Securities Law: The Scienter Requirement in an SEC Enforcement Action — Should Equity Control?

SEC v. Aaron, 605 F.2d 612 (2d Cir.), cert. granted, 48 U.S.L.W. 3258 (1979) (No. 79-66). It has been nearly five decades since the havoc of the Depression caused Congress to enact the Securities Act of 1933 and the Securities Exchange Act of 1934. In this time it has become clear that the federal courts have yet to uniformly settle the question of what constitutes a proper cause of action under the antifraud provisions of these Acts. A related problem is whether the elements in a proper cause of action should differ in an action brought by the Securities and Exchange Commission (SEC) as opposed to one for damages brought by a private party. The Supreme Court decision in Ernst & Ernst v. Hochfelder has added to this general uncertainty. While the Hochfelder decision dealt with a private action for damages under the antifraud provisions, the reasoning employed by the Supreme Court may indicate that the scienter standard set forth therein also applies to the SEC. The net effect of Hochfelder, if applied to the SEC, would be to make it more difficult for the SEC to bring a successful action because of the greater burden of proof associated with the scienter standard. On the other hand, a line of Supreme Court decisions, contemporaneous with Hochfelder, may indicate that the nation’s highest court is only seeking to limit private access to the securities laws. In light of Hochfelder and surrounding uncertainties, a panel of the Second Circuit decided SEC v. Aaron. The Aaron court determined that Hochfelder, a private action for damages, did not apply when the SEC brought suit for injunctive relief. Therefore, the SEC in Aaron was required to show only negligent conduct rather than scienter as set forth in Hochfelder. Thus, the elements for a proper cause of action under the same antifraud provisions will differ depending upon the identity of the party bringing suit. This apparent inconsistency must be justified if the securities laws are to be rationally applied