Mark Cuban and Insider Trading

(Analyzed using a consequentialist framework)

Background

In the fall of 2008, the Securities and Exchange Commission (SEC) levied civil charges against NBA team owner Mark Cuban for alleged insider trading.  The charges stemmed from trades Cuban made related to a small internet search company (Mamma.com).  Prior to his trades, Cuban was informed by the company’s CEO that they were planning to do a secondary equity offering in the near future and that they would like for him to buy some additional shares of the company.  Knowing that the offering would (at least temporarily) depress Mamma.com’s stock price, Cuban refused and instead began immediately selling his 6.3% stake of the company.  The following day, shares of Mamma.com opened approximately 10% lower.  Because Cuban successfully sold all of his shares, he was able to avoid losing any money.[1]

Facts about the case

Applicable facts (assumptions are noted as such) surrounding the case include the following:

  • Mark Cuban was a significant shareholder of the internet company Mamma.com.
  • The CEO of Mamma.com informed Cuban that they were planning to undertake a secondary equity offering prior to informing the public (e.g., Cuban was privy to material nonpublic information).
  • After learning of the planned secondary equity offering, Cuban immediately sold his entire stake in the company.
  • Had the secondary offering been completed, the total market value of Cuban’s position would have decreased (assumption).
  • Cuban was solely responsible for the large, single-day decrease in Mamma.com’s stock price (assumption).

Ethical issue

Is it ethical to trade on material nonpublic information in order to benefit oneself?

Stakeholders

Primary and secondary stakeholders (and why they are considered such) of this case include the following:

Primary Stakeholders:

  • Mark Cuban – he is the primary decision-maker and a party to the transaction.
  • Mamma.com – the value and reputation of this company is directly tied to its stock price; large selloffs typically signal that bad news is on the horizon (and may affect a potential investor’s decision to buy).
  • Mamma.com’s employees – sudden and prolonged negative performance of the company’s stock price could result in layoffs.
  • Mamma.com’s investors – although Cuban was a large shareholder, his stake represented less than 10% of the company – many other investors suffered as a result of his actions.

Secondary Stakeholders:

  • Investing community – investors in the stock market assume that trades are made fairly and based upon publically available information.
  • Mamma.com’s employees’ families – if layoffs occur, the wellbeing of the employees’ families could be at risk.
  • Mark Cuban’s employees – may question Cuban’s character and lose faith in his leadership abilities.

Identifying the relevant consequences

Under a Consequentialist framework such as Utilitarianism, a decision is considered ethical if its positive consequences outweigh its negative consequences for the greatest number of people.  Several sub-elements of the consequences should be considered during the decision-making process to ensure thoroughness.  These sub-elements consist of identifying positive and negative consequences for the parties affected by the decision; gauging the magnitude of the consequences and the probability that such consequences will occur; considering both the short- and long-term consequences of the decision; and understanding the systemic consequences (i.e., symbolic and secrecy) that may result from a decision.

Particular to this case, positive consequences of Cuban’s decision include:

  1. Cuban was able to save hundreds of thousands of dollars as a result of dumping his shares of stock.
  2. Shares of Mamma.com stock effectively went on sale for investors looking to buy.
  3. Investors who were short Mamma.com stock (if any) likely profited as a result of Cuban’s trades.
  4. Cuban could be regarded as a savvy investor because he sold his shares before the price declined.
  5. Cuban provided liquidity in the stock.

In contrast, negative consequences of Cuban’s decision include:

  1. The remaining 94% of the stockholders who were long Mamma.com stock likely realized severe economic losses.
  2. Insider trading is an illegal activity and undermines the idea of a fair trade.
  3. The legal action brought against Cuban may tarnish his reputation.
  4. Cuban’s legal woes may negatively impact his employees’ morale.
  5. Mamma.com’s reputation may be negatively affected by the selloff (due to the signaling effect).
  6. Cuban may be forced to pay hefty fines for breaking the law.
  7. Public cynicism surrounding industry insiders may be perpetuated.

The magnitude of the positive consequences is very small relative to the magnitude of the negative consequences.  Cuban saved $750 thousand while the aggregate market value of Mamma.com stock plummeted nearly $13 million as a result of his trades.[2] The probability of the positive consequences occurring as a result of Cuban’s decision are high, primarily because of his (formerly) 6.3% stake in the company.  The magnitude of the negative consequences is relatively large compared to the magnitude of the positive consequences and possesses much farther-reaching implications.  Cuban’s decision effectively resulted in massive losses for numerous stockholders and could have potentially ruined Mamma.com.  The probability of the negative consequences occurring is also high because of Cuban’s (formerly) sizable stake in the company.

The positive and negative consequences of Cuban’s decision should be analyzed on both a short-term and long-term basis.

The positive short-term consequences of his decision include:

  1. Cuban avoided any monetary losses.
  2. Investors who were short (if any) Mamma.com stock likely gained as a result of the depressed stock price.
  3. Temporary liquidity was provided in the stock.

The primary negative short-term consequence of Cuban’s decision is that anybody with a vested interest in Mamma.com suffered.

Positive long-term consequences of Cuban’s decision are few and far between (read: nonexistent).

The negative long-term consequences could include:

  1. Cuban’s character may become tarnished as a result of his illegal trading activity.
  2. Public cynicism of company insiders is perpetuated.
  3. Businesses associated with Cuban may face consumer backlash as he may be perceived as a cheater.
  4. Drawn out litigation could ultimately lead to substantial fines.

Additional consequences that should be identified and analyzed when using a consequentialist framework are symbolic and secrecy consequences.  The symbolic consequences of Cuban’s decision may include:  Cuban has a ‘win at all cost’ mentality and he is willing to oblige it; current legal ramifications for insider trading are not sufficient enough to prevent it from happening; and Mamma.com has significant near-surface nonpublic deficiencies.

Secrecy consequences of Cuban’s decision may include:  his reputation and character will become questionable at best; since insider trading is illegal, if Cuban’s decision becomes public then he will face legal ramifications; and the perceived integrity of Mamma.com’s CEO will be called into question as the public will know that he is divulging material nonpublic information to stockholders.

Cognitive barriers/biases

Cuban may have been prevented from making a good ethical judgment in this case because he failed to consider the consequences for anybody but himself.  It seems as though Cuban lost sight of the core ethical issue and was able to morally disengage himself by reducing his identification with the other stakeholders.

Proposed solution

Based on the above consequentialist analysis, I believe that Cuban’s decision was unethical.  The magnitude of the negative consequences is much greater than the magnitude of the positive consequences.  The primary positive consequences reside only in the short-term and are far from being significant enough to outweigh the short- and long-term negative consequences of his decision.  Additionally, Cuban’s decision yields many symbolic and secrecy consequences, none of which happen to be favorable.  Cuban should have considered the bigger picture and the greater good before making his decision.  An alternative (ethical) avenue that Cuban could have pursued to get his point across would have been to voice his concerns about the impact of an additional equity offering during the stockholders meeting to encourage a vote on the proposal.

Contributed by: Phil Whalen

 


[1] Michael J. de la Merced and Floyd Norris, “Cuban Cuban is Charged with Insider Trading,” The New York Times, 17 November 2008, www.nyt.com

[2] Ibid.

 

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