Chapter 16 - § 16.20 • PRIVATE ACTIONS VERSUS THE SEC'S CIVIL ENFORCEMENT PROCEEDINGS

• Jurisdiction: Colorado

§ 16.20 • PRIVATE ACTIONS VERSUS THE SEC'S CIVIL ENFORCEMENT PROCEEDINGS

There may be a higher burden of proof required in civil actions under Rule 10b-5 between private parties than is required of the Securities and Exchange Commission in enforcement proceedings.

The "shingle theory" implies a representation to a customer, whenever a brokerage firm is functioning in the securities industry (i.e., "hanging out its shingle"), that it has expertise in the industry and will deal with its customers in accordance with standards of the industry. The SEC announced the shingle theory in an administrative proceeding against a broker under § 17(a) of the 1933 Act and § 15(c)(1) of the 1934 Act even before Rule 10b-5 was promulgated. The court in In re Duker & Duker stated:⁵¹⁹

Inherent in the relationship between a dealer and his customer is the vital representation that the customer will be dealt with fairly, and in accordance with the standards of the profession. It is neither fair dealing, nor in accordance with such standards, to exploit trust and ignorance for profit far higher than might be realized from an informed customer.⁵²⁰

The shingle theory and the duty of brokers to deal fairly with their customers first won judicial approval in Charles Hughes & Co. v. SEC,⁵²¹ where the Second Circuit affirmed the SEC's revocation of a broker's license for selling stock to customers at excessive prices without disclosing the mark-up. The court stated:

An over-the-counter firm . . . holds itself out as competent to advise in the premises [of the securities industry] . . . . Even considering petitioner as a principal in a simple vendor-purchaser transaction . . . , it was still under a special duty, in view of its expert knowledge and proffered advice, not to take advantage of its customers' ignorance of market conditions. . . . The law of fraud knows no difference between express representation on the one hand and implied misrepresentation or concealment on the other.⁵²²

There is no question that every stockbroker has at least the limited duty to serve a customer's financial interest within the framework of each transaction.⁵²³

In 1997, the shingle theory was revived by the Third Circuit, which held that broker-dealers are "expected to use reasonable efforts to maximize the economic benefit" to their clients in each transaction.⁵²⁴ The broker-dealer asked the court:

1) Whether a broker-dealer that makes no false statements, obeys customer orders, and routinely executes small retail transactions at NBBO

...