§ 6.1.1.4

• Jurisdiction: Arizona

§ 6.1.1.4 Participant Liability

Under common-law rules in Arizona¹⁶³¹ and elsewhere,¹⁶³² an officer, director, or other agent who actively participates in a corporate tort like fraud is individually liable to those who are injured. Early on, case law in some states developed to allow securities purchasers to sue in a rescission action not only the seller but corporate officers who induced the purchase.¹⁶³³ Similarly, at least by implication, early Arizona case law allowed an action for rescission against the seller and joinder of corporate officers and directors in the same suit on a claim for damages based on the individual defendant's participation in the fraud.¹⁶³⁴ Thus, state securities laws that impose civil liability on corporate officers and agents who participate in their company's securities fraud are essentially declaratory of the common law.¹⁶³⁵

Like the common law, the early blue-sky statutes also provided for liability on the basis of participation.¹⁶³⁶ The first of these was a 1919 participant-liability statute enacted by Utah.¹⁶³⁷ Others soon followed¹⁶³⁸ and where the state's blue-sky statutes only provided criminal penalties, civil liability was implied from the criminal violation and extended to those who participated in the violation.¹⁶³⁹ Section 16(1) of the 1929 Uniform Sale of Securities Act, which provided for civil liability when a seller's director, officer, or agent participated or aided in making a fraudulent sale, is a leading example of this type of state statute.¹⁶⁴⁰

In 1987, Professor Douglas Abrams listed nearly twenty states with securities statutes that provided for some form of participant liability.¹⁶⁴¹ An earlier, 1948 study listed 28 states with securities laws that provided for civil liability.¹⁶⁴² The study described as representative of these statutes a 1927 North Carolina statute that provided for joint-and-several liability of the seller and every officer, director, and agent of the seller who "participated or aided in making in any way in making such sale."¹⁶⁴³ Participant liability continues to be a prevalent basis for secondary liability in modern state-securities statutes.¹⁶⁴⁴

Ohio¹⁶⁴⁵ and Oregon's¹⁶⁴⁶ statutes have produced considerable case law and are similar to § 44-2003(A)'s participant-liability formulation. Cases in those states have broadly interpreted their statutes.¹⁶⁴⁷ In Oregon, for example, participation does not require direct participation in the sale—the participation may result from participation in the fraudulent conduct that makes the sale unlawful.¹⁶⁴⁸

In Arizona, the Court of Appeals' 1996 decision in Standard Chartered¹⁶⁴⁹ was the first decision to define participation. The only other decision that said anything about what participation meant was Little v. First California Co., an unpublished 1977 district court decision.¹⁶⁵⁰Little held that statutory participation requires something more than participation in the undisputed financial transaction.¹⁶⁵¹Little suggested that the something more was direct or indirect participation in the fraud that violated § 44-1991.¹⁶⁵²

Standard Chartered arose out of a commercial transaction in which one bank was purchasing another bank. The defendant, Price Waterhouse, was an audit firm. The plaintiff was the purchaser of a bank that Price Waterhouse had audited. The audit that preceded the purchase overstated the bank's income by $27 million and failed to account for problem loans that negatively affected the bank's equity.¹⁶⁵³ The plaintiff relied upon the audit in buying the bank. The jury found that Price Waterhouse had committed securities fraud and assessed damages of $338 million.¹⁶⁵⁴ Before trial, the trial court granted partial summary judgment in the plaintiff's favor and held that Price Waterhouse had, as a matter of law, "participated in or induced" the lawful sale of securities on which the plaintiff's claims were based.¹⁶⁵⁵

On appeal, the Court of Appeals reversed the verdict on the securities-fraud claim with instructions that Price Waterhouse was entitled to judgment as a matter of law on that claim.¹⁶⁵⁶ In reaching this conclusion, the court undertook to define both "participate" and "induce."

The court began its analysis by acknowledging that an earlier Supreme Court decision, State v. Superior Court (Davis),¹⁶⁵⁷ "can be interpreted as extending participation-or-inducement liability under section 44-2003 to nonparties or non-agents who make untrue statements or material omissions while providing information about corporations whose securities are being sold, even though they take no active part in bringing about the transaction and receive no consideration from it."¹⁶⁵⁸ But the Standard Chartered panel distinguished Davis as having been decided on a motion to dismiss under circumstances where the court was not required to explicitly decide the meaning of "participate" or "induce."¹⁶⁵⁹ For that reason, the Court of Appeals concluded that Davis was not controlling and proceeded to define "participate" and "induce."

Other than the Davis decision, Standard Chartereddid not discuss any of the previous Arizona decisions that had found participation or inducement.¹⁶⁶⁰ Nor did the court acknowledge the legislature's directive to avoid narrow or restricted interpretations in favor of a broad remedial interpretation that protects the public.¹⁶⁶¹ And the opinion shows no awareness that just months before it was issued, the Arizona legislature amended several sections of the Securities Act to expressly recognize the existence of a private action under § 44-1991.¹⁶⁶²

The court began its analysis by quoting the definition of participate in Webster's Third New International Dictionary:

2a: to take part in something (as an enterprise or activity) usu. in common with others . . . b: to have a part or share in something. . . .¹⁶⁶³

It then referred to a 1985 Webster's dictionary that listed "partake" as a synonym for "participate."¹⁶⁶⁴ Using "partake" as the standard for participant liability, it concluded that Price Waterhouse "did not partake in the sale of United's [the bank's] stock to Union any more than it made the sale."¹⁶⁶⁵ Price Waterhouse had "no stake in the sale."¹⁶⁶⁶ It prepared its yearly audits for the bank as a matter of course and provided them to the plaintiff only because its client had asked it to do so.¹⁶⁶⁷ In these circumstances, the court held that the auditor did not "participate in" the sale for purposes of § 44-2003.¹⁶⁶⁸ In the court's view, participation under § 44-2003 was not intended to reach collateral actors "remote from the transaction" who do not financially participate in it.¹⁶⁶⁹ Merely providing false information that contributes to the investor's decision to invest is not enough for participant liability.¹⁶⁷⁰

Three subsequent district-court decisions involving public investors took a more expansive view of participation. The first (Allstate), a 2010 decision,¹⁶⁷¹ involved two law firms that had prepared the offering documents for a bond offering. Judge Snow distinguished Standard Chartered and held that the law firms "took part in" the bond sales.¹⁶⁷² "[U]nlike the auditor in Standard Chartered, who would have conducted an audit irrespective of the securities transaction, the law firms were hired for work that was not merely 'tangentially' related to the sale of a security or that otherwise would have performed if no sale had been in progress."¹⁶⁷³ To the contrary, the law firms "were retained for the sole purpose of preparing, drafting, and reviewing documents that were primarily designed to solicit purchasers for the Bonds."¹⁶⁷⁴ Under the facts, the court held that the plaintiffs had adequately pleaded statutory participation.¹⁶⁷⁵

The second decision (Facciola), a 2011 decision,¹⁶⁷⁶ involved the officers, directors, and insiders of two companies alleged to have joint ventured the sale of securities by an insolvent company. Three of the defendants (the Hirsch defendants) argued that they did not take part in the sales and had no dealings with the plaintiffs.¹⁶⁷⁷ The court found the argument irrelevant because "direct contact with the Defendants is not necessary to support allegations under Arizona's fraud statute."¹⁶⁷⁸ But aside from that, the court found that all three of the Hirsch defendants had participated in misleading sales presentations and in preparing misleading offering documents.¹⁶⁷⁹ Citing the "liberal construction to be given A.R.S. § 44-2003(A)," the court concluded that the complaint supported "claims that the Hirsch [d]efendants participated or induced the sale or purchase of securities."¹⁶⁸⁰ The court reached the same conclusion as to a second set of defendants (the Denning defendants) who had participated in preparing misleading private-offering memorandums used to make sales.¹⁶⁸¹

A third district-court decision, decided in 2012,¹⁶⁸² recited Standard Chartered's definitions but applied them broadly in denying a motion to dismiss. The defendants were corporate officers.¹⁶⁸³ They argued in a motion to dismiss that the plaintiff had not adequately pleaded that they "participated in or induced" the sale of securities.¹⁶⁸⁴ The district court first observed that complaints "need not ordinarily engage in an analysis of whether a person should be separately characterized as having participated in or induced the unlawful sale."¹⁶⁸⁵ The court then held that the plaintiff had stated claims under §§ 44-1991(A)(2) and 44-2003(A) by alleging that each defendant made a misrepresentation and either "encourage[d]" the plaintiff to invest or engaged in conduct that was "designed to persuade" the plaintiff to invest."¹⁶⁸⁶

In the 2010 Grand v. Nacchio decision (Grand II),¹⁶⁸⁷ the Arizona Supreme Court, for the first time, addressed the proper interpretation of § 44-2003(A). Unlike Standard Chartered, the Supreme Court began its statutory analysis by quoting from the 1951 statement of intent.¹⁶⁸⁸ It held that the legislature intended the Securities Act to be...