IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 09-10996

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff - Appellant

v.

MARK CUBAN,

Defendant - Appellee

Appeal from the United States District Court

for the Northern District of Texas

Before KING, HIGGINBOTHAM, and GARZA, Circuit Judges.

PATRICK E. HIGGINBOTHAM, Circuit Judge:

This case raises questions of the scope of liability under the

misappropriation theory of insider trading. Taking a different view from our

able district court brother of the allegations of the complaint, we are persuaded

that the case should not have been dismissed under Fed. R. Civ. P. 9(b) and 12

and must proceed to discovery.

Mark Cuban is a well known entrepreneur and current owner of the Dallas

Mavericks and Landmark theaters, among other businesses. The SEC brought

United States Court of Appeals

Fifth Circuit

F I L E D

September 21, 2010

Lyle W. Cayce

Clerk

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this suit against Cuban alleging he violated Section 17(a) of the Securities Act

of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5

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by trading in Mamma.com stock in breach of his duty to the CEO and

Mamma.com—amounting to insider trading under the misappropriation theory

of liability. The core allegation is that Cuban received confidential information

from the CEO of Mamma.com, a Canadian search engine company in which

Cuban was a large minority stakeholder, agreed to keep the information

confidential, and acknowledged he could not trade on the information. The SEC

alleges that, armed with the inside information regarding a private investment

of public equity (PIPE) offering, Cuban sold his stake in the company in an effort

to avoid losses from the inevitable fall in Mamma.com’s share price when the

offering was announced.

Cuban moved to dismiss the action under Rule 9(b) and 12(b)(6). The

district court found that, at most, the complaint alleged an agreement to keep

the information confidential, but did not include an agreement not to trade.

Finding a simple confidentiality agreement to be insufficient to create a duty to

disclose or abstain from trading under the securities laws, the court granted

Cuban’s motion to dismiss. The SEC appeals, arguing that a confidentiality

agreement creates a duty to disclose or abstain and that, regardless, the

confidentiality agreement alleged in the complaint also contained an agreement

not to trade on the information and that agreement would create such a duty.

15 U.S.C. § 77q(a).

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15 U.S.C. § 78j(b).

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17 C.F.R. § 240.10b-5.

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We review de novo the district court’s dismissal for failure to state a claim

under Rule 12(b)(6). We accept “all well pleaded facts as true, viewing them in

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the light most favorable to the plaintiff.” The “‘complaint must contain

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sufficient factual matter, accepted as true, to ‘state a claim to relief that is

plausible on its face.’’’ “‘Factual allegations must be enough to raise a right to

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relief above the speculative level, on the assumption that all the allegations in

the complaint are true (even if doubtful in fact).’”

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The SEC alleges that Cuban’s trading constituted insider trading and

violated Section 10(b) of the Securities Exchange Act. Section 10(b) makes it

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unlawful for any person, directly or indirectly, by the use of any

means or instrumentality of interstate commerce or of the mails, or

of any facility of any national securities exchange . . . [t]o use or

employ, in connection with the purchase or sale of any security . . .

any manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the Commission may

prescribe as necessary or appropriate in the public interest or for

Flaherty & Crumrine Preferred Income Fund, Inc. v. TXU Corp., 565

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F.3d 200, 206 (5th Cir. 2009). As the district court noted, to the extent

Cuban’s arguments under Rule 9(b) are distinct from his Rule 12(b)(6)

arguments, the complaint pleads facts with sufficient “particularity” and thus

does not violate Rule 9(b). See id.

In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir. 2007).

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Gonzalez v. Kay, 577 F.3d 600, 603 (5th Cir. 2009) (quoting Ashcroft v.

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Iqbal, 129 S.Ct. 1937, 1949 (2009)).

In re Katrina Canal Breaches Litig., 495 F.3d at 205, (quoting Bell Atl.

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Corp. v. Twombly, 550 U.S. 544, 555 (2007)).

The parties agree the allegations under section 17(a) of the Securities

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Act are evaluated under the same legal standard as the section 10(b) claim.

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the protection of investors.

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Pursuant to this section, the SEC promulgated Rule 10b-5, which makes it

unlawful to

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to

state a material fact necessary in order to make the statements

made, in the light of the circumstances under which they were

made, not misleading, or

(c) To engage in any act, practice, or course of business which

operates or would operate as a fraud or deceit upon any person, in

connection with the purchase or sale of any security.

The Supreme Court has interpreted section 10(b) to prohibit insider trading

under two complementary theories, the “classical theory” and the

“misappropriation theory.”

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The classical theory of insider trading prohibits a “corporate insider” from

trading on material nonpublic information obtained from his position within the

corporation without disclosing the information. According to this theory, there

exists “a relationship of trust and confidence between the shareholders of a

corporation and those insiders who have obtained confidential information by

reason of their position with that corporation.” Trading on such confidential

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information qualifies as a ‘deceptive device’ under section 10(b) because by using

that information for his own personal benefit, the corporate insider breaches his

15 U.S.C. § 78j.

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United States v. O’Hagan, 521 U.S. 642, 652 (1997).

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Chiarella v. United States, 445 U.S. 222, 228 (1980).

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duty to the shareholders. The corporate insider is under a duty to “disclose or

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abstain” —he must tell the shareholders of his knowledge and intention to trade

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or abstain from trading altogether.

There are at least two important variations of the classical theory of

insider trading. The first is that even an individual who does not qualify as a

traditional insider may become a “temporary insider” if by entering “into a

special confidential relationship in the conduct of the business of the enterprise

[they] are given access to information solely for corporate purposes.” Thus

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underwriters, accountants, lawyers, or consultants are all considered corporate

insiders when by virtue of their professional relationship with the corporation

they are given access to confidential information. The second variation is that

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an individual who receives information from a corporate insider may be, but is

not always, prohibited from trading on that information as a tippee. “[T]he

tippee’s duty to disclose or abstain is derivative from that of the insider’s duty”

and the tippee’s obligation arises “from his role as a participant after the fact in

the insider’s breach of a fiduciary duty.” Crucially, “a tippee assumes a

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fiduciary duty to the shareholders of a corporation not to trade on material

nonpublic information only when the insider has breached his fiduciary duty to

the shareholders by disclosing the information to the tippee and the tippee

Id. at 227.

12

Id.

13

Dirks v SEC, 463 U.S. 646, 655 n.14 (1983).

14

Id.

15

Id. at 659 (internal quotation marks omitted).

16

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knows or should know there has been a breach.” The insider breaches his

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fiduciary duty when he receives a “direct or indirect personal benefit from the

disclosure.”

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Both the temporary-insider and tippee twists on the classical theory retain

its core principle that the duty to disclose or abstain is derived from the

corporate insider’s duty to his shareholders. The misappropriation theory does

not rest on this duty. It rather holds that a person violates section 10(b) “when

he misappropriates confidential information for securities trading purposes, in

breach of a duty owed to the source of the information.” The Supreme Court

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first adopted this theory in United States v. O’Hagan. There, a lawyer traded

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the securities of a company his client was targeting for a takeover. O’Hagan

could not be liable under the classical theory as he owed no duty to the

shareholders of the target company. Nevertheless, the court found O’Hagan

violated section 10(b). The Court held that in trading the target company’s

securities, O’Hagan misappropriated the confidential information regarding the

planned corporate takeover, breaching “a duty of trust and confidence” he owed

to his law firm and client. Trading on such information “involves feigning

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fidelity to the source of information and thus utilizes a ‘deceptive device’ as

Id. at 660.

17

Id. at 663.

18

United States v. O’Hagan, 521 U.S. 642, 652 (1997).

19

Id. at 650.

20

Id. at 653.

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required by section 10(b).” The Court stated that while there is “no general

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duty between all participants in market transactions to forgo actions based on

material nonpublic information,” the breach of a duty to the source of the

information is sufficient to give rise to insider trading liability.

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While O’Hagan did not set the contours of a relationship of “trust and

confidence” giving rise to the duty to disclose or abstain and misappropriation

liability, we are tasked to determine whether Cuban had such a relationship

with Mamma.com. The SEC seeks to rely on Rule 10b5-2(b)(1), which states

that a person has “a duty of trust and confidence” for purposes of

misappropriation liability when that person “agrees to maintain information in

confidence.” In dismissing the case, the district court read the complaint to

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allege that Cuban agreed not to disclose any confidential information but did not

agree not to trade, that such a confidentiality agreement was insufficient to

create a duty to disclose or abstain from trading under the misappropriation

theory, and that the SEC overstepped its authority under section 10(b) in issuing

Rule 10b5-2(b)(1). We differ from the district court in reading the complaint and

need not reach the latter issues.

The complaint alleges that, in March 2004, Cuban acquired 600,000

shares, a 6.3% stake, of Mamma.com. Later that spring, Mamma.com decided

Id. at 660.

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Id. at 662. Because the duty flows to the source of the information

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and not to shareholders “if the fiduciary discloses to the source that he plans

to trade on the nonpublic information, there is no ‘deceptive device’ and thus

no § 10(b) violation.” O’Hagan, 521 U.S. at 655.

17 C.F.R. § 240.10b5-2(b)(1).

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to raise capital through a PIPE offering on the advice of the investment bank

Merriman Curhan Ford & Co. At the end of June, at Merriman’s suggestion,

Mamma.com decided to invite Cuban to participate in the PIPE offering. “The

CEO was instructed to contact Cuban and to preface the conversation by

informing Cuban that he had confidential information to convey to him in order

to make sure that Cuban understood—before the information was conveyed to

him—that he would have to keep the information confidential.”

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After getting in touch with Cuban on June 28, Mamma.com’s CEO told

Cuban he had confidential information for him and Cuban agreed to keep

whatever information the CEO shared confidential. The CEO then told Cuban

about the PIPE offering. Cuban became very upset “and said, among other

things, that he did not like PIPEs because they dilute the existing

shareholders.” “At the end of the call, Cuban told the CEO ‘Well, now I’m

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screwed. I can’t sell.’”

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The CEO told the company’s executive chairman about the conversation

with Cuban. The executive chairman sent an email to the other Mamma.com

board members updating them on the PIPE offering. The executive chairman

included:

Today, after much discussion, [the CEO] spoke to Mark Cuban

about this equity raise and whether or not he would be interested in

participating. As anticipated he initially ‘flew off the handle’ and

said he would sell his shares (recognizing that he was not able to do

anything until we announce the equity) but then asked to see the

Compl. at ¶ 12.

25

Compl. at ¶ 14.

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Id.

27

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terms and conditions which we have arranged for him to receive

from one of the participating investor groups with which he has

dealt in the past.

The CEO then sent Cuban a follow up email, writing “‘[i]f you want more details

about the private placement please contact . . . [Merriman].’”

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Cuban called the Merriman representative and they spoke for eight

minutes. “During that call, the salesman supplied Cuban with additional

confidential details about the PIPE. In response to Cuban’s questions, the

salesman told him that the PIPE was being sold at a discount to the market

price and that the offering included other incentives for the PIPE investors.”

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It is a plausible inference that Cuban learned the off-market prices available to

him and other PIPE participants.

With that information and one minute after speaking with the Merriman

representative, Cuban called his broker and instructed him to sell his entire

stake in the company. Cuban sold 10,000 shares during the evening of June 28,

2004, and the remainder during regular trading the next day.

That day, the executive chairman sent another email to the board,

updating them on the previous day’s discussions with Cuban, stating “‘we did

speak to Mark Cuban ([the CEO] and, subsequently, our investment banker) to

find out if he had any interest in participating to the extent of maintaining his

interest. His answers were: he would not invest, he does not want the company

to make acquisitions, he will sell his shares which he can not do until after we

Compl. at ¶ 16 (alteration in original).

28

Compl. at ¶ 17.

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announce.’”

30

After the markets closed on June 29, Mamma.com announced the PIPE

offering. The next day, Mamma.com’s stock price fell 8.5% and continued to

decline over the next week, eventually closing down 39% from the June 29

closing price. By selling his shares when he did, Cuban avoided over $750,000

in losses. Cuban notified the SEC that he had sold his stake in the company and

publically stated that he sold his shares because Mamma.com “was conducting

a PIPE, which issued shares at a discount to the prevailing market price and

also would have caused his ownership position to be diluted.”

31

In reading the complaint to allege only an agreement of confidentiality, the

court held that Cuban’s statement that he was “screwed” because he “[could not]

sell” “appears to express his belief, at least at that time, that it would be illegal

for him to sell his Mamma.com shares based on the information the CEO

provided.” But the court stated that this statement “cannot reasonably be

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understood as an agreement not to sell based on the information.” The court

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found “the complaint asserts no facts that reasonably suggest that the CEO

intended to obtain from Cuban an agreement to refrain from trading on the

information as opposed to an agreement merely to keep it confidential.”

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Finally, the court stated that “the CEO’s expectation that Cuban would not sell

Compl. at ¶ 20 (alteration in original).

30

Compl. at ¶ 25.

31

SEC v. Cuban, 634 F. Supp. 2d 713, 728 (N.D. Tex. 2009).

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Id.

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Id.

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was also insufficient” to allege any further agreement.

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Reading the complaint in the light most favorable to the SEC, we reach a

different conclusion. In isolation, the statement “Well, now I’m screwed. I can’t

sell” can plausibly be read to express Cuban’s view that learning the confidences

regarding the PIPE forbade his selling his stock before the offering but to

express no agreement not to do so. However, after Cuban expressed the view

that he could not sell to the CEO, he gained access to the confidences of the PIPE

offering. According to the complaint’s recounting of the executive chairman’s

email to the board, during his short conversation with the CEO regarding the

planned PIPE offering, Cuban requested the terms and conditions of the

offering. Based on this request, the CEO sent Cuban a follow up email providing

the contact information for Merriman. Cuban called the salesman, who told

Cuban “that the PIPE was being sold at a discount to the market price and that

the offering included other incentives for the PIPE investors.” Only after

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Cuban reached out to obtain this additional information, following the statement

of his understanding that he could not sell, did Cuban contact his broker and sell

his stake in the company.

The allegations, taken in their entirety, provide more than a plausible

basis to find that the understanding between the CEO and Cuban was that he

was not to trade, that it was more than a simple confidentiality agreement. By

contacting the sales representative to obtain the pricing information, Cuban was

able to evaluate his potential losses or gains from his decision to either

participate or refrain from participating in the PIPE offering. It is at least

Id.

35

Compl. at ¶ 17.

36

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plausible that each of the parties understood, if only implicitly, that Mamma.com

would only provide the terms and conditions of the offering to Cuban for the

purpose of evaluating whether he would participate in the offering, and that

Cuban could not use the information for his own personal benefit. It would

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require additional facts that have not been put before us for us to conclude that

the parties could not plausibly have reached this shared understanding. Under

Cuban’s reading, he was allowed to trade on the information but prohibited from

telling others—in effect providing him an exclusive license to trade on the

material nonpublic information. Perhaps this was the understanding, or

perhaps Cuban mislead the CEO regarding the timing of his sale in order to

obtain a confidential look at the details of the PIPE. We say only that on this

factually sparse record, it is at least equally plausible that all sides understood

there was to be no trading before the PIPE. That both Cuban and the CEO

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The parties dispute Mamma.com’s motive in providing the

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information to Cuban. Cuban contends that the offering was already

oversubscribed and that this demonstrates the sole purpose of the phone call

was to prevent Cuban from trading ahead of the offering. We express no

opinion on this factual dispute or the potential implications of Cuban’s

allegations if they are true. At the motion-to-dismiss stage we must view all

the facts in light most favorable to the SEC and assume that Mamma.com

had a legitimate reason for contacting Cuban.

Such an arrangement would raise serious tipper/tippee liability

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concerns were it explicit. If the CEO knowingly gave Cuban material

nonpublic information and arranged so he could trade on it, it would not be

difficult for a court to infer that the CEO must have done so for some personal

benefit—e.g., goodwill from a wealthy investor and large minority

stakeholder. “A reputational benefit that translates into future earnings, a

quid pro quo, or a gift to a trading friend or relative all could suffice to show

the tipper personally benefitted.” SEC v. Yun, 327 F.3d 1263, 1277 (11th Cir.

2003). This of course is not to suggest any such improprieties occurred;

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expressed the belief that Cuban could not trade appears to reinforce the

plausibility of this reading.

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Given the paucity of jurisprudence on the question of what constitutes a

relationship of “trust and confidence” and the inherently fact-bound nature of

determining whether such a duty exists, we decline to first determine or place

our thumb on the scale in the district court’s determination of its presence or to

now draw the contours of any liability that it might bring, including the force of

Rule 10b5-2(b)(1). Rather, we VACATE the judgment dismissing the case and

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REMAND to the court of first instance for further proceedings including

discovery, consideration of summary judgment, and trial, if reached.

rather, it simply reinforces the plausibility of the interpretation of the alleged

facts as evidencing an understanding that the agreement included an

agreement by Cuban not to trade.

Compl. at ¶¶ 14 & 20.

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Nor must we reach the validity of Rule 10b5-2(b)(1).

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