On Monday, July 18, 2011, a Federal Judge in Texas, Sidney Fitzwater, granted a Motion to Strike by the SEC in its case against Mark Cuban, the owner of the Dallas Mavericks, eliminating his affirmative defense of "unclean hands" in the Commission’s case against him. Notably, although it did strike the defense in Mr. Cuban’s case, the Court rejected the SEC’s argument that the defense is barred in SEC enforcement actions as a matter of law, and held that it is available, but "only in strictly limited circumstances."
The SEC brought this insider trading case alleging that, when Mamma.com, Inc. was planning a PIPE offering, Mr. Cuban, its largest known shareholder, was contacted several times about the proposed offering (and that prior to information about the transaction was provided to him, Mr. Cuban agreed to maintain its confidentiality). Mr. Cuban declined to participate in the offering, and was reportedly upset because it would dilute his interest. Before the public announcement of the offering, Mr. Cuban sold his entire stake in the company, avoiding what the SEC claims was potentially a $750,000 loss. SEC v. Cuban No. 3-08-cv-2050 (N.D. Tex. filed Nov. 17, 2008). Mr. Cuban moved to dismiss the Complaint on the grounds that the SEC did not adequately allege that he owed Mamma.com a fiduciary or similar duty of trust and confidence. The Motion was granted in the District Court, but the Fifth Circuit Court of Appeals reversed and remanded the case to the District Court. SEC v. Cuban, No. 09-10996, slip op. (5th Cir. Sept. 21, 2010).
Back in the District Court, in his answer, Mr. Cuban asserted the affirmative defense that the SEC had "unclean hands." Mr. Cuban argued that: (1) the SEC staff members were committed to bringing the enforcement action against him while still investigating the matter; (2) the SEC staff deliberately undermined the Wells process; and (3) the SEC Staff "engaged in acts of outright investigative and litigation misconduct" during the investigation. The SEC moved to strike the defense, arguing, among other things that the defense is unavailable as a matter of law in an SEC enforcement action.
Judge Fitzwater ruled that "under the present state of the law, the affirmative defense of unclean hands is not barred as a matter of law in an SEC enforcement action." However, the Court held that the defense is available in strictly limited circumstances and that
[t]he SEC’s misconduct must be egregious, the misconduct must occur before the SEC files the enforcement action, and the misconduct must result in prejudice to the defense of the enforcement action that rises to a constitutional level and is established through a direct nexus between the misconduct and the constitutional injury.
In doing so, Judge Fitzwater noted that the bar was set so high for asserting the defense because SEC enforcement actions are intended to promote the interests of the public, which should not be derailed except in narrow circumstances.
The Court summarily rejected two of Mr. Cuban’s arguments, focusing instead on the accusation that the SEC Staff engaged in acts of misconduct during the investigation. Judge Fitzwater held that Mr. Cuban did not allege that the Commission’s conduct resulted in any prejudice to his defense of the enforcement action, and, as a result, he had failed to adequately plead the defense. The Court granted the SEC’s motion to strike and further ruled that it was not granting him leave to replead the defense.