Shedding More Light on the World of Shadow Trading: So Many Questions… We’ve Got The Answers
During our recent webinar, A Regulator & A Prosecutor Walk Into A Bar: Shadow Trading Unveiled, hosted by StarCompliance (Star) for the regulatory compliance community, the level of engagement was extraordinary. With so many insightful questions from attendees, we couldn’t address them all during the live session. Fortunately, Howard A. Fischer, former SEC Enforcement Attorney and Partner at Moses & Singer, generously extended his time with us to provide answers to your outstanding questions.
As part of our continued efforts to have meaningful discussions, to follow are the Top Eight Questions we didn’t have time for. Also note, the entire webinar is available to view on demand here.
What Can Compliance Officers Do To Mitigate Firm Risks When Addressing Shadow Trading?
The best way to mitigate firm risk for shadow trading is to:
- Make sure your firm has a policy in place
- Effectively communicate the policy
- Ensure that employees have received and understand the policy
A shadow trading policy should clearly specify that improper trading based on material non-public information (MNPI) may extend beyond securities of the employing company or its direct counterparties to include those of companies with potential economic ties to them.
What Is The Duty Needed For Shadow Trading?
Like in other insider trading cases, there must be a duty to keep information confidential. That duty can arise by contract (e.g. as part of a firm’s policies and procedures, or an employment agreement) or as a result of one’s position (i.e., an executive might have a duty to keep MNPI confidential regardless of any contractual obligation).
With Shadow Trading, Does There Always Need To Be An Economic Link To Another Firm?
Determining what constitutes an “economically linked” company remains challenging, as this area of law is still evolving. In many cases, it may come down to subjective intent: did the trader believe that the MNPI they received about one company would materially impact the price of another company’s security?
A key question to ask is: Would I have made this trade without the information obtained through my employment? If the answer is No, that strongly suggests a potential compliance risk.
An Industry Compliance Consultant Has Suggested That Firms May Face Less Risk If They Avoid Implementing A Specific Shadow Trading Policy, As Recent Novel Cases Have Primarily Targeted The Companies Involved. What Are Your Thoughts On This Approach?
Insider trading cases are based on a duty to maintain the confidentiality of MNPI, either due to a fiduciary relationship or a contractual obligation. In both the Panuwat and Bechtolsheim cases, this duty was explicitly outlined in company policies.
In Panuwat, the insider had signed an agreement prohibiting the use of MNPI to trade securities of other companies. Similarly, in Bechtolsheim, the policy barred the misuse of nonpublic information related to external entities such as distributors, vendors, customers, collaborators, suppliers, and competitors. It also stated that nonpublic information obtained during employment at Arista Networks could only be used for legitimate business purposes and must comply with relevant nondisclosure agreements.
It may be tempting to assume that the absence of a specific policy reduces risk. However, in recent years, the SEC has taken an increasingly aggressive stance in sanctioning firms for failing to implement adequate policies to prevent securities law violations—particularly regarding the protection of MNPI—even without clear evidence of wrongdoing. While not having a defined policy might make it more challenging for the SEC to build a case against an individual, it could ultimately expose the firm to greater regulatory risk.
Is There Any Threshold Of Correlation That Could Be A Useful Guideline?
Establishing clear rules for correlation in shadow trading is challenging, as the doctrine is still in its early stages. A key question remains: how broadly will the SEC interpret “economically linked” firms?
Consider an insider at a car company who notices a rise in car loan defaults and subsequently bets against financial stocks, anticipating a broader economic slowdown affecting finance or even mortgage markets. While connections between companies within or across industries may seem obvious in hindsight, those links may have been tenuous at the time of the trades. In this scenario, if car loan defaults are later followed by mortgage defaults, regulators might be tempted to retroactively establish a causal link—despite it being speculative or unforeseeable when the initial trade occurred.
The concern is that regulators may take an overly broad, hindsight-driven approach. The mere fact that two securities moved in tandem should not, in itself, be considered sufficient evidence of meaningful correlation for enforcement purposes.
In The Bechtolsheim Case, It Seems That The Individual Traded Based On Inside Information Because He Traded On The Basis Of Inside Information Shared By His Business Partner, So Not So Much Shadow Trading But Plain Insider Trading. I Can See A Difference With The Panuwat Individual Who ‘Estimated’ Price Movement In Another Company. Can You Clarify?
While the Bechtolsheim case is definitely less egregious than Panuwat, what both have in common is that they involve trading based on the perceived intent of other parties (rather than on the firm at which the insider trader worked). Many SEC observers view Bechtolsheim as an extension of the doctrine outlined in Panuwat.
Re: The Panuwat Case, I Thought While Medivation And Incyte Were In The Same Industry They Weren’t Direct Competitors But Rather Considered Somehow “Connected.” Also, I Don’t Think Incyte Was Acquired. Its Stock Price Increased Based On The Premise That It Might Get Acquired. Can You Clarify These Two Items?
Both Medivation Inc. (where Matthew Panuwat, the defendant, worked as head of business development) and Incyte Corp. were mid-cap oncology-focused biopharma companies. (For those interested, the SEC Complaint can be found here)
Incyte’s share price increased not due to an actual acquisition, but because analysts speculated that it would be. According to the SEC, part of Panuwat’s motivation stemmed from his experience working with investment banks engaged in Medivation’s potential acquisition—having previously been an investment banker himself. These banks suggested that Medivation and Incyte were in similar positions, that the pool of mid-cap oncology research firms available for acquisition was limited, and that analysts categorized both companies within the same market segment.
Some SEC observers believe that these particular facts make the Panuwat case an outlier. However, it is not unusual for the SEC to build prosecution theories by focusing first on the most obvious cases. Then, once they have established a template, they move to prosecute more broadly.
And finally, we promised a response to every question, so for the audience member who wanted Howard’s perspective on Crypto… here it is!
Speaking Of Pump-And-Dump Schemes, What’s Howard’s View On The Recent Memecoin Launched By POTUS And FLOTUS?
For those who are hoping that the SEC will pivot from a regulation through enforcement approach to a regulation through regulation approach (with notice and comment), there is some concern that an embrace of some of the shadier aspects of digital assets might tarnish the industry and retard general acceptance. If the world of crypto and related assets becomes a lawless hellscape of grift and manipulation, then ultimately the most cynical naysayers will be proven right. It would be far better for Congress to enable the SEC and the CFTC to write regulations, on a tight timeframe, so that there can be an agreed upon framework that protects all participants, including investors and industry representatives.
Looking Ahead
Regulatory expectations around MNPI, conflicts of interest, and insider trading continue to evolve, with increasing scrutiny from regulators worldwide. As enforcement actions rise and new compliance mandates emerge, firms must take proactive steps to mitigate risk. Strengthening compliance frameworks is not just about meeting regulatory requirements—it’s about protecting employees, fostering investor trust, and ensuring business integrity.
To learn more about Star’s solutions for managing shadow trading risks, schedule your personalized demo here.
Disclaimer: The above does not constitute legal advice or an opinion of Moses & Singer LLP or any member of the firm. It does not create or invite an attorney-client relationship and may be rendered incorrect by future developments. Feel free to reach out to me at HFischer@mosessinger.com or 212-554-7872 if you want to discuss further.
