SEC Overrides Motion to Dismiss Lawsuit Claiming Insider Trading

The Securities and Exchange Commission (SEC) has triumphed over a motion to dismiss a closely watched lawsuit alleging that the defendant engaged in insider trading based on news of a yet-to-be-announced company acquisition when it purchased securities of a company not involved in that transaction. Resolution of January 14, 2022 in SEC Banoat (ND Cal.) This is the first time that a court has considered the “shadow trading” theory, which involves the trading of securities of a public company that is not a direct subject of material non-public information (“MNPI”) in question.

the Banuat The decision does not seem to open new horizons under the theory of misappropriation of insider trading in light of the alleged private facts. But the “shadow trading” theory warrants attention because, in other sets of claims, it can have widespread repercussions for traders.

factual background

The facts of the complaint, described in detail here, included Matthew Panwat, head of business development at the time at a pharmaceutical company called Medivation. The Securities and Exchange Commission alleged that Panwat learned that Medivation was about to be acquired by a large pharmaceutical company and that prior to announcing the acquisition, he had purchased call options on securities issued by one of Medivation’s competitors, Incyte.

The SEC theory was that many potential acquirers were interested in buying Medivation, that Incyte was one of a “limited number of mid-size companies” in the Medivation business, and that Incyte would become more attractive to potential investors once the Medivation deal was in place. announced, and that Incyte’s stock price will rise as a result. The facts allegedly supported the SEC theory: When the Medivation deal was announced, Incyte’s stock price soared, and Panuwat made $107,066 on his put options.

Court decision

Banawat moved to dismiss the SEC’s complaint for two reasons. First, he argued that the SEC’s complaint failed to meet three elements of the embezzlement theory of insider trading: materialism, breach of duty, and science. Second, he asserted that the SEC’s allegations violate his due process rights because shadow trading theory improperly extended insider trading law beyond its generally understood standards, and thus failed to provide adequate notice of what is prohibited by law. The court opposed and rejected Banawat’s request to dismiss the case.


The court began by addressing the material claims of the parties, which constituted “the bulk of the arguments of the parties”. It first assessed the parties’ competing readings of whether information about Incyte – which was not a direct subject of the MNPI about the Medivation acquisition – could be material under Section 10(b) of the Securities Act and SEC rules 10b-5 and 10b5-1(a). ). Panwat argued that Rule 10b5-1(a) required the SEC to prove that he had traded Incyte securities based on the MNPI about Incyte itself; The Securities and Exchange Commission has emphasized that Rule 10b5-1(a) is not exhaustive and that trading in connection with “any security” could violate Section 10(b).

The court agreed with the SEC’s interpretation. It held that Section 10(b) and Rule 10b-5 “throw a wide net” to ban insider trading for “Which security” and that neither of these provisions nor Rule 10b5-1(a) require that information come from or relate to the same source (in another meaning, Missy). The court read the Supreme Court’s decision in Basic vs. Levinson, 485 US 224 (1988), to focus on whether the information is important to a securities issuer without “foreclosure”[ing] The probability that the information is important to the issuer even if it comes from outside the company.”

Applying the SEC’s reading, the court found it reasonable to conclude at the pleading stage that Panuwat’s MNPI on the acquisition of Medivation would be significant to Incyte in light of “the limited number of mid-size biopharmaceutical companies focused on oncology with commercial-stage drugs in the 2016” and the number of other companies that were interested in buying Medivation. The surge in Incyte’s share price following the announcement of the acquisition of Medivation confirmed the court’s material analysis. In addition, the court’s summary of factual allegations indicated that Banwat had reviewed offers by investment bankers to Medivation, which “discussed Medivation’s counterpart companies in the biopharmaceutical industry, including Incyte”, and that Banwat himself had “indicated to the investment bankers that they had would like Incyte to be considered a company similar to Medivation.”

breach of duty

The court then determined that the Securities and Exchange Commission had sufficiently alleged a breach of Panuwat’s fiduciary duties to Medivation under the misappropriation of liability theory: he used MNPI obtained from the employer for his own benefit in violation of an agreement not to do so. Banawat signed off on Medivation’s Insider Trading Policy, which stated that signatories “may be in a position to profit financially by buying, selling or otherwise dealing in the Company’s securities . . . Or the securities of another company offered for public circulation, including all significant collaborators, customers, partners, supplies or competitors of the Company. . . . For anyone to use this information for personal benefit. . . illegal.” (emphasis added.)

In light of this broad prohibition, the court held that “the clear language of the policy covers” the securities of another publicly traded company, IncludingThe categories are enumerated. . . . Word [‘including’] Do not block the application of the policy to the types of listed companies only. . . . As Incyte is a publicly traded company, it is covered by the Medivation Trading Policy.”


In assessing whether the Securities and Exchange Commission adequately entrusted Banawat’s imagination, the Court noted the disagreement among the Ninth Circuit district courts over whether the defendant should actually use MNPI in trade execution or whether he or she just needs it conscious from him. The court held that the Ninth Circuit’s decision in United States vs. Smith, 155 F.3d 1051 (9th Cir. 1998), which required actual use, did not solve the problem, because Smith It was a criminal case, it explicitly left open the question of whether the standard of use was required in civil proceedings like this, and that was decided before the Securities and Exchange Commission issued Rule 10b5-1, which only requires awareness and not actual use, of the MNPI.

However, the court held that the SEC’s claims met even the most stringent actual use standard. The Securities and Exchange Commission (SEC) has pledged several examples of circumstantial evidence showing actual use, including that Panuwat purchased Incyte options “within minutes” of knowing that a Medivation deal was imminent and that Incyte’s stock had never been traded before. The awareness criterion was also met, as the complaint detailed allegations that Panuwat knew of the impending acquisition before it purchased Incyte’s options.

Accepting ‘shadow trading’ as a viable theory of responsibility

The court rejected Panuwat’s argument for due process and, in doing so, indicated her acceptance of “shadow trading” as covered by the theory of misappropriation of insider trading.

Banawat argued that his due process rights were violated because the SEC’s new theory of “shadow trading” extended misappropriation theory beyond its previously recognized limits. The court acknowledged that “there do not appear to be other cases where [MNPI] concerned third party.” But, in the court’s view, the “shadow trading” theory still falls under the misappropriation theory, which, on its own terms, amounts to trading by outside firms and can include material information for more than one company. The theory also with what the court called the “extended” language of Section 10(b.) The court concluded that “science and materiality provide adequate barriers to insider trading liability” even where the special liability theory has not been adjudicated before.


The court’s decision appears to validate the SEC’s reliance on the “shadow trading” theory in which a trader breaches his or her duty to use an MNPI about one company to trade another company’s stock. But the decision was based on pleadings and relied on the specific factual allegations involved, including (I) The third-party issuer (Incyte) was one of only a “limited number” of companies in the business and financial space for an acquisition target, (Secondly(MNPI specifically identified the third party issuer as a comparable company,)Third. That the trader has signed a confidentiality agreement that expressly prohibits trading in the securities of Which A public company relies on unofficial background information it learned from the employer, and (FourthlyThe trader was directly involved in the company’s discussions and key presentations related to the business owner’s acquisition. Changing these variables can lead to different results. The factual nature of these allegations made it more difficult to obtain an adjudication at the pleading stage.

For example, at what point does a “limited number” of similar companies become so many that information about Company A is not material to Company B (or C, D, or E? To what extent? Should Firms A and B be comparable Would the court have come to a different conclusion if the presentations by the investment bankers at Medivation had been? Not Incyte mentioned as a similar company, or if Panuwat has Not You saw those articles? What if you don’t do insider trading frankly Covering the “securities of another publicly traded company”? Would a lack of such language have been fatal to the SEC’s claims? Could the Securities and Exchange Commission have invoked the general principles of corporate fiduciary duty that prohibit insiders from using a company’s MNPI for their own benefit? These and other issues may arise in future cases.

As noted in our previous report on this case, companies and dealers, including private funds, should consider whether insider trading policies and procedures, as well as any relevant nondisclosure agreements, cover the securities of third-party companies. The language and breadth of these policies can be a determining factor – and can influence any trade restrictions or “walls” that companies implement.

Future cases may also explore the legal issue that is not decided by the court Banuat: Whether mere awareness of the MNPI is sufficient to establish the existence of a scientist (as SEC Rule 10b5-1 states), or whether actual use is required. Courts have taken different positions on this issue.

© 2022 Proskauer Rose LLP. National Law Review, Volume XII, No. 19

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