The Securities and Exchange Commission (SEC) won an important victory last week when a San Francisco jury found a former executive liable for so-called “shadow trading.” This novel theory of insider trading was previously untested before the SEC brought the action against Matthew Panuwat, a former development executive at Medivation, a biopharmaceutical company. The SEC alleged that Panuwat used material, non-public information regarding Pfizer’s imminent purchase of Medivation to purchase stock options in another company—one “similarly situated” to Medivation. The SEC prevailed under the “shadow trading” theory of liability and could increase insider trading actions, opening the door for the Department of Justice (DOJ) to bring criminal cases based on similar facts, and change general counsel’s guidance to company executives regarding 10b5-1 letters.

Much of the SEC’s case hinged on an internal email from Medivation CEO David Hung that disclosed Pfizer’s intention to immediately purchase Medivation. The evidence showed that Panuwat bought call options in Medivation’s competitor, Incyte, seven minutes after learning of the acquisition. The SEC also presented evidence that Panuwat had signed Medivation’s insider policy prohibiting employees from “gain[ing] personal benefit” by using company information to “profit financially by buying or selling” either securities issued by Medivation “or the securities of another publicly traded company.” ¹ In addition, the SEC introduced a number of analyst reports and financial news articles that tied Medivation’s acquisition to Incyte’s future. Panuwat, however, presented evidence that Medivation and Incyte were not similarly situated, as they developed and sold different products. Panuwat also testified that the confidential information about Medivation’s sale did not influence his decision to purchase Incyte stock options. However, the SEC pointed out during Panuwat’s cross-examination that he did not raise any alternate justification when asked by investigators during the early stage of the investigation into his trades.

By the time the Pfizer-Medivation deal was announced publicly several days after Panuwat’s options purchases, Incyte’s share price had risen 7.7 percent. As a result of his trades, Panuwat made approximately $110,000.

After hearing the evidence, the jury determined that Panuwat violated insider trading laws. In so doing, the jury recognized that Panuwat owed a fiduciary duty to Medivation and that his employment put him in a position to have non-public information that altered the total mix of information available about Incyte; in other words, that was material in relation to Incyte. The jury also had to find that Panuwat bought the stock options based on his knowledge of that information, which he knew was confidential, and that he had acted recklessly in deciding to trade without Medivation’s permission.

While the SEC enforcement director Gurbir Grewal said the ruling was nothing new – claiming Panuwat’s conduct was “insider trading, pure and simple” ² – the case opens up new territory for SEC enforcement actions. The SEC is not the only agency that can use the “shadow trading” theory, however. The DOJ can also seek criminal charges for violations of insider trading laws. Although a criminal “shadow trading” case has not been brought yet; it is foreseeable that DOJ could seek to test the theory further if it has a strong case to prosecute. There will also be ripple effects within corporations, as in-house lawyers advise executives, often privy to material non-public information, to exercise caution in trading securities under similar circumstances. The SEC’s case against Panuwat is only the first test for the “shadow trading” theory. While the scope of the liability for “shadow trading” could be limited following an appeal of the verdict and in future cases with different facts, corporate legal and compliance staff should be aware of the risks of employees trading the securities of competitors while in possession of material non-public information about their own companies and consider revisions to insider trading policies to address those risks.

^{[1] Complaint ¶ 20, SEC v. Panuwat, No. 21-cv-06322 (N.D. Cal. Aug. 17, 2021).
[2] https://www.sec.gov/news/statement/grewal-statement-040524.}

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.