Securities and Exchange Act Section 10(b) and Rule 10b-5

Violations of section 10(b) of the Securities Exchange Act of 1934 (or “Exchange Act") and Rule 10b-5 are common sources of liability for corporate defendants. A drop in a stock's price often triggers such cases. Investors typically claim that the stock's change in value reflects new public information the company concealed improperly.

Federal securities laws govern the offer and sale of securities. Unfortunately, securities fraud occurs and impacts investors. Actionable securities fraud generally involves spreading false or misleading information. Federal securities laws also govern the following:

• Securities trading
• Activities of certain professionals in the industry
• Investment companies (such as mutual funds)
• Content of financial statements
• Tender offers
• Proxy statements
• Regulatory oversight of public companies

In 1948, the Securities and Exchange Commission (SEC) began to enact rules against fraud in securities trading under the authority granted to it by the Securities Exchange Act of 1934.

Read more about Exchange Act Section 10(b) and Rule 10b-5 below. You'll also learn how the SEC has used these provisions to combat securities fraud.

For more articles and resources about securities law, see FindLaw's Securities Law section.

Federal Securities Laws

Securities fraud claims usually arise under the Securities Act of 1933 and the Securities Exchange Act of 1934. Claims under the Exchange Act arise under Sections 10(b) and 20(a) and SEC Rule 10b-5.

Section 10(b) and SEC Rule 10b-5 prohibit fraud connected with the purchase or sale of a security. Fraud can occur in purchases made on a stock exchange, such as the New York Stock Exchange, a self-regulatory organization.

Section 10(b) makes it unlawful to "use or employ, in connection with the purchase or sale of any security" a "manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." This is as stated in 15 U.S.C. section 78j(b).

Background and Purpose of Rule 10(b)

The Exchange Act created the SEC. The SEC declared Rule 10b-5 under Section 10(b) of the Exchange Act. The Exchange Act gives the SEC the power to enact rules against "manipulative and deceptive practices" in securities trading. Congress passed the Exchange Act in response to the 1929 stock market crash. Congress wanted to provide more transparency in the secondary securities market.

The SEC has the authority and flexibility to create and revise rules. Congress hoped the rules could effectively deter and punish manipulative and deceptive practices. Congress wanted to prevent fraud in the securities market.

Subsections of Rule 10(b) list the SEC's anti-fraud provisions. These regulations continue to evolve through amendments.

What Sorts of Activities Does Rule 10(b) Cover?

Rule 10b-5 is a broad rule and the most well-known SEC rule. It's discussed in more detail below. Other notable regulations of Rule 10(b) include the following:

• Rule 10b-1: SEC rules against fraud apply to transactions of exempt securities. These securities are exempt from registration. For example, a security issued by a state or local government is exempt from registration. But SEC rules against fraud apply.
• Rule 10b-3: This rule prohibits broker-dealers from directly or indirectly engaging in securities fraud. Along with Rule 10b-5, this is one of the SEC's most important tools against fraud.
• Rule 10b-10: Requires brokers and dealers to disclose certain information in writing before completing a securities transaction. For example, a broker must list the date and time of the transaction, the company name, the share price, the number of shares the customer is buying or selling, and whom the broker is working for.
• Rule 10b-21: This rule prohibits a seller of securities from deceiving buyers on the date of sale.

Rule 10b-5

Rule 10b-5 is a catch-all provision. It's also the most widely used anti-fraud securities rule. For example, the SEC typically uses this rule to charge a person with illegal insider trading. The rule applies to "any person" who "defrauds" another person in "the purchase or sale of any security."

Rule 10b-5(1) also contains built-in defenses that a person can assert against a charge of illegal insider trading. If a person can show that they planned to make a trade before coming across the material, confidential information, they may be exempt from a charge of illegal insider trading.

Rule 10b-5(2) clarifies when someone must maintain the confidentiality of material information. This rule states that if a person knows, or should know, that information they receive is material and confidential, they must maintain its confidentiality.

Examples of Rule 10b-5 Violations

Rule 10b-5 violations include, but are not limited to, the following:

• Creative accounting and misstatements used to hide losses or low revenue
• Untrue statements by corporate executives intended to increase the market share price
• Misrepresentations by a corporate executive intended to decrease market share price so that they can purchase those shares at a lower price

10b-5 Letters

A 10b-5 letter is known as a disclosure or negative assurance letter. It's issued by a security issuer's legal counsel. It certifies that the security transaction contains no false statements or misleading material information. The sale of a security requires a 10b-5 letter. It attests to the purchaser's due diligence.

A 10b-5 letter is drafted by the issuer's counsel. It states that the information in the issuer's official statement is complete and accurate. The letter provides that counsel has not identified any misrepresentations or omission of material fact in the prospectus or the offering memorandum.

Supreme Court Clarifies Scope of Liability for Omission Under Rule 10b-5

In 2024, the United States Supreme Court issued a unanimous decision with implications for issuers of registered securities. The Court held that a "pure omission" under Item 303 of the Securities and Exchange Commission Regulation S-K does not give rise to a private right of action for securities fraud.

Rule 10b-5(b) makes it unlawful to omit material facts in connection with buying or selling securities when that omission renders "statements made," in light of the circumstances under which they were made, misleading. This is stated in 17 CFR section 240.10b-5(b).

Item 303 of Regulation S-K has disclosure requirements. It requires companies to disclose known trends or uncertainties that have had or are reasonably likely to have a material impact on revenue.

For decades, federal courts of appeals disagreed on whether a company's failure to disclose information required by Item 303 alone could support a private plaintiff bringing a claim under Section 10(b) and Rule 10b-5(b).

Pursuant to the Supreme Court's opinion interpreting federal law, a pure omission under Item 303 isn't actionable in a private Rule 10b-5(b) suit. For example, plaintiffs can't make a claim for a material omission in a registration statement or prospectus.

To state a scienter-based fraud claim under Rule 10b-5(b), a plaintiff must establish that material information allegedly omitted made some other affirmative statement false and misleading. A pure omission isn't actionable.

A company's failure to disclose a known trend or uncertainty required under Item 303 of SEC Regulation S-K does not support securities fraud claims under Securities Exchange Act Rule 10b-5(b).

This ruling narrows the defendants' potential liability. It limits the circumstances under which a failure to disclose under Item 303 can give rise to a federal securities fraud claim. The ruling will likely reduce the number of securities class actions based solely on Item 303 violations.

Getting Help for a Securities Claim

The scope of Rule 10b of the Securities and Exchange Act is broad. Rule 10b-5 alone is the basis for many SEC charges. Some law firms have entire sections focused on this one rule. Contacting a securities litigation attorney when you think you've been a victim of securities fraud is wise. If you have questions about your investment decisions, an attorney specializing in securities law can help.