Jury Verdicts in Novel Cases Foreshadow More Aggressive Government Approach to Insider Trading

The government has a longstanding preference to use its enforcement arsenal (instead of rulemaking) to expand the boundaries of what constitutes illegal insider trading. Although it remains to be seen what happens in any post-verdict motions or on appeal, two recent jury verdicts may embolden the Securities and Exchange Commission (“SEC”) and Department of Justice (“DOJ”) to bring “test cases” as they continue to try to stretch the scope of insider trading law.

In SEC v. Panuwat¹—the SEC’s first “shadow trading” case—the jury found the defendant, whose employer was an acquisition target, liable for insider trading because he purchased securities of a third company (i.e., not a transaction participant). In United States v. Peizer,² a jury convicted a defendant on criminal insider trading charges that arose from trades made pursuant to a plan that the defense argued qualified under Rule 10b5-1 of the Securities Exchange Act of 1934 (“Rule 10b5-1”), affording the defendant an affirmative defense against insider trading charges.³

Both cases potentially expand the conduct that triggers insider trading liability under Section 10(b) of the Exchange Act and Rule 10b-5 and may embolden the government to bring similar cases or others that attempt to expand the bounds of liability even further.

“Shadow Trading” and Panuwat

The term “shadow trading” first appeared in a 2020 academic article to describe situations where trading data suggests that corporate insiders “circumvent[ed] insider trading restrictions” and “avoid[ed] regulatory scrutiny” by using confidential information about their own companies to trade in separate, but supposedly “economically linked,” companies.⁴ Panuwat was the SEC’s test case for this novel theory.

Matthew Panuwat worked at Medivation, Inc., a cancer drug development company. At trial, the SEC presented evidence that Panuwat started buying Incyte, Inc. call options seven minutes after Panuwat received an email from Medivation’s CEO stating that Pfizer wanted to acquire Medivation “this weekend.” Incyte and Medivation were among a small handful of mid-sized companies working to develop cancer drugs. After Pfizer’s planned acquisition of Medivation was disclosed publicly, the price of Incyte stock rose, and Panuwat sold his Incyte call options for a profit of more than $120,000.

Traditionally, the SEC would have limited an insider trading investigation to trading in Medivation and, potentially, Pfizer. Incyte was not a party to the Pfizer-Medivation transaction. But given the particular facts of this case—for example, the SEC presented evidence that Panuwat was aware that Medivation’s investment bankers identified Medivation and Incyte as two of only a small number of commercial-stage oncology companies—the SEC may have concluded that the evidence in Panuwat presented an opportunity that it could not pass up to pursue the shadow trading theory identified by the academic literature. 

At trial, the judge instructed the jury that to find Panuwat liable for insider trading, the SEC needed to show: (1) Panuwat owed a duty of “trust, confidence or confidentiality” to Medivation; (2) by trading in Incyte stock, he knew or should have known that he was violating his duty to Medivation; (3) he possessed nonpublic information that was material to trading in Incyte securities; and (4) he bought call options in Incyte on the basis of the material nonpublic information. 

At trial, the SEC advanced three bases for the jury to find that Panuwat violated the duty of trust and confidence he owed Medivation when he purchased Incyte call options after receiving confidential information from his employer. First, Panuwat violated Medivation’s Insider Trading Policy by trading on insider information. Second, he violated Medivation’s Confidentiality Agreement by using Medivation’s confidential information for his own personal benefit. Third, Panuwat misused confidential information that Medivation had entrusted to him. 

As to materiality, in denying Panuwat’s motion for summary judgment, the court concluded that a reasonable jury could find that the information that Pfizer was likely to acquire Medivation was material to trading in Incyte securities—i.e., that a reasonable investor would perceive the information about Medivation as significantly altering the total mix of information available about Incyte.⁵ Among other reasons, the court concluded that the SEC had identified sufficient evidence to support a jury’s finding that a “market connection” existed between Medivation and Incyte because both were part of a “niche section of the biopharmaceutical market.”⁶

On April 5, 2024, in less than two hours, the jury found Panuwat liable for insider trading. The court denied Panuwat’s motion for a new trial on September 9, 2024.

Rule 10b5-1 Trading Plans and Peizer

Rule 10b5-1 establishes an affirmative defense to insider trading charges for trading plans that are, among other things, (i) “entered into in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5‐1” and (ii) “adopted at a time when the person trading was not aware of any material non‐public information.”⁷

Peizer is the first criminal prosecution where all of the charged trades were made pursuant to trading plans that purported to satisfy Rule 10b5-1. The jury convicted Terren Scott Peizer, executive chairman of Ontrak, of insider trading for selling Ontrak securities in May and August 2021, when he knew that Ontrak would likely lose its contract with its biggest customer, Cigna. Although the sales in question were made pursuant to two trading plans, the DOJ alleged that Peizer established those plans while knowing that Ontrak would likely lose Cigna’s business—a fact that would undermine the ability of Peizer to rely on Rule 10b5-1 to defeat the charges of insider trading. The government alleged that Peizer’s sales avoided losses of approximately $12.5 million. 

Although the DOJ touted Peizer as the first criminal case involving Rule 10b5-1 plans, it is not the first time that trading under Rule 10b5-1 plans has drawn scrutiny. In amending Rule 10b-5(1) in December 2022, the SEC cited several academic studies finding that corporate insiders’ trading pursuant to 10b5-1 plans outperformed trading outside those plans.⁸ Among other things, the SEC amended Rule 10b5-1 to include a 30 or 90-day “cooling off” period between the adoption or modification of a plan and the first plan trade.

Takeaways

Until such time as the outcome of any potential appeals by Peizer or Panuwat, we expect the SEC and DOJ to continue to attempt to expand the definition of what constitutes illegal insider trading through its prosecution of insider trading cases. 

In the wake of these developments, companies should consider working with counsel to (i) assess whether any changes to their insider trading policies are warranted, (ii) confirm that their Rule 10b5-1 policies (if any) comport with the SEC’s recent amendments, and (iii) assess whether additional training should be provided to company personnel.

And it would be prudent for individuals seeking to avail themselves of Rule 10b5-1’s affirmative defense to work with their own counsel when setting up a trading plan.

¹ 4:21-cv-6322 (N.D. Cal. filed Aug. 17, 2021).
² 2:23-cr-89 (C.D. Cal. filed Feb. 24, 2023).
³ A 10b5-1 plan is an arrangement where a corporate insider can show that a trade is made pursuant to a contract, instruction or plan entered into at a time when the person was not in possession of material nonpublic information, that specifies the amount of securities to be sold and the pricing and timing parameters of such sales and over which the person does not exercise any subsequent influence.
⁴ Mehta, Mihir N., Reeb, David M. and Zhao, Wanli, “Shadow Trading” (September 6, 2020), The Accounting Review, July 2021, available at SSRN: https://ssrn.com/abstract=3689154.
⁵ SEC v. Panuwat, 2023 WL 9375861, at *5 (N.D. Cal. Nov. 20, 2023) (denying summary judgment).
⁶ Id. at *6.
⁷ 17 C.F.R. §§ 240.10b5-1(c)(1)(ii)(A), (c)(1)(ii)(C)(1).
⁸ SEC Adopting Release, “Insider Trading Arrangements and Related Disclosures,” 87 FR 80362-01, at 9 n. 19 (Dec. 29, 2022) (collecting articles).

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Sharon M. Bunzel, an O'Melveny partner licensed to practice law in California; Jorge deNeve, an O’Melveny partner licensed to practice law in California; Andrew J. Geist, an O'Melveny partner licensed to practice law in New York; Mia N. Gonzalez, an O'Melveny partner licensed to practice law in New York; Michele W. Layne, an O’Melveny of counsel licensed to practice law in California; Waqas A. Akmal, an O'Melveny counsel licensed to practice law in California; Bill Martin, an O'Melveny counsel licensed to practice law in New York; and Danny Hirsch, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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