Last summer, the Securities and Exchange Commission commissioned another person inside the company, Matthew Banwar, for insider trading. This case was unusual because Mr. Banwar did not trade in the securities of his employer, Medivation, or an as yet undisclosed acquirer. Instead, he bought stock options in another company in the industry on the grounds that the acquisition of Medivation would make that company a more valuable target. Earlier, U.S. District Court Judge William H. Oryx Mr. Banwar’s proposal to reject Mr. Banwar’s proposal. Among securities attorneys, the SEC theory is known as “insider shadow trading.” For a more detailed discussion of Judge Orrick’s decision, see this blog post by Cydney Posner.
The California Corporate Securities Act of 1968 also makes insider trading illegal. However, unlike the Securities Act of 1934, the CSL explicitly does so. Corporate Law Section 25402 provides:
It is unlawful for the issuer or any person in charge, director, or controlling person of the issuer or any other person whose relationship with the issuer gives it access, directly or indirectly, to material information about the issuer that is not generally available to the public, to buy or sell any security of the issuer in This is the case at a time when it knows material information about the issuer gained from this relationship that would significantly affect the market price of that security and which is not generally available to the public, and which it knows is not intended to be available as such, unless He has reason to believe that the person from whom he is buying or selling also possesses the information.
Since “inside shadow trading” necessarily involves someone who is not related to the issuer, this behavior does not appear to violate Section 25402. Another issue might be that the information should be “about the issuer”. It would be quite an exaggeration for a court to find that information about the acquisition of an unrelated company is “about the issuer” information.
Whether “shadow insider trading” should or shouldn’t be illegal, the SEC v. Banwat case highlights a deeply troubling aspect of federal insider trading jurisprudence. In the absence of a law expressly prohibiting internal behavior, courts are forced to formulate theories. Understandably, defendants feel that they only learn after the truth of the theory under which they were convicted. Mr Banawat argued unsuccessfully that until he was charged “no one ever understood that insider trading laws prohibit the kind of behavior alleged”. However, Justice Orrick dismissed this argument, “Although unique, the SEC’s liability theory falls within the confines of misappropriation theory and the language of applicable law.
© 2010-2022 Allen Matkins Leck Gamble Mallory & Natsis LLP National Law Review, Volume XII, No. 25