On April 5, 2024, a federal jury in SEC v. Panuwat (N.D. Cal.) agreed with the SEC that a corporate official engaged in insider trading when he purchased securities of a company based on material nonpublic information (“MNPI”) about a different company, the first ever guilty verdict based on the so called “shadow trading” theory of insider trading.

Shadow trading is a novel theory of insider trading in which MNPI from one company is leveraged to execute a transaction in the securities of a second company whose share price is predictably correlated to the disclosure of the MNPI. The term was recently coined in an academic article to describe when “corporate insiders attempt to circumvent insider trading restrictions by using their private information to facilitate trading in economically linked firms.”

Factual Background

Matthew Panuwat was the head of business development at Medivation, a biopharmaceutical company. Around April 2016, in connection with a failed takeover attempt of Medivation, a theory emerged among industry analysts that a larger company’s successful acquisition of Medivation would increase the attractiveness of Incyte, a company similar to Medivation. The SEC alleged that on August 18, 2016, Panuwat learned that Medivation was about to be acquired by a large pharmaceutical firm and that, shortly after receiving this information, he purchased call options on Incyte’s securities. When the Medivation acquisition was announced, Incyte’s stock price rose 7.7%, and Panuwat made more than $100,000 on his call options.

The SEC claimed that Panuwat violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b5 thereunder when he traded in Incyte options, allegedly based on the MNPI he received while working at Medivation. On November 20, 2023, in a victory for the SEC, the United States District Court for the Northern District of California denied defendant Panuwat’s motion for summary judgment, and on April 5 after an 8-day trial and less than three hours of deliberation the jury delivered a verdict against Panuwat.

Insider Trading – Misappropriation Theory

The SEC’s theory turned on its claim that Panuwat “misappropriated Medivation’s confidential information” to buy securities “whose value he anticipated would materially increase when the Medivation acquisition announcement became public.”

Courts currently recognize two theories of insider trading liability—the “classical” theory, when a corporate insider trades in his or her own company’s securities based on material non-public information. This theory, however, does not apply to Panuwat because he did not execute any transactions in Medivation securities. The second is the “misappropriation” theory, first recognized by the Supreme Court in United States v. O'Hagan, which is implicated when a person “misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.”

In its summary judgment ruling, the court held that three independent duties could apply to Panuwat: (i) his duties under Medivation’s Insider Trading Policy, which prohibited trading “the securities of another publicly-traded company” based on MNPI obtained through his Medivation employment, (ii) his duties under Medivation’s Confidentiality Agreement, and (iii) his common-law employment duties, which imposed “a duty of trust and confidence” on him when he was entrusted with confidential information, and which prohibited him from using that information for his personal benefit “without disclosing that fact to” his employer.

Regarding the insider trading policy, Panuwat claimed that Medivation’s policy did not preclude him from trading in other companies’ securities, but the court rejected this argument, pointing to the “plain language of the policy,” which stated:

“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.”

At trial, the jury was asked to determine whether Panuwat had owed a duty of “trust, confidence or confidentiality” to Medivation (it found that he did) and whether, as a result of his employment, he had possessed nonpublic information that was material to Incyte (it found that he did). The jury also needed to assess whether Panuwat had purchased the Incyte call options based on that nonpublic information and whether he had “acted recklessly” in doing so.

Panuwat testified that his purchase of Incyte options was unrelated to the news he received about the upcoming acquisition of Medivation and was instead based on an analyst report he had read the month prior. Under cross-examination, the SEC cast doubt on the fact that Panuwat’s purchase of the Incyte securities a mere seven minutes after learning of the acquisition was simply a “coincidence.”

The jury deliberated a little more than two hours and rendered a verdict in favor of the SEC.

Questions and Take-aways

As it has done throughout this litigation, the SEC made clear in its post-verdict statement its view that there was nothing “novel” about this case. Indeed, the SEC has avoided using the phrase “Shadow Trading” or suggesting that this case is anything other than a traditional misappropriation theory insider trading case. After the verdict, the SEC Division of Enforcement Director Gurbir Grewal said, “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.”

Whether or not the theory is novel, this case and verdict expands otherwise well-settled concepts of duty and materiality and will likely result in the SEC bringing similar actions.

Below are some questions and guidance based on this decision:

• This was a trial court verdict that will likely be appealed.
• If the guilty verdict is sustained on appeal, how important will Medivation’s trading policy be to that decision?
• What is/will be the standard for determining whether and the extent to which unrelated securities issuers are “linked” for the purposes of insider trading?
  • Companies within the same industry based on a classification system?
  • A more statistical model, such as companies whose share prices exhibit a certain level of correlation over a given period?
• Firms should consider the idea of “shadow trading” when determining which issuers to add to their restricted lists and potentially consider restricting not only the company whose material non-public information is learned, but also any potential other companies with a “market connection.”
• Firms should review the language in confidentiality agreements and insider trading policies, ensuring they are broad enough to cover trading in companies other than the employer.