The high profile long-running saga between Mark Cuban -- entrepreneur, television personality, and billionaire owner of the Dallas Mavericks -- and the SEC has finally ended with Mr. Cuban emerging victorious. On October 16, 2013, after less than four hours of deliberation, a jury found in favor of Mr. Cuban on an insider trading claim arising out of his purchase and sale of shares of the company Mamma.com in 2004. While the verdict ultimately vindicates Mr. Cuban, defense counsel should take note of how the court defined insider trading in Mr. Cuban's case.
CUBAN SELLS SHARES OF MAMMA.COM AND THE SEC CALLS FOUL
In 2004, Mr. Cuban was investing in an online search engine called Mamma.com. After purchasing a large stake in the company, he had conversations with the company's CEO and investment bank about the company's strategy for raising additional capital through a PIPE transaction. After expressing his displeasure with their approach, Mr. Cuban sold his stock. Later that day, the strategy was announced to the market and price of the stock dropped, ultimately losing almost 40 percent of its value over the span of nine days. By selling his shares prior to the announcement, Mr. Cuban saved more than $750,000 in potential losses. Based on these facts, the SEC filed suit against Mr. Cuban on November 17, 2008, alleging insider trading in violation of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934.
AT WHAT POINT DOES A CONVERSATION CROSS THE LINE AND BECOME THE BASIS FOR INSIDER TRADING?
The issue at the heart of the Cuban case was what type of relationship could ultimately lead to an insider trading claim. The SEC brought suit under the misappropriation theory, which the Supreme Court recognized in United States v. O'Hagan, 521 U.S. 642 (1997). Under this theory 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 Court described this duty as "a duty of trust and confidence," which traditionally arose from a fiduciary relationship between the person conveying the information and the person trading.
In 2000, the SEC looked to codify further and, to some observers, expand the scope of the insider trading laws. The Commission adopted Rule 10b5-2, which provides additional guidance regarding the relationships that give rise to a "duty of trust and confidence" for purposes of the misappropriation theory. The provision relevant to the SEC's case against Mr. Cuban is Rule 10b5-2(b)(1), which provides that such a duty exists "[w]henever a person agrees to maintain information in confidence." These regulations seemed to significantly reduce the SEC's burden in misappropriation cases, where the SEC was historically required to prove the elements of a fiduciary relationship.
Mr. Cuban moved to dismiss the case in 2009, arguing that he owed no duty to the company and that Rule 10b5-2(b)(1) was improperly promulgated. The district court agreed, reasoning that the SEC did not have the authority to issue the rule. SEC v. Cuban, 634 F. Supp. 2d 713 (N.D. Tex. 2009). Because Section 10(b) proscribes only conduct that is manipulative or deceptive, the SEC could not issue rules that based liability on conduct that did not have these qualities. The district court did, however, relieve the SEC of the burden of proving a fiduciary relationship. The court held that liability under the misappropriation theory could be based on a duty created by agreement. Where a party agrees to keep information confidential and not to trade on it for his personal gain, that agreement can serve as the basis for an insider trading claim. However, this decision was later vacated by the Fifth Circuit. SEC v. Cuban, 620 F.3d 551 (5th Cir. 2010). Viewing the allegations in the light most favorable to the SEC, the circuit court held there was "more than a plausible basis" for finding that Mr. Cuban had agreed not to trade on the information -- not simply to keep the information confidential. The Fifth Circuit, however, declined to issue any ruling regarding the district court's legal conclusions as to how a duty of trust and confidence was created, or whether Rule 10b5-2(b)(1) was valid and enforceable.
Although its earlier decision had been vacated, and thus deprived of any legal effect, the district court still considered its opinion on Mr. Cuban's motion to dismiss -- including its holding that a non-fiduciary agreement could serve as the basis for a misappropriation claim -- to be the law of the case. SEC v. Cuban, No. 3:08-CV-2050-D, 2013 WL 791405 (N.D. Tex. Mar. 5, 2013). In denying Mr. Cuban's motion for summary judgment before trial, the court analyzed whether the SEC had presented facts sufficient to show that there was a confidentiality agreement, as well as whether the SEC had offered facts to support an agreement not to trade. This standard also made its way into the final jury instructions. Over the SEC's objection, the court's charge to the jury stated that the SEC had to prove the following elements:
That Mr. Cuban received material, nonpublic information;
That Mr. Cuban expressly or implicitly agreed to keep the information confidential and not to trade on or otherwise use the information for his own benefit;
That Mr. Cuban traded on that information;
That Mr. Cuban did not first disclose that he planned to trade on the information;
That Mr. Cuban acted knowingly or with severe recklessness;
That Mr. Cuban's conduct was in connection with the sale of a security; and
That Mr. Cuban used interstate commerce in connection with the sale of a security.
THE RESULT: A WIN FOR CUBAN AND A MESSAGE TO FUTURE LITIGANTS
Just one day after the close of the eight-day trial, the jury returned a verdict for Mr. Cuban. They found the SEC had proved the sixth and seventh elements of its claim but had failed as to the each of the remaining five elements. Judgment was entered in Mr. Cuban's favor on October 16, 2013.
While the verdict was unquestionably a victory for Mr. Cuban, the jury charge and the decisions leading up to the trial should still give pause to individuals, such as hedge fund managers, as to how they must rigorously treat non-public information. A casual conversation with a corporate insider who conveys confidential information could land you in court if you agree not to pass the information along or use it for trading. According to the SEC, a simple agreement not to disclose the information could be sufficient to create liability -- and that question remains unresolved.
The Cuban case also gives a rare loss to the SEC. The Commission has announced that it intends to take a more aggressive approach in settling and litigating cases. For example, SEC Chairman Mary Jo White announced in June that the Commission would start seeking admissions of wrongdoing in certain cases, which it demonstrated in its recent settlement in August with hedge fund adviser Philip A. Falcone and his firm, Harbinger Capital Partners. The Cuban verdict is unlikely to deter the SEC from expending significant resources litigating cases wherever it deems circumstances warrant. After all, it had won the case against Fabrice Tourre, the former Goldman Sachs employee, just before this loss. This previously slumbering lion is now on alert and poised to strike at any infractions of the law, even minor ones.