One of the primary differences between criminal and civil liability is that criminal liability requires the government to prove that the defendant acted wrongfully. In a civil case, an employer may be held liable under a theory of respondeat superior if an employee does something wrong. This can’t happen in a criminal case. (Conspiracy is a whole different ballgame.)
Federal agencies, however, have increasingly sought to take advantage of “control person liability” to impose civil liability against directors, officers, and other “control persons” for the wrongdoing of their subordinates.
Historically, the SEC and Commodity Futures Trading Commission (CFTC) only used control person liability statutes in enforcement actions against executives who were already facing charges as primary violators. More recently, though, both agencies have aggressively used this theory of liability against executives who do not face any liability except under this theory.
The case by the CFTC against former New Jersey Senator and Governor Jon Corzine illustrates this trend. Mr. Corzine was the head of MF Global Holdings, which collapsed amid allegations of financial mismanagement.
The CFTC and SEC cases using this theory may be “only” civil or administrative in nature, but the punishment resulting from them can have severe consequences. So, is control person liability fair? Is it just being used to pin the blame on those who run Wall Street?
Control Person Liability: The SEC View
Control person liability applies when an executive is held liable for the actions of an employee, based on the legal construct that the executive had control over the employee’s actions. It allows the control person to be punished to the same extent as the controlled person, with joint and several liability being imposed in certain civil cases.
It’s long been used by the SEC.
Defining control person liability, 15 U.S.C. § 78t(a) states:
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 (including to the Commission in any action brought under paragraph (1) or (3) of section 78u(d) of this title), 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.
Regarding the definition of “control,” the SEC regulations (17 C.F.R. § 230.405) clarify:
The term ‘control’… means the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.
Historically, there has been a split in authority regarding the appropriate test for liability under 20(a) of the Securities Exchange Act, which grants the SEC the authority to pursue these claims. Some circuits (the Second and Third) have required “culpable participation” by the executive in the wrongdoer’s actions, increasing the burden on the government to win under this theory.
Most other courts have adopted a lower standard, which requires the following:
- that a primary violator violated the federal securities laws;
- that the alleged control person actually exercised control over the general operations of the primary violator; and
- that the alleged control person possessed, but did not necessarily exercise, the power to determine the specific acts or omissions upon which the underlying violation is predicated.
What is the CFTC?
The CFTC has flown under the radar for many years but has recently exercised its enforcement muscle in higher profile cases.
The CFTC oversees trading in derivatives and other financial products—such as futures and swaps—that are subject to the Commodity Exchange Act (CEA). Its mission is
to foster open, transparent, competitive, and financially sound markets, to avoid systemic risk, and to protect the market users and their funds, consumers, and the public from fraud, manipulation, and abusive practices related to derivatives and other products that are subject to the Commodity Exchange Act.
To fulfill these roles, the Commission oversees designated contract markets, swap execution facilities, derivatives clearing organizations, swap data repositories, swap dealers, futures commission merchants, commodity pool operators and other intermediaries.
(Got that that last part? Yeah, me neither. Lucky for you, we’ll be sticking to the fairly straightforward topic of control person liability. I’ll save a fascinating post on “swap data repositories” for another time.)
The CFTC’s Use of Control Person Liability
Since the recent financial crisis, the CFTC has been aggressively regulating the financial markets within its jurisdiction. Its authority to bring control person claims against executives is found in Section 13(b) of the CEA. This section requires that the executive
[D]id not act in good faith or knowingly induced, directly or indirectly, the act or acts constituting the violation.
To prove inducement, the CFTC must prove
that the controlling person had actual or constructive knowledge of the core activities that constitute the violation at issue and allowed them to continue.
Constructive knowledge means that the defendant “should have known” of the wrongdoing. So, even if the executive didn’t actually know about the wrongdoing, the executive may still be held liable.
The CFTC has fairly broad to assert these claims. Section 2(a)(1)(B) of the CEA:
The act, omission, or failure of any official, agent, or other person acting for any individual, association, partnership, corporation, or trust within the scope of his employment or office shall be deemed the act, omission, or failure of such individual, association, partnership, corporation, or trust, as well as of such official, agent, or other person.
The CFTC’s Case Against Jon Corzine
Jon Corzine was sued by the CFTC under a control person liability theory. He ran MF Global, a futures brokerage. Investors and the CFTC sued MF Global after the company faced financial collapse (including a Chapter 11 filing) and there were reports that customers’ money had been used to cover shortages. The company settled with the CFTC for $100 million.
Mr. Corzine’s case remains active. The agency alleges that Mr. Corzine was “in control” when MF Global Holdings allegedly tapped customer funds without authorization to support its troubled operations.
In the litigation in the Southern District of New York, the CFTC has informed the court that it intends to move for summary judgment, arguing that Mr. Corzine, as CEO, failed to supervise his employees in a diligent manner. It asserts that because Mr. Corzine was responsible for hiring and firing, making investment decisions, influencing firm policies, and monitoring firm liquidity, he had “general control.”
Further, the CFTC argues that because Mr. Corzine shaped the policies of the firm and knew that they were ignored, it has demonstrated a lack of good faith.
Mr. Corzine, on the other hand, denies his involvement in any wrongdoing and denies that he had the requisite level of control. He argues that he did not direct or authorize the misuse of any MF Global funds and that he did not even know about the wrongdoing until at least $1 billion in funds were used improperly.
He also intends to move for summary judgment, arguing that personnel who did not report to him handled the transactions in question and that he reasonably delegated his supervisory responsibility.
(These are not actual motions for summary judgment. Rather, under Judge Marrero’s Individual Practices, the parties had to send a letter requesting a pre-motion conference on the proposed cross-motions for summary judgment. These letters to the court are on the docket and contain these substantive arguments. The SDNY is a strange bird. I’ve never appeared in another court where you file letter-briefs rather than formal motions.)
No Motions Yet But a Trial Date Set
The parties haven’t filed their motions yet. Trial, however, has been set for October 2016, giving the court plenty of time to decide the motions after they are filed. I’ll be sure to update this post when they are filed and when the court issues a decision on them.
This is a very high-profile use of the CFTC’s control person theory of liability. Even if it breaks no new legal ground, the case will no doubt garner a lot of attention by executives who are nervously watching to see if they too can be held liable simply because of their job title.
For now, executives can implement certain safeguards to protect themselves. Conducting thorough financial audits is a necessity, not only to ensure compliance with company policy but also as evidence that those in control had no direct knowledge of wrongdoing and were consistently acting in good faith.
And, like any situation, it’s also a good idea to make sure that you have broad D&O insurance coverage in the event that something like this happens to you.