Securities Fraud

Article excerpt

I. INTRODUCTION

Seven statutes regulate securities transactions.(1) Congress passed the most important of these statutes, the Securities Act of 1933 ("1933 Act") and the Securities Exchange Act of 1934 ("1934 Act") in response to both fraud in securities markets and a perceived lack of public information in the stock markets.(2) Both Acts seek to ensure vigorous market competition by mandating full and fair disclosure of all material information in the marketplace.(3)

This Article discusses the methods by which these Acts monitor the securities markets. Section II analyzes securities fraud under [sections] 10(b) of the 1934 Act(4) and Rule 10b-5 promulgated by the Securities and Exchange Commission ("SEC") under the 1934 Act;(5) provides definitions of offer, purchase, or sale of securities; and explains the requirement of the use of interstate commerce or the mails. In addition, it examines [sections] 32(a) of the 1934 Act (6) to illustrate how civil causes of action can rise to the level of criminal prosecutions where there have been willful violations of [sections] 10(b) or Rule 10b-5. Section III explains common defenses to charges of substantive fraud. Sections IV and V discuss the enforcement mechanisms available to the government and the penalties for committing securities fraud, respectively. Finally, Section VI highlights several recent developments in this area of the law.

Practitioners should note that although this Article is limited to federal securities law, any securities law issue must be analyzed in conjunction with the applicable state "blue sky"(7) laws that regulate the offering and sale of securities in each state.(8)

II. ELEMENTS OF THE OFFENSE

Although both the 1933 Act and the 1934 Act prohibit various types of criminal conduct,(9) the sections employed in criminal prosecutions for fraud in the purchase or sale of securities are [sections] 10(b) of the 1934 Act,(10) Rule 10b-5 promulgated thereunder,(11) and [sections] 32(a) of the 1934 Act.(12)

To maintain a securities fraud cause of action under Rule 10b-5, the government must prove: (1) the existence of a substantive fraud, which may include material misrepresentations or omissions, schemes or artifices to defraud, or fraudulent acts, practices, or courses of business; (2) the defendant perpetrated the fraud in connection with the purchase or sale of a security or in the offer or sale of a security; (3) the use of interstate commerce or the mails; (4) reliance by the investor, or other effect of the scheme on investors; and (5) willfulness to commit the prohibited act.(13)

Securities fraud causes of action may be criminal, civil, or administrative in nature.(14) The SEC can initiate only civil and administrative proceedings to investigate potential violations and to rectify past and prevent future violations, while the Department of Justice ("DOJ") has sole jurisdiction over criminal proceedings.(15) Most criminal proceedings result from an SEC investigation and a subsequent SEC referral to the DOJ.(16)

A. Substantive Fraud

The following two subparts address types of fraud that can be a basis for a securities violation: (1) Rule 10b-5 material misrepresentations and omissions and (2) insider trading.(17)

1. Material Misrepresentations and Omissions

Material misrepresentations and omissions give rise to the most common securities fraud actions. Rule 10b-5 proscribes any and all such false statements if made in connection with the purchase or sale of securities.(18) A defendant can be both criminally and civilly liable under Rule 10b-5. The elements of a Rule 10b-5 civil cause of action and a 10b-5 criminal proceeding are similar. Both require a false statement or omission of a material fact made with scienter. "Impact of the scheme on the investor" is required for criminal liability to attach, whereas for civil liability, the plaintiff must prove reliance by the plaintiff, which was causally related to the plaintiff's injury. …