Aaron v. SEC

Summary

The petitioner, Aaron, was a managerial employee of E. L. Aaron & Co., a New York broker-dealer that made a market in the stock of Lawn-A-Mat Chemical & Equipment Corp., a seller of lawn-care franchises. He supervised the firm's salesmen and kept its due diligence files. Between November 1974 and September 1975 two of his registered representatives, Norman Schreiber and Donald Jacobson, told prospective buyers that Lawn-A-Mat was about to manufacture a new small car and tractor and that its stock would rise sharply. None of it was true, and the company was losing money. A lawyer for Lawn-A-Mat twice telephoned the petitioner to report the false statements; he promised they would stop but did little beyond passing the complaint to one of the salesmen. In February 1976 the Securities and Exchange Commission sued for an injunction. The District Court found that he had intentionally failed to stop statements he knew were fraudulent and enjoined him; the Second Circuit affirmed on the ground that negligence alone suffices when the SEC seeks an injunction. The question was whether the Commission must prove scienter, an intent to deceive, manipulate or defraud, to enjoin violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. Aaron argued that Ernst & Ernst v. Hochfelder (1976) had read Section 10(b) to require intent and that the same words cannot mean something different when the SEC sues. The Commission answered that public injunction suits differ from private damages actions, that equity traditionally granted relief against misrepresentation without proof of intent, and that the agency needs flexible tools to stop deception early. On 2 June 1980 the Court vacated the judgment, six to three. Justice Stewart held that Hochfelder's reading of Section 10(b) depended on the statute's words and history, not on who brings the suit, so scienter is required there in SEC actions too. Section 17(a) divided differently: its first clause, forbidding any device, scheme or artifice to defraud, requires scienter, but its second and third clauses, about obtaining money through untrue statements and about practices that operate as a fraud, focus on the effect on investors and require none. The injunction provisions add nothing to these elements, though a defendant's intent remains relevant to whether future violations are likely. Because the lower court had not decided the case on these terms, it was sent back. Chief Justice Burger concurred, noting that the record amply supported a finding of intentional failure and that an injunction should not issue against someone acting in good faith. Justice Blackmun, with Justices Brennan and Marshall, agreed about Section 17(a)(2) and (3) but would not require scienter anywhere in SEC injunction suits, relying on equity's tradition and on SEC v. Capital Gains Research Bureau (1963). The library text includes Stewart's and Burger's opinions in full and a large part of Blackmun's, with notes removed.

Top Lessons

• One statute, three standards

  Stewart's opinion reads the three clauses of Section 17(a) one by one and finds that they ask different questions: the first about the defendant's purpose, the second and third about the effect on investors. Careful attention to each clause produced a split result that neither side had fully urged.

• Does the plaintiff change the meaning?

  The Second Circuit had held that a government agency seeking an injunction should face a lighter burden than a private party seeking money. The Court rejected the idea that the words of Section 10(b) mean one thing when the SEC sues and another when an investor does, while Blackmun argued that public enforcement and private damages differ in purpose.

• Supervision and responsibility

  The facts concern a supervisor who learned of his salesmen's false statements and did almost nothing. Burger's concurrence observes that he neither discharged nor rebuked them, and the District Court found that his failure was intentional. The case shows how responsibility in a firm can attach to those who oversee others.

• Law and equity

  Blackmun's dissent draws on the old distinction between courts of law, which required proof of intent before awarding damages for fraud, and courts of equity, which could undo or stop misrepresentation without it. The majority treated the statutory words as decisive; the dissent treated the equity tradition as part of their meaning.

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Medical Lens

An SEC enforcement action over false sales talk about a lawn-care franchiser's stock; nothing in the opinions bears on medicine or health.