In a motion filed January 22, both the SEC and Mark Cuban jointly requested an extension to complete discovery and to submit supplemental briefing on Mr. Cuban’s motion for attorney’s fees and expenses. Prior to this motion, the Court ordered discovery to be completed by February 1, 2010 and supplemental briefing within 21 days of that date.

The parties request the discovery deadlines be extended as follows:  (1) February 16 for responses to document requests and interrogatories; (2) February 22 to begin depositions; (3) March 1 for the filing of motions to compel; (4) if no motion to compel is filed, discovery would be completed by March 9; (5) if a motion to compel is filed, all depositions should be concluded within 14 days of the courts ruling on the motion; (6) Mr. Cuban’s supplemental brief and evidence appendix shall be filed within 21 days of the completion of discovery; (7) the  SEC’s supplemental brief and evidence appendix should be filed within 21 days of the filing of Mr. Cuban’s supplemental brief; and (8) Mr. Cuban’s supplemental reply brief shall be filed within 14 days of the SEC’s brief.

The Court granted this motion on January 22, 2010 extending discovery dates as requested by both parties.

The primary materials for this post are available on the DU Corporate Governance website.

On January 22, 2010, the Securities and Exchange Commission (“SEC”) filed an appellate brief in the Fifth Circuit appealing the Northern District of Texas’ dismissal of the insider-trading case against Mark Cuban. The district court granted Cuban’s motion to dismiss because the SEC’s complaint failed to allege Cuban owed a duty to keep the information about Mamma.com’s PIPE transaction confidential; and therefore his trading was not deceptive as required by Section 10(b) of the Securities Exchange Act.  The SEC alleges the court made three errors.

First, the district court concluded an agreement to keep information confidential does not encompass an agreement not to trade. Therefore, trading securities even after a confidentiality agreement does not deceive the source of information.  The SEC argues that case law, logic, and experience make clear that a confidentiality agreement includes an agreement not to trade.  Citing United States v. O’Hagan, 521 U.S. 642 (1997), the SEC stated that when the Supreme Court adopted the misappropriation theory of insider trading it prohibited trading on the basis of material, nonpublic information as a breach of a duty to the source of the information.   Further, under Commission Rule 10b5-2(b)(1) it is unlawful to use or employ, in connection with the sale of any security, any manipulative or deceptive device.  The SEC argued that by its plain terms this regulation sets forth a duty on Cuban not to trade after receiving confidential information.  Finally, Commission Rule 10b5-2(b)(1) embodies a valid interpretation of the deception requirement of Section 10(b) and is entitled to Chevron deference. Under Chevron, courts must defer to the Commission’s interpretation of Section 10(b) if Congress has not forbidden the interpretation and it is “based on a permissible construction of the statute.”  In Section 10(b), a duty of trust or confidence may arise by agreement, and an agreement to maintain confidential information includes an agreement not to trade. The SEC argued its interpretation is the clear intent of Congress and its interpretation of “deceptive” is reasonable.  Therefore, because the commission’s interpretation of Rule 10b5-2(b)(1) is a valid, the court must defer to this interpretation pursuant to Chevron.

Second, trading on material, nonpublic information after agreeing to keep it confidential is deceptive under the more general terms of Section 10(b) and Rule 10b-5.  The SEC argued Cuban agreed to keep information confidential and, as discussed above, a confidentiality agreement encompasses an agreement not to trade. Therefore trading on this information is deceptive under Section 10(b).

Third, the SEC claimed its original complaint sufficiently alleged that Cuban explicitly agreed not to trade, making his subsequent undisclosed trading deceptive. The SEC stated that Cuban’s statement “Well, now I’m screwed – I can’t sell,” to Mamma.com’s CEO was an express and contemporaneous recognition that he agreed to abstain from trading on the basis of the confidential information he received. Thus, because Cuban agreed to keep this information confidential he deceptively breached his duty by selling his entire stake without disclosing to Mamma.com his plans to trade.

The SEC, therefore, argued the Fifth Circuit should reverse the district court’s ruling because Cuban did deceive Mamma.com.

The primary materials for this post are available on the DU Corporate Governance website.



On October 28, 2009, Mark Cuban filed a Reply Brief in Support of Motion for Attorneys’ Fees and Expenses (“The Reply”) in the Northern District of Texas – Dallas Division.  The Reply contends Cuban is entitled to Attorneys’ fees and expenses from the SEC for three reasons: (1) Cuban’s alleged acknowledgment of the information was confidential did not create a confidentiality agreement; (2) The SEC knew at the time it filed its Complaint it could not establish any of the elements of a contractual duty; and (3) the SEC failed to rebut the clear indicia of investigative misconduct.

First, the Reply argues that the SEC lacked both factual and legal support for its allegation that Mr. Cuban agreed to keep information confidential.  The SEC claims that when Cuban talked to Guy Fauré, Mamma.com’s CEO, about the upcoming PIPE offering, Mr. Cuban accepted a duty to keep this information confidential.  Although Mr. Fauré cannot remember the exact words of the conversation, the SEC contends Cuban must have acknowledged the information he was about to receive was confidential.  The Reply contends, however, that Cuban never “agreed” to a duty of confidentiality, only that he was receiving confidential information. The Reply contends that mere acknowledgement, or express recognition, of receiving confidential information did not constitute an agreement to keep that information confidential.

Second, Cuban argues the SEC could not establish a contractual duty to keep information confidential because there was no offer or acceptance.  Mr. Fauré never made an offer to Cuban because he never asked Cuban to keep the information confidential as a condition of receipt.  The Reply further contends that if Mr. Fauré’s statements could be construed as an offer, Cuban never accepted this offer.  Cuban stated “acknowledgement” does not constitute a promise to perform under an agreement.  Nor did his statement “now I’m screwed, I cannot sell” constitute acceptance as the court previous held.  Further, this statement could not be a valid acceptance because it came after the confidential information was conveyed and therefore the statement would be for past consideration.

Finally, the Reply argues the SEC does not rebut the instances of investigative misconduct and the court can characterize this non-responsiveness as evidence of lack of good faith.  First, the SEC failed to address the effects of Chairman Cox’s recusal from the Commission’s vote on whether to authorize the enforcement action.  Second, the SEC insists that it has no obligation to provide the Commission with Cuban’s Wells submission when in fact the federal regulation states the submissions will be forwarded to the Commission.  Third, when the SEC issued the Wells notice its investigation was not substantially complete and the SEC did not have sufficient evidence to bring an action against Cuban.  Fourth, the SEC failed to explain why the Mamma.com investigation was closed immediately before retaking Mr. Fauré’s testimony regarding Cuban.  Fifth, the SEC never addressed Cuban’s concerns regarding abuse of the Wells process in connection with re-taking Mr. Fauré’s testimony to force-feed the right answers to Mr. Fauré. 

The Reply contends the SEC knew all along that Cuban never entered into a confidentiality agreement with Mamma.com and still continued the case.  Therefore, it is appropriate for the court to sanction the SEC for its meritless case and award Mr. Cuban attorneys’ fees and expenses.

Primary materials for this case may be found on the DU Corporate Governance Website.

On September 30, 2009, the Securities and Exchange Commission (“SEC”) filed a Memorandum of Law in Opposition to Defendant Mark Cuban’s Motion for Attorneys’ Fees and Expenses  (“the Response”) in the Northern District of Texas – Dallas Division.  The Response contends the SEC properly alleged each element of an insider trading claim and that Cuban’s allegations of misconduct by the SEC are baseless; therefore, the court should deny Cuban’s Motion for attorney’s fees.

The federal standard for awarding attorney’s fees as a sanction for egregious behavior is extremely high and reserved for situations where the “very temple of justice has been defiled.”

The SEC alleges that each element of an insider trading claim were properly pled by: (1) Cuban accepting a duty to keep the information confidential, (2) Cuban knowingly breaching that duty, and (3) the information, on the basis of which he sold his Mamma.com shares, was material and nonpublic.

First the Response contends Mamma.com extensively discussed inviting Cuban to participate in the transaction and the need for confidentiality.  Mamma.com executives were aware they would be providing Cuban material, nonpublic information if they invited him to participate.  The board instructed the Mamma.com CEO to contact Cuban and ensure Cuban was aware he must keep the information confidential before the information was conveyed.

Second, the SEC argues Cuban accepted the duty of confidentiality.  Mamma.com’s CEO testified that while he cannot recall the specific words Cuban used in accepting the confidential information, he is certain that Cuban accepted.  Additionally at the end of the conversation Cuban stated, “well now I’m screwed. I can’t sell.” Cuban also e-mailed his broker the morning after he sold his shares seeking cover from possible insider trading allegations.  The SEC states that these facts provide sufficient factual basis for the SEC’s allegation that Cuban accepted a duty of confidentiality.  Furthermore, Cuban did not deny accepting this duty, but rather denied having the eight minute conversation with Mamma.com’s CEO.

Third, the SEC states the facts alleged are legally sufficient to prove an agreement to undertake a duty of confidentiality.  For a duty of confidentiality to attach, an investor must have the opportunity either (i) to accept a duty of confidentiality and its attendant restrictions in order to have access to the information, or (ii) to refuse to accept the duty and information, thereby avoiding any restrictions.  The duty cannot be imposed unilaterally.  The SEC contends the Mamma.com CEO testified under oath that he prefaced the conversation that he had confidential information to convey, and that Cuban accepted the duty of confidentiality.  The SEC states it is irrelevant that the CEO does not remember the explicit words Cuban used to accept the duty, because to reach an enforceable agreement it is not necessary for a recipient to say “I agree” or any specific magic words.

Finally the SEC argues Cuban’s allegations of investigative misconduct are baseless.  The SEC states that the unauthorized e-mails sent by Jeffrey Norris were unrelated to the investigation and litigation.  The investigation had reached an advanced stage before the Norris e-mails were sent and Norris was located in Fort Worth while the investigation was led out of Washington D.C.  Additionally, the SEC contends Cuban’s arguments about the Wells process are meritless because Cuban was not entitled to any “assurances” and Cuban’s untimely Well’s submission was still reviewed.  Also, the closing of the unrelated Mamma.com investigation had no influence on the investigation and was not in exchange for any testimony.  Lastly, the initiation of an internal investigation in response to a complaint from Cuban does not suggest improper conduct, especially when the complaint was part of an aggressive defense strategy.

Because the SEC demonstrated that Cuban’s agreement to maintain the confidentiality of the material, non-public information remains a disputed issue of fact and each of Cuban’s allegations of investigatory misconduct are without merit, the SEC has not acted in bad faith.  Therefore, the SEC argues Cuban’s Motion for attorneys’ fees should be denied.

The primary materials for this post are available on the DU Corporate Governance website.

On Wednesday October 7th, the SEC filed a Notice of Appeal to the Fifth Circuit Court of Appeals in the case against Mark Cuban.  Today’s notice did not provide much detail, but we will post on subsequent details as they develop. A copy of the Notice of Appeal can be found on the DU Corporate Governance website.

On August 28, 2009, Mark Cuban filed a Motion for Attorneys’ Fees and Expenses (“the Motion”) in the Northern District of Texas – Dallas Division.  The Motion contends Cuban is entitled to Attorneys’ fees and expenses he incurred defending against the Securities and Exchange Commission’s (“SEC”) complaint against Cuban for insider trading. Cuban states he should receive these expenses, not because the Court rejected the SEC’s claim but rather because the SEC filed the suit in bad faith.

Cuban argues the court should sanction the SEC because: (1) it can award fees either under inherent power or 28 U.S.C. § 2412(b); (2) the SEC acted in bad faith in bringing the suit; and (3) the fees are appropriate in this case. 

Section 2412(b) permits the court to award  attorneys’ fees and expenses against the government just like any other party.  28 U.S.C. § 2412(b).  This statute has been held to specifically include bad faith conduct both prior to and during litigation.  Bad faith includes abusive conduct that constitutes or is tantamount to bad faith.  Specifically, it is bad faith to institute an action where no reasonable attorney could conclude the elements of the claim could be established.

Cuban argues that the SEC acted in bad faith by  (a) ignoring exculpatory evidence; (b) initiating the Wells process and informing Cuban of plans to bring an action for insider training despite an absence of evidence of a confidentiality agreement; (c) improperly reviewing Cuban’s second Wells Submission; (d) closing its investigation into Mamma.com just days before seeking new testimony from key witnesses; and (e) taking testimony of Mamma.com’s CEO for a second time in hopes of getting him to change prior statements. 

Cuban asserts that the sole support for the SEC’s claim was Cuban’s alleged acknowledgement that information he received from Mamma.com’s CEO regarding its stock was confidential.  The Court addressed this issue in its decision dismissing the case and held there was no evidence of any type of confidentiality agreement.  Cuban contends the SEC brought the action in bad faith by making a factual assertion of this confidentiality agreement knowing the evidence flatly contradicted it.

Third, the Motion argues attorneys’ fees and expenses are appropriate in this case as a sanction to deter frivolous litigation.  Cuban states his attorneys’ fees and expenses have exceeded $1 million and an award of this magnitude will deter the SEC from pursuing future meritless claims.

Because the SEC pursued the insider trading claim against Mark Cuban knowing it lacked evidence of a confidentiality agreement, the SEC acted in bad faith in bring the suit.  Therefore because the SEC acted in bad faith, Cuban contends it is appropriate to sanction the SEC by awarding attorneys’ fees and expenses.

The SEC intends to resond to Cuban’s Motion for Attorneys’ Fees.  The SEC’s brief is due by September 30, 2009.  The blog will post on those arguments once the SEC files with the Court.

The primary materials for this post are available on the DU Corporate Governance website.

Yesterday the SEC requested Chief Judge Sidney Fitzwater close the case against Mark Cuban. Last month the Chief Judge ruled against the agency in its insider trading charges and granted Cuban’s motion to dismiss. However, the SEC had thirty days to re-file a new complaint with stronger charges. The agency’s attorneys decided to forego that option by asking to close the case, leaving the opportunity to appeal the motion to dismiss. The agency has thirty days to appeal Chief Judge Fitzwater’s decision. As part of our continuing coverage of the case, we shall update when the SEC makes its decision.

The trial judge dismissed the Cuban case because the confidentiality agreement alleged to have been executed by Cuban did not inclue a ban on trading.

There are several problems with the analysis.  Despite the prodigious effort by the court to separate the concept of confidentiality and use, the two are not so clearly separated.  First, the purpose of confidentiality agreements is typically and inherently an attempt to prevent use.  Second, confidential information can easily be revealed through use.  Third, the interconnected nature of the concepts means that parties using the concept of confidentiality can easily have meant it as a synonym for use.  In other words, it is a matter of the intent of the parties. 

That the concept can encompass both can be seen by the language in Regulation FD, 17 CFR 243.100(b)(2).  Regulation FD prohibits intentional selective disclosure.  The regulation, however, exempts disclosure if made "To a person who expressly agrees to maintain the disclosed information in confidence";  the use of the term "confidence" in Regulation FD means that the recipient will not use the information to trade.  In other words, the concept of confidentiality encompasses use.

What will happen next?  Most likely, the SEC will file an amended complaint and allege that the parties intended the confidentiality agreement to encompass use.  To the extent the case remains good law, officers who disclose confidential information to shareholders will have to ask that it be kept confidential and not be used to trade.  In other words, the case will have limited impact.  Regulation FD may need to be amended.

Nonetheless, it shows the problems with the development of the law of insider trading.  The reality is that insider trading does not always encompass material non-public information deliberately passed along by corporate officers to someone they know will trade.  To ordinary investors, this looks terribly unfair and suggests that the trading markets are not open but fixed.

The issue was whether the alleged confidentiality agreement orally executed by Cuban before trading in the Company's shares was enough to create a duty of "trust and confidence" that meant he couldn't trade on the information.

The trial court found first that the matter was not controlled by state law (concerning the definition of duty). Second, the court found that the requisite duty of trust and confidence could in fact arise from an an agreement.  As the court noted:

• Because under O’Hagan the deception that animates the misappropriation theory involves at its core the undisclosed breach of a duty not to use another’s information for personal benefit, there is no apparent reason why that duty cannot arise by agreement. Further, recognizing that a duty analogous to the fiduciary’s duty of “loyalty and confidentiality” can be created by agreement fully comports with Chiarella’s teaching that the duty must arise out of a relationship between specific parties and not the mere possession of confidential information. The court therefore concludes that a duty sufficient to support liability under the misappropriation theory can arise by agreement absent a preexisting fiduciary or fiduciary-like relationship.

Ultimately, however, the court found that the alleged agreement was not sufficient to create the requisite duty of trust and confidence.  It had to be more than an agreement to keep the non-public information confidential.  There also had to be a component of the agreement that prohibited the use (read the right to trade on) the information.  As the court concluded:

• The agreement, however, must consist of more than an express or implied promise merely to keep information confidential. It must also impose on the party who receives the information the legal duty to refrain from trading on or otherwise using the information for personal gain. With respect to confidential information, nondisclosure and non-use are logically distinct.   A person who receives material, nonpublic information may in fact preserve the confidentiality of that information while simultaneously using it for his own gain. Indeed, the nature of insider trading is such that one who trades on material, nonpublic information refrains from disclosing that information to the other party to the securities transaction. To do so would compromise his advantageous position. See O’Hagan, 521 U.S. at 656 (“The misappropriation theory targets information of a sort that misappropriators ordinarily capitalize upon to gain no-risk profits through the purchase or sale of securities.”). But although conceptually separate, both nondisclosure and non-use comprise part  of the duty that arises by operation of law when a fiduciary relationship is created. Where misappropriation theory liability is predicated on an agreement, however, a person must undertake, either expressly or implicitly, both obligations. He must agree to maintain the confidentiality of the information and not to trade on or otherwise use it. Absent a duty not to use the information for personal benefit, there is no deception in doing so. As in the fiduciary context, the deception occurs when a person secretly trades on confidential information in violation of the source’s legitimate and justifiable expectation that the recipient will not  do so.

In other words, a confidentiality agreement wasn't enough.  It had to include, apparently, an express provision prohibiting the recipient from trading on the basis of the disclosed information. 

The Cuban agreement lacked this restriction, according to the court.  This was true even though Cuban allegedly responded to the information by saying:  “Well, now I’m screwed. I can’t sell.” As the court concluded:

• Thus while the SEC adequately pleads that Cuban entered into a confidentiality agreement, it does not allege that he agreed, expressly or implicitly, to refrain from trading on or otherwise using for his own benefit the information the CEO was about to share. Although at one point Cuban allegedly stated that he was “screwed” because he “[could not] sell,” this appears to express his belief, at least at that time, that it would be illegal for him to sell his Mamma.com shares based on the information the CEO had provided. This statement, however, cannot reasonably be understood as an agreement to sell based on the information. Further, the complaint asserts 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.

In short:  "Outside a fiduciary or fiduciary-like relationship, a mere unilateral expectation on the part of the information source —one that is not based on the other party’s agreement to refrain from trading on the  information —cannot create the predicate duty for misappropriation theory liability."

We've posted the complaint and other primary material on the DU Corporate Governance web site.

The district court dismissed the SEC's case against Mark Cuban today.  A copy of the opinion is posted on the DU Corporate Governance web site.

The case involved allegations that Cuban violated the prohibitions on insider trading when he received material non-public information from the CEO of Mamma.com Inc.  According to the SEC's complaint, the CEO asked and Cuban agreed to keep the information confidential.  Shortly after receiving the information, however, Cuban liquidated his position in Mamma.com, selling 600,000 shares.

Based upon the allegations in the complaint (many of which were disputed), there was little question that Cuban received material information before it was disclosed to the public.  As the trial court described (relying on the complaint), once the Company disclosed the news, "[t]rading in the company’s stock opened substantially lower the next day and continued to decline in the days following."  Moreover, the complaint likewise set out facts indicating that Cuban benefited from the information.  As the complaint noted in para. 24:  "By selling his Mamma.com shares prior to the public announcement of the PIPE, Cuban avoided losses in excess of $750,000."

In short, if the complaint is to be believed, Cuban was given information in advance of the market that made the downward movement in the Company's share prices clear.  In other words, the loss avoided was not (again according to the complaint) a result of acumen but a result of a tip from a corporate insider.  To anyone without an understanding of the law, this represents quintessential insider trading.  Unfortunately, the law in this area interferes with common sense. 

The issue in the case was the nature of the relationship that Cuban had with the Company.  Insider trading does not arise from an unfair informational advantage.  It arises from a violation of a fiduciary duty or duty of trust and confidence.  Cuban argued that a duty of trust and confidence was fiduciary like and could not arise solely because he agreed to keep the material information confidential.  As the trial judge described:

• Specifically, Cuban contends that the SEC has alleged merely that he entered into a confidentiality agreement, which is of itself insufficient to establish misappropriation theory liability because the agreement must arise in the context of a preexisting fiduciary or fiduciary-like relationship, or create a relationship that bears all the hallmarks of a traditional fiduciary relationship;

As we shall set out, the court essentially found for the SEC on all major legal issues.  The relationship did not have to be a fiduciary one.  It was not controlled by state law.  The requisite duty of trust and confidence could arise from an agreement.  Yet the case was dismissed.  We'll explain the basis, an unusual one, in the next post.

On April 16, 2009, Chief Judge Sidney Fitzwater filed an order granting Cuban’s request for oral argument of his Motion to Dismiss. See also Memo in Support of Cuban’s Motion to Dismiss. We discussed Cuban’s Motion to Dismiss as well as the SEC’s response in previous posts.

The next day, Judge Fitzwater filed another order setting the date for the oral argument to May 26, 2009, at 2:00pm. The details of the oral argument are as follows:

• Each side is allotted 30 minutes for argument
• Defendant may reserve up to 10 of his 30 minutes for rebuttal
• Demonstrative aids may be used at oral argument only if both of the following prerequisites are satisfied:

(1) the exhibit is a duplicate, enlargement, photograph, or computer-generated      representation of an exhibit that is already part of the motion record; and

(2) notice that the aid will be used during argument has been given to opposing counsel at least  10 days before the date for oral argument

The primary materials for this case are available on the DU Corporate Governance website.

On March 20, 2009, Mark Cuban filed a reply brief in support of a Motion to Dismiss (“the Reply”) in the northern district of Texas – Dallas division. This filing is in response to the SEC’s Law in Opposition to Mark Cuban’s motion to dismiss. The Reply contends Cuban did not engage in inside trading when he sold his Mamma.com stock because a confidentiality agreement does not establish a fiduciary duty. Insider trading is based on the deception that occurs when a person fails to disclose the use of nonpublic information when they have a duty to disclose. The source of this duty is a fiduciary or fiduciary-like relationship between the trader and the source of the information.

The Reply is centered around five arguments: (1) The SEC’s position is not supported by the Supreme Court’s O’Hagan decision, (2) State law should be applied to determine the existence of a fiduciary duty, (3) A confidentiality agreement alone is insufficient to create the requisite duty, (4) Rule 10b5-2(b)(1) is invalid if construed as creating liability in the absence of a fiduciary duty, and (5) Rule 10b5-2(b)(1) does not apply to business relationships.

The Reply states that the O’Hagan decision does not support the SEC’s position because the SEC’s interpretation of O’Hagan is completely contrary to its holding. Conversely to the SEC’s position, O’Hagan holds that a confidentiality agreement does not independently create a fiduciary relationship. The Reply contends that O’Hagan does not discuss how to determine the existence of a fiduciary duty, although the SEC proffered that the Supreme Court must have rejected state law as the source of determining this duty.

Cuban argues that state law determines the existence of a fiduciary or fiduciary-like duty. Prior Supreme Court decisions have held that state law is the proper source for determining this duty by discouraging the formation of federal common law and holding there is no conflict between Section 10(b) and state fiduciary law. The Reply states the Court has also held that failure to apply state fiduciary law in insider trading cases brought under the misappropriation theory was a fatal flaw.

The Reply also argues that a confidentiality agreement alone is not sufficient to create the requisite duty. A violation of a confidentiality agreement may be a breach of contract, but it is not necessarily a breach of a duty leading to insider trader liability. The cases that the SEC relies upon do not hold a person liable exclusively on the existence of a confidentiality agreement but rather find the existence of a longstanding confidential relationship. Also, Cuban insists the SEC ignores a previous case decided in this district that reasoned it was insufficient to examine a confidentiality agreement when determining if a fiduciary duty existed.

Next, it is argued that if Rule 10b5-2(b)(1) is construed as creating liability in the absence of a fiduciary or fiduciary-like duty the rule is invalid. The Reply states the SEC’s argument that Rule 10b5-2(b)(1) creates liability solely based on a confidentiality agreement is unfounded, the rule conflicts with the Supreme Court’s interpretation of “deceptive” conduct, and it also exceeds the SEC’s rulemaking authority. The Reply points out that the SEC, without proper authority, is attempting to make law in which the existence of a confidentiality agreement is enough to give rise to a fiduciary-like duty.

Lastly, the Reply argues that even if Rule 10b5-2(b)(1) is valid, the Rule does not apply to business relationships. Cuban states the only two cases that consider whether the Rule applies to business relationships conclude that the Rule does not apply in that context. Additionally, this argument relies upon the SEC’s own proposing release that the rule only applies to “family or other non-business relationships.” The Reply states the SEC simply cannot promulgate one view of a rule and then adopt a different view upon enforcement.

Because a confidentiality agreement alone does not establish a fiduciary or fiduciary-like duty, the Reply states Mark Cuban did not engage in insider trading and therefore all the claims against Mr. Cuban should be dismissed with prejudice.

The primary materials for this post are available on the DU Corporate Governance Website.

The SEC responded to Mark Cuban’s motion to dismiss by taking the position that this case involved  a well-settled application of insider trading principles and that Cuban traded on material, non-public information after he agreed to keep the information confidential.

In Cuban’s Memo in Support of Motion to Dismiss, he asserted, among other things, that under Texas law, he did not violate a fiduciary or similar duty of trust or confidence; and to apply Rule 10b5-2(b)(1) would impermissibly expand its reach to business relationships.  In its response, the SEC made three major arguments: the case is a textbook example of unlawful misappropriation, it involved no new theory of liability, and Cuban’s motion to dismiss focused on irrelevant state case law. These arguments are summarized below.

Cuban’s agreement to keep the information confidential is a textbook example of insider trading under the misappropriation theory because Rule 10b5-2(b)(1) applies in the context of a business relationship. The plain language of the Rule states that a duty of trust or confidence exists “[w]henever a person agrees to maintain information in confidence . . . .” Here, according to the SEC, Cuban established a duty when he agreed to keep the offering information confidential. In an opinion from February of this year, a Massachusetts district court denied a defendant’s motion for summary judgment where the defendant argued, like here, that Rule 10b5-2(b) did not apply to business relationships. Here, the SEC argued the court should do the same. Additionally, Cuban virtually ignored SEC v. Kornman, where the SEC survived summary judgment by arguing, like here, that Rule 10b5-2(b)(1) applied to a business relationship. Moreover, of the two cases Cuban cited to argue Rule 10b5-2(b)(1) does not apply to a business relationship, the first case involved a social relationship, not a business relationship; and the second cited dicta and the case was eventually overturned by the Ninth Circuit.

The SEC also argued that this case involves no new theory of liability. According to the SEC, the Supreme Court in O’Hagan endorsed the proposition that a duty may arise under the misappropriation theory through acceptance of a duty of confidentiality or through the pre-existence of a fiduciary relationship. The Court recognized that a contractual duty (not fiduciary duty) could create insider-trading liability under the misappropriation theory. The Second Circuit and the Eleventh Circuit have recognized that a confidentiality agreement establishes a duty. Here, the Complaint alleged that Cuban accepted a duty of confidentiality when he agreed to keep offering information confidential. To survive summary judgment, “[n]o further analysis is necessary.” Moreover, the cases Cuban cited obscure the law: Chiarella v. United States applied the classical theory, not the misappropriation theory; and United States v. Cassese held that a fiduciary relationship, while sufficient, is not necessary to establish a duty.

Cuban’s argument that state law should define misappropriation is “contrary to established insider trading law” and “bad policy.” Under the misappropriation theory, courts typically do not apply state law to determine a duty, therefore, Cuban erred by arguing state law fiduciary duty cases applied. The Supreme Court in O’Hagan did not rely on state law of a specific jurisdiction. Instead, it relied on synthesized case law to determine misappropriation. If courts were to apply specific state law, liability for insider trading would depend on where one was located. Such a policy, the SEC argued, would “inject uncertainty” and lead to different results for the same conduct.

The primary materials for this post are available on the DU Corporate Governance website.

This post discusses the Memorandum of Law of Mark Cuban in Support of Motion to Dismiss for the case of SEC v. Cuban.

In previous posts we introduced the case, discussed the complaint and summarized insider trading law. Cuban received information regarding an upcoming private investment in public equity (“PIPE”) during a phone conversation with the CEO of Mamma.com. Shortly after this conversation, Cuban sold his entire 600,000 share holding of Mamma.com. The SEC alleged that Cuban breached a duty of trust and confidence to disclose or abstain.

As we discussed in our prior post on insider trading law, for 10b-5 liability under the misappropriation theory the SEC must show that Cuban had a fiduciary-like duty to keep the information he received confidential, and that he breached this duty by selling his shares.  Cuban asserted that regardless of whether Texas state law or federal common law applies, the SEC failed to adequately plead that either his 6.3% ownership of Mamma.com, or his 8 minute phone conversation with the CEO imposed a duty of trust and confidence to keep the information confidential.

Although the SEC’s complaint did not discuss Rule 10b5-2(b)(1), Cuban argued that the rule does not apply. The rule states that a duty of trust or confidence arises “whenever a person agrees to maintain information in confidence.” An SEC release that purports to limit this rule to family or non-business transactions supports Cuban’s argument, stating:

• “Rule 10b5-2 addresses the issue of when a breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading.”

Further, Cuban’s brief cites Joon Kim where the court explained “The language of the release makes clear the new rule applies to family or other non-business relationships.” United States v. Joon Kim, 184 F. Supp. 2d 1006, 1015 (N.D. Cal. 2002).

Cuban also argued that Mamma.com knew that he would sell his shares when the company informed him of the PIPE. After Cuban spoke with the CEO, an internal email to the board stated “as anticipated he initially 'flew off the handle' and said he would sell his share.” Since the company knew Cuban would sell the shares, no deception occurred:

• “Because the deception essential to the misappropriation theory involves feigning fidelity to the source of information, if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no ‘deceptive device’.”

United States v. O'Hagan, 521 U.S. 642, 655. This case will turn on how the court interprets the alleged confidentiality agreement as well as 10b5-2(b)(1).

The primary materials for this case are available on the DU Corporate Governance website.

The recent action brought by the SEC against Mark Cuban for allegedly violating SEC Rule 10b-5 by selling stock in Mamma.com on the basis of information he allegedly expressly promised to keep confidential has drawn an amicus brief from five distinguished securities law professors urging dismissal of the complaint. The professors argue that the misappropriation theory of liability for insider trading (approved by the Supreme Court in the O'Hagan case) requires that a relationship of trust and confidence exist between the individual trading the securities and the source of the information in order for that theory to apply. They also argue that to the extent SEC Rule 10b5-2 allows for liability based on a mere promise to the source, which is not made in the context of a relationship of trust and confidence, Rule 10b5-2 exceeds the scope of the SEC's authority to make rules under Section 10(b) of the Securities Exchange Act of 1934. With all due respect to the distinguished professors, their argument ignores the actual context in which the O'Hagan case uses the term “relationship of trust and confidence.”

O'Hagan was a partner at a Minneapolis law firm. His firm was representing a firm which was about to make a tender offer for the stock of a publicly traded company. Through his firm's representation of the acquirer he learned of the pending offer for the target firm, and in advance of the public announcement of the tender offer, purchased stock in the target company. The Supreme Court overturned the Eight Circuit's reversal of O'Hagan's conviction for a criminal violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

The opinion of the Court, written by Justice Ginsburg, does, as suggested by the amicus brief, heavily emphasize that a relationship of both trust and confidence existed between O'Hagan and his sources of information, his law firm and its client, the acquiring firm. However, the reason that Justice Ginsburg heavily emphasized the relationships of trust and confidence that O'Hagan had with the sources of his information was that, in the actual case, the relationship was necessary to establish that O'Hagan's conduct “satisfie[d] Section 10(b)'s requirement that chargeable conduct involve a 'deceptive device or contrivance'.” O'Hagan could not be found to have engaged in deception against the sellers of the target company's stock since he, like the defendant in Chiarella, did not have any duty to disclose the information because he had no fiduciary type of relationship with those sellers. O'Hagan did not deceive his law firm or its client in the sense that he expressly lied to them about what he was going to do with the information. At least as reflected in the Supreme Court's opinion, O'Hagan never expressly promised or assured either his firm or its client that he would keep the information confidential. However, his status as a fiduciary of those two entities created an implied promise that he would use information he obtained from them only for the purposes for which they supplied it. By “feigning fidelity” and not telling the sources that he intended to trade upon the information, O'Hagan broke that implied promise, and “deceived” the sources of his information, thereby satisfying Section 10(b)'s deception requirement.

When a person breaks an express promise to keep information confidential, as alleged in the Cuban case, or as contemplated by Rule 10b5-2, one deceives the source of the information just as much as if the person broke an implied promise to keep the information confidential. It is true that at the time the promissor makes the promise of confidentiality he or she may have no intention of breaking that promise. That, however, should make no more difference to a finding of deception than if the maker of the implied promise intended to keep his or her implied promise at the time he or she entered into the fiduciary relationship, or received the confidential information.

The bottom line is that a relationship of trust and confidence plays a very different role in a misappropriation insider trading case than in a case brought under :”the classical theory” of insider trading. In the latter, some form of relationship of trust and confidence is necessary to show that an insider deceived persons on the other side of securities transactions by withholding material information from them, i.e., that a pure omission was the equivalent of an affirmative misrepresentation. In the former theory, the relationship of trust and confidence is sometimes needed to show that the defendant somehow deceived the source of his or her information. When the defendant breaks an express promise to keep the information confidential, a relationship of trust and confidence is no longer needed to show deception. A breach of the express promise will show deception at least as well as a breach of the implied promise. The argument that O'Hagan precludes a finding on insider trading based upon a mere breach of an express promise of confidentiality ignores the different roles that fiduciary relationships play in the two theories, as well as the specific legal issues Justice Ginsburg was addressing in O'Hagan.

The Securities and Exchange Commission (“SEC”) has filed suit against Mark Cuban for insider trading. In brief, the SEC complaint alleged that Cuban, a large shareholder in Mamma.com, learned of an upcoming PIPE offering in Mamma.com. He agreed to keep that information confidential and to not sell his shares until after the company made the information public. The complaint alleged that Cuban, in violation of his agreement, sold his shares, and that these actions violated 10(b) and 10b-5.

Five law school professors (Professors Bainbridge, UCLA, Bromberg, SMU, Ferrell, Harvard, Henderson, Chicago, and Macey, Yale), filed an amici curiae brief in support of Cuban’s motion to dismiss. They argued that even if there was a confidentiality agreement, which there might not have been, Cuban still did not commit insider trading.

They made three arguments.  First, Cuban did not have the requisite relationship of trust and confidence required under O'Hagan.  The amicus noted that in U.S. v. O’Hagan, 521 U.S. 642 (1997), the Supreme Court applied the misappropriation theory of insider trading to trading in violation of a fiduciary or similar “relationship of trust and confidence.” As a result, the mere execution of a confidentiality agreement, as Cuban is alleged to have done, does not create a fiduciary or similar relationship.

Second, the behavior did not violate Rule 10b5-2.  The provision provides that a duty of trust and confidence arises "[w]henever a person agrees to maintain information in confidence."  The Rule, according to the Amicus, applied only to non-business relationships.  The amicus relied on language in the adopting release noting that the Rule was intended to apply to "a breach of a family or other non-business relationship. "Exchange Act Release No. 43154 (August 15, 2000).  As least one court has apparently agreed with this interpretation.  See SEC v. Talbot, 430 F. Supp. 2d 1029, 1061 n.91 (C.D. Cal. 2006).

Third, even if the rule applied, it was an invalid exercise of the SEC's rulemaking authority.  The professors argued that the SEC promulgated Rule 10b5-2 after the Court’s opinion in O’Hagan and that the standard used in the Rule was more expansive than what the Supreme Courts set out because it created liability for a relationship of “trust or confidence” rather than “trust and confidence.”  Creating liability under 10b5-2’s “trust or confidence” would expand the scope of the O’Hagan test and would overstep its rule making authority citing Santa Fe Industries, Inc. v Green, 430 U.S. 462 (1977); Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).

The primary materials for this post are available on the DU Corporate Governance Website.

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This post discusses insider trading law and the specific claims contained in the complaint against Mark Cuban. The SEC alleged that Cuban violated 10b of the Exchange Act and Rule 10b-5 by selling his entire holding of stock in Mamma.com while he possessed material, non-public information. For discussion of the complaint, go here.

Generally, two theories exist for finding liability for insider trading: the classical theory, and the misappropriation theory.

Under the classical theory, a defendant violates §10b and Rule 10b-5 when:

• a corporate insider

• trades in the securities of his corporation

• on the basis of material, nonpublic information

Dirks v. SEC, 463 U.S. 646, 653-654 (U.S. 1983).  As we have noted on this Blog in Insider Trading and Gifts, classical insider trading applies to corporate insiders with fiduciary obligations.  The Supreme Court explained that a “relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.” Chiarella v. United States, 445 U.S. 222, 228 (U.S. 1980).  Thus, the theory extends to officers and directors.

In Dirks, however, the Court made clear that the theory could, in some instances, apply to corporate outsiders.  Outsiders may be treated as corporate insiders if “they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes.” Dirks, 463 U.S. at 655.  Outsiders can include attorneys, accountants, and consultants.  

In this case, Cuban is not a corporate insider.  The SEC, however, may try to treat him as a constructive or temporary insider.  This may be difficult to establish.  In the Memorandum in Support of Defendant’s Motion to Dismiss, Cuban claims that "No court has ever held, however, that a confidentiality agreement alone creates a fiduciary or fiduciary-like duty to act loyally to the source of the information.”

Alternatively to classical insider trading, the misappropriation theory applies to corporate outsiders that have access to non-public information.  Under this theory a defendant violates §10b and Rule 10b-5 when:

•  misappropriates confidential information

•  for securities trading purposes

•  in breach of a duty owed to the source of the information
  

United States v. O'Hagan, 521 U.S. 642, 652 (U.S. 1997).  With respect to misappropriation, the defendant need not have a fiduciary obligation to the issuer’s shareholders, but must have a duty of trust and confidence with respect to the information.  O'Hagan, 521 U.S. at 652-53. In addition, the duty of trust and confidence need not run to the company or its shareholders. The SEC had defined a duty of trust and confidence in Rule 10b5-2 and applies any time "a person agrees to maintain information in confidence."

 Professor Bainbridge speculates that the SEC will argue Cuban’s agreement to keep the information confidential created a duty of trust and confidence under Rule 10b5-2.  Cuban argues that 10b5-2 is not applicable because this rule only applies to non-business relationships.  Regardless whether the SEC pursues Cuban under the classical theory or the misappropriation theory, the central issue will likely be how the court interprets Cuban’s alleged agreement to keep the information confidential during his phone conversation with Mamma.com’s CEO.  

The primary materials are available on the DU Corporate Governance website.  

In a complaint filed on November 7, 2008 (the “Complaint”), the SEC charged Mark Cuban with committing securities fraud by engaging in unlawful insider trading. According to the Complaint, Cuban violated §17(a) of the Securities Act, §10(b) of the Exchange Act and Rule 10b-5 thereunder because he used material, nonpublic information to avoid losses in excess of $750,000 when he sold shares of Mamma.com Inc. The Complaint seeks a judgment enjoining Cuban from engaging in future violations of the antifraud provisions of the federal securities laws; ordering Cuban to disgorge the losses avoided; and ordering Cuban to pay a civil money penalty pursuant to §21A of the Exchange Act.  

The Complaint makes the following assertions. Mamma.com wanted to raise money through a private investment in public equity (PIPE) offering. The CEO of Mamma.com called Cuban to invite him to participate in the PIPE offering. At this time, Cuban owned 6.3% of the company and was the company’s largest shareholder. The CEO prefaced the conversation by saying that the information disclosed is confidential and Cuban agreed to the keep the information confidential. The CEO, in reliance on Cuban’s agreement, told Cuban about the PIPE offering. Cuban became angry after hearing the news and said he did not like PIPEs because, among other reasons, they dilute the existing shareholders. Near the end of the conversation, Cuban told the CEO “Well, now I’m screwed. I can’t sell.”  

Although angry about the PIPE, Cuban asked to see the terms and conditions of the offering. The CEO sent an email to Cuban providing contact information for the sales representative at the investment bank advising Mamma.com on the offering. Cuban called the sales representative on June 28, 2004 and received additional confidential details about the PIPE. Specifically, the salesman told Cuban the PIPE was being sold at a discount to the market price and included many other incentives for investors.  

One minute after this phone conversation with the sales representative, Cuban called his broker and directed him to sell his whole position in Mamma.com, which totaled 600,000 shares. During after-hours trading on June 28, 2004, Cuban sold 10,000 of his shares at an average of $13.499 per share. The following morning of June 29, 2004, Cuban sold his remaining 590,000 shares at an average cost of $13.2937 per share. After the markets closed on June 29, 2004, Mamma.com publicly announced the PIPE offering. On the first trading day following this announcement, Mamma.com opened at $11.89 (down $1.215 from the June 29, 2004 closing price of $13.105). Mamma.com continued to decline, closing at $8.00 on July 8, 2004.

Based on these allegations, the SEC asserts that Cuban sold his Mamma.com shares based on material, non-public information that he received from the CEO and investment banker allowing him to avoid losses in excess $750,000. Further, while selling based on this information, Cuban knew or was reckless in not knowing that he possessed material, nonpublic information and he breached a duty of trust and confidence that he owed to Mamma.com. As a result, the SEC asserts that Cuban violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.  

Professor Bainbridge wrote a post about the SEC’s charges against Cuban here. In his post, Professor Bainbridge describes the central legal issue in this case as “whether Cuban assumed a fiduciary obligation of confidentiality with respect to Mamma.com.” In other words, the issue is whether Cuban is a “constructive insider.”  

We will follow up with an in-depth post on the legal issues that exist in this case.  The primary materials for the post are available on the DU Corporate Governance Website.

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The Race to the Bottom still has the rare distinction of combining the work of faculty and students.  For students, working on the Blog provides an opportunity to write in a pithy fashion about important developments in the corporate governance area.  

Another way to enhance the pedagogical value of the Blog and to provide new and interesting content is to identify ongoing cases that raise corporate governance or related issues and have students follow the case.  Posts can be written on any new developments, including new filings in the case.  This Blog covered the criminal case against David Stockman until the case was terminated by the Government.  It is currently covering the civil suit against Chiquita arising out of the company's payments to guerillas in Columbia.  

Today we add another case, SEC v. Mark Cuban.  Cuban is the sometimes controversial owner of the Dallas Mavericks.  With a brief already filed by an illustrious group of faculty, the case may push the boundaries of insider trading law.  We will deliver over the next couple of days several posts on the case, all written by students.