Ernst & Ernst v. Hochfelder
The Facts of The Case
Leston B. Nay, the former president of First Securities Company of Chicago (First Securities), left a suicide note in 1968 revealing how the organization dealt with fraudulent stocks and securities. In this case, Ernst & Ernst (the petitioner) was the accounting firm tasked with auditing First Securities’ books and records, implying that they should have been aware of the company’s bankruptcy and spurious accounts (Ernst & Ernst v. Hochfelder, 1976). Hochfelder, the respondents, filed the first legal action against Ernst & Ernst at the United States District Court of the Northern District of Illinois. The respondent sought to have the petitioner charged for damages incurred from First Securities’ fraudulent scheme, citing a violation of §10(b) of the Securities Exchange Act of 1934 (Ernst & Ernst v. Hochfelder, 1976). Hochfelder’s major claim was that Ernst & Ernst deliberately aided First Securities’ fraudulent scheme by failing to utilize the right auditing procedures. Therefore, the United States Supreme Court had to debate whether the theory of negligence and nonfeasance applied to Ernst & Ernst’s responsibilities at First Securities.
The Issue at The Law of The Court Considering
The court is considering whether §10(b) of the 1934 Act and Securities and Exchange Commission Rule 10b-5 can be used as an action for civil damages. The bigger question is how to apply the two rules if the accused had no intentions to deceive, defraud, or manipulate the defendant. The case involving Ernst & Ernst and Hochfelder has limitations on the application of the two sections, given that the petitioner served First Securities devoid of the responsibilities to present investors with material facts (Ernst & Ernst v. Hochfelder, 1976). The respondents had the burden of proof in establishing scienter against Ernst & Ernst, after which the court would deliberate whether negligent conduct or scienter is necessary for such legal claims. The court has to consider to which extent the ethical standards of honesty and fair dealing apply to Ernst & Ernst regarding First Securities’ fraudulent scheme.
How The Law Was Applied in This Case
The Securities and Exchange Commission Rule 10b-5 and §10(b) of the 1934 Act were insufficient to convince the court whether to use scienter or negligent conduct alone. Limitations by Rule 10b-5 and §10(b) were the missing guidelines for definite civil remedy in case a violation or fraudulent action occurred. Therefore, the court applied §11(e) of the Securities Act of 1933, which outlined private actions for the scienter through material facts misstatement or omission (Ernst & Ernst v. Hochfelder, 1976). However, as Ernst & Ernst did, experts dealing with a firm can avoid civil liability by proving that they did not commit negligence when presenting audit facts. Although §11(e) of the 1934 Act contradicts §10(b) of the 1934 Act, the US Supreme Court determined that §10(b) had significant procedural restrictions that included scienter in civil liability claims.
Conclusion of The Court
The court held that there could be no private claims for damages against Ernst & Ernst under §10(b) and Rule 10b-5 because the firm showed no intentions to deceive, defraud, or manipulate. The key rationale is that US Supreme Court was unwilling to overlook the scienter by admitting the two rules’ applicability to negligent conduct alone. For one reason, interpreting Rule 10b-5 implies liability claims must encompass negligent and intentional behavior (Ernst & Ernst v. Hochfelder, 1976). The final ruling was a reversal of the Court of Appeals ruling, which had granted a proceeding to Hochfelder for private action legal suit. Most importantly, the US Supreme Court clarified party responsibilities when a corporate corruption case arises, where intentional negligence attracts liability claims on the involved firms.
Lehman Brothers and Madoff Scandals from 2008
Corporate scandals are often so costly that one organization can trigger a global economic downturn, an example being the Lehman Brothers Bank. De Paoli and Hill (2022) detailed that Lehman Brothers’ collapse was be beginning of the 2008 financial crisis, although traces of the former financial giant exist to date. The institution collapsed following a scandal where the company’s auditor, Ernst & Young, conspired with firm executives to hide $50 billion in loans (The University of Texas Permian Basin, 2022). The conspired misrepresentation was a corporate scandal because it gave investors the wrong picture about a company that had gone bankrupt but used unscrupulous means to stay afloat (Tandoh, 2021). Lehman Brothers committed a similar crime to the First Securities in the case study above, given that the institution used experts to alter financial statements even after making several drastic and unethical mergers (Tandoh, 2021). A key lesson from the Lehman Brothers crisis is that companies can prevent crises through compliance with national investment statutes and integrity standards at internal and external business environmental levels.
Bernie Madoff’s Ponzi Scheme was a remarkable corporate scandal showcasing how flexible investment risks are when venturing into a firm with no accountability structures. Madoff Investment Services LLC was Bernie Madoff’s Ponzi Scheme, a zero-profit investment, which he used to con investors by paying older shareholders using capital from new entrants (CFI Team, 2022). A Ponzi Scheme is a fraudulent business deal where a firm takes money from investors but has no actual investments. The business owner can encourage as many willing investors to join the firm, a plot to skim cash from the numerous transactions while buying investment equities (CFI Team, 2022). Bernie Madoff managed to run the fraud undetected for decades, making $65 billion in profits (International Banker, 2021). Corporate fraud is costly to the perpetrator as much as it is to those who lose their capital. Bernie Madoff was charged with eleven perjury, fraud, and money laundering counts, attracting a 150-year jail term and $170 billion in restitution fines (Jones & Mendoza, 2021). The key lesson learned from Madoff’s case is that accountability is far-reaching, and unscrupulous deals fail to add up no matter how long it takes before detection.
Applying the Chapter to My Career
Although the chapter covers legal statutes and restitution approaches through legal action, the case outcomes teach more valuable lessons on the ethics of accountability and personal integrity. I will like to implement the chapter lessons in my professional conduct while serving as an employee in the financial industry or as a firm manager. As an employee, I will ensure strict compliance with ethical codes and legal guidelines on investment management, a measure I will take to safeguard personal integrity. However, as a firm manager/executive, I will ensure strict compliance by setting the tone from the top. That will entail sharing an integrity vision with other executives, influencing the board to hire reputable experts for audits, and ensuring subordinates are compliant with legal and ethical standards for balancing shareholder interests with firm profitability. I will circumvent liability claims and damaged firm reparation by setting high integrity standards, including transparency, honesty, and accountability.
McDonald’s France: Tax Evasion Scandal
McDonald’s France’s latest tax evasion scandal is a costly lesson to the firm and other organizations doctoring financial records to evade accountable remissions. McDonald’s has run a fraudulent tax scheme in France for over a decade, transferring fees received from its French franchisers to an intermediate firm, artificially lowering the profits and tax figures (Le Monde, 2022; Dean, 2022). Although the allegation appeared in 2014, McDonald’s managed to run the scheme for six more years, culminating in further losses to France by 2020. The multinational firm doubled its brand fees paid to its European parent company in Luxemburg, creating an impression that McDonald’s made significantly lower profits in France (Le Monde, 2022). The company failed to meet its burden of proof showing that it did not transfer twice as many brand fees to Luxemburg for tax evasion reasons (Associated Press, 2022). The McDonald’s case justifies the need to update companies’ tax methodologies, a step to promote closer corporate scrutiny for maximum compliance.
Punitive charges and a possibly damaged brand image are the current outcomes in the McDonald’s case. However, the parties managed an out-of-court settlement with the French tax administration and relevant authorities. The restitution framework adopted during the arbitration required that the multinational company pays 2.5 times the value of skipped taxes, in addition to a public interest fine totalling $530 million (Dean, 2022). McDonald’s agreed to pay $1.3 billion in total costs for the fines and other damages, France’s second highest restitution claim after Airbus paid the country €2.1 billion in 2020 (Le Monde, 2022). Corporate scandals hardly stay hidden for long, albeit restitution claims become costly for the accused organization. However, executives and boards of governance can prevent legal action by insisting on total legal and ethical compliance with investment laws based on the country of operation.
References
Associated Press. (2022). McDonald’s to pay France $1.3 billion in tax fraud case. US News. Web.
CFI Team. (2022). Bernie Madoff. Web.
Dean, G. (2022). McDonald’s agrees to pay France $1.3 billion to settle a case accusing it of tax evasion over a 10-year period. Business Insider Africa. Web.
Ernst & Ernst v. Hochfelder – 425 U.S. 185, 96 S. Ct. 1375 (1976). Web.
International Banker. (2021). Bernie Madoff’s Ponzi Scheme (2008). Web.
Jones, C., & Mendoza. (2021). Who was Bernie Madoff? Who did his Ponzi scheme impact and how did he get caught? Your questions, answered. USA Today. Web.
Le Monde. (2022). France: McDonald’s fined €1.25 billion to settle tax evasion case. Web.
Paoli, L., & Hill, J. (2022). The last of Lehman Brothers. Bloomberg L.P. Web.
Tandoh, B. (2021). The failure of the Lehman Brothers: Causes, effects, and lessons for the future. LinkedIn. Web.
The University of Texas Permian Basin. (2022). How accounting scandals have shaped modern accounting. Web.