Legal Definitions - antifraud rule

The term antifraud rule most commonly refers to Rule 10b-5, a crucial regulation issued by the U.S. Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934. This rule makes it unlawful for any person, directly or indirectly, to engage in fraudulent activities in connection with the purchase or sale of any security.

Specifically, Rule 10b-5 prohibits:

• Employing any device, scheme, or artifice to defraud.
• Making any untrue statement of a material fact or omitting to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading.
• Engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person.

In essence, it is a broad prohibition against deception, misrepresentation, and other fraudulent conduct in the securities markets, designed to protect investors and maintain fair and orderly trading.

Here are some examples illustrating the application of the antifraud rule:

• Misleading Corporate Disclosures: A publicly traded pharmaceutical company issues a press release announcing promising results for a new drug trial, but deliberately omits critical information about severe side effects observed in a significant portion of participants. This omission causes the company's stock price to surge, and investors purchase shares based on an incomplete and misleading picture of the drug's safety profile.

  This illustrates the antifraud rule because the company made a material omission of fact (the severe side effects) that was necessary to prevent their statements from being misleading, thereby deceiving investors in connection with the purchase of their securities.

• Insider Trading: An executive at a technology company learns that their firm is about to announce a major acquisition that will significantly boost its stock value. Before the public announcement, the executive secretly buys a large number of shares in their own company, knowing that the price will likely increase once the news is public.

  This demonstrates the antifraud rule because the executive used material, non-public information to engage in a deceptive scheme (insider trading) for personal gain, defrauding other investors who were unaware of the impending acquisition.

• Broker Misrepresentation: A financial advisor convinces a client to invest their entire retirement savings in a highly speculative and illiquid private equity fund, falsely claiming it is a "guaranteed safe investment" with "minimal risk" and "high returns," despite knowing the fund carries substantial risks and is unsuitable for the client's financial situation and risk tolerance.

  This example shows the antifraud rule in action because the financial advisor made untrue statements of material fact (regarding safety, risk, and returns) and omitted crucial information about the fund's true nature, operating as a deceit upon the client in connection with their investment.