Last month, Holland & Knight published an alert that broke down the U.S. Securities and Exchange Commission's (SEC) Division of Enforcement (Division) Annual Report for the fiscal year (FY) 2021. Highlights from the report included, among other things, 1) a decrease in total enforcement actions but an increase in newly filed standalone actions, 2) a record-breaking year for the whistleblower program and 3) a continued decrease in admissions of wrongdoing by public company and subsidiary defendants.

In the insider trading space, the agency filed 28 total insider trading actions in FY 2021 – 19 civil actions and nine standalone administrative proceedings – down from 33 total actions in FY 2020.1 Although the insider trading numbers were down year over year, looking at numbers alone is a misguided approach to assessing the Division's focus on insider trading, or any particular case classification for that matter. That is because a lag exists between the time it takes to open an investigation and ultimately file an enforcement action, typically multiple years. A better predictor is to assess whether the Division "pushed the envelope" in any of its matters and whether the frequently evolving case law in the space materially changed during the course of the year. In FY 2021, it did.

Although the agency continued to bring "bread and butter" insider trading actions in FY 2021 against insider trading rings, corporate insiders and individuals perpetuating front running schemes, two of the SEC's enforcement actions prove instructive on how the Division is seeking out new and creative ways to charge individuals with insider trading. This blog post explores these matters below and considers how a recent directed verdict dismissing one of the agency's insider trading actions mid-trial could impact prosecutions going forward.

Pushing the Bounds of Insider Trading

In July 2021, the SEC charged Apostolos Trovias with violating Section 10(b) of the Exchange Act and Rule 10b-52 by perpetrating a scheme to sell "insider trading tips" on the dark web, a part of the internet that requires specialized software to access and is designed to obscure users' identities. According to the SEC's complaint, Trovias told dark web users that his tips consisted of material, nonpublic information (MNPI) from a securities trading firm.3 Though presented as an "insider trading case," the SEC's complaint essentially alleges two alternative theories under Section 10(b): 1) the advertisements were materially false and misleading because the "insider tips" were fictitious or 2) Trovias shared MNPI in breach of a duty of trust and confidence for a personal benefit because the "insider tips" were true.4

The SEC's first – and likely primary – theory is fraud. That theory echoes in many respects a 2009 U.S. Court of Appeals for the Fourth Circuit case in which the defendant was charged with violating Section 10(b) by selling a "Super Insider Tip" via email to prospective investors that wasn't an insider tip at all.5 There, the court upheld fraud charges under Section 10(b) despite a somewhat tangential connection between the defendant's alleged fraud and the emailreaders' purchase of securities.6 Trovias may raise similar issues and could once again test a Section 10(b) fraud theory premised on selling "fake" insider tips – though this time to entirely anonymized dark web users. Given the alternative theories, as the litigation unfolds, it will be interesting to see whether the SEC has to put forth evidence on the insider trading theory, specifically concerning Trovias's breach of duty. Any ruling in that capacity will have far-ranging implications on the agency's ability to police insider trading on the dark web going forward.

Second, in what has come to be known as the "shadow trading" case, the SEC in August 2021 filed an action based on a new variation of alleged insider trading. According to the complaint, Matthew Panuwat was the head of business development at Medivation, a biopharmaceutical company, when he bought short-term stock options in anticipation of the unannounced merger of his company with a separate entity. The twist? Panuwat did not purchase securities in either company associated with the merger. Rather, he bought securities of a similar yet entirely separate biopharmaceutical company, Incyte Corp., with the hopes that news of his company's merger would collaterally boost Incyte's stock. Panuwat never received any direct confidential information about Incyte.

The case is ongoing, and whether the "shadow trading" theory will actually expand the scope of fiduciary responsibilities remains an open question. Although there are several unique facts in the case that may render it an outlier,7 the SEC's misappropriation insider trading theory raises numerous gating questions for insider trading law. For example, it is unclear how the SEC plans to establish that Panuwat traded "on the basis of" MNPI "about that security or issuer" – namely, Incyte – as required by Rule 10b5-1(a).8 Based on existing case law, the SEC will need to establish a novel theory that confidential information about Company A can constitute MNPI about other companies in Company A's industry. The court heard oral arguments on Panuwat's motion to dismiss on Jan. 12, 2022, during which the judge asked, "You'll concede, won't you, there isn't another case where the material nonpublic information that is being used involves some third party, as opposed to the actual employer company?" Only time will tell if the "shadow trading" theory has any long-term viability, but the case will have significant repercussions for insider trading enforcement. Holland & Knight will follow up with a deeper dive after the court rules on the motion.

A Setback for the SEC's Use of Data Analytics?

Despite the SEC's new and novel theories, a recent litigation setback may give the Division some pause on insider trading actions based predominantly on statistical, data-driven circumstantial evidence. A federal judge in the U.S. District Court for the Eastern District of Virginia recently granted a defendant's motion for directed verdict at the end of the SEC's case in chief, dismissing the insider trading case before the defense was required to put on any evidence, finding that the SEC's circumstantial evidence did not support an inference of insider trading. Although the agency presented evidence about the timing of the defendant's communications with his brother-in-law, a former corporate insider, and details on the allegedly suspicious nature of the defendant's trades, the court granted the defendant's oral motion for judgment as a matter of law. The court noted that it had not heard any direct or circumstantial evidence that the defendant actually obtained any MNPI. It is unclear whether the SEC will appeal the court's ruling.

Given the agency's increased reliance on data analytics to identify suspicious trading, this case may be a blow to circumstantial cases where the agency cannot present more concrete evidence of actual MNPI changing hands, a difficult task in the age of ephemeral and anonymized messaging apps. Although some have asserted that the SEC's loss has "rattled its insider trading strategy," this is likely an overblown reaction. The case is a healthy reminder for the Division to not become myopic in the way it analyzes trading data, but there is no doubt the Division will continue to leverage data analytics as a key tool for identifying, investigating and litigating its insider trading prosecutions.

Looking Ahead: What's Likely in FY 2022?

Although the recent directed verdict may prompt the agency to take a closer look at circumstantial-evidence-only insider trading actions, a complete read of the tea leaves suggests a lot of enforcement activity is to follow in FY 2022. In addition to the push-the-envelope theories detailed above, statements by SEC Chair Gary Gensler and proposed rulemaking by the Commission signal the agency is looking to beef up all possible enforcement avenues in the space. The SEC has, for example, already proposed amendments to narrow the availability of the Rule 10b5-1 affirmative defense, which allows corporate insiders to trade securities in accordance with a pre-set trading plan. Gensler said the proposals "would add new conditions to the existing affirmative defense under Rule 10b5-1(c)(1), to help address concerns about potentially abusive practices associated with the use of that defense." As the SEC continues to pursue actions in this space, Holland & Knight will provide updates on noteworthy developments.