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The Elements of a Securities Fraud Claim

According to the Federal Bureau of Investigation, the term “securities fraud” covers a broad spectrum of activities characterized by the misrepresentation or omission of material information to investors in during the purchase or sale of securities. It can also extend to manipulation of national financial markets. Some of the activities the FBI designates as securities fraud include Ponzi and pyramid schemes, high yield investment fraud, advance fee schemes, insider trading, falsifying details in corporate filings, lying to auditors, and manipulating share prices. The Security and Exchange Act of 1934 created the Securities and Exchange Commission (SEC) to monitor and enforce laws related to securities fraud. The SEC provides a detailed guide to avoiding securities fraud through the office of investor education and advocacy that is a useful tool in keeping business operations legal.

According to the Securities Exchange Act of 1934, Section 10(b),

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange… [to] use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement… any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.”

In addition to these specifications, securities fraud cases are also held to the SEC’s Rule 10b-5, which states:

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

  • To employ any device, scheme, or artifice to defraud,

  • To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

  • To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

Securities fraud cases brought under the 1934 Securities and Exchange Act and Rule 10b-5 require the plaintiff to meet a number of requirements. These elements are critical to proving securities fraud occurred; and, if not met, will frequently result in cases being dismissed.

The elements of a securities fraud claim include:

  1. A material misrepresentation or omission by the defendant. Allegations of securities fraud are usually based on the defendant misrepresenting or failing to provide financial information to the plaintiff who is seeking to buy or sell a security. This information may include the issuer’s profits, future prospects, contractual obligations, or the nature of the product the issuer of the security was selling. The misrepresentation or omission must be considered material, meaning that a reasonable buyer or seller of the securities would deem that information important. A material omission can satisfy this element.

  2. Scienter, or knowledge of the act being deceptive or illegal. The plaintiff must put forth evidence showing the defendant knew their statements were false or acted with reckless disregard of the truth. This element is difficult to prove without physical evidence because it is impossible to know what the defendant was thinking. Evidence will often be circumstantial in these cases. Evidence of a strong motive for the defendant to lie may exist and can potentially fulfill the scienter requirement.

  3. Transactional causation, or a connection between the misrepresentation or omission and the buying or selling of securities. The plaintiff must prove that the misrepresentation or omission caused him/her to sell or buy their stock.

  4. Detrimental reliance, or reliance upon the misrepresentation or omission for guidance. The plaintiff must prove that when engaging in the detrimental transaction, he/she relied on what the defendant said or did not say when making decisions to buy or sell. The court will assess if the plaintiff’s reliance on those statements or lack thereof was reasonable. The court will take into consideration the full picture of the transaction, including complexity, the scope of financial investment, mental state of all parties involved, and context of any agreements between the plaintiff and defendant.

  5. Economic loss. The plaintiff must prove that they suffered a financial loss as a direct result of the decision to buy or sell securities based on the defendant’s information. This is the easiest to show in court as it can be seen in the transaction.

  6. Loss causation. The plaintiff must show that the misrepresentation or omission was the direct cause of their losses and not another outside force. For example, if there was an overall drop in the stock market and not just the specific stocks of one company, the purchaser of securities may not be able to show the decline in value of his/her shares was due to a violation of Rule 10b-5.

In addition to federal securities fraud claims governed by the Securities and Exchange Acts of 1933 and 1934, most states have enacted their own securities laws. In Texas, the Texas Securities Board oversees the Texas Securities Act. While the Texas Securities Act often mirrors the elements of federal securities fraud laws, a Texas Securities Act misrepresentation claim has distinct differences from a claim brought under Rule 10b-5. Notably, most misrepresentation claims brought under Texas Revised Civil Statute 581-33 do not require scienter/intent or reliance. E.g., Dorsey v. Portfolio Equities, Inc., 540 F.3d 333, 344 (5th Cir. 2008). Similarly, a claim for fraud in a stock transaction under Texas Business & Commerce Code § 27.01 does not require a plaintiff prove the defendant knew the false information was false when statement was made.

Securities fraud claims can be detrimental to any company facing a claim and the fraud associated therewith can cost investors millions in financial losses. Whether it is individuals in an organization who have committed fraud or multiple company employees or directors, it is critical to have proper representation when filing or facing a securities fraud claim.

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