## Facts

- A broker-dealer’s research analyst and numerous registered representatives recommended and sold shares of Scientific Control Corporation to customers during 1968–1969.
- Scientific operated from roughly 1964 until bankruptcy in 1969, never earned a profit, and had a deteriorating financial condition.
- Scientific’s public communications and management statements were often overly optimistic and, at times, inaccurate.
- The analyst recommended that customers buy or hold Scientific while relying heavily on the issuer’s filings and management representations without adequate independent verification and despite warning signs about reliability.
- The analyst received certain material, nonpublic information from Scientific and used it in forming recommendations.
- Many sales personnel relayed the firm’s favorable view to retail customers and, in some instances, made additional statements, including specific optimistic price predictions, favorable comparisons to established companies, and claims that listing on an exchange was imminent.
- Some sales efforts relied on an inaccurate, overly positive newspaper article and included high-pressure tactics urging prompt purchase.
- The SEC alleged inadequate firm supervision of both research and sales personnel and insufficient internal controls to prevent misleading recommendations and sales communications.
- The matter proceeded as an SEC administrative enforcement action that concluded with censures, certain individual sanctions, customer compensation of about $1.6 million, and undertakings to improve procedures and training.

## Issues

1. Whether the analyst and sales personnel willfully violated Securities Act § 17(a), Exchange Act § 10(b), and Rule 10b-5 by making materially misleading statements or omissions in connection with recommendations and sales of Scientific stock.
2. Whether the broker-dealer and certain supervisors failed reasonably to supervise employees with a view to preventing securities-law violations.
3. Whether optimistic opinions and stock-price predictions are actionable under the antifraud provisions when they imply an unsupported factual basis or omit adverse facts.

## Decision

- The SEC found that the research and sales conduct relating to Scientific involved material misstatements and omissions and misleading predictive statements lacking a reasonable basis, constituting antifraud violations.
- The SEC found that the firm’s supervisory systems and oversight were inadequate to prevent or detect the misconduct and therefore amounted to a failure reasonably to supervise.
- The SEC rejected the defense that characterizing statements as “opinions” or conditional predictions immunized respondents when the statements conveyed unwarranted certainty or omitted known contrary information.
- The SEC imposed and/or accepted remedial measures including censure of the firm, customer compensation of approximately $1.6 million, and commitments to strengthen written guidelines and training; certain employees accepted suspensions and/or censures.

## Legal Principles

- Broker-dealers and associated persons must have a reasonable basis for research opinions and investment recommendations; uncritical reliance on issuer statements in the face of warning signs can render recommendations misleading.
- Specific price predictions, comparisons, and assertions about near-term corporate milestones may be material and actionable when unsupported or when adverse facts are omitted.
- An opinion or prediction can violate § 17(a), § 10(b), and Rule 10b-5 if it implies a factual foundation that does not exist or is misleading in context because material risks or contrary information are withheld.
- Broker-dealers have a duty to reasonably supervise personnel and maintain/enforce internal procedures designed to prevent antifraud violations in both research dissemination and retail sales communications.
- Remedial sanctions in SEC administrative proceedings may include censure, restitutionary payments to customers, individual suspensions/censures, and undertakings to improve compliance systems and training.

## Conclusion

The SEC concluded that misleading, unsupported research-driven recommendations and sales communications regarding a speculative issuer, coupled with inadequate firm supervision, violated the federal antifraud provisions, and it ordered remedial relief including firm censure, customer compensation, and strengthened supervisory controls.


In re Merrill Lynch, Pierce, Fenner & Smith, Inc., Exchange Act Release No. 14149 (Nov. 3, 1977)