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Securities Law Commentary
Laperriere v. Vesta Insurance Case Defines the Scope of Controlling Party Liability
Kittie Laperriere, et al. v. Vesta Insurance Group, Inc., et al.
Posted: 05/19/2008
By: Joel B. Ginsberg, Esq.
Companies Mentioned: Florida State Board of Administration, KPMG Peat Marwick, LLP, The Cleaners & Caulkers Local 1 Pension Fund, Torchmark Corp., Vesta Insurance Group, Inc.
Introduction
In the precedent-setting case of Laperriere et al v. Vesta Ins. Group, et al, ____ F.3d ____, 2008 WL 1883482 (11th Cir. 2008), the 11th Circuit harmonized the proportionate liability scheme of the Private Securities Litigation Reform Act of 1995 (PSLRA) with the provisions of the Securities Exchange Act of 1934 (the “Act”) that provide for derivative liability of controlling persons. In this case of first impression, the Vesta court set forth a test for litigants and courts to apply to determine whether a controlling person has any liability for the acts of someone he controls, and, if so, whether proportionate or joint and several liability should apply.
Detailed Commentary
Background
PSLRA’s proportionate liability scheme
Congress passed the PSLRA, the Private Securities Litigation Reform Act of 1995, to deter strike suits – securities lawsuits of questionable merit filed by private plaintiffs for the purpose of extracting large settlements from the defendants. Laperriere et al v. Vesta Ins. Grp., et al, Slip. Op. pp.4-5; Novak v. Kasaks, 216 F.3d 300, 306 (2d Cir. 2000).
Before the PSLRA was passed, the general rule in most securities law cases was that any and all defendants who were found liable were jointly and severally liable for all of the plaintiff’s damages. Id. Under that practice, a defendant who was only 1% liable may have been forced to pay 100% of the damages.
To counter this problem, the PSLRA replaced the previous joint and several liability scheme with a proportionate liability scheme that allows a holding of joint and several liability only against those who knowingly violate the Act. Id. at 5; PSLRA, Section 21(D)(f), codified at 15 USC §78u-4(f)(2) (West 2007). Specifically, Section 21(D)(f) says in part:
(f) Proportionate liability
……
(2) Liability for damages(A) Joint and several liability
Any covered person against whom a final judgment is entered in a private action shall be liable for damages jointly and severally only if the trier of fact specifically determines that such covered person knowingly committed a violation of the securities law.(B) Proportionate liability
(i) In general
Except as provided in subparagraph (A), a covered person against whom a final judgment is entered in a private action shall be liable solely for the portion of the judgment that corresponds to the percentage of responsibility of that covered person, as determined [by the fact finder].
The proportionate liability scheme in 21(D)(f) requires the court to undertake a three-step process: 1) determine whether the person alleged to be a liable party by the plaintiff actually violated the securities laws in such a way as to cause or contribute to plaintiff’s loss; 2) determine the percentage of responsibility of each liable person or entity that did violate the securities law; and 3) determine whether that person knowingly violated the securities laws. Vesta, Slip op. pp 6-7.
The Act’s derivative liability for controlling persons
Prior to the enactment of the PSLRA, the Act contained a provision setting forth derivative liability for persons who control the primary violator – controlling persons. That provision, Section 20(a) of the Act, provides:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.15 USC §78t(a).
This provision was included in the Act to prevent controlling individuals from avoiding liability by using straw parties, agents or subsidiaries to separate themselves from the primary violator. Vesta, Slip op. p. 9. This is more than mere agency or respondeat superior theory – under those theories, only the formal principal/master/employer (i.e. the company) of a bad actor could have the bad actor’s liability imputed to it. Section 20(a) breaks past that formal barrier and looks to any person who actually had control over the primary violator and his actions.
There is another major difference, however, between agency/ respondeat superior theories and Section 20(a) – Section 20(a) gives the controlling person an out, an absolute defense. A controlling person who proves that she acted in good faith and did not induce the bad acts has an absolute defense under Section 20(a). More standard agency theories merely impute liability without providing a defendant with this out.
The Vesta court harmonizes PSLRA with Section 20(a)
The Vesta court was charged with resolving a matter of first impression among the courts, and one that would be subject to dispute among courts if it did not get resolved: determining whether, and how, the proportionate liability scheme of the PSLRA, Section 21(D)(f), impacted the controlling person provision of Section 20(a), that appears to mandate joint and several liability for liable parties.
In the proceedings below, the district court had decided that the PSLRA provision “trumps” the older Section 20(a). But that district court also granted the appellant’s motion to file an interlocutory appeal and certified the issue.
The Vesta court rejected the lower court’s “trumping” argument, stating that the two provisions could and should be read together and work together without excluding or amending the other. The court determined that Section 20(a) sets forth the standard by which a controlling person may be found liable; once found liable, section 21(D)(f) defined the method under which damages would be allocated. Vesta, Slip op. p. 22. (“The proportionate liability provisions of section 21(D)(f) are applicable only after liability is determined, and liability is governed by the standard set out in section 20(a).
The Vesta 5-step framework
Therefore, under the Vesta analysis, there is essentially a 5-step framework for determining the scope of liability of a controlling person:
.1) Underlying violation: Consistent with previous precedent, the first step is to determine whether the alleged primary violator actually did violate the securities laws, thereby causing the plaintiff to suffer a loss. This is not an analysis of the controlling party’s actions, it is an analysis of the controlled party’s actions. If the controlling party committed a direct violation of the securities laws and/or directly injured the plaintiff, that person has direct liability, not derivative liability as a controlling party.
a. If NO – No Liability for controlled or controlling person
b. IF YES – Go to Inquiry #2
2) Was there “control?” Did the alleged controlling person exercise “control” over the primary violator? The court declined to offer a specific definition of “control,” acknowledging that “it would be difficult, if not impossible, to enumerate or anticipate the many ways in which actual control may be exercised…” Vesta, Slip op. p. 12.
The court discusses at length the various court opinions that have discussed whether or not an allegedly controlling person exercised control, as well as the extent and nature of the burden plaintiffs have had to meet to prove control in various jurisdictions. Id. at 13-14. The court did reach the following conclusion on the issue of control: “Despite the varying standards, courts for good reason appear to be in agreement that a controlling person need not commit an intentional violation of the Act to be liable under section 20(a).” Id. at 14.
a. If NO, no control -- No Liability for controlling person
b. If YES – Go to Inquiry #3
Did the controlling person act with good faith and no inducement? If an alleged controlling person was found to have exercised control over a primary violator, the next question under Vesta is to inquire about whether the controlling person has established the “good faith defense.”1
In order to meet this burden, a controlling person cannot prove merely a lack of participation in the primary violation. Rather, a controlling person must prove that he “’did not act recklessly in inducing, either by his action or inaction, the act or acts constituting the violation.’” Vesta, Slip op. pp. 15-16 (quoting G.A. Thompson & Co. Inc. v. Partridge, 636 F.2d 945, 960 (5th Cir. 1981).
The burden is solely on the controlling person to establish that it acted with good faith and without recklessness and that it did not induce the bad acts.
c. If Yes, good faith established -- No liability for controlling person
d. If No, controlling person fails to establish good faith defense – Go to Inquiry #4
3) Percentage of liability. If the controlling person did exercise control over the primary violator and fails to affirmatively establish the good faith defense, the controlling person will be liable for at least some part of the plaintiff’s damages. The next inquiry, then, is a determination by the fact finder of the percentage of liability attributable to the controlling person, “’measured as a percentage of the total fault of all persons who caused or contributed to the loss incurred by the plaintiff.’” Vesta, Slip op. p. 7 (quoting 15 USC §78u-4(f)(3)(A)). Once that percentage is determined, go to Inquiry #5.
4) Proportionate or Joint and Several? For the last inquiry, the fact finder must decide whether it can “specifically determine” that the controlling person committed a knowing violation of the securities laws. The Court makes it clear that “knowing” is not the same thing as “reckless.” Vesta, Slip op. p. 25. Therefore, a fact finder can hold a controlling person liable (for recklessness, for example), without finding that he acted knowingly.
The burden is on the plaintiff to prove sufficient facts to reach the determination that the controlling person acted knowingly.
a. If the fact finder makes a specific finding that the controlling person knowingly violated the securities laws—the controlling person is jointly and severally liable for plaintiff’s damages.
b. If the fact finder cannot or does not make a specific finding of a knowing violation, but the controlling person is still liable after Inquiry #3, that controlling person is liable only for its proportionate share of damages as determined in Inquiry #4.
Conclusion
The 11th Circuit summed up its analysis in the following way: “Where a controlling person fails to affirmatively establish good faith and lack of inducement under section 20(a) but the fact finder does not specifically find a knowing violation, there is liability for the violation but responsibility for the damages is only proportionate, not joint and several. 15 USC §78u-4(f)(2)(B)(i).” Vesta, Slip op. p. 23.
The author, Joel B. Ginsberg, Esq., is an associate in the transactional department of Zuber & Taillieu LLP, focusing on corporate law, and securities and finance law.
1The Court does note that a plaintiff has other remedies besides the provisions of Section 20(a) of the Act. The common law theory of respondeat superior is available to plaintiffs in addition to the Section 20(a) theory of liability. Vesta, Slip op. p. 16. Therefore, in the face of a viable good faith defense, plaintiffs can rely, in the alternative on common law agency theories, which don’t have that defense. As noted, however, common law agency theories reach fewer possible defendants than Section 20(a).
Securities Law Summary
Read the related Securities Law summary: 11th Cir. Clarifies Parent Cos.’ Liability under the PSLRA in Vesta Insurance Case
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