Companies that are issuing securities should be mindful of the SEC’s rules on fraud and deceit (and comparable state securities laws and rules). The most notable of the SEC’s rules on fraud is Rule 10b-5, which prohibits any act or omission resulting in fraud or deceit in connection with the purchase or sale of any security. In particular, clause (b) of the Rule is important in the context of making statements and solicitations to investors and prospective investors; it states: “(It shall be unlawful for any person)…To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.” It should be noted that the Rule covers both statements, as well as omissions of facts (‘non-statements’, if you will). While making a false statement (or a misstatement) is prohibited, the Rule also prohibits omissions of material fact — leaving out information is just as bad. According to the Supreme Court, a fact is material “…if there is a substantial likelihood that a reasonable shareholder would consider it important…”. Therefore, if a company states that they are going to generate $1 million in revenue in the fiscal year when they’re only going to generate $500,000, that could be deemed a material misstatement; just as if they omitted to report that a client that represents 70% of its business is considering terminating its contract with the company, that could be deemed a material omission. Like many things, the general rule of thumb with materiality is that if you have to ask whether a fact is material or not, the answer is probably yes. Most importantly, in order for a successful Rule 10b-5 violation case to be brought, it must be alleged that the the defendant (usually the company/issuer and/or its directors/executives) have intentionally caused fraud or deceit, an element of the claim that the Supreme Court has termed ‘scienter’. It is not enough that a company negligently makes a material misstatement or omission; however, the Supreme Court has declined to decide whether “recklessness” fulfills the scienter standard, and the various federal appeals courts are all over the place on the issue — the Second Circuit has recognized ‘simple recklessness’, while the Ninth Circuit has recognized recklessness that reflects “some degree of intentional or conscious misconduct” that they termed ‘deliberate recklessness’, and the Eleventh Circuit has required ‘severe recklessness’ that they defined as “an extreme departure from the standards of ordinary care, and that present a danger of misleading buyers or sellers which is either known to the defendant or is so obvious that the defendant must have been aware of it”.