New and Comprehensive Duties of Securities Sellers to Investigate, Disclose, and Have an “Adequate Basis” for Representations
The duties of investigation and disclosure imposed upon securities salesmen have been significantly enlarged by several recent cases generated by the Second Circuit’s 1963 decision of Berko v. SEC. In a hearing before the Securities and Exchange Commission it was found that Berko was a salesman working out of an acknowledged “boiler room.” His employer had provided its salesmen, including Berko, with fraudulent sales brochures, some of which were subsequently distributed by Berko. The action by the Commission against Berko arose out of the sale of a specific security to a customer who had received fraudulent sales brochures and had called Berko to inquire about investment in the stock. In the course of this particular sale, Berko represented that there was a “good possibility” that the market value of the stock would, within a year, increase to fifteen from its sale price of seven. In finding this conduct to be a violation of the antifraud provisions of the securities acts, the Commission had before it evidence that the salesman had himself purchased a large amount of the stock and had sold varying amounts to his relatives as well as to others. In addition, the stock did, in fact, increase in value (albeit not within the predicted time), and there was uncontroverted testimony by the customer that he had understood Berko’s prediction of increase in value to be only an opinion. On petition for review, the Court of Appeals for the Second Circuit remanded to the Commission, which affirmed its previous order without further hearing, but with a revised opinion. In this reiterated order finding Berko a “cause” of revocation of his employer’s broker-dealer registration, the Commission emphasized that its findings were not based on any value judgment as to the qualities of the stock involved, and that the customer’s understanding as to Berko’s representations had no significance insofar as the gravamen of the salesman’s offense was concerned. Rather, Berko’s breach of duty, in the first instance, consisted of his failure to have an “adequate basis” for his statements as to future increases in the market value of the stock. The court of appeals affirmed this holding and, further, affirmed the Commission’s additional holding that a salesman working out of a boiler room is to be held to a higher duty of independent investigation and disclosure than a salesman in a legitimate securities sales operation, and that a boiler-room salesman’s conduct is fraudulent if the information he presents to the public to induce sales is misleading. On this latter ground, the Commission, and the court of appeals on review, rejected as a defense the salesman’s contention that he was justified in relying on the fraudulent brochures prepared by his employer.