Trading Securities: Section 10(b) & Rule 10b-5

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From the course by University of Illinois at Urbana-Champaign

Corporate & Commercial Law II: Business Forms, Financing & Governmental Regulation

3 ratings

University of Illinois at Urbana-Champaign

Corporate & Commercial Law II: Business Forms, Financing & Governmental Regulation

3 ratings

This course is the second course in a two-part series on corporate and commercial law. In this part, we focus on three main topics: business organizations, business financing, and governmental regulation. In the first module, we discuss the characteristics of a number of the most common forms of business entities, such as corporations and LLCs. Module two is devoted to debtor-creditor relationships, including bank financing, debt financing, secured transactions, and bankruptcy. We wrap up the course with two modules that focus on the most important aspects of governmental regulation, including the process by which administrative agencies make rules, and the regulation of anti-competitive behavior and securities transactions.

From the lesson

Module 4: Regulation Part II: Antitrust and Securities

In this module, we continue our discussion of administrative regulations from the previous module, focusing specifically on antitrust and securities regulation. Prohibiting anticompetitive behavior and ensuring fair securities transactions are two of the most important ways the government regulates commerce. By the end of this module, you will understand the basics of federal antitrust and securities laws.

Trading Securities: Section 10(b) & Rule 10b-54:37

Meet the Instructors

Professor Michael R Fricke
Teaching Assistant Professor
Department of Business Administration

In this lesson, we're going to discuss regulation of securities trading.

What are some of the important statutes and regulations that govern the trading of

securities between individuals and companies?

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In this lesson,

we shift our focus from the issuance of securities to the trading of securities.

So there are a couple of very,

very important laws that regulates securities trading.

Most important, the 34 Act generally regulates securities trading, but

Section 10b of the 34 Act

does a ton of heavy lifting when it comes to regulating securities trading.

So we’re going to talk about some of 10b’s requirements and then the Securities and

Exchange Commission has adopted rule 10b-5

that also plays a big role in regulating securities trading.

So Section 10b, the text is on the slide,

and it is long and hard to understand and seems to follow the general rule for

people who draft legislation is that, the longer the run on sentence the better.

because then the fewer people can understand it, right?

In English, if you read this paragraph, all it basically says is that,

manipulation and deception in the trading of securities,

which is in violation of SEC rules, is prohibited.

Now, so what you gotta know is what are those SEC rules that you can manipulate

and deceive with respect to, well, Rule 10b-5 will tell us.

Any communication that defrauds, someone using any quote,

device, scheme or artifice is in violation of SEC rules.

Also, rule 10b-5 says any untrue statements of material fact,

any omission of a material fact, or any act, practice, or

course of business resulting in fraud.

Now, as a general rule, if you could summarize all these things, basically it

says, you gotta be honest when you're communicating in a securities transaction.

You gotta tell people what's necessary, you can't leave out stuff,

you can't tell them any untrue stuff, and you can't actively mislead them.

So, when do we see this in real life?

A couple of really, really common violations of sections 10b and

rule 10b-5, the first is, investment newsletters that manipulate stock prices,

these, unfortunately, are pretty common.

And if an investment newsletter is sent out to recipients and

it says, hey buy this stock, it's a great stock, but

it doesn't actually tell you to buy that stock because it really is a great stock.

It says buy this stock because the person who writes the newsletter wants to

drive up the stock price, and then sell when it's high,

before it crashes back down to Earth.

That is a violation,

because they're misleading you as to the purpose of their stock recommendation.

The second common violation of sections 10b and rule 10b-5 are Ponzi schemes.

Now Ponzi scheme is when a person or organization takes investment money from

its customers, promising them to invest their money in the stock market usually,

or in other investment vehicles, and promises them a certain rate of return.

But, instead of actually investing their money, it takes their money, and

then uses money from new clients to pay the return for existing clients.

So, as long as you keep getting a steady stream of new clients,

you could pay the returns of your existing clients and it works fine for a while.

But eventually, your pool of new clients dries up, and

then your existing clients say, where's my money?

And you say, I don't have any, time for me to go to jail,

or try to escape to some country with no extradition treaty.

So by far the most famous Ponzi scheme in history is that of

Bernie Madoff who was convicted of running a Ponzi scheme up

to 50 billion dollar, now the actual amount is in debate, but

Bernie Madoff is now sitting in prison as a result of his Ponzi scheme.

So though investment news letters and Ponzi schemes,

two very common unfortunately, violations of sections 10b and Rule 10b-5.

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