Control person liability requires culpable participation.

Control person liability does not lie unless the controlling person was, in some meaningful sense, a culpable participant in the fraud. General deficiencies in supervision, are insufficient, liability requires culpability regarding specific trades and misrepresentations.

Wallace v. Buttar, 02 Civ. 4297(RWS) (S.D.N.Y. 1/8/03). Appealability * Award Challenge * Vacatur of Award * Manifest Disregard * 1933 Act (§15 “Control Person”) * 1934 Act (§20 “Control Person”) * Derivative/Vicarious Liability (Respondeat Superior).

“Control person” must have actual control and supervisory responsibility and participate in the fraud with knowledge that the securities laws were being violated or with reckless indifference as to whether a violation occurred.

On 3 individual defendants’ appeal, Court overturns $1.2 million arbitration award in favor of customer, who claimed he was fraudulently induced to purchase large blocks of 2 stocks for which broker-dealer Montrose Capital Management served as placement agent. Montrose filed for bankruptcy and panel found individual defendants liable as control persons, Wallace as the President and the others as Montrose’s only 2 directors. Two appellants, “investment bankers,” brought the two transactions to the firm. Wallace had only marginal contact with Claimants and no supervisory authority over the broker.

There are 5 grounds for vacating an arbitration award under the Federal Arbitration Act and 2 additional grounds recognized by federal court, i.e., manifest disregard of the law and manifest disregard of the facts. Manifest disregard of the law occurs when the arbitrators knew of a governing legal principle and refused to apply or ignored it and the law was well-defined and clearly applied to the case and the arbitrators knew of it or appreciated that it existed.

The Court relies on Halligan v. Piper Jaffray, 148 F.3d 197 (2d Cir. 1998), for “manifest disregard of the facts,” which requires that the award run contrary to strong evidence; if there is “even a barely colorable justification for the outcome,” the award must be confirmed.Respondeat superior liability applies only to the employer, not to individual respondents. The panel’s imputation of fraud liability manifestly disregarded the law in that the “intent” element was not proved: appellants had no contact with the Claimants, no knowledge or no reason to be aware of wrongdoing in the customers’ account, no supervisory responsibility over the broker and lacked control or power over the broker.

Control person liability will not lie unless the “controlling person was in some meaningful sense a culpable participant in the fraud.” General deficiencies in the firm’s supervision are irrelevant given that control person liability requires culpability concerning the specific trades and representations at issue: “officer or director status alone does not constitute control.” (S. Anderson) (ed: The underlying Award was rendered on March 8, 2002 in Raleigh, NC, NASD ID No. 00-03950. This will be an important Opinion for arbitration defense counsel seeking to shield managers and officers from strict liability for errant brokers’ conduct. A large part of the vacated Award was for punitive damages against the “control” trio.) (SLC Ref. No. 03-04-02).

Securities Attorney at Sallah Astarita & Cox | 212-509-6544 | | Website | + posts

Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.

He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page -, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.