California District Court Allows Novel SEC Insider Trading Theory To Proceed

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On January 14, 2022, Judge William Orrick of the United States District Court for the Northern District of California issued an order denying a former biopharmaceutical company executive’s motion to dismiss and allowing the Securities and Exchange Commission (“SEC”) to proceed with a first-of-its-kind insider trading action against a corporate insider for misappropriating confidential nonpublic information related to his employer’s upcoming merger to purchase securities issued by a third company that was not involved in the transaction.

In August 2021, the SEC charged a former executive of California-based biopharmaceutical company, Medivation Inc. (“Medivation”), with violating § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 for allegedly relying upon inside information that he obtained through the course of his employment at Medivation to purchase stock of a different company, Incyte Corporation (“Incyte”), a practice that some academics have dubbed “shadow trading.” See SEC Brings Insider Trading Charges Based on Novel Theory (August 26, 2021). The SEC alleged that Matthew Panuwat, the former head of business development at Medivation, learned information related to Medivation’s expected acquisition by Pfizer, Inc., and minutes after receiving this information, Panuwat purchased out-of-the-money, short-term stock options in Medivation’s competitor, Incyte, anticipating that Incyte’s value would materially increase when the Medivation acquisition became public.

Panuwat moved to dismiss the SEC’s complaint, which he called an “unprecedented expansion” of the Exchange Act. Specifically, Panuwat argued that the SEC failed to adequately plead that the information Panuwat received related to the impending Pfizer-Medivation acquisition was material to Incyte. Panuwat argued that Rule 10b-5 required the SEC to plead that he traded Incyte on the basis of material nonpublic information about that security or issuer, and that the SEC could not rely upon Panuwat’s possession of nonpublic information related to Medivation. In response, the SEC argued that Panuwat was attempting to improperly narrow the meaning of materiality and that information, including the information Panuwat received related to Medivation, could be material to more than one company. The court found the SEC’s reading of Section 10(b) more persuasive and noted that that Rule 10b-5 has a wide reach, prohibiting insider trading of “any security” using “any manipulative or deceptive device.” See § 15 U.S.C. § 78(j)(b); 17 C.F.R. § 240.10b-5. Moreover, the court noted that information may be significant to an issuer even if it comes from outside the company and that the language of Rule 10b-5 makes clear that the text of the rule does not provide an exhaustive list of the manipulative schemes or devices that the rule might prohibit.

Additionally, Panuwat argued that he did not breach a duty to Medivation, as required under the misappropriation theory of insider trading, because Medivation’s insider trading policy did not prohibit trading in Incyte securities and the SEC had failed to allege that Incyte was a significant collaborator, customer, partner, supplier, or competitor of Medivation, as would be covered by the policy. The court rejected this argument, finding that the abovementioned categories of companies listed in the Medivation insider trading policy were just examples and not an exclusive list and that Medivation’s insider trading policy was broad enough to limit the purchase of any publicly traded company based on nonpublic information received by an employee of Medivation during the course of employment.

Panuwat further argued that the SEC had not sufficiently alleged that he acted with scienter, arguing that the SEC’s allegations that he “used” the information about Medivation’s acquisition to purchase the Incyte stock options lacked the specificity required under Rule 9(b) of the Federal Rules of Civil Procedure. The court also disagreed on this point, finding that the totality of the circumstances surrounding Panuwat’s purchase of Incyte stock, as alleged, suggested that Panuwat used the material nonpublic information about the Medivation acquisition and therefore acted with scienter. Finally, Panuwat argued that the SEC’s novel application of the misappropriation theory, which the SEC conceded was the first such action, would improperly expand the law and violate Panuwat’s due process rights. The court recognized that while there were no other insider trading cases where the material nonpublic information at issue was used to purchase the security of a third party, the SEC’s theory still fell within the general insider trading framework and the broad language of Section 10(b) and its corresponding regulations. The court also noted while the SEC’s theory of liability was novel, the requirement that the nonpublic information used be material to the third party and the scienter requirement served as “guardrails” which would prevent the outer limits of insider trading liability from becoming “entirely unclear.”

As mentioned, this case marks the first time that the SEC has brought an insider trading case where the confidential information related to a company’s acquisition was used to trade the securities of a company unrelated to the transaction. While this decision at the trial court represents a significant victory for the SEC, several hurdles remain for the SEC, including whether it can convince a jury that the Medivation information in question was in fact material to Incyte and, if so, whether a Ninth Circuit panel will ultimately agree with Judge Orrick’s ruling. Nonetheless, this opinion underscores the need for companies to carefully consider whether their insider trading policies and training materials adequately reflect this insider trading theory.

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Order from Judge William Orrick of the United States District Court for the Northern District of California

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