Liability Under Section 10 and Rule 10b5 - Explained
Rule 10b5 Liability - Explained
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What is liability under Section 10(b) and Rule 10(b)(5) of the 1934 Act?
Section 10(b) prohibits fraud in connection with the purchase and sale of any security. This provision applies whether or not the security is registered under the 34 Act. The SEC adopted Rule 10(b)(5) to implement section 10(b). Together, these anti-fraud provisions are the basis for most litigation under the 34 Act. These provisions make it unlawful to use most communication methods (such as the mail, internet, or wire) or any national securities exchange to defraud any person in connection with the purchase or sale of any security. Any party directly connected to the sale of securities is potentially liable; though there may be limits on the liability of certain professionals, such as auditors, bankers, accountants, etc. Rule 10(b)(5) allows for a cause of action by the SEC as well as private actions.
Next Article: Insider Trading - Rule 10(b)(5) Back to: SECURITIES LAW
What is Prohibited Under Rule 10(b)(5)?
Generally, Rule 10(b)(5) prohibits the following conduct in connection with the sale of a security:
- using any device, scheme, or other artifice to defraud purchasers;
Example: A device or scheme includes any sales or investment program, whether done in person or via distant communication, to defraud participants.
- making any untrue statement or failing to disclose any material fact that make the statement misleading; or
Example: This includes making false statements or failing to disclose relevant information in the process of selling or transferring a security.
- employing any practice that would deceive or defraud.
Note: This is a very broad, catch-all provision. These prohibitions give rise to a potential cause of action for plaintiffs under Rule 10(b)(5), the elements of which are as follows:
What Must be Proved for Rule 10(b)(5) Liability?
Deceit - A plaintiff must demonstrate deceit through the misrepresentation or omission of information. This must be done either intentionally or recklessly. Simple negligence is not enough to establish liability.
Material Information - The information must be material to the purchaser of the security. That is, the information must be important to a potential investor in making the decision of whether or not to purchase the security. What is material information is interpreted very broadly and based on the individual situation of the company.
Purchase of Sale of a Security - The information must directly related to the purchase or sale of a security. An individual who does not purchase or sell a security based upon the deceitful information cannot bring an action under this provision.
Reliance on the Information - The actual purchaser must rely on the misrepresented information. Reliance is assumed if material information is omitted or broadly stated to the whole market.
Cause Damages - The plaintiff must suffer some actual damages resulting from or caused by the omission or misrepresentation. This normally comes in the form of a diminution in the value of the shares purchased.
In summary, to recover under Rule 10(b)(5), a plaintiff, whether the SEC or a private plaintiff, must show that an individual trading in securities had an intent to deceive the purchaser. Intent to deceive may be inferred from a partial or untimely disclosure of important information.
How do you feel about the extensive liability or breadth of potential actions available under Section 10(b) or Rule 10(b)(5)? Do you think these provisions are overly broad? Why or why not?
Bernie is the head of a new investment firm. His firm solicits money from investors and invests that money in short-term, high-risk securities. Bernie has been suffering substantial losses, but has been able to continue to pay investor returns from the funds invested by new investors. In order to attract new investors, he is falsifying much of the information on his investment returns. The DOJ gets word of his practices and begins an investigation. In the meantime, shareholders bring a civil action under Rule 10(b)(5) to recover their losses from Bernie. What elements will they have to demonstrate in Bernie's conduct to find him liable?
- Securities Law (Intro)
- What are Securities Laws?
- What is a Security?
- What qualifies as an Investment contract?
- What are the primary federal securities laws?
- What are the regulatory goals of security laws?
- What is the Securities and Exchange Commission?
- What is an Initial Public Offering?
- What is a Direct Public Offering?
- What is Crowdfunding?
- Securities Act of 1933
- What is an Offer to Sell securities?
- Who are the parties regulated in an offer to sell securities?
- What are the primary disclosure documents required in an offer to sell securities?
- Forward Looking
- Red Herring Prospectus (Securities) Definition
- Registration of Securities
- What is an issuer allowed to do at each stage of the registration process?
- How are issuers classified for purposes of the registration and offering process?
- What is an issuer allowed to do during the Pre-filing Period?
- What are the limitations on the issuer during the Post-filing, Waiting Period?
- What is an issuer allowed to do during the Post-Effective Period?
- What is an Emerging-Growth Company?
- What type of information must an issuer disclose?
- What laws govern the mechanics of disclosure in a securities offering?
- Deficiency Letter (Securities Law)
- Registration Exemptions Securities Act of 1933
- What are Exempt Securities and Exempt Transactions?
- What are Restricted Securities?
- Section 3(a)?
- Section 3(b)?
- What is a Rule 147 Exemption?
- What is a Section 4(a) Exemption?
- Section 4(a)(5)?
- What is a Regulation A Exemption?
- What are Regulation D Exemptions?
- What is a Rule 504 Exemption?
- What is a Rule 505 Exemption?
- What is a Rule 506(b) Exemption?
- What is a Rule 506(c) Exemption?
- What is Rule 502(d) and the Rule 144 Safe Harbor?
- Rule 144a
- What are the disclosure requirements for companies employing an exemption?
- What is the requirement to file Form D?
- What is the effect of failing to register an offering under Section 5?
- Liability Under the Securities and Exchange Act of 1933
- What is civil liability under Section 11 of the 33 Act?
- What is civil liability under Section 12 of the 33 Act?
- What are defenses available to charges under Sections 11 and 12?
- What is civil liability under Section 17 of the 33 Act?
- What is potential criminal liability under the 33 Act?
- The Security Exchange Act of 1934
- When must an issuer register pursuant to the 34 Act?
- What disclosures are required of reporting companies under the 34 Act?
- What is liability under Section 10(b) and Rule 10(b)(5)?
- What is insider trading under Rule 10(b)(5)?
- What damages are available under Section 10 and Rule 10(b)(5)?
- What is insider trading under Section 14 of the 34 Act?
- What is liability under Section 16 of the 34 Act?
- What is liability under Section 18 of the 34 Act?
- What is criminal liability under the 34 Act?
- Liability under the Securities Enforcement Remedies Act?
- Blue Sky Laws State Securities Laws
- What are Blue Sky Laws?
- When is an issuer required to comply with state securities laws?
- What are the registration requirements under state law?
- What is Coordinated Registration under state law?