Shadow Insider Trading: the Case SEC v. Panuwat

In the last decade, insider trading has undergone increased scrutiny as regulatory bodies seek to maintain the fairness and integrity of the financial markets. Traditionally, insider trading is the practice of engaging in the acquisition or selling of stocks, based on non — publicly available information. However, the groundbreaking case SEC v. Panuwat, the SEC (Securities and Exchange Commission) pioneered a legal theory referred to as “shadow” insider trading.

On April 5, 2024, a federal jury in the Northern District of California found defendant Matthew Panuwat liable for insider trading in the SEC’s first-ever case involving the “shadow trading”, thus expanding the reach of insider trading laws, impacting relevant stakeholders. In practice, it refers to situations where an individual capitalises on non-public information of one company to trade securities in another company.

The case began when the SEC charged Matthew Panuwat, a former executive at Medivation, a biopharmaceutical company, with insider trading based on MNPI (material nonpublic information) he had about Medivation’s acquisition. Instead of trading Medivation’s stock, Panuwat bought call options for another company, Incyte, within 7 minutes after receiving an email by Medivation’s CEO, learning about the potential buyout. The SEC argued that although Incyte was not directly involved in the Medivation’s acquisition, the deal could increase its attractiveness as a target, thereby affecting its stock price, considering that both companies were in the oncology market. Therefore the market facts appeared to support the SEC’s theory: when the acquisition was announced Incyte’s stock rose 7,7%, and Panuwat earned over $100,000 from his call options.

In this case the so called misappropriation theory, used when someone trades on confidential information, breaching a duty of trust to the information’s source, was extended to include “shadow trading,”. This theory posits that an individual can be guilty of insider trading not only if they are insider of a company but also if they misappropriate MNPI from any source and trade security, based on that information. This indeed suggested that the duty of confidentiality applies even if the trading involves a different company within the same sector.

Moreover, the court found that Panuwat had the duty to avoid trading on MNPI. Three bases for this duty were taken in consideration: Medivation’s Insider Trading Policy, Confidentiality Agreement and Common-Law Duty of Trust and Confidence. The first policy prohibited employees from trading in other public companies’ securities based on MNPI obtained during their employment. Furthermore Panuwat had agreed to confidentiality terms that restricted the use of Medivation’s proprietary information. Finally, the court referenced principles from agency law, which dictate that employees must act in their employer’s interest and not use privileged information for personal gain.

The jury deliberated the verdict in favour of the SEC. As a consequence Panuwat moved for judgment as a matter of law or for a new trial, but the court denied the motions. The decision makes clear that the duty of trust or confidence underlying an insider-trading claim can arise not only when an express agreement exists but in particular when it is based on the trust given to employees when dealing with confidential information. Instead, Medivation was entitled, as his employer, to expect that Panuwat would only use the information it entrusted to him to benefit the company and would abstain from or disclose any trades he made based on that information.

The court’s post-trial decision once again validates the SEC’s reliance on a “shadow trading” theory where a trader breaches his or her duty by using MNPI about one company to trade another company’s securities. The Panuwat case, while based on specific facts, highlights the need for a broad interpretation of materiality in cases involving MNPI. The court’s rulings and jury’s verdict caution against a narrow view of what constitutes material information and when trading based on MNPI may breach a duty. First, Panuwat’s case suggests that prospective traders should adopt a broad scope of insider trading law, recognising that MNPI about one company may impact another company, even if they are not direct competitors or partners. Traders should consider the wider market context, including industry competitors, alternatives, and the overall number of companies in a specific sector. Second, companies may need to revise insider trading policies and confidentiality agreements to explicitly address the potential for “shadow trading.” Lastly, the case reiterates that fiduciary duties restrict employees from benefiting personally from their employer’s MNPI. This duty exists independently of any formal insider trading policies, stemming instead from general principles of trust and confidence.

The Panuwat case highlights the SEC’s reliance on litigation to adapt insider trading laws to complex modern markets. Critics argue that legislation, rather than court decisions, should clarify the boundaries of insider trading liability, specifically for shadow trading. Clear legislative standards would provide transparency and fairness for all market participants, balancing the need for market integrity with the fundamental role of price discovery.

The SEC v Panuwat case marks a pivotal moment in the evolution of insider trading law, with several implications. By holding Panuwat accountable for “shadow” trading the SEC is signaling its intent to close some gaps and legal loopholes and thus protect the participants in the financial markets. For companies, this includes re-evaluating their insider trading policies and educate their employees accordingly through policy revisions, employees education, monitoring system, consultations with experts and finally 10b5–1 trading plans.

Policy revisions provide that companies might consider narrowly tailored insider trading policies that define prohibited trades in a way that accounts for potential market impacts, rather than broad sector restrictions. Secondarily it is necessary a regular training on insider trading, emphasizing the implications of the misappropriation theory and shadow trading, can help prevent inadvertent violations. In addition, enhanced tracking of employee trades can help detect unusual trading patterns that may warrant closer review. Moreover, companies should be encouraged to seek advice from legal and financial experts to interpret insider trading policies in light of specific market contexts, particularly those related to economic correlation. Finally, amending 10b5–1 trading plans (a written agreement between a corporate insider and a broker that establishes predetermined trading instructions for company stock), as suggested by some experts, can protect employees from liability by providing a defence for pre-scheduled trades, although recent SEC reforms have made these plans less flexible.

Ultimately, Congress needs to set clear legislation on what is and what is not illegal insider trading. Up to this date, one can easily debate what is considered illegal insider trading or not, but through the intervention of Congress these discussions can be settled and provide for a more encompassing view regarding insider trading laws. Concluding, this case serves as a reminder of ethical and legal business practices associated with insider knowledge and how its outcome shapes the regulatory environment, meant to prevent future illegal practices.

CC: Alessandra Albescu, Giulia Consumi, Sophie Gasparotto