“Materiality”: The “Reasonable Investor” Standard Applies Under Both Section 1348 And 10(b)5
In recent years, DOJ prosecutors have weaponized Title 18 USC 1348 - the securities fraud statute enacted as part of Sarbanes Oxley - to charge defendants with a wide array of conduct that may not be actionable under the more “traditional” securities fraud statutes (such as Title 15, 10(b)(5) - the statute used most by the Securities and Exchange Commission (SEC) to charge “traditional” securities fraud). Part of the reason that the DOJ has been doing this is to attempt to sweep in a lot of alleged false statements and conduct - insider trading, pump and dump schemes, or social media touting of securities - that may not be actionable under Title 15 because a hypothetical “reasonable investor” would not find various statements or actions to be material.
One example of this is the Atlas Trading case involving statements made on Twitter and Discord, where charges against the defendants were recently dismissed (on other grounds). “Reasonable investors” would not (for obvious reasons) find such social media posts material, so the DOJ switched gears and employed Section 1348 in attempt to circumvent that standard.
The DOJ has typically argued that Section 1348 has a lower materiality standard than 10b5 because materiality under the Title 18 fraud statutes is framed in terms of a statement (or omission) as being material if it has a “natural tendency to influence a decision-maker.” Prosecutors have seized on that language and have interpreted that as basically encompassing every statement that can lead any person to take action (or think about taking action) as a result of that statement. This blog post takes issue with prosecutors’ assessment of Section 1348 materiality, and argues that both statutes have the same strict materiality standard - that of the “reasonable investor.”
A. The 10b-5 “Reasonable Investor Standard for Materiality
As every law student knows, for an omission or statement to be actionable, it must be material to a “reasonable investor.” See Basic Inc. v. Levinson, 485 U.S. 224 (1988). For decades, courts have applied the following standard, derived from Levinson, to assess whether information is material to a securities transaction:
To be actionable as securities fraud, a misrepresentation or omission of a fact, must be material. A misrepresentation is “material” if there is “a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision.” An omission is “material” if there is “a substantial likelihood that disclosure would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.”
Critically, this “materiality” standard is objective, not subjective. Rougier v. Applied Optoelectronics, Inc, No. 4:17-CV-2399, 2019 WL 6111516, at *8 (S.D. Tex. Mar. 27, 2019). This means that how an individual investor views the statements does not really matter - it is how a hypothetical “reasonable” investor would view the information that is critical. The SEC’s primary weapon against securities fraud is Section 10(b)(5) of Title 15, which uses the “reasonable investor” standard.
B. The Applicable “Materiality” Standard in Title 18 Fraud Cases
In Neder v. United States, 527 U.S. 1, 16 (1999), the Supreme Court made clear that “materiality” was an important element of the federal fraud laws contained in Title 18. The Neder Court defined materiality as being a false statement that has a “natural tendency, or [is] capable of influencing, the decision of the decision making body to which it was addressed.” In short, the Supreme Court stressed that in determining “materiality,” one must analyze it in the context of the “decision making body” to whom the statement was addressed. This makes sense. Not surprisingly, pattern jury instructions have largely followed Neder. For example:
Ninth Circuit: Materiality (for immigration fraud) means that a statement had a natural tendency to influence, or was capable of influencing, the agency’s decisions or activities;
Sixth Circuit: Following Neder and specifically noting that the statement must influence the decision of the decision making body to whom it was addressed.
This definition, which uses the term “decision making body” is critical in many cases. Typically, the Government will argue that with Title 15 securities fraud, the objective "reasonable investor” standard applies, but with Title 18 securities fraud, the standard is much lower. The DOJ argues that it need only prove that people’s decisions were influenced or that the statements were capable of influencing. This can have major consequences. For example, in the Atlas Trading case, which Dynamis succeeded in getting dismissed, the DOJ argued that all Twitter followers of the defendants were the “decision-making body” to whom the allegedly false tweets were addressed.
The defense rejected that position, arguing that that regardless of on what medium the statements were made (i.e. on Twitter or Reddit), the decision makers were still "investors”. Just because the people buying and selling stock consumed content on social media, that does not mean that they are not “investors.” And, clearly, to the extent that various tweets were aimed at anyone, they would have been aimed at potential purchasers of stock, rather than the Twitter audience at large.
Frequently, it is important to point out, the Government will often allege in the Indictment who the “decision maker” actually is. This helped us in the Atlas Trading case, where the Indictment stated in paragraph 14 as follows:
“the Defendants “messages were false and misleading, and omitted material information, because the defendants concealed their intent to use these messages to induce other investors to purchase the securities so that defendants could sell their shares at a higher price at and around the time of the messages.”
Thus, by the Government’s own charging instrument, the alleged decision makers were “other investors” and not just all Twitter followers. Moreover, because the test for materiality is an “objective” one, if the decision-maker is an investor, then materiality must naturally point to “reasonable investors.” See, e.g., United States v. Jonas, 824 F. App’x 224, 232 (5th Cir. 2020) (“[t]he natural-tendency test is an objective one focused on whether the statements is of a type capable of influencing a reasonable decision maker …”).
Hence, its not a stretch to argue that regardless of whether securities fraud is charged under Title 15 or Title 18, the “reasonable investor” standard applies.
In short - Defense counsel should insist that the decision-making body be defined in jury instructions under Section 1348 as being “reasonable investors” and not just the public writ large.
C. The Bank Fraud Statute, 18 U.S.C. § 1344, Confirms That There is a “Reasonable Investor” Standard For Title 18 Securities Fraud
The federal bank fraud statute further confirms that the jury instructions for securities fraud under Section 1348 must define the decision-maker as a “reasonable investor.” Section 1348 is nearly identical to the bank fraud statute.
The bank fraud statute (18 U.S.C. § 1344) provides that:
Whoever knowingly executes, or attempts to execute, a scheme or artifice¾
1) To defraud a financial institution; or
2) To obtain any of the moneys, funds, credits, assets, securities, or other property owned by, or under the custody or control of, a financial institution, by means of false or fraudulent pretenses, representations, or promises …
The securities fraud statute (18 U.S.C. § 1348) is nearly identical to the bank fraud statute (although it is limited to publicly traded securities and commodities):
Whoever knowingly executes, or attempts to execute, a scheme or artifice—
1) to defraud any person in connection with any commodity for future delivery, or any option on a commodity for future delivery, or any security …
2) to obtain, by means of false or fraudulent pretenses, representations, or promises, any money or property in connection with the purchase or sale of any commodity for future delivery, or any option on a commodity for future delivery, or any security …
Notably, in bank fraud cases, courts have largely used the “reasonable bank” standard of materiality, which makes sense as the decision-maker is the “bank.” See, e.g., United States v. Williams, 865 F.3d 1302, 1313 (10th Cir. 2017) (applying reasonable bank standard); United States v. Casher, 2020 WL 2557849, *3 (D. Montana 2020) (citing to “reasonable bank” standard); United States v. Raza, 876 F.3d 621 (4th Cir. 2017) (“[T]he correct test for materiality ... is an objective one, which measures a misrepresentation’s capacity to influence an objective ‘reasonable lender,’”); see also United States v. Lindsey, 850 F.3d 1009, 1015 (9th Cir 2017) (“a false statement is material if it objectively had a tendency to influence, or was capable of influencing, a lender to approve a loan”).
In other words, courts specify in appellate court approved jury instructions that the relevant type of “reasonable person” or “decisionmaker” for “bank fraud” is a “bank” or “lender,” as opposed to an amorphous person. That specific instruction prevents speculation or confusion by a jury needlessly assessing what type of “person” is the relevant “decision-maker.” The same concept applies here: the decision maker for jury instructions purposes should be the “reasonable investor” because statements encouraging people to buy securities are aimed at investors.
D. The Reasonable Investor Standard in Title 18 comports with Section 10(b)(5)
Under both statutes—and as described—a misrepresentation or omission in connection with a securities transaction must be “material” to be actionable.
Liability under Section 10(b), for example, requires proof of “a material misrepresentation or omission by the defendant.”
Liability under Section 1348 requires proof “[t]hat the scheme to defraud employed false material representations.” Under both statutes, the material representation must be “in connection with” a “security.”
Consequently, when enacting Section 1348 in 2002 and amending the statute in 2009, Congress had full knowledge of the jurisprudence regarding the “materiality” standard in connection with securities transactions. See, e.g., United States v. Blaszczak, 56 F.4th 230, 249 (2d Cir. 2022) (“Congress enacted § 1348 with full knowledge of the jurisprudence regarding insider trading violations under Title 15. And, in 2009, when Congress amended the statute, Congress broadened its scope to include schemes to defraud that involved commodities futures.”). More specifically, Congress had notice of the definition of “materiality” for securities transactions
Thus, when passing Section 1348, Congress knew of that universal definition for “materiality” in the context of securities transactions and securities fraud under Section 10(b). If Congress had intended to change that materiality standard—such that traditionally unimportant information could be material if, for example, an unreasonable Twitter follower subjectively considered the information to be important—then Congress could have and would have made the change when enacting Section 1348 in 2002 or when amending Section 1348 in 2009.
But it makes rationale sense for Congress to have kept the materiality standard the same. If Title 15 and Title 18 impose different materiality requirements for securities transactions, then investors and other participants in the securities industry will face confusing, inconsistent obligations. For example, the same piece of information given to the same person in connection with the same securities transaction could be both immaterial (under Title 15) and material (under Title 18) to that securities transaction. For example, if a social media influencer said to his Twitter followers that a certain company had “strong sales” or “is poised for growth,” the statement would be inactionable puffery and immaterial as a matter of law to the investor’s purchase of the company stock. Decades of jurisprudence confirm that investors should not rely on that type of information. And a case under Section 10(b)—whether civil or criminal—would be dismissed pursuant to reams of binding precedent. Yet, the Government has consistently argued, inaccurately, that, under Section 1348, that same exact statement could be material to that same transaction (if the investor is sufficiently foolish). This inconsistency makes no sense and proves unworkable. Counsel should make this distinction clear when arguing jury instructions in court.
In sum, prosecutors try to “dumb down” materiality by charging Title 18 securities fraud, thinking that they can turn immaterial statements into material ones by utilizing a different statute. Don’t let them.
