SEPTEMBER 27, 2010
SEC ENFORCEMENT UPDATE
Fifth Circuit Reinstates Insider Trading Complaint Against
On September 21, 2010, the Fifth Circuit Court of Appeals issued an opinion reversing and remanding the District
Court’s order dismissing the SEC’s insider trading complaint against businessman Mark Cuban. S.E.C. v. Cuban, ---
F.3d ----, 2010 WL 3633059 (5th Cir. 2010), reversing 634 F. Supp. 2d 713. The SEC’s complaint alleged that Cuban
violated Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 pursuant to the misappropriation theory
of insider trading, which imposes insider trading liability for the use of material, nonpublic information by someone
who trades in breach of a duty owed to the source of that information. The District Court dismissed on the ground
that as to a non-fiduciary of the issuer, a confidentiality agreement, without an accompanying agreement not to trade,
could not be the basis of liability under the misappropriation theory and the allegations of the Complaint alleged, at
most, an agreement to keep the information confidential.
The Fifth Circuit reversed and remanded, holding that the SEC’s complaint did allege sufficient facts to infer that
Cuban agreed not to trade. The Fifth Circuit’s decision declined to take a position on the legal question of whether a
confidentiality agreement, without more, is sufficient to impose insider trading liability on a non-fiduciary.
Factual Background and the SEC’s Complaint
The SEC contended that Cuban engaged in insider trading when, after agreeing to maintain the confidentiality of
material, nonpublic information about a planned private investment in public equity (“PIPE”) offering by
Mamma.com, Cuban sold his stock in the company without first disclosing that he intended to trade on the
information. According to the SEC’s Complaint, Cuban held 600,000 shares – a 6.3% stake – in Mamma.com, making
him its then largest-known shareholder. During the course of raising capital with the PIPE offering, Mamma.com
decided to inform Cuban and invite him to participate. According to the complaint, Mamma.com’s CEO called Cuban,
prefacing his remarks by telling Cuban that he had confidential information to convey, and asking Cuban to maintain
the confidentiality of the information. Cuban agreed, and the CEO proceeded to tell Cuban about the offering.
Cuban reacted negatively to the news, stating that he did not like PIPE offerings because they diluted existing
shareholders. At the close of the call, Cuban allegedly told the CEO “Well, now I’m screwed. I can’t sell.” Later that
day, at the suggestion of the CEO, Cuban allegedly contacted an investor representative to obtain additional
confidential information about the terms and conditions of the PIPE, including the discounted sale price and other
incentives being offered to PIPE investors. After that call Cuban instructed his broker to sell all 600,000 of his
Mamma.com shares. Cuban did not inform Mamma.com of his intent to do so. After the PIPE announcement,
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SEC ENFORCEMENT UPDATE
Mamma.com’s stock price fell, eventually closing down 39%. By selling his stake, Cuban avoided a loss of
The District Court’s Decision
Cuban moved to dismiss the SEC’s complaint, arguing that the SEC failed to plead a violation of Section 10(b) and
Rule 10b-5 under the misappropriation theory. Under the misappropriation theory, “a person commits fraud ‘in
connection with’ a securities transaction, and thereby violates §10(b) and Rule 10b-5, 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 District Court dismissed the case, concluding that the SEC’s allegation that Cuban agreed to keep the information
confidential was not enough to impose liability on a person who was not a fiduciary of the issuer without an agreement
also to refrain from trading. The District Court concluded that the allegations about Cuban’s statements in the
Complaint merely reflected Cuban’s belief that “it would be illegal for him to sell his Mamma.com shares,” but could
not “be understood as an agreement not to sell.” The District Court further found that the SEC’s allegations about the
communications by Mamma.com’s CEO demonstrated only that the CEO expected Cuban not to sell, and did not
“suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading.” The District Court also
rejected the SEC’s argument that Rule 10b5-2(b)(1) imposed a duty not to trade in connection with the confidentiality
The Fifth Circuit Opinion
The Fifth Circuit, focusing on the pleading standards under Federal Rules of Civil Procedure 9(b) and 12(b)(6),
disagreed with the District Court’s interpretation of the facts alleged surrounding Cuban’s communications with
Mamma.com and its investment bankers. The court noted that, in isolation, Cuban’s statement that he couldn’t sell
might not constitute an agreement not to trade on the information. But, after Cuban made such statements to the
CEO, he then contacted the investment bank handling the PIPE transaction - as suggested by the CEO - to learn
additional information. These facts were sufficient to give rise to an inference that there was an agreement not to
trade. As the court reasoned, it was “plausible that each of the parties understood, if only implicitly, that Mamma.com
would only provide the terms and conditions of the offering to Cuban for the purpose of evaluating whether he would
participate in the offering, and that Cuban could not use the information for his own personal benefit.”
Moreover, the court observed that if the CEO of Mamma.com had disclosed nonpublic information only with an
agreement of confidentiality, and without an explicit agreement not to trade, “[s]uch an agreement would raise serious
tipper/tippee liability concerns” if circumstances suggested that the insider received a personal benefit from the
disclosure. Finally, because the court held that the facts alleged were sufficient to give rise to an inference of an
agreement not to trade, it declined to address the validity of the SEC’s argument that Rule 10b5-2(b) imposed a duty
not to trade in connection with a confidentiality agreement.
The Cuban decision is significant in several respects. First, the Fifth Circuit rested its decision on factual inferences and
the rules of pleading, by reasoning that sufficient facts were pled to raise an inference that Cuban agreed not to trade.
The Fifth Circuit left for another day the issue of whether an agreement not to trade is a necessary element of a
misappropriation claim against an outsider. Courts in other jurisdictions have imposed liability on the basis of only a
confidentiality agreement. For instance, in United States v. Falcone, 257 F.3d 226 (2d Cir. 2001) (Sotomayor, J.), the court
upheld imposition of misappropriation theory liability against a broker who obtained pre-release copies of a Business
Week column from an employee of the magazine’s distributor, where the distributor had agreed to maintain the
confidentiality of the magazine. The court held that that “a fiduciary relationship, or its functional equivalent, exists
only where there is explicit acceptance of a duty of confidentiality or where such acceptance may be implied from a
similar relationship of trust and confidence between the parties.” Id. at 234; see also S.E.C. v. Yun, 327 F.3d 1263, 1273
SEC ENFORCEMENT UPDATE
(11th Cir. 2003) (“Of course, a breach of an agreement to maintain business confidences would also suffice” to yield
insider trading liability); United States v. Chestman, 947 F.2d 551, 571 (2d Cir. 1991) (noting that fiduciary status may be
established by “a pre-existing fiduciary relation or an express agreement of confidentiality”); SEC v. Lyon, 529 F. Supp.
2d 444, 452-53 (S.D.N.Y. 2008) (holding that the SEC adequately alleged existence of predicate duty for
misappropriation theory liability where it alleged that purchase agreement and other materials related to PIPE offering
contained confidentiality conditions and provisions, including requirements that defendants use information for sole
purpose of evaluating possible investment in the offering).
In addition, the decision suggests that companies considering sharing confidential, nonpublic information with third
parties – and insiders tasked with relaying such information – should consider not only seeking an agreement to
maintain the confidentiality of that information, but also an explicit agreement not to use the information. And,
persons who receive material nonpublic information from a public company without giving an express undertaking
either to keep the information confidential or not to trade on the basis of the information should keep in mind that
public company representatives who communicate such information may well have a different recollection of what was
undertaken if questions are raised by the SEC.
If you have any questions regarding this update, please contact the Sidley lawyer with whom you usually work.
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