SEC puts concept of ‘shadow insider trading’ to test in court action

Biotech executive Matthew Panuwat bought options on stock of another company he was not privy to inside information about. Was it insider trading?

When biotech executive Matthew Panuwat bought options on a rival drug company’s stock, he earned a hearty sum of $120,000. But the SEC says he committed insider trading, even though he didn’t buy his employer’s stock and was not privy to inside information about the company on which he bet.

The case goes to trial next month and has become the latest test of what insider trading is under the law.

Purchasing the call options

Panuwat is a former employee at Medivation, an oncology-focused biopharmaceutical company. In late March 2016, another pharmaceutical company attempted a hostile takeover of Medivation. Thereafter, Medivation launched its own sales process.

As part of that process, Medivation insiders and outside analysts considered its relative position as compared to other biopharmaceutical companies and the impact that a Medivation acquisition would have on other similar biopharmaceutical companies, including a company called Incyte Corp.

Although the market was aware that Medivation was looking to be acquired, the negotiations and sales process themselves were confidential, as were details about the sales price and the precise timing of the bid process. Panuwat was involved in the process and aware of these confidential details. As an employee of Medivation, Panuwat agreed to abide by the company’s confidentiality agreement and insider trading policy, the latter of which contained language stating that he could not use the company’s information to profit by trading in the securities of any public company.

On August 18, 2016, Medivation’s CEO sent Panuwat and 12 other Medivation employees an email containing non-public information that a certain well-known large pharmaceutical company wanted to close a deal to acquire Medivation “this weekend”. The email disclosed both the name of the acquiring pharmaceutical company and the anticipated price at which Medivation would be acquired. Seven minutes after the transmission of the email, Panuwat started purchasing call options for a rival company, Incyte, expecting its shares to go up.

The following Monday, Medivation announced the acquisition pre-market, and, sure enough, Incyte’s stock price had increased by nearly 8%. Panuwat then sold his Incyte options, making a good profit.

‘Shadow trading’

The SEC initiated its lawsuit in August 2021, and on November 20, 2023, a federal district court denied summary judgment for Panuwat, rejecting his argument that the SEC had no case here and should find for him without a trial on the merits.

The case proceeds to trial next month, and it has become yet another test of insider-trading law. Since Congress has never explicitly defined it (but see below), it’s often up to the courts to decide what constitutes a true case of it, with appellate courts often being more hesitant than trial courts to broaden the definition further.

The trial will involve a test of what has been called “shadow trading,” which involves trading the securities of a public company that is not the direct subject of the material nonpublic information (MNPI) at issue. Put another way, it’s about executives making well-timed bets in the shares of other companies, armed with specialized knowledge – but not armed with MNPI about those other companies.

No court has ever tackled the idea that executives can go too far when they deploy their specialized knowledge or expertise to trade in the shares of rivals, said Karen Woody, a professor at the Washington and Lee University School of Law. “I do think this is a push of the law and they are seeing if they can get a court to bless what is a bit of a stretch of the existing parameters,” Woody said of the SEC’s case.

SEC’s allegations

The SEC says several facts about Panuwat’s trading make it illegal. First of all, his employer had a policy that forbade trading other companies’ shares when employees had MNPI about Medivation. And second, Panuwat traded on his work computer just seven minutes after he allegedly learned that another company (Pfizer) was buying his company.

The evidence in the summary judgment record also showed that:

  • Analysts had been following Medivation’s sales process and had discussed the potential impact that Medivation’s acquisition could have on other biopharmaceutical companies, including Incyte.
  • Panuwat had been involved in the search for an appropriate buyer for Medivation and in analysis of the potential impact of a sale.
  • The sale process was confidential within Medivation, with code names assigned to all involved parties.

To succeed with an insider trading charge, the SEC needs to establish that he breached “some fiduciary, contractual, or similar obligation” to Medivation when he traded the Incyte call options. The agency has sought to show such a breach of duty under different theories, each of which sufficed to defeat Panuwat’s summary judgment.

“If the SEC loses, it’s only because there is a hesitation about extending the jurisdiction of insider trading to peer companies. I don’t think they lose on the facts.”

Daniel Taylor, UPenn professor specializing in insider-trading research

Those theories include the fact that Medivation had the Insider Trading Policy as noted above; that Panuwat had signed a confidentiality agreement that required him not to use Medivation’s confidential information for his personal benefit; and that by being entrusted with such confidential details, a jury could find Panuwat had breached a duty of trust and confidence.

Panuwat ended up selling some of the Incyte contracts just days after buying them, court records show. He sold others weeks later and lost money on those, but still earned a good profit overall.

The SEC is seeking a fine that could equal three times Panuwat’s $120,000 trading gain, and the agency wants to bar him from serving as an officer or director of a public company in the future.

A tough case for Panuwat

Panuwat has argued that there was no evidence that he traded with scienter, or a culpable state of mind. He argued the email he received about the impending deal did not contain “non-public” information and, along those lines, that the acquisition of Medivation had not been finalized at the time of his trades.

Also, Panuwat said in his argument from the motion to dismiss that there was no evidence he actually used the MNPI, as opposed to only being exposed to it.

Incyte’s stock was strongly correlated with Medivation’s during the year before Panuwat’s trading, said Daniel Taylor, a professor at the University of Pennsylvania who specializes in insider-trading research. Incyte’s stock increased 8% on the day in August 2016 that Pfizer announced it would acquire Medivation, he said.

Panuwat’s case shows that “if you have information about one company, based on the historical correlation, you also have information about the other,” Taylor said. “If the SEC loses, it’s only because there is a hesitation about extending the jurisdiction of insider trading to peer companies. I don’t think they lose on the facts.”

Insider trading policy at Medivation

Medivation’s insider-trading policy had expressly covered “the securities of another publicly-traded company,” apart from Medivation itself. So would the absence of such language not convey the requisite breach of duty?

The summary judgment decision suggests it still could. The court has now held that, even apart from the Insider Trading Policy and the Confidentiality Agreement, Panuwat had a duty to his employer under “traditional principles of agency law” not to use his employer’s confidential information “for his own personal benefit without disclosing that fact to [the employer]”. That duty does not depend on the breadth of the Insider Trading Policy, it said.

GRIP comment

Legal and compliance professionals should consider the possibility of “shadow trading”, especially when determining which issuers to add to their firms’ restricted lists in their insider trading and confidentiality policies.

The court’s summary judgment order shows that when two companies share a sufficient “market connection” – such that material information about one could be material to the other – certain guardrails need to be imposed.

Looking for these connections beforehand is key – so potentially consider restricting not only the company whose MNPI is learned, but also any potential other companies with a “market connection”.

And, no matter how the Panuwat case is ultimately decided, businesses are wise to use this case in training on handling MNPI in a manner that is legally safer for both the business and individual.

Insider trading cases and discussions have been plentiful in the last couple of years. Here are few that come to my mind.

Earlier this month, a former Goldman Sachs International analyst in the UK was sentenced to 22 months in prison for using inside information to buy shares in listed companies and make more than £140,000 ($175,650).

Last month, the US Attorney for the Southern District of New York announced a guilty verdict against Amit Dagar for insider trading and conspiracy to commit insider trading, with a jury finding Dagar stole information about Paxlovid from his employer, Pfizer, and used his inside knowledge to profit in the stock market.

In December 2022, the SEC modified the rules governing preset stock trading programs for corporate insiders, known as 10b5-1 plans, and the rules began taking effect in late February 2023. The new rules require businesses to add lengthy “cooling-off periods” for directors and officers between the time they establish a pre-set trading plan and the date a first trade can be made.

And a bipartisan bill, the Insider Trading Prevention Act, is winding its way through Congress and would prohibit sale or purchase of covered financial instruments by members of Congress and their spouses, and for other purposes. Another bipartisan bill – the Holding Foreign Insiders Accountable Act – would require executives and principal stockholders at foreign firms that raise money in the United States to disclose their trades to investors within two business days, giving the market and regulators a chance to spot (and discipline for) any insider trading.