SEC INSIDER TRADING CASE IS NOVEL, BUT NOT AN EXPANSION OF THE LAW
Last month the SEC filed a novel insider trading case worth taking a look at (a link to the SEC release is here). The SEC alleged that Matthew Panuwat, an executive at the publicly traded biopharma company Medivation Inc., learned that his company was being acquired by Pfizer. At this point in the typical insider trading story the executive then either trades in his own company’s securities or tips a friend to do so. Not in Mr. Panuwat’s case. Mr. Panuwat did not trade in Medivation’s securities when he found out the company was being acquired, but instead bought short-term, out of the money options in Incyte Corporation – another public company in the same line of business as Medivation. The SEC alleges that Mr. Panuwat knew that Incyte and Medivation were comparable companies and that when the acquisition of Medivation was publicly announced it would cause the price of Incyte’s stock to rise. When the acquisition of Medivation was announced, Incyte’s stock price rose by about 8% and Mr. Panuwat made a profit of $107,000 on his options trades.
This is the first time the SEC has brought an insider trading case where the confidential information in question did not directly relate to the company whose securities were traded. However, the concept underlying the case is not new and it fits within the existing framework of insider trading law. Some commentators are referring to this type of trading as “shadow” trading. We have always called this “sympathetic” trading because it involves information that relates, or is material to – to use the correct terminology – more than one issuer whose prices react similarly (sympathetically) to the disclosure of the information. Regardless of the label, and although a purposeful simplification, the essential elements of insider trading have for years been: (1) obtaining or using information in breach of a duty (the exact type of duty and to whom the duty is owed generally do not matter), (2) the information is material to the issuer whose securities are traded, and (3) the information is nonpublic. A few relevant concepts: first, the duty is not required to be to, or even relate to, the issuer whose securities are traded. Second, it is possible for information “about” one company to be material to another (imagine learning that one company has created a drug that is vastly superior to the single drug made by another company). Applying these concepts here you can see the SEC’s case fitting into these elements: (1) Mr. Panuwat breached a duty to his employer by using the confidential information about the acquisition, (2) the information was material as to Incyte, and (3) the information was nonpublic.
Thus, where material nonpublic information about issuer A has been obtained in breach of some duty, but the information is also material to issuer B (the drug company example above), practitioners have for years counseled traders to refrain from trading in the securities of both issuers A and B. The issue that arises most frequently in these situations is determining whether the information is actually material to the “sympathetic” issuer. Not surprisingly, in the Panuwat case the SEC goes to some length to allege why the acquisition of Medivation was material to Incyte (and how Mr. Panuwat knew it to be material). Like many insider trading concepts, this can get a little vague at the edges. For example, if one has MNPI that a leading semiconductor company is going to beat quarterly earnings estimates – then clearly trading in that issuer is prohibited; but is that information also material to all or some other semiconductor companies since perhaps the earnings beat means that the whole segment is having an unexpectedly good quarter? As alleged, the materiality in the Panuwat case appears solid. However, now that the SEC has brought a sympathetic trading case and they are on its radar screen, it is quite possible that less material situations are going to come under scrutiny. For traders, when a company is placed on the restricted list it should also be asked if the information is also material to any other issuers. It is probably a good idea to incorporate this step into compliance policies. Bigger picture, keeping the essential concepts of insider trading in mind is a useful way to avoid trouble in both novel and typical insider trading scenarios. If you answer yes to these three questions you probably will be trading on inside information: (1) did I obtain the information through anyone breaching any kind of duty to anyone, or does my use of the information breach any kind of duty to anyone, (2) is the information material to the company whose securities I want to trade, and (3) is the information nonpublic? While this is a bit of a simplification of the law and there are caveats aplenty, this simple test has saved countless traders and would have saved Mr. Panuwat a good deal of trouble too.