Dust Off Your Insider Trading Policy in Light of Shadow Trading Enforcement

On April 5, 2024, the widely discussed and controversial “shadow trading” trial concluded with a Securities and Exchange Commission (“SEC”) victory and a jury verdict that found Mathew Panuwat (“Panuwat”) liable for insider trading. The verdict brings “shadow trading” into the light, providing a backdrop for insider trading enforcement actions beyond the two precedent theories: “classical” or “misappropriation.”

To recap the case, Panuwat, a former executive at Medivation, Inc. (“Medivation”), was found liable for insider trading when he purchased out-of-the-money, short-term stock options in a competitor after learning material, nonpublic information regarding Pfizer, Inc’s planned acquisition of Medivation. When the acquisition was publicly announced, the value of Panuwat’s stock options nearly doubled and he realized a profit of approximately $107,066. The SEC argued that Panuwat (1) engaged in shadow trading when he used confidential, nonpublic information about Medivation’s pending acquisition to trade in the securities of the competitor and (2) that he violated Medivation’s insider trading policy, which prohibited him from personally profiting using material, nonpublic information about Medivation by trading in Medivation securities or the securities of another publicly traded company.

Moving forward, the verdict in this case strongly suggests that the SEC (and courts) view shadow trading within the scope of insider trading. Because of this development, and because most companies will be required to publicly file their insider trading policy (“Policy”) with their next Annual Report on Form 10-K, companies should evaluate whether their current Policy guards against potential shadow trading liability.

Consider the following when dusting off your Policy:

  • Confirm that your Policy covers the right insiders.
    • Beyond directors and named executive officers, consider whether other individuals with access to confidential or material, nonpublic information due to their position or intimate association with your company should be subject to your Policy’s trading restriction.
  • Review your blackout periods and pre-clearance procedures.
    • Confirm they are consistent with your actual practice and are followed closely.
  • Ensure that your Policy specifically prohibits insiders from trading on the basis of material, nonpublic information of your company, and consider whether it is appropriate to include a prohibition on trading in the securities of any other company on the basis of material, nonpublic information.
    • Consider whether your insider trading restrictions should apply to economically-linked companies.
    • Economically-linked companies are generally considered to be competitors, those in a similar industry or market segment, and other companies where the material, nonpublic information of an insider would likely affect the stock price.
    • While restricting trading in economically-linked companies would protect employees who follow the Policy, it would likely increase potential liability for anyone who violates the Policy, like the result in Panuwat.
  • Assess compliance with your 10b5-1 plans including the applicable cooling off periods and the requirement that an individual not enter into a Rule 10b5-1 plan while in possession of material nonpublic information.

Insider Trading Theories

  • Classical theory is focused on punishing the “insider” who furnished material, nonpublic information to another individual who then uses it to illegally trade securities.
  • Misappropriation theory attributes liability to the “outsider” who benefits from using information provided by an “insider” who is entrusted with material, nonpublic information in a position of confidence, thereby violating the fiduciary duties owed to the information’s source.
  • Shadow trading, stemming from misappropriation theory, attributes insider liability to the improper trading of securities based off material, nonpublic information of a related or linked company.

As enforcement actions evolve following this shadow-trading decision, companies should regularly analyze the scope of their current insider trading policies, confidentiality agreements, and training processes.

If you have any questions about this SEC enforcement action or your insider trading policy, please contact a member of Harter Secrest & Emery’s Securities and Capital Markets group.

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