New SEC ‘Ghost Insider Trading’ Law Enforcement – Four Lessons for Private Money Managers | Akin Gump Strauss Hauer & Feld LLP

Key points

  • Last week, the United States Securities and Exchange Commission filed a lawsuit in federal court in California based on the new legal theory that insider trading laws apply when an insider uses confidential information. concerning the activities of one company to trade the securities of another issuer, which would correlate in one way or another, as a comparable company in the same relatively small industry.
  • The SEC faces obstacles in establishing the illegality of such behavior at trial, which some have dubbed “shadow trading”.
  • Private fund managers should follow this case, as it may have broader implications, particularly for advisers who are active investors in industries where the SEC may claim that issuers are closely related to each other from the point of view. commercial view.

The SEC has a long history of adopting new theories in litigation to convince courts to expand the reach of federal insider trading laws. The SEC’s latest effort comes in an August 17, 2021 complaint (SEC c. Panuwat1) filed against a biopharmaceutical executive for a practice colloquially known as the “shadow trade”. “Shadow trading” involves buying or selling the securities of one company while in possession of confidential information from another closely related or “economically linked” company. The Panuwat The complaint is the SEC’s first instance to litigate a phantom insider trading case.

SEC complaint alleges Matthew Panuwat, former head of business development at Medivation Inc., misappropriated confidential information he obtained during his employment at Medivation and that he was the target of an acquisition by Pfizer . Panuwat, however, did not buy any securities from Medivation – he bought short-term options in Incyte Corporation, a competitor “which he predicted would increase in value significantly when the announcement of the Medivation acquisition went public. “.

The SEC alleged that the defendant: (1) was aware that the stock prices of both companies had recently risen in response to the acquisition of a third comparable company in the same space, (2) had discussed that Medivation and Incyte were closely matched with bankers working on the deal, and (3) was aware that large pharmaceutical companies were interested in acquiring mid-cap oncology companies and, when the Medivation transaction went public, Incyte would be one of the few candidates available for future transactions in space. The SEC also pointed out that after the publication of the Medivation transaction, Incyte’s share price rose 8%.

These allegations provide a roadmap for how the SEC will seek to establish materiality, which will undoubtedly be a very controversial issue in litigation. In doing so, the SEC will likely seek to take advantage of the broad and sometimes murky Basic vs. Levinson definition that courts have adopted for materiality – that is, whether there is a substantial likelihood that a reasonable investor will consider the information to have significantly altered the “total mix” of information that would be material to a decision to trade the securities concerned. Ultimately, whether the two companies were sufficiently correlated for the SEC to establish materiality will require a careful analysis of the facts in this or any other “shadow insider trading” case. Although the SEC appears to have concluded that it has sufficient evidence to proceed here, where the agency will draw the line when assessing potential future enforcement actions – or whether a court or jury will agree with it. the position of the SEC in the Panuwat case – remains to be seen.

The SEC also appears to anticipate that the defendant will argue that his transactions in Incyte did not violate a duty of confidence to his employer, another essential element of insider trading under the theory of hijacking set out in the O’Hagan case line. In the complaint, the SEC alleged that Medivation’s internal policies should be interpreted as prohibiting Panuwat from personally profiting whatever sort of from material non-public information about Medivation. In taking this position, the SEC relied heavily on the language of Medivation’s insider trading policy which prohibited the defendant from profiting by trading “the securities of any other publicly traded company, including all securities. employees, customers, partners, suppliers or significant competitors of [Medivation]. According to the SEC, the defendant therefore breached a duty of confidence he owed to Medivation, even though the transaction did not involve the securities of Medivation. It also remains to be seen whether a court or jury will agree that the policy at issue. is sufficient to establish a legal obligation of confidence in these circumstances.

Finally, the SEC must show that Mr. Panuwat had the required “scientist” or intent to deceive, manipulate or defraud, which is necessary to establish an insider trading violation under Rule 10b-5. of the SEC. This will raise questions as to whether Mr. Panawut was given sufficient warning that he was in breach of an obligation or was at fault in trading Incyte options. Since the enforcement action against Panuwat is civil in nature, the SEC will likely argue that it does not need to prove actual intent and can establish scienter by evidence of reckless driving.


The Panuwat The case clearly shows that the SEC now sees so-called “shadow trading” as another potential arrow in its enforcement quiver. Unless the SEC loses this substantive litigation, whether by summary judgment or after a lawsuit, it could embolden itself to pursue similar actions in the future, especially in the area of ​​funds. private. The SEC Examinations Division may also be on the lookout for potential examples of “parallel trade” when examining investment advisers who actively trade in relatively small sectors or sub-sectors with a limited number of investors. actors who could be considered as “economically linked”. “

The term “shadow trading”, which is not explicitly used in the SEC complaint, appears to have been coined in an academic study claiming that the behaviors indicative of this type of trading are on the rise..2While it is too early to say how aggressively the SEC will pursue allegations of “parallel trading” in future business, there have been previous cases, such as in the case of backdated options, where similar academic studies sparked new waves of enforcement activity. .

Even before Panuwat, we have seen review staff ask whether an adviser’s policies and procedures address the perceived risk that an adviser may obtain material non-public information about public issuers from private holding companies or other channels.

For all these reasons, legal and compliance professionals of private fund managers should pay particular attention to Panuwat litigation. In the meantime, however, they should consider measures such as the following:

  • Improved, targeted and interactive training. Panuwat could potentially represent a significant expansion of insider trading liability, and any response to this threat requires the involvement of investment professionals. Legal and compliance professionals should consider interactive teach-ins with their analysts and portfolio managers to discuss this case and its implications, and to holistically identify any vectors of MNPI that might fit in. in a “shadow trading” fact model.
  • Risk assessment. By incorporating front office feedback, legal and compliance departments should assess the extent to which parallel trading poses practical risk to the company’s particular business model and investment strategy. Areas to focus on include situations where the company receives confidential information from any company (including formal nondisclosure agreements, as well as situations where company personnel are acting as administrator). This assessment should include exposure to information from or about private companies, as well as publicly traded companies.
  • Review of policies and procedures. Legal and Compliance should then determine whether revisions to the company’s insider trading policies, procedures or programs would be desirable based on the above review. They should examine how the SEC has used a general corporate policy in the Panuwat cases before adopting any amendments, while being aware of the advisor’s obligations under section 204A of the Investment Advisers Act.3Given the novel nature of this theory, compliance staff may consider supplementing traditional surveillance techniques with more interactive measures involving staff receiving confidential information.
  • Future non-disclosure language. Legal staff should consult with a lawyer on a language model for future non-disclosure or confidentiality agreements in light of a possible new “parallel trade” legal regime.

1 SEC c. Panuwat, n ° 4: 21-cv-06322 (ND Cal. August 17, 2021), available here; SEC accuses biopharmaceutical company employee of insider trading, SEC Press Release No. 2021-155 (August 17, 2021), available here.

2 See Mihir N. Mehta et al., Shadow trade, Compt. Rev. (Sep 6, 2020), available here.

3 Section 204A requires investment advisers to establish, maintain and apply written policies and procedures reasonably designed to prevent the misuse of material non-public information.

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