SEC Extends the Misappropriation Theory of Insider Trading Beyond Targets of Acquisitions to Companies “Economically Linked” to Such Targets
4 min read
In a landmark action, the US Securities and Exchange Commission ("SEC") filed a complaint alleging insider trading that expands the potential reach of insider trading law. On August 17, 2021, the SEC charged a former employee of Medivation Inc., a mid-sized oncology-focused biopharmaceutical company, with insider trading based on trades he made in advance of the company's announcement that it would be acquired by Pfizer Inc.1 The trades were not, however, in Medivation shares, but in shares of Incyte Corporation, a comparable mid-cap oncology-focused biopharmaceutical company, that had traded similarly to Medivation after a previous announcement of a merger in their sector.
According to the SEC's complaint, just days before the announcement that Pfizer would acquire Medivation at a significant premium, Matthew Panuwat, the then-head of business development at Medivation, purchased "out-of-the-money, short-term stock options" in Incyte. Panuwat allegedly purchased the options in Incyte "within minutes" of learning highly confidential information concerning the merger between Pfizer and Medivation, and allegedly with knowledge that the acquisition of Medivation would likely lead to an increase in Incyte's stock price. Following the announcement of Medivation's acquisition, Incyte's stock price increased by approximately 8%, resulting in $107,066 in profit for Panuwat.
The complaint alleges that, as an employee of Medivation, Panuwat owed Medivation a duty to refrain from using Medivation's information for his own personal gain. Further, the complaint alleges that Panuwat's trading was in violation of Medivation's insider trading policy, which expressly forbade him from using confidential information he acquired at Medivation to trade in the securities of any other publicly traded company (emphasis added). As a result, the complaint alleges violations of the anti-fraud provisions of the US federal securities laws, and seeks a permanent injunction, civil penalty, and an officer and director bar.
Extension of the Misappropriation Theory
The prohibition against insider trading has developed incrementally over the years through rulemaking by the SEC and judicial decisions interpreting the securities laws' anti-fraud provisions. A person or entity can be liable for insider trading under two theories: the "classical theory" and the "misappropriation theory."
Under the classical theory of insider trading, a corporate insider violates the anti-fraud provisions by trading in the securities of their own company on the basis of material non-public information ("MNPI") in breach of a duty owed to that company and its shareholders. By contrast, the misappropriation theory extends liability one step further – to a person who is not an insider at a company (i.e., a corporate outsider, who is not an employee, officer or director) -- and prohibits these corporate outsiders from trading based on MNPI obtained in breach of a duty owed to the source of the information.
The suit against Panuwat, if successful, could expand the misappropriation theory. For example, in U.S. v. O'Hagan2, a partner in a law firm, who was retained to represent an acquiror in a tender offer, purchased stock in the target company prior to commencement of the tender offer. In that situation, the partner owed no duty of trust or confidence to the target or its shareholders. Rather, such duty was owed solely to the acquiror. When the partner misappropriated the acquiror's confidential information (namely, its intention to make the tender offer) for securities trading purposes, the court found that a breach of that duty had occurred. The US Supreme Court in O'Hagan explained that:
"In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary-turned-trader's deception of those who entrusted him with access to confidential information…The misappropriation theory is thus designed to 'protec[t] the integrity of the securities markets against abuses by 'outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders.'"3
If successful, the suit against Panuwat would expand the misappropriation theory of insider trading beyond target companies like the one in O'Hagan to companies that are comparable to those targets and somehow economically linked.
Companies Should Revisit Insider Trading Policies & Consider Additional Trading Restrictions
Looking at this action in combination with SEC Chair Gary Gensler's recent speech and rulemaking agenda scrutinizing Rule 10b5-1 trading plans, it appears that the SEC Enforcement Staff may have the support to aggressively pursue novel theories of insider trading.4 While the SEC has not provided any specific guidance on when it will consider companies "economically linked" for insider trading purposes, companies may want to consider restricting trading in "economically linked" companies to avoid such scrutiny. This could include an assessment of whether material non-public information held by insiders of a company could affect the share price of companies in the same sector or subsector. Further, it may be time to revisit insider trading policies and guidelines on Rule 10b5-1 plans to ensure they are aligned with current best practices.
1 The SEC's complaint is available here.
2 See U.S. v. O'Hagan, 521 U.S. 642 (1997).
4 For more information, see our prior alert, "SEC Statements Suggest Heightened Insider Trading Scrutiny Even if Using a Rule 10b5-1 Trading Plan."
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