Today, it’s fairly well establish that an investment adviser should not be buying positions on their own behalf shortly before recommending that position to its clients. Fifty years ago, there was some question as whether the Securities and Exchange Commission could take steps to prevent this or require disclosure.
The test case came against Capital Gains Research Bureau. The firm produced a monthly newsletter recommending securities. In 1960 the firm purchased securities before recommending them in its 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, the firm sold its position at a profit.
The SEC sought an injunction to stop that practice unless the firm disclosed that it may be trading in the securities mentioned in the report. The firm challenged the injunction by saying the SEC has to show an intent to injure clients or an actual loss of money. The trial court and the appellate court agreed with the firm. The SEC continued the fight and the case ended up in the hands of the Supreme Court.
The justices of the high court came to the rescue of the SEC.
The high standards of business morality exacted by our laws regulating
the securities industry do not permit an investment adviser to trade on the market effect of his own recommendations without fully and fairly revealing his personal interests in these recommendations to his clients.
Experience has shown that disclosure in such situations, while not onerous to the adviser, is needed to preserve the climate of fair dealing which is so essential to maintain public confidence in the securities industry and to preserve the economic health of the country.
And so, the SEC gained the ability to expand the types of activity that could be considered fraudulent, deceptive, or manipulative. And to do so without having to show an intent to injure clients or an actual loss of money.
- SEC v. Capital Gains Research Bureau, Inc. 375 U.S. 18 (December 9, 1963) (.pdf)
- SEC v. Capital Gains Research Bureau and the Investment Advisers Act of 1940 (.pdf) by Arthur B. Laby
Image is The scalping of Josiah P. Wilbarger
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