SEC v. Mark Cuban: Reply Brief of Mark Cuban Argues a Confidentiality Agreement does not Establish a Fiduciary Duty

On March 20, 2009, Mark Cuban filed a reply brief in support of a Motion to Dismiss (“the Reply”) in the northern district of Texas – Dallas division. This filing is in response to the SEC’s Law in Opposition to Mark Cuban’s motion to dismiss. The Reply contends Cuban did not engage in inside trading when he sold his Mamma.com stock because a confidentiality agreement does not establish a fiduciary duty. Insider trading is based on the deception that occurs when a person fails to disclose the use of nonpublic information when they have a duty to disclose. The source of this duty is a fiduciary or fiduciary-like relationship between the trader and the source of the information.

The Reply is centered around five arguments: (1) The SEC’s position is not supported by the Supreme Court’s O’Hagan decision, (2) State law should be applied to determine the existence of a fiduciary duty, (3) A confidentiality agreement alone is insufficient to create the requisite duty, (4) Rule 10b5-2(b)(1) is invalid if construed as creating liability in the absence of a fiduciary duty, and (5) Rule 10b5-2(b)(1) does not apply to business relationships.

The Reply states that the O’Hagan decision does not support the SEC’s position because the SEC’s interpretation of O’Hagan is completely contrary to its holding. Conversely to the SEC’s position, O’Hagan holds that a confidentiality agreement does not independently create a fiduciary relationship. The Reply contends that O’Hagan does not discuss how to determine the existence of a fiduciary duty, although the SEC proffered that the Supreme Court must have rejected state law as the source of determining this duty.

Cuban argues that state law determines the existence of a fiduciary or fiduciary-like duty. Prior Supreme Court decisions have held that state law is the proper source for determining this duty by discouraging the formation of federal common law and holding there is no conflict between Section 10(b) and state fiduciary law. The Reply states the Court has also held that failure to apply state fiduciary law in insider trading cases brought under the misappropriation theory was a fatal flaw.

The Reply also argues that a confidentiality agreement alone is not sufficient to create the requisite duty. A violation of a confidentiality agreement may be a breach of contract, but it is not necessarily a breach of a duty leading to insider trader liability. The cases that the SEC relies upon do not hold a person liable exclusively on the existence of a confidentiality agreement but rather find the existence of a longstanding confidential relationship. Also, Cuban insists the SEC ignores a previous case decided in this district that reasoned it was insufficient to examine a confidentiality agreement when determining if a fiduciary duty existed.

Next, it is argued that if Rule 10b5-2(b)(1) is construed as creating liability in the absence of a fiduciary or fiduciary-like duty the rule is invalid. The Reply states the SEC’s argument that Rule 10b5-2(b)(1) creates liability solely based on a confidentiality agreement is unfounded, the rule conflicts with the Supreme Court’s interpretation of “deceptive” conduct, and it also exceeds the SEC’s rulemaking authority. The Reply points out that the SEC, without proper authority, is attempting to make law in which the existence of a confidentiality agreement is enough to give rise to a fiduciary-like duty.

Lastly, the Reply argues that even if Rule 10b5-2(b)(1) is valid, the Rule does not apply to business relationships. Cuban states the only two cases that consider whether the Rule applies to business relationships conclude that the Rule does not apply in that context. Additionally, this argument relies upon the SEC’s own proposing release that the rule only applies to “family or other non-business relationships.” The Reply states the SEC simply cannot promulgate one view of a rule and then adopt a different view upon enforcement.

Because a confidentiality agreement alone does not establish a fiduciary or fiduciary-like duty, the Reply states Mark Cuban did not engage in insider trading and therefore all the claims against Mr. Cuban should be dismissed with prejudice.

The primary materials for this post are available on the DU Corporate Governance Website.