Under the Securities Exchange Act of 1934, Rule 10b-5 is the principal antifraud rule used to prohibit insider trading.
The SEC adopted Rule 10b-5 under Section 10(b) of the Exchange Act. It broadly prohibits schemes to defraud, material misstatements or omissions, and fraudulent conduct in connection with buying or selling securities. Courts have applied the rule to insider trading when a trader misuses material, nonpublic information in breach of a duty of trust or confidence.
Rule 10b-5 is not limited to company officers. Liability can arise under the classical theory, involving insiders who trade in their company’s securities, or the misappropriation theory, involving outsiders who exploit confidential information obtained through a duty to its source. Tipping and trading by tippees can also raise issues of knowledge and breached duties.
A common mix-up is Rule 10b5-1. Adopted in 2000, that rule defines when a person is considered to trade “on the basis of” material nonpublic information and provides a conditional affirmative defense for certain prearranged trading plans. Rules 144, 506, and 701 address different securities-law matters.