The Securities and Exchange Commission's (SEC or Commission) actions in 2021 demonstrate that insider trading remains a key enforcement priority. While the absolute number of insider trading enforcement actions brought by the SEC has declined in recent years1 the actions brought in 2021 demonstrate the SEC's interest in pursuing new categories of actors and novel theories that push the boundaries of insider trading jurisprudence. As discussed below, the SEC brought its first insider trading case involving the "dark web," where anonymized internet activity has long been suspected to be a breeding ground for unlawful trading, and brought a rare enforcement action involving "shadow trading," which involves trading in the securities of a company about which the person has no direct material nonpublic information (MNPI) while in possession of MNPI about a similarly situated company. The SEC also brought its first securities fraud case against an alternative data provider, which, while not an insider trading matter, may serve as a warning sign of insider trading actions to come. In addition, the Commission brought its second case that uses Exchange Act Section 13(b)(2)(B), a long-standing requirement that public companies maintain internal accounting controls, as a tool to police alleged corporate insider trading activity.
These boundary-pushing cases are not without challenge. Two of the four cases mentioned above are in litigation, and the SEC is currently litigating other insider trading-related matters as well. Notably, one of the SEC's cases predicated in large part on a pattern of trading following contact with a relative who was an insider was dismissed earlier this month before the defendant even had to present any evidence.2 It remains to be seen whether this and other instances of judicial scrutiny will impact the SEC's approach.
Relatedly, the SEC recently released proposed rules to "freshen up" Exchange Act Rule 10b5-1, the rule that provides an affirmative defense against claims of insider trading to corporate insiders and companies that buy and sell company stock pursuant to an appropriately adopted written trading plan. As described in our alert about that proposal, the amendments would impose significant restrictions on the adoption and use (from an affirmative defense perspective) of Rule 10b5-1 trading plans by both individuals and companies.
We will continue to watch for further developments in these areas as well as other insider trading developments at the SEC.
SEC Shines a Light on the Dark Web and Shadow Trading
The "dark web" is a portion of the internet that contains hidden websites that cannot be accessed through traditional web browsers. It allows users to purchase and sell products-oftentimes, illegal products-under the cover of anonymity. While the dark web has long been suspected to be a tool for unlawful insider trading,3 it had not been a subject of SEC enforcement action until this year.
In July, the SEC brought insider trading and other fraud charges against Apostolos Trovias, a participant on the dark web who operated under the pseudonym "The Bull" and sold "insider trading tips" to investors.4 Over the course of several years, Trovias is alleged to have sold such tips through over 100 weekly and monthly subscriptions, as well as through one-off sales.5 According to the complaint filed by the SEC, either Trovias wrongfully obtained and traded on or sold genuine MNPI-in which case he engaged in garden-variety insider trading and tipping-or he made up the alleged MNPI in order to trick his subscribers into believing he was selling inside information-in which case he did not engage in insider trading but did engage in garden-variety securities fraud.6
In August, the Commission brought a rare case predicated on what has been dubbed the "shadow trading" method of insider trading.7 Shadow trading can occur when a person trades in the securities of Company A while in possession of MNPI about Company B, and Companies A and B are similarly situated companies. In SEC v. Panuwat, the SEC charged Matthew Panuwat with insider trading in advance of the public announcement that his employer, Medivation, a midsize oncology-focused biopharmaceutical company, would be acquired by pharmaceutical giant Pfizer.8 Notably, Panuwat did not trade in the securities of Medivation or Pfizer; instead, he is alleged to have bought options in Incyte, another midsize oncology-focused biopharmaceutical company, minutes after Medivation's CEO internally relayed positive news about the potential for a Pfizer acquisition to move forward.9 On the day that the Medivation-Pfizer deal was publicly announced, Incyte's share price went up 8%.10 At the time, Medivation's insider trading policy prohibited employees possessing MNPI about Medivation from trading in securities of Medivation or of other publicly traded companies based on that information.11
The following facts were among those cited by the SEC in support of its theory: that Panuwat, an expert in the biopharmaceutical industry and a former investment banker himself, worked closely with investment bankers advising Medivation; reviewed presentations authored by those investment bankers that discussed Medivation's "peer companies" and "drew close parallels between Medivation and Incyte"; had himself noted to the investment bankers that they may want to consider Incyte a company comparable to Medivation; and knew that, to the extent a large-cap pharmaceutical company was interested in acquiring a mid-cap oncology-focused biopharmaceutical company, there were only a few left to acquire and the acquisition of one made the others potentially more valuable acquisition targets.12 Relatedly, the complaint alleges that Panuwat knew the stock prices of both Medivation and Incyte had risen following the 2015 announcement that a third then-peer firm would be acquired by a large pharmaceutical company.13 These facts are relevant to establishing not only that information about Medivation was material to Incyte but also that Panuwat knew or was reckless in not knowing that the Medivation MNPI was material to Incyte when he traded Incyte securities.
Following this case, it is clear that market participants who come into possession of MNPI about one company need to carefully consider whether to restrict trading not only in that company but also in other, similarly situated companies. However, this presents a potentially challenging line-drawing exercise. And it is a context in which market participants operate at a disadvantage, as they must assess materiality and make determinations whether to trade or restrict trading based on only the facts and circumstances known to them at the time. In contrast, the SEC and other regulators judge market participants' conduct with the benefit of hindsight, i.e., after they see how share prices of one company were potentially impacted by the disclosure of previously nonpublic information about another company. In Panuwat, the SEC alleged numerous facts to demonstrate Panuwat's understanding of the relationship between Medivation and Incyte. It remains to be seen how aggressively the SEC will push shadow trading theories in future cases and whether, for example, the SEC will seek to rely solely on circumstantial rather than direct evidence of scienter. Relatedly, when evaluating how the MNPI of a given company can and cannot be used, market participants must also be mindful of their corporate investment and securities trading policies, nondisclosure agreements, confidentiality agreements, and employment contracts.
Pursuing "Insider Trading" Through Internal Controls
The SEC is continuing to leverage Section 13(b)(2)(B) of the Exchange Act-which requires public companies to devise and maintain internal accounting controls-in the insider trading context, this time in a litigated matter filed in September 2021 against Cavco Industries, Inc. This theory, which the SEC first employed in a settled action against Andeavor in late 2020, is not without controversy. Notably, Commissioners Hester Peirce and Elad Roisman had voted against the Andeavor settlement and objected publicly. At the time, they emphasized that Section 13(b)(2)(B) imposes not a general requirement of internal controls but a specific requirement to devise and maintain appropriate internal accounting controls.14 While Commissioners Peirce and Roisman noted that Andeavor's internal policies "left substantial room for improvement,"15 they questioned whether "it is our role under Section 13(b)(2)(B) to second-guess management's decision processes on matters that do not directly implicate the accuracy of a company's accounting and financial statements."16
The question raised by Commissioners Peirce and Roisman in that settled action-whether Section 13(b)(2)(B) is a proper tool to police compliance by public companies with internal insider trading policies-is now teed up in the litigated Cavco matter. As relevant here, the complaint alleges that Cavco violated Section 13(b)(2)(B) by failing to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that its securities trading would be executed in accordance with its board's authorization, its corporate investment policy, and its securities trading policy.17 In particular, the complaint alleges that although Cavco had an investment policy that imposed certain requirements on corporate investments and an insider trading policy that prohibited employees from purchasing securities while in the possession of MNPI, Cavco's CEO caused the company to purchase the shares of four companies with which it was in ongoing direct merger or joint venture negotiations.18 This was possible, the SEC alleges, because Cavco did not have processes or controls in place to ensure that the investment policy and insider trading policy were being followed.19 Such gaps, the SEC argues, showed that Cavco lacked accounting controls "sufficient to provide reasonable assurances that transactions were executed in accordance with management's general or specific authorization."20
As the case proceeds through litigation, the courts may very well provide needed clarity on the scope of Section 13(b)(2)(B)'s application to securities trading by public companies. As indicated first in Andeavor and now in Cavco, though, the SEC has taken the position that failing to appropriately implement securities trading policies and procedures could be viewed as an accounting controls violation under Section 13(b)(2)(B).
The First Enforcement Action Against an Alternative Data Provider
In September, the SEC brought an action against app data provider App Annie and its founder for securities fraud. While this action-the first against an alternative data provider-is not premised on an allegation of insider trading, it suggests that the Commission may pursue insider trading investigations based on similar fact patterns and analogous theories of liability in the future.
"Alternative data" refers to data about a company that is not in its financial statements, or, as the SEC describes it, "data gleaned from non-traditional sources."21 App Annie collects and analyzes app usage and provides information to trading firms. The case represents the first enforcement action by the SEC against an alternative data provider. In recent years, the SEC's Office of Compliance Inspections and Examinations has repeatedly noted its interest in the use of "alternative data" by market actors, noting in particular questions about whether firms have appropriate compliance policies, procedures, and controls governing use of such data.22
App Annie represented to the companies that provided their data that the data would be aggregated and anonymized before it was provided to trading firms.23 Despite this, the SEC alleged, App Annie incorporated non-anonymized and non-aggregated data into its models in order to make its analyses more valuable to trading firms.24 Additionally, according to the SEC, App Annie misrepresented to its trading firm customers that its analyses were generated in a manner consistent with its terms of service.25 The SEC charged that because App Annie lied to its data sources about how their data would be used, and lied to the trading firms about the content of the data they would then trade on, App Annie engaged in securities fraud.26 Of note, though, the decision was not unanimous-Commissioner Peirce tweeted that the settlement "stretches the 'in connection with the purchase or sale of securities' requirement . . . beyond where I think it should go."27
The App Annie case raises important considerations for any market participant that receives data analyses from third-party aggregators. In App Annie, the SEC identified the trading firms as victims of App Annie's alleged fraud. But in the future, the SEC may be inclined to bring enforcement actions against trading firms based on different facts: Should the trading firms have spotted any red flags about the data or the conduct of the data aggregator? Did the trading firms know, or should they have known, whether the data was obtained, collected or provided improperly? This matter highlights the need for consumers of such information to develop and maintain robust procedures to review the quality of controls at their counterparties and the data they provide.
Other Regulatory (and Legislative) Developments Around Insider Trading
Beyond its enforcement actions targeting insider trading and securities fraud, the SEC is pushing ahead to add additional restrictions on Rule 10b5-1 trading plans to address what Chairman Gary Gensler called "real cracks in our insider-trading regime."28 In June, Chairman Gensler first made a speech endorsing additional regulations to impose cooling-off periods, disclosure requirements, termination limitations, and limits on the number of 10b5-1 plans one can have.29 The SEC's Investor Advisory Committee endorsed changes to the regulations in mid-September.30 On December 15, the SEC released proposed amendments to the 10b5-1 rules31-a separate Client Alert analyzing this proposal can be found here. That same day, the SEC also released proposed rules governing disclosures related to share buybacks32-WilmerHale's Client Alert analyzing that proposal can be found here.
As we reported in prior Client Alerts, legislation that would explicitly define and prohibit unlawful insider trading was passed by the House of Representatives in 2019. However, that legislation was never taken up by the Senate. In the new Congress, this past May, the House again passed an identical bill, which has been referred to the Senate and now awaits consideration by the Senate Banking Committee.33 Our analysis of the prior, identical legislation can be found in our previous Client Alert.
Footnotes
1. In Fiscal Year 2018, the SEC brought 51 insider trading enforcement actions; however, those actions dropped to 32, 33, and 28, in Fiscal Years 2019, 2020, and 2021, respectively. See SEC, Div. of Enforcement, Annual Report 20 (2018), https://www.sec.gov/files/enforcement-annual-report-2018.pdf; SEC, Div. of Enforcement, Annual Report 29 (2019), https://www.sec.gov/files/enforcement-annual-report-2019.pdf; SEC, Div. of Enforcement, Annual Report 29 (2020), https://www.sec.gov/files/enforcement-annual-report-2020.pdf; Press Release, SEC, SEC Announces Enforcement Results for FY 2021, Addendum (Nov. 17, 2021), https://www.sec.gov/news/press-release/2021-238 See Order, Sec. & Exch. Comm'n v. Clark, No. 21-cv-06322 (E.D. Va. Dec. 13, 2021); see also Dean Deal,SEC's Stunning Trial Loss Rattles Its Insider Trading Strategy, Law360(Dec. 16, 2021), https://www.law360.com/articles/1449115/sec-s-stunning-trial-loss-rattles-its-insider-trading-strategy.
2. See Jesse Atlas, Insider Trading on the Dark Web, Forbes (Mar. 25, 2014), https://www.forbes.com/sites/realspin/2014/03/25/insider-trading-on-the-dark-web/.
3. See Complaint at 1, Sec. & Exch. Comm'n v. Trovias, No. 21-cv-05925 (S.D.N.Y. July 9, 2021). According to the Complaint, Trovias' customers purchased securities based on his "tips"-sometimes confirming in writing that they had engaged in profitable trades based on his information. See id. at 9.
4. Id. at 2, 6-7.
5. Id. at 7. In March, the SEC and Department of Justice brought fraud charges against James Roland Jones based on his scheme to sell fake "insider tips" on the dark web. While Jones claimed he was selling his customers MNPI about different companies received from corporate insiders, he did not in fact have any MNPI and was merely giving them his own predictions about stocks based on his research. See Press Release, SEC, SEC Charges California-Based Fraudster With Selling "Insider Tips" on the Dark Web(Mar. 18, 2021), https://www.sec.gov/news/press-release/2021-51; see also Complaint at 4-5, Sec. & Exch. Comm'n v. Jones, No. 21-cv-00659 (S.D. Ind. Mar. 18, 2021).
6. The term "shadow trading" comes from a recently published academic article examining trading that involves "private information held by insiders [that is also] relevant for economically-linked firms and [is] exploited to facilitate profitable trading in [the linked] firms." See generally Mihir Mehta, David Reeb & Wanli Zhao, Shadow Trading, 96(4) Acct. Rev. 367 (July 2021).
7. Complaint at 1-2, Sec. & Exch. Comm'n v. Panuwat, No. 21-cv-06322 (N.D. Cal. Aug. 17, 2021).
8. Id. at 5-9.
9. Id. at 9.
10. Id. at 5.
11. Id. at 5-7.
12. Id. at 6.
13. See Hester Peirce & Elad Roisman, Statement of Commissioners Hester M. Peirce and Elad L. Roisman - Andeavor LLC(Nov. 13, 2020), https://www.sec.gov/news/public-statement/peirce-roisman-andeavor-2020-11-13#_ftn1.
14. Id. In the Andeavormatter, Andeavor's CEO was involved in direct negotiations with another company, Marathon, which was considering an acquisition of Andeavor. As these negotiations were ongoing, the CEO ordered a share buyback, which Andeavor's legal department approved. This approval, the SEC alleged, evidenced Andeavor's insufficient controls because, although Andeavor's securities trading policy prohibited 10b5-1 share buybacks while the company possessed MNPI, Andeavor lacked procedures sufficient to ensure that no one at the company possessed MNPI at the time of the buyback (which, the SEC alleged, the CEO did). See Order Instituting Cease-and-Desist Proceedings ¶¶ 2-3, 14, 17-21, Andeavor LLC, Exchange Act Release No. 90208 (Oct. 15, 2020).
15. See Peirce & Roisman, supran.14.
16. Complaint at 1-4, Sec. & Exch. Comm'n v. Cavco Indus., Inc., No. 21-cv-01507 (D. Ariz. Sept. 2, 2021).
17. Id. at 5-6, 9-10, 14, 17-18.
18. Id. at 22-23.
19. Id.
20. SEC, Div. of Examinations, 2021 Examination Priorities 26 (2021), https://www.sec.gov/files/2021-exam-priorities.pdf.
21. See id., see alsoSEC, Off. of Compliance Inspections & Examinations, 2020 Examination Priorities 14 (2020), https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2020.pdf.
22. Order Instituting Cease-and-Desist Proceedings ¶ 2, App Annie Inc., Exchange Act Release No. 92975 (Sept. 14, 2021).
23. Id. ¶¶ 3, 29-30, 45-47.
24. Id. ¶¶ 18-21.
25. Id. ¶¶ 2-5.
26. @HesterPeirce, Twitter (Sept. 14, 2021, 3:34 PM).
27. Gary Gensler, Chair, SEC, Prepared Remarks CFO Network Summit (June 7, 2021), https://www.sec.gov/news/speech/gensler-cfo-network-2021-06-07.
28. See id.
29. Recommendation of the Investor Advisory Committee regarding Rule 10b5-1, Secs. & Exch. Comm'n Inv. Advisory Comm. (Sept. 9, 2021), https://www.sec.gov/spotlight/investor-advisory-committee-2012/20210916-10b5-1-recommendation.pdf.
30. Press Release, SEC, SEC Proposes Amendments Regarding Rule 10b5-1 Insider Trading Plans and Related Disclosures(Dec. 15, 2021), https://www.sec.gov/news/press-release/2021-256.
31. Press Release, SEC, SEC Proposes New Share Repurchase Disclosure Rules(Dec. 15, 2021), https://www.sec.gov/news/press-release/2021-257.
32. See Insider Trading Prohibition Act, H.R. 2655, 117th Cong. (2021).
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