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Apr. 18, 2024

SEC trial victory in ‘shadow’ trading trial – what ‘shadow’?

A jury found former Medivation executive Matthew Panuwat liable for insider trading by trading in Incyte's stock, based on the theory that acquisition interest in Medivation spilled over to Incyte and boosted its stock price. The verdict shines a light on shadow trading and company compliance programs.

Barry O'Connell

Partner, Davis Wright Tremaine LLP

Barry O'Connell is a partner at Davis Wright Tremaine LLP, and spent more than a decade in high-level enforcement roles, prosecuting a variety of conduct as a senior counsel for the Securities and Exchange Commission's Enforcement Division, primarily as part of its Market Abuse Unit.


On April 5, following an eight-day trial, a jury deliberated for just over two hours before finding that the SEC established by a preponderance of evidence that former Medivation executive Matthew Panuwat is liable for insider trading by trading not in Medivation's stock but instead its alleged competitor Incyte's stock (minutes after learning from his CEO that Pfizer was close to acquiring Medivation).

This first ever so-called "shadow" insider trading case revolved around the theory that acquisition interest in Medivation spilled over to its arguable competitor, Incyte, and boosted its stock price by making Incyte a more appealing takeover target. Both companies focused on oncology drugs.

Following the jury's verdict, SEC Enforcement Director Gurbir Grewal issued a statement that there was "nothing novel" about the matter and that there was no "shadow" to speak of, but instead this was vanilla, business-as-usual insider trading. Putting aside that this sort of insider trading theory had never been brought before, and that there was no parallel criminal involvement in the matter, there still appears to be a "shadow" to consider and seek to define after this verdict--specifically, how linked do competitor companies need to be to satisfy the materiality element of insider trading charges?

Judge Orrick, after denying Panuwat's motions to dismiss or issue summary judgment in the case, instructed the jury that in order to find Panuwat liable the SEC needed to show by a preponderance of the evidence that Panuwat (1) owed a duty of trust, confidence, and confidentiality to his employer, Medivation; (2) that he possessed material nonpublic information that was material to Incyte; (3) that he bought stock in Incyte on the basis of that particular information and in breach of a duty to Medivation; and (4) that Panuwat knew or should have known that by trading in Incyte's stock he was violating his duty to Medivation.

The M&A team working on Medivation's possible acquisition termed this deal "Project: Masterpiece" and nicknamed the bidding companies to acquire Medivation after famous painters. But the real masterpiece is the confluence of facts in the SEC's favor that allowed it to bring its first case under this theory.

Panuwat bought out-of-the money short term call options seven minutes after receiving the email from his CEO that the Pfizer deal was imminent; it was the largest call option trade or single-issuer trade Panuwat ever made; he told no one at Medivation about it and then sold two days after the announcement of the deal. Internal documents produced by Medivation showed that investment bankers hired to assist the deal specifically identified Incyte as a similarly situated company to Medivation. And, Panuwat's duty with respect to trading Incyte's stock was expressly spelled out in the company's policies; Medivation's insider trading policies specifically articulated a duty to refrain from trading competitor's stocks.

But despite the masterpiece fact pattern for the SEC, there were still some relatively murky facts potentially undermining the materiality of the information in question. For starters, the email Panuwat received did not refer to a fully consummated deal--instead, it referred to Pfizer's "overwhelming interest" in finalizing such a deal. Obviously, anything can happen and deals fall apart all the time. After that hurdle, even if Director Grewal rejects the term "shadow"--it remained necessary for the SEC to prove that the information about Company A was material to Company B under these allegations (or, using the shadow analogy, Company A's silhouette was similar to Company B's). Or, put another way, Panuwat's Incyte trading had to fall within the shadow cast by Medivation.

Following announcement of the deal, Medivation's stock jumped 19.7%, whereas Incyte's stock jumped only 7.7%. Yes, they both marketed leading drugs approved for treating cancer, but they were different cancer drugs for different patients. Historical analyst reports about the two companies were mixed, some identifying the two as possible peers but some notably calling out that long-rumored acquisition interest in Medivation was not redounding to the benefit of Incyte's stock price. Some analysts thought of Incyte as a much smaller and inferior company. More, although Medivation (a larger, more diverse oncology-focused biopharmaceutical company) had significant reported acquisition interest in 2016, Incyte didn't receive a single bid that year.

The SEC stressed in pre-trial briefing and at trial that the limited number of mid-cap, oncology-focused biopharmaceutical companies with commercial-stage drugs in 2016 meant that acquisition interest in one such company would make others (like Incyte) more attractive acquisition targets, and therefore would drive up their price. The SEC's economic expert at trial called this the "spillover effect." But the substantive differences between the companies here, combined with the disparate price impact of the announcement, suggest that this equivalence might not have been a foregone conclusion. On everyone's mind is whether the DOJ will charge this conduct criminally in the future, and that question brings into focus whether the "shadow" or "link" between the relevant companies can meet the criminal standard--can a jury find beyond a reasonable doubt that a reasonable investor would view material information about Company A as also material to Company B? If it's not Coke versus Pepsi, how close should the company profiles be? Must the industry be insular and niche? There may be quite a bit of room for doubt when making the comparisons.

Was the jury focused squarely on this question? I imagine it could have alienated the jury from the outset of trial to characterize this trading, as the defense did, as a "coincidence," a "reverse-engineered" theory by the SEC, or even the agency "set[ing] [Panuwat] up" by myopically focusing on one email. The one email, received seven minutes before Panuwat's trades, was from the CEO conveying that the deal was about to go through. You have to respect the jury's intelligence and level with them--focus their attention where the real dispute is. Regardless, we expect to learn more about these types of cases in the near future. The Panuwat team immediately appealed their verdict to the Ninth Circuit seeking a standard for materiality in these cases. We will all be staying tuned and in the meantime contemplating how company compliance programs should signal this caution to its employees and outline policies to clearly acknowledge insider trading duties as extending to competitor companies.

To that end, I'll be joining my former SEC Enforcement colleagues from our specialized insider trading unit (the Market Abuse Unit) to consider this case further during an upcoming PLI briefing. Please join us then!

Link to event: In the "Shadow" of Panuwat: SEC Insider Trading Unit Alumni Discuss Compliance Considerations Following Successful Shadow Trading Enforcement Action.


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