The Private Securities Litigation Reform Act of 1995 1 (PSLRA or the Act) reformed the federal securities laws in a myriad of ways. The inevitable battles over interpreting the PSLRA’s requirements soon followed. Many of the statutory construction debates have since been, at least ostensibly, resolved. 2 Others, such as its §21(D)(f), which provides for proportionate liability for damages in certain circumstances, are now just coming to the fore, over a decade after the PSLRA was enacted.
In a matter of first impression, the U.S. Court of Appeals for the Eleventh Circuit, in LaPerriere v. Vesta Insurance Group Inc., 3 addressed the intersection of the Act’s proportionate liability rules with §20(a) control person claims under the Securities Exchange Act of 1934 (Exchange Act).
A control person claim is brought where a primary violator of the securities laws is controlled by another person or entity, such as a parent company, director or major shareholder. The Eleventh Circuit held that the PSLRA’s proportionate liability scheme applies to Exchange Act control person claims, but did not change the basic standard for liability under §20(a). The decision did not address, however, how to apply the proportionate liability provisions to control persons. Nor is the Eleventh Circuit’s reading the only plausible interpretation of the statutory text.
This article discusses the Eleventh Circuit’s decision in LaPerriere, analyzes alternative approaches to harmonizing the PSLRA’s damage provisions and §20(a), and addresses some of the practical implications of the ruling.
Under §20(a) of the Exchange Act, actors who “control” a primary violator are “liable jointly and severally with and to the same extent” as the controlled person, “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.” 4
Thus, control persons need not have committed independent violations of the securities laws themselves, but are derivatively liable for the securities law violations of those they control. To be found liable as a control person, the plaintiff need not prove that the alleged control person actually exercised control, but merely that it had the power to influence the controlled person. 5
The PSLRA introduced the notion of proportionate liability to the federal securities fraud regime. Under the proportionate liability rules, defendants who did not commit a “knowing” violation are liable solely for the portion of the judgment that corresponds to the percentage of responsibility of that defendant, as determined by the jury or the court in mandatory special interrogatories or special findings. Defendants who knowingly violated the securities fraud provisions are jointly and severally liable, as was the case for all defendants who violated the securities laws before the PSLRA, for all of the plaintiffs’ damages.
For purposes of the damages liability provisions, the PSLRA specifies when a defendant “knowingly commits a violation of the securities laws.” This occurs when a defendant makes an untrue statement of a material fact with actual knowledge that the statement is false; omits a material fact that makes another statement false or misleading with actual knowledge that the statement is false or misleading; or engages in conduct that violates the securities laws, knowing such conduct violates the securities laws.
Any defendant who violated the securities laws but did not act “knowingly” is proportionately liable for damages under the PSLRA. The Act provides the fact finder with two considerations required to be used to determine the allocation of damages among those found to be proportionately liable. The fact finder first considers the “nature of the conduct of each covered person found to have caused or contributed to the loss incurred” and then “the nature and extent of the causal relationship between the conduct of each such person and the damages incurred . . . .”
The ‘LaPerriere’ Decision
In the context of a plaintiff’s motion to strike affirmative damages defenses offered in a securities class action litigation by control person defendant Torchmark Corporation, 6 the U.S. District Court for the Northern District of Alabama interpreted for the first time the impact of §21(D)(f) on §20(a).
The district court denied the motion to strike on the grounds that the later-enacted provision, §21(D)(f), “trumped” the control person provision. The plaintiffs requested permission to take an interlocutory appeal, which the court granted; the district court certified the following question to the circuit court: “Whether, and to what extent, the proportionate liability provisions of [the PSLRA] amended the joint and several liability provisions of section 20(a).”
The Eleventh Circuit took the question. Although recognizing a tension between §20(a) and the PSLRA’s proportionate liability scheme, the Eleventh Circuit held that the proportionate liability rules apply to §20(a) control person claims:
Where a controlling person fails to firmly establish [the defenses to a control person claim] 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 damage is only proportionate, not joint and several. 7
Reconciling the Provisions
There are a number of alternative ways one could reconcile the PSLRA’s proportionate liability provisions with the control person liability provision in §20(a); four possible ones are discussed below.
One possibility is that the “joint and several” language in §20(a) irreconcilably conflicts with the proportionate liability rules in the PSLRA. As the PSLRA is the later-enacted statute, it “trumps” the control person provision.
The obvious flaw with this approach is that it would read control person liability out of the federal regulatory regime in violation of the clear language of §21(D)(f)’s applicability provision, which states that nothing in the PSLRA “shall be construed to create, affect, or in any manner modify, the standard for liability associated with any action arising under the securities laws” (“Applicability Provision”). Reading a long-standing securities claim out of existence when there is no evidence that Congress intended to abolish it, and instead specifically legislated the opposite, cannot be a correct reading of the two provisions.
Another possible reading of the two provisions is that the proportionate liability rules do not apply at all to §20(a) claims. The argument would be that §20(a) claims, which clearly state on the face of the statute that liability is to be “joint and several,” cannot by definition ever be “proportionate.” This reading would thus leave control persons open to liability for the entirety of plaintiffs’ damages, as before the PSLRA. Because control persons are “covered persons” under the Act, all of whom are expressly entitled to the proportionate liability defense, the plain language of the statute once again would appear not to permit the proposed alternative reading.
A third possible harmonization of the provisions is that a control person will be proportionately liable up to the maximum of the controlled person’s liability. This is what the Eleventh Circuit held, in part because it rejected the idea that the control person could ever be liable for more damages than the controlled person. Under this scenario, the proportionate liability scheme would be applied to each of the controlling persons and the controlled person. The §20(a) “joint and several” language would act as a cap on the control person’s damage liability.
There are several flaws with this approach. First, it is inconsistent with the fundamental nature of control person liability as derivative liability. Second, the requirement of §20(a) that control persons are liable “to the same extent as” controlled persons does not seem to permit the controlling person to bear a smaller share of liability than the controlled person. Third, control persons do not fit naturally into the specific proportionate liability provisions of §21(D)(f); to do so rather feels a bit like trying to fit a square peg into a round hole.
For example, the PSLRA specifies two factors that the finder of fact must consider in determining the percentage of responsibility for each actor. Neither factor – the (i) nature of the conduct that caused the plaintiffs’ loss or (ii) the causal relationship between the covered persons’ conduct and the plaintiffs’ damages – applies to control person claims. The power to control another (and even reckless lack of control) is not conduct that “causes” injury to the plaintiffs.
A fourth interpretive possibility, in which proportionate liability applies derivatively to the control person via the controlled person, may best reconcile the statutory language and purposes. As “covered persons,” control persons would be subject to §21(D)(f). But since control persons do not themselves violate the securities laws (they are just derivatively liable for the violations of their controlled persons), the answer to the fact finder’s threshold proportionate liability question (“whether such person violated the securities laws”), would be “no.”
But, that is not the end of the inquiry. Because the controlled person violated the securities laws, the controlled person would be subject to apportionment or full joint and several liability in accordance with §21(D)(f). Under §20(a), the control person would then be liable “to the same extent as” the controlled person, and thus would benefit from any reduction in the allocation of damages to the controlled person derivatively, albeit not directly. Because the control person benefits from the allocation of liability of the controlled person, §21(D)(f) would be satisfied consistent with the plain “with and to the same extent as” language of §20(a).
Impact on Settlements
As a result of the many pro-defendant changes to the securities laws, the PSLRA shifted the settlement dynamic in defendants’ favor in a number of ways.
Indeed, one of the express purposes of the PSLRA was to lessen the pressure on corporations to settle nuisance strike suits as well as diminish the pressure to settle on deep-pocket, but peripheral, non-issuer defendants. One of the ways in which the PSLRA tried to accomplish this goal was by adopting the proportionate liability scheme.
The LaPerriere decision provides the basis for an even further shift in favor of control person defendants. Under LaPerriere, control person defendants inevitably will avoid joint and several liability for the entirety of plaintiffs’ damages and may even be held responsible for a lesser amount of damages than that attributed by the fact finder to the persons they control.
While this should facilitate settlements of securities class actions, the law of unintended consequences may apply. D&O insurers play a major role in the settlement of securities class actions. Often times, it is the control person that provides the D&O insurance hook (since D&O carriers resist paying to settle claims against knowing primary violators based on the fraud and intentional violation exclusions in D&O policies). To the extent that control persons now may be liable for proportionate, rather than joint and several, damages (as the court in LaPerriere held), D&O insurers may be more reluctant to contribute to a settlement based on the potential liability of a control person insured.
It remains to be seen whether other circuits agree with LaPerriere. In the meantime, counsel may wish to consider these issues when assessing the next securities litigation that crosses their desk.
Gregg L. Weiner is a litigation partner, and Julie E. Kamps is a litigation associate, with Fried, Frank, Harris, Shriver & Jacobson.
1. 15 U.S.C.A. §78u-4 (Westlaw 2008).
2. See, e.g., Tellabs Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) (setting forth test for assessing PSLRA’s “strong inference” requirement).
3. 526 F.3d 715 (11th Cir. 2008).
4. 15 U.S.C.A. §78t(a) (Westlaw 2008).
5. Control is left to the courts to assess. The PSLRA does not define control, but there is some guidance in the rules. According to 17 C.F.R. §230.405, “[T]he 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 . . . “
6. In this case, the control person was the former parent company of the controlled person. The analysis would be the same for other control relationships.
7. 526 F.3d at 728.