John Nuveen & Co., Inc. v. Henry T. Sanders

Background

A broker-dealer, John Nuveen & Co., sold short-term promissory notes (commercial paper) issued by Winter & Hirsch in the late 1960s. The dealer prepared a sales report relying mainly on the company’s certified financial statements, bank inquiries, and a brief inspection of records. Unknown to the dealer, company officers and the auditing firm had falsified the financial statements; fraud was discovered in 1970, auditors and officers were convicted, and paperholders were paid about 65 cents on the dollar. Buyers sued to recover losses.

Reasoning

The legal question was whether the seller met the Securities Act’s requirement that it “in the exercise of reasonable care could not have known” the statements were false. The District Court found liability under §12(2), and the Seventh Circuit affirmed, saying the dealer’s limited checks were not a sufficient investigation and that it should have examined tax returns, minute books, and auditors’ workpapers. Justice Powell, dissenting from the Supreme Court’s denial of review, argued the Seventh Circuit blurred §12(2)’s “reasonable care” standard with the stricter “reasonable investigation” standard used for registered offerings under §11, and improperly limited customary reliance on certified accountants.

Real world impact

Because commercial paper dealers traditionally rely on audited statements, the Seventh Circuit’s approach could push dealers to undertake costlier investigations. That would likely increase dealers’ transaction costs and widen the dealers’ “spread,” making short-term borrowing more expensive. The Supreme Court’s denial leaves the lower-court ruling intact but does not resolve the statutory disagreement nationwide.

Dissents or concurrances

Justice Powell (joined by Justice Rehnquist) would have granted review, warning that the decision could harm the efficiency of the Nation’s short-term financing markets.