I was hoping to let a week go by without criticizing the SEC. I thought about it a lot, tried to think of something nice to say, but sorry, I just couldn't do it. I remembered that there's an open sore out there, a continuing reminder of everything that's wrong about our securities watchdogs. It can be summed up in two words: Mark Cuban.It's hard to escape Cuban. This guy generates so many headlines nowadays (take a look at the results when you search Google on the term "Mark Cuban." ) and is so generally obnoxious and abrasive, that it's easy to forget a headline that he generated a couple of years ago: Cuban was accused of insider trading. It will surely go down in history as one of the dumbest cases the Securities and Exchange Commission ever brought against anyone since it emerged from the muck of the Great Depression in 1934. To refer to SEC vs. Cuban as a case of "misplaced priorities" fails to capture the majesty of its inanity. It reminds me of the scene in a Pink Panther film in which Inspector Clouseau writes a ticket on a car whose driver has gone in to rob a bank. At its heart is one of the most notorious financing methods ever to rook investors in small-cap stocks, and the SEC has done absolutely nothing about it. I mean, it's not even pretending to do anything. Let's take a look at the SEC complaint to refresh our memories about the horrible things Cuban was supposed to have done. Seems that in March 2004, Cuban made the mistake of buying a substantial stake in a company called Mamma.com (now called Copernic) ( CNIC). Three months later the CEO called him and said that he had some "confidential" information to give him. The information consisted of detailing just how bad a mistake Cuban had made. Cuban was told that the company was engaged in a PIPE ("private investment in public equity") financing. Cuban was teed off, and you'd be too. You see, PIPEs let companies raise money easily -- all they have to do is give their existing shareholders the shaft. If their shareholders are lucky, the companies sell shares at a discount to new investors, diluting the holdings of existing shareholders. If they're not lucky, the companies sell what has come to be known as "death spiral convertibles." These have a lovely feature: Their conversion price declines as the shares fall, making them a "one-way ticket to Palookaville," as Marlon Brando once put it..
The sheer unfairness of PIPEs didn't bother the Securities and Exchange Commission. What got 'em mad was that the victim, Cuban, acted rationally. He talked to the banker handling the PIPE, confirming that it was being carried out at a below-market price, screwing the existing shareholders. At that point, Cuban did what any rational person would do, which was to sell his shares. The SEC felt that being rational was bad. It felt that the requirements of good citizenship made it necessary for Cuban to be a masochist, to just sit there and watch his Mamma.com shares take a $750,000 dive, which is precisely what he avoided by selling before the PIPE was announced. The shares declined 9.3% when the PIPE was announced. In July 2009, the case was tossed out by a federal judge in New York. The laws governing insider trading simply could not be stretched far enough to make a rational decision illegal. Just because a CEO calls and says that you and the rest of the shareholders are about to be screwed, that doesn't mean that you have to bend over and make the best of it. You can sell, the judge ruled, you just can't go around blabbing about it. It was a common sense decision so, naturally, the SEC appealed. This case should be studied in law schools, not for its legal finesse but because of what it says about the behavior of the SEC. PIPE deals hurt investors, but they don't make headlines in the sports pages. Mark Cuban does. So what does the SEC do? It acts like Inspector Clouseau. Now, the honorable thing would be for the SEC to drop its case against Cuban. But let's be realistic. The case was brought for one purpose only, which was to advance the careers of the SEC lawyers who reared this particular puppy. They're not about to put it to sleep, no matter how much it may be stinking up the neighborhood. But there's a simple step that the SEC can take to make the whole thing seem less loony: It can do something about PIPEs. I'm not suggesting that they actually do something, God forbid, such as impose a total ban, though frankly I'm hard-pressed to figure out what harm would be wrought by a prohibition on such shareholder-dilution machines. All they have to do is study the dag-blamed things. Certainly death-spiral financing deserves a close look.
If that doesn't ring their chimes, there are plenty of other priorities that make a heck of a lot more sense than twisting the insider trading laws into a pretzel. The good people of the SEC could redeploy whatever resources they've used to nail Cuban to expand their probe of Goldman Sachs ( GS), to determine if other banks let John Paulson design their toxic waste. They can try to get some results from whatever probe they're conducting into the book-cooking scheme at Lehman Brothers. Except for the Goldman suit, nobody has been charged over any of that stuff. Is that because nobody did anything wrong? But if they're hot on insider trading, I have an idea. There's a guy named Gary Aguirre -- remember him? He's the ex-SEC lawyer who claimed that the SEC obstructed his probe of possible insider trading by Pequot Capital's Art Samberg, and contended that the SEC prevented him from interviewing the gent whom he suspected of tipping off Samberg -- John Mack, just before he became CEO of Morgan Stanley ( MS). Aguirre just won a $755,000 settlement of his suit against the SEC, and Samberg just paid $28 million to settle insider trading charges involving Microsoft ( MSFT) shares, which would seem to indicate that maybe Aguirre wasn't totally off base. So how about it, guys? How about going after Mack? Oh, sorry, I plumb forgot: He ran a company that might hire you after you leave the SEC. My mistake.