There has been lots of breathless commentary in the financial press and the blogosphere over the SEC's August 2021 filing of an insider-trading case involving so-called "shadow trading." Shadow trading as defined in a 2020 academic paper occurs when someone possessing material, nonpublic information ("MNPI") obtained from his or her employer uses it to trade in the securities of a competitor or economically-linked public company.1 This is in contrast to the more usual insider trading, in which the stock being traded is that of the subject company. In Panuwat, the defendant is charged with misappropriating MNPI from his employer and using it to trade in a competitor's securities.2 Earlier this week, a district court in the Northern District of California denied a motion to dismiss the SEC's complaint, allowing the enforcement action to proceed.3
According to the complaint, the defendant, Matthew Panuwat, learned of an impending merger involving the company he worked for, a mid-sized, oncology-focused biopharmaceutical company. Within minutes, he bought short-term, out-of-the-money stock options in another mid-sized oncology-focused biopharmaceutical that investment bankers had identified as a competitor. The defendant allegedly deduced that the announcement of the buy-out of his employer would lead to a rise in the price not only of his employer's stock, but that of its competitor.
Commentators have universally labeled this case the first shadow trading enforcement action following the 2020 academic paper. But is it truly unprecedented? Not exactly. In fact, a prior case that involved MNPI misappropriated from an employer and used to trade other companies' securities went to a jury trial and resulted in liability for the trader.
In 2015, the SEC charged Bonan Huang, an ex-Capital One data analyst, with insider trading in the securities of various retailers.4 The analyst, who investigated fraud for the credit-card company, used credit-card sales information obtained in his job to project and predict overall sales numbers for the companies. He then transacted securities in those other companies to reap enormous insider-trading profits. The case went to trial, and the SEC prevailed. Huang was found liable for insider trading and ordered to pay $13.5 million in disgorgement and civil penalties. Based on this prior case, it not particularly helpful to label Panuwat as advancing a groundbreaking, first-of-its-kind theory.
To be sure, the two cases are not identical. In the earlier case, the defendant Huang did not trade in the stock of competitors or economically linked companies. That is factually true, but legally insignificant. Panuwat allegedly traded another company's stock based on his company's impending merger, while Huang used his company's information about other companies to project those companies' earnings and obtain illicit insider-trading proceeds.
What difference does this factual distinction make from a legal standpoint? None. In both cases, the defendant faced charges that he misappropriated MNPI from his employer and used it to trade in other companies' securities. The teaching of both cases is clear: don't misappropriate MNPI from your employer and use it to trade in any securities – those of your employer, a competitor, or some other company.
1. Mihir N. Mehta, et al., Shadow Trading, The Accounting Review, Sept. 6, 2020, available at https://ssrn.com/abstract=3689154.
2. See SEC Litigation Release, SEC Charges Biopharmaceutical Company Employee with Insider Trading (Aug. 17, 2021), available at https://www.sec.gov/litigation/litreleases/2021/lr25170.htm
3. See Jody Godoy, SEC's 'Shadow Trading' Case Can Move Forward, Judge Rules, Reuters, Jan. 18, 2022, available at https://www.reuters.com/legal/government/secs-shadow-trading-case-can-move-forward-judge-rules-2022-01-18/.
4. See SEC Litigation Release, SEC Obtains Final Judgment Against Former Capital One Employee for Insider Trading (Feb. 26, 2016), available at https://www.sec.gov/litigation/litreleases/2016/lr23476.htm.
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