Corporate Governance

SEC v. Cuban: SEC's Reply Brief (Insider Trading without a Fiduciary Obligation)

By Todd Penner

On April 12, 2010, the Securities and Exchange Commission ('SEC') filed a Reply Brief that addresses issues raised by Mark Cuban's ('Cuban') Appellate Brief.  The Northern District of Texas dismissed the original case because the complaint failed to allege Cuban owed a duty to disclose sufficient to constitute deception, as required under Section 10(b) of the Securities Exchange Act.  

First, in its initial brief, the SEC argued that Cuban's explicit agreement to keep the information about Mamma.com's Private Placement in Public Equity ('PIPE') offering confidential included a duty of non-use.  Therefore, Cuban's failure to publicly disclose that information prior to trading constituted a breach of that duty and amounted to deception under the misappropriation theory of insider trading.  Under the misappropriation theory 'a person commits fraud ‘in connection with' a securities transaction . . . when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.'  United States v. O'Hagan, 521 U.S. 642, 652 (1997).  The SEC argued that an agreement to keep information confidential necessarily creates an agreement to keep the information 'in trust,' which includes the duty to refrain from using the information for personal gain. 

Further, the SEC replied to Cuban's contention that a traditional fiduciary duty is required for insider trading liability by asserting that language in O'Hagan indicates a 'similar obligation' would suffice.  The SEC argued that a duty not to use the information suffices for application of the misappropriation theory.  Therefore, the SEC is not required to plead a traditional fiduciary duty because Cuban is bound by the duty not to trade implied in the confidentiality agreement.

Second, the SEC argued that the 1934 Act Rule 10b5-(2)(b)(1) (the 'Rule') establishes 'a duty of trust or confidence' when a person agrees to keep information confidential.  Moreover, the SEC's interpretation of the Rule is a reasonable interpretation of Section 10(b)'s deception requirement and is therefore entitled to Chevron deference.  Additionally, the SEC maintained that the Rule is applicable to business relationships because it applies to all agreements of confidentiality.  The SEC contended that the cases cited by Cuban, supporting the notion that the Rule applies only to close personal or familial relationships, are irrelevant because the plain language of the regulation controls.

Next, the SEC argued that the evidence supports a reasonable inference that Cuban explicitly agreed not to trade, and therefore a duty of non-use was established.  The SEC relied upon Cuban's statement, 'Well, now I'm screwed. I can't sell,' as primary evidence that he explicitly agreed not to trade.  Further, the SEC relied upon two internal Mamma.com emails reflecting that Cuban agreed not to sell.  Therefore, the SEC contended that notwithstanding a duty imposed by the Rule, a duty of non-use of the information was sufficiently alleged, despite Cuban's claim that the complaint did not plead evidence that 'Mamma.com's CEO sought an agreement not to trade.'

Finally, the Reply Brief addressed an Amicus Brief filed by four law professors in support of Cuban.  The SEC argued that the brief presents a 'fundamental disagreement with the controlling Supreme Court decision[s]' regarding the misappropriation theory and not a disagreement about its application to this case.  The SEC relied upon O'Hagan in arguing that 'deception through nondisclosure' was the primary objective of the adoption and application of the misappropriation theory.  Therefore, the application of the misappropriation theory is warranted here. 

The SEC maintained the district court's judgment should be reversed.

Primary materials for this post are available on the DU Corporate Governance website.

Full post as published by The Race to the Bottom on August 20, 2010 (boomark / email).