Shadow Trading: Redefining Securities Regulation
By Aishwari Krishna (CAS ‘25)
Today, a common adage of financial advice involves urging the general public to invest — more particularly, to invest in what they know. However, due to a recent legal decision that broadened the scope of insider trading as an offense, this suggestion could soon result in scrutiny. In SEC v. Panuwat, the Securities and Exchange Commission (SEC) argued to extend the definition of insider trading to include a novel concept: shadow trading. 1 Shadow trading involves leveraging material non-public information about one company to trade securities—financial assets that can be traded—in another, seemingly unrelated company. 2 This expansion marks a significant shift in the legal landscape, potentially placing even well-meaning investors at risk of charges, and has sparked debates on whether this decision aligns with established legal principles of the misappropriation theory of insider trading.
The SEC, a regulatory body founded in 1934, plays a crucial role in preventing market manipulation and ensuring fair practices in the economy. 3 In the case SEC v. Panuwat, the SEC pursued charges against Matthew Panuwat, an executive at Medivation, a pharmaceutical company. While privy to confidential information regarding Medivation’s acquisition agreement with Incyte, a competing company, Panuwat executed trades in Incyte’s securities. 4 Accordingly, on April 5, 2024, a federal jury in the Northern District of California found Panuwat liable for insider trading. 5 This extension of insider trading to cover trading related to a company that is distinct but similarly situated has implications for market participants and the securities regulatory landscape, especially concerning how intent and motivation are established in these cases.
Indeed, establishing the intent behind the trader’s actions is one of the more delicate aspects of insider trading cases, and this extends to SEC v. Panuwat. In traditional insider trading cases, where the trader uses material, non-public information about the company whose securities they trade, intent can often be inferred from the circumstances of the trade itself. 6 Meanwhile, for the charge of shadow trading, the SEC must demonstrate that the defendant intended to use the confidential information to trade in a different company’s securities for personal gain which raises the standard for the burden of proof that must be met. 7
Proving motivation in such cases introduces significant practical challenges — the defendant may argue that the trade was based on public market trends or other factors unrelated to the confidential information. As such, establishing a causal link between the possession of confidential information and the specific decision to trade in a different company’s securities is a task that relies heavily on circumstantial evidence. This makes shadow trading cases more complex to litigate and raises concerns about the standards of proof required to secure a decision against the defendant.
Historically, the law has sought to curb the exploitation of material nonpublic information for personal gain, especially in instances where a fiduciary duty, or a relationship of trust, is breached. The misappropriation theory, established by the Supreme Court in United States v. O’Hagan in 1997, serves as a cornerstone of modern insider trading jurisprudence. 8 Under this theory, a violation occurs when an individual uses confidential information in breach of a duty owed to the source of that information. 9 Typically, this involves a fiduciary or quasi-fiduciary relationship — a legal responsibility to act in the best interest of another party — where the trader exploits material, nonpublic information for personal gain, thereby committing fraud on the information’s source. In Panuwat, however, the SEC expanded this concept by applying it to a scenario in which the trader did not trade in the securities of the company to which he owed a fiduciary duty, but instead traded the securities of a different, though related, company.
The SEC’s case against Panuwat hinges on the idea that by using material nonpublic information about his employer to gain an advantage in trading the stock of a competitor, Panuwat engaged in improper conduct under the misappropriation theory. 10 Specifically, the novel concept of shadow trading derives from the idea that “private information held by insiders can also be relevant for economically-linked firms and exploited to facilitate profitable trading in those firms.” 11 So, in Panuwat’s case, the confidential information regarding his employer’s merger could imply that similar companies, such as the competitor whose stock he traded, could experience a corresponding shift in value.
As such, this raises a critical issue: the materiality — the significance of information in relation to a particular legal matter — and the directness of the information. Since insider trading laws have historically required that confidential information directly pertains to the securities being traded, by charging individuals under shadow trading, the SEC is effectively asserting that information about one company may be material to another, provided there is a “reasonable market correlation.” 12 13 This broadens the traditional boundaries of insider trading, leaving open questions about the constitution of materiality and the type of information that ought to be protected under the misappropriation theory.
This notion of “market connection” was central to the court’s analysis in SEC v. Panuwat, as it established the necessary link between the material nonpublic information about Medivation’s acquisition and Panuwat’s trades in Incyte stock options. 14 The Panuwat ruling used this concept by acknowledging that such information about one company can be material to another company, provided there is a sufficient connection between the two companies within the same market or industry.
In its ruling, the court emphasized that in niche industries — such as the biopharmaceutical sector, where both Medivation and Incyte operated — information about one company can significantly affect the stock prices of other companies within the same market. 15 This is particularly true in industries where there are few comparable companies and where major corporate events, such as mergers, can signal broader industry trends. The acquisition of Medivation by a larger pharmaceutical company, for example, had the potential to increase investor interest in other midsized oncology companies like Incyte, as these companies might also be seen as attractive acquisition targets. 16
Additionally, the court highlighted the role of industry analysts and market observers in establishing this connection. For example, “[analysts] noted the positive impact of the Medivation acquisition announcement on Incyte’s and other peer biopharmaceutical companies’ stock prices.” 17 The court found that this evaluation, combined with the subsequent rise in Incyte’s stock price following the announcement of Medivation’s acquisition, was sufficient to establish a market connection between the two companies. 18 Thus, one of the implications of the Panuwat ruling is the precedent it set for the use of economic and financial analysis to establish market connections between companies, even when they are not direct competitors. In future cases, litigants will likely rely on expert testimony to demonstrate how information about one company can materially affect another.
The ramifications of the Panuwat decision extend beyond mere theory. If shadow trading becomes widely recognized as a form of insider trading, policies ensuring governmental compliance across the financial industry will likely require significant revisions. Firms may need to broaden their compliance measures, effectively restricting employees with access to material non-public information from trading not only in their own company’s securities but also in the securities of competitors or companies within the same sector.
Such broad restrictions could petrify market participation, particularly for individuals working in industries where mergers, acquisitions, and other strategic developments are common. Market professionals, including executives, analysts, and consultants, who have access to sector-wide information may find themselves severely limited in their ability to trade securities, even when their trades are not directly related to their employer’s activities. Perhaps this will newly coin an idiom to encourage investors to trade what they don’t know. In an already complex regulatory landscape, this legal shift raises questions about the balance between preventing fraudulent trading and enabling economic growth through legitimate market participation.
Therefore, SEC v. Panuwat represents a significant development in the field of securities regulation, as it tests the boundaries of insider trading law under the misappropriation theory. By expanding the definition to include shadow trading, the court in this case has taken a bold step toward regulating trading behaviors that, until recently, fell outside the purview of insider trading laws. 19 However, this expansion also raises important legal and practical questions, particularly regarding the standards of proof required to establish intent and the impact this could have on market participation.
As courts grapple with these issues, the outcome of this case will likely shape the future of insider trading enforcement and compliance practices across the securities industry. Should this broader interpretation be upheld, market participants will need to adjust to an expanded regulatory framework, where trading on information about one company could trigger liability when trading in another. In light of this landmark decision, market participants and legal practitioners alike must navigate a delicate balance between safeguarding the integrity of the markets and preserving the right to informed, lawful trading—an equilibrium that may be fundamentally reshaped by the ultimate outcome of SEC v. Panuwat.
Works Cited
SEC v. Panuwat, 702 F.Supp.3d 883 (2023).
Mihir N. Mehta, David M. Reeb, and Wanli Zhao, “Shadow Trading,” Accounting Review 96, no. 4 (2021): 367–368, https://doi.org/10.2308/TAR-2017-0068.
“Mission,” Securities and Exchange Commission, updated August 9, 2023, https://www.sec.gov/about/mission.
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 1–2.
SEC v. Panuwat, 702 F.Supp.3d 883 (2023).
United States v. O’Hagan, 521 U.S. 642 (1997).
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 5.
United States v. O’Hagan, 521 U.S. 642 (1997).
United States v. O’Hagan, 521 U.S. 642 (1997), 652.
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 1–2.
Mehta, Reeb, and Zhao, “Shadow Trading,” 367–368.
United States v. O’Hagan, 521 U.S. 642 (1997).
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 7.
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 7.
SEC v. Panuwat, 702 F.Supp.3d 883 (2023).
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 7.
Complaint, SEC v. Panuwat, Case No. 3:21-cv-06322-WHO, N.D. Cal., (2021), 9.
SEC v. Panuwat, 702 F.Supp.3d 883 (2023).
United States v. O’Hagan, 521 U.S. 642 (1997).