SEC Rule 10b-5

1. SEC Rule 10b-5 Overview

3. Rule 10b-5 Text Continued (a) To employ any device, scheme or artifice to defraud, (b) 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 light of the circumstances which they were made, not misleading, or

4. Rule 10b-5 text continued [c] 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

5. Who May Bring 10b-5 Action? The SEC The Department of Justice (Criminal) Private Parties No express private remedy under Section 10 Private Cause of Action Implied under Rule 10b-5

6. Keys to Rule 10b-5 Liability Misstatement or omission Materiality Scienter Reliance (Transaction Causation) Proximately Caused Damages (Loss Causation)

7. Elements Use of Jurisdictional means, that is, interstate commerce (usually easily proven) In private action, that plaintiff is actual purchaser or seller Blue Chip v. Manor Drug, 421 U.S. 723 (1975) Showing a material misrepresentation or nondisclosure or manipulation (breach of fiduciary duty with out misrepresentation is insufficient Santa Fe Ind. V. Green, 430 U.S. 462 (1977)

8. Elements Continued The misrepresentation, omission or half-truth must be material Basic v. Levinson, 485 U.S. 224 (1988] Defendant acted with scienter Ernst & Ernst v. Hochfelder, 425 U.S. 185 ( 1976) Reliance by plaintiff Proximate Cause of loss ( �in connection with the purchase or sale� requirement] Damages

9. Misstatement or Omission Exchange Act reports, press releases, oral statements, web pages, etc Sarbanes-Oxley Act of 2002 (Section 409) requires reporting companies to disclose to the public on a rapid and current basis material changes

10. Materiality The omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision Put another way, there must be a substantial likelihood that the omitted disclosure would have been viewed by the reasonable investor as having significantly altered the �total mix� of information made available Basic v. Levinson, 435 U.S. 224 (1988)

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12. Scienter Must be proven by private plaintiff and SEC Federal courts have held recklessness meets scienter requirement Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)

13. Scienter Defined A mental state embracing intent to deceive, manipulate or defraud in certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability

14. Private Right of Action 10b-5 can be enforced by SEC in civil penalty and injunctive actions, and by the Justice Dept. for criminal violations Private Right of Action is IMPLIED by the courts, therefore the parameters of the Private Right of action defined by the Courts. Section 804 of Sarbanes-Oxley Act extends the Statute of Limitations for private 10b-5 actions to the earlier of Two (2) years from discovery of facts ; or five (5) years after such violation

15. Reliance and Causation Reliance is a necessary element of a 10b-5 claim, and plaintiff must prove proximate causation. However, reliance on omissions may be presumed in certain cases: Face-to-Face transactions Affiliated Ute Citizens v. US, 406 U.S. 128 (1972) Fraud on the Market Basic v. Levinson, 485 U.S. 224 ( 1988) Presumptions are rebuttable.

16. Fraud on the Market A theory of causation in securities fraud premised on distortions in the market price of a security because of a material misrepresentation or omission; Based upon Economic Theory called Efficient Market Hypothesis, which posits that securities prices reflect all relevant information. Allows investors to sue for damages without showing that they personally relied on allegedly fraudulent statements issued by a corporate defendant.

17. Remedies and Damages Section 28 of the 1934 Act limits damages to �actual damages� Pendant state �blue sky� or common law claims may give rise to a claim for punitive damages, however Usual measure is �out of pocket� measure

18. Insider Trading Trading on the basis of MATERIAL NONPUBLIC information Disclose or Abstain from trading Tipper and Tippee both potentially liable Mere possession of material inside information not actionable, you need a breach of duty. Chiarella v. U.S. , 455 U.S. 222 (1980) There is no requirement of Parity of Information in the markets.

19. Insider Trading is not a �Good Thing�

20. Remedies for Insider Trading SEC Injunctions and Disgorgement Civil Liability for Contemporaneous Traders Civil Penalties Criminal Sanctions

21. The Misappropriation Doctrine Does the misappropriation of information in order to trade in securities in violation of a duty of confidentiality to an employer or corporation provide a basis for insider trading liability ? Wall Street Journal �Heard on the Street � Case, Carpenter v. U.S. 484 U.S. 19 (1987) ~ Supreme Court splits 4-4 on misappropriation

22. Misappropriation Doctrine Upheld Finally, in 1997, the Supreme Court endorsed the misappropriation doctrine in U.S. V. O�Hagan, 117 S.Ct. 2199 (1997) O�Hagan was an unethical lawyer who used inside information he took from his law firm regarding a possible tender offer by the firm�s client for the Pillsbury Company

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24. Aiding and Abetting Liability There is no liability in a PRIVATE Cause of Action for aiding and abetting primary violations of the securities laws. Central Bank of Denver v. First Interstate, 511 U.S. 164 (1994) However, the SEC may bring actions for A&A �Controlling Persons� have liability under Section 20 of the Exchange Act

25. Defenses Due Diligence, Unclean Hands, Estoppel and in pari delicto are all possible defenses If some insider-tipper gave a tippee a FALSE tip, may the defrauded tippee successfully bring suit against the tipper, since both have violated the law, in pari delicto ?

26. Defense of In Pari Delicto The Supreme Court has held that for the Defendant -tipper in the false tip scenario to prevail, she must prove that Plaintiff-Tippee: by plaintiffs �s actions, he bears at least substantially equal responsibility for the violations; and barring plaintiff�s recovery would not offend the policies underlying the securities laws, that is, protection of the investing public

27. SEC Regulation FD FD= �Fair Disclosure� Prohibits selective disclosure of material nonpublic information to analysts, institutional investors and others unless widespread public disclosure is concurrently made. Intentional disclosure of non-public information must be done publicly and simultaneously Unintentional disclosure of material non-public information triggers a requirement to promptly disclose that information publicly (within 24 hours)

28. Sarbanes-Oxley Act of 2002 Violation of Sarbanes Oxley Act (�SOA�) treated as violation of Securities Exchange Act Senior Management Accountability Certification of financial reports by CEO and CFO Prohibition of insider trades during pension fund blackouts Criminal penalties:fines up to $1 million and/or imprisonment up to 10 years; if willful violation $5 million and up to 20 years SEC may bar persons from serving as officers or directors of public companies if they have violated Securities laws and their conduct demonstrated unfitness

29. Sarbanes- Oxley Continued The SEC may freeze �extraordinary payments� to persons charged with securities law violations Liabilities for securities law violations are NOT discharged by personal bankruptcy Section 804 of SOA extends the Statute of Limitations for private 10b-5 actions to the earlier of : Two (2) years from discovery of facts ; or Five (5) years after such violation