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E-MailThis post comes to us from Todd Cosenza of Willkie Farr & Gallagher LLP, and is based on a Willkie Farr & Gallagher client memorandum by Mr. Cosenza and Tariq Mundiya. This post discusses the recent opinion by the U.S. Court of Appeals for the Fifth Circuit in S.E.C. v. Cuban, which is available here.
On September 21, 2010, in S.E.C. v. Cuban, 2010 WL 3633059, No. 09-10996 (5th Cir.), a federal appeals court vacated a lower court decision that had dismissed the SEC’s well-publicized insider trading lawsuit against Mark Cuban. The Fifth Circuit held that it was at least “plausible,” based on the SEC’s allegations, that Cuban had violated a duty not to trade on material, nonpublic information and remanded the case for further proceedings.
Factual and Procedural Background
In November 2008, the SEC brought a civil enforcement action against Mark Cuban, the owner of the NBA’s Dallas Mavericks franchise. The action arose from Cuban’s June 2004 sale of his entire 6.3 percent ownership interest (600,000 shares) in Mamma.com Inc. (now Copernic, Inc.), a Canadian internet search company. According to the SEC’s complaint, during the spring of 2004, Mamma.com’s executives decided to initiate a private investment in public equity (“PIPE”) offering to raise additional capital. Because such offerings tend to dilute the value of existing shares, the company expected Cuban, its largest known shareholder at the time, to be unhappy. The company’s CEO telephoned Cuban, informing him of the PIPE offering. Cuban orally agreed to keep the information regarding the PIPE offering confidential, but allegedly ended his call with the CEO by saying, “Well, now I’m screwed. I can’t sell.” Nevertheless, following this telephone conversation and another discussion with the investment bank conducting the PIPE offering, Cuban instructed his broker to sell his entire stake in Mamma.com. The next day, the company publicly announced the PIPE offering, and the stock price of Mamma.com declined. By selling on the nonpublic information, Cuban avoided over $750,000 in losses.
The district court found (on a motion to dismiss) that, even assuming the SEC’s allegations were true, Cuban only agreed to keep confidential the information he received from the company’s CEO. According to the court, he never agreed to refrain from trading on it and could not be liable under the antifraud provisions of the Securities Exchange Act of 1934 for insider trading. The district court held that a third party (such as Cuban) who accepts material, nonpublic information from an issuer on a confidential basis is not precluded from trading on that information absent a specific agreement with the issuer not to trade. S.E.C. v. Cuban, 2009 WL 2096166 (N.D. Tex. July 17, 2009). After the court dismissed the action, the SEC appealed to the Fifth Circuit.
Fifth Circuit’s Decision
Reviewing the district court’s ruling de novo, the Fifth Circuit noted its disagreement with the lower court’s interpretation of the facts. It commented that only after Cuban told the company’s CEO “I can’t sell” did the company send him more information about the PIPE offering.
According to the appellate court, that factual allegation, among others, provided “more than a plausible basis to find that the understanding between the CEO and Cuban was that he was not to trade.” The Fifth Circuit thus concluded that it was premature for the lower court to dismiss the action based on one plausible interpretation of the facts alleged in the SEC’s complaint. In remanding the case to the district court, the court acknowledged the “paucity of jurisprudence” on the question of what constitutes a “relationship of trust and confidence” and the “inherently fact-bound nature of determining whether” Cuban’s interaction with the company had created a duty to abstain from trading on nonpublic information.
Conclusion
Although each case will obviously turn on its facts and circumstances, any person in possession of what might be material, nonpublic information should exercise great caution before engaging in securities trading — even in the absence of an explicit agreement to keep the information confidential or other restrictions concerning its use. Corporate insiders and related parties similarly should continue to exercise caution when providing confidential information to outsiders because that, too, creates a risk of “tipper” liability. Lastly, while the appellate court’s decision has generated much publicity, it remains unclear how the lower court will ultimately resolve this case as it now proceeds into formal discovery.
