Securities Fraud

The crimes related to security fraud are incredibly broad.

The category of crimes under the umbrella of securities fraud can include anything from insider trading to conversion to fraudulent misrepresentation to late trading to disguising losses that caused the subprime mortgage crisis to the Bernard Madoff-type Ponzi schemes.

 

The most basic prosecution involves misrepresenting facts which others reply upon in the purchase or sale of a security. As in any prosecution related to fraudulent misrepresentation, the central inquiry is separating the puffery and sales hype from an actual factual misrepresentation. A broker encouraging a client to purchase a security is vastly different than overstating the assets or understating a public company's liabilities on a financial statement. The more interesting questions arise when brokers and other fiduciaries accurately represent the facts, but fail to disclosure their economic interest in the securities they sell to clients.

Section 10(b) of the 1934 Securities Act and SEC Rule 10b-5 are the most significant statutes governing securities fraud.  There is significant overlap, but both sections address the same type of behavior. Section 10(b) states:

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--

    1. To effect a short sale, or to use or employ any stop-loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

    2. Paragraph (1) of this subsection shall not apply to security futures products.

To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Rule 10b-5 lists enumerates similar elements of an offense:

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.

Finally, 18 U.S.C. § 1348 provides a general catch-all statute under the Mail Fraud Chapter prohibiting Securities Fraud:

Whoever knowingly executes, or attempts to execute, a scheme or artifice—

(1) to defraud any person in connection with any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o (d)); or

(2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o (d)); shall be fined under this title, or imprisoned not more than 25 years, or both.

The central issues that are explored at the beginning of the defense are: 

  • What constitutes a material fact?
  • Why were the statements made?
  • Is it fair that investors happily take the profits when the stocks rise, but later look to sue for any reason when stocks fall?
  • What if the statements cause a person to act, but they aren't manipulative or wholly untrue?
  • What if representations were truthful at the time that they were made, but later prove to be untrue?
  • Is there a difference between intentionally untrue statements and innocently incorrect statements?
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