In an unprecedented recent decision, four members of the Board of Directors of the brokerage firm Stratton Oakmont were hit with a $10 million dollar punitive damage award. This is the largest punitive damage award ever rendered in a securities arbitration case. It is newsworthy not just because of the size of the award, but because the hefty penalty was levied against the President of the brokerage firm, the Vice President, the head of Corporate Finance, and the firm’s head trader. Some of these individuals had no contact with the aggrieved investor or the stockbroker involved in the case.

Run-Of-The-Mill

In many respects, the case appeared to be your run-of-the-mill securities case: a California doctor complained that his broker put him in risky investments, made unauthorized trades, and churned the account (made too many trades) to the tune of $185,000 in damages. Typically, such cases are brought against the stockbroker and the brokerage firm and if wrongdoing is found, the brokerage firm pays. Problems arise when the brokerage firm is in financial straits, as Stratton Oakmont was. Last December, the NASD expelled the firm for, among other things, using boiler room tactics in the sale of risky securities to investors. In January, Stratton Oakmont filed bankruptcy, in a failed attempt to protect itself from having to pay some $5 million in unpaid arbitration judgments. The bankruptcy judge rejected Stratton Oakmont’s application and ordered it to liquidate.

What good is a judgment if you can’t collect it? The California attorney who brought the case, a friend of mine, knew that when wrongful activity flourishes, someone behind the scenes is typically profiting. In Stratton Oakmont’s case, it was the Board of Directors. So my friend added to his lawsuit the Board of Directors on the theory that these individuals failed to supervise the erring stockbroker. This theory is also known as "control person" liability.

Are You A Control Person?

You are a control person if you are employed in the securities industry and if you have the ability to influence or direct the actions of those also employed in the securities industry. This would most likely cover all individuals in management positions. It does not require, though, that you be the direct supervisor of the violator; you can bet that the stockbroker in the Stratton case did not report to the President of the company. He may have had no idea who the President was!

In some states, the governing law requires that the control person have actually participated in the wrongdoing in order to be held liable for it. Not so in the majority of states, including Colorado. As a control person, you could be found liable for the actions of others when you played no role whatsoever in the wrongful activity. Nor is it necessary that you even know about the wrongful activity. The officers in the Stratton case defended by simply denying knowledge of any of the wrongdoing. Ignorance was no defense for them.

It is enough if you merely possess the power to control the actions of the wrongdoer. You may be liable, even though the stockbroker is an independent contractor, even though you never met the stockbroker, and even though you never communicated with the client. Further, you may not be able to defend yourself simply by pointing to the supervisory procedures you had in place. A greater showing is required - you must show that you enforced those supervisory procedures.

Hollow Victory

The root of the word "punitive" is punire - in Latin "to punish". The arbitration panel’s award sent a message loud and clear to securities firm Board of Directors nationwide. However, it may be a hollow victory for the doctor in California and his attorney. I currently have a multi-party case pending against Dickinson & Company, a brokerage firm which recently closed its retail brokerage operation business. I suspect this move was motivated, in part, by the pendency of my multi-million dollar cases. Even if we prevail, my clients cannot collect against a company that has shut its doors. Fortunately, I named the President of Dickinson & Company as a responsible party. We will see what happens. I will report later on my friend’s effort to collect his $10 million dollar award, but odds are these same men will re-emerge, after a bankruptcy cleansing, in management positions in new brokerage firms. As so many in this business do.

Tracy Pride Stoneman is an attorney specializing in investment related complaints. Email her at Tracy@InvestorFraud.com.