Since the introduction of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder barring any "device, scheme, or artifice to defraud . . . in connection with the purchase or sale of any security," 17 C.F.R. §240.10b-5, judge-made law and regulator enforcement have operated in tandem to push forward and continually reshape the legal landscape for the investigation and prosecution of insider trading and the misuse of material, non-public information (MNPI).
As the Securities and Exchange Commission (SEC) comes under the authority of a new presidential administration with its own enforcement priorities, it is useful to revisit the most recent innovations in insider trading and MNPI enforcement, and ask whether the SEC under this administration will continue to pursue expansive enforcement theories on this front, or pull back from what some consider novel and perhaps ill-conceived extensions.
Recent statements by SEC personnel affirm that insider trading remains an SEC enforcement priority. Acting Chairman Mark T. Uyeda recently told the Florida State Bar Association's Federal Securities Institute and M&A Conference: "The Commission's enforcement work has not stopped. The agency continues to bring charges for insider trading." This theme was echoed in recent remarks by Antonia M. Apps, SEC Regional Director of the New York Office and Acting Deputy Director of Enforcement, during the American Bar Association White Collar Crime Institute.
Notwithstanding the messaging, however, how aggressively these cases are charged remains to be seen, and the SEC's recent groundbreaking enforcement wins on theories of so-called "shadow trading," and targeting companies for failing to maintain sufficiently specific policies and procedures concerning MNPI, may come to represent a high-water mark in these enforcement areas, at least in the near term.
MNPI and the "Misappropriation Theory" of Insider Trading
The two branches of insider trading liability are familiar to most practitioners. First, the "classical" concept of insider trading, which hinges on wrongdoing by the "insider" and their tippees.
When "a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information," such trading "qualifies as a 'deceptive device' under §10(b) . . . because a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." United States v. O'Hagan, 521 U.S. 642, 651-52 (1997) (internal quotations omitted).
This definition of insider trading quickly presented a conundrum, however, for individuals outside the corporation, who had no direct relationship of trust and confidence with the corporation's shareholders, but who nonetheless had access to and traded on the corporation's MNPI.
The fact patterns in this second scenario abounded, resulting in a new enforcement weapon: the broader "misappropriation" theory of insider trading, whereby "a person commits fraud 'in connection with' a securities transaction . . . when he misappropriates confidential information"—MNPI—"for securities trading purposes, in breach of a duty owed to the source of the information," rather than a duty to the shareholders of the issuer.
Presenting an archetypal example, James O'Hagan was a partner in the law firm retained to represent a company poised to make a tender offer for the stock of the Pillsbury Company, who used that advance knowledge to purchase Pillsbury securities and reap the rewards when the stock surged following the tender offer announcement.
The law firm had a duty of confidentiality by virtue of its attorney-client relationship with Pillsbury, and O'Hagan breached that duty, and his own duty to the firm, by "misappropriating" Pillsbury's MNPI. Various "outsiders" have been successfully pursued under the misappropriation theory. See, e.g., United States v. Gupta, 747 F.3d 111 (2d Cir. 2014) (Goldman Sachs board member convicted of insider trading for tipping confidential information concerning Goldman's performance, permitting tippee to buy or sell Goldman shares accordingly); Securities & Exchange Commission v. London, et al., No. 13-CV-2558-RGK (C.D. Cal. 2013) (KPMG lead audit partner charged with insider trading for trading in KPMG audit clients' securities using pre-release earnings information); United States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990) (psychiatrist charged with insider trading in BankAmerica Corp. securities based on information he learned from treatment of Sanford Weill's wife during Weill's efforts to be named Bank America's CEO).
These examples demonstrate the core features of misappropriation cases: (i) violation of the defendant's duty in a clearly defined confidential relationship—e.g., attorney-client, principal-agent, doctor-patient—and (ii) a direct connection between the source of the confidential information and the securities traded by the defendants.
The SEC's more recent insider trading and MNPI enforcement actions, however, are notable for casting an even wider net, based on more tenuous links between the defendant's duty, the MNPI and the securities at issue, and pushing a more expansive view of the information subject to misappropriation.
SEC v. Panuwat and "Shadow Trading"
A jury decision after a one-week trial, confirmed by the Hon. William H. Orrick in September 2024—Securities & Exchange Commission v. Panuwat, 2024 WL 4602708 (N.D. Cal. Sept. 9, 2024)—delivered the SEC's first victory on a brand new variation on the misappropriation theory, a novel approach called "shadow trading."
The defendant, Matthew Panuwat, was employed by a company called Medivation, a mid-cap biopharmaceutical company where his role involved investigating potential acquisition opportunities for Medivation, including access to Medivation MNPI relating to deal offers the company entertained, and monitoring investment news concerning the company and other biopharma companies.
Throughout Medivation's exploration of a potential deal, industry analysts speculated concerning the company's relative position within the biopharma space and hypothesized about the potential impact of any M&A deal on other, comparable market players, including a company called Incyte Corporation (Incyte).
Medivation sought a suitable buyer for several months, but within minutes of learning that Pfizer planned to acquire Medivation, Panuwat began acquiring Incyte call options—having no MNPI concerning Incyte, but apparently hoping that the impending, as yet unknown, news concerning Medivation's acquisition would boost Incyte's share price. When that bump materialized, Panuwat sold, realizing gains of approximately $120,000.
Attacking his conviction after trial, Panuwat argued that he did not have any Incyte MNPI, and he did not misappropriate anything from Medivation because its policies concerning MNPI did not prohibit trading in a company such as Incyte with whom Medivation "had no business relationship."
The court rejected this argument, finding Panuwat did improperly use Medivation MNPI, specifically the timing of its acquisition by Pfizer, in order to more precisely effect his trading in Incyte.
As explained by the court, Panuwat's breach of his duty of confidentiality to his employer was sufficient on a misappropriation theory, even without evidence that "he knew that the trades were prohibited by Medivation," and to prevail the SEC need not prove "the employee, at the time he traded, understood the 'scope' of the policy to encompass the at-issue trade."
It was sufficient to show "that he intended to defraud Medivation . . . by knowingly or recklessly using, without the company's consent, its confidential and material information for . . . trading" the securities of another issuer. A new "shadow trading" variation on the misappropriation theory was born.
Enforcement Focus on MNPI Policies
Although the Panuwat court emphasized the breach of a general duty, and eschewed reliance on particular MNPI policy language, to establish misappropriation, two other recently settled enforcement actions against registered investment advisers focused specifically on the lack of details in the advisers' MNPI policies, which were deemed insufficiently tailored to guard against MNPI misuse given the nature of the advisers' specific businesses.
These cases suggest that notwithstanding its ability to charge and win insider trading cases even without clearly-defined policy prohibitions, the SEC also expanded its MNPI enforcement regime by drilling down on MNPI policies.
In re Marathon Asset Management, L.P., Inv. Advisers Act Rel. No. 6737 (Sept. 30, 2024), was an enforcement action settled just a few weeks after Panuwat was decided. Marathon was a substantial investor in distressed corporate bonds and other similar debt, and often participated in ad hoc creditor committees formed to explore debt restructuring for the issuer.
For one issuer, Marathon engaged a consultant as a go-between during negotiations with the issuer, and the consultant signed a non-disclosure agreement (NDA) with the issuer allowing him to receive issuer MNPI.
While in regular communication with the consultant, however, Marathon did not sign an NDA, or restrict its trading in the issuer's securities, until the following month. At all times prior to Marathon's execution of the NDA, the consultant provided Marathon with information stating that it was prepared "on the basis of information publicly available, disclosed by the relevant company(ies) or by third parties," and Marathon received the issuer's MNPI only after Marathon signed the NDA.
Despite the apparently effective constraints imposed by the NDAs—there was no allegation that MNPI was improperly received or used—the SEC still determined that Marathon's MNPI policy was insufficient.
Although it provided general guidance for evaluating and handling potential MNPI, and noted that an employee "serving on a creditors' committee of a restructuring" should consider including the company on a watch list or restricted list, the policy was "not reasonably designed to address the risks specifically related to . . . participation in ad hoc creditors' committees."
In particular, the policy lacked a procedure to review consultants' handling of MNPI, and did not have any requirement that consultants provide representations concerning their own MNPI policies.
In light of these alleged deficiencies, Marathon settled the SEC's claims, under Investment Advisers Act Sections 204A and 206(4) (15 U.S.C. §§80b-4a, 80b-6(4)), and Rule 206(4)-7 thereunder (17 C.F.R. §275.206(4)-7), that it failed "to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of [its] business, to prevent the misuse of [MNPI]," agreeing to a civil monetary penalty of $1.5 million.
The SEC also charged a violation arising out of an insufficiently detailed MNPI policy in another settled enforcement matter—In the Matter of OEP Capital Advisors, L.P., Inv. Advisers Act Rel. No. 6514 (Dec. 26, 2023)—imposing a $4 million penalty.
The target in that case, OEP, invested in "middle market" mergers, including public companies, and maintained an MNPI policy broadly requiring that "[i]nside information . . . with respect to any Fund, [or] any potential or actual portfolio company of any fund or any other company ... must be kept strictly confidential," and should not be disclosed "except as may be necessary for legitimate business purposes," e.g., during the course of the merger transactions coordinated by OEP.
Like Marathon, OEP used NDAs—both with parties to potential transactions, and with its clients and investors—to maintain confidentiality, including for "merger-related MNPI [disclosed] to current investors, potential investors, and industry contacts" while soliciting investment.
As in Marathon, the SEC deemed OEP's MNPI policy deficient, in particular citing the lack of any procedure to determine whether a disclosure was in fact "necessary for legitimate business purposes."
In Marathon and OEP the SEC pressed a new theme in MNPI enforcement and put market participants on notice that it understood the broad wording of Rule 206(4)-7—requiring advisers "to establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of its business, to prevent the misuse of [MNPI]" (emphasis added)—as necessitating detailed, specifically-tailored MNPI policies.
Conclusion
Taken together, Panuwat, Marathon, and OEP show the SEC employing innovative, multi-faceted approaches under the misappropriation theory—recognizing that MNPI obligations emanate from a general duty of confidentiality, and not from any particular policy language, while simultaneously demanding policies tailored to the unique nature of each business.
These cases marked novel expansions in the SEC's enforcement priorities and tactics. The dominant question for the near future will be whether the SEC will continue to push boundaries, and force market participants to respond accordingly, or beat a retreat from some of its more creative, and successful, recent enforcement efforts.
Originally published by New York Law Journal
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
