Northern District of California Validates SEC’s “Shadow Trading” Theory of Insider Trading Liability | Goodwin

In this case

Northern California validates the SEC’s “shadow trading” theory of insider trade liability. Seventh Circuit overturns dismissal of stockholders’ derivative lawsuit against Boeing based on Forum’s Selection Regulation; Delaware ecclesiastical court denies expedited action in breach of fiduciary duty lawsuit against directors of Arena Pharmaceuticals.


On January 14, 2022, the US District Court for the Northern District of California denied Defendant Matthew Banwat’s motion to dismiss the Securities and Exchange Commission’s first major insider trading enforcement action involving allegations of “shadow trading.” The SEC complaint alleges that Panuwat used confidential information he knew about the Pfizer, Inc. acquisition. on Medivation, Inc. , a mid-size biopharmaceutical company focused on oncology and for which he worked as a business development executive, to purchase stock options in Incyte Corp. , another mid-cap biopharmaceutical company focused on oncology that Banawat expected would increase in value significantly when the targeted acquisition of Pfizer became public.

Relying on the theory of misappropriation of insider trading, the Securities and Exchange Commission confirmed claims against Panuwat under Section 10(b) of the Securities Act of 1934, and Section 10-b5 issued thereunder. Banawat moved to dismiss the lawsuits against him. In addition to saying that the Securities and Exchange Commission (SEC) failed to adequately defend any claim under Section 10(b) because, among other things, the information he allegedly learned was about Medivation and not Incyte, Banawat argued that “the new application of misappropriation theory” by the SEC. It would improperly expand the scope of insider trading laws to make those laws “completely opaque” in violation of his due process rights. The court rejected both arguments, allowing the case to proceed.

In rejecting Banwat’s motion for dismissal, the court first addressed Banwat’s arguments that the SEC’s claims had not been sufficiently advanced. The court found that the SEC had adequately defended the material significance of the information received by Banawat, aligned with the SEC’s interpretation of Section 10(b) and Rule 10-b5, in its belief that the SEC’s claims could continue on The basis for Banat’s possession of non-public material information. About the Pfizer-Medivation merger, even without claiming that Panuwat owns material non-public information about Incyte. The court then found that the Securities and Exchange Commission had stated a claim for breach of a duty imposed by Medivation’s Insider Trading Policy, which applies to “the securities of another publicly traded company, including those of” an important collaborator, customer, partner, supplier or competitor of meditation.” The court rejected Banawat’s argument that because Incyte did not fall into one of those five mentioned categories, the Securities and Exchange Commission failed to make a claim, arguing that the categories were “mere examples of what was covered,” rather than an exhaustive list. Finally, the court rejected Banawat’s arguments that the SEC had not properly undertaken science, arguing that the alleged circumstances were sufficient to find Banwat behaving in the requisite state of mind. Specifically, the court found it significant that Panuwat only purchased Incyte stock options after he received an email from the CEO of Medivation about the acquisition of Pfizer, despite the fact that Medivation had been exploring a potential transaction over the previous several months, and that Panuwat had been buying Incyte options “within minutes” of receiving this email.

The court then took up the due process argument made by Banawat. Although the court held that the SEC theory was new, as no other cases appeared to involve material non-public information involved in a third party, it nonetheless concluded that “the SEC’s liability theory falls within the general framework for insider trading, as well as the expanded language of Section 10(b) and corresponding regulations.” Siding with the SEC, the court referred to the requirements of science and materiality as “two significant liability checks” and further noted the cautionary language of the Supreme Court against dismissing insider-trading claims based on “new or unusual schemes.”

Seventh Circuit reverses expulsion of shareholder derivative suit against Boeing on the basis of forum selection bylaws

On January 7, 2022, the United States Court of Appeals for the Seventh Circuit overturned the dismissal of a derivative suit brought by a shareholder of Boeing alleging that current and former officials of the airline and members of its board of directors made false and materially misleading public statements about the development. And the operation of the 737 Max aircraft in the Boeing assignment materials 2017, 2018, and 2019.

The plaintiff, a pension plan that owns shares in Boeing, confirmed a derivative claim under Section 14(a) of the Securities Act of 1934 (the Exchange or Act), alleging that the defendants published false and materially misleading proxy statements from 2017 through 2019. The plaintiff claimed that in the aftermath of the Boeing 737 Max crashes, false and misleading proxy statements enabled the re-election of directors who failed to activate adequate oversight of safety, regulatory compliance and risk management during the development of the 737 Max. The plaintiff also alleged that the power of attorney statements misled the shareholders and led them to reject the shareholders’ proposal to divide the position of the company’s CEO and Chairman of the Board of Directors.

Exchange Act gives the Federal Courts exclusive jurisdiction over claims brought under the Act; Accordingly, the plaintiff filed his complaint in the US District Court for the Northern District of Illinois. Dismissal of Action On June 8, 2020 on the grounds of improper forum, the District Court applied the Boeing Forum Selection Regulation that requires all derivative actions to be lifted from shareholders in Delaware court.

On appeal, the Seventh Circuit objected. Circuit Judge David F. Hamilton, writing for a 2–1 majority (joined by Circuit Judge Dianne B. Wood Circuit, with Judge Frank H. Easterbrook disapproving), concluded that the district court’s application of the Bylaws conflicts with Delaware Corporation law and federal securities law. The Seventh Circuit concluded that the Bylaws are not enforceable as they apply to a derivatives claim because their application would violate Section 115 of the Delaware General Corporation Code and Section 27 of the Exchange Act. Section 115 of the Delaware General Corporation Act states that corporation bylaws “may require . . . that any or all internal corporate claims must be brought individually and exclusively in any or all of the courts in this state,” and defines “internal corporate claims” to include Derivative claims. However, Section 27 of the Exchange Act gives the federal courts exclusive jurisdiction over claims brought under the Act.

The court held that while Section 115 gives companies leeway when crafting their bylaws (including ones containing forum choice clauses), it does not allow companies to avoid enforcement of the federal securities law. In contrast to the district court, the Seventh Circuit justified that because the Exchange Act grants the federal courts exclusive jurisdiction over actions arising under the law, the application of the Boeing Regulation—which would give the Delaware court jurisdiction—to the derivative procedure means that it can not be heard in any forum.

The Seventh Circuit returned the case to the district court, although remand is subject to full review by the Seventh Circuit. While the separate court decision is also subject to appeal to the US Supreme Court, Boeing has yet to appeal the decision.

Delaware court dismisses expedited action in violation of credit agency’s lawsuit against Arena drug directors

On January 10, 2022, Vice-Chancellor Paul A. Ferravanti, Jr. of the Delaware Chancellor’s Court denied the expedited proceedings in a presumed class action lawsuit against the biopharmaceutical company Arena Pharmaceuticals, Inc. In connection with a proposed merger between Arena and a subsidiary of Pfizer, Inc.

The plaintiff, a shareholder of Arena, has sued the company and its board members asserting one claim for breach of fiduciary duty caused by alleged omissions in the proxy statement provided to shareholders in connection with the proposed merger. The plaintiff’s complaint alleged that the Arena Board of Directors’ financial advisor provided a fair opinion regarding the merger, relying on non-public business and financial information prepared by Arena’s senior management. But, according to the complaint, the agent’s statement only disclosed certain financial projections and omitted management of other information provided to the financial advisor. Simultaneously with the filing of the complaint, the plaintiff also moved to expedite the proceedings, seeking to order a shareholder vote on the merger in principle until Arena provides corrective disclosures.

The court rejected the plaintiff’s request, arguing that although the court was “well known for its responsiveness to plaintiffs seeking expedited action in order to obtain an injunction,” the plaintiff failed to exceed the “minimum” required for relief sought by not pleading the prosecution or proving the existence of Sufficient threat of irreparable damage to warrant urgent action costs.

Specifically, the court found that the complaint “did not allege the financial expectations disclosed in the proxy statement.” [were] false or materially misleading.” The Court further found that the plaintiff’s complaint and request for expedited “were based on the unsupported general presumption that all information provided to the Board’s financial advisor is material to be disclosed in connection with the shareholder action request”—a proposition for which The court noted the plaintiff did not cite a supporting authority.

Leave a Comment