During the depths of the depression, in order to “clean up” Wall Street, who largely (rightly or wrongly) took the brunt of ire over the economy going from bad to worse, Congress enacted various security laws designed to help level the playing field between insiders and outside investors. In that process, the newly formed Securities and Exchange Commission was tasked with creating rules to effect the changes Congress desired, including Rule 10B-5, which is under Title 17, chapter II, Part 240, Subpart A/ titled “Manipulative and Deceptive Devices and Contrivances.”

The purpose was to stop marketers (and others) from making misleading statements regarding securities they were trying to sell (or purchase as the case may be).

Statute 240.10b-5 Employment of manipulative and deceptive devices:
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 any facility of any national securities exchange,
A. To employ an 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 order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
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

The rule was updated in 2004 to the following:
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,
1. To employ any device, scheme, or artifice to defraud,
2. 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
3. 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.

Courts have ruled that in order for the SEC (or private party) to succeed on a Rule 10b-5 fraud, the plaintiff must establish the following:
1. A false statement or omission of material fact
2. Made with SCIENTER,
3. Upon which the plaintiff justifiably relied, and
4. That proximately caused the plaintiff’s injury
Robbins v. Koger Props., Inc., 116 F.3d 1441, 1447 (11th Cir. 1997) (citing Bruschi v. Brown, 876 F.2d 1526, 1528 (11th Cir. 1989)).

When thinking about the causation element, it’s important to note that in this context, causation means BOTH transaction causation and damages/loss causation. For transaction causation to be found, it means the plaintiff (reasonably) relied upon the defendant’s misleading statements and the loss was caused by the tortious statements. In other words, for example, if the Plaintiff bought shares in a company in reliance of the Defendant’s (misleading/fraudulent) statements, the transaction causation is likely met, however, if the loss occurred regardless of the statements, and the statement didn’t cause the shares to fall in price, the Plaintiff may not succeed on the claim. Another way to view this is to ask if the shares were inflated in price BECAUSE of the fraudulent statement by the Defendant? If yes, then the element is met, however, if no, then the loss causation element is not met.

Also, regarding the loss causation, some courts have accepted the theory of “fraud on the market” as a loss causation, while other courts have rejected this theory. In other words, depending on the jurisdiction, a Plaintiff may succeed or fail on the same set of facts. “the fraud on the market theory, as articulated by the Supreme Court, is used to support a rebuttable presumption of reliance, not a presumption of causation.” Id. at 1448 (citing Basic v. Levinson, 485 U.S. 224, 241-42, 108 S. Ct. 978, 992, 99 L. Ed. 2d 194 (1988)).