Ernst & Ernst v. Hochfelder

Supreme Court of the United States · 1976 · Corporations

425 U.S. 185 (1976)

Updated August 1, 2026

Corporationsscienter under 10b-5securities fraudRule 10b-5Section 10(b)scienterintent to deceivenegligence insufficient

Facts

Ernst & Ernst audited First Securities Company of Chicago and prepared annual reports required under § 17(a) of the 1934 Act. First Securities' president, Leston Nay, induced customers to invest in fictitious 'escrow' accounts and converted their funds to his own use; those accounts were not reflected on the firm's books or filings. The customers sued Ernst & Ernst under § 10(b) and Rule 10b-5 on a theory of negligent nonfeasance, claiming the firm failed to use appropriate auditing procedures that would have uncovered Nay's mail-opening rule and led to discovery of the fraud. The customers specifically disclaimed fraud or intentional misconduct by Ernst & Ernst.

Issue

May a private action for civil damages be maintained under § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 when the complaint alleges only negligent conduct and no intent to deceive, manipulate, or defraud by the defendant? More specifically, is negligence alone enough to impose civil liability under § 10(b) and Rule 10b-5?

Rule

A private cause of action for damages under § 10(b) and Rule 10b-5 does not lie absent scienter. Section 10(b)'s prohibition of the use or employment of any manipulative or deceptive device or contrivance requires a mental state embracing intent to deceive, manipulate, or defraud, and cannot be extended to negligent conduct alone.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Phoenix, investors sued Mesa Ledger Partners, an accounting firm that audited a small securities dealer. The complaint alleges only that the firm carelessly failed to notice irregularities that would have exposed the dealer’s president’s stock-selling fraud, and it expressly disclaims any intent to deceive by the accountants.

In the investors’ private action for damages under § 10(b) and Rule 10b-5, which is the strongest argument for the accounting firm?

Explanation. A private damages action under § 10(b) and Rule 10b-5 requires scienter—intent to deceive, manipulate, or defraud. The majority held that negligence alone is insufficient because the statutory terms 'manipulative or deceptive device or contrivance' connote intentional misconduct, not mere carelessness.