January 26, 2022

Insider Trading: SEC Prevails on Novel “Shadow Trading” Theory

The SEC recently scored a big win on the insider trading front, when a California federal court endorsed its novel “shadow trading” theory as the basis for a Rule 10b-5 enforcement proceeding. Here’s the intro to Cleary’s memo on the decision:

On January 14, 2022, the United States District Court for the Northern District of California issued a decision in SEC v. Matthew Panuwat validating the legal theory advanced by the Commission that trading in the securities of a competitor company could form the basis of an insider trading violation where the defendant learned that an acquisition of his employer was imminent.

In denying the defendant’s motion to dismiss the complaint, the court ruled that the SEC had sufficiently pled a claim, marking the first judicial decision concerning alleged insider trading in securities of a company based on material, nonpublic information (“MNPI”) about another company, a practice that has sometimes been referred to as “shadow trading.”

The court’s refusal to dismiss the SEC’s novel legal theory that trading on the basis of MNPI of one company to profit on a securities transaction involving a competitor constitutes actionable insider trading should be considered by companies and individuals as they assess trading decisions and policies.

The defendant allegedly traded stock of a direct and close competitor in a small market, and the memo points out that the straightforward facts of the case provided the SEC with an optimal setting for asserting its novel theory. This except says that the SEC might find other cases provide tougher sledding:

Other shadow trading fact patterns will likely have to grapple with more complicated determinations, including how material information about one company is for the value of securities of other companies in larger markets or less direct competitors (e.g., an insider at a company trading in the securities of a supplier or customer of the company).

John Jenkins