Rule 10b-5

Rule 10b-5 is a regulation formally known as the Employment of Manipulative and Deceptive Practices that was created under the Securities Exchange Act of 1934. This rule deems it to be illegal for anybody to directly or indirectly use any measure to defraud, make false statements, omit relevant information, or otherwise conduct operations of business that would deceive another person in relation to conducting transactions involving stock and other securities.

This rule is the main basis for the Securities and Exchange Commission (SEC) to investigate possible security fraud claims.

Examples of offenses that would violate rule 10b-5 would be: executives making false statements in order to drive up share prices or a company hiding huge losses or low revenues with creative accounting practices. Such action might be down to grant current shareholders a better return on their investments, at least so long as the deception remains undiscovered. These schemes typically require ongoing stream of misleading statements to perpetuate the fraud.

 Conversely, the rule also covers instances where an executive issues false statements in order to artificially drive down the price of a company’s stock in order to buy up more shares at a discount. These and other manipulative uses of confidential information can be described as insider trading as well as other types of schemes to influence the market for their gain and favor. In addition to making illicit profits or attracting more investors, these schemes could also be put into motion to change the balance of outstanding shares in order to further efforts to take over the company.

The SEC further defined and clarified such issues relating to potential securities fraud. With the ratification of the related rules 10b5-1 and 10b5-2, matters of insider trading were put into newer legal perspectives. Under rule 10b5-1, the SEC deems that an individual is trading based on material nonpublic information if that person knows of said information while engaging in a sale or purchase. There are also exceptions and stipulations that allow individuals to proceed with trades even though they have such information. This can include trades that are part of plans that were already set in motion though a contract or process that would not be affected by knowledge of the information.

Through rule 10b5-2, the SEC explained ways that the misappropriation theory can apply even under nonbusiness circumstances. It further states that an individual who obtains confidential information is obliged to a duty of trust.