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CALIFORNIA CORPORATE & SECURITIES LAW

Was This “Whiz Kid” An Investment Adviser?

Earlier this week, the Securities and Exchange Commission announced that a self-styled “stock trading whiz kid” and his Los Angeles, California company have agreed to pay $1.5 million to settle a complaint for violations of Rule 10b-5.  There is an odd disconnect between the SEC’s press release and its complaint.  The press release is headlined “stock newsletter fraud” and repeatedly refers to the defendant’s “newsletter company”.  In fact, the SEC never uses the word “newsletter” in the complaint.  Rather, the SEC alleges that the defendant and his company defrauded subscribers and potential subscribers to an on-line “chat room”, and two stock picking “alert services”.  It seems that the SEC used “newsletter” in its press release because it wanted to make a point about newsletters:

The SEC has warned investors that investment newsletters can be used as tools for fraud, noting in an investor alert for example to beware false performance claims misrepresenting the track record of the newsletter’s investment recommendations and be suspicious if the newsletter does not disclose having received any compensation.

The SEC alleged only violations of Rule 10b-5 under the Securities Exchange Act of 1934.  Assuming that the defendants had actually published an investment newsletter, would that make them “investment advisers” subject to registration under either California or federal law?

California excludes from the definition of an “investment adviser” a publisher of any bona fide newspaper, news magazine or business or financial publication of general, regular and paid circulation and the “agents and servants thereof”.  Cal. Corp. Code § 25009(a)(5).  This mirrors the exception found in Section 202(a)(11) of the Investment Advisers Act of 1940, which was the source of Section 25009.  In Lowe v. S.E.C., 472 U.S. 181 (1985), the Supreme Court held:

As long as the communications between petitioners and their subscribers remain entirely impersonal and do not develop into the kind of fiduciary, person-to-person relationships that were discussed at length in the legislative history of the Act and that are characteristic of investment adviser-client relationships, we believe the publications are, at least presumptively, within the exclusion and thus not subject to registration under the Act.

Id. at 210.

Was the SEC afraid to charge “Jesus” with securities fraud?

I also found it interesting that throughout the complaint the SEC chose to refer to one of the defendants by his alias rather than his actual surname – “Defendant Manuel E. Jesus aka Manny Backus (“Backus”)”.  I can only speculate the SEC chose to refer to the defendant as “Backus” so that it could avoid accusing “Jesus” of securities fraud.

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