In July 2009, Chief Judge Fitzwater of the Northern District of Texas dismissed the SEC’s insider trading complaint against Dallas resident (and owner of the Dallas Mavericks) Mark Cuban, finding that the SEC had not adequately alleged that Cuban undertook a duty of non-use of certain information required to establish liability under the misappropriation theory of insider trading. Yesterday, a panel of the 5th Circuit Court of Appeals reversed Chief Judge Fitzwater’s decision, finding that the SEC’s complaint should not have been dismissed, and that the case against Cuban must proceed to discovery.
A pdf copy of the 5th Circuit’s decision in SEC v. Cuban is here. The SEC alleges that Cuban—after agreeing to maintain the confidentiality of material, nonpublic information concerning a planned private investment in public equity (“PIPE”) offering by Mama.com—sold his stock in Mamma.com (a Canadian search engine company in which Cuban was a large minority stakeholder) without first disclosing to Mamma.com that he intended to trade on this information, thereby avoiding losses in excess of $750,000 when the stock price declined after the PIPE was publicly announced.
Chief Judge Fitzwater had found that, at most, the complaint alleged an agreement to keep the information confidential, but did not include an agreement not to trade. According to Chief Judge Fitzwater’s decision, a simple confidentiality agreement was not enough to create a duty to disclose or abstain from trading under the securities laws, and, accordingly, Chief Judge Fitzwater granted Cuban’s motion to dismiss.
The 5th Circuit began its decision by noting that there are two theories of insider trading under section 10(b) of the Securities Exchange Act. The “classical theory” of insider trading “prohibits a ‘corporate insider’ from ‘trading on material nonpublic information obtained from his position within the corporation without disclosing the information.’” The corporate insider is under a duty to “disclose or abstain,” meaning that “he must tell the shareholders of his knowledge and intention to trade or abstain from trading altogether.”
The second theory, known as the “misappropriation theory,” holds that “a person violates section 10(b) when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.”
The 5th Circuit ultimately found that the SEC adequately pled that Cuban was liable under the “misappropriation theory,” given that the SEC’s complaint asserted that Mamma.com’s CEO told Cuban that he had confidential information for him and Cuban agreed to keep whatever information the CEO shared confidential. The CEO then told Cuban about the PIPE offering, which, according to the SEC, upset Cuban. The CEO sent Cuban a follow-up e-mail, inviting Cuban to contact Merriman, the investment bank conducting the offering. Cuban, according to the SEC’s complaint, called the Merriman representative, and, during the call, the representative provided Cuban additional confidential details about the PIPE. The SEC alleges that, with that information and one minute after speaking with the Merriman representative, Cuban called his broker and instructed the broker to sell Cuban’s entire stake in the company. Mamma.com’s stock price eventually fell 39% following the public announcement of the PIPE offering. The 5th Circuit noted that, by selling his share when he did, Cuban avoided over $750,000 in losses.
The 5th Circuit’s decision held in relevant part:
The [SEC’s] allegations, taken in their entirety, provide more than a plausible basis to find that the understanding between the CEO and Cuban was that he was not to trade, that it was more than a simple confidentiality agreement. By contacting the sales representative to obtain the pricing information, Cuban was able to evaluate his potential losses or gains from his decision to either participate or refrain from participating in the PIPE offering. It is at least plausible that each of the parties understood, if only implicitly, that Mamma.com would only provide the terms and conditions of the offering to Cuban for the purpose of evaluating whether he would participate in the offering, and that Cuban could not use the information for his own personal benefit. It would require additional facts that have not been put before us for us to conclude that the parties could not plausibly have reached this shared understanding. Under Cuban’s reading, he was allowed to trade on the information but prohibited from telling others—in effect providing him an exclusive license to trade on the material nonpublic information. Perhaps this was the understanding, or perhaps Cuban mislead the CEO regarding the timing of his sale in order to obtain a confidential look at the details of the PIPE. We say only that on this factually sparse record, it is at least equally plausible that all sides understood there was to be no trading before the PIPE. That both Cuban and the CEO expressed the belief that Cuban could not trade appears to reinforce the plausibility of this reading.
Accordingly, the 5th Circuit vacated Chief Judge Fitzwater’s judgment dismissing the case and remanded the case to Chief Judge Fitzwater for further proceedings, including discovery, consideration of summary judgment, and trial, if appropriate.
Cuban has been (or is currently) represented by a number of highly noted attorneys, including Paul Coggins, of Locke Lord Bissell & Liddell LLP; Thomas Melsheimer, John Sanders, Jr., and Steven Stodghill, all of Fish & Richardson; Christopher Clark, Lyle Roberts, Ralph Ferrara, and Stephen Best, all of Dewey & LeBoeuf LLP; Stephen Ryan, of DLA Piper LLP; and Henry Asbill, of Jones Day LLP.
The SEC is represented by Kevin O’Rourke, Adam Aderton, Julie Riewe, Thomas Karr and Toby M Galloway.