Rule 10b-5

SEC Rule 10b-5 is the primary anti-fraud provision of the federal securities laws. It was adopted pursuant to Section 10(b) of the Securities Exchange Act of 1934 (“1934 Act”), as amended and is the primary rule used in securities fraud cases.  Violations of SEC Rule 10b-5 can result in SEC civil actions and can also be the basis for criminal charges by the Justice Department.

Section 10(b), makes it unlawful for any person, directly or indirectly, by use of interstate commerce, the mails, or a national securities exchange, “to use or employ, in connection with the purchase or sale of any security… any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.”

Rule 10b-5 makes it unlawful to:

• employ any device, scheme, or artifice to defraud,
• make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
• engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

The SEC may enforce Rule 10b-5 in a civil or administrative action. The Department of Justice may enforce 10b(5) in a criminal action.

There is also an implied private right of action under Rule 10b-5. Investors damaged by false or misleading statements or omissions of material fact that affect trading on the secondary market can bring individual or class action lawsuits to recover damage.

Rule 10b-5 Private Actions

A private plaintiff must establish each of the following to establish a claim for securities fraud under 10b-5:

• a material misrepresentation or omission by the defendant;
• an intent to defraud;
• a connection between the misrepresentation or omission and the purchase or sale of a security;
• reliance upon the misrepresentation or omission;
• economic loss; and
• loss causation.

Materiality Under 10b-5

Materiality is determined on a factual basis, taking into account the totality of the available information. The existence or absence of a particular type of information is rarely, if ever, determinative of whether something is material.

Duty to Disclose

Without a Duty to Disclose, there can be no securities fraud under 10b-5. As such, absent a Duty to Disclose, the holder of material nonpublic information may remain silent. A defendant is not required to disclose a fact merely because a reasonable investor would like to know that fact.

The Duty to Disclose is triggered in these circumstances, among others:

• When an insider uses material nonpublic information to trade in an issuer’s securities;
• When disclosure is required by a statute or regulation; and
• When the issuer has previously made a statement of material fact that is false, inaccurate, incomplete, or misleading in light of the undisclosed information.

Section 11 of the Securities Act permits a plaintiff to pursue a private action with respect to a registration statement that, when it became effective, “contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein necessary to make the statements therein not misleading.” The Supreme Court has held that a plaintiff may forgo the express right of action under Section 11 in favor of an implied right of action under Rule 10b-5, thus avoiding the restraints of Section 11. In these actions, damages are limited and many defendants escape liability altogether.