Document: 425 U.S. 185 96 S.Ct. 1375 47 L.Ed.2d 668 ERNST & ERNST, Petitioner,v.Olga HOCHFELDER et al. No. 74-1042. Argued Dec. 3, 1975. Decided March 30, 1976. Rehearing Denied May 19, See 986, 2194. Syllabus Petitioner accounting firm was retained to audit periodically a brokerage firm's books and records. Respondents, who were customers of the firm, invested in securities scheme ultimately revealed as fraudulent perpetrated by president principal stockholder. After fraud came light, respondents filed an action for damages against petitioner under § 10(b) Securities Exchange Act 1934 (1934 Act), which makes it unlawful use or employ "any manipulative deceptive device contrivance" contravention Commission (SEC) rules. It alleged that president's violated SEC Rule 10b-5, had "aided abetted" violations its "failure" conduct proper audits thereby failing discover internal practices prevented effective audit. The District Court granted petitioner's motion summary judgment dismissed action, holding whether not cause could be based merely on allegations negligence, there no genuine issue material fact conducted accordance with generally accepted standards. Appeals reversed remanded, one breaches duty inquiry disclosure owed another is liable aiding abetting third party's violation 10b-5 if would have been discovered but breach, issues committed such breach led discovery prevention fraud. Held : 1. A private will lie absence any allegation "scienter," I. e., intent deceive, manipulate, defraud defendant's part. Pp. 194-214. (a) words "manipulative," "device," "contrivance" clearly shows intended proscribe type quite different from more particularly word virtualla term art used connection markets, connotes intentional willful designed deceive investors controlling artificially affecting price securities. 197-201. (b) Act's legislative history also indicates addressed involving some element scienter cannot read impose liability negligent alone. 201-206. (c) structure interrelated 1933 (1933 Act) does support contention since 10(b), contrast certain other sections these Acts, terms explicitly restricted willful, knowing, purposeful conduct, should construed require than inaction precondition civil liability. In each instance Congress Acts created express favor purchasers sellers specified recovery premised knowing entirely innocent mistake. recognition behavior 11, example, stands sharp language 10(b). Moreover, remedies allowing subject significant procedural restrictions indicating judicially remedy has comparable extended, consistently Congress' intent, actions do so allow causes brought instead nullifying effectiveness those remedies. 206-211. (d) While arguably proscribing misstatement omission course effect defrauding investors, wrongdoing not, reading comport Rule's administrative clear apply only activities scienter. More importantly, scope exceed power whose compel interpreting wrongdoing. 212-214. 2. case remanded further proceedings proof misfeasance petitioner, throughout proceeded theory specifically disclaiming engaged misconduct. P. 215. 503 F.2d 1100, reversed. Robert L. Berner, Jr., Chicago, Ill., petitioner. Willard King, Hochfelder others. J. Lassers, Allison Paul Gonson, Washington, D. C., as, Amicus curiae, special leave Court. Mr. Justice POWELL delivered opinion 1 this may 48 Stat. 891, 15 U.S.C. s 78j(b), 17 CFR 240.10b-5 (1975), part defendant. 2 * Petitioner, Ernst Ernst, firm. From 1946 through 1967 First Company Chicago (First Securities), small member Midwest Stock National Association Dealers, perform periodic prepared filing (Commission) annual reports required 17(a) Act, 78q(a).1 responses financial questionnaires (Exchange). 3 Respondents Leston B. Nay, owner 92% Of stock. Nay induced invest funds "escrow" accounts he represented yield high rate return. did 1942 1966, majority transactions occurring 1950's. fact, escrow converted respondents' his own immediately upon receipt. These customary form dealings between customers. drew their personal checks payable designated bank account. No reflected records Securities, none shown investments. Nor they included Securities' filings Exchange. 4 This light 1968 when suicide, leaving note described bankrupt "spurious." subsequently action2 Ernst3 United States Northern Illinois Act. complaint charged Nay's 10b-5,4 Securities. As discovery, rested nonfeasance. premise failed utilize "appropriate auditing procedures" said prevent practice principally relied rule open mail him at attention, even arrived absence. contended audit, "mail rule." existence then disclosed irregular procedure investigation scheme. disclaimed misconduct Ernst.5 5 extensive Ernst's action. court rejected maintained s10(b) negligence. concluded, however respect standards.6 6 Seventh Circuit breach. 1100 (1974).7 reasoned common-law statutory into adequacy control system because contracted prepare report condition 17a-5.8 beneficiaries inquire9 related disclose irregularities discovered. F.2d, 1105-1111. concluded failure comment rule10 constituted duties disclosure, Id., 1111, 1115.11 7 We certiorari resolve question "scienter" defraud.12 421 909, 95 1557, 43 773 (1975). conclude therefore we reverse.13 II 8 Federal regulation emerged aftermath market crash 1929. 74, amended, 77a seq., provide full information concerning public offerings commerce, protect and, imposition liabilities, promote ethical standards honesty fair dealing. H.R.Rep.No.85, 73d Cong., 1st Sess., 1-5 (1933). manipulation stock prices exchanges over-the-counter regular reporting requirements companies listed national exchanges. S.Rep.No.792, 2d (1934). Although contain numerous carefully drawn criminal penalties, recognized efficient trading accomplished rigid program. Commission, provided arsenal flexible enforcement powers. See, E. g., §§ 8, 20, 77h, 77s, 77t; 9, 21, 78i, 78s, 78u. 9 Section 10 "unlawful person . (t)o employ, purchase sale security contrivance rules regulations prescribe necessary appropriate interest protection investors." 78j. 1942, acting pursuant conferred promulgated now provides: "Employment devices. 11 'It shall person, directly indirectly, means instrumentality interstate mails facility exchange, 12 "(a) To device, scheme, artifice defraud, 13 "(b) make untrue statement omit state order statements made, circumstances misleading, 14 "(c) engage act, practice, business operates operate deceit "in security." 16 create violation, indication Congress,14 adopting 10b-5,15 contemplated remedy, statute well established. Blue Chip Stamps v. Manor Drug Stores, 723, 730, 1917, 1922, 44 539, 546 (1975); Affiliated Ute Citizens States, 406 128, 150-154, 92 1456, 1470-1472, 31 741, 759-761 (1972); Superintendent Insurance Bankers Life Cas. Co., 404 6, 13, n. 165, 169, 30 134 (1971). During 30-year period first implied 10b-5,16 substantial body law commentary developed elements. Courts commentators long differed regard alone sufficient.17 addressing question, turn "(t)he starting point every construction itself." Stamps, supra, 756, 1935, 561 (Powell, J., concurring); see FTC Bunte Bros., Inc., 312 349, 350, 61 580, 581, 85 L.Ed. 881, 883 (1941). employment "manipulative deceptive" conjunction "device strongly suggest Texas Gulf Sulphur 401 833, 868 (CA2 1968) (Friendly, concurring), cert. denied Sub nom. Coates SEC, 394 976, 89 1454, 22 756 (1969); Loss, Summary Remarks, Bus. Law. 163, 165 (Special Issue 1975). Kohn American Metal Climax, 458 255, 280 (CA3 1972) (Adams, concurring dissenting). 18 curiae brief, however, contends nothing limits operation practices.18 view, cites overall congressional purpose false might injure them. 151, 1470, 760; U.S., 11-12, 168, 134; Case Co. Borak, 377 426, 432-433, 84 1555, 1559-1560, 423, 427-428 (1964). Capital Gains Res. Bur., 375 180, 195, 275, 284, 237, 248 (1963). reasons "effect" given same regardless intentional, must bar all just done knowingly intentionally. logic effect-oriented approach wholly faultless where results harm result unlikely support. But apart lead, add gloss operative commonly meaning. e. Addison Holly Hill Fruit Products, 322 607, 617-618, 64 1215, 1221, 88 1488, 1496 (1944).19 argument simply ignores unmistakable negligence.20 Use "manipulative" especially significant. virtually markets. securities.21 19 addition relying Commission's statute, contend are dealing "remedial legislation," Tcherepnin Knight, 332, 336, 548, 553, 564, 569 (1967), " 'not technically restrictively, flexibly effectuate remedial purposes.' S.Ct., L.Ed.2d, 760 quoting Research Bureau, 285, 248. They argue purposes" demand embraces negligence standard seeking accomplish broad goals, adopt uniformly classes defendants, predicated exercise reasonable care. 11(b)(3)(B), 82, 77k(b)(3)(B) (liability "experts," accountants misleading portions registration responsible).22 situations good faith absolute defense. 18, 897, 78r (misleading document Act). And still fault, 11(a), 77k(a) (issuer statement). 20 thus evident fashioned fault particularized basis. Ascertainment particular section rest primarily section. Where, here, deal liability, certainly less important. view misconduct, mindful controls sufficiently context, Oregon, 366 643, 648, 81 1278, 1280, 575, 579 (1961); Packard Motor Car NLRB, 330 485, 492, 67 789, 793, 91 1040, 1050 (1947), unnecessary now, nevertheless, ascertain meaning attributed respondents. B 21 bereft explicit explanation think relevant our conclusion involve original version what develop contained identical bills introduced Senator Fletcher Representative Rayburn. S. 2693, Sess. (1934); H.R. 7852, 9(c) bills, present evolved, proscribed which, way manner find detrimental subsections proposed specific empowered regulate rulemaking power. 9(a) (short sale), ("stop-loss order"). Soon after hearings House bill held, substitute both Houses abbreviated modified 9(c)'s contrivance." 8720, 3420, Still bill, retaining enumerated prior omitting reference authority devices general, passed House. 9323, final Senate amendment last bill. H.R.Conf.Rep.No.1838, 32-33 23 Neither nor changes deals aspects legislation. There indication, preceded passage touched briefly 10, most discussion devoted 10(a). exposition provision become Thomas G. Corcoran, spokesman drafters. Corcoran indicated: 24 "Subsection (§ 7852 later 10(b)) says, 'Thou shalt devise cunning devices.' 25 "Of subsection catch-all clause I objection kind clause. new devices." Hearings 8720 before Committee Interstate Foreign Commerce, 115 26 brief drafters rightly "catchall" enable "to (or cunning) difficult believe lawyer, draftsman, legislator acts omissions.23 briefs supporting identify usage construing devices" include negligence.24 27 address catchall function directly. considering left regulation, indicate attach absent scienter, lesser Report 3420 discusses various abuses precipitated need legislation inadequacy self-regulation analyzes component provisions parse 10. following: 28 "In discretionary elastic powers authority, several reinforced penal sanctions, aimed demonstrated fulfill useful function. sanctions found 16." 29 portion general-analysis entitled Manipulative Practices, considered inimical prohibition "wash" sales "matched" orders,25 cases serve legitimate purposes, stabilization grants options. 7-9. latter Commission. (6), (c), 890, 78i(a)(6), (c). Significantly, think, category manipulative, Furthermore, commenting liabilities explains: "(I)f investor suffered loss reason illicit practices, equitable allowed recover guilty party. (T)he provides unlawfully manipulates security, w induces statements, corporation, bought sold affected statement. burden plaintiff show thereon damage. defendant escape showing made Good faith." Supra, 12-13 (emphasis supplied). reveals function" stemming "illicit practices," acted faith. views expressed consistent interpretation. H.R.Rep.No.1383, 10-11, 20-21 (1934) (H.R. 9323). anyone unless interpreted broadly. C 32 constitute components federal regulatory governing 727-730, 1921-1922, 46 544-546. indicated 393 453, 466, 571, (1969), "the interdependence laws factor interpretation chosen .." Recognizing this, imposed conduct. misconceive significance Acts. 33 argues requiring intended, citing 889, proscribes prices. Sections 9(a)(1) (a)(2), respectively prohibit "(f)or creating appearance active security," "for inducing others." 9(a)(4). 9(e) imposes "(a)ny willfully participates act transaction of" purchased activities. concludes 34 argument. 12, 15, 84, 77k, 77L, 77O ; 899, 78r, 78t. For unambiguously creates includes facts fails therein misleading. Within 11(e), issuer held absolutely resulting omission. experts accorded "due diligence" effect, standard. An expert avoid responsible "after investigation" "reasonable ground(s) believe" true fact.26 11(b) (3)(B)(i). Escott Barchris Const. Corp., 283 F.Supp. 697-703 (S.D.N.Y.1968). significantly undercuts 35 consider 12(2), 77l), 77o,27 applicable 10(b).28 11(e) authorizes bringing suit thereof post bond costs, including attorneys' fees, assess costs litigation. specifies limitations year time discovered, event three years offer sale, 15. restrictions, significantly, amendments adopted Prior payment costs. 27, 1933, c. 38, 83. June 1934, 404, 206(e), 907. substantially shortened 13. Compare 77n. 207, 908. restrictions29—cannot Congress, Such extension covered nullify actions.30 Fischman Raytheon Mfg. 188 783, 786-787 1951); 867-868 Rosenberg Globe Aircraft 80 123, 124 (E.D.Pa.1948); 17, 1787-1788; R. Jennings H. Marsh, Regulation 1070-1074 (3d ed. 1972). unwilling bring about history, none.31 D 36 addressed, point, contends, cast standing encompass behavior. "(t)o Viewed isolation (b), proscribing, respectively, omission, not. 37 harmonized Rule, making involved scienter.32 grand agency administration law. Rather, 'the carry statute.' Dixon 381 68, 1301, 1305, 223, 228 (1965), Manhattan General Equipment Commissioner, 297 129, 134, 56 397, 399, 528, 531 (1936). Thus, despite advanced case, stated above, compelled Gerstle Gamble-Skogmo, 478 1281, 1299 1973); Lanza Drexel 479 1277, 1304-1305 1766; id., 3883-3885. When speaks deception, implementing contrivances understood terminology reflects expansive extend conduct.33 III 38 nonfeasance trial whatever adopted. Throughout lengthy misconduct.34 circumstances, inappropriate remand proceedings. 39 Reversed. 40 STEVENS took consideration decision case. 41 BLACKMUN, whom BRENNAN joins, dissenting. 42 Once again (1975) interprets restrictively narrowly stultifies victim. confining is, "intent defraud." Sheer within reach great reforms effectuated Perhaps right, doubt it. Government too, evidenced thrust Solicitor behalf curiae. Court's opinion, sure, technical consistency seems me, can victimized much positive logical drive wedge two, saying other. questions here victims practiced Nay. What issue, course, accountant involvement responsibility 10b-5. security" 45 person," succinctly, proscribed, beyond fraud, commission. repeatedly Court, enacted avoiding frauds "not purposes." (1963); (1971); 741 (1972). On judgment, therefore, allegations, my sufficient, dismissal improper extent proposition mere opposite appears true, least Second Circuit, suits enjoin Rule. Management Dynamics, 515 801 Spectrum, Ltd., 489 535, 541 (1973); 854-855 (1968), (1969). real distinction situation one, surely violates depend plaintiff's identity. If sues, party sues. And, posture, concerned secondary entitlement reef. Rondeau Mosinee Paper 422 49, 2069, 72 49 critical importance accountant's role insuring overestimated. emphasized certifying "is safeguard interest, client." re Touche, Niven, Bailey Smart, S.E.C. 629, 670-671 (1957). complex society certificate lawyer's instruments inflicting pecuniary potent chisel crowbar." Benjamin, 328 854, 863 (CA2), Howard 953, 1631, 497 initial preparation certification negligent, perceive extraordinary rule, respects, violated, thwarted. 50 today decides thwarted; once rests rephrase re-enact, victims, these, ever relief thought broad, needed, deserving benefit.* requires brokers dealers "make preserve books, records, reports, 17a-5, 240.17a-5 file stating "clearly principles therein." Release 3338 (Nov. 28, 1942), X-17A-5(h). certificate, Inter alia, "whether circumstances" "be imply independent ordinarily expressing opinions required" Two separate, identical, complaints initially members group Subsequently jointly Amended Complaint. two treated consolidated, consolidated formally appeal. count directed Exchange, charging omissions aided abetted affirmed 364 (CA7), denied, 419 875, 137, 114 (1974). Immediately suicide commenced receivership except asserted claims accounts. 463 981, 986 409 880, 93 85, (1972), aider abettor. response interrogatories conceded accuse deliberate, fraud," "inexcusable negligence." App. 81. barred doctrine estoppel years. 29, Infra. sent confirmation forms 17a-5 requesting verify accuracy notify exceptions. accounts, notified fact. completed December until February 1971. holding, cited detailed elements establish claim solely inaction. Supra. "that knowledge or, inquiry, possessing due motive disclosure." 374. explained instant "elements comprise amplified according peculiarities case." 1104. Brennan Midwestern Ins. 259 673 (1966) 286 702 (N.D.Ind.1968), aff'd, 417 147 (CA7 1969), 397 989 (1970) (defendant giving assistance laws). Ruder, Multiple Defendants Law Fraud Cases: Aiding Abetting, Conspiracy, Pari Delicto, Indemnification Contribution, 120 U.Pa.L.Rev. 597, 620-645 1, "grounded concern (respondents)," without reaching "direct duty" 1105. arising contract foresee limited class suffer compare Glanzer Shepard, 233 N.Y. 236, 135 N.E. 275 (1922), Ultramares Corp. 255 170, 174 441 (1931); see, Rhode Island Hospital Trust Nat. Bank Swartz, 455 847, 851 (CA4 rely opinion. 1107. allude failings inquire collectibility loans follow up 1965 memorandum characterized weak centralization functions cashier. mentioned deficiencies although discuss matters 370-371, insufficient put notice affairs required. limitations. disposition issues. verbal formulations applied varied, substance sufficient White Abrams, 495 724, 730 (CA9 1974) ("flexible standard); Myzel Fields, 386 718, 735 (CA8 1967), 390 951, 1043, 1143 (1968) (negligence suffi- cient); Kohler 319 634, 637 1963) (knowledge required). Other reckless disregard truth, Clegg Conk, 507 1351, 1361-1362 (CA10 1974), 1007, 2628, 669 (an "scienter conscious fault"); 1306 1973) ("willful disregard" truth). few decisions announcing suffices actually Smallwood Pearl Brewing 579, 606 (CA5), 873, 113 (1974); dissenting); Bucklo, Scienter Nw.U.L.Rev. 562, 568-570 refers mental embracing defraud. areas recklessness purposes imposing act. whether, Since concerns injunctive Cf. 237 them direct base duty. litigation amended aver 17a-5. properly us assuming assert independently 5-6 Note, Implied Liability Under Harv.L.Rev. 858, 860 (1948). 3230 (May 1942); Birnbaum Newport Steel 193 461, 343 956, 1051, 1356 (1952). Kardon Gypsum 69 512 (E.D.Pa.1946). Compare, Comment, Col.L.Rev. 1057, 1080-1081 Negligent Misrepresentations U.Chi.L.Rev. 824, 839-844 (1965); 82 938, 947 Civil 10B 10B-5: Suggestion Replacing Doctrine Privity, 74 Yale L.J. 658, 682-689 with, 1766 (2d 1961); 3883-3885 permit cases. harmonize limit (i) knew reasonably (ii) rely, (iii) amount caused definite ascertainable. Brief Curiae 23-33. record conditions foreseen induce audits, unascertainable. 33-36. accept basic analysis reject additional violations. "To let general draw nourishment thing. unexpressed spirit outside bounds normal another. all, common run men sense thing, ordinary man right him." L.Ed., 1496. Frankfurter, Some Reflections Reading Statutes, 527, 536-537 (1947). Webster's International Dictionary 1934) defines "device" "(t)hat devised, formed design; contrivance; invention; project; scheme; often, deceive; stratagem; artifice," pertinent thing contrived contriving; plan, artifice." turn, "contrive" defined devise; plan; plot fabricate invent employ," supportive intend embrace Dictionary, "manipulate" manage treat artfully fraudulently; Manipulate 4. Exchanges. force (prices) down, matched orders, wash sales, fictitious .; rig." Infra, 208, 26. position modern many things you crimes sheer negligence" crime." Subcommittee Practices Banking Currency, 6509-6510 comments, taken context shed Corcoran's remarks during arise 8(a)(3) incorporated influence gain. remarks, moreover, observations activity Ferdinand Pecora, counsel committee draftsman Foremost-McKesson, Inc. Provident 423 232, 249-250 24, 508, 519, 464, 477 (1976), "(e)xcluding ulterior motives set forth act." 6510. Further, prerequisite 8(c) 2693. relies objections draft 2693 201-202, raised representatives industry hearings. warned vague outlaw anything. 6988; 258 Remarks debate persons drafting little weight. Mine Workers, 258, 276-277, 677, 687-688, 884, 903 (1947); Wrightwood Dairy 315 110, 125, 62 523, 529, 86 726, (1942). opponents "(i)n zeal defeat understandably tend overstate reach." NLRB Packers, 58, 66, 1063, 1068, Schwegmann Bros. Calvert Distillers 341 384, 394-395, 71 745, 750-751, 1035, 1047-1048 (1951). "Wash" change beneficial ownership. "Matched" orders entered size, price, sale/purchase security. (1) 78i(a)(1), registered A. Latimer 790 (1958); Thornton 208 individuals sign statement, directors issuer, underwriter similarly complete defense belief 11(b)(3)(A), (C), (D), Feit Leasco Data Processing 332 544, 575-583 (E.D.N.Y.1971) (underwriters, officer-directors, established due-diligence defense). 1018-1027 1972), sources therein; Folk, Liabilities Acts: Case, 55 Va.L.Rev. 199 12(2) potential seller purchaser transaction. exculpated proves know, care, known untruth Title "control" severally controlled "had ground exist." 77O. Each expressly directors, officers, 10% Beneficial holders securities, 16(b), 78p(b), 464 (1976); Kern County Land Occidental Petroleum 411 582, 1736, (1973), contains state-of-mind something "willfully participates" exchange. 78i(e). "he misleading." 78r. "controlling person(s)" control, exculpates "acted constituting ." Emphasizing important difference 14(a) 78n(a), contrasted courts shareholder recipients materially proxy corporation. 1973). 289-290 forum State followed Holmberg Armbrecht, 327 392, 395, 66 584, 90 743, 746 (1946), therein. always followed, statutes usually longer 1773-1774. regarded introducing providing (amendment) all." 78 Cong.Rec. 8669 One deter settlement value. ibid.; 740-741, 1927-1928, 539 deterrent lacking district court's award fees sharply circumscribed. Alyeska Pipeline Service Wilderness Society, 240, 1612, 141 ("bad faith" requirement); F. Rich ex rel. Industrial Lumber 116, 94 2157, 2165, 703, 713 persons, accountants, made" documents basis 18. extends who, reliance statements. limited, "good Consistent suggests recovery. 18(a), 7855, care profession objected honest errors judgment. 7175-7183; 653. subsequent drafts current formulation relatively short similar 18(c). authorized 18(a). Apparently hastily drafted Regional Administrator Boston reported Director Trading Division corporation telling shareholders doing poorly purchasing shares resultant depressed prices, exceptionally well. approved day received. Conference Codification Laws, Bus.Law. 922 (1967) (remarks Milton Freeman, codrafters); 767, 1940, 567 (Blackmun, derived 77q. g. 1940 867 sub Indeed release issued contemporaneously explained: "The announced adoption prohibiting previously existing dealers. closes loophole protections administered buying purchase." 1942). That year, Annual Report, "fraud": "During fiscal X-10B-5 investors. prohibits while dealers." dispositive occasion examine considerations "policy," parties, influenced lawmakers statute. urged broaden plaintiffs seek services Last Term, 747-748, 1931, 556, pertinently observed: "While development elimination artificial barriers claims, inexorable broadening sue area good. (1931), Chief Judge Cardozo observed 'a indeterminate class: 'The hazards extreme enkindle flaw exist implication exposes consequences.' 179-180, N.E., 444." facts, illustrates initiated foreseeable users Ernst. either certificates supra. eligible benefit standard, though numbered thousands Acceptance frontiers "hazards" rendering advice raising serious policy yet Congress. 1104, 1119; 5, understandably, number suggested briefs. Ante, 191-192, 7; 11; 194 12; 13; 214-216, 33. reached served dissent.

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