How to Protect Your Firm from Risks Associated to Insider Trading Financial Compliance Regulation

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Insider Trading: The Panuwat Case

How to Protect Your Firm from Risks Associated to Insider Trading

Both the SEC and the DOJ have continued their pursuit of insider trading cases as well as other illegal trading that serve to undermine investor confidence in the securities market. Additionally, the regulators and the enforcers are using ever-increasing sophisticated detection tools, including homegrown artificial intelligence tools and data analytics, to identify patterns that may suggest illegal trading activity. 

In August 2021, the Commission charged and alleged Matthew Panuwat, the former head of business development at Medivation, Inc. of illegal trading on the basis of Material Non-Public Information (MNPI) in violation of a duty owed to the employer against a former employee. What was arguably unique about this case was the allegation that the former employee traded, not in the securities of his employer, but in securities of a peer or economically linked company, whose share price was materially impacted by news of M&A activity in the industry sector. Allegedly, the employer’s policy expressly prohibited such peer company trading.

Some legal experts view the Commission’s case, which is being litigated, as expanding the contours of insider trading law. Nonetheless, registered investment advisers should take note and take immediate steps to enhance their Code of Ethics and their related compliance program policies, procedures and testing regime to address trading in peer or economically linked issuers. Under Rule 206(4)-7 (the Compliance Rule) under the Investment Advisers Act of 1940 (Advisers Act), it is unlawful for a registered investment adviser to provide investment advice unless the adviser has adopted and implemented written policies and procedures reasonably designed to prevent violation of the Advisers Act and the rules thereunder by the adviser or any of its supervised persons. In addition, under Section 204A of the Advisers Act, RIAs are required to establish, maintain and enforce written policies and procedures reasonably designed, taking into consideration the nature of such investment adviser’s business, to prevent the misuse of material, nonpublic information by such investment adviser or any person associated with such investment adviser in violation of the Advisers Act or the Exchange Act or the rules or regulations thereunder. There is no requirement under Section 204A that an underlying violation be found to establish the basis for a violation predicated on a violation of the firm’s policies and procedures. 

Given the conduct and insider trading legal theory alleged in Panuwat, Kroll recommends that compliance officers immediately: 

  • Identify which issuers are reasonably classified as economically linked or peers of the issuer in question; use SIC codes to assist with the identification of such companies.
  • Review and revise as necessary, their insider trading policies and procedures to address the risk of trading in economically linked issuers.
  • Enhance the frequency of their chaperoning of calls with experts and, at a minimum, keep a log of meetings with C-suite contacts.
  • Conduct risk-based reviews of notes of meetings with investment bankers and company insiders.
  • Enhance training and obtain certifications from supervised persons regarding their lack of MNPI.
  • Identify and analyze the firm's data sources, as well as employee trading data; cross-reference with public disclosures of market moving events.
  • Enhance systems used to detect illegal trading.
  • Review and enhance pre-clearance policy for not just equities, but also exotics and derivatives.
  • Review and timely update restricted lists.
  • Perform a look-back analysis to evaluate: a) whether supervised persons or clients traded within a reasonable period ahead of market-moving events involving issuers and those companies that are economically linked to such issuers, and b) whether such trading was based on material nonpublic information.

In 2020, 32 of the 405 standalone cases were related to insider trading and the commission obtained record-breaking monetary remedies in enforcement actions. 

Insider-Trading Examples
  • The Commission charged a compliance analyst working for an investment bank with insider trading. The analyst had broad access to highly sensitive information regarding mergers and other transactions in which his firm was involved. The compliance analyst traded in multiple trading accounts in the names of his parents in small quantities and gained modest profits in his attempt to avoid detection.
  • The Commission charged a Greek national with perpetrating a fraudulent scheme to sell alleged “insider trading tips” on the Dark Web. The Dark Web facilitates anonymity by obscuring users’ identities and allowing users to purchase and sell illegal products and services. The Greek national claimed to be in receipt of insider trade information from sources working at a securities trading firm. The information was sold over the Dark Web by the Greek national. 
  • The Commission charged a clinical trial project manager with trading on inside information. The senior project manager was overseeing a clinical trial and learned of negative efficacy results from the trial. She tipped her husband, who then sold all of his stock ahead of the public announcement. He also tipped his uncle, who also sold his shares. The stock dropped approximately 50%. Public company employees owe shareholders a duty to safeguard public company information and not to personally benefit, directly or indirectly, from the misuse of such information.
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