that assertion, provide a reason to hesitate before concluding that Congress meant to confer such authority.’” This was not one of those cases.  Rather, in this instance, “the SEC’s asserted authority is an ordinary exercise of its power to approve exchange listing rules”—“business as usual for the SEC.”  Nor was the “SEC’s approval of a rule requiring disclosures of board diversity information…economically and politically significant enough to trigger the major questions doctrine.” Moreover, even if it were, the delegation of authority to approve the Nasdaq rule is not ambiguous; the “authorization is plain on the face of the Exchange Act.” The Court held “that the SEC’s Approval Order fell within its statutory authority under the Exchange Act.”  A petition for a rehearing en banc has been filed—although apparently not challenging the decision on the issue of “major questions.” (See this PubCo post.)

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