WASHINGTON -- The Supreme Court yesterday left intact a lower court ruling that may make it easier for investors to hold financial firms liable for securities fraud committed by their employees.
The high court's justices declined to review a ruling by the U.S. Court of Appeals for the Ninth Circuit that a federal district court improperly dismissed securities fraud claims against American General Life Insurance Co.
The Supreme Court gave no reason for its decision not to review the case. Because the court did not issue a formal ruling in the case, the appeals court's decision is binding only within the Ninth Circuit, which includes California. Oregon, Washington, Montana, Idaho, Nevada, Arizona, Alaska, Hawaii, Guam, and the Northern Mariana Island.
The case began after James Earl Davis, an American General employee who served as a financial planner, was convicted of defrauding John R. DeShurley and other investors by embezzling their funds. DeShurley then filed a suit against American General seeking to recover his losses.
The district court found that American General could conceivably be held liable as a "controlling person" because Davis worked for the company. In other words, American General exercised power and influence over Davis' work, and as a result could be held liable for misdeeds committed by Davis.
But because American General proved it had no knowledge or reasonable grounds to believe Davis was committing fraud, the court ruled that there was no basis for holding the firm liable.
DeShurley appealed, and the Ninth Circuit reversed on March 19. The appeals court held that the district court erred because a jury could reasonably conclude that American General was responsible for Davis' actions under the legal doctrine of respondent superior. According to that doctrine, employer may be held liable for the crimes of their employees regardless of fault.
Appealing that ruling to the Supreme Court, lawyers for American General cited language from the Securities Exchange Act of 1934, which states that firms that act in good faith and do not induce fraud by employees are not liable for any fraud the employees commit.
In general, the securities law requires proof of an intent to defraud before imposing liability. In 1976, the Supreme Court in Ernst & Ernst v. Hochfelder ruled that intent to defraud is an essential requirement for imposing liability in securities fraud cases.
In a legal brief filed with the court, American General's lawyers said the Ninth Circuit's ruling essentially guts the high court's 1976 ruling by eliminating the need to prove intent.
American General's lawyers and federal securities law should supersede the common-law doctrine of respondeat superior, as in the rule in three U.S. circuit courts of appeal. Common law, also known as case law, is a collection of principles gleaned from previous cases, not from written statutes.
However, federal courts of appeal for the first, second, fifth, eight, and 10th circuits all have adopted similar approaches.
Because three circuits take a contrary approach, the issue may yet get an airing before the Supreme Court. The court often agrees to hear disputes when the circuit courts are split on the proper method of legal analysis for a given issue.
However, federal courts of appeal for the first, second, fifth, eight, and 10th circuits have adopted similar approaches to the Ninth Circuit's.
In other action yesterday, the Supreme Court declined to review a New Jersey Supreme Court ruling that upholds state fishing regulations.
Ampro Fisheries Inc., a Virginia commercial fishing company, alleged that the rules violated the Constitution's commerce and supremacy clauses.
The state court found the regulations did not inhibit interstate commerce, and that they were not in conflict with any applicable federal navigational laws.
The commerce clause prohibits states from erecting barriers to the free flow of goods and services across state lines, and has been used to limit state autonomy and taxing powers. The supremacy clause states that when state and federal laws clash, the federal laws take precedence.