The past has a way of repeating itself. In 1909, the New York Supreme Court declined to enforce a contract to manipulate stock prices (which was successful), with payments due to a publisher of an investment newsletter (Ridgely) and its co-conspirator (Keene) held to be unenforceable immoral profits. Ridgely v. Keene, 134 App. Div. 647, 119 N. Y. Supp. 451 (1909), cited in SEC vs. Capital Gains Research Bureau, 375 U.S. 180 (1963). The Court in Capital Gains, supposing that Congress was well aware of this kind of common law fraud went on to find investment advisers to be fiduciaries, and scalping to violate the duty of an adviser to its clients: “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.”
The SEC announced on October 4th its settlement of a complaint in the Northern District of Georgia against Mark J. Melnick (a self-described “Director of Trading Psychology” and host of a webcast) alleging Melnick traded on over 100 occasions timed to rumors he disseminated to “sizable on line followings”. In this modern version of scalping, it was Trader A who picked the stocks ripe for manipulation – referred to as “chatter plays”, and Melnick leveraged the market impact of his rumor mongering through short term call options. Melnick split his profits with Trader A.
The SEC brought charges under Section 17(a) of the 1933 Act and 10(b) of the 1934 Act, and no allegation was made that Melnick was an investment adviser. Fund managers and investment advisers will recognize that here we have a scalping case, but without a fiduciary duty to the ones being scalped. Thus, investment advisers now have to view scalping as potentially exposing themselves to civil money damages for harm to “the market”.
