Kay Hollinger Richard Llewelyn Jones Edward E. Nissen Judy D'Arcy K-Judy, Ltd. v. Titan Capital Corp. Emil Wilkowski Painter Financial Group, Ltd.

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:

1. What standard of recklessness meets the scienter requirement for a claim under Sec. 10(b) and Rule 10b-5?1

2. Is a broker-dealer a "controlling person" with respect to its registered representatives within the meaning of Sec. 20(a) of the 1934 Act?2 And does plaintiff or defendant bear the burden of proving the good faith exception to controlling person liability under Sec. 20(a)?

3. May broker-dealers be held vicariously liable under the common law doctrine of respondeat superior for securities law violations committed by their registered representatives?

We will address each of these questions in the course of considering appellants' various claims under the federal securities laws.I

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 fingerprints 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 antifraud provisions of the federal securities laws and under state law. The district court awarded summary judgment to both Titan and Painter on all of appellants' federal claims and dismissed appellants' pendent state claims.3 We affirm summary judgment in favor of Painter on all federal claims. We affirm summary judgment in favor of Titan on all federal claims, except three: 1) the claim that Titan is liable for Wilkowski's wrongdoing as a "controlling person" under Sec. 20(a) of the 1934 Act, 15 U.S.C. Sec. 78t(a); 2) the claim that Titan is liable as a "controlling person" under Sec. 15 of the Securities Act of 1933 Act ("1933 Act"), 15 U.S.C. Sec. 77o4; and 3) the claim that Titan is liable as Wilkowski's employer under the common law theory of respondeat superior.

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 Sec. 10(b) of the 1934 Act and Rule 10b-5 for failing to disclose to investors Wilkowski's prior forgery conviction.5 Section 10(b) makes it unlawful "[t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 15 U.S.C. Sec. 78j(b). Rule 10b-5, which implements Sec. 10(b), makes it unlawful:

(a) to employ any device, scheme, or artifice to defraud,

(b) to make any untrue statement of a material fact, or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading.

17 C.F.R. Sec. 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 Sec. 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 Sec. 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 Sec. 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,6 has held that recklessness may satisfy the element of scienter in a civil action for damages under Sec. 10(b) and Rule 10b-5. E.g., Kehr v. Smith Barney, Harris Upham & Co., 736 F.2d 1283, 1286 (9th Cir.1984); Nelson v. Serwold, 576 F.2d 1332, 1337-38 (9th Cir.), cert. denied, 439 U.S. 970, 99 S.Ct. 464, 58 L.Ed.2d 431 (1978). We continue to adhere to that view.

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),7 and adhered to, albeit with some variation, by a majority of circuits.8 In Sunstrand, the Seventh Circuit held that "a reckless omission of material facts upon which the plaintiff put justifiable reliance in connection with a sale or purchase of securities is actionable under Section 10(b) as fleshed out by Rule 10b-5." Id. at 1044. The Sunstrand court quoted with approval a lower court's definition of recklessness in the context of omissions:

[R]eckless conduct may be defined as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.

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 must be actually known or so obvious that any reasonable man would be legally bound as knowing, and the omission must derive from something more egregious than even 'white heart/empty head' good faith." Id. (footnotes omitted); accord Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 47 (2d Cir.) (Reckless conduct is conduct that is "highly unreasonable" and represents "an extreme departure from the standards of ordinary care ... to the extent that the ... defendant must have been aware of it.") (quoting Sanders v. John Nuveen & Co., 554 F.2d 790, 793 (7th Cir.1977)), cert. denied, 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698.

In adopting the Sunstrand standard of recklessness, we put to rest the "flexible duty standard"9 announced in White v. Abrams, 495 F.2d 724, 735-36 (9th Cir.1974). As noted by Judge Ferguson in his special concurrence in Spectrum Fin. Cos. v. Marconsult, Inc., 608 F.2d 377, 382 (9th Cir.1979) (Ferguson, J., concurring), cert. denied, 446 U.S. 936, 100 S.Ct. 2153, 64 L.Ed.2d 788 (1980), the flexible duty test was expressly disapproved in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), because it is essentially a negligence standard. Even after the Supreme Court had rejected White 's flexible duty test, see 425 U.S. at 193 n. 12, 96 S.Ct. at 1381 n. 12,10 the test continued to resurface in our cases.11 But as Judge Ferguson rightly pointed out, the flexible duty test is a negligence test "designed to compartmentalize and simplify a negligence inquiry," Spectrum, 608 F.2d at 385, and Hochfelder rejected negligence in favor of a scienter requirement.

In applying the Sunstrand test to the facts of this case,12 the essential inquiry becomes: Was Titan's failure to disclose Wilkowski's eleven-year old forgery conviction highly unreasonable and did it constitute an extreme departure from standards of ordinary care?

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:13 that he believed that his record had been expunged after five years under the terms of his plea agreement.14

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. Sec. 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. Sec. 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,15 the fact that Wilkowski was registered unconditionally and that the registration was neither revoked nor conditioned after the forgery conviction surfaced is relevant to the question of whether Titan acted recklessly when it omitted to inform appellants of the conviction.

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 conclude that the evidence would be insufficient to support a finding of fact that the conviction created a highly unreasonable risk that should have been obvious to Titan. A broker-dealer is not required to inform investors of every negative fact it knows about its registered representatives. It is a matter of judgment whether the negative facts create such a highly unreasonable risk of untrustworthiness that it would constitute recklessness. Here, we conclude that Titan's failure to disclose Wilkowski's eleven-year old conviction did not create such an unreasonable risk to investors that Titan's failure to disclose the conviction was an extreme departure from the standard of ordinary care.

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 Sec. 10(b) and Rule 10b-5.

Appellants also claim that Titan should be primarily liable under Sec. 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' Sec. 10(b) and Rule 10b-5 claim.

We next consider whether Titan can be held vicariously liable as a "controlling person" under Sec. 20(a) of the 1934 Act for Wilkowski's violations of the securities laws. Section 20(a) provides:

Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, 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.

15 U.S.C. Sec. 78t(a).

To hold Titan liable under Sec. 20(a), appellants must first establish that Titan was a "controlling person" within the meaning of the statute.16

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 Sec. 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' Sec. 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 of funds; did not benefit from the defalcation of funds; and did not authorize Wilkowski to receive personal checks. See id. Second, the court concluded that because Titan and Wilkowski had contractually agreed that Wilkowski would be an independent contractor, Titan had no duty to supervise unauthorized and unknown transactions and therefore could not have been a "culpable participant" in Wilkowski's misdeeds. See id. at 34. In applying the language in Buhler, the District Court made the question of whether Titan controlled Wilkowski turn on the particular business arrangement of the parties.

* 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 Sec. 20(a) for Wilkowski's misdeeds. We agree. Today we hold that a broker-dealer is a controlling person under Sec. 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.17 In Zweig, we noted that Congress adopted Sec. 20(a) in an attempt to protect the investing public from representatives who were inadequately supervised or controlled:

Purchasers of securities frequently rely heavily for investment advice on the broker-representative handling the purchaser's portfolio. Such representatives traditionally are compensated by commissions in direct proportion to sales. The opportunity and temptation to take advantage of the client is ever present. To 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. The very nature of the vast securities business, as it has developed in this country, militates for such a rule as public policy and would seem to suggest strict court enforcement.

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 Sec. 15 of the 1934 Act,18 which the SEC has interpreted as authority to impose sanctions on broker-dealers who have failed to provide adequate supervision of their registered representatives. See, e.g., In re Reynolds & Co., 39 S.E.C. 902, 916-17 (1960); In re Bond & Goodwin, Inc., 15 S.E.C. 584, 601 (1944).

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 Sec. 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.19 Because a sales representative must be associated with a registered broker-dealer in order to have legal access to the trading markets, the broker-dealer always has the power to impose conditions upon that association, or to terminate it. The broker-dealer's ability to deny the representative access to the markets gives the broker-dealer effective control over the representative at the most basic level. Moreover, because the broker-dealer is required by statute to establish and enforce a reasonable system of supervision to control its representatives' activities,20 the broker-dealer necessarily exerts ongoing control over the types of transactions made by the representative and her ways of handling clients' accounts.

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 Sec. 20(a) because Wilkowski was an independent contractor, not an agent.21 We find no support in the statutory scheme for such a restrictive definition of controlling person that would exclude independent contractors, and thus, we do not distinguish for purposes of Sec. 20(a) between registered representatives who are employees or agents and those who might meet the definition of independent contractors.

In sum, Sec. 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."22

To summarize, we hold that a broker-dealer is a controlling person under Sec. 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 Sec. 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 ruled that a broker-dealer is not a "controlling person" under Sec. 20(a) unless the plaintiff proves that the broker-dealer was a "culpable participant" in the violation.23

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 Sec. 20(a).24 The statute does not place such a burden on the plaintiff. Section 20(a) provides that a "controlling person" is liable "unless [he] acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action." 15 U.S.C. Sec. 78t(a). Thus, the statute premises liability solely on the control relationship, subject to the good faith defense. According to the statutory language, once the plaintiff establishes that the defendant is a "controlling person," then the defendant bears the burden of proof to show his good faith.25

Today we return to what had once been the law of our circuit, namely that Sec. 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 Sec. 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 Sec. 20(a). By recognizing this control relationship, we do not mean that a broker-dealer is vicariously liable under Sec. 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 Sec. 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 Sec. 20(a) dependent upon the broker-dealer's good faith.26C

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 Sec. 10(b) violation under the common law theory of respondeat superior. Although it has been the law of our circuit that Sec. 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,