Most S&P 500 companies write rules to stop employees from using confidential information to trade other businesses’ stock, but some are now thinking about scaling back their bans to avoid exposing their executives to new legal troubles.
That’s perhaps one unintended consequence for the Securities and Exchange Commission following its win in the first-ever trial over “shadow trading,” some lawyers say.
A key part of the SEC’s case against a former biopharma executive, Matthew Panuwat, was that his company’s policies prohibited him from buying any public company’s stock based on his insider knowledge about his own employer’s pending deal.
The Wall Street regulator’s victory, likely to eventually reach a federal appeals court, is forcing companies to take a second look at their own insider trading policies. Some have expanded those policies to explicitly address shadow trading, according to a Bloomberg Law search. Others are considering narrowing their prohibitions, hoping to limit employees’ exposure.
“Companies across the board are taking the Panuwat verdict seriously,” said Edward Imperatore, a Morrison & Foerster LLP partner and former federal prosecutor.
The case also raises questions about how much influence companies’ policies have on insider trading law, which can result in civil and criminal penalties. Congress has never defined insider trading, leaving regulators and courts to sketch out its contours.
Trading Bans
Panuwat, who worked at mid-cap biotech company Medivation Inc., bought call options in rival Incyte Corp. in 2016, minutes after learning that Pfizer Inc. planned to acquire his employer, the SEC said. Panuwat thought the Pfizer deal would make Incyte a more valuable acquisition target, and made more than $107,000 from the trades, the agency said.
Arguing Panuwat had a duty to avoid trading on news of Pfizer’s planned acquisition, the SEC pointed to, among other things, Medivation’s own employee policy, which prohibited using inside information about Medivation to buy or sell stock of any publicly-traded company.
Such broadly written policies aren’t unique.
As of December 2023, more than 60% of S&P 500 companies prohibited trading of any other company’s stock based on material, nonpublic information, research by Geeyoung Min, a law professor at Michigan State, shows. Relatively few were limited just to banning trades in the employer’s stock.
Companies can be liable for insider trading by their employees, and may have viewed the broad language as a way to minimize potential liability, Min said. If regulators or prosecutors came knocking, companies could argue their policies went beyond what was required.
The Panuwat case “changed the whole dynamic,” Min said.
‘Unintended Consequence’
It’s not clear the SEC would’ve sued Panuwat had his trades not been prohibited by the company’s policy, some lawyers said. Now, some companies are considering narrowing their policies, wary of exposing their employees to similar liability.
“From the SEC’s perspective, that is perhaps an unintended consequence of the Panuwat case,” Imperatore said.
But other companies have already moved in the opposite direction, underscoring the difficult decisions firms face.
At least some insider trading policies now include the term “shadow trading” and reference the Panuwat case, a Bloomberg Law review of company disclosures found.
One small biotech company’s policy posted this year describes shadow trading as an “emerging” legal theory, and prohibits workers from trading in the securities of companies in the same “industry segment.”
A New York investment company’s policy spells out a pending acquisition scenario similar to Panuwat’s and makes clear employees can’t invest in a competitor viewed as “economically linked” whose stock would likely rise when the investment company’s deal is announced.
Lawyers who urge companies to explicitly restrict shadow trading in their policies note there may have been other reasons Panuwat found himself in hot water: the SEC also argued he had a duty to avoid trading on the merger news, even absent Medivation’s policy, because the company entrusted him with confidential information.
“The SEC and the Department of Justice always view these facts with the benefit of hindsight,” said Tami Stark, a White & Case LLP partner and former SEC enforcement attorney. “It’s often better to take a conservative position when making those judgment calls.”
Company Discretion
The SEC has maintained the Panuwat case is a straightforward example of insider trading.
Following the verdict last month, the agency’s director of enforcement, Gurbir Grewal, said “there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple.” Grewal at industry conferences has also pushed back on suggestions the SEC is broadening its approach to insider trading.
But many legal scholars and lawyers see it differently. Panuwat in court filings argued no one thought his actions were illegal until the SEC brought the civil lawsuit against him.
The case is also raising questions about how much courts should defer to companies’ own policies on insider trading. Before trial, the district judge permitted the SEC’s case to proceed in part because a jury could find Panuwat breached Medivation’s policy.
Under that logic, whether a person’s trade is illegal may depend on what’s in their employer’s insider trading policy, legal scholars said.
“That does seem to give companies too much discretion to make a special law for themselves and themselves only,” said Columbia law professor John Coffee, whose specialties include securities regulation and white collar crime. “The criminal law doesn’t like the idea of different scopes depending upon the decision of the corporate issuer.”
Panuwat is expected to appeal the decision to the US Court of Appeals for the Ninth Circuit.
It’s unclear how aggressively the SEC will pursue its shadow trading theory in the meantime, and whether criminal prosecutors will take it up. There are also questions about whether shareholders may try to employ it in private litigation.
While attorneys believe the SEC is emboldened by the Panuwat verdict, Coffee said the case might’ve gotten more attention than the agency anticipated.
“In that light, they may be very cautious in how often they use it,” he said.
