Judge in Mark Cuban Case Sets Standards for 'Unclean Hands' Defense

July 2011

In June 2011, Mark Cuban’s Dallas Mavericks pushed aside the Miami Heat to win the NBA Championship, four games to two. Unfortunately for Cuban and his long-running battle with the United States Securities and Exchange Commission (SEC), the SEC is proving to be a much tougher opponent than the Heat, and recently won a procedural ruling against Cuban striking down an affirmative defense raised by Cuban.

The SEC filed a civil complaint against Cuban in 2008, alleging insider trading in connection with his sale of shares in Mamma.com, Inc. (now called Copernic, Inc.). The case was dismissed in 2009, and Cuban moved for sanctions against the SEC, which were denied. An appellate court reinstated the case against Cuban in 2010. In his pleadings, Cuban raised “unclean hands” on the part of the SEC as an affirmative defense. The SEC moved to strike the affirmative defense, and in a ruling dated July 18, 2011, US District Court Judge Sidney Fitzwater granted the SEC’s motion to strike.

The doctrine of “unclean hands” is an equitable defense based on the theory that a plaintiff seeking equitable relief should not be entitled to such relief if the plaintiff has acted unethically or in bad faith. In the context of an SEC proceeding, the court in Cuban’s case ruled that the affirmative defense should only be available in strictly limited circumstances where the conduct of the SEC was egregious, where the misconduct occurs prior to the filing of the enforcement action, and where the misconduct results in prejudice to the defense that rises to a constitutional level and there is a direct nexus between the misconduct and the impairment of the defense.

Cuban alleged that the SEC misconduct fell into three separate categories:

That the SEC staff members investigating him were committed to bringing the enforcement action regardless of what the investigation actually showed;
That the SEC staff deliberately undermined and abused the Wells process, by relying on unsubstantiated allegations, making the decision to bring a civil enforcement action before the investigation was complete, and no reviewing submissions from Cuban’s counsel that refuted certain allegations; and
That the SEC staff engaged in deliberate misconduct during the course of its investigation, by among other things, discouraging a potential defense witness from making himself available and threatening him with a perjury charge and by filing a complaint asserting that Cuban had entered into a specific agreement with Mamma. com when there was no evidence that he had done so.

In his decision, Judge Fitzwater rejected the SEC’s assertion that the defense of unclean hands should not be available in an SEC enforcement and ruled that it was in fact available, albeit in the strictly limited circumstances described above. In his opinion, Judge Fitzwater stated that a “high bar” was needed in such cases, because the government and its agencies are substantially different than private litigants, in that they are trying to protect the interests of the public.

However, Judge Fitzwater went on to rule that Cuban had failed to sufficiently plead his defense, in particular failing to allege facts that gave the SEC adequate notice that the misconduct he was claiming resulted in prejudice to his defense that rose to a constitutional level and that there was a direct nexus between the misconduct and the prejudice. The court saw this failure as fatal, and granted the SEC’s motion to strike (a relatively rare procedural action with respect to an affirmative defense). Further, the court took the additional step of ruling that Cuban could not amend or replead his Answer, eliminating a frequently used tactic when adverse rulings are made on the pleadings alone.

While Judge Fitzwater’s ruling is helpful in clarifying the standards applicable to an unclean hands defense in a governmental action, it will likely have very little impact on the overall case. With the NBA in a lockout for the foreseeable future, Cuban can now focus his attention on the underlying defenses in the case, which will likely still be pending by the time the NBA starts playing basketball again.

For additional information on this topic, please do not hesitate to contact Mark J. Tarallo or any other member of the Public Company practice group.

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