A pending case penalizes the use of insider information about one company to trade another company’s stock.
The U.S. Securities & Exchange Commission (SEC) scored its first victory on the “shadow” theory of insider trading after a federal jury found defendant Matthew Panuwat liable for violating securities laws in April 2024. The U.S. Court of Appeals for the Ninth Circuit is set to review the case—SEC v. Panuwat—in 2025. Upholding the result in Panuwat would expand potential insider trading liability far beyond previously established theories, marking a major advancement for the SEC in its ability to pursue securities fraud enforcement actions.
Section 10(b) of the Securities Exchange Act of 1934 authorizes the SEC to regulate securities fraud. Using its authority under that section, the SEC issued rules 10b-5 and 10b5-1, which prohibit insider trading.
The classical theory of insider trading imposes liability when corporate affiliates take advantage of their access to confidential information to trade their own company’s securities. For example, executives could face penalties if they sold off stock in their company after learning of a negative, non-public development that would decrease the stock’s price.
The U.S. Supreme Court expanded insider trading liability beyond the classical theory when it endorsed the SEC’s misappropriation theory in United States v. O’Hagan. Under the misappropriation theory, individuals can be liable for insider trading when they misappropriate confidential information for their own gain, even if they owe no duty to the company whose stock they trade. For example, even though the O’Hagan defendant was not affiliated directly with the companies whose stock he profited from, the fact that he effectively stole information about a pending deal from partners at his law firm supported a finding of liability.
In SEC v. Panuwat, the SEC claimed to be pursuing a “pure and simple” application of the misappropriation theory. According to a Commission representative, Panuwat used insider information in violation of his company’s policies in order to make an advantageous trade—a clear misappropriation of the information. Numerous legal scholars and practitioners were quick to point out, however, that the SEC actually applied a “quirky new theory of liability” not previously adopted by the courts.
Instead, the shadow theory of insider trading advances the misappropriation theory a step further: It makes corporate affiliates liable for insider trading if they use non-public information gained from their company to trade another company’s stock—even if the information about that other company was not misappropriated from it. Liability can hinge on a mere violation of company policy.
The facts of the Panuwat case help illustrate the nuances of this new theory. Matthew Panuwat was an employee of the pharmaceutical company Medivation. In the course of his employment, Panuwat learned that Medivation would be acquired by Pfizer. Believing that news of Medivation’s acquisition would increase the stock price of similar companies in the industry, Panuwat immediately purchased options in Incyte—another midsized pharmaceutical company pursuing research similar to Medivation’s.
Panuwat’s market prediction proved correct: When Medivation announced that Pfizer would pay a premium to acquire its shares, the Medivation stock price rose by 20 percent, and the Incyte stock price rose by 8 percent—doubling the value of Panuwat’s options. He exercised his Incyte options and profited more than $100,000.
In the district court, Panuwat argued that he could not be liable for insider trading because he did not receive material, non-public information about Incyte, the company whose stock he traded, from Medivation, the company he worked for. Information is material if a reasonable investor would likely view it as altering the “total mix” of information available about a company. The court acknowledged that Panuwat had not received such information from Incyte.
But he had still traded upon material, non-public information about Incyte that he received from Medivation—namely, the Medivation acquisition announcement. The district court reasoned that “because Medivation and Incyte were connected as part of a niche section of the biopharmaceutical market, Panuwat was aware of information that was material to Incyte.” By trading on that information—in violation of Medivation’s insider trading policy and confidentiality agreement—Panuwat breached his duty to Medivation, rendering him liable for insider trading of Incyte’s securities.
The district court upheld the jury’s verdict over the defendant’s post-trial challenges. If the Ninth Circuit upholds the outcome in Panuwat, it will be the first federal court of appeals to recognize the shadow theory of insider trading, significantly broadening the scope of liability.
Some commentators predict that, as a result of the Panuwat decision, public companies will begin implementing more restrictive securities trading policies for their employees. These practitioners warn that an emboldened SEC is likely to pursue similar actions in the future; they encourage companies to educate employees on potential risks.
Legal scholars J.W. Verret and Gregory T. Lawrence characterize the theory as a “harmful, unwarranted, and unfair expansion through litigation” of insider trading rules. In their view, the shadow trading theory discourages company insiders from trading any securities within their industry—destroying “a key source of efficient price discovery in the market.”
Other opponents of the theory criticize the SEC for equating Panuwat’s violation of company policy with a violation of federal law. Kayla Kershen, for example, argues that making insider trading liability dependent upon highly varied company policies will yield inequitable results.
The SEC’s adoption of this expansive view of insider trading may form part of a broader trend toward more entrepreneurial enforcement. Although many commentators view the SEC as a passive enforcer, law professor James J. Park argues that the SEC in recent years has pursued cases applying innovative legal theories that disregard court-imposed limitations on Rule 10b-5. Park and other scholars cite SEC v. Panuwat as a prime example of the SEC’s growing ambition.
If the Ninth Circuit overturns the Panuwat verdict, the shadow theory of insider trading may be laid to rest, at least temporarily. But if the appeals court endorses the theory, the debate may soon come before the U.S. Supreme Court. In light of enforcement uncertainty, some scholars urge Congress to pass legislation clearly defining the scope of insider trading.
