The Implications of SEC v. Panuwat

On January 14, 2022, in SEC v. Panuwat, Index No. 21-cv-06322 (N.D. Cal.), Judge William H. Orrick denied the defendant’s motion to dismiss the SEC’s first-ever “shadow trading” enforcement action. “Shadow trading” is the name given to a novel theory of insider trading by a recent academic article that describes an individual’s use of inside information about one company to trade the stock of a separate but “economically-linked” company, such as a competitor, business partner, or supplier. That theory seems to have gained some traction with Judge Orrick. His decision denying Panuwat’s motion to dismiss has already been hailed as a significant victory for the SEC. But predictions that shadow trading actions are here to stay may be premature.

A motion to dismiss—in which the court must accept the SEC’s allegations as true and draw reasonable inferences in the SEC’s favor—remains a poor procedural mechanism to test the long-term viability of a novel fact-dependent theory of liability such as shadow trading. Other recent efforts by the government to extend the boundaries of insider trading liability—such as the application of insider trading laws to government information in United States v. Blaszczak—have faced their true tests only at trial and in post-trial appeals. Even though shadow trading has now survived a motion to dismiss, the long-term viability of the theory will likely be tested only after the numerous open factual questions in Panuwat get answered. 

Matthew Panuwat worked as the senior director of business development at Medivation, a mid-cap biopharmaceutical company. In that role, he learned that Pfizer had expressed “overwhelming interest” in acquiring Medivation. According to the SEC, within minutes of learning that information, Panuwat purchased 578 call options for shares of Incyte, another mid-cap biopharmaceutical company. In SEC v. Panuwat, filed last year, the SEC alleged that Panuwat engaged in insider trading by purchasing those options. The case is the SEC’s first attempt to enforce its insider trading rules based on a “shadow trading” theory.

According to the SEC, “shadow trading” is a version of the “misappropriation theory” of insider trading. “The ‘misappropriation theory’ holds that a person commits” insider trading “when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information” regardless of whether that person has any duty to the “purchaser or seller of the company’s stock.” United States v. O’Hagan, 521 U.S. 642, 652 (1997). Under the misappropriation theory, insider trading breaches a duty to the source of the information because it “defrauds the principal of the exclusive use of [its] information.” Id.

In SEC v. Panuwat, the SEC’s Complaint alleges that Panuwat’s conduct breached his duty to Medivation. In opposing Panuwat’s motion to dismiss, the SEC flagged the[SS1]  Ninth Circuit’s decision in SEC v. Talbot, which held that J. Thomas Talbot, a member of Fidelity’s board of directors, committed insider trading by purchasing stock in Lending Tree based on confidential information that he learned about Lending Tree at a Fidelity board meeting. (Docket Entry 19 at 17 (citing S.E.C. v. Talbot, 530 F.3d 1085 (9th Cir. 2008)). The Ninth Circuit concluded that Talbot’s conduct fell within the “misappropriation theory” of insider trading because Talbot breached his duty to Fidelity when he used confidential information from Fidelity for his own benefit. Talbot, 530 F.3d at 1096-1097. The court in Talbot explained that Talbot’s conduct was unlawful regardless of whether Fidelity was harmed by Talbot’s trading or whether Talbot owed Lending Tree any fiduciary duties. Id. at 1093,1096-1097.

While Talbot seems to support broad liability for “shadow trading,” Judge Orrick’s decision does not appear to go so far. Despite the SEC’s invocation of Talbot, Judge Orrick concluded that Panuwat’s conduct breached his duty to Medivation because Medivation’s broadly-worded insider trading policy prohibited employees from using non-public information to trade in “securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company.” (Docket Entry 26 at 2, 9.) Judge Orrick interpreted that expansive language to include securities of any “publicly traded company,” thus encompassing Incyte’s securities. (Id. at 8-9.) Based on the policy, Judge Orrick concluded that Panuwat’s purchase of Incyte’s securities violated his duty to Medivation. 

By focusing on Medivation’s insider trading policy, Judge Orrick did not resolve whether “shadow trading” would be unlawful absent an explicit policy prohibiting the conduct (or whether a narrow policy that fails to prohibit the conduct would provide a defense). As one article on NYU’s Compliance & Enforcement blog noted, Judge Orrick’s decision prompts the question: “if the prohibition is not contained in the policy, which presumably means there is no duty of trust and confidence with respect to the information, is the insider free to trade?” The answer to that question may have significant implications because researchers found that out of 267 companies with insider trading policies, only 53% prohibit trading other companies’ stock based on non-public information. Moreover, those statistics do not indicate whether any of those companies’ insider trading prohibitions are as broad as Medivation’s. It will be important to see whether “shadow trading” remains a viable theory in the absence of such a broad policy, as well as the degree to which companies review and potentially amend their policies in light of Panuwat (as some have called for). 

Judge Orrick’s decision also does not resolve precisely what information is “material” in the context of “shadow trading.” Regarding materiality, Judge Orrick concluded that the SEC had alleged sufficiently that Pfizer’s “looming acquisition” of Medivation was material to Incyte because the two companies were part of a limited group of mid-cap biopharmaceutical firms with commercial-stage drugs. According to Judge Orrick, these similarities made it plausible that Pfizer’s interest in Medivation would make Incyte more attractive to investors or to other companies that had considered acquiring Medivation. (Docket Entry 26 at 7-8.)

That conclusion is notable because it accepts that information about one company may be material to investments in a separate company. Because Judge Orrick only considered whether the SEC’s allegations were sufficient to survive a motion to dismiss, however, it remains to be seen whether the SEC’s theory will stand up after discovery or at trial. In particular, Panuwat may well seek to establish that information about Medivation would not be significant to a reasonable investor’s decision to trade Incyte’s stock based on possible differences (revealed in discovery or at trial) in the two companies’ historic stock-price movement, financial projections, drug pipeline, and corporate strategy. Industry participants and their counsel should look closely at whether Panuwat can ultimately persuade a factfinder (or an appellate court) that Medivation’s “looming acquisition” was not material to Incyte despite the SEC’s allegations highlighted in Judge Orrick’s decision, and where the materiality line gets drawn.     

Judge Orrick’s acceptance of “shadow trading” as a viable theory of insider trading is undoubtably noteworthy. But a motion to dismiss is far from an ideal mechanism to test a fact-dependent theory of liability, and particularly one that raises as many questions for market participants (catalogued in part here) as the broad theory of “shadow trading.” Only time will tell whether Panuwat is merely the “perfect storm” for “shadow trading,” or if the theory is viable beyond the unique facts of this particular case.

Penina Moisa, an associate at the firm, assisted in the preparation of this blog post.

To read more from Brian A. Jacobs, please visit www.maglaw.com.