Control Person Liability in Colorado

• Publication year: 2004
• Pages: 43

33 Colo.Law. 43 Colorado Lawyer 2004.

2004, March, Pg. 43. Control Person Liability in Colorado

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43

Vol. 33, No. 3, Pg. 43

The Colorado Lawyer
March 2004
Vol. 33, No. 3 [Page 43]

Specialty Law Columns
Business Law Newsletter
Control Person Liability in Colorado
by Jeffrey J. Scott

This column is sponsored by the CBA Business Law Section to apprise members of current information concerning substantive law. It focuses on business law topics for the Colorado practitioner, including, but not limited to, issues surrounding anti-trust, bankruptcy, business entities commercial law, corporate counsel, financial institutions franchising, nonprofit entities, securities law, and small business entities

Column Editors:

David P. Steigerwald of Sparks Willson Borges Brandt & Johnson, P.C., Colorado Springs - (719) 475-0097, dpsteig@sparkswillson.com; Troy Keller, senior attorney at Qwest, (303) 992-6167, troy.keller@qwest.com. Column Ed. for Bankruptcy Law: Curt Todd of Lottner, Rubin, Fishman, Brown & Saul, P.C., Denver - (303) 292-1200, ctodd@rflegal.com

Jeffrey J. Scott

About The Author:

This month's article was written by, Jeffrey J. Scott, Denver, an attorney with Scott & Associates PC specializing in securities litigation and arbitration matters - (303) 832-6500, JJscottlaw@aol.com.

Securities laws provide for civil liability of "control persons" of issuers and sellers of securities. This article reviews and summarizes the law in Colorado regarding control person liability and defenses to such claims, and discusses the practical implications of such liability.

An issuer or seller of securities has certain obligations under state and federal securities laws. Issuers and sellers may not offer or sell unregistered securities without an exemption. Further, they must avoid making misleading statements or omitting pertinent information. Failure to meet such obligations can subject issuers and sellers to various liabilities and penalties, including subsequent claims for buyer damages.

Although securities law practitioners, issuers, and sellers may be well-versed in the obligations of issuers and sellers, they may be less familiar with issues pertaining to "control persons." Given the broad definition of a "security,"1 control persons of a security's issuer or seller are exposed to considerable risk of liability. The kinds of matters that are prohibited in connection with the purchase or sale of a security include: (1) material misstatements or omissions; (2) misleading information in a registration statement; (3) offer or sale of an unregistered security; or (4) offer or sale of a security that contains a material misstatement or omission.2

This article reviews the scope of control person liability under Colorado and federal law. It also discusses the history and application of the law of control person liability.

Origins of Federal Control Person Liability

Under the common law, vicarious liability is imposed on a principal when its agent appears to have the authority to act on behalf of such principal. According to a First Circuit Court case, if an agent commits fraud,

[v]icarious liability is based upon the fact that the agent's position facilitates the consummation of the fraud, in that from the point of view of the third person the transaction seems regular on its face and the agent appears to be acting in the ordinary course of the business provided to him.3

Control person liability has its origins in common law vicarious liability, as well as the federal securities laws: the Securities Act of 1933 ("1933 Act") § 15 and the Securities Exchange Act of 1934 ("Exchange Act") § 20. By enacting the control person provisions of the federal securities acts, Congress expanded the common law agency principle of apparent authority to impose liability on persons who directly or indirectly control the agent engaged in misconduct.

The federal legislative history of control person liability "makes clear that the section [20 of the Exchange Act] was aimed at expanding [common law] liability, rather than contracting it."4 The purpose of both 1933 Act § 15 and Exchange Act § 20 is "to prevent evasion of the [Act] . . . by organizing dummies who will undertake the actual things forbidden by the [Act]."5 The legislative history of § 20 of the Exchange Act shows:

Congress thus saw this section as imposing liability upon, say, a shareholder or a director who controlled a corporation engaged in misrepresentation, presumably including persons beyond the reach of ordinary common law agency liability.6 (Emphasis in original.)

Control person liability exists in addition to the more well-known and specific statutory liabilities of certain responsible persons. For example, this includes directors, who have statutory liability for the filing of a false registration statement.7

Colorado Securities
Act and Control
Person Liability

The Colorado Securities Act ("Act"),8 as amended in 1990, is designed "to provide better enforcement tools against persons who engage in fraudulent securities transactions" and "to make Colorado law even more compatible with federal law and accepted practices."9 The Act imposes secondary liability (liability for acts performed by another) on controlling persons where, based on all the circumstances, "the alleged controlling person in fact directly or indirectly controlled the primary violator."10

The Act provides for civil liabilities for violation of the Act's provisions.11 The control person liability provision appears in paragraph 5(a) and (b):

(a) Every person who, directly or indirectly, controls a person liable under subsection (1), (2), (2.5), (2.6), or (3) of this section is liable jointly and severally with and to the same extent as such controlled person, unless the controlling person sustains the...