WILLIAM A. NORRIS, Circuit Judge:
Emil Wilkowski, a dishonest securities salesman, embezzled money entrusted to him by four clients. As a result, Wilkowski was convicted of criminal securities fraud and grand theft. In this civil action for alleged violations of federal securities and state laws, the victimized investors seek to recover their losses from a brokerage firm and a financial counseling firm with which Wilkowski was associated. The district court granted summary judgment to both defendants, which plaintiffs now appeal.
On appeal, the panel called sua sponte for the case to be heard en banc to review various questions of Ninth Circuit securities law raised by this case. They are as follows:
We will address each of these questions in the course of considering appellants' various claims under the federal securities laws.
Defendant/appellee Painter Financial Group, Ltd. ("Painter") was formed in May 1983 to provide financial counseling and to sell insurance to individuals and small businesses. Shortly thereafter, Emil Wilkowski rented space in Painter's office in Bellevue, Washington, from which he sold insurance and counseled individuals as a Painter representative. During the summer of 1983, Wilkowski met appellants Judy D'Arcy and Kay Hollinger, two business partners who were seeking financial advice. Wilkowski assisted them with a real estate transaction and was soon doing their bookkeeping, advising them on tax matters, and offering them investment advice.
In November 1983, Wilkowski and several other Painter representatives in the Bellevue office applied to the National Association of Securities Dealers ("NASD") for registration as securities salesmen for defendant/appellee Titan Capital Corporation ("Titan"), a registered broker-dealer firm regulated by the Securities and Exchange Commission ("SEC") and by the NASD. Sales representatives of broker-dealers must be registered with the NASD if the broker-dealer is a member of this self-regulatory organization.
When Wilkowski filled out his application for registration with the NASD, he answered "no" to questions asking whether he had ever willfully made a false statement, been the subject of a major legal proceeding, or been convicted or pleaded guilty to a felony. He supplied a photo and finger-prints as requested. The NASD registered Wilkowski as a securities salesman for Titan on December 12, 1983, and on January 26, 1984, Wilkowski entered into a contract in which Titan authorized him to engage in the securities business as a registered representative of Titan, operating out of Painter's office in Bellevue. That office became a Titan branch office: Titan provided Wilkowski with business cards and stationery and required the office to display a sing with Titan's logo.
As part of its usual registration process, the NASD requested the FBI to run a fingerprint check on Wilkowski. The FBI report, which was not completed until after the NASD had approved Wilkowski's registration, revealed that he had pleaded guilty in 1972 to three counts of felony forgery, for which he received a five-year suspended sentence. The NASD immediately sent a copy of the rap sheet to Titan and requested that Titan return to the NASD a written statement from Wilkowski, providing details about the conviction and an explanation of his failure to disclose the information on the registration form.
When Titan asked Wilkowski for an explanation, he responded with a letter explaining that he believed that pursuant to his plea agreement, his forgery conviction would be expunged upon his making restitution of $16,000. Without saying so explicitly, Wilkowski gave the impression that he had in fact made restitution by indicating that he believed the conviction had been removed from his record before he prepared the application for the NASD. Along with this explanation, Wilkowski submitted a new application form, on which he disclosed the forgery conviction. The NASD did not revoke Wilkowski's registration and Titan did not terminate him as a registered representative. Painter, however, did terminate Wilkowski as a financial counselor.
During the time that Wilkowski worked as a registered representative of Titan, he received funds from appellants to invest. Wilkowski legitimately invested some of the funds in securities through Titan. Sometimes, however, Wilkowski instructed appellants to make the checks payable to him personally, and they complied. Rather than investing these funds, Wilkowski diverted them for his own use. He used Titan stationery to generate bogus receipts and financial statements that indicated that the stolen funds had been used to purchase securities and mutual funds through Titan. Ultimately, Wilkowski's activities were discovered and he was convicted of criminal securities fraud and grand theft.
In this civil action, appellants seek to recover their losses under various anti-fraud provisions of the federal securities laws and under state law. The district
We address appellants' various theories of liability under the federal securities laws in turn. In doing so, we make an independent determination whether appellees were entitled to summary judgment. Darring v. Kincheloe, 783 F.2d 874, 876 (9th Cir.1986). Summary judgment is appropriate if "there is no genuine issue as to any material fact and ... the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c).
Appellants claim that Titan is primarily liable under § 10(b) of the 1934 Act and Rule 10b-5 for failing to disclose to investors Wilkowski's prior forgery conviction.
17 C.F.R. § 240.10b-5 (emphasis added). Appellants do not contend that Titan employed "any device, scheme or artifice to defraud" the people who invested with Wilkowski; rather, appellants proceed on the theory that Titan should be liable for failing to disclose Wilkowski's prior forgery conviction.
In Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193, 96 S.Ct. 1375, 1380, 47 L.Ed.2d 668 (1976), the Supreme Court held that scienter is a necessary element in an action for damages under § 10(b) and Rule 10b-5. The Court defined scienter as "a mental state embracing intent to deceive, manipulate, or defraud." Id. at 194 n. 12, 96 S.Ct. at 1381 n. 12. The Court adopted the view that the language of § 10(b), in particular the terms "manipulative," "device," and "contrivance," revealed an unambiguous intent on the part of Congress to proscribe only "knowing or intentional misconduct." Id. at 197-99, 96 S.Ct. at 1382-83; see also Aaron v. SEC, 446 U.S. 680, 690, 100 S.Ct. 1945, 1952, 64 L.Ed.2d 611 (1980). Although the Court acknowledged that in some areas of the law recklessness is considered to be a form of intentional conduct, the Court reserved the question whether reckless behavior is actionable under § 10(b) and Rule 10b-5. See 425 U.S. at 194 n. 12, 96 S.Ct. at 1381 n. 12.
Our circuit, however, along with ten other circuits,
In our past decisions, we declined to define recklessness; instead, we tried to delineate its contours. We have said that recklessness is a lesser form of intent rather than a greater degree of negligence, see Vucinich v. Paine, Webber, Jackson & Curtis Inc., 739 F.2d 1434, 1435 (9th Cir.1984) (citations omitted), and that it involves conduct that is "more culpable than mere negligence," but with an intent less culpable than "deliberately and cold-bloodedly ... conceal[ing] information." Nelson v. Serwold, 576 F.2d at 1337. At times, however, we have articulated a standard of recklessness that is not clearly distinguishable from negligence. See, e.g., Keirnan v. Homeland, Inc., 611 F.2d 785, 788 (9th Cir.1980) (scienter requirement satisfied if defendant "had reasonable grounds to believe material facts existed that were misstated or omitted, but nonetheless failed to obtain and disclose such facts although [defendant] could have done so without extraordinary effort"); see also Burgess v. Premier Corp., 727 F.2d 826, 832 (9th Cir.1984); Bell v. Cameron Meadows Land Co., 669 F.2d 1278, 1283 (9th Cir.1982).
Today we adopt the standard of recklessness articulated by the Seventh Circuit in Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033, 1044-45 (7th Cir.), cert. denied, 434 U.S. 875, 98 S.Ct. 224, 54 L.Ed.2d 155 (1977),
Id. at 1045 (quoting Franke v. Midwestern Okla. Dev. Auth., 428 F.Supp. 719, 725 (W.D.Okla.1976), vacated on other grounds, 619 F.2d 856 (10th Cir.1980)). The Sunstrand court went on to explain that "the danger of misleading buyers
In adopting the Sunstrand standard of recklessness, we put to rest the "flexible duty standard"
In applying the Sunstrand test to the facts of this case,
We start our inquiry by considering what Titan did know. In February, 1984, less than a month after the NASD had registered Wilkowski as a securities salesman, Titan learned from the NASD that Wilkowski had failed to disclose a prior conviction on his application. When Titan received Wilkowski's rap sheet, it learned that eleven years earlier Wilkowski had received a suspended five-year sentence for felony forgery. When Titan asked Wilkowski to explain, Wilkowski gave what appeared on its face to be a plausible explanation:
Titan also knew the NASD, after reviewing all the information that Titan had on Wilkowski, decided not to revoke his registration as a registered representative. Titan was also aware that the NASD had not imposed any restriction or conditions on Wilkowski's license to sell securities, although it was within its power to do so.
Titan further knew that an eleven-year old forgery conviction was not considered disqualifying by either Congress or the NASD for purposes of determining whether a person should be licensed to work as a salesperson in the securities industry. As part of the 1934 Act, Congress provided that any person who met all of the requirements imposed by the NASD and who was not statutorily disqualified could be registered without restrictions as a representative of a broker-dealer to sell securities. See 15 U.S.C. § 78o(b)(1). Congress expressly provided that a forgery conviction was a statutory disqualification only if it occurred within ten years preceding the application registration. 15 U.S.C. § 78o(b)(4)(B)(iii). Under its rules, the NASD will give an unconditional registration to an applicant who is not statutorily disqualified and who "passes the applicable qualification examination, provides all necessary information and pays all required fees." Aff't of Andrew McR. Barnes, Associate General Council of the NASD, Clerk's Record ("C.R.") 80:1. The NASD may either refuse to register a person who is subject to statutory disqualification or impose special conditions on the registration. Id. at 80:3. Such conditional registrations typically require the sponsoring broker-dealer to engage in increased supervision of the registered representative's work. Id. at 80:3. Wilkowski, who was not subject to a statutory disqualification, was granted an unconditional registration. Although the NASD's unconditional registration did not mean that it had certified Wilkowski to be a trustworthy securities salesman,
On the record, we hold that appellants have failed to make "a showing sufficient to establish the existence of an element essential to [their] case, and on which [they] will bear the burden of proof at trial." See Celotex Corp. v. Catrett, 477 U.S. 317, 322, 106 S.Ct. 2548, 2552, 91 L.Ed.2d 265 (1986). When we view Wilkowski's conviction in light of Congress' decision not to make an eleven-year old forgery conviction a statutory disqualification and the NASD's decision not to revoke or condition Wilkowski's registration, we
In the final analysis, Titan may have made an error in judgment in failing to disclose Wilkowski's conviction to his clients. Indeed, it is arguable that a fair-minded jury might reasonably find that the failure to disclose the conviction constituted negligence. But in our view, a fair-minded jury could not find that Titan acted recklessly under the Sunstrand standard that we adopt today. Thus, we hold that appellants have failed to raise a triable issue of fact as to their claim that Titan acted with the requisite scienter under § 10(b) and Rule 10b-5.
Appellants also claim that Titan should be primarily liable under § 10(b) and Rule 10b-5 for failing to inform them that Wilkowski had not made full restitution as of March 1984 to the individuals he had defrauded, although the terms of his plea agreement required restitution to be made by 1977. We also reject this claim. The only evidence that appellants point to is Wilkowski's letter to Titan and the NASD, in which he explained his understanding of the plea agreement. See R.E. at 321-22. Even when we view that document in the light most favorable to appellants, we do not believe that a fair-minded jury could infer from it that Titan knew that Wilkowski had not made restitution. Thus, appellants have failed to raise a triable issue as to their claim that Titan knew that Wilkowski had failed to make full restitution as of March 1984.
In sum, we affirm the district court's order granting Titan summary judgment on appellants' § 10(b) and Rule 10b-5 claim.
We next consider whether Titan can be held vicariously liable as a "controlling person" under § 20(a) of the 1934 Act for Wilkowski's violations of the securities laws. Section 20(a) provides:
15 U.S.C. § 78t(a).
To hold Titan liable under § 20(a), appellants must first establish that Titan was a "controlling person" within the meaning of the statute.
The district court interpreted the law of this circuit as requiring appellants to prove that Titan exercised "actual power or influence" over Wilkowski's fraudulent dealings and that Titan was a "culpable participant" in the alleged illegal activity in order to establish that Titan was a "controlling person" for the purpose of § 20(a). R.E. at 32 (citing Buhler, 807 F.2d at 835). The district court, after applying this test, granted Titan summary judgment on appellants' § 20(a) claim. First, the court reasoned that Titan had no "power or influence" over Wilkowski because Wilkowski was an independent contractor and Titan did not exercise any control over Wilkowski's defalcation
The SEC, as amicus curiae, joins appellants in arguing that the district court erred in holding that Titan could not be held vicariously liable as a "controlling person" under § 20(a) for Wilkowski's misdeeds. We agree. Today we hold that a broker-dealer is a controlling person under § 20(a) with respect to its registered representatives.
First, the SEC notes that this circuit and other circuits have interpreted the securities laws to impose a duty on broker-dealers to supervise their registered representatives.
521 F.2d at 1135.
The SEC argues that the representative/broker-dealer relationship is necessarily one of controlled and controlling person because the broker-dealer is required to supervise its representatives. This requirement arises from § 15 of the 1934 Act,
Second, the SEC argues that as a practical matter the broker-dealer exercises control over its registered representatives because the representatives need the broker-dealer to gain access to the securities markets. Again, the SEC points to § 15(a) of the 1934 Act, which provides that a person cannot lawfully engage in the securities business unless he or she is either registered with the NASD as a broker-dealer or as a person associated with a broker-dealer.
In contrast to the SEC's position, the district court's reasoning implied that even if Titan had the power to deny Wilkowski access to the trading markets or was required by statute to supervise his securities transactions, Titan still should not be considered a controlling person under § 20(a) because Wilkowski was an independent contractor, not an agent.
In sum, § 20(a) of the Act provides that a person cannot lawfully engage in the securities business unless he is either registered as or associated with a broker-dealer, and we see no basis in the statutory scheme to distinguish between those associated persons who are employees and agents on the one hand, and those who are independent contractors on the other. To exclude from the definition of controlling person those registered representatives who might technically be called independent contractors would be an unduly restrictive reading of the statute and would tend to frustrate Congress' goal of protecting investors. Thus, we reject the argument that broker-dealers can avoid a duty to supervise simply by entering into a contract that purports to make the representative, who is not himself registered under the Act as a broker-dealer, an "independent contractor."
To summarize, we hold that a broker-dealer is a controlling person under § 20(a) with respect to its registered representatives. This result is consistent with Zweig, where we said that "[t]o ensure the diligence of supervision and control, the broker-dealer is held vicariously liable if the representative injures the investor through violations of Section 10(b) or the rules thereunder promulgated." 521 F.2d at 1135. Thus, for appellants to establish that Titan was a controlling person, they need only show that Wilkowski was not himself a registered broker-dealer but was a representative employed by or associated with a registered broker-dealer. This they have done. The facts are not in dispute that Wilkowski was a registered representative associated with Titan. Accordingly, Titan was, as a matter of law, a "controlling person" under § 20(a) with respect to Wilkowski.
Titan also argues that it was not a controlling person because it was not a "culpable participant" in Wilkowski's deeds as required by Buhler, 807 F.2d at 835-36, and Christoffel v. E.F. Hutton & Co., 588 F.2d 665, 668-69 (9th Cir.1978).
The district court, citing earlier cases from our circuit, agreed with Titan and
Today, however, we hold that a plaintiff is not required to show "culpable participation" to establish that a broker-dealer was a controlling person under § 20(a).
Today we return to what had once been the law of our circuit, namely that § 20(a) requires the defendant to prove his good faith. In Safeway Portland Employees' Federal Credit Union v. C.H. Wagner & Co., Inc., 501 F.2d 1120, 1124 (9th Cir.1974), in discussing the analogous controlling person provision of the 1933 Act, we had said that "[t]hose claiming the exemption have the burden of proving it." In Buhler, Kersh, and Christoffel, however, we placed on the plaintiff the burden of disproving the defendant's good faith. In Orloff v. Allman, 819 F.2d 904, 906 n. 1 (9th Cir.1987), we noted the shift: "Buhler and Kersh II rely upon Christoffel v. E.F. Hutton & Co. ..., which overlooked prior circuit law." Now, we make clear that in an action based on § 20(a), the defendant who is a controlling person, and not the plaintiff, bears the burden of proof as to defendant's good faith. Thus, a plaintiff need not make a showing as to defendant's culpable participation; rather, a defendant has the burden of pleading and proving his good faith.
To summarize, a broker-dealer controls a registered representative for the purposes of § 20(a). By recognizing this control relationship, we do not mean that a broker-dealer is vicariously liable under § 20(a) for all actions taken by its registered representatives, Nor are we making the broker-dealer the "insurer" of its representatives, which is a result we rejected in Christoffel as going beyond the scope of the vicarious liability imposed upon a broker-dealer by § 20(a). The mere fact that a controlling person relationship exists does not mean that vicarious liability necessarily follows. Section 20(a) provides that the "controlling person" can avoid liability if she acted in good faith and did not directly or indirectly induce the violations. By making the good faith defense available to controlling persons, Congress was able to avoid what it deemed to be an undesirable result, namely that of insurer's liability, and instead it made vicarious liability under § 20(a) dependent upon the broker-dealer's good faith.
Contrary to the district court's ruling, the broker-dealer cannot satisfy its burden of proving good faith merely by saying that it has supervisory procedures in place, and therefore, it has fulfilled its duty to supervise. A broker-dealer can establish the good faith defense only by proving that it "maintained and enforced a reasonable and proper system of supervision and internal control." Zweig, 521 F.2d at 1134-35; see also Paul F. Newton & Co., 630 F.2d at 1120 (broker-dealer must show it "diligently enforce[d] a proper system of supervision and control"). Accordingly, the district court erred in ruling that because "Titan had adopted rules for accepting investment payments and for supervising a contractor's compliance with securities laws and regulations," it had satisfied its duty to supervise. R.E. at 34. Should Titan choose to rely upon the good faith defense, then it must carry its burden of persuasion that its supervisory system was adequate and that it reasonably discharged its responsibilities under the system. The evidence below raised material issues of fact as to whether Titan's supervision of Wilkowski was sufficient to entitle Titan to the good faith defense. Summary judgment was, accordingly, improper.
Appellants also claim on appeal that the district court erred in granting summary judgment to Titan on appellants' claim that Titan was secondarily liable for Wilkowski's § 10(b) violation under the common law theory of respondeat superior. Although it has been the law of our circuit that § 20(a) "supplants vicarious liability of an employer for the acts of an employee applying the respondeat superior doctrine," Christoffel, 588 F.2d at 667 (citing Zweig, 521 F.2d at 1132-33; Kamen & Co. v. Paul H. Aschkar & Co., 382 F.2d 689, 697 (9th Cir.1967), cert. dismissed, 393 U.S. 801, 89 S.Ct. 40, 21 L.Ed.2d 85 (1968)); see also Buhler, 807 F.2d at 835 n. 4 ("we continue to adhere to our prior holdings that the common law is supplanted by sections 15 and 20"), we now join several other circuits
In our earlier cases, we had concluded, without much explanation, that § 20(a) supplanted the doctrine of respondeat superior. For example, in Kamen, 382 F.2d at 697, we concluded that cases relying on respondeat superior had "no application to actions maintained under the Securities Acts." Then, in Zweig, 521 F.2d at 1132-33, we cited with approval our earlier decision in Kamen, in which we had rejected "[t]he contention that the more stringent doctrine of respondeat superior remained effective to establish vicarious liability." Id. at 1132. With no further explanation, we noted that "[t]he Kamen rule is well established in this circuit" and that "Kamen provides the controlling authority in [the Zweig] appeal." Id. More recently, in Christoffel, we reaffirmed, without elaboration, that it was "the established law of this circuit that section 20(a) supplants vicarious liability of an employer for the acts of an employee applying the respondeat superior doctrine." 588 F.2d at 667. In Buhler, 807 F.2d at 835 n. 4, we held that we would continue to abide by our prior holdings that "the common law is supplanted by sections 15 and 20." The only explanation we offered at the time was that "the securities laws in general were meant to impose liability only on culpable parties with enforceable control." Id.
After reexamination of the issue as an en banc court, we are now satisfied that "the `controlling person' provision of Section 20(a) was not intended to supplant the application of agency principles in securities cases, and that it was enacted to expand rather than to restrict the scope of liability under the securities laws." Marbury Management, 629 F.2d at 712; accord Paul F. Newton & Co., 630 F.2d at 1118 (The legislative "history does not reflect any congressional intent to restrict secondary liability for violations of the acts to the controlled persons formula.").
Section 20(a), which was modelled after the controlling person provision of § 15 of the Securities Act of 1933, 15 U.S.C. § 77o, was intended "to prevent evasion" of the law "by organizing dummies who will undertake the actual things forbidden."
Only if both respondeat superior and § 20(a) are available is the statutory scheme comprehensive and the public protected by the federal securities laws. "To allow a brokerage firm to avoid secondary liability simply by showing ignorance, purposeful or negligent, of the acts of its registered representative contravenes Congress' intent to protect the public, particularly unsophisticated investors, from fraudulent practices." Paul F. Newton & Co., 630 F.2d at 1118-19. When both remedies are available, then the agent who personally committed the wrong is primarily liable
Whether appellants will ultimately be able to hold Titan liable under either § 20(a) or respondeat superior depends on issues to be resolved on remand.
We now turn to appellants' remaining claims against Titan under federal securities laws.
We reverse the district court's order granting summary judgment to Titan on appellants' claim that Titan is secondarily liable under § 15 of the 1933 Act, 15 U.S.C. § 77o, for Wilkowski's violations of § 12(2).
Next, we affirm the district court's order granting summary judgment to Titan on appellants' claims under § 15 of the 1934 Act, 15 U.S.C. § 78o, because this section does not give rise to a private right of action. See SEC v. Seaboard Corp., 677 F.2d 1301, 1313-14 (9th Cir.1982). We also hold that the claims under § 17(a) of the 1933 Act, 15 U.S.C. § 77q(a), fail for the same reason. See In re Washington Pub. Power Supply Sys. Sec. Litig., 823 F.2d 1349, 1354-55 (9th Cir.1987) (en banc).
Finally, we affirm the district court's order granting summary judgment to Titan on appellants' claim that Titan was primarily liable under § 12(2) of the 1933 Act, 15 U.S.C. § 77l, because appellants abandoned that claim before the district court. See R.E. at 36.
We address appellants' claims against Painter separately. The character and basis of plaintiffs-appellants' claims against Painter were murky in the district court and remain so on appeal. Basically, appellants
We affirm summary judgment in favor of Painter on appellants' federal securities claims based on §§ 10(b) and 15 of the 1934 Act and on § 17(a) of the 1933 Act. With respect to appellants' claims attempting to hold Painter vicariously liable under § 20(a) of the 1934 Act and § 15 of the 1933 Act, the district court properly granted summary judgment to Painter. Painter is not a registered broker-dealer, nor does it engage in the sale of securities. Accordingly, Painter cannot be considered a controlling person under our analysis in Part III above. Appellants have cited no evidence that Painter exercised actual "power and influence" over Wilkowski's actions in embezzling funds. Thus, we hold that appellants have failed to raise a triable issue of material fact under either § 20(a) or § 15.
We AFFIRM the district court's order granting summary judgment in favor of Painter on all federal claims and dismissing all state law claims against Painter. We AFFIRM summary judgment as to Titan on all federal claims except for appellants' claims that Titan is secondarily liable under § 20(a), § 15, and respondeat superior for Wilkowski's violations of federal securities laws. Accordingly, we VACATE the district court's order dismissing pendent state claims against Titan.
CYNTHIA HOLCOMB HALL, Circuit Judge with whom RYMER, Circuit Judge, joins dissenting:
I concur in all but section IV of the majority opinion. I would hold that section 20(a) of the Act, which already imposes vicarious liability upon all employers for the fraudulent acts of their employees, precludes the grafting of the common law doctrine of respondeat superior onto a federal securities law action. The inclusion in the securities laws of statutory provisions which expressly impose controlling person liability indicates that Congress intended to exclude other forms of vicarious liability. If we impose secondary liability under respondeat superior upon Titan for Wilkowski's rule 10b-5 fraud, we effectively nullify the exculpatory provision of section 20(a) as well as the scienter element of a 10(b) claim. The majority bases its holding on an analysis of the legislative history behind section 20(a) and on policy arguments regarding the remedial nature of the Act. Majority opinion at 1577-1578. Both of these arguments are unpersuasive for a number of reasons.
A more comprehensive examination of the legislative history behind section 20(a) reveals the majority's conclusion to be somewhat facile. While preventing "dummy" corporations from escaping liability under the Act may have been one reason for the enactment of section 20(a) (see majority opinion at 1577),
Id. at 668.
Furthermore, the comments to section 20(a) made by Representative Rayburn, the then-Chairman of the House Committee on Interstate and Foreign Commerce, show that employers were meant to fall within that section, and thus be given the protection of the good faith defense. Rep. Rayburn's statement, contained in both the House Report and made on the floor of the House, includes "agency" among other forms of legal relationships under the rubric "control."
Finally, the majority's reading of the legislative history is illogical. On the one hand, the majority contends, Congress was so concerned with organizational "dummies" set up for the sole purpose of avoiding the antifraud provisions of the Act that it enacted section 20(a) and (b) just to catch them. At the same time, however, the majority suggests that Congress deliberately gave these "dummy" organizations a good faith defense which it denied to ordinary controlling persons such as lawful employers.
To hold an individual liable for securities fraud committed by his employee without proof of fault, in addition to being contrary to the position of Congress established in its legislative history, would violate the express language of the Act. Section 20(a) extends the good faith defense to employers, and nowhere is there an express statutory provision for expanding employer liability under respondeat superior. Section 10(b) prohibits manipulative or deceptive practices, but does not provide that it shall also be unlawful to employ a person who engages in such practices. When engaging in statutory interpretation, recent Supreme Court cases mandate that the courts consider only the actual language of the statute to divine Congressional intent, and not general principles of tort law or public policy. An analogy to those cases concerning when a private right of action is implied in federal securities cases is instructive. In Touche Ross & Co. v. Redington, 442 U.S. 560, 568, 99 S.Ct. 2479, 2485, 61 L.Ed.2d 82 (1979), the Court held that the lower court's reliance on tort principles to sustain a private cause of action under section 17(a) of the Securities Exchange Act of 1934 was "entirely misplaced." The Court stated that "[t]he invocation of the `remedial purposes' of the 1934 Act is ... unavailing. Only last Term we emphasized that generalized references to the `remedial purposes' of the 1934 Act will not justify reading a provision `more broadly than its language and the statutory scheme reasonably permit.'" Id. at 578, 99 S.Ct. at 2490. See also Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 15-16, 100 S.Ct. 242, 245, 62 L.Ed.2d 146 (1979) (Court refused to imply a private damage remedy under section 201 of the Investment Advisers Act of 1940, holding that a court should not consider "the desirability of implying private rights of action in order to provide remedies thought to effectuate the purposes of a given statute.").
Furthermore, the requirement of culpability underlying section 20(a) and the Act in general would be vitiated by the use of respondeat superior.
Respondeat superior, on the other hand, is a strict liability doctrine. See Restatement (Second) of Agency § 219 (1958) (stating that employees are servants, and a master is responsible for the torts of his servant when the torts are done while the servant is acting within the scope of his employment). The only inquiry under the doctrine of respondeat superior is whether the individual's fraudulent act was committed within the scope of his employment;
F. Harper & F. James, Jr., The Law of Torts 1367 (1956).
In common actions like the present one based upon misrepresentation by employees in connection with the purchase and sale of securities, a broker-dealer will virtually never be able to prove that such a representation was made outside an employee's scope of employment. See, e.g., Holloway v. Howerdd, 536 F.2d 690 (6th Cir.1976) (trial court concluded firm had met good faith defense but appellate court found firm vicariously liable for fraud of employee anyway as the brokerage firm "must be clearly disassociated from [the unlawful transactions] as otherwise it will incur liability on the basis of respondeat superior ..."). Holding broker-dealers secondarily liable under the common law doctrine of respondeat superior would render superfluous section 20(a), for they would be responsible despite their having fulfilled a stringent good faith test based on their having maintained and enforced reasonable and proper supervision and internal controls. See generally W. Fitzpatrick & R. Carman, Respondeat Superior and the Federal Securities Laws: A Round Peg In a Square Hole, 12 Hofstra L.Rev. 1 (1983).
Section 28(a) of the 1934 Act
While I realize that several other circuits have reached the opposite conclusion on this issue, there is not as strong a consensus as the majority suggests.
Holloway v. Howerdd, 536 F.2d 690 (6th Cir.1976), upon which the majority rely for the proposition that the Sixth Circuit holds that section 20(a) supplements respondeat superior, can be as easily read to support the dissenting position. Although not completely clear from the opinion, it appears that the court applied respondeat superior to a common law cause of action, not to a federal securities violation. "The use of the doctrine of respondeat superior to impose liability on TSI must be predicated on a finding that Tucker engaged in some illegal activity. The District Judge imposed liability on TSI on the basis that its employee, Tucker, was guilty of fraud and misrepresentation in his sale of Modular shares." Id. at 695. This interpretation is bolstered by the court's refusal to award attorney's fees to the plaintiff. "Liability has been imposed on TSI under the common law doctrine of respondeat superior for the misdeeds of its agent; however, TSI has been absolved of any liability arising under the Securities Act of 1933 itself. Therefore the statutory authorization for an award of attorney's fees [15 U.S.C. § 77k(e)] cannot be applied because the liability of TSI does not originate in the Act but in the common law." Id. at 697 (emphasis added). See also SEC v. Washington County Util. Dist., 676 F.2d 218, 224 n. 11 (6th Cir.1982), ("In essence, the Commission, in Coffey, attempted to hold King liable on the basis of respondeat superior. We refused to impose liability on that theory. Coffey, 493 F.2d at 1315. Accord, Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880, 886 (3d Cir.1975); Zweig v. Hearst Corp., 521 F.2d 1129 (9th Cir.1975.)").
Though it is true that the First, Second, Third, Eighth and Tenth Circuits hold to the contrary, we are not, of course, bound by those decisions. Following the letter of the statute and allowing a broker-dealer his good faith defense in no way diminishes his obligation under the Act. He is still accountable, both administratively to the Commission and civilly to the public, for his misdeeds and failure to supervise his employees. The public is well protected by state, federal, and common law without subjecting employers to insurer liability for acts they did not commit and could not have reasonably anticipated or guarded against. Therefore, I respectfully DISSENT.
Although the Fourth Circuit has not explicitly found recklessness to be sufficient, district courts in that circuit have so held. See In re EPIC Mortgage Ins. Litig., 701 F.Supp. 1192, 1250 (E.D.Va.1988) (citing cases), aff'd in part, rev'd in part on other grounds sub nom. Foremost Guar. Corp. v. Meritor Sav. Bank, 910 F.2d 118 (4th Cir.1990).
Record Excerpts ("R.E.") at 321-22.
17 C.F.R. § 230.405.
15 U.S.C. § 78o(b)(4).
15 U.S.C. § 78o(a).
15 U.S.C. § 78o(b)(4)(E)(i).
R.E. at 311-12.
The Third Circuit has held that respondeat superior "should not be widely expanded in the area of federal securities regulation," but that it should be available against broker-dealers and accounting firms in view of "the public trust of the firms involved, and the duty to supervise arising therefrom." Sharp v. Coopers & Lybrand, 649 F.2d 175, 182-83 (3d Cir.1981), cert. denied, 455 U.S. 938, 102 S.Ct. 1427, 71 L.Ed.2d 648 (1982); see also Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 884-86 (3d Cir.1975).
The Fourth Circuit law is in a state of confusion. Compare Carras v. Burns, 516 F.2d 251 (4th Cir.1975) with Carpenter v. Harris, Upham & Co., 594 F.2d 388 (4th Cir.), cert. denied, 444 U.S. 868, 100 S.Ct. 143, 62 L.Ed.2d 93 (1979). One district court thinks that Carpenter overruled Carras sub silentio. Haynes v. Anderson & Strudwick, Inc., 508 F.Supp. 1303, 1311 (E.D.Va.1981). Two other district courts, disagreeing, distinguished Carpenter and continued to follow Carras. Frankel v. Wyllie & Thornhill, Inc., 537 F.Supp. 730, 740-42 (W.D.Va.1982); Baker v. Wheat First Sec., 643 F.Supp. 1420, 1425-27 (S.D.W.Va.1986).
The Seventh, Eleventh, and District of Columbia Circuits have not directly spoken to the issue.
Although the dissent suggests that the Sixth Circuit in Holloway v. Howerdd did not apply respondeat superior to federal causes of action, but only to state law causes of action, there is no mention of any state law cause of action in that case. Holloway v. Howerdd 536 F.2d at 692. The district court decision, which the Holloway court affirmed, explicitly applied respondeat superior to a § 12(2) claim. Id. at 694 (the district court held that "the liability of TSI under § 12(2) was predicated upon the doctrine of respondeat superior"). Significantly, Holloway explicitly disagreed with the Ninth Circuit authority we overrule today. Id. at 695.
15 U.S.C. § 77o.
Securities Exchange Act of 1934 § 20(b), 15 U.S.C. § 78t(b) (1976).
When referring to the two sections, the report of the Committee on Interstate Commerce stated that section 20(a) makes "a person who controls a person ... liable to the same extent as the person controlled unless the controlling person acted in good faith and did not induce the act in question." 78 Cong.Rec. 7709 (1934). In discussing section 20(b), the Committee noted that that section "makes it unlawful for any person to do, through any other person, anything that he is forbidden to do himself." Id.
Securities and Exchange Act of 1933 § 15, as amended, 15 U.S.C. § 77o (1976) provides:
78 Cong.Rec. 7709 (1934) (daily ed. April 30, 1934 statement of Representative Rayburn); accord H.R.Rep. No. 1383, 73d Cong., 2d Sess. 26 (1934).
The Seventh, Eleventh, and District of Columbia Circuits have apparently not spoken on this issue.