Under the Securities Exchange Act of 1934, §20(a) control person claims often play second fiddle—tagging alongside lead claims asserting securities fraud under §10(b) of the Securities Exchange Act and SEC Rule 10b-5.[i] This ordinarily makes sense because §20(a) claims are predicated on a primary violation of the Exchange Act. As such, when any §10(b) claims survive a motion to dismiss, the corresponding §20(a) claims will usually survive as well. However, an often-overlooked aspect of control person liability occurs when a §10(b) claim has been dismissed as to the controlling person, but the motion to dismiss a §10(b) claim against a co-defendant has been denied.

When multiple defendants are named in a complaint and the court finds liability for some, but not all defendants, those found not liable for §10(b) violations can still be liable for control person claims. An example fact pattern is as follows: defendant A, the CEO, and defendant B, the CFO are alleged to have made false and misleading statements in violation of §10b-5 in reports filed with the SEC by defendant C, the company. In an order partially granting the defendants’ joint motion to dismiss, the court finds the CEO liable for misrepresentations made with scienter. At this point, there is a primary violation of a controlled person (the company), which forms the basis of the control person claim. The court then goes on to find that CFO did not have scienter, and thus dismisses both the §10b-5 claim and §20(a) claim against the CFO.

Dismissing both claims could be incorrect, however, because the CFO could still be liable for the control person claim. For instance, if the CFO signed the annual and quarterly reports containing the alleged fraud, and the plaintiff alleged the CFO had control over the company, then the CFO can still be liable under control person liability for the company’s violations.  Furthermore, because a “‘plaintiff does not have the burden of establishing that person’s scienter distinct from the controlled corporation’s scienter’” control person liability can be found for a defendant who otherwise had no scienter. [ii]

A similar fact pattern arose in Moradpour v. Velodyne Lidar, Inc., 2022 U.S. Dist. LEXIS 241994 (N.D. Cal. Oct. 12, 2022) (“Velodyne”) where the Court incorrectly dismissed a control person liability claim. In Velodyne, the plaintiffs asserted fraud claims brought under §10(b) and advanced four categories of false or misleading statements by the defendants related to their efforts to drum up support for the SPAC merger and inflate the price of Velodyne securities. [iii] The court sustained the §10(b) claims against defendants Velodyne, Anand Gopalan (“Gopalan”), and Michael Dee (“Dee”) based on untrue or misleading statements relating to the ouster of the founder David Hall (“Hall”). [iv] The court likewise sustained the §20(a) control person claims for defendants Gopalan and Dee based on Velodyne’s statements about Hall’s ouster. [v] However, the plaintiffs moved for clarification of the court’s dismissal, in full, of claims asserted against another defendant, Andrew Hamer (“Hamer”), Velodyne’s CFO and Treasurer who signed several Velodyne SEC filings which contained the same actionable material misstatements about Hall’s ouster. [vi]

To demonstrate “a prima facie case under § 20(a), plaintiff must prove: (1) a primary violation of federal securities laws[;] and (2) that the defendant exercised actual power or control over the primary violator[.]” [vii] In Velodyne, the court found a primary violation of the securities laws against defendants Velodyne, Gopalan, and Dee for statements about the ouster. Thus, the plaintiffs needed only to prove that Hamer exercised control over the violator, and courts routinely sustain §20(a) control claims against corporate officers who, as with defendant Hamer, sign written documents containing actionable misstatements. [viii]

In the order granting plaintiff’s motion to clarify, the court acknowledged that “[d]ismissing claims against Hamer was an oversight[]” and corrected its prior order to deny the motion to dismiss as it pertains to the §20(a) claim against Hamer based on Hall’s ouster. [ix]

This example serves to demonstrate that close attention pays off, even for the often overshadowed §20(a) claims.

[i] 15 U.S.C. §§ 78j(b) and 78t(a)), 17 C.F.R. § 240.10b-5.

[ii] Howard v. Everex Sys. Inc., 228 F.3d 1057, 1065 (9th Cir. 2000).

[iii] Id. at *5.

[iv] Id. at *5-6.

[v] Id.

[vi] Moradpour v. Velodyne Lidar, Inc., No. 21-cv-01486-SI, ECF No. 124 (N.D. Cal. July 22, 2022).

[vii] Howard 228 F.3d at 1065.

[viii] See Howard, 228 F.3d at 1065-66 (“review and signature of the financial statements[]” sufficient to “presume control[.]”).

[ix] Moradpour v. Velodyne Lidar, Inc 2022 U.S. Dist. LEXIS 241994, at *9-10 (N.D. Cal. Oct. 12, 2022).