In an insider trading case against Mark Cuban, the high-profile self-made billionaire and owner of the NBA Dallas Mavericks, the SEC was rebuffed in its latest effort to expand by enforcement action and rule-making authority the scope of insider trading liability under the so-called misappropriation theory. On July 17, 2009, the U. S. District for the Northern District of Texas (Fitzwater, J.), dismissed (with leave to amend) the SEC’s civil enforcement complaint against Mr. Cuban for failure to state a claim as a matter of law. SEC v. Mark Cuban, Civil Action File No. 3:08-CV-2050-D.
The question presented by Cuban’s motion to dismiss was whether the SEC adequately alleged that Cuban undertook a fiduciary obligation or other legal duty not to use certain material non-public information given to him so as to establish liability under the misappropriation theory of insider trading. The SEC’s claim was based on Cuban’s decision to sell his entire position in Mamma.com, the morning after Mamma.com’s CEO called him to inform him that the company was planning a private investment in public equity (“PIPE”) offering, but before the PIPE offering was publicly announced. By doing so, Cuban allegedly avoided a loss of more than $750,000. The SEC alleged that during the operative phone call, the CEO asked Cuban to keep the information confidential, but there was no allegation that Cuban agreed not to use the information, or that Cuban had any relationship with the company other than as a minority shareholder.
The court squarely held that Cuban’s alleged oral agreement to keep the information confidential by itself was not sufficient as a matter of law to create the requisite fiduciary relationship on which the misappropriation theory of insider trading is based, according to U.S. Supreme Court precedent, namely U.S. v. O’Hagan, 521 U.S. 642 (1997). The district court ruled that an insider trading claim based on agreement (rather than the existence of a fiduciary relationship between the source of the information and the recipient) must impose upon the recipient of the information the legal duty to refrain from trading on or otherwise using the information for personal gain. In so ruling, the court explained that, under the misappropriation theory of insider trading liability, it is the undisclosed use of confidential information for personal benefit, in breach of a duty not to do so, that constitutes the deception that is at the essence of an alleged violation of § 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder.
Consistent with this rationale, the court further ruled that the SEC could not rely on its own Rule 10b5-2(b)(1), 17 C.F.R. § 240.10b5-2 (2009), because, by its plain language, the rule attempts to predicate misappropriation theory liability on a mere confidentiality agreement lacking a non-use component. The court reasoned that to allow the SEC to promulgate and enforce a rule imposing liability on the basis of a confidentiality agreement alone would exceed the SEC’s § 10(b) authority to proscribe conduct that is deceptive. See O’Hagan, 521 U.S. at 651 (“Liability under Rule 10b-5, our precedent indicates, does not extend beyond conduct encompassed by § 10(b)’s prohibition.”).