On March 26, 2010, Mark Cuban (“Cuban”) filed an appellate brief in the Fifth Circuit Court of Appeals replying to the Securities and Exchange Commission’s (“SEC”) appeal of the Northern District of Texas’ dismissal of the insider-trading case against him. The district court granted Cuban’s motion to dismiss because the SEC failed to adequately allege that (1) Cuban owed a “duty of disclosure” to keep the information about Mamma.com’s private investment in public equity (“PIPE”) offering confidential, and therefore Cuban’s trading was not fraudulent as required by Securities Exchange Act Section 10(b); and (2) Rule 10b-5(2), as applied in this case, exceeds the SEC’s rulemaking authority and could not be relied on.
Cuban argued the District Court correctly dismissed the SEC’s case because (1) Cuban’s supposed confidentiality agreement (“the Agreement”) did not give rise to a duty of disclosure, and therefore breaching the Agreement did not constitute fraud; (2) Cuban’s trading was not a breach of the Agreement, and thus there is no basis for fraud liability; (3) Cuban’s alleged statement expressing concern for his inability to trade was neither a confirmation of an earlier agreement not to trade, nor a separate agreement not to trade; and (4) the SEC’s reliance on Rule 10b-5(2)(b)(1) is unavailing because it was improperly applied by the SEC in this case and does not apply to business relationships.
First, Cuban claimed that even if he entered into a confidentiality agreement with the CEO of Mamma.com, prior to their conversation about the PIPE offering, it did not give rise to a duty of disclosure. Therefore, even if Cuban would have breached the agreement, it could not form the basis for fraud liability based on the misappropriation theory of insider trading alleged by the SEC. The misappropriation theory prohibits trading on material, nonpublic information in breach of a duty of disclosure to the source of the information. Cuban argued that a duty of disclosure, akin to a fiduciary duty, arises only from a “relationship of trust and confidence” and the SEC failed to allege that the Agreement created this type of duty.
Cuban further argued that even if a court found that the agreement gave rise to a duty of disclosure, he would not have breached the duty simply by liquidating his Mamma.com stock holding. The duty of disclosure would only have required him to keep the information about Mamma.com’s PIPE offering confidential, but would not have prohibited trading. Cuban claimed he kept the information confidential and trading Mamma.com stock did not amount to a disclosure of confidential information.
Similarly, Cuban argued that even if he entered into a confidentiality agreement with the CEO of Mamma.com, he did not breach the Agreement by selling his Mamma.com stock. Cuban claimed that the SEC alleged only that he agreed to keep the information about Mamma.com’s upcoming PIPE offering confidential. Cuban asked the court to “reject the SEC’s self-serving attempts to transform a bare confidentiality agreement into a no-trade agreement.” Specifically, he argued, “Mamma.com’s supposed understanding that [the Agreement] contained a no-trade agreement is factually unsupported and legally irrelevant” because the SEC did not allege that Mamma.com sought anything more than a confidentiality agreement with Cuban. Moreover, according to Cuban, contract law requires an objective finding that there was a “meeting of the minds” on the existence of a no-trade agreement. The SEC did not establish an objective “meeting of the minds,” and therefore, could not incorporate a no-trade agreement into the “bare” confidentiality agreement.
The SEC supported its argument that a no-trade agreement existed through a statement Cuban allegedly made after agreeing to keep his conversation with Mamma.com’s CEO confidential. Cuban, upset with Mamma.com for its proposed PIPE offering, supposedly exclaimed, “Well now I’m screwed; I can’t sell.” Cuban argued that this statement “was neither a confirmation of an earlier agreement not to trade, nor a separate agreement not to trade.” Cuban argued the SEC only alleged that he agreed to keep information about the PIPE offering confidential, but did not allege that he entered into a no-trade agreement. Therefore, “there can be no reasonable inference that Cuban acknowledged an agreement not to trade.” Cuban further argued that his statement could not have confirmed an earlier agreement not to trade, as it would have constituted past consideration in violation of contract law. It also was not a separate no-trade agreement, because it lacked consideration necessary to form a valid contract.
Finally, Cuban argued that the SEC’s reliance on Rule 10b-5(2)(b)(1) (“the Rule”) is “unavailing.” Cuban claimed the SEC applied the Rule improperly, and further, that the Rule applies only to “family and personal” relationships, not business relationships. Cuban, citing numerous cases, argued that the “mere breach of a confidentiality agreement does not fall within the scope of §10(b)”; thus the SEC exceeded its authority by applying the Rule in this manner. Cuban cited the SEC’s own releases and commentary to support his assertion that the Rule intends that a breach of a confidentiality requirement can only “form the basis for insider trading liability when the parties to the agreement have an existing family or other personal relationship.” Thus, the Rule cannot impute liability on Cuban because the SEC failed to allege that he had a family or personal relationship with Mamma.com or its CEO.
Therefore, Cuban argued, the circuit court should affirm the district court’s dismissal of the case.
Primary materials for this post are available on the DU Corporate Governance website.