Scienter

• Author: Jeffrey Lehman, Shirelle Phelps

Page 31

[Latin, Knowingly.] Guilty knowledge that is sufficient to charge a person with the consequences of his or her acts.

The term scienter refers to a state of mind often required to hold a person legally accountable for her acts. The term often is used interchangeably with MENS REA, which describes criminal intent, but scienter has a broader application because it also describes knowledge required to assign liability in many civil cases.

Scienter denotes a level of intent on the part of the defendant. In Ernst and Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976), the U.S. Supreme Court described scienter as "a mental state embracing intent to deceive, manipulate, or defraud." The definition in Ernst was fashioned in the context of a financial dispute, but it illustrates the sort of guilty knowledge that constitutes scienter.

Scienter is relevant to the pleadings in a case. Plaintiffs and prosecutors alike must include in their pleadings allegations that the defendant acted with some knowledge of wrongdoing or guilt. If a legislative body passes a law that has punitive sanctions or harsh civil sanctions, it normally includes a provision stating that a person must act willfully, knowingly, intentionally, or recklessly, or it provides similar scienter requirement. Legislative bodies do not, however, always refer to scienter in statutes.

In the Ernst case, the investors in a brokerage firm brought suit against an accounting firm after the principal investor committed suicide and left a note revealing that the brokerage firm was a scam. The investors brought suit for damages against the brokerage firm's accounting firm under sections 10(b) and 10b-5 of the Securities Exchange Act of 1934 (15 U.S.C.A. § 78a et seq.), which makes it unlawful for any person to engage in various financial transgressions, such as employing any device, scheme, or artifice to defraud, or engaging in any act, practice, or course of business that operates as a FRAUD or deceit upon any person in connection with the purchase or sale of any security.

Significantly, the Securities Exchange Act does not mention any standard for intent. The courts had to decide whether a party could make a claim under the act against a person without alleging that the person acted intentionally, knowingly, or willfully.

The investors in Ernst did not allege that the accounting firm had an intent to defraud the...