Shadow Trading in the Spotlight

• Pages: 30-36
• Date: 01 October 2024
• Author: Hunter Bezner,Jessica B. Magee,Allison Kernisky

30 THE BRIEF❭ Fall 2024

FUNTAP/ISTOCK/GE TTY IMAGES PLUS VI A GETTY IMAGES

SHADOW

TRADING IN

THE SPOTLIGHT

By Hunter Bezner,

Jessica B. Magee, and

Allison Kernisky

In Hollywood movies, evil often lurks in the shadows.

Although “shadow trading,” the U.S. Securities and

Exchange Commission’s (SEC’s) newest theory of insider

trading enforcement, may not have the makings of a box oce

smash horror lm, it has led to some amount of fright and

uncertainty among corporate management and governance

professionals who are watching closely to see what comes

next as shadow trading steps into the agency’s enforcement

spotlight.

The SEC has long enforced the prohibition against illegal

insider trading. While shadow trading is but the newest avor

of insider trading, reviewing the historical underpinnings of

the historically prohibited practices helps highlight the idea

behind this new rendition.

“Insider trading”—the commonly prosecuted and dis-

dained practice—technically has no statutory denition. Yet,

the body of common law developed by courts around the

country over time has led to what most people understand to

be the prohibited practice: buying or selling securities while in

possession of material information not known to the public.

Though a few types—or “theories”—of insider trading have

taken shape over time, the traditional fact pattern involves a

corporate insider (such as an employee, ocer, or director)

trading in their employer’s secur ities based on material, nonpublic

information (MNPI) gained at and about their employer.1

In recent months, the SEC—with some success in courts

to date—has claried (or expanded, perhaps, depending on

one’s perspective) what constitutes insider trading. Specically,

according to the SEC, unlawful conduct can also take the form

of “shadow trading,” using MNPI learned from one company to

engage in a securities transaction involving a dierent company

whose share price is predictably inuenced by the MNPI’s

disclosure.

Shadow Trading: Coming to a Courtroom Near You?

As an example, consider an ocer of a pharmaceutical com-

pany, Company A, who is involved in condential negotiations

for Company A to be purchased by Buyer. On a Friday, the

ocer learns that Buyer has agreed to purchase Company A

and that the sale will be announced the following Monday.

After learning this, but before it is publicly announced, the

ocer buys options for Company B, which she knows is a

competitor pharmaceutical company in a similar market posi-

tion as Company A—even though Company A has a policy

forbidding sales in any company’s securities while in possession

of MNPI. When Company A’s sale is announced, Company B’s

stock price enjoys its own boost, and Company A’s ocer prof-

its as a result. According to the SEC—which recently secured a

jury win in a rst-of-its-kind case on similar facts—CompanyA’s

ocer engaged in unlawful insider trading of a new sort now

commonly referred to as “shadow trading.”

What the exact reach of the SEC’s new shadow insider

trading theory will be is not yet clear. In the example above,

Company A notably had an internal policy forbidding ocers

PUBLISHED IN THE BRIEF, VOLUME 54, NUMBER 1, FALL 2024. © 2024 BY THE AMERICAN BAR ASSOCIATION. REPRODUCED WITH PERMISSION. ALL RIGHTS RESERVED. THIS INFORMATION OR ANY PORTION THEREOF MAY

NOT BE COPIED OR DISSEMINATED IN ANY FORM OR BY ANY MEANS OR STORED IN AN ELECTRONIC DATABASE OR RETRIEVAL SYSTEM WITHOUT THE EXPRESS WRITTEN CONSENT OF THE AMERICAN BAR ASSOCIATION.

PUBLISHED IN THE BRIEF, VOLUME 54, NUMBER 1, FALL 2024. © 2024 BY THE AMERICAN BAR ASSOCIATION. REPRODUCED WITH PERMISSION. ALL RIGHTS RESERVED. THIS INFORMATION OR ANY PORTION THEREOF MAY

NOT BE COPIED OR DISSEMINATED IN ANY FORM OR BY ANY MEANS OR STORED IN AN ELECTRONIC DATABASE OR RETRIEVAL SYSTEM WITHOUT THE EXPRESS WRITTEN CONSENT OF THE AMERICAN BAR ASSOCIATION.