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Who is the tall dark stranger there?
Maverick is the name.
Riding the trail to who knows where
Luck is his companion
Gamblin' is his game.
- “Maverick” TV series, Theme Song
The SEC has seen a couple of high-profile cases go the wrong
way. One recently hit a brick wall (WSJ, 18 July, “Mark Cuban
Scores In SEC Case”) when a federal judge in Dallas threw out the
SEC’s insider-trading case against billionaire Mark Cuban.
At issue was Cuban’s alleged promise not to sell his 6% stake in
the common stock of Mamma.com after a phone conversation in
which the Mamma.com CEO told Mr. Cuban about a proposed
PIPE (“Private Investment in Public Equity”) offering.
We are not attorneys, and we offer here only our own observations
from a compliance professional’s perspective. We caution that you
should not rely on this for a legal interpretation. Nor are we giving
legal advice. We are – like Jim Cramer – just providing
That being said, it is clear that what Judge Sidney Fitzwater, of the
US District Court in Dallas, has done is to define the concept of
Duty in very specific terms. In so doing, he has stuffed the SEC’s
attempt pretty decisively. As the Journal article points out, quoting
a former SEC Enforcement attorney, the SEC “already put in all
their best facts, and the court said those weren’t sufficient.”
What we like about this ruling is it says corporate executives can
not use the law to bludgeon their shareholders. It is clear to us that
Mamma.com’s proposed capital raise was in violation of promises
made to Mr. Cuban at the time he took his stake. We can just
imagine the conversation in the boardroom at Mamma.com’s
offices. No doubt, it boiled down to one conclusion: Mark
Cuban’s gonna be pissed.
Based on this conclusion, the CEO seems to have hit on the
brilliant strategy of calling this significant shareholder and, in the
jargon of investment banking, “bringing him over the wall” by
disclosing that the financing was going forward. The CEO no
doubt figured that, once Cuban knew of the proposed offering, he
would be prevented from selling his shares – to do so, the CEO
reasoned, would be a textbook case of insider trading.
Indeed, according to the SEC complaint, Mr. Cuban’s response
was “Well, now I’m screwed.”
But the court thought not.
This ruling leads to the conclusion that, while recipients of
information may not disclose it, they may be permitted to trade on
it. We should point out that this is not the first time this concept
has been applied to exonerate people accused of insider trading.
But coming from a federal district court, and in such a high-
visibility case, this hits the SEC where they live.
The longstanding practice of the SEC Staff has been to prosecute
persons or entities for trading in a security while in possession of
MNPI regarding the issuer. The Dallas ruling appears to hold the
Commission to the strict letter of US insider trading law, which
prohibits trading on the basis of MNPI. According to the definition
which the court appears to favor, mere possession of such
information also does not create Duty – the other required element
under US law. Indeed, the court found that even being a major
shareholder and having a conversation with the CEO does not in
itself create a Duty.
We think this is a big ruling. It puts executives of small companies
on notice that they can not use securities laws to manipulate their
shareholders. It puts large shareholders on notice that they have
rights and remedies, and that they must be properly guided as to
how to proceed, in order to best protect those rights. And it puts
the SEC on notice that they can’t make up the law as they go
along. You thought activist judges were a problem – how about
It is not lost on us that Mark Cuban (“Luck is his companion”) is
the owner of the Dallas Mavericks, and that the court that threw
out the SEC’s case was the US District Court in Dallas. The SEC
lawyers assigned to this case couldn’t even figure out how to
forum shop for a better venue. And from reading the complaint
and what has appeared in the press, the SEC’s case hinged on
whether or not Mr. Cuban had promised not to trade on the
information allegedly conveyed in the phone call. The complaint
was drafted to rely solely on the alleged promise not to sell the
shares. The complaint further relies on one of the most difficult
things of all to prove in a court of law – intent and mental state. In
legal terms it’s called “scienter”. How the SEC’s attorneys figured
they were going to prove scienter in this case is anybody’s guess.
We think it is not the hubris of hindsight to suggest that, with the
entire case hanging on the intent embodied in a single telephone
conversation between two men who are out to get one another –
and with the single key sentence in that conversation under dispute
– it would have been prudent to add some meat to the complaint
beyond a single deniable utterance.
This looks like rather poor lawyering. Clearly, the SEC attorneys
who prepared this case will not be offered high paying jobs on
Wall Street any time soon. No, only the really smart lawyers get to
leave government and go to work on Wall Street. Those not
competent enough to get an offer from Goldman Sachs stay on at
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