SEC’s Efforts to Stretch 10b-5 Insider Trading Liability Survives Motion to Dismiss

The SEC is attempting to broaden the scope of liability under federal insider trading laws, and it just secured its first incremental victory along the way.

The win comes as a newly formulated legal theory offered by the SEC survived a motion to dismiss in SEC v. Panuwat, a case proceeding in the U.S. District Court for the Northern District of California.[1] The SEC’s legal theory states that the practice of “shadow trading” constitutes a violation of federal securities law, namely Section 10(b) of the Exchange Act and Rule 10b-5.[1]

“Shadow trading” occurs when a person with a connection to one publicly held company uses material, nonpublic information (MNPI) they have gained from their connection with that company to inform their trading decisions in a separate publicly held company. Typically, this separate company is economically connected in some way to the company for which the person possesses MNPI. [2]

In SEC v. Panuwat, the SEC alleged that the defendant, Panuwat, engaged in an instance of shadow trading which constituted illegal insider trading under 10b-5. At the time of the alleged shadow trading, Panuwat was Senior Director of Business Development at Medivation, Inc., where he reported directly to the company’s Chief Financial Officer. Medivation Inc. was a “publicly-traded, mid-cap, oncology-focused” corporation in the biopharmaceutical industry. [3]

On August 18^th, 2016, Panuwat received a confidential email from Medivation’s CEO stating that plans were being finalized for Meidvation’s acquisition by Pfizer, Inc. [3] Within minutes of receiving this confidential news, and on his work computer, Panuwat purchased shares in Incyte, one of Meidvation’s peers in the biopharmaceutical sector. [3]

When news of Pfizer’s acquisition of Medivation was released to the public just four days later, Incyte’s stock price rose appreciably, as did the stock prices of other industry peers.[3] As a result of Panuwat’s August 18^th trades, Panuwat generated gains in excess of $100,000.[3]

In SEC v. Panuwat, the SEC argues that Panuwat’s profits in this situation constitute “ill-gotten gains” in violation of federal insider trading laws because Panuwat based his purchase of Incyte shares on the material, nonpublic information he had received about Medivation’s impending acquisition by Pfizer. [3]

Panuwat moved to dismiss the SEC’s claims on the grounds that the SEC had not adequately pled that the information he received about the impending acquisition was material and nonpublic, that he breached his duty to Medivation; and that he acted with the requisite scienter. [1]

The court rejected each of these arguments and ultimately stated that the federal securities laws in question are indeed broad enough to permit MNPI from one company to be considered material in relation a separate company’s as well. This broad interpretation of Section 10(b) of the Exchange Act opens the door for the SEC’s argument that such “shadow trading” may indeed constitute actionable insider trading under federal law.

The court’s denial of Panuwat’s motion to dismiss, as well as their decision on the remainder of this case, will be of keen importance for public corporations and employees alike. Corporations may well begin considering revisions to the language of their internal insider trading guidelines to include explicit prohibitions on shadow trading.

Furthermore, individuals may need more carefully evaluate the basis on which they are making trades in the market, ensuring their trades are not motivated by material, nonpublic information that might also apply to a company besides the one they are directly connected to.

As SEC v. Panuwat unfolds, those interested in learning more about its implications may reach out to the attorneys at Savage Villoch with questions.

Sources: [1] https://www.troutman.com/insights/secs-new-insider-shadow-trading-theory-survives-its-first-test.html#_ftn1 [2] https://www.troutman.com/insights/securities-and-exchange-commission-tests-new-insider-trading-theory.html [3] https://www.sec.gov/litigation/complaints/2021/comp-pr2021-155.pdf