Rule 10b-5 is the general antifraud provision of the federal securities laws. The Rule covers fraud in the purchase or sale of securities as well as insider trading in securities.
Rule 10b-5 prohibits the following types of conduct in connection with the purchase or sale of a security:
(a) Employing any device, scheme, or artifice to defraud,
(b) Making any untrue statement of a material fact or omitting 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
(c) Engaging in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person
Fraud. The literal words of 10b-5 can be thought of as a version of common law fraud applied to the securities context. Thus, if one makes an untrue statement of a material fact in connection with the purchase or sale of a security, that person may have committed securities fraud.
Insider Trading. The Supreme Court has also applied Rule 10b-5 to prohibit insider trading, which is nowhere apparent from the text of the Rule. The literal words of 10b-5 certainly do not cover insider trading, because in general a failure to disclose material informaiton between participants in a market transaction does not constitute fraud. The Supreme Court has ruled, however, that insider trading is a form of 10b-5 fraud based on the fiduciary relationship of insiders to shareholders. An insider, such as an officer or director (an insider) has a duty to disclose material facts. Thus, the insider who trades with a shareholder (or prospective shareholder) based on inside information is committing a sort of "fraud" on that other person.
Types of Transactions Covered
Rule 10b-5 applies to transactions in the securities of public or private companies. However, an important limitation on 10b-5 is that it applies only in connection with the purchase or sale of a security. Thus. a person who says he or she was defrauded into not purchasing or not selling a security generally will not be able to assert a 10b-5 claim.
Unlike many provisions of the federal securities laws, the Supreme Court has implied a private right of action under Rule 10b-5. The private action, however, has additional elements that are not present in a SEC enforcement action.
Rule 10b-5 was promulagated by the Securities and Exchange Commission under the authority given to it in Section 10(b) of the Securities and Exchange Act of 1934.