SEC v. Cuban: Affirmative defense of “Unclean Hands” no longer available to Cuban

In SEC v. Cuban, a Texas district court held that Mark Cuban had not sufficiently pled the requirements of the affirmative defense of unclean hands.  Sec. Exch. Comm’n v. Cuban, 2011 U.S. Dist. LEXIS 77549 (N.D. Tex., July 28, 2011). 

The SEC claimed that Cuban violated §17(a) of the Securities Act of 1933, §10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.  The claims stemmed from allegations that Cuban dumped stock in Mamma.com Inc. after learning nonpublic information.  The SEC claimed that Cuban had a conversation with Guy Faure, Mamma.com’s CEO, in which Faure told Cuban of an impending stock offering by the company.  Cuban then avoided substantial losses by acting on the information.

An enforcement action is an equitable remedy.  The defense of unclean hands arises when a party seeking an equitable remedy acts inequitably by committing some wrongdoing or acting in bad faith.  Cuban asserted an affirmative defense of unclean hands contending that the SEC acted with egregious misconduct during their investigation of the enforcement action. 

In response, the SEC claimed that when the government was acting in the public interest, equitable defenses were not available.  The SEC, as a regulatory agency, had the right to seek injunctive relief because Congress “provided this statutory remedy for the public’s benefit as a mechanism for effective law enforcement.”  The court rejected this approach, holding that the defense of unclean hands was not strictly barred in actions against government regulatory agencies.  Nonetheless, the standard for invoking unclear hands was very exacting.

Describing the demanding requirements to plead unclean hands, the court said the:

“SEC’s misconduct must be egregious, the misconduct must occur before the SEC files the enforcement action, and the misconduct must result in prejudice to the defense of the enforcement action that rises to a constitutional level and is established through a direct nexus between the misconduct and the constitutional injury.”

The only allegation of unclean hands pled with enough facts to make an inquiry into whether it met the standard was Cuban’s allegation that the SEC engaged in acts of “outright investigative and litigation misconduct.”  Cuban alleged that an SEC agent deterred the counsel of a key witness from talking to Cuban’s attorneys.  He also alleged that the SEC threatened the same witness with perjury for not remembering statements from a phone call from almost a year earlier.  Additionally, he alleged that the SEC reopened its investigation of Mamma.com in an attempt to get a key witness to change his testimony.

The court found Cuban’s allegations to be insufficient to justify application of the unclean hands doctrine.  The court determined that plaintiff had not shown that the alleged misconduct "impaired his ability to defend” or that any prejudice “rose to a constitutional level.”  

Further posts on SEC v. Cuban can be found here.

The primary materials for this case may be found on the DU Corporate Governance website.