Securities Law - Mark Cuban Fouls Out!

The SEC sued Mark Cuban, owner of the Dallas Mavericks and other businesses claiming that he wrongfully traded insider information in violation of § 17(a) of the Securities Act of 1933 and § 10 of the Securities Exchange Act by trading in the stock of Mamma.com in breach of his duty to the CEO of Mamma.com and Mamma.com amounting to insider trading under the misappropriation theory of liability. Cuban was a large minority stockholder of Mamma.com. In a telephone call from the CEO of Mamma.com, Cuban learned that Mamma.com was going to trade a public equity offering (PIPE). Cuban agreed in that call to keep the information confidential. Cuban then sold his stake in the Mamma.com to avoid losses from the inevitable fall in share price when the offering was announced. Cuban moved to dismiss.

The District Court found that the SEC Complaint alleged an agreement to keep information confidential, but did not include an agreement not to trade. The SEC appealed arguing that a confidential agreement creates a duty to disclose or abstain and that regardless the confidentiality agreement alleged in the Complaint contained an agreement not to trade on the information. (If interested, see our prior posts on this topic below).

The SEC alleges that Cuban’s trading constituted insider trading and violated Section 10(b) of the Securities Exchange Act. Section 10(b) makes it
unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange . . . [t]o use or employ, in connection with the purchase or sale of any security … any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful to
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

The Supreme Court has interpreted Section 10(b) to prohibit insider trading under two complementary theories, the “classical theory” and the “misappropriation theory.” The Cuban case involved the misappropriation theory.

The misappropriation theory rests on the principle that if a person violates Section 10(b) when he misappropriates confidential information for securities trading purposes, in a breach of a duty owed to the source of information. This theory was adopted by the United States Supreme Court in United States v. O’Hagan, 521 U.S. 642 (1997). In O’Hagan, the Supreme Court held that a lawyer who traded on confidential information misappropriated that information breaching a duty of trust and confidence he owed to his law firm and the law firm’s client.

The CEO of the Mamma.com was instructed to contact Cuban and to preface the conversation by informing Cuban that he had confidential information to convey to him in order to make sure that Cuban understood before the information was conveyed that he would have to keep the information confidential. Cuban agreed to keep the information concerning the PIPE offering confidential. At the end of the call, after learning about the offer, Cuban said “Well, now I’m screwed. I can’t sell.” Cuban then had a call with a sales representative of the proposed offering to get details of the offering. Following that call he immediately sold his entire stake in the company consisting of over six percent (6%).

The District Court found that the Complaint asserted no facts that reasonably suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential.

The Fifth Circuit held that it was entirely plausible that the CEO understood that in addition to keeping the information confidential, Cuban would not sell. Accordingly, the Fifth Circuit without taking a stand on whether the disclosure by the CEO was intended to restrict Cuban from trading would only be determined following further proceedings in the District Court. Accordingly, the motion dismissing the case was vacated and the parties can proceed with discovery, a summary judgment motion and a trial, if necessary.

Edward X. Clinton, Sr.
Copyright 2010