Securities & Exchange Commission v. Cuban
634 F. Supp. 2d 713, 2009 U.S. Dist. LEXIS 71343 (2009)
Rule of Law:
Under the misappropriation theory of insider trading, a duty sufficient to establish liability requires an agreement that explicitly or implicitly imposes not only an obligation to maintain confidentiality but also a duty to refrain from trading on or otherwise using the material, nonpublic information for personal benefit.
Facts:
- In March 2004, Mark Cuban purchased 600,000 shares, representing a 6.3% stake, in Mamma.com, a Canadian company that operated an Internet search engine and traded on NASDAQ.
- In the spring of 2004, Mamma.com decided to raise capital through a private investment in public equity (PIPE) offering.
- The CEO of Mamma.com telephoned Cuban to inform him of the PIPE offering, prefacing the call by stating he had confidential information and obtaining Cuban's agreement to keep the information confidential.
- After learning of the PIPE, Cuban reacted angrily, stating he did not like PIPE offerings and that he was "screwed" and "can't sell."
- The CEO sent Cuban a follow-up email, after which Cuban contacted an investment bank sales representative who supplied him with additional confidential details about the PIPE.
- One minute after ending his call with the sales representative, Cuban telephoned his broker and directed him to sell all 600,000 of his Mamma.com shares.
- Cuban did not inform Mamma.com of his intention to trade on the information he had been given in confidence and agreed to keep confidential.
- After the markets closed on June 29, 2004, Mamma.com publicly announced the PIPE offering, and Cuban avoided losses exceeding $750,000 by selling his shares prior to this announcement.
Procedural Posture:
- The Securities and Exchange Commission (SEC) sued Mark Cuban in the United States District Court for the Northern District of Texas, alleging insider trading under the misappropriation theory.
- Cuban moved to dismiss the complaint under Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim and under Rule 9(b) for failing to plead fraud with particularity.
- On July 17, 2009, the district court granted Cuban's motion to dismiss the SEC's complaint for failure to adequately plead a duty required for misappropriation theory liability but allowed the SEC 30 days to file an amended complaint.
- On August 12, 2009, the SEC filed a notice stating it would not file an amended complaint and requested the court enter final judgment to initiate an appeal.
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Issue:
Does an agreement merely to maintain the confidentiality of material, nonpublic information, without an explicit or implicit undertaking not to trade on or use that information for personal benefit, create a duty sufficient to establish liability under the misappropriation theory of insider trading?
Opinions:
Majority - Sidney A. Fitzwater
No, an agreement merely to maintain the confidentiality of material, nonpublic information, without an explicit or implicit undertaking not to trade on or use that information for personal benefit, is insufficient to establish liability under the misappropriation theory of insider trading. Chief Judge Fitzwater explained that the essence of the misappropriation theory, as articulated in United States v. O’Hagan, is the undisclosed, self-serving use of a principal’s information in breach of a duty of loyalty and confidentiality, which constitutes the “deception” required by Section 10(b) of the Exchange Act and Rule 10b-5. This duty must encompass both an obligation to maintain the confidentiality of the information and an obligation not to use it for personal benefit. While a fiduciary relationship inherently imposes both, an agreement in the absence of such a relationship must explicitly or implicitly establish both aspects of the duty. The court rejected the SEC’s argument that Rule 10b5-2(b)(1), which states a duty exists "whenever a person agrees to maintain information in confidence," was sufficient. It reasoned that the plain meaning of the rule only addresses confidentiality, not the crucial non-use component. The court found that Cuban’s alleged statement, "Well, now I’m screwed. I can’t sell," expressed his belief regarding the legality of trading, not an actual agreement not to trade. Therefore, the SEC’s complaint failed to adequately allege that Cuban undertook a duty to refrain from trading on the information, which is necessary for the conduct to be deemed deceptive under the misappropriation theory.
Analysis:
This case provides a critical clarification on the scope of the misappropriation theory of insider trading, particularly concerning duties arising from express or implied agreements. It firmly establishes that a mere confidentiality agreement, by itself, is insufficient to create the legal duty required for Section 10(b) liability. The decision underscores that the necessary 'deception' hinges on the secret exploitation of confidential information for personal gain in violation of an agreed-upon restraint on such use, not just a promise to keep secrets. This limits the application of SEC Rule 10b5-2(b)(1) and requires the SEC to demonstrate a broader undertaking by the defendant, impacting how companies and individuals handle material nonpublic information and how insider trading cases based on non-fiduciary relationships are pleaded and litigated.
