## Facts

- USA Managed Care Organization (USAMCO) conducted a Regulation A offering of 290,000 shares of common stock at $1 per share.
- Shearson, Hammill & Company (Shearson), a registered broker-dealer, was not labeled the formal underwriter but functioned as the de facto underwriter for the distribution.
- On November 14, 1960, Shearson began trading USAMCO stock and became the security’s main, and effectively only, market maker.
- Shearson initiated the market with a bid of $3 per share, well above the $1 offering price.
- From late 1960 through June 1961, Shearson’s bid-and-ask quotations increased progressively into the mid-to-high teens per share.
- During the price run-up, Shearson and USAMCO insiders sold substantial amounts of USAMCO stock acquired at or near the $1 offering price into the public market at much higher prices.
- By June 12, 1961—shortly after Shearson and USAMCO insiders had sold, or were finishing selling, much of their USAMCO positions—Shearson imposed a “work-out market.”
- Under the work-out market, Shearson would accept a customer sell order only if Shearson could match it with an actual buy order or an expected buy order, because Shearson feared public buy demand was insufficient to absorb selling pressure.
- Despite shifting to a work-out market, Shearson continued to publish bid-and-ask quotations that conveyed the appearance of a normal, two-sided market.
- During the work-out period, Shearson (1) sold 8,752 shares held by Shearson or USAMCO insiders, (2) induced customers to purchase shares at prices between $13.75 and $16 per share, and (3) purchased only 210 shares from the public.
- Shearson did not disclose to customers that the market had been placed on a work-out basis while it continued quoting prices and soliciting purchases.
- On September 11, 1961, Shearson stopped soliciting buy orders in USAMCO; the market then collapsed.
- The SEC instituted an administrative proceeding against Shearson and certain individuals based on the conduct surrounding the Regulation A distribution and the subsequent market making and solicitations.

## Issues

1. Whether a broker-dealer that functioned as the de facto underwriter and dominated the trading market for a Regulation A security engaged in fraudulent or manipulative conduct by quoting and soliciting at rising prices while the firm and insiders sold into the market.
2. Whether continuing to publish quotations and induce customer purchases, without disclosing that the dealer had imposed a “work-out market” that restricted customer selling, constituted a deceptive omission in violation of the antifraud provisions (including Exchange Act § 10(b) and Rule 10b-5).
3. Whether a broker-dealer’s domination or control of the market, and special trading conditions imposed because of inadequate demand, are facts that must be disclosed to customers when recommending or selling the security.

## Decision

- The SEC found that Shearson’s conduct in connection with the USAMCO distribution and its dominated aftermarket trading involved violations of the federal securities laws’ antifraud and anti-manipulation provisions.
- The SEC determined that Shearson’s failure to disclose the work-out market, while continuing to quote prices and solicit purchases, created a misleading appearance of normal liquidity and independent market demand.
- The SEC concluded that, given Shearson’s market control and knowledge of the lack of genuine buy interest, its solicitation of customer purchases at elevated prices without disclosure was deceptive.
- The SEC imposed disciplinary sanctions on Shearson and certain individual respondents arising from the misconduct found in the proceeding.

## Legal Principles

- A broker-dealer that dominates or controls the market for a security, particularly in connection with a distribution, must not create a false appearance that quotations and prices reflect independent trading interest.
- If a dealer imposes special market conditions—such as a work-out market where customer sell orders are accepted only when matched—those conditions can be material and must be disclosed when the dealer continues quoting prices and recommending or selling the security.
- Continuing to solicit customer purchases while concealing weakened demand, restricted liquidity, and the dealer’s market control can constitute a deceptive course of business under Exchange Act § 10(b) and Rule 10b-5.
- When a dealer’s own interests (including selling firm or insider holdings) coincide with its ability to influence price and liquidity in a dominated market, the dealer must deal fairly with customers through truthful statements and complete disclosure of material facts.

## Conclusion

In *Matter of Shearson, Hammill & Company*, the SEC held that a broker-dealer acting as a de facto underwriter and dominant market maker committed fraud and manipulation by maintaining public quotations and soliciting purchases while secretly operating a work-out market to manage selling pressure, all as the firm and insiders sold shares at inflated prices; the SEC sanctioned Shearson and certain individuals for the resulting violations.


Matter of Shearson, Hammill & Company, 42 S.E.C. 811 (1965)