By: Kenneth B. Winer and Marc B. Dorfman
A district court recently dismissed the highly touted securities enforcement action that the SEC filed against Dallas Mavericks owner Mark Cuban. SEC v. Cuban, 2009 U.S. Dist. LEXIS 61574 (N.D. Tex. July 17, 2009). Four lessons can be drawn from this case:
SEC Allegations and Dismissal of SEC Complaint
On November 17, 2008, the SEC filed a heavily publicized complaint charging that Mr. Cuban had engaged in unlawful insider trading by selling stock in a company, Mamma.com, Inc. The SEC alleged that in June 2004, the CEO of Mamma.com, Inc. spoke to Mr. Cuban by telephone and invited Mr. Cuban to participate in an offering in which Mamma.com stock would be sold at a discount to the prevailing market price, thereby diluting the shares of existing Mamma.com shareholders. The complaint further alleged that before telling Mr. Cuban information regarding this planned offering, the CEO obtained from Mr. Cuban an oral promise to keep this information confidential. According to the complaint, within hours of receiving this information, Mr. Cuban avoided Mamma.com losses in excess of $750,000 by selling his entire stock position prior to the public announcement of the offering.
On July 17, 2009, Chief Judge Sidney A. Fitzwater, the highly respected Chief Judge of the U.S. District Court for the Northern District of Texas, dismissed the SEC’s complaint. Chief Judge Fitzwater held that the SEC had failed to state a claim against Mr. Cuban because the SEC had alleged neither that Mr. Cuban had a fiduciary relationship with Mamma.com (although Mr. Cuban owned a 6.3-percent stake in Mamma.com, he was not an officer, employer, or director of Mamma.com) nor that Mr. Cuban had agreed not to trade based on the information provided by the CEO.
Chief Judge Fitzwater explained that the essence of the misappropriation theory of insider trading on which the SEC had based its complaint “is the traders undisclosed use of material, nonpublic information that is the property of the source in breach of a duty owed to the source to keep the information confidential and not to use it for personal benefit.” Id. at 19. Chief Judge Fitzwater explained that the duty not to use the information for personal benefit can arise by operation of law from a fiduciary relationship. According to Chief Judge Fitzwater, a duty not to trade based on information also can be based on an express or implied agreement between the source of the information and the trader.
Chief Judge Fitzwater stated that to form the basis for a misappropriation charge, an agreement including a promise to keep the information confidential is insufficient if the agreement does not also include a promise to refrain from trading based on the information:
The agreement ... must consist of more than an express or implied promise merely to keep information confidential. It must also impose on the party who receives the information the legal duty to refrain from trading on or otherwise using the information for personal gain. With respect to confidential information, nondisclosure and non-use are logically distinct. A person who receives material, nonpublic information may in fact preserve the confidentiality of that information while simultaneously using it for his own gain. Indeed, the nature of insider trading is such that one who trades on material, nonpublic information refrains from disclosing that information to the other party to the securities transaction. To do so would compromise his advantageous position.
Id. at 26.
Based on the absence of sufficient allegations giving rise to a duty not to trade, Chief Judge Fitzwater dismissed the SEC’s complaint with leave to file an amended complaint addressing this deficiency.
* This alert is based on an article published by Securities Law 360.
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If you have any questions about this alert or would like to discuss the topic further, please contact your Foley attorney or the following individuals:
Kenneth B. Winer
Marc B. Dorfman
Members of our Securities Enforcement & Litigation Practice have many years of experience as government attorneys who investigated and prosecuted a broad range of securities activities. Our vast experience includes defending investigations by the SEC and other securities regulators as well as a wide range of matters involving enforcement actions by the SEC Division of Enforcement, grand juries, state securities regulators, and self-regulatory organizations such as FINRA and the NYSE.