Why Smart People Don't Deserve the Protection of Disclosure Law
Lawrence Melton has posted three interestings articles about the defences that brokerage firms try to use when they are sued by their clients for giving them misleading advice, Are You a Sophisticated Investor?
In the previous three blogs, I argued that sophistication is not a defense to specific causes of action, such as securities fraud, unsuitable recommendations and broker negligence.' Now I want to discuss the criterion for designating an investor as 'sophisticated.''
Who is sophisticated?' Who is not sophisticated?' And Why?'
The standards by which sophistication is measured are anything but uniform.' The truth is nobody knows at what point an unsophisticated investor becomes sophisticated.' There are no common indices by which sophistication is identified.' Presumably, investor sophistication, if it is to be considered by an arbitration panel at all, should at a minimum require a factual evaluation of the client's level of understanding with respect to risk.
Read the entire article and previous ones also.
A similar problem bedevils franchisees who face a confusing mix of legal tests for common law negligent misrepresentation and statutory disclosure of either essential or material facts necessary for the purchase of a franchise.
At common law, one of the necessary elements of a negligent misrepresentation case is is reliance. Reliance is not determine by what a honest person testifies to; mindful of 20/20 hindsight, Judges are reluctant to accept a) had a fact been dislcosed, b) the purchase of the franchise would not have been made, and c) therefore, the purchaser is entitled to put back in the position before the purchase was made.
But with statutory remdedies, for incomplete disclosure according to one of the registrant state's requirements, there is no requirement of reliance.
Typically, the aggrieved purchaser only has to show the material non-disclosure caused or brought about damages, whether or not the purchaser relied upon the misrepresentations.
Sophisticated purchasers of franchises are sometimes caught in a similar trap as so call sophisitcated investors - they are treated as if some how they partially responsible for being lied to.
For example, consider the SonaMed Spa franchise and Kempton Coady's discussion of due diligence and the sophisticated purchaser. Kempton Coady recently "won" a $400,000 arbitrator's award against Sona Med Spa.
"Is this a successful franchise business which people should invest in? How does one justify that many people lost their life savings and in at least one case there was an attempted suicide? How does one explain that many of the franchisees including those in the Franchise Advisory Counsel went to Jim Amos and Heather Rose and Carousel Capital Partners' principals with detailed explanations of the medical and business facts/falsehoods and they chose to do nothing?How does one explain that Amos and Rose simply blamed the franchise operators? These were generally "extremely competent" business people, that is, former CEOs, private owners of successful companies, MacDonald's executives, high level television executives, etc. Most of these people also had advanced graduate degrees JDs. MBAs, CPAs, MDs. etc. These people worked very hard at making their Sona Med Spas succeed, and simply lost all or a significant amount of their life savings?
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This should be intolerable. No industry of capital formation can tolerate this level of misprepresentation for long: investors will simply find more transparent businesses to invest in.
