By John R. Fletcher
Mark Cuban is inside another controversy. This time it is not because he is angry with the officiating in the National Basketball Association, yelling at opponents of his Dallas Mavericks, or even scooping out ice cream at a Dallas area Dairy Queen store. The fact that Cuban has been sued by the Securities and Exchange Commission for violating its insider trading laws might not draw a great deal of attention either. However, his response to that lawsuit is remarkable. Call it unique, brilliant or any number of other adjectives but Cuban has offered to help the government in its case against him. Amazingly, he has offered to pay the government’s legal bill in order to expedite the process.
What is the original issue?
The issue brought forth by the SEC is whether Cuban has violated Federal insider trading laws. After gleaning information from the chief executive officer of Mamma.com regarding a potential private investment public equity offering (PIPE), Cuban sold his entire 6.3 percent stake in the company. This case, on appeal from the United States District Court for the Northern District of Texas, centers on the scope of liability under insider trading laws. The SEC brought this action against the entrepreneur alleging 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. Cuban is also alleged to have breached his duty by trading stock in Mamma.com after receiving confidential information from the CEO. By selling his stock, he was able to avoid financial losses attributed to the PIPE.
In 2004, Cuban acquired an equity stake in Mamma.com, a search engine company. Shortly thereafter, Mamma.com tried to raise more money through a public offering based on the advice of investment bank Merriman Curhan Ford & Co. The bank suggested that the company invite Cuban to participate in the offering with the understanding that any information conveyed to him be held in confidence. Cuban agreed that he would not sell his shares although he feared his equity position would be diluted. Merriman gave Cuban confidential information, including that the offering would be sold at a discount to the market price. He understood he would be unable to trade his shares based on existing insider trading laws. Upon learning the confidential information and admitting his knowledge of the insider trading laws, he told Mamma.com’s CEO “Well, now I’m screwed. I can’t sell.” Securities and Exchange Commission v. Cuban, No. 09-10996 (5th Cir. Sep. 21, 2010).
Cuban, after properly notifying the SEC, sold his entire stake despite being bound to refrain from such action per his agreement with the CEO. By selling, he saved himself approximately $750,000 as the stock price fell nearly 40% within a week of the public offering announcement.
How did the district court rule?
The district court found that there was an agreement to keep the information confidential but not to refrain from trading the stock. Cuban moved to dismiss the original claim. The court granted Cuban’s motion to dismiss by finding the confidentiality agreement did not create a duty to disclose or abstain from trading under securities laws. The court read the complaint as only an agreement of confidentiality. Despite his statement that he was “screwed,” by not being able to sell his holdings, the court held that his statement “cannot reasonably be understood as an agreement not to sell based on the information.” Further, the court found “the complaint asserts no facts that reasonably suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential.” Also, the court found that “the CEO’s expectation that Cuban would not sell was also insufficient” to allege any further agreement. The SEC appealed, alleging the agreement precluded Cuban from trading on the confidential information.
Did the court of appeals agree?
No. They found that Cuban, by asking for and receiving additional confidential information, provided a believable basis that there was an understanding between the CEO and himself not to trade and that “it was more than a simple confidentiality agreement.” Further, by contacting the investment bank representative, Cuban was able to ascertain his potential losses from the PIPE offering. The court found it plausible that each of the parties understood that Mamma.com would provide the information to Cuban so he could evaluate whether to participate in the offering and “that Cuban could not use the information for his own personal benefit.” Moreover, both the CEO and Cuban “expressed the belief that Cuban could not trade” his shares. The appeals court vacated the original judgment and remanded to them for further proceedings.
Where does the case stand now?
In an effort to further the process along, Cuban has offered to pay the government in its case against him. However, it initially appears as if the government has balked at his unprecedented offer. An attorney for the SEC, Melinda Hardy, was quoted in court as saying the commission fears that people “with deep pockets would come in and go to the front of the line.” (Jones, A. 2010. The Wall Street Journal) However, according to Bloomberg News, it would take a single attorney approximately eight months to go through Cuban’s files. (McQuillen, W. 2010. Bloomberg Business Week) Cuban’s attorneys appear to be looking for a creative and rather gutsy resolution to the case. It remains to be seen whether Cuban’s strategy will be perceived as a bluff or acted upon by the government.
Are there other legal proceedings ancillary to this?
Cuban has sued the SEC in a separate case involving both the Freedom of Information Act and the Privacy Act. That case is still ongoing, although in September, a judge in the US District Court of the District of Columbia ruled that the SEC is required to process documents and other information requested by Cuban. The SEC sought a three year stay in hopes that it would not have to continue with Cuban’s requests. The Court deferred ruling on that particular issue until it can hold a status conference. Also, in a much publicized email spat, Cuban and SEC trial lawyer Jeffrey Norris exchanged a series of messages in 2007. Cuban had considered financing a movie called “Loose Change” that tried to determine the truth about the September 11 terrorist attacks. Norris felt this was unpatriotic and a direct jab at the Bush administration. In a long string of emails, he even went so far as to end his fan allegiance to the Mavericks. Cuban claimed he did not agree with the premise of the film but wanted to promote the dissemination of truth.
John R. Fletcher is a doctoral student in the Sport Management program at Florida State University. He is also adjunct faculty for St. Ambrose University and Iowa Wesleyan College.
