We all hope you enjoy this blog from our colleague, Christian Moffit.
The SEC has lived to fight another day in its case against Mark Cuban over his sale of shares in Mamma.com as Judge Sidney Fitzwater denied Cuban’s motion for summary judgment, and it now looks like the billionaire investor will be headed to trial. Ultimately, the Court determined that, although the case was close, the SEC had set forth sufficient evidence in opposition to Cuban’s motion and had demonstrated that sufficient evidence exists in the record to place the suit before a jury. This case is of particular interest to securities litigators because it is one of several cases since the landmark Supreme Court case of United States v. O’Hagan to broaden the scope of insider trading liability under the misappropriation theory.
By way of background, the SEC alleges that Cuban violated § 17(a) of the Securities Act of 1933, § 10(b) of the Securities Exchange Act of 1934, and SEC Rule 10b-5 by selling his shares in Mamma.com after receiving inside information from Mamma.com’s CEO about an upcoming capital raise through a planned private investment in public equity (“PIPE”) offering by the company. A PIPE is a private sale of equity by a public company to a limited number of investors, and generally results in a decline in the issuing entity’s share value. Prior to the company’s public announcement of the PIPE, the CEO of Mamma.com called Cuban and stated that he had confidential information that he wanted to discuss. Cuban agreed to keep the information confidential and was then informed about the PIPE offering. Upon learning of the offering, Cuban became upset because the PIPE would necessarily dilute his interest in the company. He ended the call by stating “Well, now I’m screwed. I can’t sell.” Relying on Cuban’s promise of confidentiality, the CEO subsequently sent Cuban an email telling him that he could obtain more information about the offering from the company’s banker, who Cuban promptly called to obtain more information. One minute of after that call ended, Cuban directed his broker to liquidate his entire interest in Mamma.com.
The SEC filed suit in the Northern District of Texas and alleged that Cuban traded on the basis of material, non-public information in breach of his duty of trust or confidence to Mamma.com under the misappropriation theory of insider trading, which was first adopted by the Supreme Court in O’Hagan. In O’Hagan, the Supreme Court held that the misappropriation theory applies when a defendant misappropriates confidential information and then trades on that information in violation of a duty that the defendant owed to the source of the information. Critically, the O’Hagan Court failed to define what constitutes a fiduciary, fiduciary-like, or other relationship of trust and confidence required for a finding of liability under the misappropriation theory. Since O’Hagan, courts have struggled with this issue, particularly in light of the SEC’s promulgation of Rule 10b5-2(b), which seeks to further expand the circumstances in which a “duty of trust or confidence” may give rise to an insider trading claim.
Ruling on Cuban’s motion to dismiss, the Court rejected Cuban’s contention that a true fiduciary or fiduciary-like relationship must exist between the parties for a defendant to be held liable under the misappropriation theory. The Court found, instead, that a legal duty can arise between the parties by either an express or implied agreement that the parties intended to keep the information confidential and that the party receiving the information would refrain from trading on or otherwise refrain from using the information for personal gain. Reading the complaint in the light most favorable to the SEC, the Court held that the complaint failed to state a cause of action for insider trading because the SEC had failed to adequately plead that Cuban had agreed to refrain from trading on the stock until after the PIPE.
The Fifth Circuit disagreed, finding that the allegations set forth a plausible basis to find that Cuban agreed to keep the information that he received from the CEO confidential. The Court further stated that it was “plausible that 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.” Accordingly, the Fifth Circuit vacated the Judge Fitzwater’s order and remanded the case for further proceedings and discovery, but declined to address the lower court’s analysis of the misappropriation theory.
Following the close of discovery, Cuban moved for summary judgment on multiple grounds, including arguments set forth in his original motion to dismiss. After reviewing the evidentiary record, the Court determined that a reasonable jury could find: (1) that Cuban agreed to keep the PIPE information confidential; (2) that Cuban agreed to not trade on the PIPE information; (3) that Cuban failed to disclose that he would sell his shares prior to the PIPE announcement; (4) that the PIPE information was nonpublic and, therefore, confidential; and (5) that the information that Cuban traded on was material.
Of particular note, the Court rejected Cuban’s argument that the SEC must prove all elements of a contract, including offer, acceptance, and an exchange of consideration, for it to demonstrate that he agreed to maintain the confidentiality of the information and to refrain from trading. To the contrary, the Court held that the SEC need only prove that Cuban agreed, at least implicitly, to maintain the confidentiality of the company’s material, nonpublic information and not trade on it or otherwise use it. This finding was consistent with the Court’s earlier expansion of the nature of the duty that may give rise to misappropriation theory of liability, and, if the case proceeds that far, will hopefully provide the basis for an appeal that will allow the Fifth Circuit to address the legal questions raised by the district court and provide the industry with a bit more certainty.