Law Professors' Amicus Brief in Cuban Case Stressed that Confidentiality Agreement Not Enough

An amicus brief filed by a consortium of law professors in an SEC enforcement action emphasized that a confidentiality agreement alone is not enough to create a fiduciary or similar relationship of trust and confidence that could support the misappropriation theory of insider trading liability. Under both state and federal common law, reasoned the professors, a confidentiality agreement alone creates only an obligation to maintain the secrecy of the information, not a fiduciary or fiduciary-like duty to act loyally to the source of information. In the absence of any other facts, indicating the existence of a fiduciary or similar relationship of trust and confidence, said amici, there can be no insider trading liability based on the misappropriation theory pursuant to the securities antifraud provision. SEC v. Cuban, USDC, ND TX.

Similarly, the professors argued that, if SEC Rule 10b5-2(b)(1) creates potential liability based solely on the existence of a confidentiality agreement, the rule is an invalid exercise of the Commission’s rulemaking authority. Interpreted in this manner, continued amici, the rule contradicts Supreme Court rulings on the scope of Section 10(b) liability for insider trading because it would create liability without the existence of a fiduciary or similar relationship of trust and confidence.

In the SEC enforcement action, a federal judge ruled that the agreement required to invoke the misappropriation theory of insider trading liability must include both an obligation to maintain the confidentiality of the inside information and not to trade on or otherwise use the information. Thus, the SEC did not state a duty arising by agreement since the Commission failed to allege that the defendant, the company’s largest shareholder, undertook a duty to refrain from trading on information about an impending PIPE offering. However, the court gave the SEC 30 days to replead if the Commission can allege that the shareholder undertook a duty, expressly or implicitly, not to trade on or otherwise use inside information about the offering. The court also ruled that, because SEC Rule 10b5-2(b)(1) attempts to predicate misappropriation theory liability on a mere confidentiality agreement lacking a non-use component, the SEC could not rely on it to establish the shareholder’s liability under the theory.

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