Aaron v. Securities and Exchange Commission

• Decision Date: 02 June 1980
• Docket Number: No. 79-66,79-66
• Citation: 64 L.Ed.2d 611,100 S.Ct. 1945,446 U.S. 680
• Parties: Peter E. AARON, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION
• Court: U.S. Supreme Court

446 U.S. 680

100 S.Ct. 1945

64 L.Ed.2d 611

Peter E. AARON, Petitioner,

v SECURITIES AND EXCHANGE COMMISSION.

No. 79-66.

Argued Feb. 25, 1980.

Decided June 2, 1980.

Syllabus

Section 17(a) of the Securities Act of 1933 (1933 Act) makes it unlawful for any person in the offer or sale of any security "(1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact . . ., or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser." Section 10(b) of the Securities Exchange Act of 1934 (1934 Act) makes it unlawful to use, in connection with the purchase or sale of any security, "any manipulative or deceptive device or contrivance" in violation of such regulations as the Securities and Exchange Commission (SEC) may prescribe, and Rule 10b-5 was promulgated to implement this section. Section 20(b) of the 1933 Act and § 21(d) of the 1934 Act authorize the SEC to seek injunctive relief against violations of the respective Acts and further provide that, "upon a proper showing," a district court shall grant the injunction. Pursuant to §§ 20(b) and 21(d), the SEC filed a complaint in a District Court against petitioner, a managerial employee of a broker-dealer, alleging that he had violated, and aided and abetted violations of, § 17(a) of the 1933 Act, § 10(b) of the 1934 Act, and SEC Rule 10b-5, in connection with his firm's sales campaign for certain securities. Concluding that there was scienter on petitioner's part, the District Court found that he had committed and aided and abetted the violations as alleged. The Court of Appeals affirmed, declining to decide whether petitioner's conduct would support a finding of scienter and holding instead that when the SEC is seeking injunctive relief, proof of negligence alone will suffice.

Held : The SEC is required to establish scienter as an element of a civil enforcement action to enjoin violations of § 10(b) of the 1934 Act, Rule 10b-5, and § 17(a)(1) of the 1933 Act, but need not establish scienter as an element of an action to enjoin violations of §§ 17(a)(2) and 17(a)(3) of the 1933 Act. Pp. 687-702.

(a) Scienter is an element of violations of § 10(b) and Rule 10b-5, regardless of the identity of the plaintiff or the nature of the relief sought. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668. Section 10(b)'s language, particularly the terms "manipulative," "device," and "contrivance," clearly refer to "knowing and intentional misconduct," and the section's legislative history also points toward a scienter requirement. SEC v. Capital Gains Research Bureau, 375 U.S. 180, 84 S.Ct. 275, 11 L.Ed.2d 237, distinguished. Pp. 689-695.

(b) Section 17(a)(1)'s language, "to employ any device, scheme, or artifice to defraud," plainly evinces an intent on Congress' part to proscribe only knowing or intentional misconduct. By contrast, § 17(a)(2)'s language, "by means of any untrue statement of a material fact or any omission to state a material fact," is devoid of any suggestion of a scienter requirement. And § 17(a)(3)'s language, "to engage in any transaction, practice, or course of business whichoperates or would operate as a fraud or deceit," plainly focuses upon theeffect of particular conduct on members of the investing public, rather than upon the culpability of the person responsible. Cf. SEC v. Capital Gains Research Bureau, supra. There is nothing in § 17(a)'s legislative history to show a congressional intent contrary to the conclusion that scienter is thus required under § 17(a)(1) but not under §§ 17(a)(2) and 17(a)(3). Pp. 695-700.

(c) The language and legislative history of §§ 20(b) and 21(d) both indicate that Congress intended neither to add to nor detract from the requisite showing of scienter under the substantive provisions at issue. Pp. 700-701.

605 F.2d 612, vacated and remanded.

Barry M. Fallick, Asst. Dist. Atty., New York City, for petitioner.

Ralph C. Ferrara, Washington, D. C., for respondent.

Mr. Justice STEWART delivered the opinion of the Court.

The issue in this case is whether the Securities and Exchange Commission (Commission) is required to establish scienter as an element of a civil enforcement action to enjoin violations of § 17(a) of the Securities Act of 1933 (1933 Act), § 10(b) of the Securities Exchange Act of 1934 (1934 Act), and Commission Rule 10b-5 promulgated under that section of the 1934 Act.

I

When the events giving rise to this enforcement proceeding occurred, the petitioner was a managerial employee at E. L. Aaron & Co. (the firm), a registered broker-dealer with its principal office in New York City. Among other responsibilities at the firm, the petitioner was charged with supervising the sales made by its registered representatives and maintaining the so-called "due diligence" files for those securities in which the firm served as a market maker. One such security was the common stock of Lawn-A-Mat Chemical & Equipment Corp. (Lawn-A-Mat), a company engaged in the business of selling lawn-care franchises and supplying its franchisees with products and equipment.

Between November 1974 and September 1975, two registered representatives of the firm, Norman Schreiber and Donald Jacobson, conducted a sales campaign in which they repeatedly made false and misleading statements in an effort to solicit orders for the purchase of Lawn-A-Mat common stock. During the course of this promotion, Schreiber and Jacobson informed prospective investors that Lawn-A-Mat was planning or in the process of manufacturing a new type of small car and tractor, and that the car would be marketed within six weeks. Lawn-A-Mat, however, had no such plans. The two registered representatives also made projections of substantial increases in the price of Lawn-A-Mat common stock and optimistic statements concerning the company's financial condition. These projections and statements were without basis in fact, since Lawn-A-Mat was losing money during the relevant period.

Upon receiving several complaints from prospective investors, an officer of Lawn-A-Mat informed Schreiber and Jacobson that their statements were false and misleading and requested them to cease making such statements. This request went unheeded.

Thereafter, Milton Kean, an attorney representing Lawn-a-Mat, communicated with the petitioner twice by telephone. In these conversations, Kean informed the petitioner that Schreiber and Jacobson were making false and misleading statements and described the substance of what they were saying. The petitioner, in addition to being so informed by Kean, had reason to know that the statements were false, since he knew that the reports in Lawn-A-Mat's due diligence file indicated a deteriorating financial condition and revealed no plans for manufacturing a new car and tractor. Although assuring Kean that the misrepresentations would cease, the petitioner took no affirmative steps to prevent their recurrence. The petitioner's only response to the telephone calls was to inform Jacobson of Kean's complaint and to direct him to communicate with Kean. Otherwise, the petitioner did nothing to prevent the two registered representatives under his direct supervision from continuing to make false and misleading statements in promoting Lawn-A-Mat common stock.

In February 1976, the Commission filed a complaint in the District Court for the Southern District of New York against the petitioner and seven other defendants in connection with the offer and sale of Lawn-A-Mat common stock. In seeking preliminary and final injunctive relief pursuant to § 20(b) of the 1933 Act and § 21(d) of the 1934 Act, the Commission alleged that the petitioner had violated and aided and abetted violations of three provisions—§ 17(a) of the 1933 Act, § 10(b) of the 1934 Act, and Commission Rule 10b-5 promulgated under that section of the 1934 Act.¹ The gravamen of the charges against the petitioner was that he knew or had reason to know that the employees under his supervision were engaged in fraudulent practices, but failed to take adequate steps to prevent those practices from continuing. Before commencement of the trial, all the defendants except the petitioner consented to the entry of permanent injunctions against them.

Following a bench trial, the District Court found that the petitioner had violated and aided and abetted violations of § 17(a), § 10(b), and Rule 10b-5 during the Lawn-A-Mat sales campaign and enjoined him from future violations of these provisions.² The District Court's finding of past violations was based upon its factual finding that the petitioner had intentionally failed to discharge his supervisory responsibility to stop Schreiber and Jacobson from making statements to prospective investors that the petitioner knew to be false and misleading. Although noting that negligence alone might suffice to establish a violation of the relevant provisions in a Commission enforcement action, the District Court concluded that the fact that the petitioner "intentionally failed to terminate the false and misleading statements made by Schreiber and Jacobson, knowing them to be fraudulent, is sufficient to establish his scienter under the securities laws." As to the remedy, even though the firm had since gone bankrupt and the petitioner was no longer working for a broker- dealer, the District Court reasoned that injunctive relief was warranted in light of "the nature and extent of the violations . . ., the [petitioner's] failure to recognize the wrongful nature of his conduct and the likelihood of the [petitioner's] repeating his violative conduct."

The Court of Appeals for the Second Circuit affirmed the judgment. 605 F.2d 612. Declining to reach the question whether the petitioner's conduct would support a finding of scienter, the Court of...