Securities Snapshot
January 25, 2022

Northern District of California Validates SEC’s “Shadow Trading” Theory of Insider Trading Liability

Northern District of California Validates SEC’s “Shadow Trading” Theory of Insider Trading Liability; Seventh Circuit Reverses Dismissal of Stockholder Derivative Suit Against Boeing Based on Forum-Selection Bylaw; Delaware Court of Chancery Denies Expedited Proceedings in Breach of Fiduciary Duty Suit Against Arena Pharmaceuticals Directors.

On January 14, 2022, the U.S. District Court for the Northern District of California denied defendant Matthew Panuwat’s motion to dismiss the SEC’s first major insider trading enforcement action involving allegations of “shadow trading.” The SEC’s complaint alleges that Panuwat used confidential information he learned about Pfizer, Inc.’s acquisition of Medivation, Inc., a mid-sized oncology-focused biopharmaceutical company for which he was a business development executive, to buy stock options in Incyte Corp., another mid-cap oncology-focused biopharmaceutical company whose value Panuwat anticipated would materially increase when Pfizer’s targeted acquisition became public.

Relying on the misappropriation theory of insider trading, the SEC asserted claims against Panuwat under Section 10(b) of the Securities Exchange Act of 1934, and Rule 10-b5 promulgated thereunder. Panuwat moved to dismiss the claims against him. In addition to arguing that the SEC failed to adequately plead any claim under Section 10(b) because, among other things, the information he allegedly learned was about Medivation and not Incyte, Panuwat argued that the SEC’s “novel application of the misappropriation theory” would improperly expand the scope of insider trading laws to make those laws “entirely unclear” in violation of his due process rights. The court rejected both arguments, allowing the case to proceed.

In denying Panuwat’s motion to dismiss, the court first addressed Panuwat’s arguments that the SEC’s claims were not adequately pleaded. The court found that the SEC had adequately pleaded the materiality of the information Panuwat received, siding with the SEC’s interpretation of Section 10(b) and Rule 10-b5, in holding that the SEC’s claims could survive based on Panuwat’s possession of material nonpublic information about the Pfizer-Medivation merger, even without an allegation that Panuwat possessed material, nonpublic information about Incyte. The court next found that the SEC stated a claim for breach of a duty imposed by Medivation’s insider trading policy, which applied to “securities of another publicly traded company, including” those of “a significant collaborator, customer, partner, supplier, or competitor of Medivation.” The court rejected Panuwat’s argument that, because Incyte did not fall into one of these five enumerated categories, the SEC had failed to state a claim, reasoning that the categories were “mere examples of what was covered,” and not an exhaustive list. Finally, the court rejected Panuwat’s arguments that the SEC had not properly pled scienter, reasoning that the alleged circumstances were sufficient to find Panuwat acted with the requisite state of mind. Specifically, the court found it significant that Panuwat did not purchase the Incyte stock options until after he received an email from Medivation’s CEO about the Pfizer acquisition, despite the fact that Medivation had been exploring a possible transaction over the preceding several months, and that Panuwat purchased the Incyte options “within minutes” of receiving that email.

The court next addressed Panuwat’s due process argument. Although the court recognized the SEC’s theory was novel, in that there appeared to be no other cases where the material nonpublic information at issue involved a third party, it nonetheless concluded that “the SEC’s theory of liability falls within the general framework of insider trading, as well as the expansive language of Section 10(b) and corresponding regulations.” In siding with the SEC, the court pointed to the requirements of scienter and materiality as “two important checks on liability” and further noted the Supreme Court’s cautionary language against dismissing claims of insider trading predicated on “new or unusual schemes.”

Seventh Circuit Reverses Dismissal of Stockholder Derivative Suit Against Boeing Based on Forum-Selection Bylaw

On January 7, 2022, the U.S. Court of Appeals for the Seventh Circuit reversed the dismissal of a derivative suit filed by a Boeing Company stockholder alleging that the aerospace company’s current and former officers and board members made materially false and misleading public statements about the development and operation of the 737 MAX airliner in Boeing’s 2017, 2018, and 2019 proxy materials.

Plaintiff, a pension plan that holds shares in Boeing, asserted a derivative suit under Section 14(a) of the Securities Exchange Act of 1934 (the Exchange Act or the Act), alleging that defendants disseminated materially false and misleading proxy statements from 2017 through 2019. Plaintiff alleged that, following the air crashes of Boeing’s 737 MAX planes, the false and misleading proxy statements enabled the re-election of directors who failed to enact adequate oversight of safety, regulatory compliance, and risk management during the 737 MAX airliner’s development. Plaintiff also alleged that the proxy statements misled stockholders and caused them to reject a stockholder proposal to bifurcate the company’s CEO and chairman positions.

The Exchange Act confers to federal courts exclusive jurisdiction over suits filed under the Act; accordingly, plaintiff filed its complaint in the U.S. District Court for the Northern District of Illinois. Dismissing the action on June 8, 2020 on forum non conveniens grounds, the district court applied a Boeing forum-selection bylaw requiring all stockholder derivative actions to be filed in the Delaware Court of Chancery.

On appeal, the Seventh Circuit disagreed. Circuit Judge David F. Hamilton, writing for the 2-1 majority (joined by Circuit Judge Diane P. Wood Circuit, with Judge Frank H. Easterbrook dissenting), reasoned that the district court’s application of the bylaw ran afoul of Delaware corporation law and federal securities law. The Seventh Circuit concluded that the bylaw was unenforceable as applied to plaintiff’s derivative claim because its application would violate Section 115 of the Delaware General Corporation Law and Section 27 of the Exchange Act. Section 115 of the Delaware General Corporation Law provides that a corporation’s bylaws “may require . . . that any or all internal corporate claims shall be brought solely and exclusively in any or all of the courts in this State,” and defines “internal corporate claims” to include derivative claims. Section 27 of the Exchange Act, however, confers to federal courts exclusive jurisdiction over suits filed under the Act.

The court acknowledged that while Section 115 affords corporations leeway when drafting their bylaws (including bylaws containing forum-selection clauses), it does not permit corporations to avoid the application of federal securities law. In reversing the district court, the Seventh Circuit reasoned that because the Exchange Act gives federal courts exclusive jurisdiction over actions arising under the Act, applying Boeing’s bylaw — which would give the Delaware Court of Chancery jurisdiction — to the derivative action would mean that it could not be heard in any forum.

The Seventh Circuit remanded the case to the district court, though the remand is subject to a full Seventh Circuit review. While the court’s split decision is also appealable to the U.S. Supreme Court, Boeing has not yet appealed the decision.

Delaware Court of Chancery Denies Expedited Proceedings in Breach of Fiduciary Duty Suit Against Arena Pharmaceuticals Directors

On January 10, 2022, Vice Chancellor Paul A. Fioravanti, Jr. of the Delaware Court of Chancery denied expedited proceedings in a putative class action against biopharmaceutical company Arena Pharmaceuticals, Inc. in connection with a proposed merger between Arena and a subsidiary of Pfizer, Inc.

Plaintiff, an Arena stockholder, brought suit against the company and members of its board of directors asserting one claim for breach of fiduciary duty stemming from alleged omissions in a proxy statement provided to stockholders in connection with the proposed merger. Plaintiff’s complaint alleged that the Arena board’s financial advisor provided a fairness opinion in connection with the merger, relying on nonpublic business and financial information prepared by Arena’s senior management. But, according to the complaint, the proxy statement disclosed only certain financial projections and omitted other information management provided to the financial advisor. Concurrent with filing the complaint, plaintiff also moved to expedite the proceedings, seeking to preliminarily enjoin a stockholder vote on the merger until Arena provided corrective disclosures.

The court denied plaintiff’s motion, reasoning that despite the court being “well known for being responsive to plaintiffs seeking expedited proceedings in order to obtain injunctive relief,” plaintiff’s failed to cross the “minimal threshold” required for the requested relief by not pleading a colorable claim or demonstrating a sufficient threat of irreparable harm warranting the costs of expedited proceedings.

Specifically, the court found that the complaint did “not allege that the financial projections disclosed in the proxy statement [were] false or materially misleading.” The court further found that plaintiff’s complaint and motion to expedite were “premised upon the general, unsupported assumption that all information provided to a board’s financial advisor is material information that must be disclosed in connection with a request for stockholder action” — a proposition for which the court noted plaintiff cited no supporting authority.

Lawyers in Goodwin’s Securities and Shareholder Litigation and White Collar Defense practices have extensive experience before U.S. federal and state courts, legislative bodies and regulatory and enforcement agencies. We continually monitor notable developments in these venues to prepare the Securities Snapshot — a bi-weekly compilation of securities litigation news delivered to subscribers via email. This publication summarizes news from the civil and criminal securities law arenas in a succinct, digestible format. Topics covered include litigation and enforcement matters, legislation, rulemaking, and interpretive guidance from regulatory agencies.

Kate E. MacLeman 

Zoe Bellars