In a breakthrough victory, the S.E.C. won its first “Shadow” insider trading case in SEC v. Panuwat.[1] A federal jury ruled that Mr. Panuwat, a Medivation, Inc. employee engaged in insider trading when he bought securities of a different company, InCyte Corp., based on material non-public information (“MNPI”) that Medivation was going to be acquired at a significant premium. This is called “Shadow” insider trading (“Shadow Insider Trading”) because it involves a person taking MNPI about Company A (Medivation) and using it to make an illicit profit trading the securities of Company B (InCyte). The Panuwat victory means that the S.E.C. will bring more Shadow Insider Trading cases in the future. This creates an emerging, important risk of insider trading liability for hedge funds, private equity funds, and all investment professionals. Below we discuss they key facts that can trigger Shadow Insider Trading liability – including a “Market Connection” between Companies A and B – and how firms can effectively take steps and develop procedures to avoid liability for this new insider trading theory.
(A) Market Connection between Company A and Company B
The lynchpin of the S.E.C.’s Shadow Insider Trading theory is to show a “Market Connection” between Company A, whose MNPI is accessed, and Company B, whose securities are traded. In Panuwat, the defendant obtained MNPI that Pfizer would acquire Medivation at a significant premium to its stock price. Seven minutes after learning this, a Medivation employee used this information to buy short-term, out of the money options in InCyte Corp. When the Pfizer-Medivation deal was announced, InCyte’s stock jumped 8%, gaining the Medivation employee a $120,000 profit. The SEC proved a market connection between Medivation and InCyte, by showing that the Defendant knew that Medivation’s investment bankers viewed InCyte as a comparable company to Medivation. The SEC also cited a significant number of analyst reports, financial news articles, and investment banker analyses calling these companies comparable. Further, the SEC cited the evidence that InCyte’s stock jumped on the disclosure of the Medivation deal as de facto evidence that the two companies were correlated. At summary judgment, the Court held this showing was sufficient to go to trial, even though the two companies had “leading drugs approved for treating different diseases and patients” and different drugs. 2023 WL 9375861 *6. In short, a court can find “Market Connection” even where it is not obvious. Therefore, “Market Connection” is likely to become a heavily litigated issue in insider trading prosecutions, where experts are called to explore the “Market Connection” between companies.
(B) Scope of Duty Regarding MNPI Could Impact Insider Trading Liability
Another important issue in the Panuwat case was whether the Defendant had a fiduciary duty or similar relationship of trust and confidence that prohibited him from using Medivation information.[2] The court found such a duty existed based on Medivation’s insider trading policy, which prohibited using Medivation confidential information to trade in the securities of any other company. But that was not the only evidence of a duty that the court considered. The court also noted that, as an employee, the Defendant had duties to refrain from such trading based on a confidentiality agreement he signed, where he agreed to hold information he learned in the course of his duties in confidence, and not to use the information except for the benefit of Medivation. Further, the court suggested that employees could have a duty based on agency law (as distinguished from a fiduciary duty), where as an agent of the company, the employee has a duty not to profit from MNPI obtained from his employer. In sum, the Panuwat court’s reasoning suggests that most employees are likely to be found to have a duty not to use employer MNPI to make a personal profit trading in the securities of another company.
On the other hand, it remains an open question how far a duty not to engage in Shadow Insider Trading could apply in other contexts. For example, if a firm negotiates a carve-out from a non-disclosure agreement (“NDA”) that the NDA cannot apply to trading in securities of other companies, it is possible this could avoid the requisite insider trading duty not to misappropriate information for personal gain – depending on the particular circumstances. Similarly, other, non-employee contexts may involve more limited duties that may not apply to Shadow Insider Trading. Thus, it is important to speak with counsel about the particular details of any duty or confidentiality agreement before taking action.
(C) Key Takeaways from the Shadow Verdict
It is important that firms consult with counsel about Shadow Insider Trading issues after the Panuwat case, including acting to assess and adjust their policies and procedures on insider trading, restricted lists, personal trading, and similar issues. Firms may wish to consider the pros and cons of whether, and how, an insider trading policy should acknowledge the “Market Connection” concept. This is a particular concern when the firm’s research or business activities put the firm’s personnel in a position likely to obtain information about companies that have a strong Market Connection to other companies. Firms may wish to consider how to educate personnel on the Market Connection theory of insider trading, both in text of the policy itself, and in training conducted on the topic. If the risk is prevalent, firms may wish to consider implementing processes designed to prevent the firm and its personnel from trading when in possession of such MNPI; such as considering requiring personnel to report when they have MNPI on an issuer and whether such company may also have a Market Connection to another company or companies. When this is reported, or detected through other means, firms may wish to consider how to implement restrictions by including the issuer names on restricted lists, stopping trades using interdiction technology, or conducting post trade surveillance on transactions in such issuers. If you would like assistance about Shadow Insider Trading issues, designing your insider trading policies and procedures, assessing your risks, or have any questions about this case, please contact Sam Lieberman, Partner and Co-Head of Litigation, slieberman@sadis.com, 212.573.8164, or Thomas Kennedy, Partner, Financial Services/Regulatory, tkennedy@sadis.com 212.573.8038.
[2] Note that trading on MNPI can be illegal in various countries even without such a duty. Similarly, tender offer insider trading rules do not necessarily require such a duty.
