Brief Fact Summary. Ernst (Defendant), and accounting firm, failed to expose an escrow account fraud plan committed by the president of the brokerage firm that retained Ernst, causing Hochfelder (Plaintiff) to seek damages for negligence under Â§ 10(b) of the 1934 Act.
Synopsis of Rule of Law. An action for civil damages fails to fall under Â§ 10(b) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 when lacking an accusation of intent to mislead, manipulate, or deceive on the part of the defendant.
Issue. Does an action for civil damages fail to fall under Â§ 10(b) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 when lacking an accusation of intent to mislead, manipulate, or deceive on the part of the defendant?
Held. (Powell, J.) No. An action for civil damages fails to fall under Â§ 10(b) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 when lacking an accusation of intent to mislead, manipulate, or deceive on the part of the defendant. The usage and employment of â€œany manipulative or deceptive device or contrivanceâ€ in breaking SEC rules is illegal under Â§ 10(b). The use of terms like â€œmanipulativeâ€, â€œdeceptiveâ€ and â€œcontrivanceâ€ intensely advocate a congressional objective to prohibit a type of behavior nothing like negligence. Such terms imply deliberate or determined behavior intended to mislead or defraud investors. The history behind the legislation also backs an explanation like this. Â§ 10(b) was intended as a â€œcatch-all clause to prevent manipulative devicesâ€¦the commission should have the authority to deal with new manipulative devices.â€ Terms like that would not be utilized by the drafters if the objective was to produce liability for simply negligent acts or omissions. A defendant could elude a liability by showing that the statement was made in good faith, as stated in the U.S. Senate report on the 1934 Act. Also each portion of the Act that is responsible for civil liabilities asserts that if recovery under S 10(b) has been generated judicially, to permit an action under Â§ 10(b) on the grounds of negligence would permit causes of action developing under other portions of the act (Â§Â§ 11, 12, and 15) to be filed under Â§ 10(b) â€œand thereby nullify the effectiveness of the carefully drawn procedural restrictions on these express actions.â€ Reversed.
Discussion. The courts of appeal were in conflict on the issue to be decided in this case. Many have held that negligence was ample to sustain an action. In the decision, the Court utilized the term â€œscienterâ€ when referencing a mental state embodying intent to mislead, manipulate or swindle. The court failed to consider if recklessness would be ample to sustain an action under Â§ 10(b) and Rule 10b-5. The Court also failed to consider the inquiry regarding if scienter is a required feature in an action for injunctive relief under that section and rule. It seemed as though Â§ 10(b) was a rapidly drafted reply to an issue â€œclearly involving intentional misconductâ€, in fact, this section was draftedÂ the same day that a Boston corporation reported to Congress aboutÂ an issue containing a fraudulent scheme.