Exch. Comm'n v. Cuban

• Decision Date: 21 September 2010
• Docket Number: No. 09-10996.,09-10996.
• Citation: 620 F.3d 551
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant, v. Mark CUBAN, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

620 F.3d 551

SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant,

v.Mark CUBAN, Defendant-Appellee.

No. 09-10996.

United States Court of Appeals,Fifth Circuit.

Sept. 21, 2010.

Michael Laurence Post, Senior Lit. Counsel, Kevin O'Rourke, Randall W. Quinn, Asst. Gen. Counsel (argued), Washington, DC, for Plaintiff-Appellant.

Stephen A. Best, Ralph Carmine Ferrara, Lyle Roberts (argued), Dewey & LeBoeuf, L.L.P., Washington, DC, Paul Edward Coggins, Jr., Locke, Lord, Bissell & Liddell, L.L.P., Dallas, TX, for Defendant-Appellee.

Nicholas Ian Porritt, Akin Gump Strauss Hauer & Feld, L.L.P., Washington, DC, for Amicus Curiae.

Appeal from the United States District Court for the Northern District of Texas.

Before KING, HIGGINBOTHAM and GARZA, Circuit Judges.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

This case raises questions of the scope of liability under the misappropriation theory of insider trading. Taking a different view from our able district court brother of the allegations of the complaint, we are persuaded that the case should not have been dismissed under Fed.R.Civ.P. 9(b) and 12 and must proceed to discovery.

Mark Cuban is a well known entrepreneur and current owner of the Dallas Mavericks and Landmark theaters, among other businesses. The SEC brought this suit against Cuban alleging he violated Section 17(a) of the Securities Act of 1933, ¹ Section 10(b) of the Securities Exchange Act of 1934, ² and Rule 10b-5 ³ by trading in Mamma.com stock in breach of his duty to the CEO and Mamma.com-amounting to insider trading under the misappropriation theory of liability. The core allegation is that Cuban received confidential information from the CEO of Mamma.com, a Canadian search engine company in which Cuban was a large minority stakeholder, agreed to keep the information confidential, and acknowledged he could not trade on the information. The SEC alleges that, armed with the inside information regarding a private investment of public equity (PIPE) offering, Cuban sold his stake in the company in an effort to avoid losses from the inevitable fall in Mamma.com's share price when the offering was announced.

Cuban moved to dismiss the action under Rule 9(b) and 12(b)(6). The district court found that, at most, the complaint alleged an agreement to keep the information confidential, but did not include an agreement not to trade. Finding a simple confidentiality agreement to be insufficient to create a duty to disclose or abstain from trading under the securities laws, the court granted Cuban's motion to dismiss. The SEC appeals, arguing that a confidentiality agreement creates a duty to disclose or abstain and that, regardless, the confidentiality agreement alleged in the complaint also contained an agreement not to trade on the information and that agreement would create such a duty.

We review de novo the district court's dismissal for failure to state a claim under Rule 12(b)(6). ⁴ We accept “all well pleaded facts as true, viewing them in the light most favorable to the plaintiff.” ⁵ The “ ‘complaint must contain sufficient factual matter’, accepted as true, to ‘state a claim to relief that is plausible on its face.’ ” ⁶ “ ‘Factual allegations must be enough to raise a right to relief above the speculative level, on the assumption that all the allegations in the complaint are true (even if doubtful in fact).’ ” ⁷

The SEC alleges that Cuban's trading constituted insider trading and violated Section 10(b) of the Securities Exchange Act. ⁸ Section 10(b) makes it

unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange ... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. ⁹

Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it unlawful 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 state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

The Supreme Court has interpreted section 10(b) to prohibit insider trading under two complementary theories, the “classical theory” and the “misappropriation theory.” ¹⁰

The classical theory of insider trading prohibits a “corporate insider” from trading on material nonpublic information obtained from his position within the corporation without disclosing the information. According to this theory, there exists “a relationship of trust and confidence between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.” ¹¹ Trading on such confidential information qualifies as a “deceptive device” under section 10(b) because by using that information for his own personal benefit, the corporate insider breaches his duty to the shareholders. ¹² The corporate insider is under a duty to “disclose or abstain” ¹³ -he must tell the shareholders of his knowledge and intention to trade or abstain from trading altogether.

There are at least two important variations of the classical theory of insider trading. The first is that even an individual who does not qualify as a traditional insider may become a “temporary insider” if by entering “into a special confidential relationship in the conduct of the business of the enterprise [they] are given access to information solely for corporate purposes.” ¹⁴ Thus underwriters, accountants, lawyers, or consultants are all considered corporate insiders when by virtue of their professional relationship with the corporation they are given access to confidential information. ¹⁵ The second variation is that an individual who receives information from a corporate insider may be, but is not always, prohibited from trading on that information as a tippee. “[T]he tippee's duty to disclose or abstain is derivative from that of the insider's duty” and the tippee's obligation arises “from his role as a participant after the fact in the insider's breach of a fiduciary duty.” ¹⁶ Crucially, “a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know there has been a breach.” ¹⁷ The insider breaches his fiduciary duty when he receives a “direct or indirect personal benefit from the disclosure.” ¹⁸

Both the temporary-insider and tippee twists on the classical theory retain its core principle that the duty to disclose or abstain is derived from the corporate insider's duty to his shareholders. The misappropriation theory does not rest on this duty. It rather holds that a person violates section 10(b) “when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.” ¹⁹ The Supreme Court first adopted this theory in United States v. O'Hagan. ²⁰ There, a lawyer traded the securities of a company his client was targeting for a takeover. O'Hagan could not be liable under the classical theory as he owed no duty to the shareholders of the target company. Nevertheless, the court found O'Hagan violated section 10(b). The Court held that in trading the target company's securities, O'Hagan misappropriated the confidential information regarding the planned corporate takeover, breaching “a duty of trust and confidence” he owed to his law firm and client. ²¹ Trading on such information “involves feigning fidelity to the source of information and thus utilizes a ‘deceptive device’ as required by section 10(b).” ²² The Court stated that while there is “no general duty between all participants in market transactions to forgo actions based on material nonpublic information,” the breach of a duty to the source of the information is sufficient to give rise to insider trading liability. ²³

While O'Hagan did not set the contours of a relationship of “trust and confidence” giving rise to the duty to disclose or abstain and misappropriation liability, we are tasked to determine whether Cuban had such a relationship with Mamma.com. The SEC seeks to rely on Rule 10b5-2(b)(1), which states that a person has “a duty of trust and confidence” for purposes of misappropriation liability when that person “agrees to maintain information in confidence.” ²⁴ In dismissing the case, the district court read the complaint to allege that Cuban agreed not to disclose any confidential information but did not agree not to trade, that such a confidentiality agreement was insufficient to create a duty to disclose or abstain from trading under the misappropriation theory, and that the SEC overstepped its authority under section 10(b) in issuing Rule 10b5-2(b)(1). We differ from the district court in reading the complaint and need not reach the latter issues.

The complaint alleges that, in March 2004, Cuban acquired 600,000 shares, a 6.3% stake, of Mamma.com. Later that spring, Mamma.com decided to raise capital through a PIPE offering on the advice of the investment bank Merriman Curhan Ford & Co. At the end of June, at Merriman's suggestion, Mamma.com decided to invite Cuban to participate in the PIPE offering. “The CEO was instructed to contact Cuban and to preface the conversation by informing Cuban that he had confidential information to convey to him in order to make...