Insider Trading Policies: Key Insights and Recent SEC Cases
Be Careful of Unintended Consequences
The United States securities laws prohibit the trading of securities on material inside information. To that end, most public companies have created and require all employees to adhere to the company’s insider trading policy and confidentiality agreements. Generally, these policies require an employee (1) to not trade while in possession of material inside information of the company, and (2) to limit trading by senior executives to established windows around the date of the release of quarterly or annual results. Some companies have gone further and make it a violation of a company’s insider trading policy to trade on material inside information of third parties. Several recent cases, however, highlight that these more expansive insider trading policies can have serious and perhaps unintended consequences.
Recent SEC Shadow Trading Cases
In SEC v. Panuwat, Civ. Action No. 4:21-cv-06322 (N.D. Cal. filed Aug. 17, 2021), the SEC charged Panuwat with insider trading in connection with his purchase of call options in Incyte Corporation (Incyte) after he learned of confidential merger discussions between his company, Medivation Inc. (Medivation), and Pfizer Inc. As a result of the announcement of the Medivation- Pfizer merger, Incyte’s stock rose. According to the SEC's theory of the case, Panuwat engaged in insider trading – under the misappropriation theory – by 1) knowingly misappropriating confidential information regarding a pending merger 2) in breach of a duty he owed to Medivation 3) to purchase Incyte stock. The second element of the SEC’s allegations – breaching a duty he owed to Medivation -- centered around the text of the insider trading policy of Medivation -- his company. Medivation’s insider trading policy expressly forbade employees from using confidential information acquired at Medivation to trade in securities of any other publicly traded company. This allowed the SEC to allege that the use of material inside information that might affect a third party – that Incyte would be affected by merger discussion that Medivation was having with a third party – was a breach of a duty the employee owed Medivation. This allowed the SEC to for the first time successfully allege that a person had engaged in prohibited shadow trading – e.g., trading the in the securities of a company to which the trader did not have direct material inside information, but rather had inside information on another company that might affect the stock of such company.
Recently, the SEC had another victory in connection with its novel shadow trading theory. In SEC v. Bechtolsheim, Civ. Action No. 5:24-cv-01845-PCP (N.D. Cal. filed Mar. 26, 2024), the SEC alleged that Bechtolsheim, who was Arista Networks' (Arista) chair at the time, illegally traded in Acacia options on July 8, 2019, after learning of Acacia's impending acquisition through his and Arista longstanding relationship with another multinational technology company that was also considering acquiring Acacia. Among other things, the SEC alleged that Bechtolsheim's trading on alleged material inside information – material information learned in the course of his employment and applied to trade in securities of a different company – violated Arista's internal insider trading policy and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Arista's insider trading policy prohibited trading while in the possession of material inside information obtained from distributors, vendors, customers and collaborators, among other sources, as well as any other nonpublic information acquired in the course of employment. Once again, the employee’s company’s insider trading policy was seminal to a finding that Bechtolsheim had breached a duty to his company and hence engaged in insider trading.
Expansive Insider Trading Policies Were Key to SEC Victories
What is key to both cases is that both companies had expansive insider trading policies which included prohibiting the trading on material insider information related to another party making it a breach of a duty to the employee’s company. While the SEC has asserted that its shadow trading theory does not require a violation of an employee’s duty to its existing company flowing from a written insider trading or confidentiality policy, both of the cases make clear that the expensive reach of the company’s insider trading policy could support the SEC’s theory.
Key Takeaways About Shadow Trading Decisions and Insider Trading Policies
What should in-house counsel do as a result of these decisions? Here are some key actions that in-house counsel should do:
1) Review the company’s existing insider trading policy to see if it reaches material insider information of, or that might relate to, third parties: If the SEC continues to win at trial on its shadow insider trading cases it may make sense to update the company’s insider trading policy to prohibit trading on material insider information gleaned from any source. In-house counsel will want to balance this with the understanding that expanding the scope of the insider trading policy now could subject their employees to the SEC’s new shadow insider trading theory if it is limited by other circuits to only exist when the employee violates an existing policy of her company.
2) Educate your employees about the use or trading on material insider information that they may gather from third parties: Without adopting or agreeing with the SEC, companies will want to educate their employees on the potential risks of trading on stock of third parties of they have material inside information regardless of whether that material inside information is about their company or relates to or affects third parties, and how that may interact with the company’s insider trading policy and the SEC’s enforcement actions.
3) Privately held companies may want to consider whether to implement an insider trading policy as well: These polices have not been generally thought as unnecessary because the typical insider trading policy is focused on trading in the company’s stock and, since the company is private, there is little risk of that occurring. However, with shadow trading in another company’s stock that is public becoming a possible insider trading violation, private companies should consider whether to implement an insider trading policy that reaches to any information that an employee may glean while at the company and prohibit trading in the stock of any company in which the employee has inside information.
4) Continue to follow the SEC’s actions in this area to glean additional information on whether this new theory will be adopted by other circuits: To date, both of these cases have been brought and resolved in the 9th circuit. It remains to be seen whether other federal circuits will adopt this new approach to insider trading.
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