Last week the United States Securities & Exchange Commission won a jury verdict in the United States District Court for the Northern District of California in a first-of-its-kind enforcement action seeking to bar employees from using non-public information on one company to trade in securities of a rival company, a practice that has become known as “shadow trading.” 

There are two theories of insider trading liability which violate Section 10(b) of the Securities Exchange Act of 1934. The “classic” insider trading case arises where a corporate insider uses material, non-public information to their advantage in the trading of the securities of their own company. The “misappropriation” theory of insider trading occurs where an individual trades stock in a company that they are not affiliated with, on the basis of material, non-public information they obtained through a breach of a fiduciary duty owed to the source of the information.  The SEC has asserted that while the fact pattern here may be new, “shadow trading” falls conceptually within the misappropriation theory of insider trading. Many commentators assert that charging insider trading for “shadow trading” is a broader conception of the misappropriation theory than the SEC has previously applied.

Here, the SEC claimed that Matthew Panuwat, former head of business development at Medivation Inc., committed insider trading when he purchased call options in a rival biopharmaceutical company “within minutes” of learning that his own company was going to be acquired by another large player in the industry. According to the SEC, Mr. Panuwat knew that news of the acquisition would drive up the stock price of his company and other pharmaceutical companies in the industry, and indeed, Mr. Panuwat generated more than $100,000 in illicit profits when the acquisition announcement caused the price of the call options he had purchased four days earlier to nearly double. 

At trial, the SEC focused on a single email that was received by Mr. Panuwat just seven minutes prior to his purchase of call options of the competitor’s stock confirming that the acquisition was set to be announced publicly. The SEC also presented evidence that Mr. Panuwat violated his company’s Insider Trading Policy, which prohibited him from trading “the securities of another publicly-traded company” based on inside information obtained in the course of his duties and put him on notice that this conduct was illegal. This is particularly relevant because not many companies have similar policies. Mr. Panuwat’s lawyers argued that he had been set up and the SEC reverse engineered a case against him. The SEC, however, told jurors that Mr. Panuwat’s explanation to the jury as to why he bought call options in the rival company – an explanation that he did not give to investigators when first questioned about the trades – “ignores coincidence after coincidence and requires you to check your common sense at the door.” After deliberating for just over two hours, the jury agreed, finding Mr. Panuwat liable under a misappropriation theory of insider trading.

While Mr. Panuwat is likely to appeal, the SEC’s victory signals that those who use material, non-public information to trade in the shares of companies similarly situated to their own may face significant civil liability.  Accordingly, companies may wish to review their current insider trading policies and related compliance controls to address the risks associated with this new avenue of enforcement.

Additional author: Anthony Todd