SEC Rescinds Motion to Dismiss Lawsuit Alleging Insider Trading

The SEC won a motion to dismiss a closely watched lawsuit alleging that the defendant engaged in insider trading based on information about a not yet public company acquisition when he had purchased securities of a company not involved in this transaction. The decision of January 14, 2022 in SEC vs. Panuwat (ND Cal.) This is the first time a court has considered the theory of “parallel trading,” which involves trading in the securities of a public company that is not the direct subject of the material, nonpublic information ( “MNPI”) in question.

the panuwat decision does not appear to break new ground within the misappropriation theory of insider trading in light of the particular facts alleged. But the “parallel trade” theory deserves attention because, on other sets of claims, it can have wide ramifications for traders.

Factual background

The facts of the complaint, detailed here, implicated Matthew Panuwat, then a business development manager at a pharmaceutical company called Medivation. The SEC alleged that Panuwat learned that Medivation was about to be acquired by a major pharmaceutical company and that before the announcement of the acquisition, he had purchased call options on securities issued by the one of Medivation’s competitors, Incyte.

The SEC’s theory was that several potential acquirers had been interested in buying Medivation, that Incyte was one of a “limited number of mid-cap companies” in Medivation’s business area, that Incyte would become more attractive to potential buyers once the Medivation deal is complete. announced, and that Incyte’s share price would rise accordingly. The facts would have supported the SEC theory: When the Medivation deal was announced, Incyte’s stock price rose and Panuwat earned $107,066 on his call options.

The Court’s decision

Panuwat asked for the SEC’s complaint to be dismissed on two grounds. First, he argued that the SEC’s complaint failed to meet three elements of the misappropriation theory of insider trading: materiality, breach of duty, and science. Second, he claimed that the SEC’s allegations violated his due process rights because the parallel trade theory improperly extended insider trading law beyond its generally understood parameters and did not therefore not provided sufficient notice of what the law prohibits. The court disagreed and denied Panuwat’s motion to dismiss.

Materiality

The tribunal began by considering the parties’ materiality claims, which constituted “the essence of the parties’ arguments”. He first assessed the parties’ competing readings on whether information about Incyte – which was not the direct subject of the MNPI regarding the acquisition of Medivation – could be material under Article 10 ( (b) the Securities Exchange Act and SEC Rules 10b-5 and 10b5. -1(a). Panuwat argued that Rule 10b5-1(a) required the SEC to prove that he traded in Incyte securities on the basis of MNPI about Incyte itself; the SEC asserted that Rule 10b5-1(a) is not exhaustive and that trading in connection with “any security” could violate Section 10(b).

The court accepted the SEC’s interpretation. He felt that Section 10(b) and Rule 10b-5 “cast a wide net” to prohibit insider trading from “any security” and that neither these provisions nor Rule 10b5-1(a) require that the information originate from the issuer itself or relate to the issuer itself (that is to say, Incyte). The court read the Supreme Court decision in Basic Inc. v. Levinson, 485 U.S. 224 (1988), as focusing on whether the information is material to the issuer of securities without “foreclosure[ing] the possibility that information could be significant for an issuer even if it comes from outside the company.

Applying the SEC’s reading, the court found it reasonable to infer at the argument stage that Panuwat’s MNPI regarding the acquisition of Medivation would be material to Incyte in light of the “limited number of mid-cap biopharmaceutical companies focused on ‘oncology with commercial-stage drugs in 2016’ and the number of other companies that had been interested in purchasing Medivation. The rise in Incyte’s share price following the announcement of the Medivation acquisition confirmed the court’s materiality analysis. In addition, the court’s summary of factual allegations noted that Panuwat had reviewed presentations from Medivation’s investment bankers, who had “discussed Medivation’s peer companies in the biopharmaceutical industry, including Incyte”, and that Panuwat -even had “noted to investment bankers that they might want to consider Incyte as a company comparable to Medivation.

Breach of duty

The court then held that the SEC had sufficiently alleged a breach of Panuwat’s fiduciary duties to Medivation under the theory of misappropriation liability: he had used MNPI obtained from his employer for his personal benefit in violation of a do not do it. Panuwat had signed Medivation’s Insider Trading Policy, which stated that signatories “may be able to profit financially by buying or selling or otherwise trading in the securities of the Company.” . . or the securities of another publicly traded company, including all of the Company’s significant employees, customers, partners, suppliers or competitors. . . . For anyone to use this information for personal benefit. . . is illegal. (Emphasis added.)

In light of this broad prohibition, the court ruled that “the plain language of the font covers ‘the securities of another publicly traded company, including‘ the listed categories. . . . Word [‘including’] does not exclude the applicability of the policy only to the types of businesses listed. . . . Because Incyte is a publicly traded company, it is covered by Medivation’s business policy.

Scientist

In assessing whether the SEC had adequately pleaded the Panuwat scientist, the court noted disagreement among the Ninth Circuit district courts over whether a defendant should actually use the MNPI in the exercise of a profession or if it is enough for him to be aware of this one. The court held that the Ninth Circuit’s decision in United States vs. Smith, 155 F.3d 1051 (9th Cir. 1998), which had required actual use, did not solve the problem, because Black-smith was a criminal case, it expressly left open whether the standard of use was required in civil proceedings such as this, and it was decided prior to the SEC’s enactment of Rule 10b5-1, which only requires awareness, not actual use, of the MNPI.

Nevertheless, the court found that the SEC’s claims met even the strictest actual use standard. The SEC had argued several examples of circumstantial evidence showing actual use, including that Panuwat bought Incyte options “within minutes” after learning that the Medivation deal was imminent and that he had never traded Incyte stock before. . The standard of knowledge was also met, as the complaint included detailed allegations that Panuwat knew about the impending acquisition before buying the Incyte options.

Acceptance of “Shadow Trading” as a Viable Theory of Responsibility

The court rejected Panuwat’s due process argument and in doing so signaled his acceptance of “parallel trading” as encompassed within the misappropriation theory of insider trading.

Panuwat argued that his due process rights were violated because the SEC’s new “parallel trade” theory extended the theory of misappropriation beyond its previously recognized limits. The court acknowledged that “there does not appear to be any other case where the [MNPI] at issue involved a third party. But, in the court’s view, the “parallel trade” theory still fell within the framework of the misappropriation theory, which, in its own words, reaches commerce through outside enterprises and may involve important information for more than one company. The theory also fell within what the court called the “expansive” language of section 10(b). The court concluded that “science and materiality provide sufficient safeguards against liability for insider trading” even where the particular theory of liability has not previously been judged.

Consequences

The court’s decision appears to validate the SEC’s reliance on a “parallel trading” theory that a trader is failing in his duty by using MNPI about one company to trade another company’s securities. But the decision was based on the pleadings and hinged on the specific factual allegations at issue, including that (I) the third-party issuer (Incyte) was one of “a limited number” of companies in the business and financial space of the acquisition target, (ii) the MNPI had specifically identified the third-party issuer as a comparable company, (iii) the trader had signed a confidentiality agreement expressly prohibiting trading in the securities of any public company based on MNPI learned from his employer, and (iv), the trader had been directly involved in the underlying corporate discussions and presentations regarding the employer acquisition. Changing these variables could possibly produce different results. And the factual nature of these allegations has increased the difficulty of obtaining a dismissal at the oral argument stage.

For example, when does “a limited number” of comparable companies become too large for information about Company A to be meaningful to Company B (or C, D, or E)? How comparable should companies A and B be? Would the court have reached a different conclusion if the Medivation investment bankers’ presentations had not mentioned Incyte as a comparable company, or whether Panuwat had not seen these materials? What if the insider trading policy hadn’t expressly covered “the securities of another publicly traded company”? Would the absence of such language have been fatal to the SEC’s assertions? Could the SEC have invoked general principles of corporate fiduciary duty prohibiting an insider from using MNPI for personal gain? These and other issues may arise in future cases.

As we noted in our previous report on this case, companies and traders, including private funds, should consider whether insider trading policies and procedures, and any relevant confidentiality agreements, cover securities of third-party companies. The language and scope of these policies could be key – and could influence the trade restrictions or “walls” companies put in place.

Future cases could also explore the legal issue that the court left undecided in panuwat: whether mere knowledge of the MNPI is sufficient to demonstrate that it is scientific (as stated in SEC Rule 10b5-1), or whether actual use is required. Courts have taken different positions on this issue.

© 2022 Proskauer Rose LLP. National Law Review, Volume XII, Number 19

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