§ 6.1.1.6

• Jurisdiction: Arizona

§ 6.1.1.6 Inducement Liability

Until 1951, Arizona did not have a securities statute that expressly provided for civil liability, much less a statute that provided for civil liability on the basis of inducement.¹⁷⁴⁵ As part of the 1951 Securities Act, the legislature enacted a general antifraud statute in § 44-1991; created a voidability remedy in § 44-2001 for violations of the antifraud statute; and enacted a statute extending liability beyond sellers to all persons who make, participate in or induce an unlawful sale in § 44-2003. Some parts of these statutes had counterparts in other state's securities statutes.¹⁷⁴⁶ Likewise, some aspects of the 1951 Act's civil-liability provisions parallel § 12(a)(2) of the 1933 Securities Act.¹⁷⁴⁷ But the participate-or-induce standard that the 1951 Act introduced through § 44-2003 has no counterpart under federal securities law.¹⁷⁴⁸ Nor is the participate-or-induce standard used in the civil-liability statutes of any other state.¹⁷⁴⁹

On the other hand, Arizona's 1921 Securities-Dealer Act included a statute that imposed criminal liability on any person who fraudulently "influence[d]" another person to purchase a security.¹⁷⁵⁰ Common-law decisions in other states held nonsellers liable for inducing misleading securities sales.¹⁷⁵¹ Arizona case law also supported this result.¹⁷⁵² But civil liability based on a statutory-inducement standard is rare.¹⁷⁵³ From the earliest blue-sky statutes forward, the statutory standard has almost always been participation, aiding, or similar language.¹⁷⁵⁴

The pre-1996 decisions that address § 44-2003 are collected above.¹⁷⁵⁵ Of these, two were decided on the basis of inducement.¹⁷⁵⁶ Two others were decided on the basis of participation.¹⁷⁵⁷ None of the pre-1996 cases made a distinction between inducement and participation. One case affirmed a defendants' liability on the basis that he had both participated in and induced the sale.¹⁷⁵⁸ Another reasoned that either inducement or participation could be found on the facts.¹⁷⁵⁹

It was not until the 1996 Standard Chartered decision that inducement and participation were separately defined.¹⁷⁶⁰ And even then the court did not suggest that participation might not be broad enough to cover some conduct that amounted to inducement.¹⁷⁶¹ To the contrary, the unusually narrow interpretation of inducement that Standard Chartered settled on—persuading or prevailing upon the plaintiff to buy the security—could easily be viewed as the kind of purposeful involvement in the sale that many courts would conclude amounts to participation.¹⁷⁶²

As it did with "participate," Standard Charteredadopted a restrictive reading of "induce." "Induce" can reasonably be read to impose liability on anyone who provides misleading information that influences the purchaser or seller of a security. The dictionary that Standard Chartered cited supported this interpretation.¹⁷⁶³ Other authority also did. For example, Arizona's 1921 securities statute made it a crime for any person to use false statements or representations to influence another person to buy a security.¹⁷⁶⁴ Common-law cases typically held that acting with intent to influence a person to purchase a security was an appropriate basis for securities liability.¹⁷⁶⁵ Some provisions in the Restatement (Second) of Torts also articulate an intent to influence standard.¹⁷⁶⁶

Without discussing these authorities, Standard Charteredconcluded that merely making a misstatement that contributes to a purchaser or seller's investment decision is not enough to create liability.¹⁷⁶⁷ The court was concerned that basing inducement liability on an influence standard was calculated to ensnare professionals and collateral participants who are only "remotely" or "tangentially" involved.¹⁷⁶⁸ To avoid that, "induce" was read narrowly to require that the defendant actively "persuade" or "prevail" upon the plaintiff to make the transaction.¹⁷⁶⁹ Then to further confine inducement liability, the court quoted dictionary definitions of "persuade" and "prevail" that suggest that the inducer must succeed in persuading the plaintiff to buy or sell. To persuade was defined as: "Persuade may suggest a winning over by appeal, entreaty, or expostulation addressed as much to feelings as to reason . . . ."¹⁷⁷⁰ To prevail was defined as: "Prevail may be used in situations in which strong opposition or reluctance is overcome by sustained argument and entreaty."¹⁷⁷¹ Under these definitions, it is nearly impossible to prove that any defendant who did not have a one-on-one role in inducing the plaintiff's investment is an inducer.

For example, professionals and other nonsellers may play an active role in what turns out to be a fraud.¹⁷⁷² Yet an investor can hardly claim that these persons persuaded or prevailed upon him or her to make the purchase if the investor did not know they existed. The problem is illustrated by Barnes v. Vozack,¹⁷⁷³ a case in which three of four defendants had no direct dealings with the plaintiff and received none of the sale proceeds. Under Standard Chartered's definitions, it is unlikely these defendants could have been held liable. But the Arizona Supreme Court upheld a judgment for the plaintiff on the basis that "the three defendants indirectly fraudulently sold stock to [the plaintiff] contrary to A.R.S. § 44-1991."¹⁷⁷⁴

The limits that Standard Chartered's participate-or-induce definitions impose are also illustrated by fraud-on-the-market cases that involve publicly traded stocks like those that trade on the New York Stock Exchange and NASDAQ.¹⁷⁷⁵ The prices at which these shares trade are influenced by news reports, SEC filings, and other publicly reported information. False information that deceptively presents news on earnings, sales, acquisitions, and any number of other events can inflate the price of a company's stock and mislead investors about the stock's value.¹⁷⁷⁶ The insiders—corporate officers and directors—who are responsible for releasing the false information will typically be unknown to investors. Yet investors buy publicly traded stocks with the belief that the market is basically honest.¹⁷⁷⁷ They assume the integrity of the market.¹⁷⁷⁸ Few investors would be able to say that they buy stock from their broker because a CEO, CFO, or director of a public company prevailed upon them to buy the stock.¹⁷⁷⁹ Nor would a public investor be able to show that the officers or directors financially took part in a purchase made through a broker. In short, in the typical fraud-on-the-market case in which corporate insiders mislead the market by publicizing false information, a securities remedy against these insiders would not exist if Standard Chartered's participate-or-induce definitions were strictly applied. The courts have avoided such strict interpretations.¹⁷⁸⁰

In Grand II,¹⁷⁸¹ the Supreme Court addressed the meaning of inducement for the first time. As discussed earlier,¹⁷⁸² the Supreme Court held that not all forms of inducement are participation.¹⁷⁸³ The Court acknowledged, consistent with earlier case law, that inducement and participation may overlap.¹⁷⁸⁴ But it rejected the argument that the words are necessarily coterminous with one another¹⁷⁸⁵ and concluded that the facts alleged described inducement but not participation.¹⁷⁸⁶

The Court cited Standard Chartered in support of its definition of inducement.¹⁷⁸⁷ But the definition that the court fashioned was new. It had no forerunner in anything that Standard Chartered said. Instead, the inducement definition was a variation on the substantial assistance element of aiding and abetting that the Supreme Court articulated in the 2002 Wells Fargo decision.¹⁷⁸⁸

More specifically, the Supreme Court defined inducement to include acts and omissions that encourage investors to buy stock:

[W]e conclude that the conduct alleged in the third amended complaint does not describe participation in the illegal sales. Rather, that pleading alleges that, through their acts and omissions, the defendants encouraged the [plaintiff] to buy stock from others in the aftermarket.¹⁷⁸⁹

The Court described this as "classic inducement"¹⁷⁹⁰ and held that under this interpretation aftermarket purchasers have an effective remedy through inducement liability.¹⁷⁹¹

This description of inducement by encouragement is markedly different than the range of inducement liability that anyone might think possible if induce is limited to persuading or prevailing in the active sense of successful persuasion articulated in Standard Chartered. Encourage nowhere appears in Standard Chartered. It connotes less active conduct than persuade or prevail. A person may encourage a sale without being the one who actually succeeds in persuading the investor to make the purchase.¹⁷⁹²

Encourage also connotes conduct that is less purposely directed at the plaintiff than conduct that is designed to persuade or prevail upon the plaintiff. For example, Webster's New World Collegiate Dictionary defines encourage to include conduct that supports, fosters, or helps:

encourage . . . 1 to give courage, hope or confidence to, embolden; hearten; 2 to give support to; be favorable to; foster; help¹⁷⁹³

The Oxford English Dictionary includes in its definitions of encourage: to recommend; to advise; to abet; to promote or assist (an activity or situation).¹⁷⁹⁴ Black's Law Dictionary cross-references to aiding and abetting in its definition.¹⁷⁹⁵ These definitions of encouragement as conduct that fosters, helps, abets, promotes or assists an activity make it far easier to reach collateral actors who have little or no direct contact with the plaintiff but nevertheless, directly or indirectly, engage in fraud prohibited by § 44-1991(A).

A 2020 decision by the Arizona Corporation Commission illustrates this. In Performance Arbitrage Company, Inc.,¹⁷⁹⁶ the Commission's Securities Division filed an enforcement action against a law firm that acted as counsel for the issuer of "income-stream...