What Is "Material" Information in Securities Fraud Cases??

In federal securities fraud cases, a fact is material if a reasonable investor would consider it important in making an investment decision. Materiality is not defined by any bright-line rule or formula; instead, what constitutes material information depends on the facts and circumstances of the specific case at hand.

The core question when determining materiality is whether disclosure (or omission) of the information at issue would have significantly altered the “total mix” of information available to the investor.

While showing materiality is a key part of establishing securities fraud (under Section 10(b) of the Securities Exchange Act, for example), it is only one element in the government’s (or a private plaintiff’s) case. Materiality alone does not establish any other element of liability, including falsity, scienter (intent to defraud), reliance, or loss causation.

In insider trading cases, the government must show that the defendant traded on information that was both material and nonpublic. However, as discussed above, nonpublic information may still be immaterial, which can be a viable defense if you’re facing allegations of trading on inside information.

The Private Securities Litigation Reform Act (PSLRA) imposes additional burdens for private plaintiffs in securities fraud litigation. It requires these plaintiffs to prove (with particularity) not only the defendant’s liability, but also that the information was material, and that it was false and attributable to the defendant. However, these are merely pleading standards, though they are often difficult to meet in practice.

How Does the Reasonable Investor Test Work in Practice?

The first thing to keep in mind is that the “reasonable investor” test is an objective one. It doesn’t matter if one particular investor (or group of investors) would have found the information important; what matters is whether the information would have been viewed as important by investors in general.

The U.S. Supreme Court’s decision in Basic Inc. v. Levinson (1988) is the seminal case here. The case involved allegations of securities fraud based on Basic’s failure to disclose its ongoing merger negotiations. Here, the Court rejected the idea of bright-line rules for when companies had to disclose contingent events. Instead, Basic adopted a “total mix” approach to determining materiality.

As a result of the “total mix” approach, in cases involving contingent events, events that may or may not come to pass in the future, courts will focus on two factors to assess materiality: (i) probability and (ii) anticipated magnitude. The more probable an event is to come to pass, the more material the information is likely to be, though the relationship isn’t strictly linear. However, even an event with a very low probability can be material if its anticipated magnitude is massive (i.e., if it has the potential to completely change the landscape for investors).

With this approach in mind, courts will assess materiality within the context of when the challenged statement was made. If the statement was made prior to the event at hand, the court will assess materiality by focusing on the probability and anticipated magnitude of the event as it appeared on the day the statement was made.

Additionally, vague corporate optimism, e.g. statements such as, “Our leadership team is among the best in the country, and our prospects are bright”, is generally treated as immaterial, non-actionable “puffery.” Such statements are typically regarded as too vague to be considered material, and investors are generally not entitled to rely on them when making an investment decision.

Can Courts Decide Materiality Before a Securities Fraud Trial?

In Matrixx Initiatives, Inc. v. Siracusano (2011), the U.S. Supreme Court rejected the idea that there needs to be some indication of statistical significance in order for an adverse event to be material. The Court noted that “materiality is a mixed question of law and fact, and the factfinder must decide, within the meaning of materiality’s general definition and relevant evidence, whether the disclosure of an adverse event would have significantly altered the total mix of information available to a reasonable investor.”

How important is evidence of a negative stock-price reaction?

Evidence of a negative stock-price reaction is relevant, and courts will frequently refer to it when determining materiality. However, as the Court’s decision in Matrixx Initiatives underscores, proving a negative stock-price reaction is not a prerequisite for proving materiality.

Can courts dismiss cases based on immateriality?

Yes, courts can (and often will) dismiss cases based on immateriality. However, this is generally limited to cases where the challenged statement (or omission) is “so immaterial that there can be no reasonable disagreement that it would not have significantly altered the total mix of information available to a reasonable investor.”

Is materiality considered a mixed question of law and fact?

Yes, materiality is considered a mixed question of law and fact. As a result, courts generally consider determining materiality to be the responsibility of the factfinder (i.e., a jury).

Can a defendant resolve the question of materiality at the summary judgment stage?

Yes, defendants can resolve the question of materiality at the summary judgment stage. However, again, this will typically be limited to cases where there is no reasonable jury that could disagree on materiality.

How does the SEC prove civil violations?

The SEC generally proves civil violations by a preponderance of evidence. In addition to proving its case by a preponderance of evidence, the SEC must also meet its burden of showing that each element of its claimed violation is present.

Can the SEC establish liability based on negligence?

Yes, in some cases the SEC can establish liability based on negligence. While most of the SEC’s claims will be under Section 10(b) of the Securities Exchange Act, it will also often file claims under Section 17(a)(2) and (3) of the Securities Act. If it can prove that the defendant acted negligently, it will be able to establish liability in each of these cases.

Spodek Law Group, led by managing partner Todd Spodek, defends clients in federal criminal and white collar matters.

When Does Silence Become a Materially Misleading Omission?

Under Rule 10b-5(b) of the Securities Exchange Act, it is prohibited to use any “device, scheme, or artifice to defraud,” or make any “untrue statement of a material fact or omit to state a material fact . .. in connection with the purchase or sale of any security.” This is a very broad prohibition, but it has substantial implications for defendants as well. For example, if you made an affirmative statement in connection with a securities transaction, you can be liable if that statement was materially false and you made it knowingly or with reckless disregard for its truth.

This prohibition also reaches the defendant’s failure to disclose information that makes any affirmative statements he or she made misleading. With this in mind, even if the statements he or she made were true in and of themselves, she or he may still be liable if she or he omitted material information, and omission made the statements that she or he did make misleading.

However, silencing your company’s material information is not, in itself, prohibited under Rule 10b-5(b). As explained in Macquarie Infrastructure Corp. v. Moab Partners, L.P., 601 U.S. 257 (2024), a private plaintiff cannot establish liability under Rule 10b-5(b) based solely on silence. The only exceptions in which silence alone constitutes securities fraud is if there was a pre-existing duty to disclose information. With this in mind, before you disclose information to the market, you have to determine if you have a duty to disclose. If you don’t have a duty to disclose, then you can remain silent.

The first step to determining if a statement is materially false is to determine if the statement made (or omitted) was false. While numbers can be false, words can be false, and even if the words in a statement are true in and of themselves, the completeness of the statement can be misleading. If the statement is incomplete, then this may constitute a misleading omission of material facts.

Does a Finding of Materiality Create an Affirmative Duty to Disclose?

No, a finding of materiality alone does not create an affirmative duty to disclose. While material non-disclosure can be misleading, you must have a duty to disclose information in order to face liability for remaining silent. And even then, you must also satisfy the other elements of liability. For example, liability under Section 10(b) of the Securities Exchange Act and Rule 10b-5 requires scienter. This means that a negligent nondisclosure is not sufficient to establish liability under Section 10(b) and Rule 10b-5. In order to be found liable, a defendant must know (or should know) that remaining silent is materially misleading. This requires that a defendant knows, or should know, that the nondisclosure is likely to be misleading to a reasonable investor.

What Are Common Examples of Materially False Disclosures?

If you are being accused of securities fraud, it is possible that the government believes you made any number of materially false disclosures. Examples include (but are by no means limited to):

• Falsely inflated (or falsely deflated) revenue, asset, liability, or risk figures. Any of these figures can distort a company’s financial reports to the point of making them materially misleading.
• Materially misleading press releases, media interviews, corporate letters, and social media posts. The government can use any of these forms of communication to establish liability for materially false disclosures. This liability is not limited to formal SEC filings such as quarterly and annual reports.
• Offering materials that misstate, omit, or mischaracterize the risks, expected performance, or expected returns of an investment.
• Materially misleading risk disclosures. As explained above, a misleading risk disclosure is more likely to be considered material when it describes a previously-realized event as though the event were merely hypothetical.
• Materially misleading quarterly and annual reports. Inaccurate revenue figures, misallocated expenses, misleading statements of managerial condition, and misleading statements of a company’s prospects, among other things, can make the quarterly or annual report materially misleading to a reasonable investor.
• False statements made to auditors and other third parties. False statements to auditors, brokers, investment advisors, other financial institutions, and other third parties can also be used to establish liability for accounting fraud.
• Any other form of a materially false disclosure. Section 11 and Section 12(a)(2) both impose liability for materially false disclosures. Section 11 imposes liability for material omissions and material inaccuracies in offering statements as well, and Section 12(a)(2) also imposes liability for offering statements that omit a material fact required by, or made material by, the omission.

Does Materiality Alone Prove a Securities Fraud Violation?

For a private plaintiff to establish liability under Rule 10b-5, the plaintiff must be able to prove more than materiality and falsity. Specifically, the plaintiff must be able to prove (to a preponderance of the evidence) the following elements: (i) reliance, (ii) economic loss, and (iii) loss causation.

How do the SEC and federal prosecutors prove liability in securities fraud cases?

Unlike private plaintiffs, the SEC generally does not need to show investor reliance or loss causation to prove liability for a securities fraud violation. Similarly, the SEC generally does not need to show that its target’s allegedly materially false disclosures caused losses for any particular investors. However, in order to establish liability (civil or criminal), the government must be able to show that its target acted with a sufficient level of culpability, i.e., with at least a negligent, reckless, or willful state of mind.

Along with the government’s burden of proving each element of the particular violation at hand, federal prosecutors must be able to prove each element beyond a reasonable doubt. This means that investor losses alone are not enough to establish securities fraud, because a defendant will not be able to be convicted in a criminal securities fraud prosecution unless the government is also able to show scienter beyond a reasonable doubt.

Do criminal insider trading prosecutions require proof of investor reliance or loss causation?

No, in addition to being unnecessary in these cases, investor reliance and loss causation are not elements of criminal prosecutions brought under Rule 10b-5.

How is criminal liability established under the Securities Exchange Act?

With respect to other criminal violations of the Securities Exchange Act, 15 U.S.C. § 78ff(a) establishes liability for any “willful violation of this title or any rule, regulation, or order issued pursuant to this title.” To show a willful violation, the government must be able to show that the defendant acted willfully and knowingly, which is a higher standard of culpability than is required in many civil and criminal cases.

Can the government establish liability for insider trading if the defendants traded on non-material or publicly-available information?

No, material nonpublic information is one of the elements the government must prove in order to establish liability for insider trading. However, along with the other elements of an insider trading violation (i.e., a breach of a fiduciary duty, a misappropriation of information, or misappropriating information), showing that an individual traded on material nonpublic information is not sufficient for establishing liability on its own.

Speak With a Federal Defense Lawyer

If you are dealing with any part of what this article describes, the next step is a conversation with a lawyer who handles these cases. Spodek Law Group is a second generation criminal defense firm practicing since 1976, representing clients nationwide from offices in New York, Brooklyn, Queens and Los Angeles. Call 212-300-5196 to speak with our team.