SEC v. Mark Cuban

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PUBLISHED OPINION FILED. [09-10996 Vacated and Remanded ] Judge: CDK , Judge: PEH , Judge: EMG Mandate pull date is 11/12/2010 [09-10996]

SEC v. Mark Cuban

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Case: 09-10996

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IN THE UNITED STATES COURT OF APPEALS United States Court of Appeals FOR THE FIFTH CIRCUIT Fifth Circuit FILED
September 21, 2010 N o . 09-10996 Lyle W. Cayce Clerk

S E C U R I T I E S AND EXCHANGE COMMISSION, Plaintiff - Appellant v. M A R K CUBAN, Defendant - Appellee

A p p e a l from the United States District Court for the Northern District of Texas

B e fo r e KING, HIGGINBOTHAM, and GARZA, Circuit Judges. P A T R I C K E. HIGGINBOTHAM, Circuit Judge: T h is case raises questions of the scope of liability under the m is a p p r o p r ia t io n theory of insider trading. Taking a different view from our a b le district court brother of the allegations of the complaint, we are persuaded t h a t the case should not have been dismissed under Fed. R. Civ. P. 9(b) and 12 a n d must proceed to discovery. M a r k Cuban is a well known entrepreneur and current owner of the Dallas M a v e r ic k s and Landmark theaters, among other businesses. The SEC brought 1

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No. 09-10996 t h is suit against Cuban alleging he violated Section 17(a) of the Securities Act o f 1933,1 Section 10(b) of the Securities Exchange Act of 1934,2 and Rule 10b-5 3 b y trading in Mamma.com stock in breach of his duty to the CEO and M a m m a .c o m -- a m o u n t in g to insider trading under the misappropriation theory o f liability. The core allegation is that Cuban received confidential information fr o m the CEO of Mamma.com, a Canadian search engine company in which C u b a n was a large minority stakeholder, agreed to keep the information c o n fid e n tia l, and acknowledged he could not trade on the information. The SEC a lle g e s that, armed with the inside information regarding a private investment o f public equity (PIPE) offering, Cuban sold his stake in the company in an effort t o avoid losses from the inevitable fall in Mamma.com's share price when the o ffe r in g was announced. Cuban moved to dismiss the action under Rule 9(b) and 12(b)(6). The d i s t r ic t court found that, at most, the complaint alleged an agreement to keep t h e information confidential, but did not include an agreement not to trade. Finding a simple confidentiality agreement to be insufficient to create a duty to d is c lo s e or abstain from trading under the securities laws, the court granted C u b a n 's motion to dismiss. The SEC appeals, arguing that a confidentiality a g r e e m e n t creates a duty to disclose or abstain and that, regardless, the c o n fid e n tia lit y agreement alleged in the complaint also contained an agreement n o t to trade on the information and that agreement would create such a duty.

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15 U.S.C. § 77q(a). 15 U.S.C. § 78j(b). 17 C.F.R. § 240.10b-5. 2

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No. 09-10996 W e review de novo the district court's dismissal for failure to state a claim u n d e r Rule 12(b)(6).4 We accept "all well pleaded facts as true, viewing them in t h e light most favorable to the plaintiff."5 The "`complaint must contain

s u ffic ie n t factual matter, accepted as true, to `state a claim to relief that is p la u s ib le on its face.'''6 "`Factual allegations must be enough to raise a right to r e lie f above the speculative level, on the assumption that all the allegations in t h e complaint are true (even if doubtful in fact).'"7 T h e SEC alleges that Cuban's trading constituted insider trading and v io la t e d Section 10(b) of the Securities Exchange Act.8 Section 10(b) makes it u n la w fu l for any person, directly or indirectly, by the use of any m e a n s or instrumentality of interstate commerce or of the mails, or o f any facility of any national securities exchange . . . [t]o use or e m p lo y , in connection with the purchase or sale of any security . . . a n y manipulative or deceptive device or contrivance in c o n t r a v e n t io n of such rules and regulations as the Commission may p r e s c r ib e as necessary or appropriate in the public interest or for

Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp., 565 F .3 d 200, 206 (5th Cir. 2009). As the district court noted, to the extent C u b a n 's arguments under Rule 9(b) are distinct from his Rule 12(b)(6) a r g u m e n t s , the complaint pleads facts with sufficient "particularity" and thus d o e s not violate Rule 9(b). See id.
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In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007).

Gonzalez v. Kay, 577 F.3d 600, 603 (5th Cir. 2009) (quoting Ashcroft v. I q b a l, 129 S.Ct. 1937, 1949 (2009)). In re Katrina Canal Breaches Litig., 495 F.3d at 205, (quoting Bell Atl. C o r p . v. Twombly, 550 U.S. 544, 555 (2007)). The parties agree the allegations under section 17(a) of the Securities A c t are evaluated under the same legal standard as the section 10(b) claim. 3
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No. 09-10996 t h e protection of investors.9 P u r s u a n t to this section, the SEC promulgated Rule 10b-5, which makes it u n la w fu l to (a) To employ any device, scheme, or artifice to defraud, (b ) To make any untrue statement of a material fact or to omit to s t a t e a material fact necessary in order to make the statements m a d e , in the light of the circumstances under which they were m a d e , not misleading, or (c ) To engage in any act, practice, or course of business which o p e r a te s or would operate as a fraud or deceit upon any person, in c o n n e c t io n with the purchase or sale of any security. T h e Supreme Court has interpreted section 10(b) to prohibit insider trading under two complementary theories, the "classical theory" and the

" m is a p p r o p r ia t io n theory."10 The classical theory of insider trading prohibits a "corporate insider" from t r a d in g on material nonpublic information obtained from his position within the c o r p o r a t io n without disclosing the information. According to this theory, there e x is t s "a relationship of trust and confidence between the shareholders of a c o r p o r a t io n and those insiders who have obtained confidential information by r e a s o n of their position with that corporation."1 1 Trading on such confidential in fo r m a t io n qualifies as a `deceptive device' under section 10(b) because by using t h a t information for his own personal benefit, the corporate insider breaches his

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15 U.S.C. § 78j. United States v. O'Hagan, 521 U.S. 642, 652 (1997). Chiarella v. United States, 445 U.S. 222, 228 (1980). 4

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No. 09-10996 d u t y to the shareholders.1 2 The corporate insider is under a duty to "disclose or a b s ta in "1 3 -- h e must tell the shareholders of his knowledge and intention to trade o r abstain from trading altogether. There are at least two important variations of the classical theory of in s id e r trading. The first is that even an individual who does not qualify as a t r a d it io n a l insider may become a "temporary insider" if by entering "into a s p e c ia l confidential relationship in the conduct of the business of the enterprise [ t h e y ] are given access to information solely for corporate purposes." 1 4 Thus u n d e r w r it e r s , accountants, lawyers, or consultants are all considered corporate in s id e r s when by virtue of their professional relationship with the corporation t h e y are given access to confidential information.1 5 The second variation is that a n individual who receives information from a corporate insider may be, but is n o t always, prohibited from trading on that information as a tippee. "[T]he t ip p e e 's duty to disclose or abstain is derivative from that of the insider's duty" a n d the tippee's obligation arises "from his role as a participant after the fact in t h e insider's breach of a fiduciary duty."1 6 Crucially, "a tippee assumes a

fid u c ia r y duty to the shareholders of a corporation not to trade on material n o n p u b lic information only when the insider has breached his fiduciary duty to t h e shareholders by disclosing the information to the tippee and the tippee

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Id. at 227. Id. Dirks v SEC, 463 U.S. 646, 655 n.14 (1983). Id. Id. at 659 (internal quotation marks omitted). 5

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No. 09-10996 k n o w s or should know there has been a breach."1 7 The insider breaches his fid u c ia r y duty when he receives a "direct or indirect personal benefit from the d is c lo s u r e ." 18 B o t h the temporary-insider and tippee twists on the classical theory retain it s core principle that the duty to disclose or abstain is derived from the c o r p o r a t e insider's duty to his shareholders. The misappropriation theory does n o t rest on this duty. It rather holds that a person violates section 10(b) "when h e misappropriates confidential information for securities trading purposes, in b r e a c h of a duty owed to the source of the information." 1 9 The Supreme Court fir s t adopted this theory in United States v. O'Hagan.2 0 There, a lawyer traded t h e securities of a company his client was targeting for a takeover. O'Hagan c o u ld not be liable under the classical theory as he owed no duty to the s h a r e h o l d e r s of the target company. Nevertheless, the court found O'Hagan v io la t e d section 10(b). The Court held that in trading the target company's s e c u r it ie s , O'Hagan misappropriated the confidential information regarding the p la n n e d corporate takeover, breaching "a duty of trust and confidence" he owed t o his law firm and client.2 1 Trading on such information "involves feigning fid e l i t y to the source of information and thus utilizes a `deceptive device' as

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Id. at 660. Id. at 663. United States v. O'Hagan, 521 U.S. 642, 652 (1997). Id. at 650. Id. at 653. 6

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No. 09-10996 r e q u ir e d by section 10(b)."2 2 The Court stated that while there is "no general d u t y between all participants in market transactions to forgo actions based on m a t e r ia l nonpublic information," the breach of a duty to the source of the in fo r m a t io n is sufficient to give rise to insider trading liability.2 3 W h ile O'Hagan did not set the contours of a relationship of "trust and c o n fid e n c e " giving rise to the duty to disclose or abstain and misappropriation l i a b ilit y , we are tasked to determine whether Cuban had such a relationship w it h Mamma.com. The SEC seeks to rely on Rule 10b5-2(b)(1), which states t h a t a person has "a duty of trust and confidence" for purposes of m is a p p r o p r ia t io n liability when that person "agrees to maintain information in c o n fid e n c e ."2 4 In dismissing the case, the district court read the complaint to a lle g e that Cuban agreed not to disclose any confidential information but did not a g r e e not to trade, that such a confidentiality agreement was insufficient to c r e a t e a duty to disclose or abstain from trading under the misappropriation t h e o r y , and that the SEC overstepped its authority under section 10(b) in issuing R u le 10b5-2(b)(1). We differ from the district court in reading the complaint and n e e d not reach the latter issues. T h e complaint alleges that, in March 2004, Cuban acquired 600,000 s h a r e s , a 6.3% stake, of Mamma.com. Later that spring, Mamma.com decided

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Id. at 660.

Id. at 662. Because the duty flows to the source of the information a n d not to shareholders "if the fiduciary discloses to the source that he plans t o trade on the nonpublic information, there is no `deceptive device' and thus n o § 10(b) violation." O'Hagan, 521 U.S. at 655.
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17 C.F.R. § 240.10b5-2(b)(1). 7

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No. 09-10996 t o raise capital through a PIPE offering on the advice of the investment bank M e r r im a n Curhan Ford & Co. At the end of June, at Merriman's suggestion, M a m m a .c o m decided to invite Cuban to participate in the PIPE offering. "The C E O was instructed to contact Cuban and to preface the conversation by in fo r m in g Cuban that he had confidential information to convey to him in order t o make sure that Cuban understood--before the information was conveyed to h im -- th a t he would have to keep the information confidential."2 5 A fte r getting in touch with Cuban on June 28, Mamma.com's CEO told C u b a n he had confidential information for him and Cuban agreed to keep w h a t e v e r information the CEO shared confidential. The CEO then told Cuban a b o u t the PIPE offering. Cuban became very upset "and said, among other t h in g s , that he did not like PIPEs because they dilute the existing s h a r e h o ld e r s ."2 6 "At the end of the call, Cuban told the CEO `Well, now I'm s c r e w e d . I can't sell.'" 2 7 T h e CEO told the company's executive chairman about the conversation w it h Cuban. The executive chairman sent an email to the other Mamma.com b o a r d members updating them on the PIPE offering. The executive chairman in c lu d e d : T o d a y , after much discussion, [the CEO] spoke to Mark Cuban a b o u t this equity raise and whether or not he would be interested in p a r t ic ip a t in g . As anticipated he initially `flew off the handle' and s a id he would sell his shares (recognizing that he was not able to do a n y th in g until we announce the equity) but then asked to see the

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Compl. at ¶ 12. Compl. at ¶ 14. Id. 8

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No. 09-10996 t e r m s and conditions which we have arranged for him to receive fr o m one of the participating investor groups with which he has d e a lt in the past. T h e CEO then sent Cuban a follow up email, writing "`[i]f you want more details a b o u t the private placement please contact . . . [Merriman].'" 2 8 C u b a n called the Merriman representative and they spoke for eight m in u te s . "During that call, the salesman supplied Cuban with additional

c o n fid e n tia l details about the PIPE. In response to Cuban's questions, the s a le s m a n told him that the PIPE was being sold at a discount to the market p r ic e and that the offering included other incentives for the PIPE investors." 29 It is a plausible inference that Cuban learned the off-market prices available to h im and other PIPE participants. W it h that information and one minute after speaking with the Merriman r e p r e s e n t a t iv e , Cuban called his broker and instructed him to sell his entire s t a k e in the company. Cuban sold 10,000 shares during the evening of June 28, 2 0 0 4 , and the remainder during regular trading the next day. That day, the executive chairman sent another email to the board, u p d a t in g them on the previous day's discussions with Cuban, stating "`we did s p e a k to Mark Cuban ([the CEO] and, subsequently, our investment banker) to fin d out if he had any interest in participating to the extent of maintaining his in t e r e s t . His answers were: he would not invest, he does not want the company t o make acquisitions, he will sell his shares which he can not do until after we

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Compl. at ¶ 16 (alteration in original). Compl. at ¶ 17. 9

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No. 09-10996 a n n o u n c e . '" 3 0 A fte r the markets closed on June 29, Mamma.com announced the PIPE o ffe r in g . The next day, Mamma.com's stock price fell 8.5% and continued to d e c lin e over the next week, eventually closing down 39% from the June 29 c lo s in g price. By selling his shares when he did, Cuban avoided over $750,000 in losses. Cuban notified the SEC that he had sold his stake in the company and p u b lic a lly stated that he sold his shares because Mamma.com "was conducting a PIPE, which issued shares at a discount to the prevailing market price and a ls o would have caused his ownership position to be diluted." 3 1 I n reading the complaint to allege only an agreement of confidentiality, the c o u r t held that Cuban's statement that he was "screwed" because he "[could not] s e ll" "appears to express his belief, at least at that time, that it would be illegal fo r him to sell his Mamma.com shares based on the information the CEO p r o v id e d ."3 2 But the court stated that this statement "cannot reasonably be u n d e r s t o o d as an agreement not to sell based on the information." 3 3 The court fo u n d "the complaint asserts no facts that reasonably suggest that the CEO in t e n d e d to obtain from Cuban an agreement to refrain from trading on the in fo r m a t io n as opposed to an agreement merely to keep it confidential." 34 F in a lly , the court stated that "the CEO's expectation that Cuban would not sell

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Compl. at ¶ 20 (alteration in original). Compl. at ¶ 25. SEC v. Cuban, 634 F. Supp. 2d 713, 728 (N.D. Tex. 2009). Id. Id. 10

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No. 09-10996 w a s also insufficient" to allege any further agreement.3 5 R e a d in g the complaint in the light most favorable to the SEC, we reach a d iffe r e n t conclusion. In isolation, the statement "Well, now I'm screwed. I can't s e ll" can plausibly be read to express Cuban's view that learning the confidences r e g a r d in g the PIPE forbade his selling his stock before the offering but to e x p r e s s no agreement not to do so. However, after Cuban expressed the view t h a t he could not sell to the CEO, he gained access to the confidences of the PIPE o f f e r in g . According to the complaint's recounting of the executive chairman's e m a il to the board, during his short conversation with the CEO regarding the p la n n e d PIPE offering, Cuban requested the terms and conditions of the o ffe r in g . Based on this request, the CEO sent Cuban a follow up email providing t h e contact information for Merriman. Cuban called the salesman, who told C u b a n "that the PIPE was being sold at a discount to the market price and that t h e offering included other incentives for the PIPE investors."3 6 Only after C u ba n reached out to obtain this additional information, following the statement o f his understanding that he could not sell, did Cuban contact his broker and sell h is stake in the company. T h e allegations, taken in their entirety, provide more than a plausible b a s is to find that the understanding between the CEO and Cuban was that he w a s not to trade, that it was more than a simple confidentiality agreement. By c o n t a c t in g the sales representative to obtain the pricing information, Cuban was a b le to evaluate his potential losses or gains from his decision to either p a r tic ip a t e or refrain from participating in the PIPE offering. It is at least
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Id. Compl. at ¶ 17. 11

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No. 09-10996 p la u sib le that each of the parties understood, if only implicitly, that Mamma.com w o u ld only provide the terms and conditions of the offering to Cuban for the p u r p o s e of evaluating whether he would participate in the offering, and that C u b a n could not use the information for his own personal benefit.3 7 It would r e q u ir e additional facts that have not been put before us for us to conclude that t h e parties could not plausibly have reached this shared understanding. Under C u b a n 's reading, he was allowed to trade on the information but prohibited from t e llin g others--in effect providing him an exclusive license to trade on the m a t e r ia l nonpublic information. Perhaps this was the understanding, or

p e r h a p s Cuban mislead the CEO regarding the timing of his sale in order to o b ta in a confidential look at the details of the PIPE. We say only that on this fa c t u a lly sparse record, it is at least equally plausible that all sides understood t h e r e was to be no trading before the PIPE.3 8 That both Cuban and the CEO The parties dispute Mamma.com's motive in providing the in fo r m a t io n to Cuban. Cuban contends that the offering was already o v e r s u b s c r ib e d and that this demonstrates the sole purpose of the phone call w a s to prevent Cuban from trading ahead of the offering. We express no o p in io n on this factual dispute or the potential implications of Cuban's a lle g a t io n s if they are true. At the motion-to-dismiss stage we must view all t h e facts in light most favorable to the SEC and assume that Mamma.com h a d a legitimate reason for contacting Cuban. Such an arrangement would raise serious tipper/tippee liability c o n c e r n s were it explicit. If the CEO knowingly gave Cuban material n o n p u b lic information and arranged so he could trade on it, it would not be d iffic u lt for a court to infer that the CEO must have done so for some personal b e n e fit-- e .g ., goodwill from a wealthy investor and large minority s t a k e h o ld e r . "A reputational benefit that translates into future earnings, a q u id pro quo, or a gift to a trading friend or relative all could suffice to show t h e tipper personally benefitted." SEC v. Yun, 327 F.3d 1263, 1277 (11th Cir. 2 0 0 3 ). This of course is not to suggest any such improprieties occurred; 12
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No. 09-10996 e x p r e s s e d the belief that Cuban could not trade appears to reinforce the p la u s ib ilit y of this reading.39 G iv e n the paucity of jurisprudence on the question of what constitutes a r e la t i o n s h i p of "trust and confidence" and the inherently fact-bound nature of d e t e r m in in g whether such a duty exists, we decline to first determine or place o u r thumb on the scale in the district court's determination of its presence or to n o w draw the contours of any liability that it might bring, including the force of R u le 10b5-2(b)(1).4 0 Rather, we VACATE the judgment dismissing the case and R E M A N D to the court of first instance for further proceedings including d is c o v e r y , consideration of summary judgment, and trial, if reached.

r a t h e r , it simply reinforces the plausibility of the interpretation of the alleged fa c t s as evidencing an understanding that the agreement included an a g r e e m e n t by Cuban not to trade.
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Compl. at ¶¶ 14 & 20. Nor must we reach the validity of Rule 10b5-2(b)(1). 13

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