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Business Associations Keyed to Coffee, 9th Ed.
Ernst & Ernst v. Hochfelder
Citation:
425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)Facts
From 1946 through 1967, Ernst & Ernst performed periodic audits for First Securities Company of Chicago, a small brokerage firm. Leston B. Nay, president and 92% owner of First Securities, induced customers to invest in fraudulent “escrow” accounts that he claimed would yield high returns. In reality, no such accounts existed, and Nay immediately converted the funds to his own use. The transactions were not reflected on First Securities’ books or in any filings with regulatory bodies. The fraud was discovered in 1968 when Nay committed suicide, leaving a note describing First Securities as bankrupt and the escrow accounts as “spurious.” The investors sued Ernst & Ernst, claiming that its negligent audits failed to discover Nay’s “mail rule” (whereby only Nay could open mail addressed to him), which prevented effective audits. The plaintiffs argued that if Ernst & Ernst had conducted proper audits, it would have discovered this irregular procedure, reported it to regulatory authorities, and the fraud would have been uncovered. Importantly, the plaintiffs specifically disclaimed any allegations of fraud or intentional misconduct by Ernst & Ernst.
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