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 FINRA's 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 SEC's broad 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
FINRA's 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
| Source | What It Covers |
|---|---|
| SEC OTC antifraud rule | Prohibits fraudulent conduct in over-the-counter (OTC) transactions |
| SEC non-member misrepresentation rule | Prohibits non-member broker-dealers from making fraudulent representations |
Exam Tip: Gotchas
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 that you own shares personally (conflict of interest)
- 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.