On petition for writ of certiorari to the United States Court of
Appeals for the Seventh Circuit.
The petition for a writ of certiorari is denied.
Justice POWELL, with whom Justice REHNQUIST joins,
dissenting.
This securities controversy, which has been in litigation for 11
years, involves sales of commercial paper in the 1960's. The Court
of Appeals for the Seventh Circuit has heard the case four times on
various issues over the years, and the present petition for
certiorari is the third to come before the Supreme Court. The Court
today denies further review, and it is indeed long past time that
this litigation should come to rest. I dissent from the denial of
certiorari, however, because I believe that the Court of Appeals
has seriously misapplied the Securities Act of 1933. Its decision
could
Page 450 U.S.
1005 , 1006
affect adversely the efficiency of the Nation's short-term
financing markets.
Justice STEVENS took no part in the consideration or decision of
this petition.
I
John Nuveen & Co. (hereinafter petitioner) is a broker and
dealer registered with the Securities and Exchange Commission
(SEC). In the late 1960's, petitioner undertook to sell the
short-term promissory notes- commercial paper-of Winter &
Hirsch, Inc. (W&H), a consumer finance company. Relying on (i)
the company's certified financial statements, (ii) responses to
inquiries from banks, and (iii) a brief inspection of company
records, petitioner issued a "Commercial Paper Report," similar to
a prospectus, on W&H commercial paper. The report reviewed the
data in certified financial statements and noted that "[t]he ratio
of debt to capital funds came to 311%-Excellent! . . . Bad debts
charged off came to $ 375,000, and recoveries in relation were
$173,000-46%, an excellent showing." Respondents and other
customers of petitioner made purchases.
Unknown to petitioner and to the public W&H at the time was
in serious financial trouble. W&H officers had conspired with
auditors from the certified public accounting firm of Lieber,
Bleiweis & Co. to tamper with the company's financial
statements to make the company appear profitable. Its financial
statement for 1968 showed that W&H had earned $ 500,000; in
fact, it had lost about $1 million.
When the fraud was discovered in 1970, officials from W&H
and Lieber, Bleiweis, were convicted of federal fraud charges.
Holders of W&H commercial paper were paid about 65 cents on the
dollar. A class of plaintiffs, respondents here, sued under a
variety of theories to recover the remainder. The issue presently
before the Court concerns liability under 12(2) of the Securities
Act of 1933, 48 Stat. 84, as amended, 15 U. S.C. 77l (2), which
provides, in pertinent part:
"Any person who-
"(2) offers or sells a security . . . by means of a pro-
Page 450 U.S.
1005 , 1007
spectus or oral communication, which includes an untrue
statement of a material fact or omits to state a material fact . .
. and who shall not sustain the burden of proof that he did not
know, and in the exercise of reasonable care could not have known,
of such untruth or omission, shall be liable to the person
purchasing such security from him. . . ."
The District Court held that petitioner was liable under 12(2)
because it had failed to use "reasonable care" when it issued the
misleading report and recommended orally to some individuals that
they buy W&H paper. The Court of Appeals affirmed. Sanders IV,
619 F.2d
1222 (7 Cir. 1980).1 It reasoned that petitioner had failed to
use "reasonable care" because petitioner had not made a reasonable
investigation of W&H's financial health. Instead, petitioner
had relied principally on the certified financial statements.
[
Footnote 2] Its inde-
Page 450 U.S.
1005 , 1008
pendent investigation consisted of inquiries to banks and a
one-day spot check of company records. The Court of Appeals thought
that petitioner also should have examined the company's tax
returns, its minute books, and the workpapers of the independent
accountants. Id., at 1228, citing Sanders II,
524
F.2d 1064, 1069 (7 Cir. 1975).
II
Although the opinion of the Court of Appeals is not explicit, it
appears to impose a duty of "reasonable investigation" rather than
12(2) 's requirement of "reasonable care."
A.
Section 11(a) of the 1933 Act, 15 U.S.C. 77k(a), imposes
liability on certain persons for selling securities in a registered
public offering pursuant to a materially false or misleading
registration statement. A registered offering is the class of
financial transactions for which Congress prescribed the most
stringent regulation. The standard of care imposed on an
underwriter is that it must have "had, after reasonable
investigation, reasonable ground to believe and did believe" that
the registration statement was accurate. 11(b)(3)(A) of the Act, 15
U.S.C. 77k(b)(3)(A) (emphasis added).
Liability in this case was not imposed on petitioner under 11,
but under 12(2). Under the latter section, it is necessary for
sellers to show only that they "did not know, and in the exercise
of reasonable care could not have known," that their statements
were false or misleading. ( Emphasis added.)
In providing standards of care under the 1933 Act, Congress thus
used different language for different situations. "Reasonable
investigation" is required for registered offerings under 11, but
nothing more than " mer[e] . . . 'reasonable care ' " is required
by 12(2). Douglas & Bates, The Fed-
Page 450 U.S.
1005 , 1009
eral Securities Act of 1933, 43 Yale L.J. 171, 208 (1933). The
difference in language is significant, because in the securities
acts Congress has used its words with precision. See, e. g., Ernst
& Ernst v. Hochfelder,
425 U.S. 185, 198-201,
1383-85 (1976); Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 755, 756,
1934, 1935 (1975) (POWELL, J., concurring). " Investigation"
commands a greater undertaking than "care." See Douglas &
Bates, supra, at 208, n. 205.
In a brief filed in this case with the Court of Appeals, the SEC
expressly stated that the standard of care under 12(2) is less
demanding than that prescribed by 11:
"[I]t would be inconsistent with the
statutory scheme to apply precisely the same standards to the scope
of an underwriter's duty under Section 12(2) as the case law
appropriately has applied to underwriters under Section 11. Because
of the vital role played by an underwriter in the distribution of
securities, and because the registration process is integral and
important to the statutory scheme, we are of the view that a higher
standard of care should be imposed on those actors who are critical
to its proper operations. Since Congress has determined that
registration is not necessary in certain defined situations, we
believe that it would undermine the Congressional intent-that
issuers and other persons should be relieved of registration-if the
same degree of investigation were to be required to avoid potential
liability whether or not a registration statement is required."
Brief for SEC in Nos. 74-2047 and 75-1260 (CA7), Sanders III, p.
69.
The Court of Appeals' opinion may be read as holding that
petitioner's duty of "reasonable care" under 12(2) required it
independently to investigate the accuracy and completeness of the
certified financial statements. It was customary, however-and in my
view entirely reasonable-for petitioner to rely on these statements
as accurately reflecting W&H's finan-
Page 450 U.S.
1005 , 1010
cial condition. [
Footnote 3]
Even under 11 of the Act, an underwriter is explicitly absolved of
the duty to investigate with respect to "any part of the
registration statement purporting to be made on the authority of an
expert" such as a certified accountant if "he had no reasonable
ground to believe and did not believe" that the information therein
was misleading. 11(b)( 3)(C) of the Act, 15 U.S.C. 77k(b)(3)(C);
see 11(a)(4), 15 U.S.C. 77k(a)(4). This provision is in the Act
because, almost by definition, it is reasonable to rely on
financial statements certified by public accountants. [
Footnote 4] Yet, in this case, the Court of
Appeals nevertheless seems to have imposed the higher duty
prescribed by 11 to investigate, but denied petitioner the right to
rely on "the authority of an expert" that also is provided by
11.5
Page 450 U.S.
1005 , 1011
B
The Solicitor General at this Court's request has filed a brief
amicus curiae. He does not embrace the decision of the Court of
Appeals, see supra, at 1009, but nevertheless suggests that we deny
certiorari because, inter alia, courts in the future "will
undoubtedly recognize" that the decision in this case is confined
to its "unusual fact situation ." Brief for United States as Amicus
Curiae 7.
If it were clear that the decision fairly must be read as thus
limited, I would not dissent from denial of certiorari. My concern
is that the opinion of the Court of Appeals will be read as
recognizing no distinction between the standards of care applicable
under 11 and 12(2), and particularly as casting doubt upon the
reasonableness of relying upon the expertise of certified public
accountants. Dealers may believe that they must undertake extensive
independent financial investigations rather than rely on the
accuracy of the certified financial statements. If this is so, the
efficiency of the short-term financial markets will be impaired. 6
I would grant certiorari.
Footnotes
Footnote 1 The District
Court also found petitioner liable under 12(1) of the Act, 15
U.S.C. 77l (1). The Court of Appeals did not decide whether
petitioner was liable under this theory, 619 F.2d, at 1224, n. 1,
although in a prior opinion it had expressed "great doubt" about
the validity of that legal theory, Sanders III,
554 F.2d
790, 794 (7 Cir. 1977).
Footnote 2 The Court of
Appeals noted that petitioner had an " 'honest belief that [the]
financial statements . . . correctly represented' " W&H's
financial condition. Sanders IV, supra, at 1224, quoting Sanders
II,
524 F.2d
1064, 1066 (1975). The Court assumed for purposes of its
decision that the audit reports and certified financial statements
were not defective on their face and that nothing in them gave
petitioner any reason to question their accuracy. Sanders IV, 619
F.2d, at 1227, n. 10. Lieber, Bleiweis represented that its audit
had been conducted "in accordance with generally accepted auditing
standards applicable in the circumstances and comprised such tests
of the accounting records and supporting evidence and such other
procedures as we considered necessary." The auditor's opinion also
noted that no "detailed audit" of certain transactions had been
performed. Petitioner erroneously stated in its Commercial Paper
Report that Lieber, Bleiweis had performed a detailed audit. The
Court of Appeals did not suggest that petitioner's error in this
respect was relevant to the question of petitioner's care in
relying on the data.
Footnote 3 Although it
appears that petitioner, in accord with general custom, relied
primarily on the financial statements of the independent auditors,
petitioner did take an additional precaution: it checked with the
major banks that extended millions of dollars of credit to W&H.
The Court of Appeals held that this inquiry was insufficient
because the banks themselves may not have acted with "prudence."
See Sanders II, at 1071, and n. 20. In my view, the fact that
petitioner ascertained that banks with national and international
reputations were extending credit to W&H is highly relevant to
whether petitioner exercised reasonable care even assuming,
arguendo, that petitioner was not entitled simply to rely on the
certified financial statements.
Footnote 4 Reliance upon
facially unexceptionable certified financial statements, as to the
correctness of the financial data shown therein, is essential to
the proper functioning of securities marketing, to the trading in
securities, to the lending of money by banks and financial
institutions, and to the reliance by stockholders on the reports of
their corporations. For the most part, certified public accountants
faithfully have fulfilled the trust placed on them. But where
breaches by accountants occur, it is the accountants themselves-not
those who rely in good faith on their professional expertise-who
are at fault and who should be held responsible.
Footnote 5 Moreover, the
duty to investigate imposed by the Court of Appeals rarely would
uncover the type of fraud involved in this case. According to the
Court of Appeals, petitioner would have learned of the fraud if it
had examined W&H's minute books, the accountant's workpapers,
and company tax returns. Sanders II, 524 F.2d, at 1069. I accept
this finding, but observe that this would be most unusual. What one
normally finds in minute books sheds no light whatever on the
accuracy of audited financial statements. Nor would it be
enlightening to examine the workpapers of the certified public
accountants. The drafters of corporate minutes and accountants bent
on fraud hardly are likely to reflect the fraud in records or
papers that are easily subpoenaed. Similarly, information can be
gleaned from tax returns only if they are honestly prepared. The
Court of Appeals itself noted: "Experience teaches us that fraud
can be skillfully hidden." Sanders II, supra, at 1071.
Footnote 6 Commercial paper,
for example, normally is issued for periods of 30 to 90 days, and
in no event more than 270 days. It is useful for borrowers with
fluctuating temporary cash needs. Dealers such as petitioner buy
commercial paper from issuers and resell it to investors. A
dealer's compensation is the "spread" between the price at which he
buys the paper from the issuer and the price charged the investor.
Comment, The Commercial Paper Market and the Securities Acts, 39
U.Chi.L.Rev. 362, 367-368 (1972). The dealer's "spread"
historically has been relatively small. Id., at 368; see Pet. for
Cert. 17, n. 20. The additional expense and legal exposure made
necessary by the Court of Appeals' decision will increase the
"spread," and hence also the cost of borrowing.