“Shadow Trading” Case Will Proceed in California Federal Court

A judge in the Northern District of California has denied the defendant’s motion for a new trial in a novel Securities and Exchange Commission case that significantly lowers the bar for a charge of insider trading. Freshfields law firm analyzes the case, which involves the concept of “shadow trading” on its website.

In SEC v. Panuwat, the defendant was alleged to have used material non-public information to make profitable stock trades. But he did not make the trades in shares of the company where he worked as a pharmaceutical executive- he did so using shares in a competitor company. This scenario, which the SEC has not flagged before, has been dubbed “shadow trading.”

The judge’s order foreclosed further challenges by the defendant at the trial court level. An appeal to the Ninth Circuit and beyond remains a possibility.

In his holding, the judge granted two of the three remedies sought by the SEC. Panuwat was ordered to pay $321,197.40, which is three times his profit on the trades and the maximum civil penalty under the Insider Trading Sanctions Act of 1984.

He was also enjoined from future securities laws violations. The judge declined to bar him from serving as a company officer or director in the future. The Department of Justice did not file criminal charges.

Panuwat is likely to open the door to similar actions by the SEC, according to the writers. They also note that in this “post-Chevron world,” where the SEC can no longer seek penalties by way of its own administrative proceedings, those actions will proceed in the federal courts, and they will be costly to defend.

After Panuwat, there are arguments pro and con for companies to update their internal policies to explicitly address the conduct that gave rise to the case. One factor in the equation will be how directors and officers (D&O) insurance providers react- they may decide to raise rates for companies that do not explicitly prohibit shadow trading.

“Sensitizing employees to the risks involved remains a best practice, regardless of the merits and eventual outcome of an enforcement action,” Freshfields concludes.