Aaron v. SEC

PETITIONER: Peter E. Aaron
RESPONDENT: Securities and Exchange Commission
LOCATION: E.L. Aaron & Co., Inc.

DOCKET NO.: 79-66
DECIDED BY: Burger Court (1975-1981)
LOWER COURT: United States Court of Appeals for the Second Circuit

CITATION: 446 US 680 (1980)
ARGUED: Feb 25, 1980
DECIDED: Jun 02, 1980

ADVOCATES:
Barry M. Fallick - on behalf of the Petitioner
Ralph C. Ferrara - on behalf of the Respondent

Facts of the case

While working for his father’s broker-dealer firm, Peter E. Aaron was in charge of supervising sales of securities made by other employees and maintaining files on the companies that issued the securities sold by the firm. In the fall of 1974, two of Aaron’s employees began telling prospective investors that they should buy shares of the Lawn-A-Mat Chemical & Equipment Corporation (Lawn-A-Mat) because the company planned to manufacture a new type of small car within the next six weeks. An attorney for Lawn-A-Mat contacted Aaron twice and informed him that the company had no plans to manufacture a car, but Aaron did not ensure that the employees would stop making those statements in promoting the Lawn-A-Mat stock. In 1976, the Securities and Exchange Commission (SEC) filed a complaint against Aaron in district court and alleged that he had violated, and aided and abetted violations of, Section 17(a) of the Securities Act of 1933 (1933 Act), Section 10(b) of the Securities Act of 1934 (“1934 Act”), and Rule 10b-5, which is a rule promulgated by the SEC to implement Section 10(b). The district court found that Aaron had violated the securities laws in question through his “intentional failure” to stop the fraudulent practices of the employees working under him. The U.S. Court of Appeals for the Second Circuit affirmed the judgment but declined to reach the question of whether Aaron’s conduct amounted to an intent to “deceive, manipulate, or defraud.” Instead the Court of Appeals held that proof of negligence is sufficient to establish a violation of Section 17(a) of the 1933 Act, Section 10(b) of the 1934 Act, and Rule 10b-5.

Question

Must the SEC prove that that the defendant intended to “deceive, manipulate, or defraud” in an action that alleges violations of Section 17(a) of the ’33 Act and Section 10(b) of the ’34 Act and Rule 10b-5?

Media for Aaron v. SEC

Audio Transcription for Oral Argument - February 25, 1980 in Aaron v. SEC

Warren E. Burger:

We will hear arguments next in 79-66, Aaron v. Securities and Exchange Commission.

Mr. Fallick.

Barry M. Fallick:

Mr. Chief Justice, and may it please the Court.

This matter concerns an appeal from the Court of Appeals for the Second Circuit which affirmed a judgment of the District Court which had permanently enjoined the petitioner from violating the anti-fraud provisions and the registration provisions of the Securities Acts of 1933 and 1934.

The issue that is raised in this appeal is whether scienter is a necessary element in an action for injunctive relief under section 10(b) and Rule 10b-5 and under Section 17(a) of the 1933 Act.

The facts surrounding the issuance of the permanent injunction are quite short and simple.

Petitioner was employed by a company known as E. L. Aaron & Company, a company owned by his father.

From 1974 through the beginning of 1975, E. L. Aaron & Company was making a market in the common stock of a company known as Lawn-A-Mat Chemical & Equipment Corp. During that period of time, a branch office was opened in Roslyn Heights, New York.

Two registered employees of E. L. Aaron & Company sent to that branch office and during their time there they made misrepresentations concerning the financial status and health of Lawn-A-Mat and also concerning future manufacturing ideas concerning Lawn-A-Mat.

The District Court, while finding that Mr. Aaron did not make any false misrepresentations, nevertheless said he willfully aided and abetted a violation of the anti-fraud provisions by failing to prevent him employees from continuing in those statements they made. Of course, Mr. Aaron was not an owner of E. L. Aaron & Company, nor was he an officer of E. L. Aaron & Company.

The Second Circuit Court of Appeals nevertheless said that it did not have to reach the issue of scienta and based on its long-term policy said that the standard in injunctive actions under section 10(b) would be a negligence standard.

Thus, the first issue was whether under section 10(b) there should be a standard of scienter in injunctive actions.

William H. Rehnquist:

Mr. Fallick, in your question presented for decision in your petition for certiorari, when you refer to the government enforcement by injunction of these acts, do you think there is fairly assumed the federal rules of civil procedure, 65 et cetera, relating to injunctions, regardless of whether the particular statutes contain a requirement of scienter or not when enforcement is brought by the government?

Barry M. Fallick:

Well, standards under the sections concerning injunctive relief, whether the defendant is engaged or likely to engage in a violation of certain sections or regulations of the securities law, and I am not quite sure if that is the same standard under the federal 65.

In the Hochfelder case, this Court had the opportunity to construe the meaning of section 10(b) in the context of a private damage action.

We submit that there is nothing in that Court's decision which indicates that a different standard should be applied here.

In Hochfelder, this Court relied on the language, legislative history and administrative history of section 10(b) to determine that that language connotes intentional conduct.

Of course, when section 10(b) was enacted, Congress did not contemplate that there would be a private damage cause of action, therefore the language and the history should reflect congressional determination and intention concerning injunctive relief under section 10(b).

The government relies heavily on the Capital Gains case in which this Court in 1940 stated that there is a difference between fraud in law and fraud in equity.

In that case, Capital Gains, Mr. Justice Goldberg heavily relied upon the legislative history surrounding the Investment Advisers Act, and this Court has said that that interpretation is premised on congressional belief that there should be standards concerning federal fiduciary relationship with investment advisers.

In addition, Mr. Justice Goldberg was clearly influenced by the fact that the injunctive relief in Capital Gains was mildly propylactic.

Here, however, in the normal course of security business, injunctive relief is no longer considered mildly prophylactic.

There is a loss of reputation, a loss of business, subject to administrative and criminal proceedings.

Courts no longer, especially in the Second Circuit, consider injunctive relief to be mildly propylactic.

Thus, because the statutory text of Capital Gains is of course different than under 10(b), because of the legislative history of the Investment Advisers Act, and because of the premise that injunctive relief is mildly propylactic, and it was in that case.

That case was clearly distinguishable from the case at bar.

There is also an issue presented here concerning whether injunctive relief should be premised on a standard of scienter under section 17(a) of the 1933 Securities Act.

Several courts, several commentators have recently commented upon section 17(a).

The Fifth Circuit, in construing subsection (1) of 17(a), said the language there, especially the words "device, scheme and artifice to defraud" clearly connote that Congress intended that a standard of scienter be established.

Of course, the Fifth Circuit in the Steadman case was relying on the language of this Court in Hochfelder.