In a recent development, the Securities and Exchange Commission (SEC) brought its first successful enforcement action against shadow trading. They convinced a California jury that a former executive at Medivation Inc. used insider knowledge to purchase Incyte Corp. options within minutes of receiving the sensitive information. There’s growing speculation that this victory may capture the attention of federal prosecutors; these legal professionals have shown a willingness to utilize novel securities fraud theories that have been effective in previous SEC endeavors.
The Department of Justice (DOJ), in the past, has adopted the SEC’s approach. Notably, last year, the DOJ filed criminal charges against a healthcare company’s CEO for using a Rule 10b5-1 trading plan while supposedly possessing material nonpublic information. The DOJ did this after a settled SEC enforcement action had charged two technology company executives using a similar theory in 2022.
A significant development in the realm of shadow trading—discernible from traditional insider trading—this SEC win may well cause the DOJ to prosecute shadow trading. Should this eventuality come to pass, market players who regularly deal with material nonpublic information (MNPI) might need to update their compliance programs, employee policies, and training processes.
The SEC triumphed against Matthew Panuwat utilizing the misappropriation theory of liability. Under this theory, a trader “misappropriates” MNPI “in breach of a duty owed to the source of the information.” While Panuwat is likely to appeal, the SEC has still shown that its theory can gain traction with both the jury and judge.
One hurdle the DOJ could face in prosecuting shadow trading lies in the burden of proof and showing criminal intent. For example, criminal cases demand a higher burden of proof than civil cases like SEC v. Panuwat. Furthermore, a criminal insider trading case would require a demonstration of willfulness, meaning the trader knowingly conducted unlawful actions. This contrasts with SEC cases that often employ a “recklessness” standard, which necessitates proof the trader acted extremely unreasonably or heedlessly.
In light of the SEC ruling in the Panuwat case, corporations should prepare for potential new enforcement risks due to this new enforcement theory. Companies must empower their employees with an understanding of their obligations relating to the use of MNPI and trading in comparable company stocks.
This ruling also provides an opportunity for firms and professionals guided by private confidentiality or nondisclosure agreements to examine these agreements carefully. It emphasizes the importance of drafting such agreements to avoid undue restrictions on trading companies outside the parties to the agreement.
Read more on the case Securities and Exchange Commission v. Panuwat and original coverage provided by Bloomberg Law.