Securities Fraud

• Pages: 1029-1083
• Date: 01 July 2025
• Published date: 01 July 2025
• Author: Kelly Brown,Madeleine Danes,Noah Dreeben,Cailey Mcbyrne,Clement Mulock,Ronglu Sun
• Subject Matter: Derecho Penal

SECURITIES FRAUD

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1030

II. ELEMENTS OF THE OFFENSE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1031

A. Material Misrepresentations and Omissions . . . . . . . . . . . . . . 1031

1. Use of Interstate Commerce or the Mails . . . . . . . . . . . . . 1032

2. Misstatements and Omissions . . . . . . . . . . . . . . . . . . . . . 1032

3. Materiality . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1036

4. Intent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1037

a. Scienter . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1038

b. Willfulness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1038

5. In Connection with the Purchase or Sale of a Security . . . 1039

a. Def‌inition of a “Security”. . . . . . . . . . . . . . . . . . . . 1039

i. Stocks and Notes Lacking a Prof‌it Motive . . . . 1040

ii. Instruments Protected by Other Legislation . . . . 1042

iii. Instruments Deemed Investment Contracts . . . . 1044

(1) Investment of Money . . . . . . . . . . . . . . . 1044

(2) Common Enterprise . . . . . . . . . . . . . . . . 1045

(3) Expectation of Prof‌its . . . . . . . . . . . . . . . 1046

(4) “Solely” Through the Efforts of Others . . 1047

b. Def‌initions of “Purchase” and “Sale”. . . . . . . . . . . . 1048

6. Reliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1050

B. Insider Trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1051

1. The “Classical Theory”. . . . . . . . . . . . . . . . . . . . . . . . . 1052

2. The “Misappropriation Theory”. . . . . . . . . . . . . . . . . . . 1054

3. Strict Regulation Under Rule 14e-3 of Material, Non-Public

Information Regarding Tender Offers . . . . . . . . . . . . . . . 1056

4. “Use” Versus “Knowing Possession” of Inside Information 1056

5. Regulation of Selective Disclosure . . . . . . . . . . . . . . . . . 1057

III. DEFENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1059

A. Intent-Based Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1059

1. Lack of Fraudulent Intent . . . . . . . . . . . . . . . . . . . . . . . . 1059

2. “No Knowledge” of the Substantive Rule . . . . . . . . . . . . 1060

3. Good Faith . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1061

4. Reliance on Advice of Counsel . . . . . . . . . . . . . . . . . . . . 1062

B. Reliance-Based Defenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063

1. Truth on the Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1063

2. Bespeaks Caution Doctrine . . . . . . . . . . . . . . . . . . . . . . . 1064

C. Defense Based on Legitimacy of Criminalization . . . . . . . . . . 1066

D. Statute of Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1066

IV. ENFORCEMENT MECHANISMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1068

1029

A. SEC Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1068

1. Development of an Enforcement Action . . . . . . . . . . . . . 1068

2. Administrative Proceedings . . . . . . . . . . . . . . . . . . . . . . 1070

a. Cease and Desist Authority . . . . . . . . . . . . . . . . . . . 1071

b. Monetary Penalties in Administrative Proceedings . . 1071

3. Civil Remedies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1072

a. Injunctive Actions and Ancillary Measures . . . . . . . . 1072

b. Disgorgement and Monetary Penalties . . . . . . . . . . . 1073

4. International Enforcement . . . . . . . . . . . . . . . . . . . . . . . 1075

B. Criminal Violations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1077

1. DOJ Criminal Enforcement . . . . . . . . . . . . . . . . . . . . . . 1078

2. Parallel or Subsequent Suits . . . . . . . . . . . . . . . . . . . . . . 1079

3. Contempt Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . 1080

V. PENALTIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1081

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”). Both acts created “a broad def‌ini-

tion of ‘security’” and allowed Congress to regulate all investments, regardless of

the form or label applied.

2

By mandating full and fair disclosure of all material in-

formation in the marketplace,

3

the acts aim to protect the national public interest in

vigorous market competition and “eliminate serious abuses in [the] largely unregu-

lated securities market.”

4

The key securities fraud provision used in federal criminal prosecutions is Rule

10b-5.

5

Rule 10b-5 was promulgated by the Securities Exchange Commission

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. SEC v. Edwards, 540 U.S. 389, 393 (2004) (quoting Reves v. Ernst & Young, 494 U.S. 56, 61 (1990)).

3. 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, 1954 (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. United Hous. Found., Inc. v. Forman, 421 U.S. 837, 849 (1975).

5. 17 C.F.R. § 240.10b-5 (2024).

1030 AMERICAN CRIMINAL LAW REVIEW [Vol. 62:1029

(“SEC”) under § 10(b) of the 1934 Act,

6

the violation of which is criminalized by

§ 32(a) of the 1934 Act.

7

Section 17(a) of the 1933 Act,

8

through § 24 of the same

act,

9

provides another ground for federal criminal prosecution.

10

In addition, appli-

cable state “blue sky” laws may trigger criminal liability.

11

This article focuses on securities fraud under federal law. 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 high-

lights penalties for a securities fraud offense.

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.

12

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. Under Rule 10b-5,

any person who, in connection with the purchase or sale of securities, (a) employs

a “device, scheme, or artif‌ice to defraud” or (b) makes a false statement or an omis-

sion of material fact

13

may be criminally or civilly liable under Rule 10b-5.

14

To succeed on a civil claim for securities fraud under Rule 10b-5, a plaintiff

must show that the defendant, (1) by some “means or instrumentality of interstate

commerce” or “the mails or . . . facility of any national securities exchange,”

15

(2) made a misstatement or omission

16

(3) of material fact

17

(4) with scienter

18

(5) in connection with the purchase or sale of a security,

19

(6) upon which the plain-

tiff reasonably relied,

20

and (7) whereby that reliance proximately caused his or her

injury.

21

The f‌inal causation element may be further separated into two sub-

6. 15 U.S.C. § 78j(b).

7. Id. § 78ff(a).

8. Id. § 77q(a).

9. Id. § 77x.

10. See Wendy Gerwick Couture, Prosecuting Securities Fraud Under Section 17(a)(2), 50 LOY. U. CHI. L.J.

669, 670–71 (2019).

11. See Manson v. State, 349 So. 2d 67 (Ala. Crim App. 1977) (aff‌irming conviction under the Securities Act

of Alabama).

12. See 17 C.F.R. § 240.10b-5 (2024).

13. Id.

14. See 15 U.S.C. § 78ff(a)–(b).

15. 17 C.F.R. § 240.10b-5.

16. Id.; see, e.g., Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341 (2005).

17. 17 C.F.R. § 240.10b-5; see also Basic Inc. v. Levinson, 485 U.S. 224, 232 (1988).

18. See Amgen Inc. v. Connecticut Ret. Plans & Tr. Funds, 568 U.S. 455, 460–61 (2013) (quoting Matrixx

Initiatives, Inc. v. Siracusano, 563 U.S. 27, 37–38 (2011)).

19. 17 C.F.R. § 240.10b-5.

20. See Goldman Sachs Grp., Inc. v. Arkansas Tchr. Ret. Sys., 594 U.S. 113, 118 (2021).

21. See Stoneridge Inv. Partners, LLC v. Scientif‌ic-Atlanta, 552 U.S. 148, 158–59 (2008).

2025] SECURITIES FRAUD 1031