SECURITIES & EXCH. COM. v. Capital Gains Research Bureau

Decision Date13 July 1962
Docket NumberNo. 30,Docket 26942.,30
CourtU.S. Court of Appeals — Second Circuit

David Ferber, Associate Gen. Counsel, Securities and Exchange Commission, Washington, D. C. (Peter A. Dammann, Gen. Counsel, Ellwood L. Englander, Sp. Counsel, Walter P. North, Asst. Gen. Counsel, Ned B. Stiles, John Frohling and Allan F. Conwill, of counsel, Securities and Exchange Commission, Washington, D. C., on the brief), for appellant.

Leo C. Fennelly, New York City (Fennelly, Douglas, Eagan, Nager & Voorhees, New York City, on the brief), for appellees.


Rehearing in Banc February 22, 1962.

MOORE, Circuit Judge.

Plaintiff (appellant), Securities and Exchange Commission (SEC) in its complaint, alleging violation of Section 206(1) and (2) of the Investment Advisers Act of 1940, 15 U.S.C.A. 80b-6(1) and (2), sought a temporary restraining order, preliminary injunction and final injunction against defendants (appellees), Capital Gains Research Bureau, Inc., and Harry P. Schwarzmann, to prevent them from employing "any device, scheme, or artifice to defraud any client or prospective client" and from engaging "in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client." By order to show cause based upon the complaint and an affidavit of an SEC investigator, a temporary restraining order was granted and a hearing upon an application for a preliminary injunction was directed. No additional proof was offered by the SEC upon the hearing; Schwarzmann, as owner of Capital Gains and as a defendant, submitted an affidavit opposing the application. The District Court upon this proof denied the motion for a preliminary injunction and vacated the stay. 191 F.Supp. 897 (1961). The SEC appealed. A panel of this court affirmed the district court's order. 2 Cir., 300 F.2d 745. A petition of the SEC for a rehearing in banc was granted.

The only question presented at this stage of the proceedings, namely, an application for a preliminary injunction in advance of a trial upon the merits, is whether a violation of section 206(1) and (2) has been so clearly established that defendants are, in effect, to be found at fault without awaiting the development of all the facts upon a trial.

The SEC brings this proceeding under subsections (1) and (2) of Section 206. These subsections make it unlawful "(1) to employ any device, scheme, or artifice to defraud any client or prospective client" or "(2) to engage in any * * * business which operates as a fraud or deceit upon any client or prospective client."

Capital Gains publishes an investment advisory service. It distributes two bulletins, one entitled "Facts on the Funds" (not involved in this proceeding), which informs subscribers as to changes in the portfolios of Mutual Funds and another headed "Special Recommendation" or "Special Bulletin" which gives financial facts and figures concerning the specific company made the subject of the analysis. Only certain bulletins involving the special situations are before the court.

The SEC did not present in support of its application for a preliminary injunction any of the reports upon which it relied as showing a failure to disclose material facts. However, this deficiency was remedied by defendants who attached the special bulletins to their answering affidavit. In substance, the bulletins contain figures showing the corporate earnings over a period of years of the companies therein analyzed, an outline of the nature and current status of the business, future prospects, earnings and price-to earnings ratios, (in some cases) the number of Funds which own the stock, and usually a brief résumé of assets and profits.

All seven companies1 analyzed are substantial companies in their respective fields and their stocks have been listed and traded on the New York Stock Exchange for many years. No charge is made by the SEC that any misstatements or false figures were contained in any of the bulletins; that the investment advice was unsound; 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. The SEC premises its entire case upon the fact that shortly before the bulletins were mailed, defendants purchased shares of the stock and, in one instance where they suggested that the stock was too high, sold short. The SEC then points to the facts that there were small market rises in each of the stocks following publication and that defendants sold the stocks previously purchased (or covered as to the short sale) by them within a week or two thereafter.

The SEC correctly argues that federal securities laws are to be construed broadly to effectuate their remedial purpose. Nor can there be any serious dispute that a relationship of trust and confidence should exist between the advisor and the advised. A good example of a violation of this principle is found in SEC v. Torr:2

"When a person gives advice to buy a stock under circumstances that lead the listener or reader to believe that the advice is disinterested, and suppresses the fact that for giving such advice he is in reality being paid by one anxious to sell the stock, the purchaser acting on the advice is imposed upon and deceived."

Or if it were established that Capital Gains made its recommendations for the purpose of endeavoring artificially to raise the market so that it might unload its holdings at a profit, such conduct might well find itself within the prohibitions of Section 206(1) and (2).

But here the SEC's proof tends only to show that, at most, defendant Schwarzmann profited personnally from the predictable market effect of his honest advice. There is no proof that defendants employed "any device, scheme, or artifice to defraud any client or prospective client" or engaged "in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client." The SEC's case, both here and in the court below, has been based entirely upon section 206, subsections (1) and (2) of the Act. And in interpreting these sections we must take account of the recent warning of the Supreme Court against excessive judicial expansion of provisions of the securities laws to accomplish objectives believed to be salutary. Blau v. Lehman, 368 U.S. 403, 82 S.Ct. 451, 7 L.Ed.2d 403 (1962).

Although there is no direct occasion to consider whether defendants' activities were "manipulative" under the prohibition added to the Act by the Act of September 15, 1960, 74 Stat. 885, 15 U.S.C.A. § 80b-6(4), or could be prohibited by an SEC rule under that section, the amendment is not without significance. To section 80b-6 containing subsections (1) and (2) were added (3) (not here relevant) and (4) which made it unlawful for any investment adviser "to engage in any act, practice, or course of business which is fraudulent, deceptive, or manipulative."

By the enactment of subparagraph (4), section 80b-6, the SEC now has been directed by Congress "by rules and regulations to define, and prescribe means reasonably designed to prevent, such acts, practices, and courses of business as are fraudulent, deceptive, or manipulative." The SEC has not shown itself reluctant to consider and draft "rules and regulations" toward this end. Already it has issued regulations dealing with registration of stock dealings by investment advisers and their staffs and with types of advertising deemed to be fraudulent or deceptive. (See SEC Releases Nos. 120, 121, October 16, 1961, November 2, 1961.) The extent, if any, to which the SEC may believe it desirable to go in regulating purchasers or sales of securities by investment advisory publishers at or about the time of comment in their publications concerning such securities has been entrusted by Congress to the SEC. However, here the SEC's case is predicated solely on the deliberately meagre provisions of § 206(1) and (2) as enacted in 1940, 54 Stat. 853, and not on § 206(4) added by the Act of September 15, 1960, 74 Stat. 885. Whether conduct such as defendant's is now forbidden as a "manipulative" practice under the first clause of (4) or only if prohibited by detailed rules and regulations promulgated by the Commission, is an issue neither presented nor determined.

The legislative history of the Investment Advisers Act strongly supports our interpretation of the language of subsections (1) and (2). The Investment Advisers Act of 1940 was not as comprehensive as the Securities Act of 1933 or the Securities Exchange Act of 1934. It did not have to deal with the purchase and sale of securities and broker-dealer-customer relationships. Rather the Act was thought to be a modest beginning — not a great and final piece of legislation. "It followed a brief supplemental report on investment advisers which the Commission had filed as an incident of its investment trust study." Loss, "Securities Regulations," Vol. II, pp. 1392-1393. The report did not even propose legislation in any formal way, let alone define its scope. It merely described the investment counselling business in the United States and set forth state legislation on the subject, as well as showing how the Investment Counsellors of America regulated themselves internally. A representative of the SEC, testifying before the Senate committee in 1940, said the SEC knew very little about the investment-advising business and, therefore, the "fundamental approach" of the proposed legislation was to get a "compulsory census" of the industry. "Aside from that fundamental approach the only other provisions in that title are just a few broad...

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    ...that the Commission could not obtain an injunction for violation of the statute unless it proved scienter. See SEC v. Capital Gains Research Bureau, 306 F.2d 606 (CA2 1962). This Court, rejecting the view of the lower court that scienter was required in all cases involving fraud, reversed. ......
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2 books & journal articles
  • Unlawful Securities Transactions and Scienter: an Emasculating Requirement
    • United States
    • Seattle University School of Law Seattle University Law Review No. 1-03, March 1978
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