Securities Fraud


Securities laws prohibit the use of fraudulent activities in connection with the offer, purchase or sale of securities. The Securities and Exchange Commission (SEC), a governmental agency established to monitor the securities market, regulates securities fraud. States also regulate securities fraud through individual state Securities Commissioners and state securities laws known as "Blue Sky Laws." Securities fraud may be committed by brokers, financial advisors or analysts, corporations or private investors. The most common types of securities fraud include misrepresentation, insider trading, and stock options fraud.


The majority of securities fraud cases in the United States involve Section 10b and Rule 10b-5 of the 1934 Securities Exchange Act. Section 10b is a general provision that prohibits any person from using fraud in connection with the purchase or sale of any security. Rule 10b-5 specifically prohibits making any false statements or omissions in connection with the sale or purchase of securities. A "false statement" is defined as any statement that misleads or creates a false impression. To be actionable under Rule 10b-5, the false statement or omission must be material. A statement is material if it would be important to a reasonable investor making an investment decision. Additionally, the statement or omission must be made with the intent to deceive, manipulate or defraud. Thus, reasonable mistakes of fact, made without a malicious intent, are not actionable under Rule 10b-5.

Misrepresentations may occur when stock brokers or financial advisors purposefully mislead investors in an effort to manipulate the financial market. Misrepresentations may also be made by corporations who conceal or distort their financial information. Overestimating assets and underreporting liabilities mislead investors into thinking that the corporation is more profitable than it is. Misrepresentation of financial information by corporations is classified as accounting fraud. As a result of several major accounting scandals, the government enacted the Sarbanes-Oxley Act of 2002, which imposes a number of securities law reforms aimed at increasing financial disclosures and discouraging corporate fraud.

Insider Trading

Though most people associate "insider trading" with illegal conduct, it can happen both legally and illegally. Legal insider trading occurs when corporate insiders buy, sell or trade stock in their own companies and report their trades to the SEC as required by law. Illegal insider trading generally occurs in one of three types of situations. The most common insider trading scheme takes place when a company's officers, directors, or holders of more than ten percent of a corporation's shares trades a security while in possession of material, non-public information. Corporate insiders owe a duty of loyalty to the corporation and its shareholders. They violate that duty when they buy or sell securities based on company-owned information. A corporate insider may also be guilty of insider trading if they share non-public information with others. For example, if a corporate employee shares confidential information, also known as a "tip," with a friend, and the friend sells or purchases securities based on that tip, both the employee (the "tipper") and the friend (the "tippee") will be guilty of insider trading. The third theory of insider trading is known as the misappropriation theory. The misappropriation theory, prohibits the purchase or sale of securities on the basis of, or the communication of, material nonpublic information misappropriated in breach of a duty of trust or confidence. The person's liability is not premised on their position as an "insider," but rather on their abuse of confidential information. For example, a lawyer working as in-house counsel for a corporation may structure a deal with another corporation. In the course of the transaction, the lawyer may learn non-public information about the other corporation. If the lawyer trades on that information, he is guilty of insider trading under the misappropriation theory.

Stock Options Fraud

Fraudulent schemes involving corporate stock options are one of the newest forms of securities fraud. Stock options are generally given to corporate employees as an incentive to stay with the company and to align their interests with the shareholders. Employees are given the option to buy stock at a certain date in the future. The price of the stock, however, is fixed at the date the stock option is granted. Thus, if the stock increases, the employee makes a profit. Stock options fraud involves backdating the granting date of the option to a time when the stock was trading at a lower price. This ensures that the stock option will already be profitable at the time it was granted. Executives at over 130 corporations have been investigated for backdating their own stock options.