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E-MailThis post is by Allen Ferrell of Harvard Law School.
I have recently filed an amicus brief on behalf of myself and Professor Bainbridge of the UCLA Law School, Professor Jonathan Macey of Yale Law School, Professor Alan Bromberg of SMU Law School and Professor Henderson of the University of Chicago Law School in the litigation filed against Mark Cuban by the SEC in the United States District Court for the Northern District of Texas.
The SEC complaint essentially alleges that Mark Cuban committed insider trading when, according to the complaint, he sold stock in a company (Mamma.com) in which he was a large shareholder (but not a director or officer) after receiving material, non-public information from the company. The basis for the SEC’s claim of insider trading is the allegation (hotly disputed) that there was a confidentiality agreement with Mr. Cuban covering this material, non-public information.
In our amicus — which can be found here — we argue that even if there was a confidentiality agreement (i.e. accepting all of the SEC’s allegations as true), as a legal matter Mr. Cuban could not have committed insider trading. The Supreme Court in U.S. v. O’ Hagan, 521 U.S. 642 (1997) emphasized that only if a defendant has breached a fiduciary or similar relationship of trust and confidence can the defendant be found to have engaged in the requisite deception through non-disclosure. Under both state and federal common law, a confidentiality agreement alone creates only an obligation to maintain the secrecy of the information, not a fiduciary or fiduciary-like duty to act loyally to the source of the information. As a result, if the SEC’s Rule 10b5-2(b)(1) is read as creating insider trading liability solely on the basis of a confidentiality agreement, this rule is an invalid exercise of the SEC’s rulemaking authority.
Of course, neither I nor any of the professors that signed the amicus brief were compensated in any way for our efforts.
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Most written confidentiality agreements would include a sole use restriction (i.e., the info is only to be used in evaluating the proposed PIPE or other transaction) and in some cases a detrimental use restriction (the info is not be used to the disclosing party’s detriment). Would either of these constitute a fiduciary-like duty?
It would seem to me that the confidentiality issue is a red herring. Is it not a illegal to trade on non-public information no matter how obtained?
Based on the allegations in the SEC’s complaint against Mark, the case is weak and Cuban has a good chance of prevailing on a motion for dismissal.
An outside shareholder cannot be converted into an insider with a duty to abstain from trading unless he willingly consents to accept that restriction. The fact that a CEO unilaterally calls him and gives him non-public information on the condition that he keep it confidential is not sufficient to bind him to forego trading. According to the complaint, Mark agreed to keep the information confidential and there is no allegation that he told anyone else about it.
Even if he said, “I’m screwed. Now, I can’t sell,” (which he may deny) that was merely an impulsive post hoc reaction to what he correctly perceived to be a proposed dilutive stock offering, not a legally binding informed promise not to trade as a quid pro quo for getting non-public information. Without an allegation that he agreed not to trade in the stock sell as a condition of receiving the inside information, there is no reason he must be a captive investor for even one minute in a company whose management was, unbeknownst to him before he found out, intending to screw him and all shareholders. Once he learned the truth about management’s plans, he has no duty to sit by helplessly until management decides to make the news public (at some time which he cannot control). Essentially, the SEC’s argument is that he should be bound to forego trading indefinitely.
The CEO could have asked Mark to agree in writing not to trade until the confidential information was made public. The normal procedure would be to ask Mark to sign an NDA. Then he would be able to know what he could and could not do before agreeing to get the information. (We have signed some NDA’s and refused to sign others if we felt they unduly constricted us.) Since the CEO didn’t do that, the SEC should go after him for negligence by disclosing non-public information selectively without first obtaining assurance from the recipient that he would not trade on it. But that should not be Mark’s problem.
In short, the complaint pointedly does not allege that Mark agreed to be an insider who would be restricted from trading. He agreed to keep the non-public information confidential and there is no allegation he broke his promise. He has no other duty to the company or to anyone else.
Especially in light of its failure to catch Madoff after Markopolous’ many credible complaints, the SEC’s priorities seem all wrong to me. They allow boards and managers to screw shareholders with impunity and punish shareholders that want to avoid get screwed by precluding them from selling their shares when they learn about the screw job. Talk about blaming the victim! It is very sad.
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[…] HARVARD LAW SCHOOL CORP. GOV. BLOG (Feb. 5, 2009): SEC vs. Mark Cuban Cuban could not have committed insider trading because a confidentiality agreement alone does not create a fiduciary or fiduciary-like duty to act loyally to the source of the information. […]