Legal Definitions - Rule 10b-5

Rule 10b-5 is a regulation created by the Securities and Exchange Commission (SEC) to prevent securities fraud. It prohibits anyone from using fraudulent schemes or making false statements in connection with the purchase or sale of any security.

The SEC created Rule 10b-5 under Section 10(b) of the Exchange Act, which gives the SEC the power to regulate securities fraud. The rule states that it is illegal for anyone to:

• Use any device, scheme, or artifice to defraud
• Make any untrue statement of a material fact or omit to state a material fact
• Engage in any act, practice, or course of business that would operate as a fraud or deceit upon any person

Rule 10b-5 applies to both public offerings and private placements.

Courts have interpreted Rule 10b-5 to create a private civil cause of action, which means that individuals can sue for damages if they have been harmed by securities fraud. However, in order to have standing to bring a lawsuit under Rule 10b-5, the plaintiff must have actually purchased or sold a security. They cannot bring a lawsuit if they only claim that a fraudulent misrepresentation caused them to forego purchasing or selling a security.

To prove a violation of Rule 10b-5, a plaintiff or the SEC must prove the following elements:

• The individual misrepresented a material fact
• The individual did so knowingly (scienter)
• The plaintiff relied on the individual's material misrepresentation
• The plaintiff suffered a loss

If the SEC establishes these elements, the individual may be criminally liable.

Suppose a company's CEO knows that the company is about to go bankrupt but tells investors that the company is doing well and encourages them to buy stock. The CEO's statement is a material misrepresentation because it is false and would influence an investor's decision to buy stock. If an investor relies on the CEO's statement and buys stock, but later suffers a loss when the company goes bankrupt, they may have a cause of action under Rule 10b-5.