Rule 10b-5

SEC Rule 10b-5, codified at 17 C.F.R. 240.10b-5, is one of the most important rules targeting securities fraud promulgated by the U.S. Securities and Exchange Commission, pursuant to its authority granted under § 10(b) of 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. The issue of insider trading is given further definition in SEC Rule 10b5-1.

In 1942, SEC lawyers in the Boston Regional Office learned that a company president was issuing pessimistic statements about company earnings while simultaneously purchasing the company's stock. Although the Securities Act of 1933 prohibited fraudulent sales of securities, no regulation existed at that time which would have precluded fraudulent purchases. Rule 10b-5, issued by the SEC under section 10(b) of the Exchange Act, was implemented to fill this regulatory void. The commissioners approved the rule without debate or comment, with the exception of Commissioner Sumner Pike who indicated approval of the rule by asking, "Well, we are against fraud aren't we?"

"Rule 10b-5: Employment of Manipulative and Deceptive Practices":

To establish a claim under Rule 10b-5, plaintiffs (including the SEC) must show (i) Manipulation or Deception (through misrepresentation and/or omission); (ii) Materiality; (iii) "In Connection With" the purchase or sale of securities, and (iv) Scienter. Private plaintiffs have the additional burden of establishing (v) Standing - Purchaser/Seller Requirement; (vi) Reliance (presumed if there was an omission); (vii) Loss Causation; and (viii) Damages.

These are roughly comparable to the elements of common law fraud, which are i) Deception; ii) Materiality; iii) with Intent to Cause Reliance; that iv) causes Actual Reliance; and v) Harm.

In a case for insider trading, anyone who uses insider information can be held liable. A tippee can be liable if the tipper breached a fiduciary duty and the tippee knew or had reason to know that the tipper was breaching the duty.

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