In February 2022, in SEC Shadow Trading Case Breaks Ground, we discussed Securities and Exchange Commission v. Panuwat,[1] the SEC’s first enforcement action brought on the theory of “shadow trading.”
Shadow trading is the premise that securities market participants can violate insider trading laws by transacting, not directly in the equity of a company about which they have material non-public information (“MNPI”), but rather in other equities whose share price reactions to the publication of the MNPI is predictable.[2] In this case, the SEC alleges that Matthew Panuwat misappropriated MNPI regarding the acquisition of his company, Medivation, Inc., when trading in equity options of a separate company, Incyte Corporate:
[W]ithin minutes of receiving this highly confidential news from Medivation’s CEO, Panuwat misappropriated Medivation’s confidential information by purchasing—from his work computer—out-of-the-money, short-term stock options in Incyte Corporation (“Incyte”), another mid-cap oncology-focused biopharmaceutical company whose value he anticipated would materially increase when the Medivation acquisition announcement became public.[3]
With the close of discovery, Defendants filed for summary judgement, asserting that the SEC cannot demonstrate a number of elements.[4] For the purposes of the shadow trading theory specifically, the most crucial is Panuwat’s argument that the SEC cannot show that any MNPI known to Panuwat was material to Incyte.[5]
Challenging the materiality of Medivation’s acquisition to Incyte investors, Panuwat asserts that the companies had “different drugs, with different mechanisms of action,” there was “no apparent research overlap between the companies,” and that the companies used different commercialization and sales methods.[6]
Regarding historical correlations in Medivation and Incyte’s stock prices, Panuwat claims that Incyte’s market price was not historically correlated with either Medivation’s stock price or industry acquisitions,[7] pointing to an event study conducted by an expert that claimed to show that Incyte’s stock price was poorly correlated with moves in Medivation’s stock price or industry acquisitions.[8]
The SEC claims that the evidence shows a material fact dispute over the correlation, including:
- An apparent correlation between a rise in Incyte’s stock price and the acquisition of Pharmacyclics by AbbeVie;[9]
- A correlation between the companies’ stock prices based on documents by Medivation advisors in connection with the acquisition;[10] and
The lack of any evidence of an alternative explanation for the eight percent rise is Incyte’s stock price on the news of the deal[11] – a return that was described as “abnormal” and “statistically significant” by Panuwat’s expert.[12]
On October 31, 2023, Judge Orrick granted[13] a motion for leave to file a brief as amicus curiae submitted by Investor Choice Advocates Network (“ICAN”)[14] over the SEC’s objection.[15] The SEC contended that ICAN’s request was both: (1) untimely; and (2) seeks to brief issues not raised by either party. Specifically, ICAN seeks to brief the issues:
- That the Court should reject the shadow insider trading theory because this would “lead to perverse results harmful to retail investors and the integrity of the market”;[16] and
- Under the major questions doctrine, the SEC does not have a sufficiently clear delegation of authority from Congress to seek shadow trading liability.[17]
However, in its ruling on Panuwat’s motion to dismiss, the Court specifically noted that:
In the absence of notice—for example, where the regulation is not sufficiently clear to warn a party about what is expected of it—an agency may not deprive a party of property by imposing civil or criminal liability.[18]
With an array of challenges to the sufficiency of the evidence and the basis for enforcement, the Court may ultimately not be called upon to cut the first bright line rule on just how correlated equities must be to trigger shadow trading liability.
We await the Court’s ruling.
The case is Securities and Exchange Commission v. Panuwat, Docket No. 3:21-cv-06322 (N.D. Cal. Aug 17, 2021).
***
[1] SEC v. Panuwat, Dkt No. 3:21-cv-06322 (N.D. Cal. Aug 17, 2021).
[2] See Shadow Trading, M. Mehta, D. Reeb & W. Zhao, Accounting Rev. (2021) 96 (4): 367-404.
[3] Complaint, Dkt. No. 1 at 2.
[4] Defendant’s Motion for Summary Judgement, Dkt. No. 63.
[5] Id. at 20.
[6] Id. at 21.
[7] Id. at 27.
[8] Dkt. No. 63-1 at 225-241 (McCarty Dep. at 110:17-124:9).
[9] SEC Opposition to Motion for Summary Judgement, Dkt. 70 at 14.
[10] Defendant’s Motion for Summary Judgement, Dkt. No. 63 at 22.
[11] Dkt. 70 at 13-14.
[12] Dkt. No. 70-1 at 264-65 (McCarty Dep. at 75:3-76:10).
[13] Dkt. No. 78.
[14] Dkt. No. 76.
[15] Dkt. No. 76.
[16] Dkt. 75-1 at 3
[17] Dkt. 75-1 at 8-9.
[18] Secs. & Exchg. Comm’n v. Panuwat, No. 21-cv-06322-WHO (N.D. Cal.), slip op. (Jan. 14, 2022) at 11 (quoting United States v. Approx. 64,695 Pounds of Shark Fins, 520 F.3d 976, 980 (9th Cir. 2008).
