Seven statutes regulate securities transactions.(1) In the aftermath of the stock market crash of 1929, Congress passed the most important of these statutes, the Securities Act of 1933 ("1933 Act") and the Securities Exchange Act of 1934 ("1934 Act"). Their purpose is to ensure vigorous market competition by mandating full and fair disclosure of all material information in the marketplace. This article focuses primarily on Section 17(a) of the 1933 Act,(2) section 10(b) of the 1934 Act,(3) and Rule l0b-5 promulgated under the 1934 Act,(4) outlining the elements of securities fraud by describing the various activities considered to be substantive frauds under these laws. This article also explains common defenses to charges of substantive fraud as well as the enforcement mechanisms available to the government. Due to the frequent overlap of civil and criminal law in securities regulation, this article incorporates an overview of the law in the civil context in addition to exploring securities fraud as a white collar crime.
1. ELEMENTS OF THE OFFENSE
Although both the 1933 Act and the 1934 Act provide for various types of criminal conduct,(5) the section employed most frequently in criminal prosecutions for fraud in the purchase or sale of securities is section 10(b) of the 1934 Act(6) and Rule l0b-5 promulgated thereunder.(7)
To maintain a securities fraud cause of action, three elements must be proven: (1) the existence of a substantive fraud, including material misrepresentations or omissions, a scheme or artifice to defraud, or a fraudulent act, practice, or course of business;(8) (2) in connection with the purchase or sale of a security or in the offer or sale of a security;(9) and (3) employing the use of interstate commerce or the mails.(10) In addition, each area of substantive fraud has its own necessary elements for establishing a cause of action.
A. Substantive Fraud
1. Material Omissions and Misrepresentations
Material misrepresentations and omissions give rise to the most common type of securities fraud action. Rule l0b-5 proscribes any and all such false statements if they are made in connection with the purchase or sale of securities.(11) In order to establish liability under the 1934 Act, four elements must be shown: (1) the defendant committed a misstatement or omission of a material fact; (2) which was made with scienter; (3) on which the plaintiff reasonably relied; and (4) which proximately caused the plaintiff's injury.(12)
a. Misstatements and Omissions
In recent years, the Securities and Exchange Commission ("SEC") and the Department of Justice have vigorously prosecuted individuals who misrepresent or omit material information in a securities filing.(13)
The Fifth Circuit has upheld the conviction of a businessman involved in a scheme to inappropriately use corporate funds to cover loan payments used to expedite the sale of a company,(14) and has found a land developer liable for failing to disclose material facts regarding his property in connection with a bond offering.(15) The Seventh Circuit has found a stock purchaser liable for falsely denying his intention to make a tender offer,(16) and other circuits have found defendants liable for misrepresentations and omissions in projections if those projections failed to suggest reliability, were not sufficiently cautious in tone, were not made in good faith, or were not founded on sound factual or historic bases.(17)
Liability has also been found in cases involving omissions and misrepresentations in connection with the sale of real estate limited partnerships,(18) misstatements regarding a stock purchaser's true speculative intentions,(19) and nondisclosure of a corporation's economic condition.(20)
Merely demonstrating an omission or misstatement is insufficient to prove securities fraud unless the information is material. In TSC Industries, Inc. …