In January 2022, a federal district court denied a motion to dismiss a novel insider trading enforcement action brought by the U.S. Securities and Exchange Commission based upon a theory known as “shadow insider trading.” In SEC v. Panuwat, the SEC takes the position that the insider trading laws apply where an insider uses material nonpublic information about his or her own company to trade securities of another company, such as a competitor or peer company in the same industry.
The SEC brought an enforcement suit in the U.S. District Court for the Northern District of California against Matthew Panuwat, a former senior director of business development at Medivation, a publicly traded biopharmaceutical company, for insider trading. The SEC alleged that Panuwat committed insider trading based upon his confidential knowledge that Medivation would soon be acquired. Panuwat, however, did not trade the securities of his own company, Medivation. Instead, Panuwat allegedly used the confidential information he learned about the acquisition to trade in the securities of Incyte, a different biopharmaceutical company that had no involvement in the acquisition. This trade violated Medivation’s insider trading policy, which prohibited using confidential Medivation information to trade securities of another company. The SEC took the position that confidential information about the acquisition of Medivation was material to Incyte because Medivation and Incyte were closely comparable mid-cap companies in an industry sector that was the subject of potential mergers and acquisitions.
As a Medivation employee, Panuwat agreed to comply with Medivation’s insider trading policy, which provided:
During the course of your employment you may receive important information that is not yet publicly disseminated about the Company. Because of your access to this information, you may be in a position to profit financially by buying or selling or in some other way dealing in the Company’s securities or the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors of the Company. For anyone to use such information to gain personal benefit is illegal.
Panuwat’s role at Medivation included following the stock prices of peer companies, such as Incyte. Minutes after receiving an internal email stating that Medivation would be acquired, Panuwat bought short-term out-of-the-money Incyte stock options. Panuwat did not notify anyone at Medivation of his options purchases, and he had not previously traded in the securities of Incyte. Shortly after the Medivation acquisition, the stock price of Incyte increased, and Panuwat made more than $100,000 in profits from the Incyte options.
The SEC sued Panuwat for insider trading in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Panuwat moved to dismiss, primarily on the grounds that (1) the information he possessed was not material and (2) he did not breach his duty to Medivation. The court denied his motion in an opinion dated January 14, 2022.
Materiality: Panuwat argued that the confidential information he obtained about the Medivation acquisition could not be material because it was not information about Incyte. Incyte, he argued, had no involvement in the acquisition, and Panuwat did not have any confidential information about Incyte’s business operations.
The court rejected Panuwat’s argument based upon its reading of the plain language of Section 10(b) of the Securities Exchange Act and Rule 10b-5. Under the law, information is material “if there is a substantial likelihood that its disclosure would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” The court rejected the defense’s contention that confidential information about an acquisition is material only to the parties of the acquisition. The court reasoned that the SEC’s complaint sufficiently alleged materiality and scienter in view of its allegations that Panuwat was aware that (1) Medivation and Incyte were closely comparable companies in a small industry sector (and he had discussed with bankers working on the acquisition that the two companies were comparable); (2) several companies had shown interest in acquiring Medivation; and (3) when Medivation was acquired, Incyte would become more attractive as one of the few remaining acquisition targets in the industry.
Breach of duty: Panuwat did not dispute that he owed a duty of trust and confidence to Medivation, his employer. Panuwat nevertheless argued that the SEC’s complaint failed to allege that he breached that duty when he traded in the securities of a company other than Medivation. The court disagreed. It concluded that Medivation’s insider trading policy, which prohibited Medivation employees from using the company’s confidential information to trade in the securities of “another publicly traded company,” was broad enough to prohibit trading in the securities of any public company based upon Medivation’s confidential information.