Securities Fraud

Article excerpt

I. INTRODUCTION

Seven statutes regulate securities transactions.(1) Congress passed the most important of these, the Securities Act of 1933 ("1933 Act") and the Securities Exchange Act of 1934 ("1934 Act"), in response to fraud in securities markets and a perceived lack of public information in the stock markets.(2) Both 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 malls. In addition, Section II examines [sections] 32(a) of the 1934 Act(6) to illustrate how civil causes of action can become criminal prosecutions when there have been willful violations of [sections] 10(b) or Rule 10b-5. Section III discusses common defenses to the charge of substantive fraud. Sections IV and V discuss the enforcement mechanisms available to the government and the penalties for committing securities fraud. Finally, Section VI highlights several recent developments in the law of securities fraud.

Practitioners should note that this article is limited to federal securities law. Any securities law issue must be analyzed in conjunction with the applicable state "blue sky"(7) law that regulates the offering and sale of securities in that particular state.(8)

II. ELEMENTS OF THE OFFENSE

Both the 1933 Act and the 1934 Act prohibit various types of criminal conduct.(9) Section 10(b) of the 1934 Act,(10) Rule 10b-5 promulgated thereunder,(11) and [sections] 32(a) of the 1934 Act are the sections utilized in a criminal prosecution for the purchase or sale of securities.(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,(13) (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,(14) (3) the use of interstate commerce or the mails,(15) (4) reliance by the investor, or other effect of the scheme on investors,(16) and (5) willfulness to commit the prohibited act.(17)

Securities fraud causes of action may be criminal, civil, or administrative in nature.(18) The SEC can initiate civil and administrative proceedings to investigate, rectify, and prevent violations.(19) However, only the Department of Justice ("DOJ") has jurisdiction over criminal prosecutions.(20) Most criminal prosecutions result from an SEC investigation and subsequent referral to the DOJ.(21)

A. Substantive Fraud

The following subparts address two types of fraud that can be a basis for a securities violation: (1) Rule 10b-5 material misrepresentations and omissions and (2) insider trading.(22)

1. Material Misrepresentations and Omissions

Material misrepresentations and omissions give rise to the most common securities fraud actions. Rule 10b-5 proscribes any false statements made in connection with the purchase or sale of securities.(23) A defendant can be criminally and civilly liable under Rule 10b-5.(24) Any person "who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies" may be liable under Rule 10b-5.(25) Once the elements of the Rule 10b-5 cause of action are met, a criminal penalty can be imposed under [sections] 32(a) if the government satisfactorily proves a willful violation of the 1934 Act.(26)

Under Rule 10b-5, the elements of a civil cause of action and a criminal prosecution are similar. …