January 22, 2017

Colorado Court of Appeals: “Newsletter Exclusion” Did Not Apply to Unlicensed Securities Advisor

The Colorado Court of Appeals issued its opinion in Mandel v. Rome on Thursday, December 30, 2016.

Colorado Securities Act—Licensure—Summary Judgment—Investment Adviser—First Amendment—Restitution—Permanent Injunction.

Defendants Mandel and Wall Street Radio, Inc. hosted a radio show devoted to security investments, Wall Street Radio (WSR). They also offered through a website a variety of investment related services under two plans. The Master Membership Plan, with a $500 annual fee, provided newsletters, seminars, and the opportunity to email or call defendant Mandel twice a week with questions about specific stocks (crystal ball readings). The Lead Trader Membership Plan, under which subscribers paid between $1000 and $2000 annually, provided the same services as Master Membership and also offered the opportunity to mimic Mandel’s own security trades through an investment vehicle known as auto-trading. In auto-trading, trades are automatically made that mimic the lead trader’s trades without the need for approval. Followers are often not aware of the trades until after they have occurred.

The auto-trading was done through a company called Ditto Trade, in which Mandel owned an interest. Ditto Trade requires its lead traders to attest that they are either registered investment advisers or exempt from registration. Neither Mandel nor WSR were licensed in Colorado as investment advisers or investment adviser representatives. In 2008, Mandel had applied for a license, but his application was denied in an administrative action. A stipulated consent order denying the application precluded him from reapplying for 10 years and barred him from acting as a solicitor or otherwise associating with any Colorado licensed investment adviser or “federally covered” adviser. Mandel attested to operating within an exemption.

This action was commenced by the Securities Commissioner of Colorado, Rome, against Mandel and WSR, alleging they had acted as unlicensed investment advisers or investment adviser representatives under the Colorado Securities Act (CSA). Defendants claimed that pursuant to the CRS § 11-51-201(9.5)(b)(III) “newsletter exclusion” they were exempt from licensure. The trial court granted summary judgment against defendants. It entered a permanent injunction and directed them to pay $80,000 in restitution ($1000 for each auto-trading subscriber).

On appeal, defendants argued that the trial court erroneously entered summary judgment because a genuine issue of material fact existed as to whether they acted as investment advisers or investment adviser representatives. The Colorado Court of Appeals found that the Commissioner presented undisputed facts sufficient to resolve the case. It therefore turned to whether judgment was appropriate as a matter of law.

There was no dispute to the evidence presented by the Commissioner that defendants met the basic definition of investment adviser or investment adviser representative. To avoid the licensing requirement, defendants had to meet the “newsletter exclusion” from the definition of investment adviser, which required their services to qualify as bona fide publications or newsletters with a regular circulation. The court found that the lead trader services were not “publications” generally disseminated to subscribers. It rejected defendants’ argument that because they disseminated a newsletter, all of their other activities fell within the exclusion. Also, the lead trader service was not bona fide because it did not consist of disinterested commentary or analysis; instead, each follower’s investment decision was directly linked to Mandel’s investment account. Thus Mandel could personally benefit from the trades. Finally, the service was not “regular.” It did not follow a routine schedule but occurred when Mandel decided to make trades. Similarly, the crystal ball readings were not regular and addressed specific investment situations. Because defendants provided both services for compensation without a license they violated the CSA.

Defendants further argued that the summary judgment was inappropriate because the Commissioner failed to controvert their affirmative defense that the First Amendment of the federal constitution and Colorado Constitution art. II, § 10 barred the enforcement action. Because the services provided were sufficiently personal to treat defendants as investment advisors or investment representatives, requiring them to obtain a license as a condition of providing these services is constitutional.

Defendants also argued that the trial court erred in imposing restitution, contending that only damages could be awarded under the CSA. The court did not need to address this argument because it held that the record and the law support the award under a common law restitution theory.

Lastly, defendants challenged both parts of the permanent injunction. Defendants argued that the first part of the injunction improperly enjoins them from engaging in lawful activity. Defendants contended that the court abused its discretion and exceeded its statutory authority by enjoining them from “associating in any capacity” with securities professionals engaged in business in Colorado. The court found that the trial court had statutory authority to enjoin defendants from associating with securities professionals to ensure compliance with the CSA. However, the court found that the first part of the injunction was overly broad and subject to different interpretations.

Defendants argued that the second part of the injunction is simply an edict to obey the law and is thus overly broad and vague. The court agreed.

The summary judgment and restitution orders were affirmed. The injunction was vacated in part and reversed in part, and the case was remanded to the trial court for further proceedings.

Summary provided courtesy of The Colorado Lawyer.

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