Securities Fraud Laws

Investors need to account for certain risks when making decisions. However, one risk for which they should not need to account is fraud. Securities fraud is a complex white collar crime. Federal prosecutors often pursue these charges, which may result in harsh penalties upon a conviction. Someone suspected of securities fraud should not try to explain their side of the story to prosecutors or investigators, even if they feel sure that they did nothing wrong. Instead, they should exercise their right to remain silent until they consult an attorney who is experienced in securities fraud cases. This can better preserve any defenses that may be available to them.

What Is Securities Fraud?

Securities fraud usually involves deception related to the offer, purchase, or sale of these financial instruments.

Elements of Securities Fraud

Probably the most notable statute prohibiting securities fraud is 15 U.S. Code Section 78j, better known as Section 10 of the Securities Exchange Act of 1934. This law prohibits using any “manipulative or deceptive device or contrivance” that violates rules and regulations enacted by the Securities and Exchange Commission in connection with the purchase or sale of a security. Under Rule 10b-5, the SEC prohibits the following conduct:

• Using a device, scheme, or artifice to defraud
• Making an untrue statement of a material fact, or omitting a material fact necessary to make a statement not misleading under the circumstances
• Engaging in an act, practice, or course of business that would operate as a fraud or deceit

The Securities Act of 1933 also contains a prohibition against fraud. 15 U.S. Code Section 77q (Section 17 of the Act) addresses “fraudulent interstate transactions,” which include three types of practices that are somewhat similar to those prohibited by Rule 10b-5. However, Section 77q applies to the “offer or sale” rather than the “purchase or sale” of securities. The provision involving an untrue statement of a material fact, meanwhile, requires that the defendant obtained money or property through the false statement or omission. The statutes have parallel mental state elements, though. A prosecutor must prove that the defendant acted "willfully" to get a conviction under either of them.

The more recent Sarbanes-Oxley Act also addresses securities fraud. 18 U.S. Code Section 1348 generally prohibits knowingly executing a “scheme or artifice” to defraud in connection with a security. It also prohibits knowingly executing a “scheme or artifice” to get money or property in connection with the purchase or sale of a security by using false or fraudulent pretenses, representations, or promises. The law covers both securities that are issued by publicly traded companies and securities that are issued by companies required to file reports with the SEC.

Example of Securities Fraud

One common type of securities fraud is a “pump and dump” scheme. This involves people who own a certain stock disseminating false or misleading information to the public, often online, about the stock being a good choice. If investors believe the information and start buying more shares, this tends to drive up the value of the stock because of the increased demand. The fraudsters then sell their stock at the inflated price, while investors who bought the stock suffer losses when the price drops.

Offenses Related to Securities Fraud

Some other offenses that could be charged in situations similar to those supporting securities fraud charges include:

• Wire fraud: using electronic communications to defraud someone
• Bribery: could be charged when someone gets paid to conceal or cooperate in a securities fraud scheme
• Forgery: could be charged when someone fakes or falsifies a legal instrument with fraudulent intent

Meanwhile, if a defendant violated both federal and state securities laws, they could face simultaneous prosecution at each level. This does not implicate the constitutional principle of double jeopardy.

Defenses to Securities Fraud

Some defense strategies involve the mental state element of the crime. A defendant might argue that they did not intend to defraud or believed in good faith that the false statements were true. In addition, the statute providing criminal penalties for violations of the Securities Exchange Act prohibits imprisonment for a violation of a rule or regulation of which the defendant was unaware. This affects only sentencing, however, and does not avoid a conviction.

Other defenses to these charges may involve challenging the manner in which law enforcement obtained evidence. For example, the Fourth Amendment to the Constitution imposes limits on searches and seizures. If the police collected evidence through an unconstitutional search, a defendant can ask the court to suppress this evidence. The prosecution then might not be able to prove its case, or might be more inclined to offer a favorable plea bargain.

Penalties for Securities Fraud

Potential prison terms for a federal securities fraud violation depend on whether the conviction occurred under the Securities Exchange Act, the Securities Act, or the Sarbanes-Oxley Act. A Securities Exchange Act violation carries up to 20 years of imprisonment, while a Securities Act violation carries only up to five years. A defendant convicted of violating the securities fraud provision in the Sarbanes-Oxley Act generally faces up to 25 years.

State blue sky laws impose separate penalties. For example, a violation of the main Florida securities fraud law is generally a third-degree felony, which carries up to five years of imprisonment. If the defendant obtained money or property worth more than $50,000 from five or more people, though, this is a first-degree felony, which carries up to 30 years of imprisonment. A violation of the main Texas securities fraud law carries 2-10 years if it involved less than $10,000 but 2-20 years if it involved at least $10,000 but less than $100,000. Securities fraud involving $100,000 or more carries 5-99 years or potentially life in prison.

In addition to prison time, a defendant might face substantial fines. They also might be ordered to pay restitution to anyone who suffered financial losses because of the fraud.

Last reviewed September 2024