SEC’s Shadow Trading Win Opens Door for Department of Justice

A first-of-its-kind enforcement action from the Securities and Exchange Commission may pique the interest of federal prosecutors, who have been willing to pursue novel securities fraud theories that were first tested successfully by the agency.

The SEC convinced a California jury last month that a former executive at biopharmaceutical company Medivation Inc. committed insider trading by buying options in a comparable company, Incyte Corp., within minutes of receiving material nonpublic information, or MNPI, about Medivation’s imminent acquisition.

The Department of Justice has followed in the SEC’s footsteps before. For example, the DOJ last year filed criminal charges against the CEO of a publicly traded health-care company based on his use of a Rule 10b5-1 trading plan while allegedly in possession of MNPI. There, the DOJ pursued its case on the heels of a settled SEC enforcement action in 2022 charging two technology company executives under a similar theory.

Still, the DOJ likely recognizes that pursuing a shadow trading case criminally would present its own distinct challenges, such as addressing burden of proof and showing criminal intent.

Observers have called this fact pattern “shadow trading.” While a logical extension of insider trading law, shadow trading differs from typical insider trading where one trades securities of the same company about which one has MNPI.

The SEC’s victory in this case may encourage similar enforcement cases and prompt the DOJ to prosecute shadow trading as well. For market participants whose personnel regularly encounter MNPI, this development may well warrant updates to compliance programs, employee training, and/or company policies.

The SEC prevailed against Matthew Panuwat using the misappropriation theory of liability, under which a trader “misappropriates” MNPI “in breach of a duty owed to the source of the information.” Although Panuwat likely will appeal, the agency has demonstrated that shadow trading can resonate with a jury, and it earlier convinced the judge that this theory is sound.

In any criminal case, the government must prove each element beyond a reasonable doubt. By contrast, civil cases such as Securities and Exchange Commission v. Panuwat require proof by a preponderance of the evidence.

Proving criminal intent is the most important challenge the DOJ would face in a shadow insider trading case. To bring an insider trading case criminally, the DOJ must prove that the trader acted willfully, meaning with “knowledge that his conduct was unlawful.”

By contrast, the SEC is permitted to rely on a “recklessness” standard—that the trader acted “highly unreasonabl[y]” in “an extreme departure from ordinary care, which is either known to the [trader] or is so obvious that [trader] must have been aware of it.”

While the SEC can satisfy this standard by showing the defendant should have known information about one company was material to another, the DOJ would need to prove beyond a reasonable doubt that information about one company was in fact material to another, that the defendant knew it was material to the company traded, and that the defendant intended to use inside information in a way that was prohibited.

Given the SEC’s victory in Panuwat, companies should ensure that their compliance and training programs appropriately address the new enforcement risk that this novel enforcement theory presents. Companies should caution employees through training programs about their obligation not to use MNPI they learn at work to trade in any comparable company’s stock. Traders should note the broadened range of nonpublic information that might be deemed material to their trading.

Finally, the scope of the duty at issue—which companies’ stock a party can’t trade—is often determined by a private confidentiality or nondisclosure agreement.

Asset managers and others who enter into such agreements should be mindful when drafting those agreements not to limit needlessly their trading in companies beyond the parties to the agreement. More broadly, companies should ensure that they are being deliberate as to what their own internal policies prohibit, so that the duty of employees not to trade doesn’t extend more broadly than what serves the company’s own interests.

The case is Securities and Exchange Commission v. Panuwat, N.D. Cal., No. 21-cv-06322, verdict 4/5/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Jeffrey A. Brown and Hartley M.K. West are co-chairs of Dechert’s enforcement and investigations practice group.

Jonathan Streeter is partner in Dechert’s enforcement and investigations practice group.

D. Brett Kohlhofer and Peter McGinley contributed to this article.

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