Ernst & Ernst v. Hochfelder

Background

A group of investors sued an accounting firm that audited a small brokerage firm after the brokerage's president ran a long-running fraudulent "escrow" scheme. The investors said the auditors failed to follow proper auditing steps and that this negligent failure helped hide the fraud. The District Court granted summary judgment for the auditors, the Seventh Circuit reversed, and the Supreme Court agreed to decide whether negligence alone can support a private damages claim under §10(b) and Rule 10b-5.

Reasoning

The Court addressed whether private damage suits under §10(b) and Rule 10b-5 can be based only on negligence or require "scienter," meaning intent to deceive, manipulate, or defraud. The majority read the statute's language and legislative history as aimed at intentional misconduct, noted that Congress expressly used different fault standards elsewhere in the securities laws, and explained that the Commission's rulemaking cannot expand the statute. Concluding that the text and history point to a state-of-mind requirement, the Court held negligence alone insufficient and reversed the Court of Appeals.

Real world impact

The decision limits private damage claims: investors generally must show intentional or sufficiently culpable mental states, not just careless audits. That reduces the risk that accountants and other experts will face broad negligence-based damages under §10(b). The Court also declined to remand for trial because the plaintiffs had framed their case only as negligence.

Dissents or concurrances

Justice Blackmun (joined by Justice Brennan) dissented, arguing the Rule's language and remedial purpose support liability for negligent omissions and that restricting recovery harms investor protection.