§ 6.1.2.5

• Jurisdiction: Arizona

§ 6.1.2.5 Controlling-Person Liability

Controlling-person liability is the cornerstone of secondary liability under the federal securities laws.¹⁹¹⁵ The 1933 and 1934 Acts establish a regime of liability, which encompasses liability for persons who control the direct perpetrators of fraudulent conduct.¹⁹¹⁶ Section 44-1999,¹⁹¹⁷ which was added to the Arizona Securities Act in 1996, embraces the federal concept of control liability through a controlling-person statute modeled on § 15 of the 1933 Act¹⁹¹⁸ and § 20(a) of the 1934 Act.¹⁹¹⁹

The controlling-person provisions reach persons who could not be held accountable under common-law rules. The separate-entity status of a corporation positions its officers and directors to claim that any securities violation is the act of the corporation rather than the act of those who formulated the corporation's conduct.¹⁹²⁰ Similarly, under traditional agency rules the securities violations of a corporation's agents would be imputed to the corporation as the principal of the agency relationship rather than to the company's officers or directors.¹⁹²¹ Through the concept of controlling-person liability, Congress created a mechanism for holding accountable those with the ability to control the securities violator.

Subsection (A) of § 44-1999 largely tracks the language of § 15 of the 1933 Act and imposes liability on persons who control violators of Arizona's counterparts of §§ 11 and 12 of the 1933 Act (i.e., §§ 44-1997 and 44-1998).¹⁹²² But a major difference exists between this part of the Arizona scheme of control liability and the federal scheme. Under the federal statutes, sales of unregistered securities are prohibited by § 12(a)(1) of the 1933 Act.¹⁹²³ In turn, § 15 imposes control liability for a violation of § 12(a)(1).¹⁹²⁴ Arizona's counterpart of § 12 is § 44-1998. Section 44-1998 covers misleading statements, but it omits language that would cover a registration violation.¹⁹²⁵

Subsection (B) of § 44-1999 follows § 20(a) of the 1934 Act and imposes liability on those who control violators of Arizona's counterpart of § 10(b) of the 1934 Act (i.e., § 44-1991(A)).¹⁹²⁶

To establish liability under the control-liability provisions, three things must be shown:

 the primary liability of the controlled person;¹⁹²⁷

? that the defendant had the legal power to control the primary violator;¹⁹²⁸ and

? the defendant's failure to satisfy the statute's defenses,¹⁹²⁹ i.e., lack of reasonable care as to subsection (A) and "good faith" and "non-inducement" as to subsection (B).¹⁹³⁰

In Eastern Vanguard, a 2003 decision, the Court of Appeals issued an opinion¹⁹³¹ addressing a variety of issues concerning the scope of control liability under § 44-1999(B)¾the subsection that imposes control liability for violations of § 44-1991(A). Some Ninth Circuit decisions suggest that control liability requires evidence that the control person actually participated in the primary violation.¹⁹³² The Court of Appeals rejected the "'actual participation' requirement as 'too restrictive to guard the public interest as directed by our state legislature.'"¹⁹³³ Instead, the court adopted a more remedial interpretation and held that a presumption of control exists when the defendant has "the power to directly or indirectly control the activities of those persons or entities liable as primary violators."¹⁹³⁴ Aided by this presumption, "the evidence need only show that the person targeted as a controlling person had the legal power, either individually or as part of a control group, to control the activities of the primary violator."¹⁹³⁵

A 2011 district-court decision held on the basis of Eastern Vanguard that "titles can be sufficient to allege control person liability."¹⁹³⁶ The district court reached this conclusion because under Eastern Vanguard control liability may be based on the "power to control" a wrongdoer without any showing that the control person participated in the wrongdoing.¹⁹³⁷

In denying a defendant's motion for summary judgment on control liability, a 2013 district-court decision cited the Arizona legislature's intent "that the Arizona Securities Act be liberally construed to effect its remedial purpose of protecting the public interest."¹⁹³⁸ The court recognized "the express legislative intent that § 44-1999(B) have broad coverage" and concluded that "if anything, the sweep of the Arizona Securities Act is broader than that of the federal securities regime."¹⁹³⁹

A control person may rebut the presumption of liability through evidence that he or she "acted in good faith and did not directly or indirectly induce the act underlying the action."¹⁹⁴⁰ Good faith and lack of inducement are separate elements that must be independently proved to establish the defense.¹⁹⁴¹ Good faith is not easily shown.¹⁹⁴² Lack of scienter is not enough.¹⁹⁴³ Thus, a good-faith belief that the defendant was not...