Holding

In this appeal arising from a securities class action, the U.S. Court of Appeals for the Eleventh Circuit affirmed a district court’s denial of plaintiff-appellant investors’ motion to strike affirmative defenses. In its motion, plaintiffs-appellants argued that such defenses of parent company Torchmark Corporation sought to improperly apply the “proportionate liability” rule under the Private Securities Litigation Reform Act (PSLRA) of 1995 because as a parent company, Torchmark should be jointly and severally liable with and to the same extent as the principal violator. In rejecting this argument, the Eleventh Circuit held that under Section 21(D)(f), a controlling person, like a parent company, shall be jointly and severally liable for all the damages only if a court specifically determines that such controlling person knowingly committed the violation. In this regard, if the controlling person fails to affirmatively demonstrate good faith and lack of inducement under section 20(a) but the court is not able to find a knowing violation, the controlling person’s liability is only proportionate, not joint and several.

Detailed Summary

This case presented what the Eleventh Circuit called “an issue of first impression in the circuit courts.” Specifically, the issue was “whether and to what extent the proportionate liability scheme of section 21(D)(f) of the Securities Exchange Act of 1934 (the “Act”), enacted as part of the PSLRA, amends section 20(a) of the Act, under which a person who controls a violator of the Act is ‘liable jointly and severally with and to the same extent’ as that violator.”

Put in another way, the question is, is a parent company liable for damages arising from securities fraud committed by primary parties, or people or companies under its control, and if so, what proportion of the damages awarded should it bear?

This case involved a securities class action filed by appellants consisting of a group of investors in publicly traded securities. On the other hand, defendants were Vesta Insurance Group, Inc. (“Vesta”) and certain of its officers and directors, KPMG Peat Marwick, LLP , Vesta’s outside auditor, and appellee Torchmark, the former parent company of Vesta. Appellants went through discovery and class certification. They also managed to overcome motions to dismiss filed by defendants.  Subsequently, they reached court-approved settlements with Vesta and KPMG. With its motion for summary being denied by the U.S. District Court for the Northern District of Alabama, Torchmark was the only remaining defendant in this case.

This appeal arose from the district court’s denial of appellants’ motion to strike two of Torchmark’s affirmative defenses. Appellants argued that these defenses improperly sought to graft the PSLRA scheme of “proportionate liability” onto the joint and several liability existing between a controlling person and a controlled person under section 20(a).  The district court concluded that , “as a matter of first impression,” the “proportionate liability regime set out in section 21(D)(f) of the Act ‘trumps’ section 20(a).” The district court thereafter granted appellants’ motion to file an interlocutory appeal, certifying that the present issue as one “involv[ing] a controlling question of law as to which there is substantial ground for difference of opinion.” 28 U.S.C. § 1292(b) (West 2007).

In affirming the decision of the district court, the Eleventh Circuit first took a look at the prevailing situation before and after the enactment of the PSLRA. Before its enactment, the general rule in most securities cases was that defendants found to have violated the Act were jointly and severally liable for all the plaintiff’s damages.  See Musick, Peeler & Garrett, 508 U.S. at 292.

In an effort to address this inequity, Congress enacted section 21(D)(f) of the PSLRA, which replaced the existing joint and several liability rule with a proportionate liability scheme that restricts joint and several liability to persons who knowingly violate the Act.  Congress clarified that section 21(D)(f) affects only the allocation of damages between liable defendants and must not “be construed to create, affect, or in any manner modify, the standard of liability associated with any action” arising under the Act. 15 U.S.C. §78u-4(f)(1).

On the other hand, section 20(a) of the Act imposes derivative liability on persons that control primary violators of the Act. Under section 20(a), a controlling person is liable to the plaintiff jointly and severally with and to the same extent as a controlled person for the controlled person’s acts, unless the controlling person can establish the affirmative defense of good faith and non-inducement. H.R. Rep. No. 73-1383, at 26 (1934).

The Eleventh Circuit likewise examined other sources of liability. Pure vicarious liability, such as respondeat superior liability, attributes liability to one party based on the actions of the other party regardless of any allegation of culpability on the party held vicariously liable. Section 20(a) is a derivative liability statute because it in effect requires, through the affirmative defense, a defendant to disprove certain wrongful conduct on its part. Musick, Peeler & Garrett v. Employers Ins. of Wausau, 508 U.S. 286, 296, 113 S. Ct. 2085, 2091 (1993).

The Eleventh Circuit made a survey of cases that had the occasion of applying section 20(a). It observed that section 20(a) “was founded and continues until today as a derivative liability statute, imputing liability to a controlling person based on its relationship to a primary violator and not based on any independent violation of the securities laws by the controlling person.” It added that secondary actors may be held liable under the Act by means other than section 20(a). It wrote that section 20(a) does not constitute an exclusive substitute for the vicarious liability of secondary actors that might otherwise exist under common law agency principles. From this survey, the Eleventh Circuit further observed that there was a consensus in the circuit courts that section 20(a) was intended to supplement, not to supplant the common law theory of respondeat superior as a basis for vicarious liability under the Act and thus, section 20(a) does not constitute an exclusive substitute for the vicarious liability of secondary actors that might otherwise exist under common law agency principles. See, e.g., In re Atlantic Fin. Management, Inc., 784 F.2d 29, 32-34 (1st Cir. 1986), cert. denied, 481 U.S. 1072 (1987); Commerford v. Olson, 794 F.2d 1319, 1322-23 (8th Cir. 1986); Marbury Management, Inc. v. Kohn, 629 F.2d 705, 712-16 (2d Cir. 1980); Paul F. Newton & Co. v. Texas Commerce Bank, 630 F.2d 1111, 1115-19 (5th Cir. 1980); Holloway v. Howerdd, 536 F.2d 690, 694-95 (6th Cir. 1976).

Given the foregoing by way of background, the Eleventh Circuit then clarified the new rule under the PSLRA. Under the new statutory regime, a controlling person is liable to the same extent as the controlled person, unless the controlling person, such as a parent company, affirmatively establishes that it acted in good faith and did not induce the violation by the controlled person. Unless the controlling person discharges its burden of establishing that affirmative defense, it is liable for violating the securities law, specifically section 20(a).

Then, for the purpose of determining whether the controlling person is responsible for the entire amount of damages or only its proportionate share, courts should apply the proportionate liability provisions of the PSLRA. Under these provisions, joint and several liability for all the damages exists only if a court specifically determines that the controlling person knowingly committed the violation. 15 U.S.C. § 78u-4(f)(2)(A). Where a controlling person fails to affirmatively demonstrate good faith and lack of inducement under section 20(a) but the court is not able to find a knowing violation, the controlling person’s liability is only proportionate, not joint and several. 15 U.S.C. § 78u-4(f)(2)(B)(i).

In conclusion, the Eleventh Circuit held that those persons “who would have been substantively liable as controlling person under section 20(a) before the PSLRA was enacted will be substantively liable after its enactment.” All that the PSLRA changed for controlling persons “is the standard for deciding whether their responsibility for damages is joint and several or proportionate. Damages are now allocated based on the proportionate liability provisions in the PSLRA, including the provision that knowing violators of the securities laws are ‘liable for damages jointly and severally.’”

On the basis of the foregoing, the Eleventh Circuit affirmed the district court’s denial of appellants’ motion to strike Torchmark’s PSLRA-based affirmative defenses.