This is from the SEC website:
“Control securities are those held by an affiliate of
the issuing company. An affiliate is a person, such as a director or
large shareholder, in a relationship of control with the issuer. Control means the power
to direct the management and policies of the company in question, whether
through the ownership of voting securities, by contract, or otherwise. If
you buy securities from a controlling person or "affiliate," you take
restricted securities, even if they were not restricted in the affiliate's
hands.”
Unfortunately, the 1933 Act
does not define the terms "control person" or "control
relationship". However, the SEC in Rule 405 sets forth a definition of
control as follows:
"The term
"control" (including the terms "controlling,"
"controlled by," and "under common control with," means the
possession, direct or indirect, of the power to direct or cause the direction
of the management and policies of a person, whether through the ownership of
voting securities, by contract, or otherwise.”
The SEC staff
and the courts utilize two rather imprecise tests in determining who is a control
person, or - using the terminology of Rule 144 - an "affiliate.
First, does the person in
question have the power to direct corporate management and policies?
Second, does the individual
have the power to compel the Issuer to file a 1933 Act registration statement
covering a proposed sale?
Obviously these
tests are largely subjective. Most securities lawyers take the position that,
generally, all corporate directors as well as senior officers of a corporation
are control persons of that corporation for 1933 Act purposes. Corporate
officers below that level, as well as officers and directors of subsidiaries
are, generally, not presumed to be control persons. The identity and number of
1933 Act control persons will vary from company to company.
With regard to
1933 Act control status, it is clear that corporate officers or directors positions
are not the only defining characteristic in determining whether or not one is
considered a control person. Large share ownership is also indicative of control
status.
However, again,
there is no precise test such as the 10% test applied to certain insiders under
the Securities Exchange act of 1934. It largely depends upon the conditions
surrounding each case.
For example,
persons occupying a certain relationship with a control person may themselves be
treated as control persons. A relative or spouse of a control person living in
the same home is also a control person. Any relative of a control person's
spouse -- for instance, a mother-in-law sharing the same home -- may also be
found to be a control person.
Therefore, you
may or may not be considered a control person depending upon your ongoing
relationship with the company, your relationship with other control persons, or
your continued ownership of a large block of the company's shares.
The SEC advises that beneficial
ownership of more than 10% percent of an issuer’s outstanding equity securities
generally gives rise to presumptive affiliate status.
In addition, affiliate
status could be attributed through other indicia of control, such as board
representation and negative control rights.
Although the presumption is
rebuttable, a person who claims that he is not an affiliate in order to use the
exemption from registration has the burden of proving the availability of the
exemption.
While there is not a substantial body of law surrounding this issue for
Rule 144, there are a number of cases discussing this issue under Sections 15
and 20(a) of the Securities and Exchange Act.
In looking at these cases, we are concerned here only with what fact
patterns establish control.
Actual control or the ability to control is certainly enough. In some
cases, the courts have ruled that indirect means of discipline or influence is
enough.
Some cases have found possession of potential power, to control is
enough, not actual use of that control.
Inaction by a defendant is enough where it is willful or done intent to
further some misconduct.
Outside directors have on occasion found to be liable. Outside directors
who own stock have been found to be liable.
Officers and directors have been found to have control, naturally.
Officers and directors with significant stock holdings obviously have control.
People who make or sign misleading statements may be found liable. Other
employees of an issuer have been found to have control, as have persons acting
in disguised capacities, nominal, figurehead or de facto office holders.
Rule 405, by its language, refers to control broadly as
"the possession, direct or indirect, of the power to direct or cause the
direction of the management and policies of a person whether through ownership
of voting securities, contract, or otherwise."
Control depends in part on the influence of
an individual.
Control can be inferred from a result. For example, one court
held that where the controlling persons so dominated those controlled as to be
able to gain upwards of 90% of the stock from the owners, those facts
demonstrated control.
We suggest that
if you own at least 10% of the stock or if you are a director or are in senior
management you should consider yourself to be a control person and an affiliate.
If members of your immediate family are any of the foregoing you are an
affiliate or control person.
