SEC Insider Trading Case Presents Liability Risk for Employers

In the pivotal insider trading case of Securities and Exchange Commission v. Panuwat, the SEC pursued a theory of what has been termed shadow insider trading.

The SEC’s shadow insider trading theory is a variant of the misappropriation theory of securities fraud. Employers should prepare for the possibility that the SEC may seek to pin some blame on them if policies and procedures fail to account for this form of insider trading.

One challenge the SEC faced in Panuwat is that the defendant didn’t trade in the securities of his employer or the acquirer. The SEC suggested the breach of duty arose in at least one of three ways:

• From the employer’s insider trading policy, which the SEC argued broadly prohibited trading in the securities of any publicly traded company on the basis of inside information
• From an employee confidentiality agreement
• Pursuant to a legal principle of “entrustment with confidential information”

Because the SEC’s victory came in the form of a jury verdict, there is no opinion articulating the basis on which the jury concluded the defendant breached a duty to his employer by using information he learned through his employment to trade in another company’s securities. As a result, employers are left wondering what the Panuwat verdict means for them and their employees.

One thing is clear: The SEC will chalk this win up as validation. SEC enforcement chief Gurbir Grewal reportedly suggested that if the agency received an adverse verdict at trial, it should think twice about bringing a similar case. Having now passed this test, it’s safe to assume the inverse is also true.

Below are some provisions under which the SEC may attempt to extend shadow insider trading liability to employers.

Section 15(g) of the Securities Exchange Act of 1934 and FINRA Rule 3110. Broker-dealers must establish and maintain supervisory procedures reasonably designed to prevent misuse of material non-public information and otherwise achieve compliance with applicable securities laws, regulations, and Financial Industry Regulatory Authority rules.

Section 204A of the Investment Advisers Act of 1940. Investment advisers must maintain and enforce written policies and procedures reasonably designed to prevent misuse of MNPI by the investment adviser or any person associated with them.

Item 408(b) of Regulation S-K. Publicly traded companies must annually disclose information regarding their insider trading policies and procedures, including the policies and procedures, which must be reasonably designed to promote compliance with insider trading laws, rules, and regulations.

Section 20(a) of the Exchange Act. The SEC may allege an employer is liable as a “control person” for the insider trading violations of an employee. Generally, a person, which includes an organization, may be deemed “controlling” if it had the power to control the insider trader’s predicate misconduct.

A control person may avoid liability if it “acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.” This “good faith” defense can be established by showing that reasonable measures were taken to prevent the violation, which may lead to a review of the adequacy of supervisory policies and procedures.

Section 21(a) and (b) of the Exchange Act. The SEC may seek civil penalties against an employer who knowingly or recklessly failed to prevent an individual’s insider trading, or to establish, maintain, or enforce an insider trading policy, and such failure substantially contributed to or permitted the violation.

Section 15(b)(4)(E) of the Exchange Act. The SEC may assert that an employer has “aided and abetted” insider trading if the employer willfully procured the violation or failed to reasonably supervise an individual.

An employer may avoid a “failure to supervise” charge if there was a system for applying procedures reasonably expected to prevent and detect such violation, and the employer reasonably discharged its duties under those procedures and systems without reasonable cause to believe there was noncompliance.

The SEC’s shadow insider trading theory has hurdles to clear before achieving long-term viability, including post-trial challenges filed by the defendant and potentially an appeal.

Employers should take note of existing laws and rules that may expose them to liability for the actions of their employees. They may consider whether to reference shadow trading in their policies, and if so, whether they will prohibit trading based on MNPI in any public company, or a smaller subset of direct competitors, vendors, or other related companies.

Companies should carefully consider these issues, as SEC scrutiny will likely grow.

The case is Securities and Exchange Commission v. Panuwat, N.D. Cal., No. 3:21-cv-06322, jury verdict 4/5/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Michael Gilbert is partner in the governmental practice at Sheppard Mullin.

Christopher Bosch is an associate in the governmental practice at Sheppard Mullin.

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