SEC Pursues Cuban

October 20th, 2009 - No Comments

The Securities and Exchange Commission is appealing a federal judge’s dismissal of an insider-trading case against Dallas Mavericks owner Mark Cuban. The Wall Street Journal reports:

In July, a federal judge in Dallas threw out the SEC’s case against Mr. Cuban that centered on trading in 2004. The SEC alleged Mr. Cuban sold his entire 6 percent stake in Mamma.com, an Internet-search company, after learning from company executives of a plan to raise money in a private stock offering. Such offerings often result in a drop in the stock price. By selling, the SEC alleged, Mr. Cuban avoided $750,000 in losses.

Mr. Cuban and his lawyers denied that he was under any obligation not to trade on the information he received.

Below, Smeal’s Steven Huddart breaks down the case against Cuban and explains how insider trading law applies:

The United States Securities and Exchange Commission (SEC) argues that Mark Cuban committed fraud when he sold stock in Mamma.com at a high price just after he had been told by Mamma.com’s CEO that more stock would soon be offered at a low price.  Cuban’s position is that, notwithstanding a promise to keep the information confidential, he had no obligation to refrain from trading in Mamma.com stock.

Whether such trading is legal depends on how the rules apply to circumstances.  From the complaint, it seems Cuban initially thought it was against the rules for him to trade:  After the CEO told him about the offering, Cuban said, “Well, now I’m screwed.  I can’t sell.”  Cuban must have changed his mind, because he later sold the stock and thereby avoided a loss.

The Cuban case is interesting because it is near the frontier between what is permissible and impermissible use of “material non-public information”—this is the wording used in rules promulgated by the SEC.  Those rules have changed over time and are often subject to new interpretations.

One way for the SEC to affect the interpretation of these rules is to launch an action [Securities and Exchange Commission v. Mark Cuban, Civil Action No. 3-08-CV-2050-D (SF)] against a trader that the Commission believes broke them.

Insider trading prohibitions must strike a balance between two public interests: (1) maintaining investor confidence and (2) promoting price efficiency.

Markets with a lot of fraud lack integrity and investor confidence suffers.  The Supreme Court has opined that “although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law.”

On the other hand, if informed traders do not buy undervalued assets and sell (or short) overvalued assets, then the economic force that moves price toward worth is stymied.  Mark Cuban exemplifies this force.  He dumped his Mamma.com stock when he found out it was overvalued.  And, he funds Sharesleuth.com, “an independent Web-based reporting aimed at exposing securities fraud and corporate chicanery.” Cuban gets the information Sharesleuth uncovers before it is published on the Web. He trades on this information, too. 

The policy question to ask in each case is:  Are we better for Mark Cuban’s actions?

Tags: Huddart, Insider Trading

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