'Deep Dive: Securities and Exchange Commission v. Cuban'

By Marc I. Steinberg

Carolina Academic Press, 360 pages, $28.95 

In 'Deep Dive: Securities and Exchange Commission v. Cuban', Professor Marc I. Steinberg has provided us with a very rare and useful contribution. He explains the SEC's Enforcement process, demystifies the intractably difficult law of insider trading, and walks the reader through, step-by-step, the Commission's investigation of, and litigation against, Mark Cuban for his alleged illegal insider trading in Mamma.com stock. The book is a very readable account in an accessible style and format which nicely complements dense treatises and specialized practice guides, many of which are authored by Professor Steinberg himself.

Steinberg is the leading expert in this field. He began his career as an attorney in the SEC's Enforcement Division, followed by a post as special counsel to the Commission's General Counsel. Throughout his over 40-year career in academia, he has authored some 40 books and 150 law review articles including many in the area of insider trading, securities enforcement, and other subjects concerning securities regulation. He is the Radford Professor of Law at SMU Dedman School of Law, and serves as an expert witness in various securities enforcement and litigation cases. He was an expert for Martha Stewart, and for Mark Cuban in the high-profile case which this book is about.

Mark Cuban, of Dallas Mavericks and Shark Tank fame, was an approximate 6% shareholder of Mamma.com, a publicly-traded Canadian tech company. Shortly after learning from management that the company was seeking to raise more money in a private placement known as a “PIPE,” (which is generally dilutive vis-à-vis existing shareholders such as Cuban), but before the PIPE was announced via press release, Cuban sold his entire stake in the company. The Commission's Enforcement Division investigated, focusing on whether Cuban had “misappropriated” confidential, material, non-public information about the PIPE, and wrongfully traded thereon. Cuban was not an officer or director of the company, and thus did not owe the shareholders the fiduciary duties that such “insiders” do; nor was he a “tippee” of corporate information disclosed by an insider for an improper purpose. Thus, the “classical” theory of insider trading could not fit in this case. Rather, to successfully proceed against him, the Commission needed to plead and prove that he misappropriated the information in breach of a duty to the source—in this case, Mamma.com's CEO—and, specifically, that he breached an agreement to treat the information confidentially and to refrain from trading thereon. See United States v. O'Hagan, 521 U.S. 642 (1997); SEC Rule 10b5-2.

Professor Steinberg follows the entire process from start to finish, from Enforcement's investigation, the unsuccessful settlement negotiations, the initial stages of the Commission's action against Cuban, including Cuban's successful motion to dismiss (which was overturned on appeal), discovery, Cuban's unsuccessful motion for summary judgment, pre-trial, key trial testimony, jury instructions, verdict and judgment. He sets forth largely verbatim key documents, pleadings and testimony and, through succinct prefaces, explanatory notes and segues, he enables the reader to derive an understanding of how an SEC insider trading investigation, litigation and trial unfolds. In the end, Cuban prevailed: The jury rendered a defense verdict, including answers in his favor to each and every special verdict question on the key elements of the charges against him.

In his brief observations at the end of the book, he sets forth a handful of factors which may have contributed to this high-profile SEC loss: The inability of the Commission to compel key Mamma.com witnesses, Canadian citizens, to testify live at trial; the decision of the SEC to sue Cuban in his “home court”—Dallas; the failure of the SEC to call its materiality expert witness to rebut testimony by the expert called by Cuban.

And he describes the state of insider trading law in the United States as “murky.” As a key example, he points out that Rule 10b5-2 appears to be at odds with economic realities. In seeking to deem contractual breaches of garden-variety agreements such as NDAs into O'Hagan-required breaches of fiduciary duty or relationships of trust and confidence, the Rule, Steinberg points out, ignores the fact that such agreements are entered into precisely because arms-length counterparties do not trust each other.

The law is at least as murky as regards tippee liability. Insider trading is a species of securities fraud under §10(b) of the Securities Exchange Act of 1934. Ever since its 1976 decision in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), the Supreme Court has made clear that liability under §10(b) requires more than negligence, but rather “scienter,” or an intent to deceive, manipulate or defraud. Yet, in its seminal case on tippee liability only seven years later, Dirks v. Securities and Exchange Commission, 463 U.S. 646 (1983), the court stated that liability for insider trading could be imposed when the tippee knows, “or should know” of the insider's improper breach of duty in making the tip. Sounds like negligence language to me. Dirks was recently reaffirmed in Salman v. United States, 137 S. Ct. 420 (2016).

Mark Cuban reportedly spent some $12million in defending himself against the SEC. Public companies and others spend enormous sums of money in designing, implementing and enforcing insider trading compliance programs; and yet more resources in the defense of various SEC insider trading investigations and litigation. Numerous others forced to deal with the gravity of an SEC investigation must do so given extremely limited resources.

One of the most revered SEC Enforcement Division directors once said, “insider trading is like prostitution: it's always been around, it's around now, and it will always be around.” I, as an SEC Enforcement attorney at the time, took this guidance not as a nod to look the other way, but simply to keep things in perspective with limited government resources to combat a whole panoply of securities law violations, particularly in the face of other perennial types of frauds which arguably cause more immediate and significant financial loss to investors, such as Ponzi Schemes, pump-and-dumps and various types of offering frauds. Combatting insider trading, though, continues to remain an outsized program priority for SEC Enforcement.

An approach to insider trading enforcement which deserves more attention is one which Professor Steinberg notes in this book, and which he has otherwise written about: at least for sellers of securities, utilizing §17(a)(3) of the Securities Act of 1933. That section makes it unlawful for offerors or sellers of securities “to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.” Significantly, liability under this section can be imposed for merely negligent conduct. See Aaron v. SEC, 446 U.S. 680 (1980) (for purchasers in alleged insider trading transactions, current law pigeonholes enforcement cases into Exchange Act §10(b) and Rule 10b-5, requiring scienter). When the doctrinal analysis of this area is so steeped in duties and their breaches, utilizing negligence-based liability would seem to make a lot of sense.

In sum, 'Deep Dive' is a readable, provocative account and cautionary tale about a rare fully-litigated insider trading case. The only modest critique I can offer is the wish that Professor Steinberg would have fleshed out a bit more his expert analysis of insider trading law, and “taken the gloves off” on what he really thinks smart regulation and enforcement can and should be in this realm.

Dennis A. Stubblefield served as an attorney with the SEC's Enforcement Division from 1977 through 1984. He practices securities enforcement defense, and teaches securities regulation as an adjunct professor of law at Lewis & Clark Law School.