On September 21, 2010, the Fifth Circuit Court of Appeals reversed the holding of the lower court and reinstated the SEC’s insider trading charges against entrepreneur Mark Cuban. This decision serves as an important reminder of the fact-intensive nature of insider trading inquiries and the perils of treading too close to the line when trading while in possession of non-public information.
Here, the SEC’s essential allegation is that Cuban violated the misappropriation theory of insider trading when, after receiving confidential information from the CEO of Mamma.com that the company was going to make a private investment of public equity (PIPE) offering, he sold his stake in the company in an effort to avoid losses from the expected fall in Mamma.com’s share price when the PIPE was announced. The district court found that the SEC’s complaint sufficiently alleged that Cuban had agreed to keep confidential information he received from the CEO, but that it had not alleged that Cuban agreed not to trade. Without that further agreement, the district court held, Cuban had not breached a duty, as required for insider trading liability. The district court therefore dismissed the case. On appeal, the Fifth Circuit disagreed, holding that it was at least plausible to conclude from the allegations in the complaint that, under the circumstances, Cuban was obligated not to trade. The appellate court therefore vacated the decision of the lower court and remanded the case to allow the SEC the opportunity to fully develop the factual record through discovery.
Although the appellate court opinion did not set forth any new legal principles, several important conclusions can be drawn from the decision. First, commentators who warned against reading the lower court decision as a change in the law of insider trading were correct: the Fifth Circuit decision makes clear that the bar for proving insider trading has not been raised. Second, the court made clear that insider trading cases are heavily fact-specific. Therefore, once the specter of insider trading is raised, it is difficult to avoid a detailed investigation into the facts. Third, even where the trial court was willing to decide the case at the motion-to-dismiss stage as a matter of law, the appellate court found that was erroneous in the presence of debatable issues of the interpretation and legal significance of certain facts.
This case is thus a reminder to proceed with caution and to seek guidance before trading while in possession of information that may be confidential. Careful analysis is essential before concluding that trading is permissible. If the circumstances surrounding a trade are likely to draw government scrutiny, there is every reason to expect the result to be a lengthy investigation (or litigation) with an uncertain eventual outcome.
SEC Issues Transitional Guidance for Broker Audits
On Friday, the SEC issued this 4-page interpretive release to provide transitional guidance on which auditing standards should be used by broker-dealers now that the PCAOB has authority to set auditing standards under Dodd-Frank. Since the SEC’s rules and the PCAOB’s standards have not yet been updated for this new legislation, the SEC’s guidance is that references in the SEC rules to auditing literature (ie. GAAS) should continue to be understood to mean auditing standards generally accepted in the US, plus any applicable SEC rules. This transitional guidance will be revisited when a rulemaking project is undertaken.
Financial Stability Oversight Council to Hold First Meeting
Last week, Treasury Secretary Tim Geithner, in his capacity as Chair of the Financial Stability Oversight Council, announced that the Council will hold its first meeting on October 1st. This press release lists all of the Council’s members.
– Broc Romanek