Private Securities Litigation Reform Act - Background: Overview of Securities Fraud Actions Under Section 10(b) and Rule 10b-5

Background: Overview of Securities Fraud Actions Under Section 10(b) and Rule 10b-5

The Securities Exchange Act of 1934 (commonly known as the "Exchange Act" or the "1934 Act") gives shareholders the right to bring a private action in federal court to recover damages the shareholder sustained as a result of securities fraud. The majority of securities fraud claims are brought pursuant to Section 10(b) of the Exchange Act (codified at 15 U.S.C. § 78j), as well as SEC Rule 10b-5, which the SEC promulgated under the authority granted to it by Congress under the Exchange Act. (This article refers to federal securities fraud actions as "Rule 10b-5 actions" or "Rule 10b-5 cases" as convenient shorthand.)

The Supreme Court has held that there are six elements that a plaintiff must allege and prove in order to prevail in a Rule 10b-5 action:

1. The defendant made a "material misrepresentation or omission";

2. the defendant acted with "scienter", or a "wrongful state of mind" (typically understood to mean that the defendant intended to make the material misrepresentation or omission, or acted with recklessness in making the misrepresentation or omission);

3. the material misrepresentation or omission was made "in connection with the purchase or sale of a security";

4. the plaintiff who was allegedly victimized by the fraud relied upon the material misrepresentation or omission (if the security is traded on a public stock exchange, such as the New York Stock Exchange or NASDAQ, the law will typically presume that shareholders rely on the integrity of the market, and therefore that the price of the stock reflected material misrepresentation and that shareholders relied upon the integrity of the market);

5. the plaintiff suffered an economic loss as a result of the alleged fraud; and

6. the plaintiff can allege and prove "loss causation", which means that the allegedly fraudulent misrepresentation or omission caused the plaintiff's economic loss. See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005).

Each of these elements has been heavily litigated in thousands of cases over the past 70 years, and the courts have applied these six elements in a multitude of different factual situations.