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.