author: SWYGERT, Chief Judge.

text:
    Olga HOCHFELDER et al., Plaintiffs-Appellants, v. ERNST & ERNST, Defendant-Appellee. Leon S. MARTIN et al., Defendants-Appellants, v. ERNST & ERNST, Defendant-Appellee.
    Nos. 73-1907, 73-1908.
    United States Court of Appeals, Seventh Circuit.
    Argued April 19, 1974.
    Decided Aug. 30, 1974.
    Rehearing Denied Nov. 22, 1974.

      Alex Elson, Donald L. Vetter, Willard L. King, Chicago, 111., for plaintiffs-appellants.
    Francis D. Morrissey, Chicago, 111., for defendant-appellee.
    Before SWYGERT, Chief Judge, CASTLE, Senior Circuit Judge, and SPRECHER, Circuit Judge.
   SWYGERT, Chief Judge.

Plaintiffs appeal from a grant of summary judgment in favor of the defendant Ernst & Ernst, a firm of independent certified public accountants. The plaintiffs were investors in a fraudulent securities scheme perpetuated by Leston B. Nay, President of First Securities Company of Chicago and owner of ninety-two percent of its stock. First Securities was a small brokerage firm in Chicago which was registered with the Securities and Exchange Commission as a broker-dealer in securities and was a member of the Midwest Stock Exchange as well as the National Association of Securities Dealers, Inc. First Securities retained Ernst & Ernst as auditors' beginning in 1946 and continued to engage its services up through the last audit of First Securities performed in November, 1967.

The instant action emanates from Les-ton B. Nay’s fraudulent securities scheme which we have described in detail in our opinion in Securities & Exchange Com’n v. First Securities Co. of Chicago, 463 F.2d 981 (7th Cir. 1972), and which needs only be briefly recounted here. The plaintiffs were brokerage clients of First Securities, dealing in securities through First Securities in regular fashion. Each plaintiff received investment counselling from Nay, and each knew Nay to be the president of First Securities. Nay induced the plaintiffs to invest funds in an “escrow” account which Nay represented would yield interest to plaintiffs at a high rate of return. Plaintiffs began to invest in the escrow accounts as early as 1942 with the majority of the transactions entered into in the 1950’s and the last of the escrow transactions consummated in 1966. It was not until 1968 that Nay’s fraudulent scheme was discovered as a result of a suicide note left by Nay describing First Securities as bankrupt due to his thefts and indicating that certain escrow accounts created by him were “spurious.” Plaintiffs had invested in the “spurious” escrow accounts. As a result of his actions, we held in Securities & Exchange Com’n. v. First Securities Co. of Chicago, 463 F.2d 981, 986 (7th Cir. 1972), that “Nay’s conduct violated the provisions of section 10(b) of the Securities Exchange Act of 1934 and its regulatory corollary, Rule lob-5,” and that First Securities was chargeable with Nay’s fraud as an aider and abettor to Nay’s Rule 10b-5 violation.

In the instant action the plaintiffs claim that Ernst & Ernst was negligent in auditing First Securities thereby aiding and abetting Nay’s Rule 10b-5 violation. It is contended that had Ernst & Ernst duly executed its audit of First Securities Nay’s fraudulent scheme would have been uncovered or prevented.

In resolving this appeal we must address the following matters: (1) the elements of a prima facie case for aiding and abetting must be properly defined; (2) the propriety of the district court’s ruling that the evidence presented no genuine issue of material fact as to the adequacy of Ernst & Ernst’s audits of First Securities under applicable auditing standards; (3) whether the district court correctly ruled that plaintiffs’ claims against Ernst & Ernst are es-topped by their conduct prior to the presentment of such claims; and (4) whether the district court properly held that plaintiffs’ claims against Ernst & Ernst are barred by the applicable statute of limitations.

In granting summary judgment for Ernst & Ernst the district judge found that there were no genuine issues of material fact and held that on the basis of the uncontroverted evidence Ernst & Ernst was entitled to judgment as a matter of law. But it is our view there are genuine issues of material fact in dispute which go to the very question of liability. We hold, therefore, that this was not an appropriate case for summary judgment and accordingly reverse and remand for trial.

I

Ernst & Ernst contends that as a matter of law, it cannot be held liable for aiding and abetting Nay’s fraud in view of the fact that admittedly it had no knowledge of Nay’s fraudulent escrow scheme. We have indirectly passed upon this contention in our recent decision in Hochfelder, et al. and Martin, et al. v. Midwest Stock Exchange, 503 F.2d 364 (1974) where we stated that a claim for aiding and abetting solely by inaction can be maintained under Rule 10b-5 by a showing:

“that the party charged with aiding and abetting had knowledge of or, but for a breach of duty of inquiry, should have had knowledge of the fraud, and that possessing such knowledge the party failed to act due to an improper motive or breach of a duty of disclosure.”

The foregoing elements comprise a flexible standard of liability which should be amplified according to the peculiarities of each case. Accordingly, where, as here, it is urged that the defendant through action as well as inaction has facilitated the fraud of another, a claim for aiding and abetting is made on demonstrating: (1) that the defendant had a duty of inquiry; (2) the plaintiff was a beneficiary of that duty of inquiry; (3) the defendant breached the duty of inquiry; (4) concomitant with the breach of duty of inquiry the defendant breached a duty of disclosure; and (5) there is a causal connection between the breach of duty of inquiry and disclosure and the facilitation of the underlying fraud; that is, adequate inquiry and subsequent disclosure would have led to the discovery of the underlying fraud or its prevention. As our analysis will demonstrate, plaintiffs state a claim of aiding and abetting a Rule 10b-5 violation under the foregoing elements.

II

With respect to the existence of a duty of inquiry it is clear that Ernst & Ernst’s contractual arranagement whereby it undertook to audit First Securities gave rise to a common law duty of inquiry. The extent and scope of that duty will be the subject of additional analysis; for present purposes, however, it is sufficient to state that Ernst & Ernst’s audit engagement imposed a common law duty of inquiry.

In addition, having undertaken the contractual duty to audit First Securities and prepare SEC Form X-17A-5 pursuant to section 17(a) of the Securities Exchange Act and SEC Rule 17a-5 thereunder, a statutory duty of inquiry is properly imposed on Ernst & Ernst. Section 17(a) and its corollary Rule 17a-5 require a member of a national securities exchange to file with the SEC an annual report of financial condition certified by an independent cei'tified public accountant, which report meets the requirements of Form X-17A-5. In accordance with the provisions of section 17(a) and Rule 17a-5 First Securities retained Ernst & Ernst. Thus, we find Ernst & Ernst chargeable additionally with a statutory duty of inquiry.

Ill

The plaintiffs must establish that they were beneficiaries of Ernst & Ernst’s duty of inquiry. Unlike the common law duty of inquiry whose benefaction is narrowly drawn, it would appear that the statutory duty of inquiry imposed on the defendant inured to the benefit of plaintiffs.

Section 17(a) requires the maintenance by brokers and dealers of reports and records pertaining to their financial affairs and the submission of these reports and records to the Securities and Exchange Commission. The Commission is specifically directed to prescribe those reports and records “necessary or appropriate in the public interest or for the protection of investors.” 15 U.S.C. § 78q(a). The explicit thrust of this statutory section is the dominant concern evinced by the whole of the securities acts that those comprising the investing public be adequately safeguarded in their financial dealings with security brokers. Without reaching the question of whether there is implicit in section 17(a) a dii'eet duty flowing to the plaintiffs, it is enough for purposes of proving defendant’s aid and abetment of a Rule 10b-5 violation that the extant duty of inquiry imposed on Ernst & Ernst is grounded on a concern for the protection of investors such as the plaintiffs.

At common law the duty of inquiry owed by Ernst & Ernst would not extend to the plaintiffs. The defendant’s common law duty emanates from its contract to audit First Securities. Plaintiffs were not a party to that contract or an intended third-party beneficiary. There is therefore an absence of privity between the parties, precluding action by the plaintiffs on the contract for a breach of duty. Arising out of the contractual arrangement, however, is a corollary duty of inquiry fashioned by decisional law and sounding in tort. The first significant case extending liability for negligence beyond privity of contract where, as here, only intangible economic damages were involved, was Glanzer v. Shepaird, 233 N.Y. 236, 135 N.E. 275 (1922). In that case, the court rejected the argument that no duty was owed to the plaintiffs because there was no contract between them and defendant. Plaintiffs were purchasers of a quantity of beans. The seller contracted with the defendant, a public weigher, to certify the correct weight of the beans. The defendant knew that the plaintiffs were to use the certificates as the basis for their payment to the seller. The defendant negligently overstated the weight, and as a result the plaintiffs overpaid. In allowing the plaintiffs to recover for their economic damages, Judge Cardozo, holding that there was a duty owed to the plaintiffs, wrote:

“We do not need to state the duty in terms of contract or of privity. Growing out of a contract, it has none the less an origin not exclusively contractual. Given the contract and the relation, the duty is imposed by law.” 233 N.Y. at 239, 135 N.E. at 276.

Although the opportunity to state the duty in terms of contract was available, Cardozo chose to fashion the duty in tort, observing that “the bounds of duty are enlarged by knowledge of a prospective use.” 233 N.Y. at 240, 135 N.E. at 276. Glanzer was viewed as the precursor of a general duty of reasonable care to avoid all foreseeable risks of economic damages to third persons not in privity of contract.

Nine years after the decision in Glanzer, Cardozo rendered his opinion in Ultramares Corp. v. Touche, 255 N.Y. 170, 174 N.E. 441 (1931). There he refused to extend the scope of liability for economic damages caused by negligence to the full limits of foreseeability in favor of a third party not in privity. In Ultramares the defendants, a firm of certified public accountants were negligent in their audit of a company, Fred Stern & Co., to which the plaintiff had loaned money in reliance on the accountants’ audit. The accountants did not know the exact persons to whom the certified balance sheet would be shown nor did they know that the financial statements would be submitted to the plaintiff. It was foreseeable however that Stern and Company in the ordinary course of its business would exhibit the financial statements to creditors and investors. Accordingly, it was generally foreseeable that the plaintiff would rely on the statements. Cardozo, in questioning the wisdom of a duty owed to all who might foreseeably rely on financial statements which were negligently audited, observed:
“If liability for negligence exists, a thoughtless slip or blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries, may expose accountants to a liability in an indeterminate amount for an indeterminate time to an indeterminate class. The hazards of a business conducted on these terms are so extreme as to enkindle doubt whether a flaw may not exist in the implication of a duty that exposes to these consequences.” 255 N.Y. at 179, 174 N.E. at 444.

Declining to extend his decision in Glan-zer v. Shepard, Cordozo instead distinguished Glanzer, stating:

“In Glanzer v. Shepard, the seller of beans requested the defendants, public weighers, to make return of the weight and furnish the buyer with a copy. . . . Here was something more than the rendition of a service in the expectation that the one who ordered the certificate would use it thereafter in the operations of his business as occasion might require. Here was a ease where the transmission of the certificate to another was not merely one possibility among many, but the ‘end and aim of the transaction,’ In a word, the service rendered by the defendant in Glanzer v. Shepard was primarily for the information of a third person, in effect, if not in name, a party to the contract, and only incidentally for that of the formal promisee. In the case at hand, the service was primarily for the benefit of the Stern Company and -only incidentally or collaterally for use of those to whom Stern and his associates might exhibit it thereafter.” 255 N.Y. at 182, 174 N.E. at 445-446.

Ultramares set the outer limit of an accountant’s common law liability for it established that there was no duty ow-q ing to all who might foreseeably rely on an accountant’s negligent misrepresentation. There existed the possibility, by analogy to Glanzer v. Shepard, that an accountant owed a duty to those third persons, whose potential reliance on the financial statements was specifically known to the accountant, the so-called “foreseen plaintiff.” The courts, however, have declined to accept the Glanzer analogy, viewing Ultramares as holding that accountants owe no duty to persons not in privity of contract. See, e. g., O’Connor v. Ludlam, 92 F.2d 50 (2d Cir. 1937); State Street Trust Co. v. Ernst, 278 N.Y. 104, 15 N.E.2d 416 (1938); Duro Sportswear, Inc. v. Cogen, 131 N.Y.S.2d 20 (Supr.Ct.1954), aff’d without opinion, 285 App.Div. 867, 137 N.Y.S.2d 829 (1955); C. I. T. Financial Corp. v. Glover, 224 F.2d 44 (2d Cir. 1955); Candler v. Crane, Christmas & Co., [1951] 2 K.B. 164; Investment Corporation of Florida v. Buchman, 208 So.2d 291 (Fla.Ct.App. 1968). It is only in recent years that inroads have been made on the reach of the Ultramares decision. See, e. g., R. I. Hospital Trust Nat’l Bank v. Swartz, et al., 455 F.2d 847, 851 (4th Cir. 1972); Rusch Factors, Inc. v. Levin, 284 F.Supp. 85 (D.R.I. 1968); Ryan v. Kanne, 170 N.W.2d 395 (Iowa 1969); Shatterproof Glass Corp. v. James, 466 S.W.2d 873 (Tex.Civ.App. 1971). The courts in diminishing the impact of Ultramares have not only embraced the rule of Glanzer — liability to a foreseen plaintiff — but have extended an accountant’s liability for negligence to those who, although not themselves foreseen, are members of a limited class whose reliance on the financial statements is specifically foreseen.

We agree with the defendant that there is no common law duty of inquiry owed the plaintiffs in the case at bar. Plaintiffs ground the instant action on the basis of their membership in a class of escrow claimants. It is clear that at no time did Ernst & Ernst specifically foresee that plaintiffs’ limited class might suffer from the consequences of a negligent audit on its part. More important, however, is the plaintiffs’ admitted lack of reliance on the financial statements and reports prepared by Ernst & Ernst and Ernst & Ernst’s certificate of opinion. The common law action against a public accountant independent of an action on the contract is grounded on negligent misrepresentation ; this necessarily requires direct reliance of some sort by the plaintiff on the professional services rendered by the accountant. Absent such reliance no common law duty is involved. Accordingly, we must continue our analysis only with respect to Ernst & Ernst’s statutory duty of inquiry.

IV

In determining whether Ernst & Ernst breached its statutory duty of inquiry our examination is twofold: (1) the scope of Ernst & Ernst’s duty of inquiry must be ascertained; and (2) the standard of conduct by which Ernst & Ernst executed its duty must be delineated.

Going first to the last element, we are of the view that when accountants undertake to perform an audit, they are required to meet only the standard of care reasonably expected of persons holding themselves out as skilled accountants. We agree with Judge McLean that, in general, “accountants should not be held to a standard higher than that recognized in their profession.” Escott v. Barchris Construction Corp., 283 F.Supp. 643, 703 (S.D.N.Y. 1968). Accordingly, the standard of care which generally prevailed in the accounting profession during the years of Ernst & Ernst’s audits of First Securities is the standard to which Ernst & Ernst must be held.

The extent or scope of Ernst & Ernst’s statutory duty of inquiry imposed by section 17(a) and Rule 17a-5 is clearly set forth in Form X-17A-5:

“The audit shall be made in accordance with generally accepted auditing standards and shall include a review of the accounting system, the internal accounting control and procedures for safeguarding securities including appropriate tests thereof for the period since the prior examination date. It shall include all procedures necessary under the circumstances to substantiate the assets and liabilities and securities and commodities positions as of the date of the responses to the financial questionnaire and to permit the expression of an opinion by the independent public accountant as to the financial condition of the respondent at that date.”

This duty to audit in accordance with generally accepted auditing standards does not differ from the duty which is otherwise imposed by law, Wessel v. Buhler, 437 F.2d 279, 283 (9th Cir. 1971); Caddell v. Goodbody & Co., CCH Fed.Sec.L.Rep. ¶ 93,938, p. 93,740 (N. D.Ala.1972); or the accounting profession itself. American Institute of Certified Public Accountants, Audits of Brokers and Dealers in Securities (1956).

Moreover, with regard to accountants’ duty to uncover fraud or irregularities, we think that in general it is properly stated that:

“In making the ordinary examination, the independent auditor is aware of the possibility that fraud may exist. Financial statements may be misstated as the result of defalcations and similar irregularities, or deliberate misrepresentation by management, or both. The auditor recognizes that fraud, if sufficiently material, may affect his opinion on the financial statements, and his examination, made in accordance with generally accepted auditing standards, gives consideration to this possibility. However, the ordinary examination directed to the expression of an opinion on financial statements is not primarily or specifically designed and cannot be relied upon, to disclose defalcations and other similar irregularities, although their discovery may result. Similarly, although the discovery of deliberate misrepresentation by management is usually more closely associated with the objective of the ordinary examination, such examination cannot be relied upon to assure its discovery. The responsibility of the independent auditor for failure to detect fraud (which responsibility differs as to clients and others) arises only when such failure clearly results from failure to comply with generally accepted auditing standards.”

With this statement in mind, the statutory duty of inquiry was breached if it can be shown that Ernst & Ernst in failing to attain the professional standard of care did not conduct its audit of First Securities in accordance with the requirements set forth therein.

V

We come then to the fundamental issue in this lawsuit: Whether the uncon-troverted evidence reveals that Ernst & Ernst conducted its audits with all due care and in accordance with generally accepted auditing standards. Plaintiffs contend that Ernst & Ernest negligently failed to detect and report an alleged lack of adequate internal accounting controls of First Securities which resulted from Nay’s “mail rule” and that Ernst & Ernst thereby failed to meet generally accepted auditing standards. Nay’s “mail rule” was an office rule which he imposed on all employees of First Securities whereby he directed that all mail addressed to him or to the company for his attention was to be opened by no one other than him and that when he was away from the office the mail was to be placed on his desk unopened regardless of the duration of his absence from the office. Plaintiffs say that Nay’s “mail rule” was the key to the concealment of his fraudulent escrow scheme and that the defendant’s regulatory duty extended to investigate this practice. On the other hand, Ernst & Ernst argues that even taking into account these mail procedures its audits were conducted in accordance with generally accepted auditing standards and that First Securities maintained adequate internal accounting controls.

It is clear that as part of Ernst & Ernst’s duty to conduct its audit in accordance with generally accepted auditing standards it was incumbent on it to investigate First Securities’ system of internal accounting controls. The generally accepted auditing standards as approved and adopted by the membership of the American Institute of Certified Public Accountants provide in pertinent part: it

Standards of Field Work
2. There is to be a proper study and evaluation of the existing internal control as a basis for reliance thereon and for the determination of the resultant extent of the tests to which auditing procedures are to be restricted.”

Moreover, SEC Form X-17A-5, in directing that the accountant’s audit be conducted in accordance with general accepted auditing standards, emphasizes that those standards shall include a review of the internal accounting control. There is therefore no question but that Ernst & Ernst was under a duty to investigate the internal accounting controls of First Securities.

Ernst & Ernst says that there may be misapprehension about the function of internal accounting control. It contends that the function of internal accounting control is not to insure the detection of all irregularities, but rather to determine the extent to which an auditor can rely on the accounting records of the firm to produce a fair reflection of its financial condition and to provide reasonable assurance as to the safeguarding of assets against loss from unauthorized use or disposition.

Internal accounting controls, as defined by the American Institute of Certified Public Accountants (American Institute), comprise:

“The plan of organization and all methods and procedures that are concerned mainly with, and relate directly to, safeguarding of assets and the reliability of the financial records. They generally include such controls as the systems of authorization and approval, separation of duties concerned with record keeping and accounting reports from those concerned with operations or asset custody, physical controls over assets, and internal auditing.”

Moreover, as noted by the American Institute: “A function of internal control, from the viewpoint of the independent auditor, is to provide assurance that errors and irregularities may be discovered with reasonable promptness, thus assuring the reliability and integrity of the financial records.” With respect to the prevention and detection of fraud the American Institute observes:

“6. Reliance for the prevention and detection of fraud should be placed principally upon an adequate accounting system with appropriate internal control. The well-established practice of the independent auditor of evaluating the adequacy and effectiveness of the system of internal control by testing the accounting records and related data and by relying on such evaluation for the selection and timing of his other auditing procedures has generally proved sufficient for making an adequate examination. If an objective of an independent auditor’s examination were the discovery of all fraud, he would have to extend his work to a point where its cost would be prohibitive. Even then he could not give assurance that all types of fraud had been detected, or that none existed, because items such as unrecorded transactions, forgeries, and collusive fraud would not necessarily be uncovered. Accordingly, it is generally recognized that good internal control and fidelity bonds provide protection more economically and effectively.”

It is Ernst & Ernst’s view that in light of the aforementioned purpose and function of internal accounting controls, Nay’s mail rule was not relevant to the system of internal accounting control and that in any event First Securities maintained adequate internal accounting controls.

Plaintiffs meet Ernst & Ernst’s contention with the affidavits of three former auditors. Fred J. Duncombe, past President of the Illinois Society of Certified Public Accountants and former Chairman of the Committee on Accountancy of the University of Illinois, stated in his affidavit: “If I had discovered in making an audit of a brokerage company that the President of the Company had established an office rule that all mail addressed to him or to the Company for his attention should not be opened by anyone but him; and that when he was away from the office for a few days, the mail addressed to him or to the Company for his attention piled up on his desk, I would not have regarded that brokerage firm as having adequate internal accounting control and would not have certified that a report based on such an audit fairly represented the financial position of the Company.” To the same effect affiant Michael K. Garst, a national bank examiner of 25 years experience, indicated that under the circumstances he would have regarded Nay’s “mail rule” as a possible violation of duality of control and would have appropriately commented on it. Likewise Gerhard Mayer, a certified public accountant with thirty years experience, comments in his affidavit: “If I had discovered in making an audit of a security brokerage business that its president had established an office rule that mail addressed to him at the business address, or to the company for his attention should not be opened by anyone but him, even in his absence; and that whenever he was away from the office such mail would remain unopened and pile up on his desk I would have to raise the question whether such rule or practice could possibly have been instituted for the purpose of preventing discovery of irregularities of whatever nature ; would, as a minimum, have to undertake additional audit procedures to independently establish a negative answer to the latter question; also failing such an answer either withdraw from the engagement or decline to express an opinion on the financial statements of the enterprise.”

The foregoing statements go directly to the adequacy of First Securities’ system of internal accounting controls and the sufficiency of Ernst & Ernst’s review of those controls. In essence they challenge Ernst & Ernst’s contention that all audits of First Securities were performed in accordance with generally accepted auditing standards. That is, a negligent failure to discover a material inadequacy in internal accounting controls does not satisfy the generally accepted auditing standard that there “be a proper study and evaluation of the existing internal control.” Auditing Standards and Procedures, Statement on Auditing Procedure No. 33, American Institute of Certified Public Accountants, at p. 16 (1963).

We realize that there never can be attainment of a perfect or a fail-safe system of internal accounting controls. The most sophisticated system of internal control may harbor inadequacies of some nature. Accordingly, the inadequacy in internal control is of signal importance only when it enters the realm of materiality. To that end we agree with the American Institute of Certified Public Accountants that:

“A material inadequacy [in internal accounting control] can be defined as a condition that would permit a person acting individually in the brokerage concern’s organization to perpetrate errors or irregularities involving the accounting records, assets of the brokerage concern, and/or assets of customers that would not be detected through the internal control procedures in time to prevent material loss or misstatement of the concern’s financial statements, or serious violation of rules of the regulatory agencies.”

On the basis of the foregoing, therefore, there are genuine issues of material fact to ,be properly decided by a trial: (1) whether Nay’s “mail rule” constituted a material inadequacy in First Securities’ system of internal accounting control; and (2) whether Ernst & Ernst failed to exercise the due care required of a professional auditor in that it did not discover a material inadequacy in internal accounting control. An affirmative finding on both issues will therefore satisfy the third element of plaintiffs’ claim of aiding and abetting, namely, a showing of a breach of duty of inquiry.

VI.

Plaintiffs further contend that Ernst & Ernst was under a duty of inquiry to detect and report First Securities’ noncompliance with Rule 27(c) of Article III of the Rules of Fair Practice of the National Association of Securities Dealers, Inc. (N.A.S.D.) In Securities & Exch. Com’n v. First Securities Co. of Chicago, 463 F.2d 981 (7th Cir. 1972), we held that First Securities’ enforcement of Nay’s “mail rule” was sufficient without more to constitute a violation of Rule 27. Accordingly, we found First Securities, a member of the N.A.S.D., liable for Nay’s fraud, due to its failure to enforce Rule 27. In Hochfelder, et al. v. Midwest Stock Exchange, 503 F.2d 364 (1974) plaintiffs raised a contention, somewhat similar to the one they raise here, that the Midwest Stock Exchange was under a duty to enforce the rules of the N.A.S.D. In response to that contention we observed (at pp. 373, 374):

“In this action plaintiffs request that we place a duty on Midwest as a national securities exchange to enforce the rules of another self-regulatory organization, namely, the N.A.S.D., a national securities association. Without facing the question whether even the N.A.S.D. as promulgator of Rule 27 could be liable because of its member’s noncompliance, plaintiffs would have us place an additional burden on Midwest to enforce the rules of another self-regulatory body. There is nothing in the 1934 Act which mandates this unique theory. Indeed, the imposition of such a burden of enforcement would be unduly onerous and result in a wasteful duplication of actions in that Midwest would be expected to enforce the rules of all self-regulatory organizations- to which a member firm might belong. This would be contrary to the avowed intention of Congress and the Securities and Exchange Commission that there be more coordination and less duplication of self-regulatory activities. We hold that Midwest was under no duty to enforce Rule 27(c) of the Rules of Fair Practice of the N.A.S.D.”

In the instant action the posture of plaintiffs’ contention that Ernst & Ernst was under a duty to examine First Securities’ compliance with the Rules of Fair Practice of the N.A.S.D. and in particular Rule 27(c) is: Public accountants are chargeable with a general duty of examining N.A.S.D. member firms for compliance with N.A.S.D. rules in view of the fact that the self-regulatory organization which promulgated the rules, the N.A.S.D., has failed to conduct examinations verifying compliance with its rules. Moreover, plaintiffs in effect claim that the duty to investigate compliance with the N.A.S.D. Rules of Fair Practice is necessarily encompassed within the body of generally accepted auditing standards. Ernst & Ernst makes the counter argument that neither SEC Rule 17a-5 Form X-17A-5, nor generally accepted auditing standards require that an auditor of a securities broker or dealer who is also a member of N.A.S.D., has any duty to review compliance by the broker or dealer with the rules of the N.A.S.D. It is claimed that such an examination for compliance with N.A.S.D. rules is entirely outside of the scope of an audit.

A fair reading of SEC Rule 17a-5 and Form X-17A-5 indicates that no duty is imposed on an auditor to ascertain compliance with N.A.S.D. rules. Moreover, it appears that the perceptible body of generally accepted auditing standards does not embrace such a requirement of audit review. In addition, even if plaintiffs were to be heard to complain of a contractual breach of duty by Ernst & Ernst, it is clear that Ernst & Ernst was not retained to verify First Securities’ compliance with the N.A.S.D. Rules of Fair Practice.

Although plaintiffs’ proposition is somewhat novel, we recognize, in agreement with the accounting profession, that it is not entirely devoid of merit. In the American Institute of Certified Public Accountants’ industry audit guide on Audits of Brokers and Dealers in Securities the admonition is given (at p. 3):

“In addition to a familiarity with the above rules of the Securities and Exchange Commission, it is necessary for the independent public accountant to have a working knowledge of Regulations T and U of the Board of Governors of the Federal Reserve System, and, if his client is a member of a stock exchange or the National Association of Securities Dealers, Inc-,, he should be familiar with the pertinent rules of those organizations. It is also considered advisable to review the applicable Accounting Series and other releases which are published from time to time by the Securities and Exchange Commission.”

And, although the defendant correctly states that generally accepted auditing standard's do not ordinarily require such investigation, we do not find that entirely compelling. The teaching of The T. J. Hooper, 60 F.2d 737 (2d Cir. 1932), is not lost to us for we recognize that we are not constrained to accept faulty standards of practice otherwise generally accepted in an industry or profession. Moreover, the potential for imposition of liability on a broker or dealer for noncompliance with N.A.S.D. rules would seem to undermine the auditor’s ability to represent that the financial statements fairly reflect the financial position of the broker or dealer unless some sort of inquiry were made into compliance with those rules.

To countenance the duty of inquiry advocated by plaintiffs, however, would in our judgment be inappropriate. To direct full examination for compliance with the various rules of all the self-regulatory organizations to which a broker or dealer might belong would be to impose a burden of inquiry — otherwise not demanded by contract, statutory law, or professional practices — of indefinable proportions which arguably could never effectively and completely be implemented. We cannot subscribe to a situation whereby the accountant has the burden of an investigation which is unascertainable and everchanging.

In summary, the burden of inquiry as to compliance with N.A.S.D. rules is placed with the N.A.S.D., where it should properly repose, for it is the promulgator of those rules and as such should command adherence thereto. Ernst & Ernst, as auditor of a member firm of the' N.A.S.D., need have only inquired as to whether the member firm received an adverse report following an examination by the N.A.S.D. Having carried the inquiry that far, Ernst & Ernst cannot be charged with more.

VII

If it were found after a trial that Ernst & Ernst breached its statutory duty of inquiry by failing to exercise due care in coming to the knowledge of a material inadequacy in the internal accounting controls of First Securities, it would follow that Ernst & Ernst concomitantly breached an extant duty of disclosure. As we have previously stated, a breach of Ernst & Ernst’s statutory duty of inquiry is a failure on its part to adhere with generally accepted auditing standards and as such clearly would not comport with the representation it made in its audit certificates that the audits were performed in accordance with generally accepted auditing standards. To prevent such a misrepresentation and to comply with the disclosure requirement of Rule Í7a5(f)(2)(B), it would, at a minimum, be incumbent on Ernst & Ernst to disclose its departure from generally accepted auditing standards which of course it did not do.

More specifically, the duty, as part of generally accepted auditing standards to investigate internal accounting controls, necessarily implies that any material inadequacy in those controls will be disclosed. Indeed, it is our view that a material inadequacy in internal accounting controls is a matter to which the accountant must properly take exception and to that end we note the requirements of Rule 17a-5(i) which direct that: “Any matters to which the accountant takes exception shall be clearly identified; the exception thereto shall be specifically and clearly stated. .” Moreover, we note that the requirement to disclose a material inadequacy in internal accounting controls, which is at least implicit in Rule 17a-5 and Form X-17A-5, was made explicit by SEC Release No. 8172. As to reports of the financial condition of security brokers and dealers filed as of November 30, 1967 or thereafter, the audit requirements of Form X-17A-5 specifically directed that:

“Based upon such audit, the ae-countant shall comment upon any material inadequacies found to exist in the accounting system, the internal accounting control and procedures for safeguarding securities, and shall indicate any corrective action taken or proposed. These comments may be submitted in a supplementary eertifi-cate and filed pursuant to Rule 17a-5(b)(3).”

Accordingly, under the circumstances, a finding of a breach of duty of inquiry requires a corollary finding of a breach of duty of disclosure.

VIII

The last element in plaintiffs’ claim for aiding and abetting a Rule 10b-5 violation is proof of a causal connection between the breach of the duty of inquiry and disclosure and the facilitation of. the underlying fraud. To that end it must be demonstrated that adequate inquiry and subsequent disclosure on Ernst & Ernst’s part would have led to the discovery or prevention of Nay’s fraud.

Ernst & Ernst contends that plaintiffs would not be able to prove at trial a causal connection. It is urged that plaintiffs’ theory of causation rests on utter speculation. On the state of the limited evidence before us and without passing on the extent of the weight and probative value of that evidence, it would not appear to be entirely outside of the realm of reasonableness for the fact finder to infer that adequate inquiry by Ernst & Ernst might not of itself have led to the discovery or prevention of Nay’s fraud. Moreover, with regard to the question of whether adequate disclosure by Ernst & Ernst of a material inadequacy in internal accounting controls would have precipitated action by the SEC or self-regulatory organizations leading to the discovery or prevention of Nay’s fraud, we are inclined to the view that this is a matter properly left to full evidentiary development at trial and not disposable on a motion for summary judgment.

IX

In accordance with generally accepted auditing standards, the basic audit procedure to determine the accuracy and correctness of the books and records of a broker or dealer in securities with respect to his customers’ accounts is to request and obtain written confirmation from the customers with regard to their accounts. Specifically, the audit requirements of Form X-17A-5 directed the auditor to obtain written confirmation from customers of their accounts.

Pursuant to these requirements, Ernst & Ernst mailed to some of the plaintiffs confirmation forms requesting that they verify the accuracy of the details stated in the confirmation forms as to the amount and composition of the customer’s account. The confirmation expressIy indicated that the customer was to note any differences and exceptions. Admittedly, no confirmation of account sent by Ernst & Ernst to the plaintiffs at any time listed or referred to plaintiffs’ escrow accounts. It is equally clear, however, that no plaintiff who received a confirmation request from Ernst & Ernst took exception to the failure of the confirmation to list his escrow account. On the basis of plaintiffs’ failure to take exception to the confirmation requests, the trial judge held that they were estopped as a matter of law from pursuing their claims against Ernst & Ernst. The judge observed :

“Plaintiffs raise no factual issue that they failed to correct defendant’s confirmation slips on their First Securities accounts, and it was only with respect to auditing First Securities Co. that defendant Ernst & Ernst had any responsibility. Therefore in the only direct dealings which plaintiffs had with this defendant, they misled defendant to its detriment in a very material respect. Had they not done so, we might infer that Ernst & Ernst would have been put on notice sufficiently to investigate further and perhaps perfect its audit, but its failure to do so was caused in part by the plaintiffs, for aught that appears in the record.”

Estoppel is properly asserted as an affirmative defense to a claim of aiding and abetting a Rule 10b-5 violation. See generally, Straley v. Universal Uranium and Milling Corp., 289 F.2d 370 (9th Cir. 1961); Royal Air Properties, Inc. v. Smith, 312 F.2d 210, 213-214 (9th Cir. 1962); Dale v. Rosenfeld, 229 F.2d 855, 859 (2d Cir. 1956). It is a rule of fundamental fairness whereby a party is precluded from benefiting from his own inconsistent conduct which has induced reliance to the detriment of another. That is, where a plaintiff has, with knowledge of the facts, initially conducted himself in a particular fashion, he cannot thereafter assume a posture inconsistent with such conduct to the detriment of a defendant who has acted in material reliance upon that conduct. See, e. g., Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1208 (9th Cir. 1970); Royal Air Properties, Inc. v. Smith, 312 F.2d 210, 212-214 (9th Cir. 1962); Hampton v. Paramount Pictures Corp., 279 F.2d 100, 104 (9th Cir. 1960). Applying the estoppel rule to the instant case, if plaintiffs knew they were to report the escrow accounts as an exception on the confirmation and failed to do so, they ought not be heard to complain of Ernst & Ernst’s failure to uncover or prevent the fraudulent escrow scheme, for the inference is strong that disclosure by plaintiffs to Ernst & Ernst of the existence of the escrow accounts would have led to the discovery of Nay's fraudulent scheme. Whether plaintiffs knew or as reasonable persons should have known that they were to report the escrow accounts as exceptions on the confirmation requests is a question to be properly decided by the fact finder. We cannot say as a matter of law that a reasonable investor of similar business sophistication and intelligence as plaintiffs would have reached no other conclusion but that disclosure of the escrow account was called for by the confirmation request. Nor can we conclude that a reasonable investor viewing the express language of the confirmation would have limited his verification to the amounts stated and noted no exceptions for the escrow account.

X

The trial judge held that the applicable three year statute of limitations had run in view of the fact that Ernst & Ernst’s last audit was filed in December, 1967 and the first complaint in plaintiffs’ actions was not entered until February, 1971. In the district court plaintiffs urged that the equitable tolling doctrine prevented the bar of the statute of limitations from beginning to run until Nay’s fraud was discovered shortly* after his suicide in June, 1968, and, on that basis, it can be stated that plaintiffs’ position refutes any claim that their actions were untimely filed. The trial judge rejected the plaintiffs’ effort to invoke the equitable tolling doctrine, holding that “the cause of action was not fraudulently concealed by this defendant.” Assuming the applicability of the tolling doctrine, the judge went on to note that the plaintiffs could not demon-' strate due care on their part in light of their failure to come to the knowledge of, the wrong of which they complained.

We have addressed this same issue in the companion case to the instant action, Hochfelder, et al. and Martin, et al. v. Midwest Stock Exchange, 364 F.2d 503 (1974). In that decision we observed that the “equitable tolling doctrine provides that where a fraud which is the foundation of the suit has actively been concealed or is of such a nature as to conceal itself, the statute of limitations is tolled until the plaintiff has obtained knowledge of the fraud or in the* exercise of due care should have obtained knowledge of the fraud. Bailey v. Glover, 88 U.S. (21 Wall.) 342, 349, 22 L.Ed. 636 (1874); Holmberg v. Armbrecht, 327 U.S. 392, 396, 66 S.Ct. 582, 90 L.Ed. 743 (1945); Morgan v. Koch, 419 F.2d 993, 997 (7th Cir. 1969).” We went on to note that the thrust of plaintiffs’ action against the Midwest Stock Exchange, as here against Ernst & Ernst, was grounded in negligence and' not on any contention that the defendant was chargeable with acts of fraud or fraudulent concealment. In rejecting the defendant’s assertion that the tolling doctrine did not embrace the plaintiffs’ action we stated:

“. . . However, we do not believe that the tolling doctrine should be s'o* narrowly drawn that it does not encompass Midwest’s alleged acts of facilitation of the fraud.
“It is charged that Midwest’s conduct amounted to negligence and that its negligence facilitated or provided the means for Nay’s fraud. Nay effectively concealed his fraud and as a result the alleged implementing negligence of Midwest was concealed and brought to the surface only when the facts surrounding Nay’s fraud were first discovered. If claims brought in the same posture as the instant action —asserting charges amounting to negligence but short of fraud — are to have any vitality, it cannot be contended that the tolling doctrine should not apply. Often the underlying fraud, carefully concealed in and of itself, would cloak the implementing actions of others. Accordingly, where the acts of a defendant facilitate the perpetration of a concealed fraud of another, the bar of the statute of limitations should not begin to run until a plaintiff obtains knowledge or through due diligence should have obtained knowledge of the underlying fraud.”

This observation is applicable in the instant action for Ernst & Ernst is charged with the negligent facilitation and implementation of Nay’s fraud. Moreover, Nay through his efforts in concealing the underlying fraud effectively cloaked and concealed the alleged negligent facilitating conduct of. Ernst & Ernst. In our judgment plaintiffs may avail themselves of the equitable tolling doctrine and the bar. of the statute of limitations does not begin to run until it can otherwise be established that they knew or in the exercise of due diligence should have known of Nay’s fraud. Whether plaintiffs knew or in the exercise of due diligence should have known of Nay’s fraud is, on the basis of. the evidence before us, an issue properly to be decided at a trial.

The judgment of the district court is reversed and the case is remanded for trial under the provisions of Circuit Rule 23.

      . The plaintiffs in Appeal No. 73-1907, Olga Hochfelder, et al., filed an action on February 19, 1971 in district court against the Midwest Stock Exchange and Ernst & Ernst. On May 18, 1971 a separate but identical complaint was filed by plaintiffs Leon S. Martin, et al., in Appeal No. 73-1908. Midwest and Ernst & Ernst filed motions for summary judgment applicable to both cases. The district court granted summary judgment in favor of the Midwest Stock Exchange which we affirmed in the consolidated appeal. Hochfelder, et al. and Leon S. Martin, et al. v. Midwest Stock Exchange, 503 F.2d 364 (7 Cir. 1974). Subsequent to the grant, of summary judgment to Midwest, the district court granted summary judgment in favor of Ernst & Ernst. The appeals were consolidated by stipulation of the parties aim our order of November 13, 1973.

      . Section 17(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78q(a), provides:
      “(a) Every national securities exchange, every member thereof, every broker or dealer who transacts a business in securities through the medium of any such member, every registered securities association, and every broker or dealer registered pursuant to section 78o of this title, shall make, keep, and preserve for such periods, such accounts, correspondence, memoranda, papers, books, and other records, and make such reports, as the Commission by its rules and regulations may prescribe as necessary or appropriate in the public interest or for the protection of investors. Such accounts, correspondence, memoranda, papers, books, and other records shall be subject at any time or from time to time to such reasonable periodic, special, or other examinations by examiners or other representatives of the Commission as the Commission may deem necessary or appropriate in the public interest or for the protection of investors.
      Pursuant to this statutory section, the Securities and Exchange Commission promulgated Rule 17a-5, 17 C.F.R. § 240.17a-5.

      . In the realm of tangible, physical harm and damage to persons and property arising out of tlie negligent performance of a contract, the defense of privity of contract was effectively abrogated six years prior to the decision in Glanzer by Judge Cardozo’s opinion in MacPherson v. Buick Motor Co., 217 N.Y. 382, 111 N.E. 1050 (1916).

      . Cardozo recognized that the duty could have been stated in contract. 233 N.Y. at 241, 135 N.E. at 277. In view of the specific nature of the transaction and the relationship of the parties, the third-party beneficiary rule of Lawrence v. Fox, 20 N.Y. 268 (1859), would have been apposite.

      . See, e. g., Note, Privity of Contract and Tort Liability, 21 Mich.L.Rev. 200 (1922).

      . Auditing Standards and Procedures, Statements on Auditing Procedure Xo. 33, American Institute of Certified Public Accountants, at pp. 10-11 (1963).

      . Auditing standards and Procedures, Statements on Auditing Procedure No. 33, American Institute of Certified Public Accountants, at p. 16 (1963).

      . The audit requirements of SEC Form X-17A-5 provide in relevant part:
      “The audit shall be made in accordance with generally accepted auditing standards and shall include a review of the accounting system, the internal accounting control and procedures for safeguarding seeurities including appropriate tests thereof for the period since the prior examination date. It shall include all procedures necessary under the circumstances to substantiate the assets and liabilities and securities and commodities positions as of the date of the responses to the financial questionnaire and to permit the expression of an opinion by the independent public accountant as to the financial condition of the respondent at that date.” [Emphasis added].

      . Auditing Standards and Procedures, Statements on Auditing Procedure No. 33, American Institute of Certified Public Accountants, at p. 28 (1963).

      . Auditing Standards and Procedures, Statements on Auditing Procedure No. 33, American Institute of Certified Public Accountants, at p. 32 (1963).

      . Auditing Standards and Procedures, Statements on Auditing Procedure No. 33, American Institute of Certified Public Accountants, at p. 11 (1963).

      . Indeed, it is presently an express audit requirement of SEC Form X-17A-5 that the accountant comment on any maierial inadequacy in internal accounting control. The relevant portion of the audit requirements provide that:
      “Based upon such audit, the accountant shall comment upon any material inadequacies found to exist in the accounting system, the internal accounting control and procedures for safeguarding securities, and shall indicate any corrective action taken or proposed. These comments may be submitted in a supplementary certificate and filed pursuant to Rule 17a-5(b)(3).”

      . Audits of Brokers and Dealers in Securities, American Institute of Certified Public Accountants, at p. 71 (1963).

      . To the extent that plaintiffs’ charge regarding First Securities’ vacation policy is relevant to a determination of the adequacy of internal accounting controls, they may offer evidence with respect thereto.

      . Rule 27 in pertinent part provides :
      “(a) Each member [of the Association] shall establish, maintain and enforce written procedures which will enable it to supervise properly the activities of each registered representative and associated person to assure compliance with applicable securities laws, rules, regulations and statements of policy promulgated thereunder and with the rules of this Association. “(b) Final responsibility for proper supervision shall rest with the member.
      “(e) Each member shall be responsible for keeping and preserving appropriate records for carrying out the member’s supervisory procedures. Each member shall review and endorse in writing on an internal record, all transactions and all correspondence of its registered representatives pertaining to the solicitation or execution of any securities transaction.”

      . Judge Learned Hand aptly stated in 'The T. J. Hooper decision :
      “There are, no doubt, eases where 'courts seem to make the general practice o’f the calling the standard of proper diligence; we have indeed given some currency to the notion ourselves. Ketterer v. Armour & Co. (C.C.A.) 247 F. 921, 931 L.R.A. 1918D, 798; Spang Chalfant & Co. v. Dimon, etc., Corp. (C.C.A.) 57 F.2d 965, 967. Indeed in most cases reasonable prudence is in fact common prudence; but strictly it is never its measure; a whole calling may have unduly lagged in the adoption of new and available devices. It never may set its own tests, however persuasive be its usages. Courts must in the end say what is required ; there are precautions so imperative that even their universal disregard will not excuse their omission. 60 F.2d at 740.

      . Ernst & Ernst utilized a short-form audi- or’s report or certificate typical in style to that customarily used (and suggested by the SEC) in which Ernst & Ernst represented in an opinion paragraph that the material in the financial questionnaire filed with the Securities and Exchange Commission presented fairly the financial position of First Securities.

      . In its certificate Ernst & Ernst invoked the customarily used scope paragraph whereby the representation was made that Ernst & Ernst conducted its examination of First Securities “in accordance with generally accepted auditing standards.” In addition, Ernst & Ernst expressly represented that their examination “included a review of the system of internal control.”

      . Rule 17a-5(g) (2) (B) provided:
      “(g) Accountant’s Certificate.

      (2) Representations as to Audit. The accountant’s certificate . . .
      (B) shall state whether the audit was made in accordance with generally accepted auditing standards applicable in the circumstances. . . .”

      . As the American Institute of Certified Public Accountants presently notes in its industry audit guide, Audits of Brokers and Dealers in Securities, at pp. 70-71 (1973) :
      “In compliance with generally accepted auditing standards, as well as the rules of the Securities and Exchange Commission and the principal national securities exchanges, the independent public accountant is required to review and make appropriate tests of the accounting system, internal accounting control, and procedure for safeguarding securities for the period since the prior examination date. If, based on his review and tests of compliance, no material inadequacies are found to exist with respect to any of the foregoing matters, the independent public accountant should so state in his report on internal control. If, however, material inadequacies are found to exist his report should disclose the nature of the inadequacies and the constructive action proposed to be taken or already taken by the brokerage concern.”

      . As we noted earlier, plaintiffs’ affiants stated that at a minimum they would have made further investigation with respect to the mail rule to assure that it was not the vehicle for irregularity and, absent a satisfactory answer to such inquiry, would have withdrawn from the audit engagement or declined to issue an opinion on the financial position of First Securities.

      . The audit requirements of Form X-17A-5 prescribed that as of the audit date the independent public accountant was to :
      “(6) Obtain written confirmations with respect to the following (see note) : U

      “(f) Customers’, partners’, officers’, directors’, and respondent’s accounts. Confirmation of these accounts may be in the form of a written acknowledgment of the accuracy of the statement of money balances, securities and/or commodities positions, and open contractual commitments (other than uncleared ‘regular way’ purchases and sales of securities) accompanying the first request for confirmation mailed by the independent public accountant. Customers’ accounts without balances, position or commitments, and accounts closed since the last prior audit shall be confirmed on a test basis. <(

        “Note: Compliance with requirements for obtaining written confirmation with respect to the above accounts shall be deemed to have been made if requests for confirmation have been mailed by the independent public accountant in an envelope bearing his own return address and second requests are similarly mailed to those not replying to the first, requests, together with such auditing procedures as may be necessary; provided, however, that with respect to customers’ accounts closed since the last prior audit the accountant may use either positive or negative confirmation request. . . . ”

      . The confirmations were sometimes prepared in the following form:

      . As to those plaintiffs to whom Ernst & Ernst sent no confirmations we find the es-toppel argument to be unavailing. It cannot be said that Ernst & Ernst relied on any direct action or express representation by such plaintiffs. Nor can Ernst & Ernst ground its estoppel defense on any alleged representation emanating from transaction confirmations sent to plaintiffs by First Securities and not sent by Ernst & Ernst in the course of its audit.


source: Caselaw Access Project

author: OAKES, Circuit Judge:

license: Public Domain

text:
    UNITED STATES of America, Appellee, v. Wilson TORRES, Appellant.
    No. 1238, Docket 74-1698.
    United States Court of Appeals, Second Circuit.
    Argued Aug. 15, 1974.
    Decided Oct. 8, 1974.

      Gary P. Naftalis, New York City, for appellant.
    David A. Cutner, Asst. U. S. Atty. (Paul J. Curran, U. S. Atty. for the S. D. of N. Y.; John D. Gordan III, Asst. U. S. Atty. of counsel), for appellee.
    Before OAKES, Circuit Judge, FRANKEL and KELLEHER, District Judges.

         Of the Southern District of New York and Central District of California, respectively, sitting by designation.

   OAKES, Circuit Judge:

This appeal is from a heroin-distribution conspiracy conviction, 21 U.S.C. §§ 812, 841(a)(1), 841(b)(1)(A) and 846 Appellant principally claims that the evidence was insufficient because his involvement was demonstrated only as to a “single act,” and that his trial was unfair in that the Government was improperly permitted to impeach a witness with his own prior inconsistent statement and by using an assistant United States attorney as a witness, an error which was compounded in the prosecutor’s summation. While we disagree on the sufficiency question, we agree that there was reversible error as to the impeachment of the witness, Ortiz. The opinion will also refer briefly, for retrial purposes, to the third point urged by appellant relating to the testimony of the Government’s principal witness, Jose Guzman, at a prior trial.

Guzman, an undercover New York City police detective, negotiated on January 11, 1972, with Jose Sanjurjo (“Jose”) for the purchase of an ounce of heroin for $1,000. The deal was consummated seven days later at the same location at which the preliminary negotiations had taken place, 121st Street and Second Avenue. By prearrangement between Sanjurjo and Guzman, co-defendant Ortiz, after emerging from a club at 2353 Second Avenue, gave Guzman a package containing the heroin on the street and received the cash in the hallway at 2353. Appellant Torres is not demonstrated to have had any connection with this January transaction.

On February 14, 1972, Guzman returned to the club and spoke with Ortiz about purchasing an eighth of a kilogram of heroin. Because Jose was supposedly in Puerto Rico, Guzman was to return later that evening to complete the sale with a close relative of Jose, Jesus San-jurjo (“Jesus”). Guzman did return and Ortiz joined him in his car. Jesus Sanjurjo came to the car, and a deal was made at $3,600. Guzman said he wanted to speak to Jose before the sale was completed. Jesus went off in a white car only to return to say that Jose’s instructions were to deal with him, Jesus. Guzman insisted, however, and Jesus went off again, returning to tell Guzman that Jose — by now plainly not in Puerto Rico — would see him around the corner at 120th Street.

Guzman walked down Second Avenue, turned the corner, and saw the white car which Jesus had been driving, Jose standing next to it and appellant Torres in it. Jose said he would complete the sale on this occasion but future dealings were to be with Jesus. Guzman went back to his own car where Ortiz and his wife, Lillian, were waiting. Guzman was told to drive with Lillian to 100th Street and First Avenue, and he did so followed by the white car containing Jesus and Torres. There Torres got into Guzman’s car and told him to drive back to 120th Street and First Avenue where Torres said he would pick up the “package” or the “material.” Because the heroin was a large amount, it was explained, the “connection” had to protect himself and Jesus would follow them to make sure the police were not behind.

At 120th Street and First Avenue, Lillian and Torres left Guzman’s car, Torres saying he would bring the “package.” Lillian returned shortly and drove with Guzman to 96th Street and Second Avenue, Torres and the others trailing in the white car. Guzman parked. Torres again appeared to say he was going to bring the package; Torres and Lillian left and after a half-hour wait no one appeared. The sale was not completed.

Eight days later Guzman tried again to negotiate a sale with Jesus after motioning him from the white ear in which he and Torres were sitting in front of the club at 2353 Second Avenue. In Torres’ hearing Jesus Sanjurjo negotiated for Guzman’s purchase for an ounce of heroin. When Guzman returned that evening as directed no one appeared, so that the third sale was likewise not completed. Guzman’s and the others’ maneuvers had been under surveillance at all material times.

On the question of sufficiency, appellant argues that the “single act” of Torres agreeing to deliver the February 14 heroin was insufficient to draw him into the broader conspiracy to violate the narcotics laws that was charged. He relies upon a line of cases in this circuit exemplified by United States v. DeNoia, 451 F.2d 979, 981 (2d Cir. 1971); United States v. Aviles, 274 F.2d 179, 190 (2d Cir.), cert. denied, 362 U.S. 974, 80 S.Ct. 1057, 4 L.Ed.2d 1010 (1960); United States v. Stromberg, 268 F.2d 256, 267 (2d Cir.), cert. denied, 361 U.S. 863, 80 S.Ct. 119, 4 L.Ed.2d 102 (1959), and United States v. Reina, 242 F.2d 302, 306 (2d Cir.), cert. denied, 354 U.S. 913, 77 S.Ct. 1294, 1 L.Ed.2d 1427 (1957). These cases all involve large, multiparty conspiracies. Their teaching is that absent proof of knowledge of the broader conspiracy, a single act such as delivery of the drugs (DeNoia; Stromberg) or actual sale (Reina) or purchase (Aviles) is insufficient evidence from which to draw an inference that a defendant knew about or acquiesced in the larger conspiracy.

Appellant’s line of cases, however, recognizes that a single act may be “sufficient for an inference” that a given defendant “was involved in a criminal enterprise of substantial scope, which was likely to involve other persons.” United States v. DeNoia, 451 F.2d at 981. Where the “single act” is such as to justify an inference of knowledge of the broader conspiracy, that is sufficient. See, e. g., United States v. D’Amato, 493 F.2d 359, 365 (2d Cir.), petition for cert. filed, 43 U.S.L.W. 3002 (U.S. Apr. 11, 1974) (No. 73-1527); United States v. Barrera, 486 F.2d 333, 337 (2d Cir. 1973), cert. denied, 416 U. S. 940, 94 S.Ct. 1944, 40 L.Ed.2d 291; United States v. Pui Kan Lam, 483 F.2d 1202, 1207-1208 (2d Cir. 1973), cert. denied, 415 U.S. 984, 94 S.Ct. 1578, 39 L.Ed.2d 881 (U.S. Mar. 19, 1974) (No. 73-5714); United States v. Calabro, 449 F.2d 885, 892 (2d Cir. 1971), cert. denied, 404 U.S. 1047, 92 S.Ct. 728, 30 L.Ed.2d 801, 405 U.S. 928, 92 S.Ct. 978, 30 L.Ed.2d 801 (1972). See also United States v. Terrell, 474 F.2d 872, 875-876 (2d Cir. 1973).

The “single act” or single transaction in each of the appellant’s cases was only a minor phase of a large, multiparty ring conspiracy. See, e. g., United States v. Aviles, 274 F.2d at 182-188. Here the alleged conspiracy itself was much less broad, involving only four known parties, one transaction and two attempted sales occurring in a three month period. In a conspiracy of small scope, such as this one, the evidentiary value of a “single act” in inferring knowledge, particularly when, as here, the “act” included statements by the defendant indicating his knowledge of the conspiracy and the “act” was one in which all the coconspirators were involved, is correspondingly greater than it would be in a broad conspiracy: the single act or transaction forms a larger proportion of the entire scheme. Thus, to speak of a “single act” is misleading; rather it is the qualitative nature of the act or acts constituting the single transaction (purchase, delivery, or the like) viewed in the context of the entire conspiracy which will determine whether an inference can be drawn as to the actor’s knowledge of the scope of the conspiracy. Indeed, Aviles recognized this when then Chief Judge Lumbard speaking for the court said, “Thus, when two men join together to commit a single robbery, one may infer from their common participation in the robbery that they have conspired to commit the robbery.” 274 F.2d at 189. Thus conduct consisting only of involvement in a single transaction , may nevertheless be treated as rationally permitting the inference of knowledge of the broader conspiracy where the single act itself shows so much familiarity with or high-level participation in the overall conspiracy as to be in and of itself indicative of the broader conspiracy. See United States v. Aviles, 274 F.2d at 190; United States v. Agueci, 310 F.2d 817, 836 (2d Cir. 1962), cert. denied, 372 U.S. 959, 83 S.Ct. 1013, 10 L.Ed.2d 11 (1963).

Appellant Torres was intimately connected with the February 14 transaction and besides participating in it until it aborted, was in Jesus Sanjurjo’s car when Guzman approached it to speak with Jose about dealing with Jesus in the future. Torres rode in Guzman’s car and told him to drive back to the initial meeting spot at 120th Street and First Avenue where Torres said he would pick up the “package” of heroin. He was in the car when either he or Lillian explained that the “connection” must be protected. Torres trailed Lillian and Guzman on their final trip down Second Avenue. Beyond this, Torres was in the white ear at 2353 Second Avenue when he heard Jesus negotiate with Guzman for the purchase of an ounce of heroin on February 22.

Of course, mere presence at a site where a narcotics sale is planned but not consummated is insufficient to support a conspiracy conviction where there is no evidence that the purpose of the meeting is known to the alleged conspirator. See United States v. Cirillo, 499 F.2d 872 (2d Cir. 1974). Here, however, there was actual knowledge on the part of the appellant that a heroin sale was about to take place. In the scope of the Sanjurjo-Ortiz operation, Torres was willingly taking a leading role in the attempted completion of the February 14 transaction. We therefore think the evidence was sufficient.

We reverse the conviction, however, as a result of the cumulative effect of three errors. The Government called as a witness Hector Ortiz, a codefendant who pleaded guilty and was awaiting sentence. Prior to his being called before the jury, a hearing was conducted in the presence of the judge, as suggested in United States v. Sanchez, 459 F.2d 100, 103 (2d Cir.), cert. denied, 409 U.S. 864, 93 S.Ct. 156, 34 L.Ed.2d 112 (1972). The Court ruled that he could be called as a witness and treated by the Government as hostile. He was so called and testified as to his involvement with Jose Sanjurjo and Jesus Sanjurjo in the heroin transactions of January 18 and February 14, 1972, but denied knowing who was going to deliver the heroin on-' February 14. He testified first that he did not know Torres and later that he knew him only by sight. He denied stating to federal agents during the previous week that Torres was supposed to make the February 14 delivery and that Torres was employed by Jose Sanjurjo as a narcotics courier between New York and Puerto Rico. The Government then called Assistant United States Attorney Robert Hemley, who had been sitting at the Government counsel table. Hemley testified that he had seen Ortiz and Torres shake hands, embrace and converse for five minutes the previous day. In summation the Government argued that Hemley’s testimony showed that Ortiz was lying to protect Torres- and did not want to tell the jury that his friend Wilson Torres “was the guy who sold heroin.” Error lay in asking Ortiz if he had said that Torres was a narcotics courier, in using Assistant United States Attorney Hemley as a • witness and in characterizing Torres as the “guy who sold heroin” in summation.

The question as to whether or not Ortiz had said that Torres was a narcotics courier for Jose between New York and Puerto Rico was itself improper. Without more, it could not have been used at trial as affirmative evidence to prove that Torres was a participant in the conspiracy at issue. Acting as a courier was not one of the overt acts alleged in the indictment. Evidence that Torres had been a courier in the past would not be admissible to prove that Torres was the courier in February. 1 J. Wigmore, Evidence § 192 (3d ed. 1940). Even if it were, there was no foundation to show that Ortiz had firsthand knowledge rather than hearsay information of that fact. An improper question is not made proper by virtue of being asked on cross-examination. 3A J. Wigmore, supra, § 1020. This court said in United States v. Cunningham, 446 F.2d 194, 197 (2d Cir.), cert. denied, 404 U.S. 950, 92 S.Ct. 302, 30 L.Ed.2d 266 (1971), quoting from Kuhn v. United States, 24 F.2d 910, 913 (9th Cir.), modified on other grounds on rehearing, 26 F.2d 463, cert. denied, 278 U.S. 605, 49 S.Ct. 11, 73 L.Ed. 533 (1928), “[t]he maximum legitimate effect of the impeaching testimony can never be more than the cancellation of the adverse answer by which the party is surprised .” The question here went beyond cancelling the adverse answer as to whether Torres was to deliver the heroin. It had all the prejudicial effect from which the rule against introducing evidence of prior bad acts was designed to protect. 1 J. Wigmore, supra, § 192.

Secondly, it was erroneous to permit Hemley to testify as to the courtroom encounter between Ortiz and Torres. No foundation had been laid for this impeachment because Ortiz had never been questioned about this incident. There was no showing that any of the other people who were in the courtroom at the time Ortiz and Torres allegedly conversed, such as marshals, court clerks, court reporters or interpreters, were unavailable to testify. See United States v. Alu, 246 F.2d 29, 33-34 (2d Cir. 1957). A Government prosecutor should not take the stand to impeach the testimony of Government witnesses unless it is unavoidably necessary. United States v. Pepe, 247 F.2d 838 (2d Cir. 1957). Sitting at the counsel table constitutes sufficient participation in the trial as to permit the calling of the prosecutor only if and when a proper foundation has been laid for impeachment and all other sources of possible testimony have been exhausted. The rule as stated by Alu is that “lawyers representing litigants should not be called as witnesses in trials involving those litigants if such testimony can be avoided consonant with the end of obtaining justice.” 246 F.2d at 33. See also United States v. Mullings, 364 F.2d 173, 175 n. 1 (2d Cir. 1966). The court below was well aware of the problems that the Government was engendering for itself and indicated that it was up to the Government to determine whether it wished to take the risk of infecting the record with error. The Assistant United States Attorney in charge replied, “I take it we will go forward and the Government will assume the risk.”

The prosecutor compounded the errors above by arguing from Hemley’s testimony that Ortiz did not want to tell the jury that Torres “was the guy who sold heroin.” In so doing the prosecutor created an implication that the impeachment testimony was affirmative evidence despite the judge’s prior limiting instruction. In fact, there was no direct evidence that Torres had ever sold narcotics. Defense counsel specifically objected to the prosecutor’s remarks as “violently unfair” and, after the summation, moved for a mistrial based on the prosecutor’s misstatements of record in summation, specifying the prosecutor’s “attempt to have the jury draw the opposite conclusions from what Mr. Ortiz testified to. • . . .”

There was thus error in the form of the question asked, in calling Hemley as a witness, and in the prosecutor’s comments on both. Cumulatively, these errors were certainly not harmless. The trial was a short one and would have turned almost entirely on the credibility of Guzman’s testimony were it not for the errors committed as we have recounted. They therefore demand a new trial.

Complaint is also made on appeal that appellant’s counsel was limited in his cross-examination of Guzman. On cross-examination of Guzman it was established that inculpatory conversations Guzman claimed he had with Torres or in his presence were neither in his report of investigation made two days after February 14 nor mentioned in his testimony at a prior trial of codefendant Jesus Sanjurjo. The conversations in question included the response to his complaint to Torres and Lillian Ortiz that he was annoyed over driving up and down between 100th Street and 120th Street to pick up the February 14 heroin since he was fearful of “getting burned” or that his car was going to get “burned.” Guzman testified at Torres’ trial that either Lillian or Torres replied that “The connection had to take care of himself because this was no little package.” On redirect the prosecutor asked Guzman whether he had been asked at the trial of Jesus Sanjurjo about the conversation with Torres, and he replied that he had not, and that he had testified to conversations with Jesus Sanjur-jo at Jesus’ trial which conversations he had not recounted in detail at the trial below. In fact, the transcript of the Jesus Sanjurjo trial shows that agent Guzman testified in detail regarding the events of February 14, 1972, and those details were the very same, and included the same conversations, that he had testified to at the Torres trial with the exception of the single “burning” conversation with Torres (or in his presence). Thus the implication of Guzman’s testimony that there were other conversations with Jesus Sanjurjo not testified to at the Torres trial was not wholly accurate. When defense counsel attempted to ask clarifying questions and offered in evidence the Sanjurjo trial transcript, Government counsel objected and the evidence was not received. Where the testimony of the Government agent as here is the main evidence on which the Government relies, we think the limitation of cross-examination — while discretionary with the court in the case of repetition, of course — was unwise, even if not necessarily reversible error. The prior transcript would have established the inaccuracy of Guzman’s testimony about the existence of other conversations with Jesus Sanjurjo, and this in turn could have tended to discredit further the prosecution’s main witness.

We find no error whatsoever in the prosecutor’s saying, “I submit that Guzman’s testimony was wholly credible. There is no reason in the world why you should disregard his testimony.” This was by no means a case of the prosecutor’s personally vouching for Guzman’s credibility.

Judgment reversed and remanded for a new trial.

      . Appellant was sentenced to one year’s imprisonment on May 17, 1974, following a three-day trial before District Judge Wyatt and a jury.

      . Although the transactions with which Torres was involved were mere attempts, a conspiracy is punishable even if unsuccessful. United States v. Rabinowich, 238 U.S. 78, 86, 35 S.Ct. 682, 59 L.Ed. 1211 (1915); United States v. Abel, 258 F.2d 485, 489 (2d Cir. 1958), aff’d, 362 U.S. 217, 80 S.Ct. 683, 4 L.Ed.2d 668 (1960). In any event the January sale and February transactions tend to show the existence of a continuing narcotics operation at or near 2353 Second Avenue. While Torres was not shown-to have been connected with the January sale,
      [t]he rule is clear that one who joins an existing conspiracy takes it as it is, and is therefore accountable for the prior conduct of co-conspirators.

        United States v. Sansone, 231 F.2d 887, 893 (2d Cir.), cert. denied, 351 U.S. 987, 76 S.Ct. 1055, 100 D.Ed. 1500 (1956). The jury may be taken to have found that Torres had joined an already established conspiracy.

      . Concededly, hearsay from a coeonspirator might, however, be admissible once Torres were shown to be a member of the conspiracy. United States v. D’Amato, 493 F.2d 359 (2d Cir.), petition for cert. filed, 43 U. S.L.W. 3002 (U.S. Apr. 11, 1974) (No. 73-1527).

      . It would make no difference if Ortiz had affirmed his supposed prior statements or if indeed the statements referred to in the question had actually been introduced into evidence (unless of course they related to Torres’ direct participation in this conspiracy). The prior statement was as to Torres’ having at some time been a courier, not as to whether he was to deliver the heroin in the February 14 transaction (or any other in the scope of this conspiracy). Thus, the specific instruction given by the trial court to the effect that any prior statement made by Ortiz after his arrest could not be considered as affirmative evidence against Torres, while helpful, did not go far enough; the question, which was objected to, should have been excluded.


author: PELL, Circuit Judge.

text:
    UNITED STATES of America, Plaintiff-Appellee, v. Isaiah Louis TWEED, a/k/a Isaiah Lewis Tweed, Defendant-Appellant.
    No. 73-1131.
    United States Court of Appeals, Seventh Circuit.
    Argued April 16, 1974.
    Decided Sept. 23, 1974.
    As Amended Oct. 21, 1974.
    Rehearing Denied Nov. 27, 1974.

      Robert F. Godfrey, E. St. Louis, 111., for defendant-appellant.
    Henry A. Schwarz, U.S. Atty., and Frederick J. Hess, Asst. U.S. Atty., E. St. Louis, 111., for plaintiff-appellee.
    Before FAIRCHILD, PELL and STEVENS, Circuit Judges.
   PELL, Circuit Judge.

Defendant-Appellant Isaiah Tweed appeals from a judgment of conviction following a verdict of guilty on two counts of an indictment for possession of destructive devices in violation of 26 U.S. C. §§ 5861(c), 5861(d), and 5871. Tweed raises a number of issues on appeal, the most significant ones being: (1) whether the district court erred in its examination and exclusion of certain veniremen; and (2) whether the district court erred in permitting the Government to introduce certain evidence in rebuttal.

I

Approximately four months prior to the trial in the present case, Tweed was tried and acquitted by a jury for possession of a sawed-off shotgun. The two Counts of the firearms trial involved a later incident than that involved in the present trial and had been severed from the remaining counts of the present trial indictment. At the voir dire in the present case, defense counsel asked that three prospective jurors be removed for cause: one had served on the jury in the prior trial and two had been on the jury panel, although not the actual jury, in the prior trial. After examining these three persons, the district court removed for cause the venireman who had actually served on the previous jury, but refused to remove for cause the two veniremen who had been in the prior jury panel. Tweed contends that the district judge erred in failing to exclude for cause these two veniremen.

The two veniremen in question, however, did not actually serve on the jury in the present case being removed apparently by means of peremptory challenges. The defendant has made no showing that the use of these peremptory challenges in any way prejudiced Kis case. In this situation no error arose from the district court’s refusal to exclude these veniremen for cause. Cf. Jordan v. United States, 295 F.2d 355, 356 (10th Cir. 1961), cert. denied, 368 U.S. 975, 82 S.Ct. 479, 7 L.Ed.2d 438 (1962).

Tweed also contends that the district judge committed error in asking the entire jury panel:

“Have any of you, those of you who served here in June and July, were you on any trial involving this defendant?”

The defendant argues that this question informed the entire jury panel in the present case that Tweed had been tried earlier in a criminal matter and permitted the panel to infer that Tweed was disposed to commit crimes.

The defendant has read too much into the district judge’s question. The question does not indicate that the earlier action was a criminal trial. In the question immediately preceding this one, the trial judge had asked, in fact, about whether any panel members had served previously on either criminal or civil juries. Moreover, the district judge’s question only indicated that Tweed had been “involved” in a prior action. From this question, the veniremen could not have known whether Tweed was a plaintiff, a defendant, or a witness in the earlier trial. We conclude that the district judge’s question does not require reversal.

Tweed further complains of the district court’s refusal to engage in further interrogation of the three jurors in question. We are satisfied that the judge sufficiently brought out their connection with the panel and their connection or lack of connection with the earlier trial. In any event, as stated before, none of the three served on the jury in the present case.

We find no merit in the contention that the entire panel should have been excused. Tweed relies on Mottram v. Murch, 458 F.2d 626 (1st Cir. 1972), and United States v. Leonard, 378 U.S. 544, 84 S.Ct. 1696, 12 L.Ed.2d 1028 (1964). In Mottram, four jurors were permitted to sit on both trials and in Leonard a jury was selected from a panel which had heard the pronouncement of a guilty verdict in the prosecution of the same defendant for a similar crime. Over and above the fact that in the present situation the defendant had been found not guilty by the prior jury of an offense arising out of the later transaction, the factual situations of the cited eases are otherwise so far removed from the present case as to make them inapplicable as authority.

No prejudice to Tweed’s right to a fair trial has been demonstrated by the district court’s manner of handling the impaneling of the jury and consequently we find no ground for reversal.

II

Tweed next argues that the district court erred in allowing the Government to introduce evidence in rebuttal for the purpose of impeaching the defendant after this evidence had been suppressed by the court due to an unlawful search and seizure. We find that this evidence was properly admitted under Walder v. United States, 347 U.S. 62, 74 S.Ct. 354, 98 L.Ed. 503 (1954), and Harris v. New York, 401 U.S. 222, 91 S.Ct. 643, 28 L.Ed.2d 1 (1971).

In Walder, a defendant charged with possession of narcotics testified on both direct and cross examination that he had never sold, possessed, or handled narcotics. The Supreme Court held that, under these circumstances, the Government was properly permitted to present, in rebuttal, evidence of a heroin capsule, which had been unlawfully seized from the defendant’s home two years earlier. The trial judge had charged the jury that this evidence was admitted solely for the purpose of impeaching the defendant’s credibility.

In Harris, the defendant had made a statement which was inadmissible under Miranda v. Arizona, 384 U.S. 436, 86 S.Ct. 1602, 16 L.Ed.2d 694 (1966). The defendant in Harris took the stand and made statements on direct examination which contrasted sharply with the prior inadmissible statement. The Supreme Court held that, in this situation, the Government could use the defendant’s prior statement to impeach the defendant’s testimony on direct where the trial judge instructed the juyy that the statement attributed to the defendant could be considered only in passing on his credibility. The Court noted that, “[h]aving voluntarily taken the stand, petitioner was under an obligation to speak truthfully and accurately, and the prosecution here did no more than utilize the traditional truth-testing devices of the adversary process.” 401 U.S. at 225, 91 S.Ct. at 645.

The Court in Harris noted that in Walder the defendant had been impeached as to collateral matters whereas Harris was impeached as to testimony bearing more directly on the crimes charged. The Court stated, however, that “[w]e are not persuaded that there is a difference in principle that warrants a result different from that reached by the Court in Walder.” 401 U.S. at 225, 91 S.Ct. at 645.

In the present case, the evidence in question was clothing worn by Tweed on the night that the offense occurred. On direct examination, Tweed testified that he did not possess dynamite on the date of the offense. Following up the denial of possession, questions were put to Tweed on cross examination as to whether during the evening in question he had carried, transported or handled explosives. He denied the nexus. In rebuttal, the Government was permitted to introduce testimony and exhibits which indicated that Tweed’s clothing contained traces of certain chemicals found in ammonia dynamite. Before permitting the introduction of this evidence, the district court admonished the jury that the evidence could only be considered in passing on Tweed’s credibility and that it could not be considered as evidence of guilt. Under these circumstances, the evidence was admissible for the purpose as limited by the court’s admonition under Walder and Harris.

Tweed contends, however, that Harris is inapplicable because the Government’s evidence did not impeach the defendant’s testimony on direct examination. Tweed stated on direct examination, the defense notes, that he did not possess dynamite, but Tweed was not questioned about whether he possessed certain chemicals. The Government’s rebuttal testimony, it is argued, only indicated the presence of certain chemicals and, therefore, did not impeach Tweed’s testimony.

This contention is without merit. The Government’s rebuttal witness, a forensic chemist, identified the various chemicals found on the clothing and stated that these chemicals were particles of ammonia dynamite. On cross examination, the chemist stated that dynamite was the only substance he knew of which contained all of the ingredients which were found on the clothing. The fact that the Government’s evidence was circumstantial in nature does not render it inadmissible as impeaching evidence.

Ill

Just as impeaching evidence may be circumstantial in character so may convicting evidence be. Tweed argues that his motion for acquittal should have been granted and it is true that no one saw him place or set off a bomb in the kitchen of a residence recently occupied by people he had threatened to kill just a few hours earlier. The Government carefully built an overpowering case of circumstantial evidence showing guilt of the charges on which Tweed was convicted. Viewing, as we must, this evidence in the light most favorable to the Government, it was more than sufficient to support the verdict.

We find no merit in Tweed’s other contentions including the claim,of bias on the part of the trial judge. ■

Accordingly, the judgment of conviction is

Affirmed.


author: EUGENE A. WRIGHT, Circuit Judge:

text:
    Dave VAN HOOMISSEN, Plaintiff, Equal Employment Opportunity Commission, Plaintiff-Intervenor-Appellant, v. XEROX CORPORATION et al., Defendants-Appellees.
    No. 74-1037.
    United States Court of Appeals, Ninth Circuit.
    Sept. 13, 1974.
    Rehearing En Banc Denied Nov. 6, 1974.
    See also, D.C., 368 F.Supp. 829.

      Carlos G. Ynostroza, E. E. O. C., San Francisco, Cal.,- Beatrice Rosenberg, Charles L. Reischel, James P. Scanlan, Washington, D. C., for plaintiff-inter-venor-appellant.
    Richard Haas of Brobeck, Phleger & Harrison, San Francisco, Cal., for defendants-appellees.
    Before DUNIWAY, WRIGHT and CHOY, Circuit Judges.
   SUPPLEMENTAL OPINION

EUGENE A. WRIGHT, Circuit Judge:

Van Hoomissen sued Xerox, his former employer, under Title VII of the Civil Rights Act of 1964 [42 U.S.C. § 2000e-2(a)], alleging that Xerox fired him and engaged in other acts of retaliation because of his efforts to recruit minorities. The Equal Opportunity Commission sought leave to intervene under 42 U.S.C. § 2000e-5(f)(1) and Fed.R.Civ.P. 24(b). In its proposed complaint in intervention, EEOC alleged that Xerox both engaged in discriminatory hiring practices and had unlawfully retaliated against Van Hoomissen. The district court granted EEOC leave to intervene, limited to the issue of retaliation, EEOC appealed, claiming that it should have been permitted to challenge Xerox’s alleged discriminatory hiring practices in its complaint in intervention. We dismissed the appeal in Van Hoomissen v. Xerox Corp., 497 F.2d 180 (9th Cir. 1974).

Xerox now petitions this court, pursuant to § 706(k) of the Act [42 U.S.C. § 2000e-5(k)], for an award of attorney’s fees as part of its costs on appeal. Section 706(k) provides:

In any action or proceeding under this subehapter the court, in its discretion, may allow the prevailing party, other than the Commission or the United States, a reasonable attorney’s fee as part of the costs, and the Commission and the United States shall be liable for costs the same as a private person.

On its face, this section authorizes an award of attorney’s fees against the Commission. The word “costs” is used twice. In its first occurrence, it is clear that it includes attorney’s fees, since the latter is explicitly denominated “a part of the costs.” In the second reference, “costs” are assessable against the Commission. Unless the meaning of “costs” changes during the eleven words which separate its two usages, it is clear that attorney’s fees can be assessed against the Commission.

The Commission makes an ingenious and indeed persuasive argument, based on the legislative history of the section, that Congress did not intend the second occurrence of “costs” to include attorney’s fees even though it did intend attorney’s fees be included in the first provision for “costs.” The Commission starts with the generally accepted premise that the government is exempt from liability for costs and attorney’s fees except as specifically and unequivocally authorized by Congress. See United States v. Chemical Foundation, 272 U.S. 1, 20, 47 S.Ct. 1, 71 L.Ed. 131 (1926); Georg Jensen, Inc. v. United States, 185 F.Supp. 251, 253 (S.D.N.Y.1960); Aycrigg v. United States, 124 F.Supp. 416, 417-418 (N.D.Cal.1954); 28 U.S.C. § 2412 (1970); 28 U.S.C. § 2412(a) (1964). The Commission also points out that the term “costs” has a well defined technical meaning that does not normally include attorney’s fees. See, e. g., 28 U.S.C. §§ 1920, 1923; Twentieth Century Fox Film Corp. v. Goldwyn, 328 F.2d 190, 222-224 (9th Cir. 1964). Thus, the Commission would have us decline to deviate from this technical meaning in the interpretation of the second reference to “costs” since attorney’s fees are not specifically and explicitly included.

The legislative history of Section 706 (k) supports the Commission’s contention that Congress did not necessarily intend “costs” to have the same meaning each time it was used. Without belaboring the analysis, the legislative history indicates that the portion of Section 706(k) dealing with attorney’s fees was added after the portion authorizing' “costs” against the government had been drafted. See 110 Cong.Rec. 12819 (1964). Thus, it can be persuasively-argued that the drafters of the provision dealing with “costs” assessed against the Commission were referring ,to the normal meaning of “costs,” not to the special meaning of “costs” including attorney’s fees that was later used when the provision dealing with attorney’s fees was added. The argument is strengthened by the fact that the Commission cannot recover attorney’s fees: Congress might not, therefore, have intended the Commission to be liable for such fees.

As useful as legislative history is as an aid to statutory construction, however, it should not be used to torture the plain meaning of the words of the statute as finally enacted. Whatever the subjective intent of the drafters, which is far from clear, we are not persuaded that under these circumstances proper statutory construction calls for a change in the meaning of a technical word over the bare space of eleven intervening words. As Justice Frankfurter stated in Greenwood v. United States, 350 U.S. 366, 374, 76 S.Ct. 410, 415, 190 L.Ed. 412 (1956):

[T]his is a case for applying the canon of construction of the wag who said, when the legislative history is doubtful, go to the statute.

We conclude that the plain meaning of Section 706 (k) authorizes an award of attorney’s fees against the Commission. See United States v. Jacksonville Terminal Co., 316 F.Supp. 567, 623 (M.D.Fla. 1970), rev’d on other grounds, 451 F.2d 418 (5th Cir. 1971), cert. denied 406 U.S. 906, 92 S.Ct. 1607, 31 L.Ed.2d 815 (1972).

Having concluded that we have the power under § 706 (k) to assess attorney’s fees against the Commission, we must decide whether to exercise our discretion to do so. The Commission argues that the attorney’s fees provision of § 706 (k) was designed to encourage private enforcement of the Act and to remove financial obstacles from the path of private litigants of limited means who could not otherwise afford to pursue their rights. See 110 Cong.Rec. 12724 (1964) (remarks of Sen. Humphrey). Although this is a factor to consider in exercising our discretion, we do not conclude that Xerox’s ability to pay its own way is necessarily a bar to an award in its favor.

The Commission also argues that Section 706 (k) authorizes an award only to the “prevailing party.” Although Xerox “prevailed” on this interlocutory appeal, it might still lose the principal case and thus not “prevail.” We agree that litigation should not be dissected to the point that the losing party be permitted to recover attorney’s fees connected with every procedural motion on which it prevails. But this interlocutory appeal is sufficiently significant and discrete to be treated as a separate unit. Thus, the fact that Xerox prevailed on this appeal qualifies it as a “prevailing party” eligible for an award of attorney’s fees connected with the appeal.

Having considered all the circumstances of the case, we exercise our discretion and award Xerox an attorney’s fee of $3,000.