Beyond the specific manipulation schemes and insider trading, securities law contains broad anti-fraud provisions that prohibit any form of deception in securities transactions.
What You'll Learn
- The three categories of prohibited conduct under the SEC antifraud rule
- How the FINRA antimanipulation rule mirrors the SEC antifraud rule for FINRA member firms
- OTC-specific antifraud rules covering fraudulent conduct and non-member misrepresentations
- The difference between material misstatements, omissions, and fraudulent conduct
The Broad Antifraud Rules
The SEC Antifraud Rule
The broad SEC antifraud rule prohibits three categories of conduct in connection with the purchase or sale of any security:
- Making any untrue statement of a material fact; lying about something important
- Omitting a material fact that makes other statements misleading; leaving out information that changes the meaning of what you said
- Engaging in any act, practice, or course of business that operates as a fraud upon any person; any scheme or conduct designed to deceive
Think of it this way: The SEC antifraud rule is the catch-all. It covers lying, hiding the truth, and any scheme designed to deceive. If someone got hurt in a securities transaction through deception, the antifraud rule probably applies.
FINRA Antimanipulation Rule
- Mirrors the SEC antifraud rule for FINRA members specifically
- Prohibits the use of manipulative, deceptive, or other fraudulent devices
- Applies to all communications and conduct by FINRA member firms and their associated persons
Exam Tip: Gotchas
The FINRA antimanipulation rule and the SEC antifraud rule overlap significantly. The correct answer depends on context: if the question focuses on a FINRA member, the answer is the FINRA antimanipulation rule. If it asks about securities fraud generally, the SEC antifraud rule is the answer.
OTC-Specific Rules
These rules narrow from the broad "any person" scope. They apply specifically to brokers, dealers, and municipal securities dealers.
| Rule | Who It Covers | What It Prohibits |
|---|---|---|
| SEC OTC antifraud rule | Brokers, dealers, and municipal securities dealers | Fraudulent conduct in connection with over-the-counter (OTC) transactions |
| SEC non-member misrepresentation rule | Brokers, dealers, and municipal securities dealers | Making fraudulent representations about the firm's registration or the merits of any security |
Exam Tip: Gotchas
- Scope is the tested difference: The broad SEC antifraud rule covers any person in connection with the purchase or sale of any security. The OTC-specific antifraud rules cover only brokers, dealers, and municipal securities dealers. When the question asks about the OTC antifraud rule, the answer is broker-dealers, not any person.
- The SEC antifraud rule applies to ALL securities (exchange-listed AND over-the-counter), while the OTC-specific antifraud rules apply only to OTC transactions. If the question does not specify OTC, the broad antifraud rule is the safer answer.
Key Concepts
- Material misstatement: Telling a customer that a bond is "risk-free" when it carries credit risk
- Material omission: Recommending a stock without disclosing a significant personal position in it (conflict of interest). A large personal stake gives the broker a financial incentive to see the price rise, which is information a reasonable investor would want before acting on the recommendation. Not every personal holding requires disclosure; only a position large enough to represent a meaningful conflict of interest triggers that obligation.
- Fraudulent course of business: Operating a Ponzi scheme or systematic overcharging of commissions
Exam Tip: Gotchas
- The SEC antifraud rule covers OMISSIONS as well as affirmative misstatements. A broker who stays silent about a material fact can be just as liable as one who actively lies. The test is whether the omission makes other statements misleading.
- An omission is only a violation if it makes other statements misleading. Simply not volunteering information is not always a violation.