We Are Living in a Material World: Ways for Companies to Mitigate Insider Trading Risk

One would think that individuals would avoid illegal insider trading like the plague. The general maxim to apply to avoid insider trading is simple: “Don’t trade in a public company’s securities while you’re aware of material non-public information.”

Also, surely the fear of potential fines, jail time, disgorgement, and being banned from serving as an officer or director of a public company is discouraging, right?

Apparently not, based on the number of recent insider trading-related civil and criminal enforcement actions brought by the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ).

This article will:

• Provide a refresher on what insider trading is
• Discuss challenges companies face with insider trading compliance
• Share a few noteworthy insider trading-related enforcement actions
• Offer strategies to help companies mitigate insider trading risk

Insider Trading: A Quick Refresher

Let’s start with what insider trading isn’t. As US Attorney Damian Williams stated last year in connection with the announcement of charges brought in four separate insider trading cases:

Insider trading is not a quick buck. It’s not easy money. It’s not a sure thing. It’s cheating.  It’s a bad bet. It’s a ticket to prison. Because my Office, the Southern District of New York, is watching. And we’re working quickly to investigate and prosecute anyone who corrupts our financial markets. And we’ll keep at it as long as it takes. You can bet on that.

There isn’t a federal statute that explicitly defines and prohibits insider trading. Instead, what we have is a long history of case law and administrative actions applying anti-fraud provisions of the federal securities laws.

At its core, insider trading is the trading of a company’s security (i.e., stock, debt, equity) based on material nonpublic information (MNPI), where the individual (or entity) violates a duty of trust or confidence owed to the company, shareholders, or the source of the information.

Information is material if a reasonable investor would consider it important in making an investment decision. Additionally, information isn’t public if it hasn’t been widely disseminated in a manner that makes it generally available to investors (e.g., news release or SEC filing), and enough time has passed for that information to be absorbed (e.g., two full trading days).

Even without getting deeper into the weeds, certain clear-cut cases generally don’t require a law degree or the need to have read a 70-page treatise on insider trading to understand that those cases don’t pass the smell test.

Easy cases include the recent one involving an employee who became aware of significantly positive news about his company’s drug trials and then decided to trade on that information before it became public, and another where a former FBI special agent trainee looked through his girlfriend’s documents to learn about a confidential deal and then traded based on that information.

The cases that tend to pose the most challenges for public companies and their insider trading compliance programs are, as you would expect, not that straightforward. More on that later.

As for the consequences associated with insider trading, they can be severe. They include both civil and criminal penalties. Individuals found liable for insider trading may face hefty fines, disgorgement of profits, and prison time.

They may also be banned from trading securities in the future and that’s separate from reputational damage.

Companies implicated in insider trading violations, as a function of their own trades or for failure to maintain an adequate insider trading compliance program, may suffer reputational damage, regulatory scrutiny, and loss of investor confidence, all potentially leading to financial penalties and legal actions.

The Evolving Nature of Insider Trading Enforcement Actions

Insider trading remains an enforcement priority for the SEC and its use of data analytics continues to take center stage in enforcement actions announcements.

The SEC has been implementing the use of data analytics in insider trading investigations since at least 2015 and based on the steady number of insider trading-related enforcement actions year over year, it seems to be helping.

Additionally, given the increased number of disclosure requirements that public companies have become subject to, including those related to cybersecurity and 10b5-1 plans, the SEC will likely have more data to mine to uncover insider trading.

This isn’t to say that the SEC is batting 1.000 when using data analytics in insider trading enforcement actions, but based on its enforcement results over the years, the SEC does appear to be getting hits often and getting more at-bats in the way of frequently unearthing suspicious trading activity.

What follows are a few notable SEC enforcement actions that companies should be aware of.

Shadow Trading, the New Flavor of Insider Trading: SEC v. Panuwat

In August 2021, the SEC brought insider trading charges against Matthew Panuwat, the then-head of business development at Medivation, an oncology-focused biopharmaceutical company.

The charges stem from a trade in securities that Panuwat made in Incyte, another oncology-focused biopharmaceutical company.

The SEC alleged that Panuwat invested in Incyte only after becoming aware that Medivation was on the verge of being acquired by a large pharmaceutical company. Up to that point, Panuwat was part of a working group tasked with exploring Medivation’s strategic options, which included a possible merger.

As part of that process, Panuwat reviewed confidential presentations prepared for Medivation that included comparable companies in the biopharmaceutical industry. One of those peers was Incyte.

The SEC alleged that Panuwat knew large-cap pharmaceutical companies were interested in acquiring oncology-focused companies like Medivation and Incyte.

Additionally, the SEC alleged that Panuwat knew that to the extent that one of those companies was acquired, it would potentially be material to the remaining companies. That is, those companies would potentially be more valuable acquisition targets, which in turn could positively affect their stock prices.

The SEC’s case relies on an expanded view of the misappropriation theory of insider trading, which applies when a person commits securities fraud when they misappropriate confidential information for securities trading purposes, in breach of a duty owed to the source of the information.

Before Panuwat’s case, misappropriation theory typically came up in the context of external service providers, like lawyers and accountants, or friends or family members learning of information that they knew or had reason to know was confidential regarding a particular company. With that information in hand, those individuals executed a trade based on that information.

Panuwat’s situation was unique since he arguably didn’t have MNPI regarding Incyte’s business and Incyte wasn’t directly involved in Medivation’s merger discussions.

In attempts to get the SEC’s case dismissed, Panuwat argued that just because he was aware of confidential information regarding Medivation, that information wasn’t material to any other allegedly similar biopharmaceutical company.

The court agreed with the SEC’s view that one can infer that because Panuwat was aware of confidential information about Medivation and because Medivation and Incyte were connected as part of a particular subset of the biopharmaceutical market, Panuwat was aware of information that was material to Incyte.

At this point and unless a settlement occurs, the next phase is trial, which is scheduled for the end of March. See this Proskauer Rose article for more information.

This is the first time that the SEC has applied this novel “shadow trading” theory of insider trading. Given that the court has already blessed the theory, we should expect the SEC to leverage the theory in other cases.

At least based on recent reports, the SEC may have several opportunities to investigate potential shadow trading cases.

“Off Channel” Communications May Help Prove Insider Trading: SEC v. Wygovsky 

In March 2023, the SEC filed insider charges against Sean Wygovsky, a former trader at a Canadian asset management firm, and Christopher Matthaei, a former partner at a US broker-dealer.

Wygovsky learned MNPI about upcoming special purpose acquisition company (SPAC) mergers from his employer’s involvement in transactions related to the mergers.

Wygovsky allegedly used an encrypted messaging service, Telegram, among other methods, to share that information with Matthaei, his close friend and trading client. Matthaei allegedly traded on that information and earned more than $3.4 million in profits.

What makes this case notable is the SEC’s focus on Wygovsky’s and Matthaei’s use of Telegram. The SEC’s complaint described Telegram as a service that offered the ability for users to have “secret chats.”

Even Telegram’s website describes its messages as “heavily encrypted and can self-destruct.” It evokes “this tape will self-destruct” vibes à la Mission Impossible and the complaint was drafted in such a way that one reading it would presume that Wygovsky and Matthaei used Telegram for nefarious reasons.

A general takeaway, and perhaps more a reminder, is that anything you put into the ether electronically is forever. How the SEC could delve into the “self-destructing” Telegram messages of these individuals was likely just a matter of searching their phones for the messages.

From an insider trading perspective, we should expect that the SEC would assume the worst if an individual suspected of insider trading is using Telegram, or a similar service, to communicate. Besides, as we have discussed previously, messaging apps like Telegram have been a shiny new object for the SEC as of late.

Insider Trading Risks Amplified by Work-From-Home: SEC v. Loudon 

In February 2024, the SEC filed insider trading charges against Tyler Loudon. The SEC alleged that Loudon, while he and his wife were working from home, overheard several of his wife’s work conversations about a proposed acquisition that her company, BP, was contemplating.

There were also a few instances when Loudon’s wife discussed aspects of the acquisition with her husband “during the normal course of marital communications.”

Unbeknownst to his wife, Loudon purchased shares in the company that BP had targeted for acquisition and immediately sold those same shares after the deal was announced. He profited $1.76 million from the trade.

Husbands behaving badly in the context of insider trading cases isn’t anything new; however, the complaint, in this case, is interesting given how much emphasis the SEC placed on explaining what Loudon’s wife did after Loudon told her of the trades.

According to the complaint, Loudon told his wife that he made the trades “because he wanted to make enough money so that she did not have to work long hours anymore.”

As chivalrous as Loudon may have thought that rationale would have landed, the complaint noted that Loudon’s wife was “[s]tunned by the revelation” and that she “reported the trading to her supervisor at BP.”

The SEC went on to explain that BP reviewed all of Loudon’s wife’s emails and texts but didn’t find evidence that she knowingly leaked the information or knew of his trading. BP nevertheless ultimately terminated her employment.

Interestingly, the SEC’s complaint gave more insight into the Loudan’s marital drama than I can recall having seen in other insider trading-related cases involving spouses. From the complaint:

After Loudon’s confession, Loudon’s wife moved out of their house and generally ceased all contact with Loudon. A few weeks later, Loudon delivered a handwritten note to his wife apologizing for violating her trust and asking for her forgiveness. Loudon’s wife initiated divorce proceedings in June 2023.

The complaint serves as a stark reminder of how this work-from-home era can increase the likelihood of insider trading violations.

The good news for individuals who get caught up in situations like the one that Loudan’s wife found herself in is that there are ways to protect yourself.

In Loudan’s wife’s case, the steps that she took after the fact (e.g., reporting to her boss, moving out of the house, and filing for divorce) likely weighed heavily on the SEC’s decision not to bring charges against her.

As discussed next, Loudon’s wife could have taken steps before any of this happened to better protect herself and the company.

Strategies to Help Better Mitigate Insider Trading Risk

Companies need to maintain strong insider trading compliance programs to help keep pace with the SEC’s insider trading enforcement strategies and the courts’ interpretations of what insider trading is.

While no program is foolproof, what follows are a few ways to help to better protect your company, directors, officers, and employees from inadvertent insider trading violations.

Revisit Insider Trading Policies

It’s a good idea for companies to revisit their insider trading policies on an annual basis. This provides an opportunity to refresh for new legal developments and requirements, as well as for changes to your business.

Notably, as part of the SEC’s recent rulemaking activities, public companies will be required to file their insider trading policies as an exhibit to their annual reports on Form 10-K or Form 20-F, for 2024, filed in 2025.

For public companies that haven’t historically made their insider trading policies available to the public, which is most, this new requirement may subject them to increased scrutiny from regulators, investors, the media, and proxy advisory firms, especially in the case of alleged insider trading cases.

See this article from Shearman & Sterling for a suggested approach to refreshing insider trading policies ahead of the SEC’s new disclosure requirements.

Conduct Annual Live In-Person Training

Annual insider trading training for directors, officers, and employees is table stakes for public companies. Pre-recorded video-based training has become a popular method of training individuals on insider trading.

While that method of training can be good, live training, whether virtual or in-person, is better. The rationale here is that live training carries the benefit of helping to ensure that the training is tailored to your company, including discussions of recent legal developments, like the ones discussed in this article.

Additionally, live training allows your employees to ask questions, something a pre-recorded, video-based training format isn’t suited for.

On this point, remember that Woodruff Sawyer provides customized training on insider trading policies to our D&O insurance brokerage clients at no additional cost. These are anecdote-driven sessions that directors, management teams, and employees typically find valuable and engaging, and are just one of many training modules we offer to help our clients improve their risk profiles.

Encourage Employees to Have a Household Conversation about Insider Trading

As many employees continue to work from home, either exclusively or on a hybrid basis, an easy way to better protect your employees and your company is to suggest that your employees sit down with members of their household and say a few words about confidentiality and insider trading.

You could use a version of the following:

“I want you to know that you may hear me talk about [company name] or other companies.  Assume what you hear is confidential. Don’t share it with anyone, and don’t trade based on the information. Sharing or trading on this information could result in your violation of insider trading laws, including the potential for fines and prison time. As a general matter, best if you don’t trade in [company name] stock.”

While having this conversation may feel a bit awkward for some, it’s important to remember that the SEC has cited similar conversations in decisions where they have chosen not to bring insider trading charges against individuals.

Ensure Effective Information Flow

Individuals tasked with administering a company’s insider trading compliance program cannot be effective if they lack a comprehensive understanding of the key matters relating to the company (e.g., anticipated regulatory approvals, cybersecurity threats/breaches, changes in outlook, or product recalls).

This is easier said than done, of course. While there isn’t a “one size fits all” model to ensure proper information flow, a first step would be to identify the internal stakeholders that may be aware of the company’s key matters at any given time. 

As companies grow, including by adding business units, it may be worthwhile for the individual(s) administering the company’s insider trading compliance program to periodically meet with these internal stakeholders as a group to talk through any current or anticipated key matter or disclosures.

Another benefit to this approach is that it may help to avoid disclosure controls and procedures violations that the SEC has been bringing more frequently. In those cases, the general theme has been that the right information wasn’t reported up the chain to those making disclosure obligations.

Utilize 10b5-1 Trading Plans for Directors and Officers

Even considering the SEC’s changes to the rules on 10b5-1 trading plans, companies should still encourage their directors and officers to put these plans in place to trade in company securities.

As a reminder, a good 10b5-1 trading plan can help to avoid the headache of insider trading allegations, as well as drawn-out SEC investigations.

Parting Thoughts

The world of insider trading compliance isn’t just about avoiding legal pitfalls for your company and employees, it’s also about safeguarding your and your company’s reputation.

Recent cases, like the ones discussed above, underscore the importance of staying in tune with the evolving world of insider trading law and regulatory developments to help design and maintain a robust insider compliance program.

Remember: Optics matter and the SEC has the benefit of hindsight. So, if there could be a question, even a small chance, as to whether an employee or the company’s decision may be impacted by MNPI, it is worth waiting for a clearer day to trade.