Section 1348 Defense: Fighting Federal Criminal Charges for Securities Fraud

Section 1348 is the federal securities fraud statute. While the Department of Justice (DOJ) also has other options for pursuing criminal charges in securities fraud cases, the breadth and simplicity of Section 1348 makes it one of the DOJ’s go-to tools for criminal enforcement. With that said, there are several potential defenses to criminal culpability, and companies and individuals that are facing prosecution should promptly engage experienced legal counsel to find out what defenses they have available.

The federal government has the ability to pursue administrative, civil, and criminal enforcement proceedings in securities fraud cases. While all three types of enforcement proceedings can pose substantial risks, criminal fines can be enormous, and individuals prosecuted for securities fraud can face federal prison time. As a result, the Department of Justice (DOJ) aggressively pursues criminal charges when warranted; and, in these cases, defendants must be prepared to defend themselves by all means available.

Increasingly, the DOJ is relying on 18 USC Section 1348 to pursue criminal charges for securities fraud.

There are a couple of reasons why. First, while multiple federal statutes allow for criminal prosecution in cases involving securities fraud allegations, Section 1348 carries up to a 25-year prison term for corporate insiders and other individuals. This is the longest potential sentence for securities fraud under federal law (though 18 USC Section 1349 imposes the same maximum sentence for attempt and conspiracy). Second, while the DOJ’s other primary tool for prosecuting securities fraud—Section 32 of the Securities Exchange Act of 1934—requires evidence of willfulness, Section 1348 allows for criminal prosecution in cases involving “knowing” violations.

What Are the Elements of a Federal Securities Fraud Case Under Section 1348?

Section 1348 has two operative provisions. Both of these provisions address multiple forms of securities fraud, and violations of both provisions carry the same potential penalties. The first operative provision is Section 1348(1). Under this portion of the statute:

“Whoever knowingly executes, or attempts to execute, a scheme or artifice—(1) to defraud any person in connection with . . . any security of an issuer with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 . . . or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 . . . shall be fined under this title, or imprisoned not more than 25 years, or both.”

The second operative provision is Section 1348(2). Under this portion of the statute:

“Whoever knowingly executes, or attempts to execute, a scheme or artifice—(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 security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 . . . or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 . . . shall be fined under this title, or imprisoned not more than 25 years, or both.”

When read together, Section 1348(1) and Section 1348(2) establish three key elements of a federal securities fraud case. To secure a conviction in federal court, the DOJ must be able to prove:

1. A Scheme or Artifice to Defraud or Obtain Money or Property By False or Fraudulent Pretenses

To establish criminal culpability under Section 1348, the DOJ must be able to prove either “a scheme or artifice . . . to defraud,” or “a scheme or artifice . . . to obtain . . . money or property” by false or fraudulent pretenses. While there is a significant amount of overlap between these two distinct grounds for prosecution, there are circumstances in which either only Section 1348(1) or only Section 1348(2) will apply.

Broadly, however, some examples of common “scheme or artifice” allegations in federal securities fraud cases under Section 1348 include:

• Corporate accounting fraud
• Making false or misleading statements online (including on social media)
• Publishing incomplete or inaccurate corporate disclosures
• Insider trading
• Market manipulation schemes

These allegations, among others, can create criminal exposure for both corporate and individual defendants. When accused of executing a scheme or artifice to defraud or to obtain money or property by false or fraudulent pretenses, it is critical to build a defense strategy focused on the specific allegations at hand. While there are several defenses to each of the allegations listed above, avoiding a conviction in federal court requires a clear understanding of the specific defenses that are applicable to the specific allegations that the DOJ has elected to pursue.

2. Nexus to a Federally Regulated Security

Establishing criminal culpability under Section 1348 also requires evidence of a “nexus” to a federally regulated security. This will generally be the easiest element for the DOJ to prove, and it will be self-evident in many cases. With that said, when facing criminal charges in federal court, it is important not to make any assumptions about what prosecutors may (or may not) be able to prove. If the alleged conduct at hand falls outside of the scope of Section 1348’s prohibition against securities fraud, then a conviction under Section 1348 is unwarranted.

With that said, while we are focusing specifically on securities fraud in this article, Section 1348 covers commodities fraud as well. As a result, cases involving allegations related to prediction markets and digital assets that do not qualify as securities can also lead to prosecution in federal district court.

3. “Knowing” Conduct

The third element of a criminal securities fraud case under Section 1348 is “knowing” conduct. Proving that a defendant acted “knowingly” requires less than proving that a defendant acted “willfully”—as required under Section 32 of the Securities Exchange Act (15 USC Section 78ff).

In cases targeting individuals, the DOJ must be able to prove that the individual defendant had actual or constructive knowledge that they were engaging in fraudulent conduct. In cases targeting companies, individuals’ knowledge can be imputed to corporate entities in appropriate circumstances. The standards for establishing “corporate knowledge” vary between federal jurisdictions, and the relevant standard can play a critical role in determining whether disputing the DOJ’s evidence of actual or constructive knowledge is a viable defense strategy.

What Are Some Potential Defenses to Criminal Securities Fraud Charges Under Section 1348?

Generally, defending against criminal securities fraud charges under Section 1348 involves challenging the DOJ’s ability to prove one or more of the elements discussed above. If the DOJ cannot prove any of these elements beyond a reasonable doubt, then criminal penalties should not be imposed.

However, as we mentioned earlier, the specific defenses that are available in any particular case will depend on the specific circumstances involved. With this in mind, here are some examples of potential defenses to the common “scheme or artifice” allegations listed above:

Corporate Accounting Fraud

Securities issuers accused of engaging in accounting fraud can defend against these allegations by challenging the DOJ’s allegations that they acted knowingly and with the intent to defraud investors. In many cases, demonstrating due diligence in choosing outside accountants and relying on outside professional advice can be viable defenses to criminal culpability as well.

Making False or Misleading Statements Online (Including on Social Media)

When accused of making false or misleading statements online (including on social media), corporate and individual defendants can assert lack of knowledge of falsity, among other defenses. Here too, asserting good faith can be a viable defense strategy as well—though good-faith errors and omissions can still trigger administrative or civil liability.

Publishing Incomplete or Inaccurate Corporate Disclosures

In these cases, challenging the DOJ’s allegations that an issuer’s public disclosures are materially incomplete or inaccurate will often be a core element of the issuer’s defense. But, here too, challenging the DOJ’s evidence of knowledge (including, but not limited to, by showing reliance on professional advice) can also be a key defense strategy.

Insider Trading

Insider trading cases under Section 1348 are complex; and, as a result, there are a variety of potential defenses available. These defenses range from disputing the DOJ’s evidence of “insider” knowledge to raising questions about the materiality of the information at issue and demonstrating that similar information was available from other sources.

Market Manipulation Schemes

When pursuing criminal prosecution in cases involving market manipulation schemes (including pump-and-dump schemes), the DOJ must be able to prove that the defendant’s efforts were sufficient to impact the price of the securities involved while also having an impact on investors’ decision-making. If the DOJ cannot prove all elements of its case beyond a reasonable doubt, then a conviction is unwarranted regardless of the underlying circumstances of the case.

Contact the Federal Securities Fraud Defense Attorneys at Oberheiden PC

The federal securities fraud defense attorneys at Oberheiden PC provide experienced legal representation for corporate and individual defendants facing scrutiny under Section 1348. If you need experienced defense counsel, call 888-680-1745 or contact us online to schedule a complimentary initial consultation today.