Thank You For Submiting Feedback!
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. Congress intended the Investment Advisers Act of 1940, 15 U.S.C.S. § 80b-1 et seq., to be construed like other securities legislation "enacted for the purpose of avoiding frauds," not technically and restrictively, but flexibly to effectuate its remedial purposes.
The Securities and Exchange Commission (SEC) instituted the present action in the United States District Court for the Southern District of New York to obtain an injunction compelling a registered investment adviser to disclose to his clients a practice of purchasing shares of 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 practice was known in the trade as “scalping”). The action was based on 206(2) of the Investment Advisers Act (15 USC 80b-6(2)), prohibiting an investment adviser from engaging in any practice which "operated as a fraud or deceit upon any client or prospective client." The District Court denied the request for a preliminary injunction, holding that the words "fraud" and "deceit" were used in 206 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. Accepting the District Court's limited construction of "fraud" and "deceit," the Court of Appeals for the Second Circuit, sitting en banc, by a 5-to-4 vote affirmed. The SEC challenged the decision.
Did the practice of “scalping” operate as a fraud or deceit upon any client or prospective client, entitling the SEC to obtain an injunction against an investment adviser engaging in such practice?
The Court reversed the judgment of the appellate court, and remanded the action because the practice of “scalping” operated as fraud on the client within the meaning of the Investment Advisers Act. The Act was given a broad remedial construction so that intent to injure was not needed to establish fraud. Failure to disclose material facts was fraudulent, and the showing of deliberate dishonesty was not required. According to the Court, the Investment Advisers Act empowered 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. The Court concluded that even if the investment adviser’s advice was "honest," in the sense that he 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.