The SEC Wins ‘Shadow Insider Trading’ Trial

On Friday, April 5, 2024, a San Francisco jury found the defendant liable in SEC v. Panuwat, the closely watched litigated enforcement action brought by the U.S. Securities and Exchange Commission (SEC) relating to so-called “shadow trading.” The jury reached its verdict following an eight-day trial and with less than three hours of deliberation. We reported previously on the filing of the lawsuit (here), the ruling on the motion to dismiss (here) and the ruling on the motion for summary judgment (here).

As we explained in those prior alerts, shadow trading involves an investor possessing material non-public information (MNPI) about “Company A” but trading in the securities of “Company B,” another company with which Company A shares some form of market connection. In this case, defendant Matthew Panuwat, in the course of his employment at a company called Medivation, was alleged by the SEC to have (a) learned that his company would be acquired, (b) seven minutes later, bought out-of-the-money, short-term call options in (c) another company, Incyte, which was closely comparable to Medivation.

Observations About the Trial

The court’s ruling that this was not a “novel” case. In the run-up to the trial, and following the verdict in the SEC’s favor, SEC leadership made numerous public statements about this case, with the common theme that despite the Company A/Company B dynamic described above, the case involved straightforward “misappropriation” of MNPI in breach of a duty. Per the SEC, there was nothing “novel” about the case.¹ The federal district judge overseeing the trial agreed with the SEC on this point, ruling on a motion in limine that the defense could not argue that the SEC’s case was “highly unusual,” “unique,” “novel,” “unanticipated,” “unexpected” or “brought without fair notice.”

Jury instructions dispute as a potential issue for appeal. Prior to the beginning of trial, Panuwat raised several objections to the court’s proposed jury instructions, going so far as to seek leave to file an interlocutory appeal. The jury instructions dispute focused primarily on the question of whether the SEC was required to prove that Panuwat breached a duty to his employer Medivation by trading Incyte stock based on confidential information about Medivation. Panuwat argued that the SEC must prove that Panuwat knowingly breached a fiduciary duty owed to Medivation; on the other hand, the SEC’s preferred instruction—adopted by the court—was that it needed prove only that Medivation “entrusted” Panuwat with the confidential information and that Panuwat did not gain Medivation’s consent to use the information to trade Incyte stock on the basis of the confidential information. This issue was especially important given the dispute at trial as to whether Medivation and Incyte were competitors, such that Medivation’s insider trading policy applied to trading in peer companies like Incyte.

Panuwat also took issue with the court’s formulation of the definition of “nonpublic,” criticizing the requirement that the information must have been “effectively disseminated in a manner sufficient to ensure its availability to the investing public.” According to Panuwat, information loses its status as non-public as soon as it is released publicly, even if the information is not widely known by the investing public. Finally, Panuwat faulted the court for failing to give a “good faith defense” instruction, which would have provided that Panuwat cannot have acted with an intent to defraud if he acted in good faith.

Three days before trial, the court denied Panuwat’s request for leave to file an interlocutory appeal on these jury instruction issues. It is likely that these jury instructions will be the focus of a post-judgment appeal taken by Panuwat.

Trial testimony and verdict. Panuwat took the stand during the defense’s case. His testimony focused largely on the question of why he purchased the Incyte securities. On direct examination, Panuwat testified that his purchase was unrelated to the news he received about the impending acquisition of Medivation, and was instead based on an analyst report he had read the month prior. The SEC cross-examined him on this point, making the rhetorical point that Panuwat was arguing the fact that he acquired the Incyte securities a mere seven minutes after learning of the acquisition was simply a “coincidence.”

Other key witnesses at trial included Panuwat’s former co-worker, who testified that Medivation and Incyte were not competitors and that he would not expect their prices to rise or fall together, attempting to undercut the notion that the two companies shared a “market connection” that would make the Medivation acquisition material as to Incyte’s securities. In response, the SEC offered expert testimony that the Medivation acquisition would be expected to have a “spillover” effect on Incyte’s stock.

While it is difficult to discern exactly what informed the jury’s decision, the relatively short deliberation after an eight-day trial suggests that the jury was not convinced by the “coincidence” story and was moved by the strong circumstantial evidence of intent shown by Panuwat’s purchase of the Incyte securities only seven minutes after he received the news. It could also signal that the jury was not persuaded by the purported differences between Medivation and Incyte, and viewed it as apparent that information material to one firm could be expected to move the other’s stock price.

Takeaways

As has been its practice throughout this litigation, the SEC made clear in its post-verdict statement its view that there was nothing “novel” about this case. Indeed, despite the use of the term “shadow insider trading” by commentators observing the Panuwat litigation, the SEC avoided using that phrase or suggesting that this case is anything other than a traditional misappropriation theory insider trading case.

Whether the SEC calls it novel or not, market participants now have a new legal theory to grapple with which expands otherwise well-settled concepts of duty and materiality. The verdict will likely embolden the SEC to bring actions that continue to push the envelope.

In our prior client alerts, we identified several steps for private fund managers to examine in response to the Panuwat case. Given the SEC’s victory at trial, we would recommend the careful review and consideration of these steps.

^{1 See, e.g., https://www.sec.gov/news/statement/grewal-statement-040524.}