SEC v. Cuban: Case Dismissed (The Analysis)

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.

Comments

[Phil Goldstein]

I think it is unfair to play "tag, you're an insider." If I am a CEO and unilaterally call you up to tell you that the company is going to have a dilutive PIPE offer without getting you to sign a NDA that prohibits trading in the stock, I screwed up but why should you be barred from trading? If anything, the SEC should have gone after the negligent CEO. But that would not get the same headlines as going after Mark Cuban. The SEC miscalculated because, like Ken Langone did with Spitzer, Cuban rightfully decided to fight. The lesson for the SEC is don't go after a billionaire with balls unless you really have the goods on him.

[Reg FD and Insider Trading]

Professor Brown's analysis misses the forest for the trees. A key ruling in the case is the court's invalidation of SEC Rule 10b5-2(b)(1), which states that the requisite duty for purposes of the misappropriation theory exists if the party receiving the information has agreed to keep it confidential. That rule was passed in conjunction with Reg FD and was meant to be complementary (if a company gets a confidentiality agreement, no Reg FD violation, but the SEC can go after the individual who receives the information for insider trading). Judge Fitzwater's ruling takes apart that structure - arguing that you can separate the concepts of confidentiality and use - and citing Reg FD to support the opposite conclusion is not very compelling.

Professor Brown appears to want a regulatory regime that operates on a "parity of information" approach. That is to say, everyone who receives material nonpublic information must either disclose it or abstain from trading. The SEC wants the same thing. But nobody wants to actually go to Congress and ask for it, perhaps because there would actually be a public debate about whether that is a good idea.

[J. Robert Brown]

My approach is not parity and it does not involve unfairness. It seems to me that when someone agrees to keep information confidential, particularly information that is only valuable with respect to trading, that they know this is a ban on use. Certainly Mark Cuban's reaction that he was screwed and couldn't trade reflected this. Had Cuban wanted to avoid this problem, he should not (if the facts in the complaint are to be believed) agreed to keep the information confidential. Of course, then he presumably wouldn't have received the information which is the obvious trade off.