11/10/2010
On September 21, 2010, the Fifth Circuit Court of Appeals reversed a district court's dismissal of insider trading claims against businessman and Dallas Mavericks owner Mark Cuban. SEC v. Cuban, 2010 WL 3633059 (5th Cir. 2010), reversing 634 F. Supp. 2d 713. The district court had held that an insider trading claim based on the misappropriation theory could not be sustained because Cuban never agreed to refrain from trading on any confidential information he received. In reversing the district court's holding, the Fifth Circuit held that it was "plausible," based on the parties' understandings and expectations, that Cuban had a duty not to trade on any material, nonpublic information.
Factual and Procedural BackgroundIn early 2004, the executives of Mamma.com, in an effort to raise additional capital, explored the feasibility of a private investment in public equity (PIPE) offering. Because PIPE offerings may dilute existing shareholder value, Mamma.com's chief executive officer telephoned Cuban, Mamma.com's largest known shareholder at the time, to inform him of the potential PIPE offering. According to the Securities and Exchange Commission's complaint, Mamma.com's CEO disclosed confidential information to Cuban only after Cuban orally agreed he would keep whatever information he received confidential. As anticipated, Cuban reacted angrily and proclaimed, "Well, now I'm screwed. I can't sell." Internal company e-mails by Mamma.com executives evidenced an expectation that Cuban would not sell his shares until after the PIPE offering was announced. In a follow-up e-mail by Mamma.com's CEO to Cuban, Mamma.com's CEO provided Cuban the contact information for the investment bank conducting the PIPE offering. Cuban contacted the investment bank's sales representative and obtained additional confidential information about the offering. "One minute" after his call with the sales representative, Cuban instructed his broker to sell Cuban's entire interest in Mamma.com.
After the markets had closed on June 29, 2004, Mamma.com publicly announced the PIPE offering. Unbeknownst to Mamma.com, Cuban had already sold his entire interest in the company. By selling his interest prior to the public announcement of the PIPE offering, Cuban avoided losses in excess of $750,000. Cuban filed the required disclosure documents and publicly stated he sold because of the PIPE offering.
In November 2008, the SEC brought a civil enforcement action against Cuban alleging insider trading based on the misappropriation theory. The misappropriation theory holds that a person violates Section 10(b) of the Exchange Act of 1934, as amended, and Rule 10b-5 when the person misappropriates confidential information for securities trading purposes in breach of a duty owed to the source of the information. Rule 10b5-2(b)(1) provides that "a 'duty of trust or confidence' exists . . . [w]henever a person agrees to maintain information in confidence[.]" Cuban moved to dismiss the complaint. The district court held that the SEC had exceeded its authority in issuing rule 10b5-2(b)(1) and that because Cuban only agreed to keep the information confidential and did not agree to refrain from trading on it, Cuban could not be found liable for insider trading. The SEC appealed the district court's decision.
The Fifth Circuit's DecisionWhile the district court had held that Cuban's statements of being "screwed" and unable to sell were just expressions of Cuban's belief, not an agreement between the parties, the Fifth Circuit held that a reasonable argument exists that this expression was the basis for Mamma.com granting Cuban access to additional confidential information. For example, Cuban learned of the offering's size and the potential discount to the market price only after he was granted access to the investment bank's sales representative. Thus, the Fifth Circuit held that a plausible argument exists that the parties understood, if only implicitly, that Cuban was receiving confidential information only in relation to Cuban's potential participation in the PIPE offering and that Cuban was to refrain from otherwise trading on this information. Noting the "paucity of jurisprudence on . . . what constitutes a relationship of 'trust and confidence' and the inherently fact-bound nature of determining whether such a duty exists," the Fifth Circuit vacated the district court's holding and remanded the case for further proceedings.
ConclusionEven though the Fifth Circuit has remanded this case for further review, it remains unclear whether a confidentiality agreement, without more, is sufficient to impose insider trading liability on a non-fiduciary. Accordingly, companies should expressly state in all confidentiality agreements that the recipient of material, nonpublic information will refrain from trading on such information. Similarly, persons in possession of material, nonpublic information should exercise discretion in all securities trading even if there is no express agreement to refrain from trading on such information.