425 U.S. 185 (1976)
From 1946 through 1967, Ernst & Ernst, an accounting firm, was retained by First Securities Company of Chicago, a small brokerage firm and member of the Midwest Stock Exchange and the National Association of Securities Dealers, to perform periodic audits of the firm's books and records.1 Ernst & Ernst prepared for filing with the Securities and Exchange Commission the annual reports required of First Securities under § 17(a) of the 1934 Act.2 It also prepared responses to the financial questionnaires of the Midwest Stock Exchange.3
Respondents were customers of First Securities who invested funds in a fraudulent securities scheme perpetrated by Leston B. Nay, president of the firm and owner of 92% of its stock.4 From 1942 through 1966, with the majority of the transactions occurring in the 1950s, Nay induced respondents to invest in escrow accounts that he represented would yield a high rate of return.5 In fact, there were no escrow accounts, as Nay converted respondents' funds to his own use immediately upon receipt.6 These transactions were not in the customary form of dealings between First Securities and its customers.7 They were not reflected on the books and records of First Securities.8 They were not shown on its periodic accounting to respondents or included in First Securities' filings with the Commission or the Exchange.9
The fraud came to light in 1968 when Nay committed suicide, leaving a note that described First Securities as bankrupt and the escrow accounts as spurious.10 Respondents subsequently filed this action for damages against Ernst & Ernst in the United States District Court for the Northern District of Illinois under § 10(b) of the 1934 Act.11 The complaint charged that Nay's escrow scheme violated § 10(b) and Rule 10b-5.12 It also charged that Ernst & Ernst had aided and abetted Nay's violations by its failure to conduct proper audits of First Securities.13
As revealed through discovery, respondents' cause of action rested on a theory of negligent nonfeasance.14 The premise was that Ernst & Ernst had failed to utilize appropriate auditing procedures in its audits of First Securities.15 This failure prevented discovery of internal practices of the firm said to prevent an effective audit.16 The practice principally relied on was Nay's rule that only he could open mail addressed to him at First Securities or addressed to First Securities to his attention.17 Respondents specifically disclaimed the existence of fraud or intentional misconduct on the part of Ernst & Ernst.18
After extensive discovery the District Court granted Ernst & Ernst's motion for summary judgment and dismissed the action.19 The Court of Appeals for the Seventh Circuit reversed and remanded.20 The Supreme Court granted certiorari to resolve the question whether a private cause of action for damages will lie under § 10(b) and Rule 10b-5 in the absence of any allegation of scienter.21
Whether an action for civil damages may lie under § 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 in the absence of an allegation of intent to deceive, manipulate, or defraud on the part of the defendant?22
Section 10(b) makes it unlawful for any person to use or employ any manipulative or deceptive device or contrivance in connection with the purchase or sale of any security.23 This prohibition applies in contravention of rules and regulations that the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. The words "manipulative or deceptive" used in conjunction with "device or contrivance" strongly suggest that § 10(b) was intended to proscribe knowing or intentional misconduct.24
No. The established facts demonstrate that respondents' cause of action rested on a theory of negligent nonfeasance. The premise was that Ernst & Ernst had failed to utilize appropriate auditing procedures in its audits of First Securities. This failure prevented discovery of internal practices of the firm said to prevent an effective audit. The practice principally relied on was Nay's rule that only he could open mail addressed to him at First Securities or addressed to First Securities to his attention. Respondents specifically disclaimed the existence of fraud or intentional misconduct on the part of Ernst & Ernst.
Because the rule requires scienter and the facts show only a claim of negligence without any allegation of intent to deceive, manipulate, or defraud, the action may not lie.
An action for civil damages may not lie under § 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 in the absence of an allegation of intent to deceive, manipulate, or defraud on the part of the defendant.25
Related opinions on this issue
Joined by Mr. Justice Brennan
Justice Blackmun dissented.26 He contended that the language of the Rule clearly and succinctly prohibits negligent as well as intentional conduct of the kind proscribed.27 He argued that it is not logical to drive a wedge between negligent conduct and positive deception.28
An investor can be victimized just as much by negligent conduct as by positive deception. He emphasized that the critical importance of the auditing accountant's role in insuring full disclosure cannot be overestimated.29 The initial inquiry into whether Ernst & Ernst's preparation and certification of the financial statements were negligent should not be thwarted.30