Manipulative, Deceptive or Fraudulent Devices
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 SEC Rule 10b-5
- How FINRA Rule 2020 mirrors 10b-5 for FINRA member firms
- OTC-specific anti-fraud rules (15c1-2 and 15c1-3)
- The difference between material misstatements, omissions, and fraudulent conduct
The Broad Anti-Fraud Rules
SEC Rule 10b-5
SEC Rule 10b-5 broadly 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: Rule 10b-5 is the catch-all anti-fraud rule. It covers lying, hiding the truth, and any scheme designed to deceive. If someone got hurt in a securities transaction through deception, 10b-5 probably applies.
FINRA Rule 2020
- Mirrors SEC Rule 10b-5 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 Rule 2020 and SEC Rule 10b-5 overlap significantly. The correct answer depends on context: if the question focuses on a FINRA member, the answer is Rule 2020. If it asks about securities fraud generally, the answer is Rule 10b-5.
OTC-Specific Rules
| Rule | What It Covers |
|---|---|
| SEC Rule 15c1-2 | Prohibits fraudulent conduct in over-the-counter (OTC) transactions |
| SEC Rule 15c1-3 | Prohibits non-member broker-dealers from making fraudulent representations |
Exam Tip: Gotchas
Rule 10b-5 applies to ALL securities (exchange-listed AND over-the-counter), while Rules 15c1-2 and 15c1-3 apply only to OTC transactions. If the question does not specify OTC, Rule 10b-5 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
- Rule 10b-5 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.