Scienter Must Be Alleged to Maintain a Civil Damages Action Under Section 10(b) of the Securities Exchange Act of 1934 and Rule l0b-5 of the Securities and Exchange Commission

Reviews the Supreme Court case, Ernst & Ernst v. Hochfelder. In Hochfelder, Olga Hochfelder and other investors in a fraudulent securities scheme brought action for damages in federal district court against the accounting firm retained to audit the brokerage firm’s books. Alleging that the defendant had negligently conducted its audits of the firm, the plaintiffs sought to recover under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 of the Securities and Exchange Commission (SEC). The district court rejected the contention that a cause of action could not be maintained under section 10(b) and rule 10b-5 for negligent misconduct but entered summary judgment for the defendant, holding that there was no issue of material fact as to whether the defendant had conducted its audits in accordance with generally accepted auditing standards. The Seventh Circuit reversed and remanded, holding that one who breaches a duty of inquiry and disclosure owed to another is liable in damages for aiding and abetting a third party's violation of rule 10b-5 if the fraud would have been discovered or prevented but for the breach. The court also held that there were genuine issues of fact as to whether the defendant committed such a breach and whether inquiry and disclosure would have led to discovery or prevention of the fraud. On certiorari, the United States Supreme Court reversed, holding that scienter must be alleged to maintain a civil damages action under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5 of the SEC.