SECURITIES FRAUD
I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1056
II. ELEMENTS OF THE OFFENSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1057
A. Material Misrepresentations and Omissions 1057
. . . . . . . . . . . . . .
1. Use of Interstate Commerce or the Mails 1058
.
2. Misstatements and Omissions 1059
. . . . . . . . . . . . . . . . . . . . .
3. Materiality. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1062
4. Intent. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063
a. Scienter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1064
b. Willfulness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1064
5. In Connection with the Purchase or Sale of a Security . . . 1065
a. Definition of a “Security”. . . . . . . . . . . . . . . . . . . . 1066
i. Stocks and Notes Lacking a Profit Motive . . . . 1067
ii. Instruments Protected by Other Legislation. . . . 1069
iii. Instruments Deemed Investment Contracts . . . . 1070
(1) Investment of Money . . . . . . . . . . . . . . . 1071
(2) Common Enterprise . . . . . . . . . . . . . . . . 1071
(3) Expectation of Profits . . . . . . . . . . . . . . . 1073
(4) “Solely” Through the Efforts of Others . . 1073
b. Definitions of “Purchase” and “Sale”. . . . . . . . . . . . 1075
6. Reliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1077
B. Insider Trading. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1079
1. The “Classical Theory”. . . . . . . . . . . . . . . . . . . . . . . . . 1079
2. The Misappropriation Theory . . . . . . . . . . . . . . . . . . . . . 1081
3. Strict Regulation Under Rule 14e-3 of Material, Non-Public
Information Regarding Tender Offers . . . . . . . . . . . . . . . . 1083
4. “Use” Versus “Knowing Possession” of Inside Information . . . 1084
5. Regulation of Selective Disclosure . . . . . . . . . . . . . . . . . 1085
III. DEFENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1086
A. Intent-Based Defenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1086
1. Lack of Fraudulent Intent . . . . . . . . . . . . . . . . . . . . . . . . 1087
2. “No Knowledge” of the Substantive Rule . . . . . . . . . . . . 1087
3. Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1088
4. Reliance on Advice of Counsel . . . . . . . . . . . . . . . . . . . . 1089
B. Reliance-Based Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 1090
1. Truth on the Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1090
2. Bespeaks Caution Doctrine . . . . . . . . . . . . . . . . . . . . . . . 1092
C. Defense Based on Legitimacy of Criminalization . . . . . . . . . . 1093
D. Statute of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1094
IV. ENFORCEMENT MECHANISMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1095
1055
. . . . . . . . . . . .
A. SEC Enforcement 1096 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1. Development of an Enforcement Action . . . . . . . . . . . . . 1096
2. Administrative Proceedings . . . . . . . . . . . . . . . . . . . . . . 1097
a. Cease and Desist Authority . . . . . . . . . . . . . . . . . . . 1099
b. Monetary Penalties in Administrative Proceedings . . 1099
3. Civil Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1099
a. Injunctive Actions and Ancillary Measures . . . . . . . . 1100
b. Disgorgement and Monetary Penalties . . . . . . . . . . . 1101
4. International Enforcement . . . . . . . . . . . . . . . . . . . . . . . 1103
B. Criminal Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1105
1. DOJ Criminal Enforcement . . . . . . . . . . . . . . . . . . . . . . 1106
2. Parallel or Subsequent Suits . . . . . . . . . . . . . . . . . . . . . . 1107
3. Contempt Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . 1109
V. PENALTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1109
I. INTRODUCTION
Although seven federal statutes govern securities transactions,
1
securities fraud
is primarily regulated through the Securities Act of 1933 (“1933 Act”) and the
Securities Exchange Act of 1934 (“1934 Act”). The 1933 and 1934 Acts target dif-
ferent markets: The 1933 Act regulates the primary market, and the 1934 Act regu-
lates the secondary market. Nevertheless, the acts share the same objective:
protecting the national public interest in vigorous market competition by mandat-
ing full and fair disclosure of all material information in the marketplace.
2
Both the
1933 Act and the 1934 Act aim to “eliminate serious abuses in [the] largely
unregulated securities market.”
3
To this end, Congress sought to create “a broad
definition of ‘security’” and to regulate all investments, regardless of the form or
label applied.
4
1. Securities Act of 1933, 15 U.S.C. §§ 77a–77aa (regulating the distribution of securities); Trust
Indenture Act of 1939, 15 U.S.C. §§ 77aaa–77bbbb (regulating the public offering of debt securities to protect
capital markets, investors, and the general public); Securities Exchange Act of 1934, 15 U.S.C. §§ 78a–78nn
(providing for regulation and control of transactions in securities to protect the national public interest
therein); Securities Investor Protection Act of 1970, 15 U.S.C. §§ 78aaa–78lll (creating a nonprofit
membership corporation that covers loss when a securities firm cannot pay its customer accounts); Investment
Company Act of 1940, 15 U.S.C. §§ 80a-1 to 80a-64 (governing the activity of publicly owned companies
that invest and trade securities); Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 to 80b-21 (providing
for regulation and registration of those in the business of advising others on securities investments); Dodd-
Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (codified in
scattered Sections of 7, 12, 15, 18, 31, and 42 U.S.C.).
2. See 15 U.S.C. § 78b (identifying one purpose of the securities law as “to insure the maintenance of fair and
honest markets”); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 (1976) (stating that the 1933 Act “was
designed to provide investors with full disclosure of material information concerning public offerings of
securities in commerce”).
4. SEC v. Edwards, 540 U.S. 389, 393 (2004) (quoting Reves v. Ernst & Young, 494 U.S. 56, 61 (1990)).
1056 AMERICAN CRIMINAL LAW REVIEW [Vol. 61:1055
The key securities fraud provisions used in criminal prosecutions are § 32(a) of
the 1934 Act
5
and Rule 10b-5.
6
Section 32(a) imposes criminal liability for willful
violations of multiple provisions of the 1934 Act, including § 10(b). Rule 10b-5
was promulgated by the Securities Exchange Commission (“SEC”) under § 10(b)
of the 1934 Act
7
and provides the foundation for a securities fraud claim.
8
Part II of this Article examines the elements of a securities fraud offense, and
Part III describes common defenses. Part IV then examines various enforcement
mechanisms. Part V highlights penalties for a securities fraud offense.
While this Article is limited in scope to federal securities law, all securities law
issues should be analyzed in conjunction with the applicable state “blue sky
laws,”
9
which regulate the offering and sale of securities in each state.
10
II. ELEMENTS OF THE OFFENSE
Two main types of fraud form the basis of a securities law violation: (A) mate-
rial misrepresentations, omissions, or both; and (B) insider trading.
11
A. Material Misrepresentations and Omissions
The first major category of securities fraud encompasses material misrepresenta-
tions or omissions related to the purchase or sale of securities. Any person who
employs (a) a device, scheme, or artifice to defraud, or (b) makes a false statement
or an omission of material fact in connection with the purchase or sale of secur-
ities
12
may be criminally or civilly liable under Rule 10b-5.
13
To succeed on a civil claim for securities fraud under Rule 10b-5, a plaintiff
must show that a defendant: (1) using interstate commerce, the mails, or the facili -
ties of any national securities exchange,
14
made (2) a misstatement or omission
15
5. 15 U.S.C. § 78ff(a) (“Penalties”).
9. The term “blue sky” refers to the practice of land salesmen who operated so fraudulently that they would
“sell building lots in the blue sky in fee simple.” See Jonathan R. Macey & Geoffrey P. Miller, Origin of the Blue
Sky Laws, 70 TEX. L. REV. 347, 359 n.59 (1991) (quoting Thomas Mulvey, Blue Sky Law, 36 CAN. L. TIMES 37,
37 (1916)).
10. The Securities Litigation Uniform Standards Act of 1998, Pub. L. No. 105-353, 112 Stat. 3227 (1998),
which amended portions of the 1933 Act and the 1934 Act, precludes “covered” class actions that allege fraud
“in connection with the purchase or sale of a covered security” from being brought in federal or state court based
on state law. See 15 U.S.C. § 78bb(f)(1); see also id. § 78bb(f)(2) (providing that “covered class action[s]” are
removable to federal court). Consequently, such class actions must be based on federal securities laws.
11. See 17 C.F.R. § 240.10b-5 (2023).
12. Id.
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