Corporate Governance

Law in Opposition to Defendant Mark Cuban?s Motion to Dismiss -- A Review of the SEC?s Arguments

By William Garehime

The SEC responded to Mark Cuban's motion to dismiss by taking the position that this case involved  a well-settled application of insider trading principles and that Cuban traded on material, non-public information after he agreed to keep the information confidential.

In Cuban's Memo in Support of Motion to Dismiss, he asserted, among other things, that under Texas law, he did not violate a fiduciary or similar duty of trust or confidence; and to apply Rule 10b5-2(b)(1) would impermissibly expand its reach to business relationships.  In its response, the SEC made three major arguments: the case is a textbook example of unlawful misappropriation, it involved no new theory of liability, and Cuban's motion to dismiss focused on irrelevant state case law. These arguments are summarized below.

Cuban's agreement to keep the information confidential is a textbook example of insider trading under the misappropriation theory because Rule 10b5-2(b)(1) applies in the context of a business relationship. The plain language of the Rule states that a duty of trust or confidence exists '[w]henever a person agrees to maintain information in confidence . . . .' Here, according to the SEC, Cuban established a duty when he agreed to keep the offering information confidential. In an opinion from February of this year, a Massachusetts district court denied a defendant's motion for summary judgment where the defendant argued, like here, that Rule 10b5-2(b) did not apply to business relationships. Here, the SEC argued the court should do the same. Additionally, Cuban virtually ignored SEC v. Kornman, where the SEC survived summary judgment by arguing, like here, that Rule 10b5-2(b)(1) applied to a business relationship. Moreover, of the two cases Cuban cited to argue Rule 10b5-2(b)(1) does not apply to a business relationship, the first case involved a social relationship, not a business relationship; and the second cited dicta and the case was eventually overturned by the Ninth Circuit.

The SEC also argued that this case involves no new theory of liability. According to the SEC, the Supreme Court in O'Hagan endorsed the proposition that a duty may arise under the misappropriation theory through acceptance of a duty of confidentiality or through the pre-existence of a fiduciary relationship. The Court recognized that a contractual duty (not fiduciary duty) could create insider-trading liability under the misappropriation theory. The Second Circuit and the Eleventh Circuit have recognized that a confidentiality agreement establishes a duty. Here, the Complaint alleged that Cuban accepted a duty of confidentiality when he agreed to keep offering information confidential. To survive summary judgment, '[n]o further analysis is necessary.' Moreover, the cases Cuban cited obscure the law: Chiarella v. United States applied the classical theory, not the misappropriation theory; and United States v. Cassese held that a fiduciary relationship, while sufficient, is not necessary to establish a duty.

Cuban's argument that state law should define misappropriation is 'contrary to established insider trading law' and 'bad policy.' Under the misappropriation theory, courts typically do not apply state law to determine a duty, therefore, Cuban erred by arguing state law fiduciary duty cases applied. The Supreme Court in O'Hagan did not rely on state law of a specific jurisdiction. Instead, it relied on synthesized case law to determine misappropriation. If courts were to apply specific state law, liability for insider trading would depend on where one was located. Such a policy, the SEC argued, would 'inject uncertainty' and lead to different results for the same conduct.

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

Full post as published by The Race to the Bottom on April 16, 2009 (boomark / email).