Before CLARK, WATERMAN and MOORE, Circuit Judges.
Plaintiff (appellant), Securities and Exchange Commission (SEC), in its complaint, alleging violations 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 and 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. The SEC appeals.
Injunctive relief before a trial on the merits should be granted most sparingly and only upon convincing proof that irreparable injury will be caused unless the courts stay the defendants' injury will be caused unless the cours stay the defendants' conduct. Furthermore, the courts generally will not grant a preliminary injunction when the effect thereof will be to give the applicant all the relief to which he would be entitled if successful upon the final injunction trial.*fn1
Applying these principles to the facts, the conclusions are inescapable that the SEC did not meet the "convincing" proof standard and that a preliminary injunction for all practical purposes would have given to the SEC all that it could have received by final injunction after trial.
Section 206 declares that it is unlawful for any investment adviser (1) "to employ any device, scheme or artifice to defraud any client or prospective client" or (2) "to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client." Fraud is the keynote of these provisions and the burden placed upon the party alleging fraud is that it be established by "clear and convincing"*fn2 proof.
The only question presented upon appeal at this stage of the proceedings (namely, in advance of a trial upon the merits) is whether the facts were so clear and convincing that fraud and deceit were being practiced upon defendants' clients that the District Court abused its discretion in not granting a preliminary injunction and in preferring to await the development of all the facts upon a trial before decreeing drastic injunctive sanctions.
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 resume of assets and profits.
All seven companies*fn3 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, consistent with their forthcoming recommendations, 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. Thus, the SEC by its own fiat would create a law not enacted by Congress or a regulation not promulgated by the SEC to the effect that the failure to disclose to clients to whom purchase was recommended that they (defendants), too, had made purchases, constituted a scheme to defraud by failing to disclose a material fact. But what is the "material fact"? The SEC does not and cannot argue that it consists of a belief that the stock was a "sell" instead of a "buy" because there is no proof of any such belief. Furthermore, the action of defendants was consistent with their recommendations and belies such an inference. Of the seven stocks involved, the purchases (or in one case the short sale) in most instances were made just three to seven days before the reports containing the recommendation were mailed to the clients. Thus it would appear that the purchases were the result of the forthcoming recommendations. Certainly without any supporting proof a conclusion would not be justified that the recommendations were made to enable defendants to unload their own recently acquired and comparatively small holdings.
Presumably the SEC relies upon the defendants' subsequent sales as implying a belief that the stock analyzed was not a good purchase to be held more than six months. But even a then present intention to sell shortly after publication will not support an inference that the recommendation to others to buy and hold for the capital gains period was fraudulent or deceptive. And if this be the material omission, what is the remedy? A mere statement in the bulletins that defendants also owned certain shares would accomplish nothing. Thousands of other persons owned shares of the same companies. A statement that defendants intended to sell within two weeks would not be accurate because their intention to buy, sell or hold could be determined only in the light of then unknown events. If the market were strong, they might wish to take a small profit on an "income" tax basis or hold for the six months capital gains period; if the market were weak they might wish to limit their losses by selling or holding for a longer period, hoping for a recovery. Surely, no one could be so naive as to believe that a small advisory service with only 5,000 subscribers could by its own recommending influence cause such stocks as Union Pacific (22,000,000 shares outstanding), Continental Insurance (12,000,000 shares outstanding) and United Fruit (8,730,000 shares outstanding)*fn4 invariably and automatically to rise so that defendants could always sell their small holdings at a small profit. In the one instance, Hart, Schaffner & Marx, where the company had less than one million shares outstanding, the clients were told that purchases were recommended "around the $23-24 level" (the then current price). Such advice would hardly be consistent with an inference that it was intended thereby to raise the market price by their own clients' buying power. Moreover, it is significant that the SEC introduced no proof that any client ever purchased any shares of the recommended securities. The SEC's conclusion that these particular 5,000 subscribers must have rushed in, thereby creating an artificial stimulant, is wholly speculative and is at variance with common sense. Consider realistically the buying power which comes from pension funds, investment trusts, university and hospital endowments, foundations, insurance companies and some 180,000,000 citizens with their millions available daily for investment. In the light of such a situation, the comparatively few shares out of 22,000,000 (Union Pacific) that Schwarzmann's clients might have ordered would have been as the proverbial grain of sand is to the beach. And flattering though it might be to Schwarzmann, would anyone believe that his recommendation would stem the tide of decline if some pessimistic world event were simultaneously announced, some Mutual Fund chose to sell or an estate had to be liquidated?
The SEC contends that present intent to sell a stock in the near future if it rises must be accepted as conclusive proof that the advice to buy was dishonest and fraudulent. However, do not the vast majority of those who buy hope to sell at some time at a profit? When the sale will take place can be determined only by considerations personal to each purchaser. his own financial needs, his trading policy, his habit of accepting small profits or his policy of buying for the so-called long pull will control his actions. Of necessity, every purchase and sale transaction involves diamertrically opposed thoughts by two individuals concerning the same stock but this does not create fraud and deception so long as false facts and figures have not motivated their action.
The result reached by the District Court in no way weakens the praise-worthy role of the SEC in its vigilant protection of unwary investors. 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 adviser and the advised. A good example of a violation of this principle is found in S.E.C. v. Torr:*fn5
"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, ...