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Control Person Liability under the Colorado Securities Act
What Investors should know
By Russell Bean - July 25, 2017
The Colorado Court of Appeals recently issued an opinion analyzing control person liability under the Colorado Securities Act. Under the Colorado Securities Act, a control person is jointly and severally liable for violations of the Act by the primary wrongdoer unless the control person can show it acted in good faith and did not induce the acts constituting the violation. In Houston v. Southeast Investments N.C., Inc. (2017 COA 66), issued on May 18, 2017, the Court held that an investor must demonstrate (1) that a primary violation of the securities law occurred and (2) that the broker-dealer is a controlling person, in order to invoke the control person rule. However, the Court recognized an exception to the general rule that a broker-dealer is a controlling person of its registered representative where (1) the plaintiff did not reasonably rely on the representative’s relationship with the broker-dealer in making their investment, (2) the plaintiff invested in markets other than those promoted by the broker-dealer, (3) the representative did not rely on its relationship with the broker-dealer to access the securities market in order to sell the subject securities to the plaintiff, and (4) the broker-dealer did not know of, or have a financial interest in the plaintiff’s business with the representative.
The exception would be an issue where a registered representative is engaging in a securities transaction away from his firm (“selling away”) or is engaging in an outside business activity. In Houston, the plaintiff gave her retirement savings to Mr. Hornick to invest. In turn, Mr. Hornick worked at 1st Consumer Financial Services (“CFS”) with Mr. Sorenson. Mr. Sorenson was a registered representative for Southeast Investments, but he had failed to disclose CFS to Southeast, and Mr. Hornick was not registered with Southeast. When the plaintiff lost her retirement savings, she brought an action against Southeast as a control person of Sorenson. The Court determined that Southeast was not a control person of Sorenson with regard to his outside activity at CFS or the securities transaction between Hornick and the plaintiff.
In response to the plaintiff’s argument that Southeast failed in its obligation to properly supervise Mr. Sorenson, the Court stated that the adequacy Southeast’s supervision would only be an issue if Southeast asserted it affirmative defense of good faith. Since Southeast did not control Mr. Sorenson’s activities in this instance, it did not need to assert its affirmative defense.
The Court’s decision is in keeping with federal law regarding control person liability.
For investors seeking to impose control person liability, make sure (1) that your representative is licensed with his broker-dealer by checking https://brokercheck.finra.org/, (2) that the products your representative is offering to you have been approved by his broker-dealer, and (3) that your funds only go to the broker-dealer and not to the representative or a third party directly.
The exception would be an issue where a registered representative is engaging in a securities transaction away from his firm (“selling away”) or is engaging in an outside business activity. In Houston, the plaintiff gave her retirement savings to Mr. Hornick to invest. In turn, Mr. Hornick worked at 1st Consumer Financial Services (“CFS”) with Mr. Sorenson. Mr. Sorenson was a registered representative for Southeast Investments, but he had failed to disclose CFS to Southeast, and Mr. Hornick was not registered with Southeast. When the plaintiff lost her retirement savings, she brought an action against Southeast as a control person of Sorenson. The Court determined that Southeast was not a control person of Sorenson with regard to his outside activity at CFS or the securities transaction between Hornick and the plaintiff.
In response to the plaintiff’s argument that Southeast failed in its obligation to properly supervise Mr. Sorenson, the Court stated that the adequacy Southeast’s supervision would only be an issue if Southeast asserted it affirmative defense of good faith. Since Southeast did not control Mr. Sorenson’s activities in this instance, it did not need to assert its affirmative defense.
The Court’s decision is in keeping with federal law regarding control person liability.
For investors seeking to impose control person liability, make sure (1) that your representative is licensed with his broker-dealer by checking https://brokercheck.finra.org/, (2) that the products your representative is offering to you have been approved by his broker-dealer, and (3) that your funds only go to the broker-dealer and not to the representative or a third party directly.