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SEC v. Waterhouse

Facts

Plaintiff Securities Exchange Commission commenced suit against defendant accountants for primary and aiding and abetting violations of securities laws, alleging that defendants made material misrepresentations in auditing company records and assisted in preparing financial statements containing material misrepresentations. The fraud allegations relate to an audit conducted by Price Waterhouse of AM International, Inc. in connection with its financial statements for the fiscal year ended July 31, 1980. The court found that the company suffered from a shortage of cash and increased its debt, leading to a postponed public offering based on the reactions of investment advisors to the company's financial statements.

Plaintiff Securities Exchange Commission commenced suit against defendant accountants for primary and aiding and abetting violations of securities laws, alleging that defendants made material misrepresentations in auditing company records and assisted in preparing financial statements containing material misrepresentations.

Issue

Whether the defendants committed primary and aiding and abetting violations of the Securities Act and the Securities Exchange Act, specifically regarding the required scienter element.

Whether the defendants committed primary and aiding and abetting violations of the Securities Act and the Securities Exchange Act, specifically regarding the required scienter element.

Rule

In securities context, recklessness required more than misapplication of accounting principles; the practices must have been entirely deficient and unreasonable.

In securities context, recklessness required more than misapplication of accounting principles; the practices must have been entirely deficient and unreasonable.

Analysis

The court applied the rule by examining the complex accounting issues involved and the diametrically opposing views from accounting experts regarding the reasonableness of the judgments made by the defendants. The court found that the SEC failed to establish that the defendants acted with the requisite scienter, as the evidence did not support a finding of fraud or recklessness.

The court applied the rule by examining the complex accounting issues involved and the diametrically opposing views from accounting experts regarding the reasonableness of the judgments made by the defendants.

Conclusion

Judgment was entered in favor of the defendants dismissing the complaint with prejudice as the plaintiff failed to establish the requisite scienter element inherent in a suit for securities violations alleging fraud.

Judgment was entered in favor of the defendants dismissing the complaint with prejudice as the plaintiff failed to establish the requisite scienter element inherent in a suit for securities violations alleging fraud.

Who won?

Defendants prevailed in the case because the court found that the SEC failed to prove the required scienter element necessary for securities violations.

Defendants prevailed in the case because the court found that the SEC failed to prove the required scienter element necessary for securities violations.

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