375 U.S. 180 (1963), 42, Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.
|Docket Nº:||No. 42|
|Citation:||375 U.S. 180, 84 S.Ct. 275, 11 L.Ed.2d 237|
|Party Name:||Securities and Exchange Commission v. Capital Gains Research Bureau, Inc.|
|Case Date:||December 09, 1963|
|Court:||United States Supreme Court|
Argued October 21, 1963
CERTIORARI TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Under the Investment Advisers Act of 1940, the Securities and Exchange Commission may obtain an injunction compelling a registered investment adviser to disclose to his clients a practice of purchasing shares of a security for his own account shortly before recommending that security for long-term investment and then immediately selling his own shares at a profit upon the rise in the market price following the recommendation, since such a practice "operates as a fraud or deceit upon any client or prospective client" within the meaning of the Act. Pp. 181-201.
(a) Congress, in empowering the courts to enjoin any practice which operates "as a fraud or deceit" upon a client, did not intend to require proof of intent to injure and actual injury to the client; it intended the Act to be construed like other securities legislation "enacted for the purpose of avoiding frauds," not technically and restrictively, but rather flexibly to effectuate its remedial purposes. Pp.186-195.
(b) The Act empowers the courts, upon a showing such as that made here, to require an adviser to make full and frank disclosure of his practice of trading on the effect of his recommendations. Pp. 195-197.
(c) In the light of the evident purpose of the Act to substitute a philosophy of disclosure for the philosophy of caveat emptor, it cannot be assumed that the omission from the Act of a specific proscription against nondisclosure was intended to limit the application of the anti-fraud and anti-deceit provisions of the Act so as to render the Commission impotent to enjoin suppression of material facts. Pp. 197-199.
(d) The 1960 amendment to the Act does not justify a narrow interpretation of the original enactment. Pp. 199-200.
(e) Even if respondents' advice was "honest," in the sense that they believed it was sound and did not offer it for the purpose of furthering personal pecuniary objectives, the Commission was entitled to an injunction requiring disclosure. Pp. 200-201.
306 F.2d 606 reversed and remanded.
GOLDBERG, J., lead opinion
MR. JUSTICE GOLDBERG delivered the opinion of the Court.
We are called upon in this case to decide whether, under the Investment Advisers Act of 1940,1 the Securities and Exchange Commission may obtain an injunction compelling a registered investment adviser to disclose to his clients a practice of purchasing shares of a security for his own account shortly before recommending that security for long-term investment and then immediately selling the shares at a profit upon the rise in the market price following the recommendation. The answer to this question turns on whether the practice -- known in the trade as "scalping" -- "operates as a fraud or deceit upon any client or prospective client" within the meaning of the Act.2 We hold that it does, and that the Commission may "enforce [84 S.Ct. 278] compliance" with the Act by obtaining an
injunction requiring the adviser to make full disclosure of the practice to his clients.3
The Commission brought this action against respondents in the United States District Court for the Southern District of New York. At the hearing on the application for a preliminary injunction, the following facts were established. Respondents publish two investment advisory services, one of which -- "a Capital Gains Report" --
is the subject of this proceeding. The Report is mailed monthly to approximately 5,000 subscribers who each pay an annual subscription price of $18. It carries the following description:
An Investment Service devoted exclusively to (1) The protection of investment capital. (2) The realization of a steady and attractive income therefrom. (3) The accumulation of CAPITAL GAINS thru the timely purchase of corporate equities that are proved to be undervalued.
Between March 15, 1960, and November 7, 1960, respondents, on six different occasions, purchased shares of a particular security shortly before recommending it in the Report for long-term investment. On each occasion, there was an increase in the market price and the volume of trading of the recommended security within a few days after the distribution of the Report. Immediately thereafter, respondents sold their shares of these securities at a profit.4 They did not disclose any aspect of these transactions to their clients or prospective clients.
On the basis of the above facts, the Commission requested a preliminary injunction as necessary to effectuate the purposes of the Investment Advisers Act of 1940. The injunction would have required respondents, in any future Report, to disclose the material facts concerning, inter alia, any purchase of recommended securities "within a very short period prior to the distribution of a recommendation . . . , " and "[t]he intent to sell and the sale of said securities . . . within a very short period after distribution of said recommendation. . . ."5
The District Court denied the request for a preliminary injunction, holding that the words "fraud" and "deceit" [84 S.Ct. 279] are used in the Investment Advisers Act of 1940 "in their technical sense," and that the Commission had failed to show an intent to injure clients or an actual loss of money to clients. 191 F.Supp. 897. The Court of Appeals for the Second Circuit, sitting en banc, by a 5-to-4 vote accepted the District Court's limited construction of "fraud" and "deceit" and affirmed the denial
of injunctive relief.6 306 F.2d 606. The majority concluded that no violation of the Act could be found absent proof that "any misstatements or false figures were contained in any of the bulletins"; or that "the investment advice was unsound"; or that "defendants were being bribed or paid to tout a stock contrary to their own beliefs"; or that "these bulletins were a scheme to get rid of worthless stock"; or that the recommendations were made "for the purpose of endeavoring artificially to raise the market so that [respondents] might unload [their] holdings at a profit." Id., 306 F.2d at 608-609. The four dissenting judges pointed out that "[t]he common law doctrines of fraud and deceit grew up in a business climate very different from that involved in the sale of securities," and urged a broad remedial construction of the statute which would encompass respondents' conduct. Id., 306 F.2d at 614. We granted certiorari to consider the question of statutory construction because of its importance to the investing public and the financial community. 371 U.S. 967.
The decision in this case turns on whether Congress, in empowering the courts to enjoin any practice which operates "as a fraud or deceit upon any client or prospective client," intended to require the Commission to establish fraud and deceit "in their technical sense," including
intent to injure and actual injury [84 S.Ct. 280] to clients, or whether Congress intended a broad remedial construction of the Act which would encompass nondisclosure of material facts. For resolution of this issue, we consider the history and purpose of the Investment Advisers Act of 1940.
The Investment Advisers Act of 1940 was the last in a series of Acts designed to eliminate certain abuses in the securities industry, abuses which were found to have contributed to the stock market crash of 1929 and the depression of the 1930's.7 It was preceded by the Securities Act of 1933,8 the Securities Exchange Act of 1934,9 the Public Utility Holding Company Act of 1935,10 the Trust Indenture Act of 1939,11 and the Investment Company Act of 1940.12 A fundamental purpose, common to these statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor, and thus to achieve a high standard of business ethics in the securities industry.13 As we recently said in a related context,
It requires but little appreciation . . . of what happened in this country during the 1920's and 1930's to realize how essential it is that the highest ethical standards prevail
in every facet of the securities industry. Silver v. New York Stock Exchange, 373 U.S. 341, 366.
The Public Utility Holding Company Act of 1935 "authorized and directed" the Securities and Exchange Commission "to make a study of the functions and activities of investment trusts and investment companies. . . ."14 Pursuant to this mandate, the Commission made an exhaustive study and report which included consideration of investment counsel and investment advisory services.15 This aspect of the study and report culminated in the Investment Advisers Act of 1940.
The report reflects the attitude -- shared by investment advisers and the Commission -- that investment advisers could not
completely perform their basic function -- furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments -- unless all conflicts of interest between the investment counsel and the client were removed.16
The [84 S.Ct. 281] report stressed that affiliations by investment
advisers with investment bankers or corporations might be "an impediment to a disinterested, objective, or critical attitude toward an investment by clients. . . ."17
This concern was not limited to deliberate or conscious impediments to objectivity. Both the advisers and the Commission were well aware that whenever advice to a client might result in financial benefit to the adviser -- other than the fee for his advice -- "that advice to a client might in some way be tinged with that pecuniary interest (whether consciously or) subconsciously motivated. . . ."18 The...
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