ProfessorBainbridge.com

Commentary on SEC v. Matthew Panuwat: The Shadow Insider Trading Case

In 2021, the SEC brought a case against an employee of Medivation, Inc., alleging Panuwat had engaged in insider trading under the so-called misappropriation theory:

Matthew Panuwat, the then-head of business development at Medivation, a mid-sized, oncology-focused biopharmaceutical company, purchased short-term, out-of-the-money stock options in Incyte Corporation, another mid-cap oncology-focused biopharmaceutical company, just days before the August 22, 2016 announcement that Pfizer would acquire Medivation at a significant premium. Panuwat allegedly purchased the options within minutes of learning highly confidential information concerning the merger. According to the complaint, Panuwat knew that investment bankers had cited Incyte as a comparable company in discussions with Medivation and he anticipated that the acquisition of Medivation would likely lead to an increase in Incyte's stock price. The complaint alleges that Medivation's insider trading policy expressly forbade Panuwat from using confidential information he acquired at Medivation to trade in the securities of any other publicly-traded company. 

Last week a jury convicted Panuwat. It's gotten a fair bit of attention.

Yours truly did a pre-trial explainer on shadow insider trading, which is available here.

Joan Heminway:

The SEC's theory of liability, an application of insider trading's misappropriation doctrine as endorsed by the U.S. Supreme Court in U.S. v. O'Hagan, has been labeled "shadow trading."

The Director of the SEC's Division of Enforcement, Gurbir S. Grewal, put it plainly in responding to the jury verdict in the Panuwat case on Friday:

As we’ve said all along, there was nothing novel about this matter, and the jury agreed: this was insider trading, pure and simple. Defendant used highly confidential information about an impending announcement of the acquisition of biopharmaceutical company Medivation, Inc., the company where he worked, by Pfizer Inc. to trade ahead of the news for his own enrichment. Rather than buying the securities of Medivation, however, Panuwat used his employer’s confidential information to acquire a large stake in call options of another comparable public company, Incyte Corporation, whose share price increased materially on the important news.

Yet, many assert that the SEC's theory in Panuwat broadens the potential for SEC insider trading violations and enforcement.  See, e.g., here, here, and here. They include:

• a wide class of nonpublic information that may be determined to be material and give rise to an insider trading claim;
• the expansive scope of insider trading's requisite duty of trust and confidence (and the potential importance of language in an insider trading compliance policy or confidentiality agreement in defining that duty); and
• the potentially large number of circumstances in which employees may be exposed to confidential information about their employer that represents a value proposition in another firm's securities.

Three of us on the BLPB have held some fascination regarding the Panuwat case over the past three years.  Ann put the case on the blog's radar screen; John later offered perspectives based on the language of Medivation's insider trading compliance policy; and I offered comments on John's post (and now offer this post of my own).  

Dave Lynn (pre conviction):

The panel that I moderated at the Northwestern Pritzker School of Law’s Securities Regulation Institute last month delved into this topic in some depth, and I was surprised to learn that a significant number of companies that were the subject of a recent academic study had very broad language in their insider trading policies that prohibited trading in other companies’ securities based on material nonpublic information, rather than more targeted language that prohibited trading in the securities of other companies with which the employer did business or was negotiating a potential transaction. Those companies that have the very broad formulation in their insider trading policies should revisit those policies to tighten up the prohibited conduct, so as not to create duties for employees that could potentially be seen as breached under the shadow insider trading concept. ...

While it is hard to say how far the SEC’s shadow insider trading theory will go, the Panuwat case highlights a need to avoid overbroad language in the insider trading policy that could potentially broaden the scope of liability for those who are subject to the policy. 

Jonathan Richman has a very detailed discussion of the case and concludes:

The jury’s verdict, like the prior court rulings in favor of the SEC, appears to validate the SEC’s reliance on a “shadow trading” theory where a trader breaches his or her duty by using MNPI about one company to trade another company’s securities. The SEC might now be encouraged to pursue more such cases because the SEC appears to believe – and certain academic literature has suggested – that “shadow trading” occurs with some frequency. ...

The employment-related duties likely will not apply to nonemployee traders, such as companies, private funds, or other organizations.  If such an entity uses its own MNPI for its own benefit, it would not be subject to the employment-related duty that bound Panuwat when he used his employer’s MNPI for his personal benefit.

But companies or funds could have contractual duties to the source of the MNPI, and those agreements could limit the use of MNPI obtained pursuant to those agreements. ...

Companies and traders, including private funds, therefore should carefully consider the terms of insider-trading policies and procedures, as well as any relevant contracts and nondisclosure agreements, to determine whether any of those materials cover securities of third-party issuers or place any other limitations on the use of MNPI obtained under those policies or agreements. 

Matt Levine Quotes my UCLAW Colleague Fernan Restrepo re Insider Trading

Matt Levine's Money Stuff newsletter from a couple of days ago quoted a new paper from my friend and UCLAW colleague Fernan Restrepo:

Here are a fun paper and related blog post by Fernan Restrepo about “How the Misappropriation Theory Affects the Amount of Insider Trading”:

My paper tests this hypothesis by examining the impact of O’Haganon a common proxy for insider trading: target run-ups in mergers and acquisitions (“M&A”) – that is, the cumulative abnormal returns for the shares of the target company before the transaction is publicly announced. The intuition behind this proxy is that individuals who hold non-public information about mergers and acquisitions can make significant profits if they buy shares in the target company before the transaction is announced (since mergers typically involve the payment of a large premium over market prices); as a result, a significant increase in the target’s pre-merger price is likely indicative of a high incidence of trading on confidential information about the transaction. ...

The results show that the run-ups in fact decreased significantly in relation to the announcement returns after O’Hagan. Before O’Hagan, the average relative run-up was 7 percentage points lower than the announcement returns; after the decision, the difference became 9 percentage points. In this sense, after O’Hagan, there was less anticipatory trading explaining the overall valuation effect of M&A bids, which is consistent with the notion of less insider trading.

I suppose a thought experiment would be: If the US got rid of its current rules and replaced them with a simpler, “if you know about a merger that hasn’t been announced yet, it is illegal to trade the stock of the target”-style rule, would that change the average run-up? My guess is no: My guess is that the current hodgepodge of rules covers basically every practical situation, so expanding them wouldn’t have much effect.[4] But I’m not sure.

Was Michael Milken railroaded?

A new book by Michael Milken's former personal lawyer Richard Sandler argues that Milken was largely innocent of the charges brought against him back in the 1980s: Witness to a Prosecution: The Myth of Michael Milken.  A review in today's WSJ finds it largely persuasive:

After reading Mr. Sandler’s account, I no longer believe in Mr. Milken’s guilt, and neither should you. The author argues that most of what we know about Mr. Milken’s misdeeds is grossly exaggerated, if not downright wrong. What the government was able to prove in the court of law, as opposed to the court of public opinion, were mere regulatory infractions: “aiding and abetting” a client’s failure to file an accurate stock-ownership form with the SEC, a violation of broker-dealer reporting requirements, assisting with the filing of a false tax return. There was no insider-trading charge involving Mr. Boesky or anyone else, because the feds couldn’t prove one. ...

When you digest the reality of the case against Mr. Milken, you find that much of it was nonsense.

Sounds like a must read, which is why I just bought it.

 

Is insider trading illegal if you're drunk when you trade?

in yesterday's Money Stuff newsletter, Matt Levine relates an interesting insider trading case:

A former Barclays Plc trader said he got an insider tip from an ex-Goldman Sachs Group Inc. vice president at a squash court after having too many drinks.

Apparently the trader had been drinking at the time he received the tip, but was sober at the time he executed the trade.

But suppose somebody with material nonpublic information traded on the basis of that information while he was intoxicated. What result?

Scienter is an element of the Rule 10b-5 insider trading violation, as Donald Langevoort explains:

"... liability for insider trading under Rule 10b-5 requires a showing that the insider or tippee acted with scienter. Once fiduciary status giving rise to a duty to disclose is determined as a matter of law, scienter is established if the defendant knew that the information was material and nonpublic, or recklessly disregarded facts that would indicate that the information in his possession was material and nonpublic." Donald Langevoort, 18 Insider Trading Regulation, Enforcement and Prevention § 5:5 (2023).

I've been unable to find any cases on whether being intoxicated at the time one commits the alleged violation negates scienter either for purposes of Rule 10b-5, the federal securities fraud laws generally, os common law fraud.

Turning to the general criminal law, a number of federal courts of appeal have held that voluntary intoxication is not a defense to a to a general intent crime. See, e.g., United States v. Gracidas-Ulibarry, 231 F.3d 1188, 1196 (9th Cir.2000) (en banc); United States v. Oakie, 12 F.3d 1436, 1442 (8th Cir.1993); United States v. Fazzini, 871 F.2d 635, 641 (7th Cir.1989); United States v. Lewis, 780 F.2d 1140, 1143 (4th Cir.1986). On the other hand, some courts have held that "voluntary intoxication is a defense to ... specific intent crimes." U.S. v. Sewell, 252 F.3d 647, 650 (2d Cir. 2001).

The Sewell court drew the following distinction between general and specific intent crimes:

"With the exception of strict liability crimes, crimes require general intent, which ordinarily is “at least an intention to make the bodily movement which constitutes the act which the crime requires,” in order for criminal liability to attach. 1 W. LaFave & A. Scott, Substantive Criminal Law, § 3.5, p. 315 (1986). In addition to general intent, some crimes require specific intent, which is “a special mental element” particular to the crime with which defendant is charged. Id. For example, common law larceny requires not only the general mental state for the act of “taking and carrying away the property of another” but also the specific mental state that defendant possessed an “intent to steal the property.” Id. (quotation marks omitted)." Id.

So, is insider trading a general or specific intent crime? The answer is that "violation of Rule 10b–5 requires 'specific intent,'” which requires the Government "to prove, inter alia, that the defendant 'acted knowingly, willfully, and with an intent to defraud,' and that 'an intent to defraud' [in the context of a tipping case] meant 'an intent to deprive the company in question of the confidentiality of its information.'” U.S. v. Whitman, 904 F. Supp. 2d 363, 372 (S.D.N.Y. 2012), aff'd, 555 Fed. Appx. 98 (2d Cir. 2014)(unpublished).

In sum, it looks like voluntary intoxication might well be a viable defense to an insider trading charge.

Insider Trading: Miller v. Verstein

Two of my favorite corporate law scholars are jousting over insider trading. I like them both too much to try to referee, but both articles are well worth reading:

Verstein, Andrew, Mixed Motives Insider Trading (March 21, 2020). Iowa Law Review, Vol. 106, 2020, UCLA School of Law, Law-Econ Research Paper No. 20-05, Available at SSRN: https://ssrn.com/abstract=3558540 or http://dx.doi.org/10.2139/ssrn.3558540

If you trade securities on the basis of careful research, then you are a brilliant and shrewd investor. If you trade on the basis of a hot tip from your brother-in-law, an investment banker, then you are a criminal. What if you trade for both reasons?

There is no single answer, thanks to a three-way circuit split. Some courts would forgive you according to your lawful trading motives, some would convict you in keeping with your bad motives, and some would hand the issue to the jury. Sometimes called the “awareness/use” debate or the “possession/use” debate, the proper treatment of mixed motive traders has occupied dozens of law review articles over the last thirty years.

This Article demonstrates that courts and scholars have so far followed the wrong reasons to the wrong answers. Instead, this Article takes trader motives seriously, drawing on insights and solutions from the broader jurisprudence of mixed motive. This analysis generates a new legal test and demonstrates the test’s superiority.

Miller, Robert T., Market Practices and the Awareness/Use Problem in Insider Trading Law: A Response to Professor Verstein’s Mixed Motives Insider Trading (November 15, 2022). Iowa Law Review, Vol. 107, No. 162, 2022, U Iowa Legal Studies Research Paper No. 2022-41, Available at SSRN: https://ssrn.com/abstract=4277164

Professor Verstein suggests that we approach the awareness/use problem in insider-trading law by analyzing the mixed-motives of insider traders, and he argues that insider trading should be illegal only when the trader’s primary reason for trading involves proscribed material non-public information (MNPI). To reach this conclusion, he assumes what he calls the “Equal Profits Principle,” which holds that two traders alike in all respects except for their knowledge of MNPI should enjoy the same expected profits from trading. This Response argues that the Equal Profits Principle can be analyzed into the “No Greater Profits Principle” (traders with MNPI should not make more than other traders) and the “No Lesser Profits Principle” (traders with MNPI should not make less than other traders), and that while the No Greater Profits Principle is intuitively plausible, the No Lesser Profits Principle is not. In particular, both classical insiders and potential misappropriators are in contractual relationships with the sources of their MNPI, and the standard market practice is for such persons to agree with the source, in exchange for compensation, to refrain from trading while in possession of MNPI (not merely to refrain from using MNPI to trade). In fact, public companies and other firms regularly in possession of large amounts of MNPI typically adopt insider trading policies that not only prohibit their employees from trading when in possession of MNPI, but also go considerably further, imposing blackout periods (when all trading is prohibited) and pre-clearance rules (which require certain senior employees to pre-clear all their trades with a compliance officer, regardless of whether they are in possession of MNPI). Such policies are efficient in the sense that they produce benefits in excess of their costs, and since they are manifestly incompatible with the Equal Profits Principle (because they violate the No Lesser Profits Principle), that principle is inefficient and very likely untenable. A better way to deal with the awareness/use problem is to follow the market consensus, which strongly favors the awareness rule.

Although not taking sides, as a point of personal privilege, I must note that only Professor Verstein cites the work of yours truly. Tsk.

Insider Trading and Corporate Takeovers: A ProfessorBainbridge.com Video

Insider trading is often said to be the most common violation of the federal securities laws. Insider trading based on information relating to corporate mergers, tender offers, and other acquisitions is a common and potentially very lucrative variant. This video reviews the basic theories of insider trading liability under Rules 10b-5 and 14e-3 as applied to takeovers.

The Senate Takes Up the Execrable Insider Trading Prohibition Act

Liz Dunshee of TheCorporateCounsel.Net reports:

Last week, the “Insider Trading Prohibition Act” was introduced in the Senate – after garnering widespread support in the House last spring. This bill has been circulating for the better part of a decade. But on the heels of the SEC’s proposals to reform Rule 10b5-1 and issuer repurchase disclosures, maybe 2022 will finally be the year we also get an insider trading statute.

At a hearing about this legislation held last week by the Committee on Banking Housing & Urban Affairs, former SEC Commissioner Rob Jackson testified that:

– The Act would close a significant gap in the current common law, by clearly outlawing trading on info obtained through cybersecurity hacks. That’s because the Act’s definition of “wrongful” trading on MNPI would extend to information obtained through theft or unauthorized access, or violation of a Federal law protecting computer data or intellectual property or privacy of computer users.

– The SEC should reconsider foreign companies’ Section 16 exemptions – in order to crack down on apparent insider trading by executives at foreign firms listed in the US. That was the topic of a study released a couple weeks ago by Professor Jackson along with Bradford Lynch and Daniel Taylor, which was reported on by the WSJ.

The Committee also heard testimony from Columbia Law prof John Coffee (who generally supported codifying insider trading law, but took issue with the Act’s murky “personal benefit” standard), as well as University of Chicago Law prof M. Todd Henderson and Heritage Foundation Fellow David Burton. UCLA’s Stephen Bainbridge has also criticized the Act.

She somewhat understates the case by describing my attitude towards this mess as "critical." My article. A Critique of the Insider Trading Prohibition Act, 2021 UNIVERSITY OF ILLINOIS LAW REVIEW ONLINE 231 (2021), https://ssrn.com/abstract=3869222, argues that:

The Insider Trading Prohibition Act of 2021 has been passed by the House of Representatives and, as of this writing, is awaiting action in the Senate. The Act’s proponents claim that it simply codifies and clarifies existing law. In fact, the Act does neither. It likely will expand the scope of insider trading in undesirable ways and introduce new ambiguities into the law.

The ways in which the Act likely will expand the insider trading prohibition, coupled with the new ambiguities it introduces, threatens the central policy on which the insider trading prohibition rests. The Supreme Court has recognized that the work of market analysts and other investment professionals inherently entails seeking information advantages. In turn, as the Court also recognized, that work is an essential part of maintaining efficient stock markets. By increasing the risk of liability, especially in light of the Draconian penalties associated with insider trading, the Act likely will chill this vital activity, to the detriment of all investors.

When a very similar bill passed the House in the 116th Congress, the legislation died in the Senate. The Insider Trading Prohibition Act of 2021 now awaits Senate action. The Senate would be well advised to let this bill die as well.

The SEC is trying to revive the discredited equal access test and turn insider trading by tippers into a status crime

Keith Bishop alerts us to a troubling case:

In Dirks v. SEC, 463 U.S. 646 (1983), the United States Supreme Court found that a tippee may be liable for trading on the basis of material, nonpublic information if he or she knows that the tipper disclosed inside information in breach of a duty and for a personal benefit.  The Court stated that a personal benefit may be inferred when the tipper receives something of value in exchange for the tip or "makes a gift of confidential information to a trading relative or friend".   In Salman v. United States, 137 S. Ct. 420 (2016), the Supreme Court made it clear that the tipper need not receive something of pecuniary value from the tippee, it is enough that the tipper provided the information as a gift to a trading relative or friend.

Yesterday, the Securities and Exchange Commission filed a civil complaint alleging insider trading by two individuals - David Sargent and Christopher Klundt.  Mr. Klundt was employed by the issuer in question and is alleged to be the tipper.  Mr. Sargent is alleged to be the tippee.  The SEC alleges that "Klundt communicated material nonpublic information to Sargent in exchange for a personal benefit or with the expectation of receiving a benefit".  Noticeably lacking is any allegation as to what that benefit was.  The complaint does include several allegations concerning the two defendants' friendship.  It will be interesting to see whether these allegations of the defendants' amity will suffice under Salman and Dirks. 

In effect, what the SEC is trying to do is to turn trading by tippees into a status crime. It is enough in the SEC's view that tipper and tippee are friends. This an extremely aggressive reading of Salman and Dirks.

The SEC's efforts in this area also appear to be an attempt to revive the discredited equal access theory. Under the SEC's approach, if the friend of a tipper has unequal access to information that suffices to hold him/her liable. Which the Supreme Court precedents do not allow.

As I explained in Equal Access to Information: The Fraud at the Heart of Texas Gulf Sulphur, 71 SMU L. REV. 643 (2018), available at https://scholar.smu.edu/smulr/vol71/iss3/3, that test was invented out of whole cloth by the Second Circuit and decisively rejected by the Supreme Court. But the SEC has never accepted that loss and has consistently tried to bring back equal access as the basic test.

Reform Rule 10b5-1 by making executives trade the same amount every day (or week or whatever)

My friend and sometime coauthor Todd Henderson recognizes that SEC Rule 10b5-1 has not prevented use of inside information by corporate executives and has come up with a unique and sensible reform proposal:

The typical big-company CEO makes enough money—more than $24 million in 2020—that he shouldn’t need to sell shares urgently. A CEO can set a goal for the year in dollar or percentage terms and then have those sales spread out evenly over every trading day to diversify his portfolio. No surprises, no allegations of trading in advance of information disclosure, no timing the market and no big risk of front-running.

I think this is an excellent idea, but I would offer what I hope is a friendly amendment: Why not allow CEOs to trade once a week or once a month. For example, the CEO could be obliged to sell the same number of shares on the same day of the week every week of the year. It's not clear to me why allowing the CEO to sell 1000 shares every Wednesday the exchange is open, for example, would not achieve essentially the same result.

SEC takes a crack at expanding misappropriation theory to “shadow” insider trading

My WLF explainer on the SEC's new shadow insider trading case is available here.

CEOs with online social media presence are more likely to have lower self-control and commit insider trading

New study reports:

Prior research finds that online social media usage may lower self-control and encourage indulgent behavior in laboratory subjects. We find that corporate CEOs show similar tendencies: CEOs with online social media presence are more likely to succumb to lower self-control and abuse their information advantage to profit from unethical insider trades. Specifically, CEOs’ social media presence strongly predicts their insider trading activity in terms of incidence, intensity (amount and frequency), and profitability. We further find that the effect is driven by insider buys (not by sells) and is more pronounced for opportunistic buys which tend to contain more material non-public information.

As an active user of Twitter and Facebook, I find all of this a little disconcerting.

My Article "A Critique of the Insider Trading Prohibition Act of 2021" is now online at the University of Illinois Law Review Online

A Critique of the Insider Trading Prohibition Act of 2021, 2021 U. Ill. L. Rev. Online 231 (Aug. 8, 2021), https://www.illinoislawreview.org/online/a-critique-of-the-insider-trading-prohibition-act-of-2021/

The Insider Trading Prohibition Act of 2021 has been passed by the House of Representatives and, as of this writing, is awaiting action in the Senate. The Act’s proponents claim that it simply codifies and clarifies ex- isting law. In fact, the Act does neither. It likely will expand the scope of insider trading in undesirable ways and introduce new ambiguities into the law.

The ways in which the Act likely will expand the insider trading pro- hibition, coupled with the new ambiguities it introduces, threatens the cen- tral policy on which the insider trading prohibition rests. The Supreme Court has recognized that the work of market analysts and other investment professionals inherently entails seeking information advantages. In turn, as the Court also recognized, that work is an essential part of maintaining efficient stock markets. By increasing the risk of liability, especially in light of the draconian penalties associated with insider trading, the Act likely will chill this vital activity to the detriment of all investors.

When a very similar bill passed the House in the 116th Congress, the legislation died in the Senate. The Insider Trading Prohibition Act of 2021 now awaits Senate action. The Senate would be well advised to let this bill die as well.

Yours Truly Quoted in The Motley Fool re the Insider Trading Prohibition Act

From The Motley Fool:

The bill before the Senate would outlaw insiders from trading or tipping in exchange for a "direct or indirect personal benefit." It also states prosecutors don't have to prove a trader knew the info was exchanged for benefit, only that they recklessly ignored its illicit source, thus negating the Newman ruling.

Potential Side Effects: Extensive research is routine for stock traders, and many insider trading cases come down to fuzzy scenarios of analysts seeking an "edge." Distinguished UCLA financial law professor Stephen Bainbridge wrote the proposed legislation could "expand the scope of insider trading in undesirable ways," leading to apprehension among stockbrokers attempting to do legitimate research.

The paper to which he refers is: Bainbridge, Stephen Mark, A Critique of the Insider Trading Prohibition Act of 2021 (June 17, 2021). UCLA School of Law, Law-Econ Research Paper No. 21-08, Available at SSRN: https://ssrn.com/abstract=3869222

Financial Times cites yours truly on the Insider Trading Prohibition Act of 2021

In today's Financial Times, Sujeet Indap reports on the House passed Insider Trading Prohibition Act of 2021. He quotes yours truly:

Another eminent professor, Stephen Bainbridge of University of California, Los Angeles, wrote in a recent paper that TPA will “expand the scope of insider trading in undesirable ways and introduce new ambiguities”. Bainbridge’s specific concern is that the legislation will chill the work that stock traders do to determine asset prices if that work is more easily prosecuted with the help of a misguided law.

The paper to which he refers is: Bainbridge, Stephen Mark, A Critique of the Insider Trading Prohibition Act of 2021 (June 17, 2021). UCLA School of Law, Law-Econ Research Paper No. 21-08, Available at SSRN: https://ssrn.com/abstract=3869222

Abstract

The Insider Trading Prohibition Act of 2021 has been passed by the House of Representatives and, as of this writing, is awaiting action in the Senate. The Act’s proponents claim that it simply codifies and clarifies existing law. In fact, the Act does neither. It likely will expand the scope of insider trading in undesirable ways and introduce new ambiguities into the law.

The ways in which the Act likely will expand the insider trading prohibition, coupled with the new ambiguities it introduces, threatens the central policy on which the insider trading prohibition rests. The Supreme Court has recognized that the work of market analysts and other investment professionals inherently entails seeking information advantages. In turn, as the Court also recognized, that work is an essential part of maintaining efficient stock markets. By increasing the risk of liability, especially in light of the Draconian penalties associated with insider trading, the Act likely will chill this vital activity, to the detriment of all investors.

When a very similar bill passed the House in the 116th Congress, the legislation died in the Senate. The Insider Trading Prohibition Act of 2021 now awaits Senate action. The Senate would be well advised to let this bill die as well.

My essay critiquing the Insider Trading Prohibition Act of 2021 is up at The Harvard Law School Forum on Corporate Governance

You can read it here.

The Insider Trading Prohibition Act (“Act”) passed the U.S. House of Representatives by a wide bipartisan margin on May 18, 2021, and is now awaiting Senate action. The Act’s proponents claimthat the bill makes only modest changes in the definition of insider trading as it has been developed in the courts, while at the same time creating “a clear definition of insider trading . . . so that there is a codified, consistent standard for courts and market participants.” Unfortunately, the Act neither codifies nor clarifies.