Should the Securities Exchange Act and 18 U.S.C. § 1348 Have the Same “Materiality” Standard?

Section 10(b) (and Rule 10b-5 promulgated thereunder) and Section 1348—both of which apply to securities transactions—have undeniable parallels and differences.

Under both statutes, 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.” Genesee Cnty. Employees’ Ret. Sys. v. FirstCash Holdings Inc., 667 F. Supp. 3d 295, 306 (N.D. Tex. 2023) (citing Mun. Emps.’ Ret. Sys. of Mich. v. Pier 1 Imps., Inc., 935 F.3d 424, 429 (5th Cir. 2019)). Liability under Section 1348 requires proof “[t]hat the scheme to defraud employed false material representations.” United States v. Baker, No. A-13-CR-346-SS, 2017 WL 4853811, at *3 (W.D. Tex. Oct. 26, 2017), aff’d, 912 F.3d 297 (5th Cir. 2019), opinion amended and superseded on denial of reh’g, 923 F.3d 390 (5th Cir. 2019), and aff’d, 923 F.3d 390 (5th Cir. 2019). Under both statutes, the material representation must be “in connection with” a “security.” See, e.g., FirstCash Holdings Inc., 667 F. Supp. 3d at 306 (stating that one element under Section 10(b) is “a connection between the misrepresentation or omission and the purchase or sale of a security”); United States v. Constantinescu, No. 4:22-CR-612, 2023 WL 5628607, at *3 (S.D. Tex. Aug. 31, 2023) (noting that Section 1348 “criminalizes . . . conduct . . . in connection with the purchase or sale of a security”). Thus, Section 10(b) and Section 1348 both require misrepresentations (or omissions) that have a nexus to securities and that are “material.”

However, the statutes diverge as to three components. First—although both statutes require a connection to securities—Section 10(b) “requires the use of an instrumentality of interstate commerce in connection with a purchase or sale of a security, which is not a requirement of a violation of § 1348.” United States v. Jun Ying, No. 1:18-CR-74-AT, 2018 WL 6322308, at *6 (N.D. Ga. Dec. 4, 2018). Second, Section 10(b) “requires . . . proof that a Defendant acted willfully, whereas a violation of § 1348 does not.” Id. Third, “securities fraud under [Section 10(b)] does not have a money or property element, whereas securities fraud under 18 U.S.C. § 1348 does require a scheme to obtain money or property, as do mail and wire fraud.” Id.

Those differences do not—and should not—extend to the definition of “materiality” in connection with securities transactions. Nonetheless, prosecutors have argued, since the statute was first passed approximately 20 years ago, that Section 1348 imposes a different materiality standard than that posed by Section 10(b). This should not be. For the reasons stated below, courts should discredit that position and, instead, apply the same materiality standard under Section 10(b) and Section 1348. 

A. When Drafting Section 1348, Congress Implicitly Adopted the Existing Standard for Assessing “Materiality” in Connection With Securities Transactions

“Congress is presumed to have acted against a background of shared understanding of the terms it uses in statutes.” Chamber of Com. of United States of Am. v. United States Dep’t of Lab., 885 F.3d 360, 373 (5th Cir. 2018) (citing Morissette v. United States, 342 U.S. 246, 263 (1952)); see also Miles v. Apex Marine Corp., 498 U.S. 19, 32 (1990) (“We assume that Congress is aware of existing law when it passes legislation.”); Goodyear Atomic Corp. v. Miller, 486 U.S. 174, 184–85 (1988) (“We generally presume that Congress is knowledgeable about existing law pertinent to the legislation it enacts.”).

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: (1) the definition of “materiality” for securities transactions; and (2) categories of information that, as a matter of law, cannot be material to a securities transaction.

1. The long-held definition of “materiality” for securities transactions

For decades, courts have applied the following standard 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.”

Genesee Cnty. Employees’ Ret. Sys. v. FirstCash Holdings Inc., 667 F. Supp. 3d 295, 314 (N.D. Tex. 2023) (cleaned up) (quoting Basic Inc. v. Levinson, 485 U.S. 224, 231 (1988) and Kapps v. Torch Offshore, Inc., 379 F.3d 207, 216 (5th Cir. 2004)).

Critically, that “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) (“[T]he question of materiality is an objective one that requires the plaintiff to establish that there was a substantial likelihood that the disclosure of the omitted facts would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” (quoting Basic, 485 U.S. at 231-32)). This standard presents a high bar, one that prosecutors may not be able to meet in evaluating certain cases, particularly ones involving social media, where people trading on the basis of tweets or DMs do not, as a matter of law, fall under the “reasonable investor” rubric. 

2. Categories of information that, as a matter of law, are never material to a securities transaction

Although “[t]he materiality analysis typically presents a mixed question of fact and law and is generally a decision for the jury[,] . . . representations can at times be determined immaterial as a matter of law on review of a motion to dismiss.” Nykredit Portefolje Admin. A/S v. Propetro Holding Corp., No. MO:19-CV-217-DC, 2021 WL 9037758, at *15 (W.D. Tex. Sept. 13, 2021) (cleaned up). Federal courts, therefore, have identified certain categories of information that, as a matter of law, cannot be material to a reasonable investor:

Applying these principles, courts have found that corporate cheerleading in the form of generalized positive statements about a company’s progress is not a basis for liability under the securities laws. A statement of the vague and optimistic type cannot support a securities fraud action because it contains no concrete factual or material misrepresentation. Generalized positive characterizations are not actionable under the securities laws. No reasonable investor would consider such statements material and investors and analysts are too sophisticated to rely on vague expressions of optimism rather than specific facts. The statements the plaintiffs rely on must be something more than a corporate officer’s generalized optimistic comments about the company’s policies, programs, or performance. As in other areas of the law, puffery is not actionable.

Delaware Cnty. Emps. Ret. Sys. v. Cabot Oil & Gas Corp., No. CV H-21-2045, 2024 WL 83503, at *4 (S.D. Tex. Jan. 8, 2024) (cleaned up).

Stated differently, “[g]eneral statements about corporate progress are too squishy, too untethered to anything measurable, to communicate anything that a reasonable person would deem to be important to a securities investment decision.” Talarico v. Johnson, No. 4:21-CV-3689, 2023 WL 2618255, at *12 (S.D. Tex. Feb. 7, 2023) (cleaned up); see also Magruder v. Halliburton Co., 359 F. Supp. 3d 452, 461 (N.D. Tex. 2018) (“As a preliminary matter, the Court addresses misrepresentations alleged in the SAC that are not actionable. Generalized, positive statements about a company, such as the company’s competitive strengths, experienced management, and future prospects, are immaterial as a matter of law.”). Additionally, “[t]he term ‘puffery’ can also refer to predictive or forward-looking statements that neither rise to the level of a guarantee nor include a specific statement of fact.” Edwards v. McDermott Int’l, Inc., No. 4:18-CV-4330, 2021 WL 1421609, at *8 (S.D. Tex. Apr. 13, 2021).

Courts have even held that inaccuracies in a company’s financial statements were immaterial to investors as a matter of law. See Budde v. Glob. Power Equip. Grp., Inc., No. 3:15-CV-1679-M, 2018 WL 4623108, at *6 (N.D. Tex. Sept. 26, 2018), aff’d, 775 F. App’x 770 (5th Cir. 2019) (“As the restatement showed, the change in Global Power’s 2013 financial results attributable to the ES Segment’s accounting errors at issue is 2.36% (for total revenue) or 0.0001% (for total cost). No reasonable investor would consider such information important in making a decision to invest.”).

Simply put, courts have determined that those categories of information are “so obviously unimportant to an investor that reasonable minds cannot differ on the question of materiality.” Nykredit Portefolje Admin. A/S v. Propetro Holding Corp., No. MO:19-CV-217-DC, 2021 WL 9037758, at *15 (W.D. Tex. Sept. 13, 2021); see also Magruder v. Halliburton Co., 359 F. Supp. 3d 452, 461 (N.D. Tex. 2018) (“Lesar’s statement was also devoid of actual ‘facts’ that are typically digested by the market in evaluating a company’s worth, and statements that Halliburton had an ‘outstanding year’ and that ‘our patient investors will be rewarded’ are immaterial as a matter of law.”). This is important, as it eliminates a vast swath of potential conduct from the grasp of aggressive regulators. 

3. When Enacting Section 1348, Congress Did Not Change Those Standards

Despite that precedent, prosecutors have argued that, under Section 1348, any misrepresentation can be material if it is “capable of influencing” a specific investor—regardless of whether that investor is reasonable or unreasonable. See United States v. Greenlaw, 84 F.4th 325, 337 (5th Cir. 2023) (“A misrepresentation is material if it has a natural tendency to influence, or is capable of influencing, the decision of the decision-making body to which it was addressed.”)). Puffery, for example, would be material if stated to an unreasonable investor known to rely on puffery when investing. This has the potential to be a far lower standard than the 10(b)-5 standard. 

But Congress did not make those changes. When passing Section 1348, Congress knew the ubiquitous definition of “materiality” in the context of securities transactions under Section 10(b). Indeed, federal district and appellate courts, including the Supreme Court, collectively applied that definition before and after Section 1348 was enacted. If Congress had intended to change that materiality standard—such that traditionally unimportant information could be material if an unreasonable shareholder subjectively considered the information to be important—then Congress would have made the change when enacting (in 2002) or amending (in 2009) Section 1348. Simply put, Congress did not change decades of jurisprudence applying a uniform definition of “materiality” for securities transactions.

B. The Securities Markets Cannot Function Properly If the “Materiality” Standard Varies Between Federal Statutes

From a policy perspective, it is untenable if Section 10(b) and Section 1348 impose discrepant materiality standards. Under those circumstances, the same piece of information could be both immaterial (e.g., under Section 10(b)) and material (e.g., under Section 1348) to the same securities transaction. For example, if the CEO of ABC Corp. stated that the company has “strong sales” and “is poised for growth,” the statement would be inactionable puffery and immaterial as a matter of law to investors. The law confirms that investors should not rely on that type of information and that Section 10(b) would not impose civil or criminal liability even if those statements were untrue. Under Section 1348, however, prosecutors have argued that the same statement by the CEO could be material if the CEO knows that a foolish, unreasonable investor is likely to rely on those statements of puffery. 

In that context, the long-standing objective materiality standard under Section 10(b) would be moot. Every company, executive, or analyst speaking about the company’s performance or plans would have to assume that any piece of information—no matter how objectively unimportant—could be deemed material and, in turn, criminally actionable. Any stakeholder seeking to speak about securities, without criminal exposure for securities fraud, would have to ignore the Supreme Court’s guidance in Basic v. Levenson and its progeny. Those stakeholders would have to treat puffery as potentially material and actionable, regardless of what federal courts have consistently held about that same issue. 

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In sum, federal law has historically defined what is “material” to securities transactions. Section 1348 changed the scope of securities fraud in some respects but was silent as to any change to the “material” definition. If Congress had intended to fundamentally change what is “material” to securities transactions, Congress could and would have said so. Finally, it is unworkable for speakers, insiders, analysts, buyers, and sellers of securities to face inconsistent standards as to the type of information that can be material to securities transactions. Hence, the long-standing definition under Section 10(b) should also apply under Section 1348.  Defense attorneys should not concede anything with respect to materiality.