An Inquiry into the Perception of Materiality as an Element of Scienter Under SEC Rule 10b-5

In any private action or enforcement proceeding based on SEC Rule 10b-5 the plaintiff, including the Securities and Exchange Commission, must prove that the defendant engaged in deception or manipulation with scienter; that is, an intent to deceive, which lower courts have held encompasses reckless conduct. Where the gravamen of the claim is deception, the deception must have been material. A fact, including forward-looking information, is material if there is a substantial likelihood that a reasonable shareholder would consider the fact important in making his investment decision. This article demonstrates that in an appropriate case an assessment of whether the defendant acted with scienter should consider whether the defendant appreciated the materiality of an omitted or misrepresented fact. For example, an insider who traded in the securities of his employer while he was aware of nonpublic information should not be found to have acted with scienter, if before trading, he made a good-faith evaluation of that information, including (but not necessarily) consulting with counsel, and concluded that the information was not material, even though a trier of fact later found that the information was material when the trade occurred.