On March 5, 2013, the United States District Court for the Northern District of Texas issued a Memorandum Opinion and Order in the case Securities and Exchange Commission v. Mark Cuban,1 denying Cuban's motion for summary judgment. While the court observed that it was a close question in some respects, it rejected Cuban's argument that no reasonable jury could find that he violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 by trading on material, nonpublic information in violation of the misappropriation theory of insider trading.
Procedural Background
The SEC charged Mark Cuban ("Cuban"), the owner of the Dallas Mavericks and an investor in start-up companies, with insider trading under the misappropriation theory when Cuban sold his shares of stock in Mamma.com Inc. ("Mamma.com") after allegedly receiving material, nonpublic information concerning a planned private investment in public equity ("PIPE") offering by the company. The SEC alleged that Cuban agreed to maintain the confidentiality of the material, nonpublic information concerning the planned PIPE offering, and accordingly, he was not allowed to trade on that information. The SEC further alleged that, after receiving the information, Cuban sold all of his stock in the company before the public announcement of the PIPE offering without first disclosing his intention to Mamma.com. As a result of his trades, he avoided substantial losses when the stock price declined after the PIPE offering was announced publicly.
According to the summary judgment record, on the eve of the PIPE offering, the CEO of Mamma.com emailed Cuban and asked to speak to him as soon as possible. When Cuban called, the CEO told Cuban, "I've got confidential information," to which Cuban replied, "Um hum, go ahead."2 The CEO then informed Cuban about the PIPE offering. Cuban reacted angrily, and near the end of the conversation said, "Now I'm screwed. I can't sell."3 Cuban claimed that he "told [the CEO] that [he] was not going to participate and [he] was going to sell [his] shares."4 After this conversation, Cuban contacted the head of the private placement group at the investment bank that was handling the PIPE to obtain the terms and conditions of the deal.
The court initially dismissed the SEC's action against Cuban for failure to state a claim upon which relief can be granted because the complaint did not assert that the CEO of Mamma.com intended to obtain from Cuban an agreement to refrain from trading on the PIPE information, as opposed to an agreement merely to maintain the confidentiality of the information.5 On appeal, the Fifth Circuit vacated and remanded the decision, holding that the understanding between the CEO of Mamma.com and Cuban provided more than a plausible basis to find that Cuban agreed not to trade on the information.6
The Order Denying Cuban Summary Judgment
On remand, Cuban moved for summary judgment, contending that the SEC failed to show: 1) that he agreed to keep the PIPE transaction confidential; 2) that he agreed not to trade on the information; 3) that he did not disclose his intention to sell his Mamma.com stock; and 4) that the PIPE information was material and nonpublic. The district court rejected each of Cuban's arguments.
First, the court ruled there was sufficient evidence for a reasonable jury to find that Cuban agreed to keep the PIPE information confidential and therefore agreed not to trade. The court held that under the misappropriation theory, an agreement does not need to be explicit and that contract law requiring a "valid offer and acceptance plus a meeting of the minds supported by consideration" does not necessarily apply.7 The court explained that Cuban's "I can't sell" statement, made in the context of a telephone call with Mamma.com's CEO, would enable a reasonable jury to find that Cuban at least implicitly agreed to keep the information confidential.8 It could be inferred that Cuban would not have considered himself foreclosed from trading unless he believed that he had agreed to treat the information as confidential.9 The court concluded there was a genuine issue of fact as to whether "Cuban agreed at least implicitly to refrain from trading on or otherwise using for his own benefit the nonpublic PIPE information."10
Second, the court ruled that there was a genuine issue of fact whether Cuban failed to disclose his intention to trade on the PIPE information. Under the misappropriation theory, if the fiduciary discloses to the source his plans to trade on nonpublic information, there is no "deceptive device" and thus no Section 10(b) violation.11 Cuban argued that he made full disclosure of his intention to trade, and he pointed to evidence from three separate individuals confirming his intention to sell his shares in Mamma.com after learning of the PIPE. The court nonetheless held that a reasonable jury could find that Cuban merely disclosed that he "was going to sell," not that he would sell before Mamma.com publicly announced the PIPE.12
Third, the court ruled that a reasonable jury could find that the PIPE information that Cuban received was both confidential and material. Cuban argued that the SEC failed to address his arguments that the information was not confidential and that only confidential information could serve as a basis for the misappropriation theory. The court rejected that notion and explained, "[I]n the context of the misappropriation theory of insider trading, the terms confidential information and nonpublic information essentially have the same meaning. Therefore, the SEC's evidence that the PIPE information was nonpublic is sufficient to defeat the summary judgment argument that the information was not confidential."13 The court went on to rule that a jury reasonably could find that information about the Mamma.com PIPE was nonpublic and rejected Cuban's arguments that certain documents related to the transaction had made the information public.14 Although Cuban argued that the information concerning the PIPE was public because the engagement letter between Mamma.com and its investment bank was public, the court disagreed and explained that the engagement letter did not disclose the PIPE transaction that Mamma.com was contemplating or even state that a PIPE transaction definitely was being considered.15 As the court observed, the engagement letter merely stated that a PIPE offering was one of several possible investment banking services that the investment bank might provide for Mamma.com.16 The court also rejected Cuban's argument that the Securities Purchase Agreement established that he had not received any nonpublic information because that agreement expressly stated that Mamma.com had not provided to the purchasers any material, nonpublic information.17 That language, the court explained, referred only to the fact that the prospective purchasers had not been provided with any material, nonpublic information about the company; the fact of the PIPE offering itself, however, was clearly nonpublic.18
The court also ruled that a jury reasonably could find that the nonpublic information about the PIPE offering was also material. The court explained that a reasonable investor would expect that a PIPE offering with incentives to investors would have the result of diluting shareholder value, and the court observed that the amount Mamma.com sought to raise via the PIPE offering significantly exceeded the funds it had received from its past four years of operations and stock issuance combined.19 For purposes of assessing materiality, the court was not persuaded by an event study, prepared by Cuban's expert witness, showing that the price reaction of Mamma.com stock to the PIPE announcement was not statistically significant.20
Practical Implications of the Order
Unlike past decisions in the case, this Order denying Cuban's motion for summary judgment does not stand for any novel proposition when it comes to insider trading law. Instead, the Order reinforces the prevailing belief that insider trading cases are dominated by fact-based questions that ultimately are decided by the jury. The fact that the court acknowledged that its decision was a close question in some respects likely foreshadows a hard-fought battle ahead at trial.21
The Order hints at some practical guidance for companies contemplating a PIPE offering and for prospective investors in such an offering. A company contemplating a PIPE offering should obtain a signed confidentiality agreement from prospective investors before divulging any mention of the PIPE offering. That confidentiality agreement should contain an explicit representation by the prospective investor not to disclose the information and also should contain an explicit prohibition on trading. Investors who are approached by a company seeking to share nonpublic information should be aware that even the slightest agreement - written or oral - to maintain the confidentiality of information may bar future trading in the security. Of course, if a prospective investor rejects signing a confidentiality agreement and does not have a duty to maintain confidentiality, the investor may be able to trade without violating insider trading laws.
1 SEC v. Cuban, No. 08-02050 (N.D. Tex. Mar. 5, 2013) (order denying summary judgment) ("Order").
2 Order at 8.
3 Id. at 8.
4 Id. at 14.
5 SEC v. Cuban, 634 F. Supp. 2d 713, 717-19 (N.D. Tex. 2009), vacated, 620 F.3d 551 (5th Cir. 2010).
6 SEC v. Cuban, 620 F.3d 551, 552-53 (5th Cir. 2010).
7 Order at 6.
8 Id. at 8-9.
9 Id. at 9.
10 Id. at 11. The court similarly rejected Cuban's arguments based on traditional contract defenses to the validity of the confidentiality agreement, such as mutual mistake of fact. Id. at 20-22.
11 Id. at 13 (quoting United States v. O'Hagan, 521 U.S. 642, 655 (1997)).
12 Id. at 14. This likely will be a critical issue at trial.
13 Id. at 17.
14 Id. at 22.
15 Id. at 23.
16 Id.
17 Id. at 23-24.
18 Id.
19 Id. at 27.
20 Id. at 26-27.
21 Id. at 13.
