Potential Ramifications of the SEC’s Novel Shadow Trading Theory


Vivek Pingili

Publish Date



  • Compliance

In August 2021, the U.S. Securities and Exchange Commission (SEC) filed a potentially groundbreaking insider trading case against a former employee of a biopharmaceutical company (Company) based on a novel fact pattern involving what is being called “shadow trading.” Notably, the defendant, who allegedly traded in advance of an announced acquisition of the Company, did not trade securities of a company to which he owed a duty of trust or confidence, his employer, or a company involved in the transaction, the acquiring company. Instead, he traded securities of a third company that was a peer to the Company.

The SEC alleged that the defendant traded based on inside information he received from the Company that was material to the value of the peer company’s stock price. He anticipated the peer company’s share price would materially increase after the acquisition announcement, which it did by 8 percent.

Further, The SEC alleged that the information concerning the Company’s imminent acquisition was material, not only to the Company but also to the peer company. According to the SEC’s complaint, the Company’s undisclosed acquisition would have been viewed by a reasonable investor in the Company or the peer company as having significantly altered the total mix of information made available.

The importance of this case

This is a novel application of the long-established, so-called “misappropriation theory” of insider trading and serves as a reminder to private markets fund managers that may come into possession of material non-public information (MNPI) about a public company to assess whether that information is material to the value of the shares of other public companies, such as peer companies or supply-chain partners (sometimes referred to as “economically linked companies”), whose value may be impacted upon the public announcement of a transaction (or other material event) involving a peer public company that a private markets fund manager may be evaluating.

While it remains to be seen if the SEC will be successful in advancing this new theory (the defendant is expected to litigate the case), if the SEC succeeds, this could require private markets fund managers to revise the ways in which they have historically managed insider trading risk.

Key takeaways

  • Firms should enhance employee training to address potential insider trading risks arising from trading in public companies that are comparable/economically-linked to a public company whose MNPI the private markets fund manager may have received.
  • In light of the SEC’s expansive approach here, a private markets fund manager that receives confidential information about a public company as part of its investment processes (e.g., evaluating a buy bid from a public company for one of its portfolio companies) should consider taking additional steps to prevent the potential for shadow trading, such as considering whether to add to its restricted list not only the target public company, but also comparable/economically-linked public companies whose market values the private equity (PE) firm reasonably believes (for one or more reasons) may be materially impacted by a transaction the PE firm is considering engaging with the target public company.
    • For example, such a derivative impact could result where the transaction, once publicly announced, may signal to investors that other similarly-situated public companies may participate in similar transactions in the foreseeable future (which could result in increased trading in such other companies’ stock, thereby materially driving up their stock values). This may especially be the case in niche industries dominated by competing public companies with similar businesses.
  • As part of their MNPI risk assessment processes, private markets fund managers should also consider assessing the likelihood that information relating to one or more comparable/ economically-linked public companies could be received when entering into confidentiality agreements and/or accessing data rooms containing sensitive data relating to a public company (e.g., in a transactional context), or when permitting employees to serve as directors of public companies.
  • From a forensic testing perspective, private markets fund managers may want to undertake focused employee personal trading reviews to identify unusual trading in the securities of comparable/economically linked public companies.

How we help

ACA has a number of solutions to help private markets firms build and maintain effective compliance programs, including RegTech surveillance solutions.

Please reach out to your ACA consultant or contact the Private Markets Team if you have any questions about this article, or want to find out how ACA can help your firm meet their compliance obligations.

Download our Private Markets Quarterly Update

This is just one of many insightful articles included in our Q4 2021 Private Markets Quarterly Update. Download the full newsletter to learn about:

  • Recent SEC Public Remarks Signal Desire for Comprehensive Reevaluation of Private Markets Regulation
  • Best Practices for Building and Implementing a Private Markets Compliance Program
  • Insider Trading Focus: Multiple Recent SEC Charges Present Cautionary Lessons for Private Markets Fund Managers
  • SEC’s Recent Sweep Enquiries Into Electronic Communications
  • Custody Rule Focus: Noteworthy Recent Trends in SEC Examinations & Enforcement Actions
  • SEC’s New Marketing Rule: An Update
  • Noteworthy SEC Enforcement Actions The UK National Security and Investment Act of 2021
  • Real Estate: Compliance Challenges for Open-End Real Estate Vehicles
  • Effectively Managing Operational Challenges in Performance Calculation and Reporting
  • ESG Update: UNPRI’s Next Reporting Period Delayed Until Early 2023