Let's Be Frank: The Future Direction of Controlling Person Liability Remains Uncertain

By Bednarz, Michael A. | Suffolk University Law Review, Spring 2013 | Go to article overview

Let's Be Frank: The Future Direction of Controlling Person Liability Remains Uncertain


Bednarz, Michael A., Suffolk University Law Review


"The explicit authority under Dodd-Frank to use control person liability under the Exchange Act may encourage further expansion of this theory of liability to attempt to cover those who are simply 'around' a violation or where a violation occurs within their chain of command." (1)

I. INTRODUCTION

In the wake of the Great Depression, Congress enacted the Securities Act of 1933 (1933 Act) and the Securities Exchange Act of 1934 (1934 Act). (2) Together, the Acts provide the Securities and Exchange Commission (SEC) with broad authority over the securities industry, and institute methods for holding those who commit securities fraud liable. (3) Section 15 of the 1933 Act and section 20(a) of the 1934 Act establish controlling person liability, a mechanism for establishing secondary liability against corporate directors and officers for securities fraud committed by their subordinates. (4) Section 15 of the 1933 Act merely permits controlling person liability to be pursued if very limited types of securities fraud have been committed. (5) As a result, pursuing a controlling person liability claim under section 20(a) of the 1934 Act has historically been both the SEC and private litigants' preferred course of action as it broadly allows for secondary liability to be attached to any underlying security claim within the Act. (6)

While drafting both Acts, Congress consciously refrained from defining the term "control" because it believed that courts could effectively apply the term depending on the given facts of a case. (7) Therefore, varying standards of controlling person liability have evolved throughout the judicial system, including within federal circuit and district courts. (8) Recently, in continuing efforts to protect investors, Congress has enacted a substantial piece of legislation that may help shed light on the inconsistent application of controlling person liability: the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). (9)

In recent history, circuit courts have been split as to whether the SEC has authority to utilize 1934 Act section 20(a) controlling person liability within its enforcement actions. (10) Section 929P(c) of Dodd-Frank addresses this issue, clarifying that the SEC has authority to bring actions founded on section 20(a) controlling person liability. (11) Nevertheless, the controlling person liability issue may remain at the forefront of securities litigation as the SEC seeks to hold corporate officers and directors secondarily liable under section 20(a). (12)

This Note examines Dodd-Frank's potential effect on the current state of the law regarding controlling person liability. (13) Part II.A provides a review of the legislative history of the 1933 and 1934 Acts and their respective controlling person liability sections. (14) Part II.B discusses the varying judicial interpretations and confusion surrounding sections 15 and 20(a) controlling person liability. (15) Part II.C discusses both the implementation of Dodd-Frank and prior inconsistent views as to whether the SEC has the power to bring controlling person liability actions pursuant to section 20(a). (16) Finally, Part III examines the two controlling person liability standards--culpable participation and potential control--and suggests which of the two the SEC would likely find more equitable. (17)

II. HISTORY

A. Statutory History of Controlling Person Liability

In response to the stock market crash of October 1929, Congress adopted the Securities Act of 1933 and the Securities Exchange Act of 1934.18 Although the two acts serve the same general purpose--to discourage fraud and provide investors with adequate information--they regulate different activities within the securities market. (19) The 1933 Act primarily concerns the initial distribution process of securities, requiring entities seeking to issue securities to provide specific information to potential purchasers and the SEC. …

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