Sec. & Exch. Comm'n v. Cuban

• Decision Date: 18 July 2011
• Docket Number: Civil Action No. 3:08–CV–2050–D.
• Citation: 798 F.Supp.2d 783
• Parties: SECURITIES and EXCHANGE COMMISSION, Plaintiff, v. Mark CUBAN, Defendant.
• Court: U.S. District Court — Northern District of Texas

798 F.Supp.2d 783

SECURITIES and EXCHANGE COMMISSION, Plaintiff,

v.Mark CUBAN, Defendant.

Civil Action No. 3:08–CV–2050–D.

United States District Court, N.D. Texas, Dallas Division.

July 18, 2011.

Kevin P. O'Rourke, Adam S. Aderton, Duane Thompson, Julie M. Riewe, U.S. Securities & Exchange Commission, Thomas J. Karr, Securities & Exchange Commission, Washington, DC, Toby M. Galloway, U.S. Securities & Exchange Commission, Fort Worth, TX, for Plaintiff.

Thomas M. Melsheimer, John CC Sanders, Jr., Steven H. Stodghill, Fish & Richardson PC, Dallas, TX, Brian D. Nysenbaum, Stephen A. Best, Brownstein Hyatt Farber Schreck LLP, George E. Anhang, Lyle Roberts, Ralph C. Ferrara, Dewey & Leboeuf LLP, Henry W. Asbill, Jones Day LLP, Leslie A. Maria, White & Case LLP, Washington, DC, Christopher J. Clark, Dewey & Leboeuf LLP, New York, NY, for Defendant.

MEMORANDUM OPINION AND ORDER

SIDNEY A. FITZWATER, Chief Judge.

The principal questions presented by plaintiff's motion to strike are whether the affirmative defense of unclean hands is available as a matter of law when the Securities and Exchange Commission (“SEC”) brings an enforcement action and, if it is, whether defendant Mark Cuban (“Cuban”) has adequately pleaded unclean hands. The court concludes that this affirmative defense is not barred as a matter of law. But to the extent it is available, it is only in strictly limited circumstances when the SEC's misconduct is egregious, the misconduct occurs before the SEC files the enforcement action, and the misconduct results in prejudice to the defense of the enforcement action that rises to a constitutional level and is established through a direct nexus between the misconduct and the constitutional injury. The court holds that Cuban has not adequately pleaded the prejudice prong of unclean hands under this exacting standard, and it grants the SEC's motion to strike.

I

This is an enforcement action brought by the SEC against Cuban under the misappropriation theory of insider trading.¹ The SEC alleges that Cuban violated § 17(a) of the Securities Act of 1933 (“Securities Act”), § 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), and Rule 10b–5 promulgated thereunder by selling shares of stock in Mamma.com Inc. (“Mamma.com”) after learning material, nonpublic information concerning a planned private investment in public equity (“PIPE”) offering by the company, thereby avoiding substantial losses when the stock price later declined. Cuban denies that he engaged in conduct that violated the Securities Act or the Exchange Act, and he asserts a number of affirmative defenses.

Cuban pleads unclean hands as an affirmative defense to the SEC's request for injunctive relief.² He alleges that the SEC and its agents prejudiced him by engaging in egregious acts of misconduct in connection with the SEC's investigation because SEC staff conducted the investigation in an unfair, biased, and improper manner designed to prevent him from successfully persuading the SEC not to bring an enforcement action and from mounting an effective defense once the action was brought. Cuban relies on three principal grounds in support of his unclean hands defense.

First, he asserts that SEC staff members involved in investigating him were committed to bringing the enforcement action regardless what their investigation actually revealed. Cuban cites email correspondence among persons who have supervisory roles within the SEC Enforcement Division that he says evidences significant bias against him, including a specific email from a staff member to the Director of Enforcement and the Chief Counsel of the Enforcement Division that contained an unflattering set of photos of Cuban, and the responses to that email. He also alleges that, before meeting with many critical witnesses in this matter, an SEC staff member responded to a comment by one of Cuban's lawyers regarding Cuban's sale of Mamma.com stock by stating, “Mr. Cuban takes irrational and silly risks every day.” Am. Ans. 7.

Second, Cuban alleges that SEC staff deliberately undermined and abused the “Wells process,” ³ under which Cuban was supposed to have been given a fair opportunity to persuade the SEC not to bring an action against him. He avers that (1) in May 2007 SEC staff initiated a Wells call to his counsel advising that staff intended to recommend initiation of a civil enforcement action and that its recommendation was supported by the evidentiary record; staff stated that, during a June 28, 2004 call between Cuban and Guy Fauré (“Fauré”), Mamma.corn's CEO, Cuban agreed to keep the information he received confidential, and Fauré created a contemporaneous document reflecting the existence of the agreement; in fact, the SEC did not have any evidence that Cuban had entered into a confidentiality agreement, and Fauré did not create any such contemporaneous document; and Cuban's first Wells submission assumed the existence of this supposed evidence; (2) the staff decision to recommend bringing a civil enforcement action was made before the investigation was “substantially complete,” in contravention of procedures in the SEC Enforcement Manual; and (3) Cuban's counsel submitted a second Wells submission in September 2007, while SEC staff was still conducting witness interviews, yet staff informed Cuban's counsel that there could be no assurance that the submission would be given to the SEC,⁴ and although staff, as part of this litigation, informed Cuban that the submission was given to the SEC, Cuban has never received confirmation that the SEC actually reviewed and considered the document as part of its deliberative process.

Third, Cuban asserts that “the SEC staff engaged in acts of outright investigative and litigation misconduct.” Am. Ans. 8. He alleges that (1) a staff member discouraged counsel for a key witness from making the witness available to speak with Cuban's counsel and, after the SEC was informed, it apparently never investigated; (2) SEC staff threatened this same witness with perjury when he was unable during sworn testimony to clearly recall certain statements he had supposedly made to the SEC in a telephone interview conducted ten months before; (3) SEC staff sent a letter to Mamma.com stating that the SEC's separate investigation of the company had been closed and, fewer than two weeks later, SEC staff took the sworn testimony of Fauré for a second time in an apparent effort to get him to change his earlier testimony concerning his June 28, 2004 call with Cuban; and (4) SEC staff filed a complaint in this action asserting that Cuban had entered into a confidentiality agreement, despite the lack of any evidentiary support for the existence of such an agreement.

The SEC moves under Fed.R.Civ.P. 12(f) to strike Cuban's affirmative defense of unclean hands. It contends that equitable defenses are generally unavailable against the government when it acts in the public interest; assuming the defense is available, Cuban cannot allege the requisite prejudice or misconduct; and failing to strike the defense would unduly prejudice the SEC and unnecessarily complicate the litigation. Cuban responds that unclean hands is available against the SEC as a matter of law and that he has adequately pleaded this defense.⁵

II

“The court may strike from a pleading an insufficient defense or any redundant, immaterial, impertinent, or scandalous matter.” Rule 12(f). The decision to grant a motion to strike is within the court's discretion. Jacobs v. Tapscott, 2004 WL 2921806, at *2 (N.D.Tex. Dec. 16, 2004) (Fitzwater, J.), aff'd on other grounds, 277 Fed.Appx. 483 (5th Cir.2008). “Both because striking a portion of a pleading is a drastic remedy, and because it is often sought by the movant simply as a dilatory tactic, motions under Rule 12(f) are viewed with disfavor and are infrequently granted.” Id. (citing FDIC v. Niblo, 821 F.Supp. 441, 449 (N.D.Tex.1993) (Cummings, J.)). “Although motions to strike a defense are generally disfavored, a Rule 12(f) motion to dismiss a defense is proper when the defense is insufficient as a matter of law.” Kaiser Aluminum & Chem. Sales, Inc. v. Avondale Shipyards, Inc., 677 F.2d 1045, 1057 (5th Cir.1982) (citations omitted).

III

The SEC initially contends in its opening brief that equitable defenses are generally unavailable against the government when it acts in the public interest. Later in the brief, and in its reply brief, the SEC refines this contention to take the unqualified position that such a defense is unavailable as a matter of law in an SEC enforcement action. See, e.g., P. Br. 6 (“However, in the context of the established statutory framework and controlling precedent in the Fifth Circuit for the issuance of an injunction in an SEC enforcement case, the alleged affirmative defense is insufficient as a matter of law.”); P. Reply Br. 1 (“[T]he law in this district is that unclean hands is unavailable as a defense to a civil enforcement action brought in the public interest by the [SEC].”). It is to this argument that the court turns first.

A

The SEC acknowledges in its reply brief that “[t]here is no Fifth Circuit ‘controlling precedent’ deciding the availability of an unclean hands defense against the SEC when it is acting in the public interest by bringing a civil enforcement action.” P. Reply Br. 2. Perhaps for this reason, the SEC begins its opening brief by relying heavily on SEC v. Hayes, 1991 WL 236846 (N.D.Tex. July 25, 1991) (Maloney, J.), which it characterizes as “the law in this District.” P. Br. 3–4 (“[T]he law in this District is that unclean hands ‘may not be invoked against a governmental agency which is attempting to enforce a congressional mandate in the public interest[.]’ ” (quoting Hayes, 1991 WL 236846, at *2)); ⁶ see also P. Reply Br. 1 (“[T]he law in this district is that unclean hands is unavailable as a defense to a civil enforcement action brought in the public interest by the [SEC].”).

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