The SEC Appeals: Mark Cuban Decieved Mamma.com

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.