"Shadow trading" refers to the use of material, nonpublic information (MNPI) about one company to trade in the securities of a different, "economically linked" company, such as a competitor or business partner. Unlike traditional insider trading, which involves trading in the securities of the company to which the MNPI directly relates, shadow trading involves trading in the securities of a company other than the one to which the MNPI directly relates. This novel basis of insider trading liability arose in the landmark case SEC v. Panuwat, in which an executive used confidential information about the pending acquisition of his employer to purchase options in a peer company whose stock price he expected to increase following the announcement of the transaction.
Factual Background
From 2014 to 2017, Matthew Panuwat was an executive of Medivation Inc., a publicly traded biopharma company. Panuwat's responsibilities included tracking business activities and developments in the biopharma industry broadly and identifying acquisition opportunities for Medivation. As a result, he was actively involved in the process of evaluating acquisition interest and strategic alternatives. When an initial indication of interest turned hostile, Medivation went to the market in search of a white knight, ultimately resulting in an acquisition proposal from Pfizer Inc. Within seven minutes of receiving an email informing him of Pfizer's strong interest, Panuwat purchased out-of-the-money, short-term call options in Incyte Corp., a peer company of Medivation. Drawing on his broad knowledge of the pharmaceutical industry, Panuwat leveraged the MNPI to predict that Incyte's stock price would increase, because following Pfizer's acquisition of Medivation, Incyte would be one of the few remaining attractive acquisition targets in the space.
At trial, the SEC emphasized the substantial "market connection" between Medivation and Incyte, noting that Incyte was one of a "imited number" of competitors in Medivation's space. Accordingly, the SEC argued that the confidential information about Pfizer's proposed acquisition of Medivation was material to investors in Incyte because it made Incyte a more attractive acquisition target, and, thus, it significantly altered the total mix of available information about Incyte. In addition, the SEC pointed to Medivation's broad insider trading policy, which expressly prohibited employees from using MNPI to trade not only in the securities of Medivation, but also in "the securities of another publicly traded company, including all significant collaborators, customers, partners, suppliers, or competitors" of Medivation. Emphasizing this contractual obligation, the SEC argued that Panuwat knowingly misappropriated MNPI and breached his fiduciary duty to Medivation by using such MNPI to purchase Incyte securities.
Public Company Response
Public company reaction to the Panuwat decision was mixed. Some companies moved quickly to update their insider trading policies. For example, Microsoft amended its insider trading policy to expressly prohibit trading in the securities of an "economically linked" company while in the possession of MNPI obtained through Microsoft. Many companies hesitated to revise their policies, either adopting a wait-and-see approach to determine whether the SEC would continue to actively pursue shadow trading cases or to observe how their peers would respond. Others deliberately refrained from making changes because the Panuwat court emphasized that Panuwat had signed a confidentiality agreement and was subject to an insider trading policy expressly prohibiting the use of MNPI to trade in the securities of other companies. The court's reliance on Medivation's insider trading policy raised an important question: If an executive has no contractual obligation, does a fiduciary duty to refrain from shadow trading exist? For many companies, the risk of inadvertently creating such a duty (and potential liability) for directors and officers outweighed the perceived benefits of amending their insider trading policies.
Today, the degree to which insider trading policies of S&P 500 companies restrict trading in the securities of other companies varies. For instance, the majority of insider trading policies prohibit trading in another company's securities only when the covered person possesses MNPI about that company obtained through their employment or relationship with the company. A smaller number of insider trading policies apply this prohibition regardless of whether the MNPI was obtained through the covered person's employment or relationship with the company. Some insider trading policies limit the restriction to companies with which they have a direct business relationship or a contractual confidentiality obligation. Very few insider trading policies, however, have been amended to expressly prohibit shadow trading. There is no one-size-fits-all approach, and companies should carefully evaluate how (and the extent to which) potential shadow trading risks should be addressed in their insider trading policies.
SEC Shifts Enforcement Priorities
Following Panuwat, the SEC repeated its success in SEC v. Bechtolsheim, securing a settlement that included a substantial financial penalty and a five-year ban from serving as an officer or director of a public company. The case further cemented the SEC's commitment to advancing shadow trading as a viable theory of insider trading liability. However, despite the SEC's success in pursuing novel insider trading enforcement actions, Samuel Waldon, the SEC's then-interim (now acting) director of the Division of Enforcement, signaled a potential shift in the SEC's priorities, stating that "creativity is probably not where we want to be," suggesting that the SEC would refocus on more traditional theories of insider trading rather than pursuing novel cases based on shadow trading.
In light of Waldon's statements, companies are increasingly unlikely to amend their insider trading policies to expressly address shadow trading, as doing so could create legal exposure without clear regulatory pressure or sustained enforcement focus. Regardless of whether and the extent to which a company's insider trading policy addresses shadow trading or trading in the securities of other companies, all companies should take proactive steps to mitigate insider trading risk through clear employee communications, regular training and education, continuous monitoring, and limiting the dissemination of MNPI to only those employees with a demonstrated need to know.
If you have questions about your insider trading policy or would otherwise like more information, please contact the authors, and we would be happy to discuss with you.