California District Court Allows Prosecution of New SEC Insider Trading Theory | Shearman & Sterling LLP

On January 14, 2022, Judge William Orrick of the United States District Court for the Northern District of California issued an order denying a former biopharmaceutical company executive’s motion to dismiss and allowing the Securities and Exchange Commission (“SEC”) to bring a first-of-its-kind insider trading action against a company insider for misappropriating non-public confidential information related to his employer’s upcoming merger to buy securities issued by a third party company that was not involved in the transaction.

In August 2021, the SEC charged a former executive of California-based biopharmaceutical company Medivation Inc. (“Medivation”) with violating Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and the Rule 10b-5 for allegedly relying on inside information he obtained through his employment at Medivation to buy stock in another company, Incyte Corporation (“Incyte”), a practice that some academics have dubbed “parallel trade”. See SEC imposes insider trading fees based on new theory (August 26, 2021). The SEC alleged that Matthew Panuwat, the former head of business development of Medivation, learned of information relating to the planned acquisition of Medivation by Pfizer, Inc., and within minutes of receiving this information, Panuwat purchased shares short-term out-of-the-money options on Medivation’s competitor, Incyte, anticipating that Incyte’s value would increase significantly when the acquisition of Medivation goes public.

Panuwat decided to dismiss the SEC’s complaint, calling it an “unprecedented extension” of the Exchange Act. Specifically, Panuwat argued that the SEC failed to adequately argue that information received by Panuwat regarding the impending acquisition of Pfizer-Medivation was material to Incyte. Panuwat argued that Rule 10b-5 required the SEC to plead that he traded Incyte based on material nonpublic information about that security or issuer, and that the SEC could not rely on Panuwat’s possession non-public information related to Medivation. In response, the SEC argued that Panuwat was attempting to inappropriately narrow the meaning of materiality and that information, including information received by Panuwat regarding Medivation, may be material to more than one company. The court found the reading of SEC Section 10(b) more persuasive and noted that Rule 10b-5 was broad in scope, prohibiting insider trading of “any security” using “any manipulative or deceptive device “. See § 15 USC § 78(j)(b); 17 CFR § 240.10b-5. Additionally, the court noted that information may be material to an issuer even if it comes from outside the company and that the wording of Rule 10b-5 makes it clear that the text of the rule does not provide a comprehensive list of manipulation schemes or devices. that the rule might prohibit.

In addition, Panuwat argued that he did not breach a duty to Medivation, as required by the misappropriation theory of insider trading, because Medivation’s insider trading policy does not did not prohibit trading in Incyte securities and that the SEC had not alleged that Incyte was a material employee, customer, partner, supplier or competitor of Medivation, who would be covered by the policy. The court rejected this argument, finding that the aforementioned categories of companies listed in Medivation’s Insider Trading Policy were only examples and not an exclusive list and that Medivation’s Insider Trading Policy was broad enough. to limit the purchase of any publicly traded company based on nonpublic information. received by a Medivation employee in the course of their employment.

Panuwat further argued that the SEC failed to sufficiently allege that he acted knowingly, arguing that the SEC’s allegations that he “used” information about the Medivation acquisition to buy the stock- Incyte’s options lacked the specificity required under Rule 9(b) of the Federal Rules of Civil Procedure. The court also disagreed on this point, finding that the totality of the circumstances surrounding Panuwat’s purchase of Incyte shares, as alleged, suggested that Panuwat had used the material non-public information on the acquisition of Medivation and had therefore acted with science. Finally, Panuwat argued that the SEC’s new application of the misappropriation theory, which the SEC said was the first such action, would unduly expand the law and violate Panuwat’s due process rights. . The court acknowledged that while there were no other insider trading cases in which the material, nonpublic information at issue was used to buy security from a third party, the SEC theory still fell within the general framework of insider trading and the general language of Section 10(b) and its corresponding regulations. The court also noted that although the SEC’s theory of liability is new, the requirement that the nonpublic information used be material to the third party and the requirement to be scientific served as “safeguards” that would prevent limits outside liability for insider trading to become “totally unclear”. .”

As mentioned, this case marks the first time the SEC has brought an insider trading case in which confidential information related to a company acquisition was used to trade in the securities of a company unrelated to the transaction. . While this trial court ruling represents a significant victory for the SEC, several hurdles remain for the SEC, including the ability to convince a jury that the Medivation information in question was in fact material to Incyte and, if so, , if a Ninth Circuit panel will ultimately agree with Judge Orrick’s decision. Nevertheless, this notice highlights the need for companies to carefully consider whether their insider trading policies and training materials adequately reflect this theory of insider trading.

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Order of Judge William Orrick of the United States District Court for the Northern District of California

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