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Ernst & Ernst v. Hochfelder - 425 U.S. 185, 96 S. Ct. 1375 (1976)

Rule:

A private cause of action for damages will not lie under §10(b) of the Securities Exchange Act of 1934, 15 U.S.C.S. § 78j(b), and Securities and Exchange Commission Rule 10b-517 C.F.R. § 240.10b-5 (1975), in the absence of an allegation of "scienter" - intent to deceive, manipulate, or defraud.

Facts:

Petitioner, an accounting firm, had been retained by a small brokerage firm for 21 years to perform periodic audits of the brokerage firm's books and records. Respondents were customers of the brokerage firm who had invested in a fraudulent securities scheme perpetrated by the president of the brokerage firm. Respondents filed an action for damages against the accounting firm under § 10(b) of the Act, which makes it unlawful to use in connection with the purchase or sale of any security any "manipulative or deceptive device or contrivance" and Rule 10b-5, which makes it unlawful to employ any device to defraud, to make an untrue statement or omit to state a material fact, or to engage in any act which operates or would operate as a fraud in connection with the purchase or sale of any security. Respondents' complaint was based on a theory of negligent nonfeasance. The district court's grant of summary judgment to the accounting firm, on the basis that a cause of action could not be maintained under § 10(b) of Act and Rule 10b-5 merely on allegations of negligence. On appeal, the court of appeals reversed and remanded, holding that there were genuine issues of fact as to whether the defendant had breached its duty of inquiry into the adequacy of the brokerage firm's internal control system, and whether such inquiry and disclosure would have led to the discovery or prevention of the fraud of the brokerage firm's president.

Issue:

Was the accounting firm be liable for damages?

Answer:

No.

Conclusion:

The US Supreme Court held that an action for civil damages could not be maintained under 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5, in the absence of an allegation of intent to deceive, manipulate, or defraud on the defendant's part, since some element of scienter was necessary and liability could not be imposed for negligent conduct alone. The Court reviewed the Act and concluded that the language of § 10(b) clearly connoted intentional misconduct. The Court stated that the language of a statute controls when it is sufficiently clear in context. The judgment of the court of appeals was reversed. 

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