The typical example of insider trading looks something like this: An employee finds out her company is about to be acquired and buys its stock before the deal is announced. But what if the employee buys a rival company’s stock on the theory it, too, will rise?
That’s the question at stake in a trial that kicks off March 25 in San Francisco, where the US Securities and Exchange Commission is accusing a former biopharmaceutical executive of illegally trading a competitor’s stock.
Securities traders and lawyers are closely watching the case, the SEC’s first attempt to pursue so-called shadow trading. It also underscores how Congress has never explicitly defined insider trading, leaving courts to decide when the SEC oversteps its authority.
A win for the former biotech executive, Matthew Panuwat, would raise questions about the agency’s ability to police shadow trading, a widespread phenomenon that researchers say has gone largely unchecked.
“It would leave the market in an uncertain environment as to whether the SEC would try to take another run at proving out its theory,” said Peter Altman, an Akin Gump Strauss Hauer & Feld LLP partner and former SEC enforcement attorney.
‘Shadow Trading’
Panuwat worked as a senior director of business development at San Francisco-based Medivation Inc., a mid-cap biotech company focused on cancer drugs.
Minutes after receiving an August 2016 email from Medivation’s CEO that said Pfizer Inc. had an “overwhelming interest” in acquiring it, Panuwat bought hundreds of call options in rival Incyte Corp., netting over $107,000 from the trades, the SEC says.
Pfizer announced the $14 billion Medivation deal days later. By taking one mid-cap biopharma company off the market, the deal made Incyte a more valuable acquisition target, the SEC says in its 2021 suit, bumping up its share price.
What makes the SEC’s case unique, attorneys say, is there was no business relationship between Incyte and Medivation. The SEC has focused on an alleged market connection between Medivation and Incyte, arguing the market considered the companies’ stock performance to be linked.
Panuwat in court filings argued no one thought what he did was illegal until the SEC charged him.
Karen Woody, a law professor at Washington & Lee University, said the SEC’s arguments aren’t “illogical” based on previous cases the agency has brought. But there are some concerns about a slippery slope.
Under the SEC’s theory, “we could get into really what analysts are doing all the time,” looking at specific industries and trends, said Woody, who focuses on securities law and white collar crime.
Breach of Duty
Researchers in a 2021 paper in an academic journal found shadow trading was a “widespread mechanism that insiders use to avoid regulatory scrutiny.” Profit from a single shadow trading event typically ranges from $139,400 to $678,000, significantly more than average profits made by defendants hit with traditional insider trading charges, according to the study.
The “legality of shadow trading appears to be relatively untested,” the researchers said.
The study attributed the scarcity of cases so far — whether civil charges from the SEC or criminal ones brought by the Justice Department — to the “lack of a clear breach of fiduciary responsibility by insiders who use private information to facilitate trading in other firms.”
The SEC argues Panuwat had a duty to avoid trading on Pfizer’s planned acquisition because Medivation’s employee policy broadly prohibited using such inside information to buy or sell Medivation stock or the “securities of another publicly-traded company.”
That duty also arose, the SEC alleges, because Medivation entrusted Panuwat with confidential information. That could end up being the “major takeaway” from the case, Woody said, potentially making shadow trading illegal even when it isn’t addressed by an employer’s policy.
Judge William Orrick in the US District Court for the Northern District of California earlier this month rejected Panuwat’s request to bar the SEC from using the term “insider trading” at trial.
Orrick also prohibited the defense from characterizing the SEC’s case as “highly unusual” or “novel.” The “prejudicial risk of such rhetoric outweighs its probative value,” the judge said.
Should the SEC win its case, there will be questions about what trades are off-limits for company insiders because of a market connection. Panuwat disputes that Medivation and Inctye were sufficiently connected, arguing the companies are fundamentally different.
“There’s at least going to be some interesting parameters around what other companies you should refrain from trading in,” Woody said.
The case is SEC v. Panuwat, N.D. Cal., No. 21-cv-06322.
