A High Profile Insider Trading Case Based On A PIPE Offering

The SEC filing another insider trading case based on a private investment in public equity offering or a “PIPE” offering. This high profile case named as a defendant Mark Cuban, owner of the Dallas Mavericks, HDNet, Landmark Theaters and a possible bidder for the Chicago Cubs baseball team. SEC v. Cuban, Civil Action No. 3-08-CV-2050 (N.D. TX Filed Nov. 17, 2008).

The claims in the complaint are based on a PIPE offering made by Mamma.com Inc., a NASDAQ traded company based in Montreal, Quebec. According to the Commission, in 2004, when the company was planning the offering, Mr. Cuban was its largest known shareholder. He was contacted by the company and offered the opportunity to participate in the upcoming offering. Before company officials made that offer however, Mr. Cuban was advised that the information he was about to be furnished was confidential. As a condition of receiving the information, Mr. Cuban agreed to maintain its confidentiality, according to the SEC.

According to the complaint, Mr. Cuban became very upset after learning about the PIPE offering because it would dilute his holdings. In additional conversations with the company about the PIPE, he learned more details about the offering and was furnished with materials about it. In each instance, Mr. Cuban expressed his opposition to the offering. He also acknowledged an obligation to keep the information confidential. In one conversation, according to the SEC, Mr. Cuban noted that he could not sell his shares until after the public announcement.

Following his last conversation with a company official about the proposed offering, Mr. Cuban called his broker and directed that his 600,000 share stake in the company be sold. Over a two-day period his shares were sold. The sales were completed the day before the announcement of the PIPE.

Following the public announcement of the offering, the share price of the company fell about 9.3%. That price continued to fall over the next week. According to the complaint, Mr. Cuban avoided losses in excess of $750,000 by selling before the announcement. The complaint alleges violations of Section 10(b) and 17(a).

This case differs from earlier PIPE cases that the SEC has litigated. In those cases
Involved Section 5 and insider trading claims based on short sale before the announcement of the offering. In each of the three litigated cases, the SEC’s Section 5 claim was dismissed on a motion to dismiss. In one, SEC v. Mangan, Civil Action No. 06-CV-531 (W.D.N.C. Dec. 28, 2006), the court also denied the SEC’s subsequent motion for summary judgment on the remaining insider trading claim, but granted the motion of defendant as discussed here. That order, entered on August 20, 2008, has not been appealed. In the other two litigated cases the insider trading claims are pending.

In contrast, the case against Mr. Cuban does not involve a Section 5 claim or short selling. Rather, it is pled as a standard insider trading case, trading on material non-public corporate information. Unlike most defendants in SEC insider trading actions however, Mr. Cuban is litigating the claims. Whether the SEC’s new approach will prove more successful than their earlier one remains to be seen.

Lessons From A Loss In A Financial Fraud Case

A ruling in a financial fraud case last week should serve as a reminder of the care which must be taken in bringing SEC enforcement actions. Last week, the District Court in SEC v. Goldsworthy, Civil Action No. 06-cv-10012 (D. Mass. Filed Jan. 4, 2006) rejected most of the Commission’s claims brought against former Applix, Inc. CEO Alan Goldsworthy and former CFO Walter T. Higler. The court rejected the SEC’s accusations of intentional fraudulent conduct amounting to “cooking the books,” finding only negligent conduct.

In its complaint, the Commission claimed that Messrs. Goldsworthy and Hilger, along with then-current director of world-wide operations Mark Sullivan, engaged in two separate schemes to inflate the revenue of Applix. The first scheme, according to the Commission, involved the premature recognition of about $890,000 in revenue for the fiscal year ended December 31, 2001. The second concerned improperly reported revenue of about $341,000 for a transaction with a German customer.

The Commission claimed that the defendants violated Section 17(a) of the Securities Act, Sections 10(b), 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act along with Exchange Act Rules 10b-5, 12b-20, 13a-1, 13a-11, 12a-13 and 13b-2-1. In addition, the complaint claimed that Messrs. Goldsworthy and Higler violated Exchange Act Section 13(b)(5), which prohibits knowing falsification of books and records and Rule 13b2-2, which prohibits officers of a company from lying to auditors.

Based on the findings of a jury made after a four-week trial, the court concluded that the Commission established its claims only as to alleged violations of Section 17(a)(3) and Rule 13b2-1 as to Mr. Hilger. The court concluded that the SEC failed to establish all of the other claimed violations by Messrs. Higler and Goldsworthy. Accordingly, the court imposed a $5,000 penalty on Mr. Higler. No injunction was entered.

The results in this case should serve as a reminder to the care which must be exercised when bringing an enforcement action. The SEC has vast investigative powers. Before it elects to bring an enforcement action, the division typically conducts an extensive inquiry to ascertain the facts. When the division conducts a full investigation there is little excuse for not having the facts to support its claims. Here, it clearly did not.

To be sure, the SEC, like every other litigant, will lose cases. Here, however the SEC suffered what can only be viewed as an almost complete loss. The Commission’s efforts to dress it up in its press release by claiming that it won a fraud finding, while technically true, misses the point. The accusation was intentional fraudulent conduct, not a negligent act meriting only a small fine and no injunction.

It is of little consequence that the company settled in a related administrative proceeding. There, the company consented to the entry of a cease and desist order and agreed to implement certain undertakings it included in its offer of settlement. Those undertakings included retaining an independent financial consultant and implementing the recommendations of that consultant. In the Matter of Applix, Inc., Adm. Proc. File No. 3-12138. But companies often settle with the SEC as a simple matter of pragmatic business judgment.

In the end, the results in this case suggest that the Commission must renew its efforts to carefully consider the facts and applicable legal principles before making an accusation in a complaint or administrative order. The SEC knows well that its power to accuse is all too often the power to convict. That the injury caused to the good name and reputation of persons by its accusations of intentional fraudulent conduct are irreparable and only compounded by the years of litigation it takes to demonstrate that the claim is wrong. In the future, it is essential that the Commission renew its efforts to carefully assess the factual and legal basis for its enforcement actions before bringing an action.