Appeal from order of the Southern District of New York dismissing complaint. Inzer B. Wyatt, J., ruled that neither SIPC nor broker's trustee in liquidation could maintain suit against accountant under section 17 of the Securities Exchange Act. Reversed as to both plaintiffs and remanded.
Before Lumbard, Mulligan and Timbers, Circuit Judges.
In this appeal, rising out of the insolvency and liquidation of the brokerage firm of Weis Securities, Inc. ("Weis"), we are presented with the question whether a private cause of action exists under section 17 of the Securities Exchange Act of 1934*fn1 against accountants who prepare misleading statements of a broker's financial affairs, and if so, who may maintain such an action.
The district court dismissed the claims herein of the Securities Investor Protection Corp. ("SIPC")*fn2 and of Edward S. Redington, Weis' Trustee in Liquidation ("Trustee"), believing that no claim for relief was stated because no cause of action could be implied from section 17.*fn3 Redington v. Touche Ross & Co., 428 F. Supp. 483 (S.D.N.Y.1977). We conclude that customers of a broker have a right of action against an accountant whose audits of the brokerage firm are false or misleading. Because we believe that SIPC and the Trustee are appropriate parties to seek (between them) total recovery of the customers' damages, we reverse and remand.
Touche Ross & Co. ("Touche Ross") served as Weis' independent certified public accounting firm from 1969 to 1973. In that capacity, Touche Ross prepared annual audits of Weis' affairs as required by section 17 and regulations thereunder.
The complaint herein alleged that during fiscal 1972, certain of Weis' officers conceived and executed a scheme to conceal from the regulatory authorities and the public Weis' dire financial condition.*fn4 The elements of this scheme appear in great detail in the complaint; for example, although Weis had suffered a loss for fiscal 1972 of greater than $1.5 million, its pre-tax earnings for that year were stated as being around $1.7 million.
When Weis' fiscal 1972 ended on May 26, 1972, Touche Ross proceeded to prepare and certify Weis' financial statements, and to answer the financial questionnaire required by the New York Stock Exchange of its member firms. In four opinion letters, dated July 7, July 7, July 21 and July 21 (all of 1972), Touche Ross represented that it had examined (i) the statement of Weis' current financial condition; (ii) Weis' answers to the financial questionnaire; (iii) Weis' consolidated balance sheet for the past year; and (iv) Weis' consolidated statement of earnings for the past five years, and found that each presented fairly and accurately the financial picture of Weis, in conformity with generally accepted accounting procedures.
In fact, Weis' financial condition was not as stated in the above four documents, but was far more precarious. As no steps were taken to attempt to remedy Weis' situation, it continued to deteriorate.*fn5 On May 24, 1973, the SEC sought an injunction preventing Weis and its officers from continuing to violate the "34 Act, and SIPC applied for a decree, pursuant to 15 U.S.C. § 78eee(a)(2), adjudging Weis' customers in need of protection under SIPA. Accordingly, Weis' liquidation was ordered by (then) District Judge Gurfein on May 30, 1973, and Edward Redington was appointed Trustee for the liquidation.
SIPC and the Trustee jointly began an action against Touche Ross in New York state court on July 3, 1975. Redington v. Touche Ross & Co., No. 1399 6/76 (Sup.Ct.N.Y.County). The common allegations of the plaintiffs in the state court complaint were the same as those in the instant case, except that three paragraphs dealing with claims under section 17 of the "34 Act were omitted. Five of the Trustee's six present "causes of action" appear in identical form in the state action, as do four of SIPC's eight present claims. The additional claims in this action are the federal securities law claims.
The instant suit was commenced on April 30, 1976. Under federal law and state common law, SIPC seeks to recover $14 million, either as subrogee of Weis' customers whose claims it has paid under SIPA, or as a member of the group directly injured by Touche Ross' delicts. Likewise under federal law and state common law, the Trustee is claiming $51 million; he contends that he may recover either by standing in the shoes of Weis' customers, since under SIPA, his is the responsibility to marshal and return their property,*fn6 or by standing in the shoes of Weis itself, since, he alleges, Weis as an entity distinct from its conniving officers was directly damaged by Touche Ross' unsatisfactory audit.
SIPC and the Trustee appeal from Judge Wyatt's order dismissing the complaint for failure to state a claim on which relief could be granted (with respect to the section 17 counts). Touche Ross asks us, in the event we reverse, to stay the federal action in favor of the state court suit.*fn7 This last issue, evidently, is one which Judge Wyatt has never had cause to consider.
The first question we address is whether customers of a brokerage firm are given any remedy by the "34 Act against accountants whose section 17 reports are false or misleading. There are two major considerations involved in this decision: the criteria laid down by the Supreme Court in Cort v. Ash, 422 U.S. 66, 95 S. Ct. 2080, 45 L. Ed. 2d 26 (1975), for finding an implied right of action in a statute which is silent on the issue; and the "purchase or sale" requirement reaffirmed by the Court in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S. Ct. 1917, 44 L. Ed. 2d 539 (1975).
One preliminary matter must be dealt with. Judge Wyatt held that section 17 "was designed to supply administrative guidance in the bookkeeping area and not to create rights in anybody," and that it "does not impose any duty on accountants." 428 F. Supp. at 489, 491. We believe that, even if no right of action were implied, to see nothing but "administrative guidance" in a provision as crucial to the regulation of brokers as section 17 is to take far too narrow a view of the statute. Certified public accountants play a significant role in the scheme created by the "34 Act for the regulation of securities trading, as is recognized by the regulations promulgated by the SEC.*fn8 See, e. g., 17 C.F.R. § 240.17a-5(b), (f), (g), (h), (i), (m). It is well established that section 10(b) of the "34 Act and rule 10b-5 thereunder impose a duty on accountants, for breach of which they may be sued. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976). We hold that section 17 of the "34 Act likewise imposes a duty on accountants.
The factors cited in Cort v. Ash, supra, 422 U.S. at 78, 95 S. Ct. 2080, familiar through much repetition, which bear on the propriety of finding an implied right of action in a statute are:
1) Whether plaintiffs belong to the class for whose special benefit the statute was enacted;
2) Whether there is any indication of legislative intent on the issue;
3) Whether implication of a right of action is consistent with the policies behind the legislative scheme; and
4) Whether the cause of action in question is one traditionally relegated to state law.
A consideration of these four factors convinces us that implication of a right of action in favor of Weis' customers is appropriate.
1. The language of section 17, the SEC rules in the 17a-5 series, and an analysis of the role played by accountants' reports in the regulation of brokers make clear the extent to which Weis' customers are members of a class peculiarly protected by section 17.
The documents and reports that the SEC is empowered to require of brokers must be "necessary or appropriate in the public interest Or for the protection of investors." 15 U.S.C. § 78q(a) (emphasis added). The same is true of the examinations that the SEC is empowered to conduct. Id.*fn9
In order to provide a complete and accurate picture of a broker's financial condition, the SEC requires that the broker enlist an independent accountant to audit and certify its statements, list any matters to which the accountant takes exception, and provide certain additional financial data. Rule 17a-5(b), (i), (k). Furthermore, a notice of any "material inadequacies" found by the accountant in the broker's procedures must be sent to the broker's customers. Rule 17a-5(m)(3).*fn10
The function of this arsenal of financial reports is to protect the broker's customers. One of the main methods adopted by the SEC to shield customers is the net capital rule, in either the form promulgated by the SEC, rule 15c3-1, or the stricter version enforced by the New York Stock Exchange, Exchange Rule 325.
The net capital rule is a requirement that a broker maintain a certain minimum ratio of liquid assets to aggregate indebtedness; its "principal purpose . . . is to require that the capital position of a broker . . . will always be sufficiently liquid to cover his current indebtedness, in order to be able at all times to promptly meet (sic) the demands of customers." Exchange Act Release No. 8024, 6 Fed.Sec.L.Rep. (CCH) P 72,129 (1967). As amended in order to take into account the creation of SIPC, the rule serves particularly to "protect customers prior to the time when the broker's . . . assets would be sufficient to satisfy customers in the event of liquidation." Exchange Act Release No. 11,497, (1975-76 Transfer Binder) Fed.Sec.L.Rep. (CCH) P 80,212.
It is the reporting system created by section 17 that provides the SEC and other regulatory authorities with the information needed to enforce the net capital rule. Thus, a failure to supply accurate reports will leave the customers without protection until the broker's insolvency can no longer be concealed, and liquidation follows.
2. We find no indication, either in the statute itself or in its legislative history, of any congressional intent either to create a private remedy under section 17 or to deny one.*fn11
The legislative history of the section is mute on the issue, leading to the conclusion that Congress never Explicitly considered the question. Nor can it be said that Congress Implicitly chose to deny a private right of action; section 17 is distinctly different in an important respect from statutes as to which such implicit intent has been found.
In SIPC v. Barbour, 421 U.S. 412, 95 S. Ct. 1733, 44 L. Ed. 2d 263 (1975), the Supreme Court noted that SIPA manifested a specific legislative intent to restrict enforcement to the SEC. Id. at 420, 425. In National Railroad Passenger Corp. v. National Association of Railroad Passengers, 414 U.S. 453, 458, 94 S. Ct. 690, 38 L. Ed. 2d 646 (1974), a similar exclusivity was found to rest with the Attorney General; in Cort v. Ash itself, Supra, 422 U.S. at ...