APPEALING CUBAN: AGGRESSIVE INSIDER TRADING ENFORCMENT

The SEC appealed from the decision dismissing its insider trading case against Mark Cuban. SEC v. Cuban, No. 08-2050 (N.D. Tex. July 17, 2009). Previously, the Commission rejected an opportunity to amend its complaint.

The decision to appeal Cuban is emblematic of the aggressive posture the SEC has consistently taken in insider trading cases. This is particularly true here, where the factual record is thin at best. The case centered on the trading by Mr. Cuban in advance of the announcement of a PIPE offering to avoid a loss. Specifically, Mr. Cuban sold his stake in Mamma.com after being told about the offering by company officials who, in the first conversation with him conditioned the discussions on his acknowledgement that the information would be maintained in confidence. While Mr. Cuban stated at one point that he could not trade after learning about the proposed offering, shortly after his second conversation about it with the company, he sold his entire stake, avoiding a loss he expected.

In dismissing the complaint against Mr. Cuban, the court rejected his position that insider trading had to be predicated on a breach of fiduciary duty. Rather, the court held that the violation could be predicated on a breach of an express obligation not to use the information to trade as discussed here.

The Commission’s appeal will have to be based on the single statement of Mr. Cuban at the beginning of his initial conversation with the company. The SEC clearly will not challenge the conclusion that a breach of fiduciary duty is not necessary for insider trading liability. Indeed, that is the position which helped the SEC win a reversal in SEC v. Dorozhko, Case No. 08-0201, 2009 U.S. App. LEXIS 16057 (2nd Cir. July 222, 2009), discussed here.

Rather, the SEC’s appeal will have to be based almost exclusively on Mr. Cuban’s acknowledgement that he would keep the information about to be conveyed confidential. Yet, in making that statement there is no indication that Mr. Cuban knew the nature of the undertaking being sought beyond a vague statement about confidentiality. As the district court concluded, this statement offers scant support for undertaking the type of obligation on which insider trading is typically based.

Similarly, the acknowledgement by Mr. Cuban that he could not trade appears to offer little support for the Commission’s case. Viewed in context, it is clear that the statement was made while expressing anger about an offering which Mr. Cuban viewed as harmful to existing shareholders.

Overall the decision to appeal Cuban clearly demonstrates the Commission’s willingness to push the edge of insider trading. Indeed, the thin factual record suggests that the SEC is pushing the edge of the required legal obligation toward a parity of information standard. That theory, of course, has long been rejected as a basis for insider trading liability.

INDUSTRY WIDE INVESTIGATION: THE STOCK LOAN BUSINESS

The U.S. Attorney’s Office for the Eastern District of New York unsealed its latest indictment in an on-going investigation of fraudulent fees, sham transactions and kickbacks in the stock loan business. The case unsealed this week names as a defendant Ronald Garcia, who did business as Independent Investor Services, Inc., a stock loan finder. U.S. v. Garcia, No. 1:09 No. 1:09-cr-00675 (E.D.N.Y. Sept. 30, 2009).

Mr. Garcia is named in a six-count indictment that grows out of the stock loan business. The securities and wire fraud charges in the indictment center on what are alleged to be fraudulent loan fees and kickbacks. Specifically, Mr. Garcia is alleged to have received finders’ fees in connection with stock loan transactions involving Schonfeld Securities and Van Der Moolen Specialists despite the fact that no services were performed. To obtain the fees Mr. Garcia is alleged to have paid kickbacks to a trader at Van Der Moolen, who in turn paid a trader at Schonfeld.

Garcia is one of a series of cases stemming from an on-going industry wide investigation focused on allegations of bribery and kickbacks in the securities lending or stock loan industry. In that business, financial institutions and their customers frequently engage in transactions that require them to borrow securities from other institutions. The terms of the deal typically include an amount of collateral posted by the borrower, loaned securities and fees and other payments that the parties make to each other as part of the transaction. Typically, the borrower pays the cash or other collateral to the lender and receives the borrowed securities. The lender earns interest on the cash collateral by using it in low risk short term loans to other financial institutions. Finders such as Mr. Garcia claimed to be, facilitated the transactions and are paid a finders’ fee or other compensation for their services.

To date cases have brought have involved former securities lending traders from A.G. Edwards, Janney Montgomery Scott, JP Morgan Chase, Kellner Dileo, Oppenheimer, Morgan Stanley, National Investors Services, Nomura Securities, Pax Clearing, PFPC Worldwide, Schonfeld and Van der Moolen.

Previously, the SEC filed an action against Mr. Garcia and several others. SEC v. Suarez, Civil Action No. 08-3900 (E.D.N.Y. Filed Sept. 24, 2008); See also Litig. Rel. 20736 (Sept. 24, 2008). The Commission’s complaint alleges that over a period of about six years the six defendants defrauded Schonfeld Securities out of at least $1.66 million through the payment of sham finder fees and undisclosed kickbacks that ultimately were paid for by the firm.