Substantive and procedural differences between criminal and civil treatment of conduct sounding in securities fraud combine to cause the following anomaly: certain false statements to investors may be actionable criminally--subjecting individual defendants to imprisonment--but not civilly--leaving victims without remedy. The imposition of criminal punishment for conduct that does not invoke civil liability risks disrupting the current scheme of securities regulation, at the expense of considerations deemed important by Congress and the courts. Moreover, the extension of criminal liability beyond the scope of civil liability debunks the assumption, which underlies the current scholarship on the civil-criminal divide, that criminal liability is a subset of civil liability in circumstances where the relevant conduct injures identifiable individuals. This article demonstrates that criminal liability is more expansive than civil liability in the context of securities fraud, analyzes the impact of this anomaly on the current scheme of securities regulation, and considers whether the rationales underlying the leading theories of the civil-criminal divide explain this unique liability configuration. This article concludes that, although this configuration has destabilizing effects, it is arguably consistent with many of the theories underlying the civil-criminal divide. Therefore, this article proposes a two-step solution to further the rationales of the civil-criminal divide while preserving the delicate balance of the current scheme of securities regulation.
Substantive and procedural differences between criminal and civil treatment of conduct sounding in securities fraud combine to cause the following anomaly: certain false statements to investors may be actionable criminally--subjecting individual defendants to imprisonment--but not civilly--leaving victims without remedy. This article examines five of these differences, demonstrates how they combine to cause this anomalous civil and criminal treatment of conduct sounding in securities fraud, analyzes the impact of this anomaly on the current scheme of securities regulation, and considers whether the rationales underlying the leading theories of the civil-criminal divide explain the anomaly.
Part II of this article demonstrates that discrepancies between criminal and civil liability for securities fraud result in the criminalization of conduct not civilly actionable. First, the elements of the federal crime are often broader than the elements of the civil cause of action. In federal criminal prosecutions for conduct sounding in securities fraud, a lower materiality standard often applies than in civil cases, forward-looking statements are not protected by the "safe harbor" that is often invoked in civil cases, and liability is not confined to primary violators as in private civil actions. Moreover, at the state level, broad blue-sky laws and federal preemption of state civil securities class actions combine to criminalize conduct that is not civilly actionable. Finally, courts do not subject criminal indictments to the same level of pretrial scrutiny as civil complaints, and motions to dismiss are less favored in criminal cases than in civil cases.
Part III of this article shows that the imposition of criminal punishment for conduct not civilly actionable risks disrupting the current scheme of securities regulation, at the expense of considerations deemed important by Congress and the courts. The lower materiality standard and the unavailability of the safe harbor in criminal cases may chill corporate disclosure and may affect what information reasonable investors rely upon when making investment decisions. In addition, the potential of criminal aiding and abetting liability may discourage secondary actors from advising less established companies. Further, the broader criminal statutes may shift enforcement responsibility away from the Securities and Exchange Commission ("SEC") to the Department of Justice and to the states. Moreover, the criminalization of wide swathes of corporate conduct affords prosecutors broad discretion to decide whom to prosecute, invoking concerns about selective prosecution and separation of powers, and affords the SEC remarkable leverage in negotiating civil settlements. Finally, the narrow scope of private civil liability leaves injured investors without remedy.
Part IV of this article examines whether any of the dominant theories about the civil-criminal divide explains the anomalous relationship between civil and criminal liability in the context of securities fraud. The extension of criminal liability beyond the scope of civil liability debunks the assumption underlying the current scholarship on the civil-criminal divide that criminal liability is a subset of civil liability, but an examination of the rationales behind the leading theories of the civil-criminal divide lends some support for this unique configuration of liability in the context of securities fraud.
Finally, Part V of this article proposes a two-step solution. First, in light of the wide-ranging consequences of imposing criminal liability for conduct that does not incur civil securities fraud liability, Congress should reign in the scope of criminal liability to the current reach of private civil liability for conduct sounding in securities fraud. Second, because the more expansive reach of criminal liability is arguably consistent with many of the theories underlying the civil-criminal divide, Congress should consider carefully whether to expand the reach of criminal liability--while recognizing and compensating for the impacts of that expansion on the carefully balanced scheme of securities regulation.
CONDUCT THAT IS NOT ACTIONABLE AS CIVIL SECURITIES FRAUD MAY BE CRIMINALLY PROSECUTED.
Five major differences between criminal and civil treatment of conduct sounding in securities fraud create an anomaly in which conduct not actionable as securities fraud may nonetheless be criminally prosecuted. First, prosecutors may use the criminal wire and mail fraud statutes, which have no civil equivalent, to prosecute conduct that does not violate the securities fraud statute ("the wire/mail fraud run-around"). Second, an individual defendant may be held criminally, but not civilly, liable for allegedly false forward-looking statements accompanied by meaningful cautionary language. Third, an individual defendant may be criminally prosecuted for aiding and abetting securities fraud, but an investor injured by the defendant's conduct is barred from asserting a private right of action. Fourth, some state blue-sky laws impose criminal liability for conduct that is not civilly actionable as securities fraud. Fifth, courts do not subject criminal indictments for securities fraud to the same degree of pretrial scrutiny as civil securities fraud complaints, leaving more issues to the jury. As shown below, these differences allow conduct that is not actionable as civil securities fraud to nonetheless be criminally prosecuted.
Differing Materiality Standards for Wire and Mail Fraud and for Securities Fraud Create the "Wire/Mail Fraud Run-Around."
Conduct cognizable as securities fraud is often within the scope of the wire and mail fraud statutes. Securities fraud liability, both civil and criminal, is premised on (1) a false or misleading statement or omission (2) that is material and (3) made with scienter. (1) Wire and mail fraud require the following elements: (1) "existence of a scheme to defraud"; (2) "using or causing the use of the mail [or wires] to execute the scheme"; and (3) "specific intent to defraud.'' (2) Virtually every statement that could form the basis of a securities fraud claim (e.g., a statement in an analyst call, in a webcast, in a press release, or in a Securities and Exchange Commission filing) is disseminated via the wires or mail, thus satisfying the jurisdictional requirement for mail or wire fraud. (3) For example, prosecutors have charged defendants with wire fraud for allegedly making false statements in forms filed electronically with the SEC, (4) in press releases distributed via the wires, (5) and in analyst and investor conference calls. In other words, if a prosecutor determines that an individual defendant made an allegedly false statement to investors, the prosecutor may often choose whether to charge securities fraud, wire fraud, mail fraud, or some combination thereof.
If the same statements were actionable as securities fraud, wire fraud, and mail fraud, a prosecutor's decision to prosecute the conduct as wire or mail fraud would have little practical consequence, other than perhaps an increased incentive for the defendant to accept a plea deal. Since each use of the mail or wires can be separately charged, prosecutors have tremendous leverage in convincing defendants to plead guilty to just one count of mail or wire fraud--rather than face trial on numerous counts. (7)
The same statements are not, however, actionable as securities fraud and as wire or mail fraud. The materiality standard for wire and mail fraud is lower than for securities fraud, opening the door of criminal prosecution to more statements. (8)
The Materiality Standard for Wire and Mail Fraud Is Lower than for Securities Fraud.
Materiality is an essential element of securities fraud and of wire and mail fraud, but materiality is defined differently in the two contexts. The materiality bar to securities fraud liability is higher than the materiality bar to wire and mail fraud liability.
In the securities fraud context, materiality is an objective standard. (9) A statement is material if '"there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote."' (10) In other words, "[i]t is not enough that a statement is false or incomplete, if the misrepresented fact is otherwise...