No one likes to lose, so the Securities and Exchange Commission is surely smarting from a jury’s decision absolving Mark Cuban, the billionaire owner of the Dallas Mavericks, of insider trading charges. Although the case garnered headlines, it is unlikely to have much impact on other investigations, and even has a potential silver lining for the S.E.C.
The case revolved around whether Mr. Cuban agreed not to trade on information about an impending transaction at Mamma.Com, an Internet search engine company in which he held a 6.3 percent stake. After speaking with the company’s chief executive, Guy Fauré, about the company’s decision to sell shares that would hurt its price, he unloaded his stock and avoided about $750,000 in losses.
The case boiled down to a “he said, he said†situation because Mr. Fauré claimed that Mr. Cuban agreed to keep the information confidential and not trade on it, but Mr. Cuban vehemently denied that was true. As just an investor in the company, Mr. Cuban was not a classic insider who has an obligation to keep corporate information confidential. So proving there was an agreement was the crux of the S.E.C.’s case.
The case had a number of peculiarities that make it hard to see it as much of a harbinger for how the S.E.C. will pursue insider trading in the future.
Unlike recent cases in which the government amassed evidence from wiretaps and confidential informers, the charges here revolved around the recollections of two men about an eight-minute telephone conversation for which there was no transcript or even another witness to what was said. That made proving insider trading turn almost entirely on the credibility of Mr. Fauré, who was a problematic witness.
Jurors no doubt wanted to see a telling moment when the crucial witness recounts damning words of the defendant, as usually portrayed in television courtroom dramas. Unfortunately, the S.E.C. could only present Mr. Fauré’s testimony by a video recording because he refused to come to the United States from Canada for the trial. In the closing statement, Mr. Cuban’s lawyer made much of Mr. Fauré’s absence, telling the jury that he “didn’t want to look you in the eye.â€
Mr. Cuban, on the other hand, is a practiced hand at dealing with the media and quite well regarded in Dallas, where the trial took place. He came across well to the jury, telling them that he did not recall the crucial conversation but that he would not have made any agreement to refrain from selling his stake in the company.
By pursuing the case in Texas, the S.E.C.’s lawsuit was reminiscent of a 1984 case filed in Oklahoma against Barry L. Switzer, then the University of Oklahoma’s head football coach. He was found not to have engaged in insider trading on information he said he inadvertently received about an impending merger.
Both trials took place where the teams of these popular sports figures play, so one lesson may be for the S.E.C. to avoid filing such lawsuits in places in which the defendants may have the home field advantage.
Bringing a case that depends largely on a single witness who would not even show up in the courtroom to testify raises the issue of why the S.E.C. filed the lawsuit in the first place. In one of my first columns for the DealBook back in 2009 when the case was filed, I asked, “Is this where we want the cop on the beat spending time?â€
Mr. Cuban is certainly a well-known figure, and law enforcement agencies will pursue cases that garner headlines to show the public that no one is above the law. Also, bringing charges when the evidence is less than overwhelming is certainly not a misuse of agency resources.
But in this instance, I wonder whether the S.E.C. may have boxed itself in by notifying Mr. Cuban that it planned to file the charges and then felt compelled to follow through. Much as a parent who threatens a child with a punishment, the S.E.C. may have seen this as a test case to send a message about how it was policing the markets, even though the evidence was shaky at best.
To prove insider trading, the S.E.C. must show that a defendant breached a “duty of trust and confidence†when trading on confidential information. That usually means the person had a close relationship with the source, like being an employee or outside adviser. Mr. Cuban’s role as a shareholder would not normally fall within the definition. Instead, the S.E.C. advanced the theory that Mr. Cuban’s purported agreement not to sell his shares was enough to establish the requisite duty.
In 2000, the S.E.C. adopted Rule 10b5-2 to expand the scope of the relationships that could lead to liability for insider trading. One provision of the rule provides that the requisite duty arises “whenever a person agrees to maintain information in confidence.†That was the basis on which the S.E.C. pursued its case, which made Mr. Cuban’s conversation with Mr. Fauré the focal point.
Judge Sidney A. Fitzwater of Federal District Court initially dismissed the charges because he found that Mr. Cuban never agreed to refrain from trading on the information. He also concluded that the portion of Rule 10b5-2 that applies to any person who agrees to keep information confidential was beyond the S.E.C.’s authority to adopt.
The United States Court of Appeals for the Fifth Circuit reversed Judge Fitzwater’s ruling and reinstated the charges, allowing the case to proceed to trial. The appeals court found the S.E.C. had enough in its complaint to proceed with the case against Mr. Cuban and overturned the finding that Rule 10b5-2 exceeded the agency’s authority.
By just getting the case to trial, the S.E.C. achieved something of a victory. The appeals court preserved Rule 10b5-2, and found that an agreement not to trade can be the basis for insider trading liability, even with just the bare allegations outlined in the complaint.
The jury verdict may cause the S.E.C. to proceed more cautiously when it has equivocal evidence to show a breach of the duty of trust and confidence, especially when it faces a defendant likely to go to trial. But that is not an issue that comes up often in insider trading cases, most of which involve a person with a close relationship to the source.
The S.E.C. lost the battle with Mr. Cuban, but preserved its ability to pursue cases that do not fit the usual paradigm of a corporate insider trading or tipping. So the real lesson may be to proceed cautiously when the case depends on a single witness. But the scope of insider trading liability remains quite broad based on an agreement to keep information confidential.
