Thomas Montano (The George Washington University) has posted The Reasonable Market Analyst: Assessing Materiality in Shadow Trading on SSRN. Here is the abstract:
Shadow trading refers to the practice of investors trading based on material nonpublic information (“MNPI”) in the securities of market-connected firms. In 2021, the Securities and Exchange Commission brought and ultimately prevailed in its first civil action on a theory of shadow trading against Matthew Panuwat for trading on MNPI in a competitor firm. An analysis of the current materiality standard demonstrates that the reasonable investor test is wholly insufficient to provide factfinders with the structure necessary to render an intelligible decision about which firms are economically linked or connected in the market. Accordingly, the application of the totality of the circumstances reasonable investor standard should be rejected in the shadow trading context. To address the market-connection problem, this Essay proposes a new two-pronged analysis for district courts to determine whether nonpublic information about a source firm is material to the security purchased. At the summary judgment stage, the government would bear the burden of demonstrating, by a preponderance of the evidence, that the security purchased has a moderate or strong ex ante correlation with a competitor or supplier. A finding of materiality by the judge would be rebuttable by the defense at summary judgment before the parties go to trial. This two-pronged test would enable regulators to prevent a pocket of immunity for trading in linked firms, while providing the financial industry with sufficient guidance on materiality in transaction planning.
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