Academic journal article Journal of Corporation Law

Control Person Liability: A Repudiation of Culpable Participation

Academic journal article Journal of Corporation Law

Control Person Liability: A Repudiation of Culpable Participation

Article excerpt

I. INTRODUCTION

In recent years, the U.S. securities market has experienced economic collapse1 and an explosion of innovative fraudulent securities schemes.2 Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934 in an attempt to prevent such market abuses under similar market conditions.3 Specifically, Congress created control person liability for the leaders of firms that fail to prevent securities violations.4 Unfortunately, the evolution of control person jurisprudence that now sometimes requires plaintiffs to show that the control person culpably participated in the securities violation significantly undercuts this congressional effort.5

This Note argues that the precise definition of "control" should be leftopen to court interpretation to account for changes in the securities market but that this definition should not require culpable participation. Part II explores the need for and provides an overview of control person liability.6 In addition, Part II introduces the Private Securities Litigation Reform Act and highlights the varying circuit court treatment of the culpable participation standard.7 Part III analyzes the fundamentally divergent circuit court standards and highlights complications that the Private Securities Litigation Reform Act presents.8 Part IV identifies the underlying problem with the culpable participation standard and calls for Congress or the Supreme Court, in a proper case, to eliminate culpable participation altogether.9

II. BACKGROUND

The complexity of the securities market presents an opportunity for innovative fraudulent schemes, tempts the greed of those in a position to capitalize on market abuse, and creates a need for control person liability.10 Congress created control person liability in an attempt to prevent so called control persons from using straw persons and other subsidiaries as a shield from liability while perpetrating fraudulent schemes.11 Courts, however, are less than clear in interpreting the meaning of control person liability statutes.12 The introduction of the Private Securities Litigation Reform Act complicates the court's interpretation.13 Consequently, circuit courts are split in interpreting the meaning of control person liability.14 At issue is whether control person liability requires the control person's culpable participation in the underlying securities violation.15

A. Need for Control Person Liability

Amidst the public's perception of fraud and corruption in the securities markets leading to the financial ruin of the late 1920s, Congress created control person liability statutes.16 In section 15 of the Securities Act and section 20(a) of the Securities Exchange Act, Congress specifically intended to hold the leaders of companies and firms perpetrating fraud and abusing the market liable for their actions and the actions of their employees.17 The purpose of section 15 and section 20(a) is to "prevent people and entities from using straw parties, subsidiaries, or other agents acting on their behalf to accomplish ends that would be forbidden directly by the securities laws."18

Unfortunately, the abuses Congress designed the Securities Exchange Act of 1934 to prevent are still prevalent in today's markets. In 2008, amidst a global economic crisis,19 the FBI uncovered a fraudulent scheme of epic proportions that further exposed the vulnerability of the securities market to manipulation.20 Later that year, FBI agents arrested Bernard Madoff, the former chairman of the NASDAQ Stock Market and founder of the prominent Bernard L. MadoffInvestment Securities LLC, and charged him with perpetrating a Ponzi scheme that lost investors an estimated $50 billion.21 Although other securities fraud schemes may not be as bold as Madoff's or have global economic consequences, Ponzi schemes and other fraudulent practices are not isolated events in today's market.22

B. Overview of Control Person Liability

Congress created control person liability under section 20(a) as a form of secondary or derivative liability for violations of securities law. …

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