Insider Trading Under The CSL - There Is No Shadow Of Turning With Thee

Last summer, the Securities and Exchange Commission charged yet another corporate insider, Matthew Panuwar, with insider trading.  This case was unusual because Mr. Panuwar did not trade in the securities of his employer, Medivation, or its yet-to-be announced acquiror.  Instead, he purchased stock options in another in the industry on the basis that the acquisition of Medivation would make that company a more valuable target.  Earlier,  U.S. District Court Judge William H. Orrick's  denied Mr. Panuwar's motion dismiss.   Amongst securities lawyers, the SEC's theory is known as "shadow insider trading".  For a more detailed discussion of Judge Orrick's decision, see this blog post by Cydney Posner.

The California Corporate Securities Law of 1968 also makes insider trading unlawful.  However, unlike the Securities Exchange Act of 1934, the CSL does so expressly.  Corporations Code Section 25402 provides:

It is unlawful for an issuer or any person who is an officer, director or controlling person of an issuer or any other person whose relationship to the issuer gives him access, directly or indirectly, to material information about the issuer not generally available to the public, to purchase or sell any security of the issuer in this state at a time when he knows material information about the issuer gained from such relationship which would significantly affect the market price of that security and which is not generally available to the public, and which he knows is not intended to be so available, unless he has reason to believe that the person selling to or buying from him is also in possession of the information.

Because "shadow insider trading" necessarily involves someone with no relationship the issuer, such conduct does not appear to violate Section 25402.  A further problem would be that the information must be "about the issuer".   It would be quite a stretch for a court to find that information about the acquisition of an unrelated company is information "about the issuer". 

Whether "shadow insider trading" should or should not be illegal, the SEC's case against Mr. Panuwat highlights a deeply troubling aspect of the federal jurisprudence of insider trading.  In the absence of a statute expressly proscribing insider conduct, the courts are forced to fashion theories.  Defendants understandably might feel that the learn only after the fact of the theory pursuant to which they were found guilty.  Mr. Panuwat unsuccessfully argued that until he was charged "no one  .  .  .  ever understood the insider trading laws to prohibit the type of conduct alleged.”  Judge Orrick, however, rejected this argument finding "Although unique, the SEC’s theory of liability falls within the contours of the misappropriation theory and the language of the applicable law." In my view, however, it is a denial of due process to find someone guilty of insider trading based on the contours of a theory.