SEC Rule 10b-5
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SEC Rule 10b-5 is one of the most important rules promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under 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, including insider trading.
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[edit] Language of the rule
The rule itself is relatively short, and to the point. The formal title is "Rule 10b-5: Employment of Manipulative and Deceptive Practices", and the complete text reads:
- 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.
[edit] Insider trading
Whether or not 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 States, 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.
[edit] 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. Levinson, 485 U.S. 224 (1988).
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.
[edit] Purchase or sale
In Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), the Supreme Court held that Rule 10b-5 provides no cause of action for a securities owner who decides not to sell based on false information. The rule specifically requires that the act or omission occur in the context of a "purchase or sale", which simply does not encompass a failure to sell. However, in SEC v. Zandford, 535 U.S. 813 (2002), the Court held that a banker who stole money from client by convincing client to buy stocks, then cashing the stocks in for himself was liable under Rule 10b-5 even though the banker's fraud had nothing to do with the value of the stock. It was enough that the fraud was connected to the purchase of the stock by the defrauded party.
More recently, the SEC staff has publicly taken the position that the Court's holding in Blue Chip Stamps prevents the SEC from taking action against someone who creates a supposedly "irrevocable" trading plan under the safe harbor provision of SEC Rule 10b5-1, but then later cancels the plan based on inside information, because no actual trade ever takes place.
[edit] 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.
