Securities Law and Shortzilla
1. Rule 10b-5 (the most widely-used Rule by the SEC to combat fraud)
Rule 10b-5: Employment of Manipulative and Deceptive Practices: “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.”
2. Item 101(c) of SEC Regulation S-K requires companies to describe certain matters “if and to the extent material to an understanding of the registrant’s business taken as a whole.”
SEC rules and regulations require companies to disclose all information that is material to investors. According to the SEC, the standard for materiality is: “a substantial likelihood that disclosure would be viewed by the reasonable investor as having significantly altered the total mix of information made available”. And, even more importantly, the SEC has emphasized that “if there is any doubt to whether something is material or not, it should be resolved in favor of the investor and, thus, disclosed.
The US Supreme Court has held that a fact is material if there is a substantial likelihood that the fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.
4. Title 18, United States Code, Section 1001
Title 18, United States Code, Section 1001 makes it a crime to: 1) knowingly and willfully; 2) make any materially false, fictitious or fraudulent statement or representation; 3) in any matter within the jurisdiction of the executive, legislative or judicial branch of the United States. Though the falsehood must be “material” this requirement is met if the statement has the “natural tendency to influence or [is] capable of influencing, the decision of the decision making body to which it is addressed.”
Rule 10b-5 attaches to all communications by and between a public company and a member of the public. These communications include, but are not limited to, regulatory reports filed with (or submitted to) the SEC and statements made at investor conferences and with analysts. Title 18, on the other hand, is expressly limited to statements made in connection with any matter within the jurisdiction of the executive, legislative or judicial branch of the US; which includes statements made to any employee of the SEC or other Federal Regulatory Agency.
It is noteworthy that the SEC has made it clear that a public company cannot arbitrarily determine that a statement is not material. If the SEC permitted companies to determine what is, and is not, material to investors—they would roam unbridled over the public and withhold any material information that could reveal fraudulent practices. This theory is supported in Rule 10b-5 wherein the rule is violated if the company: makes “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.