SEC Rule 10b-5
Encyclopedia
SEC Rule 10b-5, codified at 17 C.F.R.
§ 240.10b-5, is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under § 10(b) of the Securities Exchange Act of 1934
. The rule prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security
.
prohibited fraudulent sales of securities, no regulation precluded fraudulent purchases. Rule 10b-5, issued by the SEC under section 10b of the Exchange Act, was implemented to fill this regulatory void. The commissioners approved the rule without debate or comment, with the exception of Commissioner Sumner Pike
who indicated approval of the rule by asking, "Well, we are against fraud aren't we?"
In the case of TSC Industries, Inc. v. Northway, Inc.
, the word "material
" was defined by the U.S. Supreme Court - "an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote."
In a case for insider trading, anyone who uses insider information can be held liable. A tippee can be liable if the tipper breached a fiduciary duty and the tippee knew or had reason to know that the tipper was breaching the duty.
, holding a person with no fiduciary duty to the shareholders had no duty to disclose information before trading on it. Recently, the Supreme Court has embraced a "misappropriation" theory of omissions, holding in United States v. O'Hagan that misappropriating confidential information for securities trading purposes, in breach of a duty owed to the source of that information, gives rise to a duty to disclose or abstain.
. This "fraud on the market" presumption of the plaintiff's reliance upon the deceit is only available in situations (like in Basic) where the security is traded on a well organized, and presumably efficient, market.
Various cases have held that a statement that "bespeaks caution" is sufficient to absolve the defendant of liability. If the defendant had prefaced remarks about the health of the company with a disclaimer that he might be wrong, then his subsequent statements can not be held against him.
Code of Federal Regulations
The Code of Federal Regulations is the codification of the general and permanent rules and regulations published in the Federal Register by the executive departments and agencies of the Federal Government of the United States.The CFR is published by the Office of the Federal Register, an agency...
§ 240.10b-5, is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under § 10(b) of the Securities Exchange Act of 1934
Securities Exchange Act of 1934
The Securities Exchange Act of 1934 , , codified at et seq., is a law governing the secondary trading of securities in the United States of America. It was a sweeping piece of legislation...
. The rule prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security
Security (finance)
A security is generally a fungible, negotiable financial instrument representing financial value. Securities are broadly categorized into:* debt securities ,* equity securities, e.g., common stocks; and,...
.
History
In 1942, SEC lawyers in the Boston Regional Office learned that a company president was issuing pessimistic statements about company earnings while simultaneously purchasing the company's stock. Although the Securities Act of 1933Securities Act of 1933
Congress enacted the Securities Act of 1933 , in the aftermath of the stock market crash of 1929 and during the ensuing Great Depression...
prohibited fraudulent sales of securities, no regulation precluded fraudulent purchases. Rule 10b-5, issued by the SEC under section 10b of the Exchange Act, was implemented to fill this regulatory void. The commissioners approved the rule without debate or comment, with the exception of Commissioner Sumner Pike
Sumner Pike
Sumner T. Pike , served as acting chairman of United States Atomic Energy Commission in 1950.-Career:A 1913 Bowdoin College graduate, Pike was a member of the U.S...
who indicated approval of the rule by asking, "Well, we are against fraud aren't we?"
Language of the rule
"Rule 10b-5: Employment of Manipulative and Deceptive Practices":- It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
- (a) To employ any device, scheme, or artifice to defraud,
- (b) To 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
- (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
- in connection with the purchase or sale of any security."
In the case of TSC Industries, Inc. v. Northway, Inc.
TSC Industries, Inc. v. Northway, Inc.
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 , was a case in which the Supreme Court of the United States articulated the requirement of materiality in securities fraud cases.-Facts and procedural history:...
, the word "material
Materiality (law)
Materiality is a legal term which can have different meanings, depending on context. When speaking of facts, the term generally means a fact which is "significant to the issue or matter at hand".-In the law of evidence:...
" was defined by the U.S. Supreme Court - "an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote."
Elements of the offense
In order to establish a claim under Rule 10b-5, plaintiffs (including the SEC) must show (i) Manipulation or Deception; (ii) Materiality; (iii) "In Connection With" the purchase or sale of securities; and (iv) Scienter. Private plaintiffs have the additional burden of establishing (v) Standing - Purchaser/Seller Requirement; (vi) Reliance; (vii) Loss Causation; and (viii) Damages.In a case for insider trading, anyone who uses insider information can be held liable. A tippee can be liable if the tipper breached a fiduciary duty and the tippee knew or had reason to know that the tipper was breaching the duty.
Insider trading
To what extent Rule 10b-5 prohibits insider trading is a matter of some dispute. The SEC has long advocated an "equal access theory" with regard to 10b-5, arguing that anyone who has material, non-public information must either disclose that information or abstain from trading. However, the Supreme Court rejected the strongest version of that theory in Chiarella v. United StatesChiarella v. United States
Chiarella v. United States, , is a case in which the Supreme Court of the United States held that an employee of a printer handling corporate takeover bids who deduced target companies' identities and dealt in their stock without disclosing his knowledge of impending takeovers, had not violated §...
, holding a person with no fiduciary duty to the shareholders had no duty to disclose information before trading on it. Recently, the Supreme Court has embraced a "misappropriation" theory of omissions, holding in United States v. O'Hagan that misappropriating confidential information for securities trading purposes, in breach of a duty owed to the source of that information, gives rise to a duty to disclose or abstain.
Fraud or deceit
In order for Rule 10b-5 to be invoked, there must be intentional fraud or deceit by the party charged with the violation. Furthermore, for a private party to recover damages, they must be able to show that they were injured because they relied on the fraudulent claim. If the defendant had publicly made a fraudulent statement, every investor could sue if it could be shown that the statement affected the market as a whole - this is the "fraud on the market" theory enunciated by the Supreme Court in Basic Inc. v. LevinsonBasic Inc. v. Levinson
Basic, Inc. v. Levinson, 485 U.S. 224 , was a case in which the Supreme Court of the United States articulated the "fraud-on-the-market theory" as giving rise to a rebuttable presumption of reliance in securities fraud cases....
. This "fraud on the market" presumption of the plaintiff's reliance upon the deceit is only available in situations (like in Basic) where the security is traded on a well organized, and presumably efficient, market.
Various cases have held that a statement that "bespeaks caution" is sufficient to absolve the defendant of liability. If the defendant had prefaced remarks about the health of the company with a disclaimer that he might be wrong, then his subsequent statements can not be held against him.
Enforcement
Both the SEC and private citizens can enforce the requirements of the rule through lawsuits. The defendant need not be the seller of the stock - any person who fraudulently induces a person to purchase any stock may be held liable.Sources
- Cioppa, Paolo (2009) "Unexpected Insider Trading Abuses and the Need for Revision of Rule 10b5-1(c)," Global Jurist: Vol. 9 : Iss. 1 (Topics), Article 5.