Control person

What Is Control Person?

A control person is an individual or entity with the power to influence, direct, or control the management and policies of a publicly traded company. This designation is crucial in securities law and regulation because it subjects such individuals or entities to specific rules and liabilities designed to protect investors and maintain fair markets. The determination of control status typically depends on the specific facts and circumstances, rather than a rigid set of criteria. Factors often considered include holding a position as an officer or director, owning a significant percentage of voting securities, or having other means to influence corporate decisions.²⁴, ²⁵

History and Origin

The concept of a control person emerged from early U.S. securities legislation, particularly the Securities Act of 1933 and the Securities Exchange Act of 1934. These foundational laws were enacted to restore investor confidence following the 1929 stock market crash and the ensuing Great Depression. A primary objective was to ensure adequate disclosure of information to the public and prevent fraud.²³

The laws recognized that individuals or groups with significant influence over a company could potentially abuse their position to the detriment of other shareholders. Therefore, specific regulations were put in place to govern the actions of these influential figures. The U.S. Securities and Exchange Commission (SEC), established by these acts, developed rules like Rule 405, which broadly defines "control" 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 the ownership of voting securities, by contract, or otherwise."²¹, ²² This definition lays the groundwork for identifying who qualifies as a control person and, consequently, who is subject to enhanced regulatory scrutiny.

Key Takeaways

• A control person is an individual or entity with the power to direct or influence a company's management and policies.
• This designation is critical in securities law, triggering specific responsibilities and liabilities, particularly regarding the sale of securities.
• Officers, directors, and significant shareholders are typically presumed to be control persons, though the determination is often fact-dependent.
• Control persons are subject to stricter rules for selling company stock, such as those outlined in Rule 144.
• The aim of these regulations is to prevent the misuse of inside information and ensure transparency in the markets.

Interpreting the Control Person

Determining whether an individual or entity is a control person is a factual inquiry, often without a rigid threshold. While holding positions like officer or director, or owning a significant percentage of shares (e.g., 10% or more of voting stock), can lead to a presumption of control, these factors are not exclusively determinative.¹⁹, ²⁰ The core of the assessment is whether the person has the capacity to influence or direct the company's decisions, regardless of the formal title or exact ownership percentage. For instance, even a shareholder with less than 10% ownership might be deemed a control person if they exert substantial influence through board representation or other relationships.¹⁸ Conversely, an officer without actual decision-making power might not be considered a control person in certain contexts. Courts and the SEC evaluate the overall facts and circumstances, focusing on actual influence rather than just formal roles.¹⁶, ¹⁷

Hypothetical Example

Consider "Apex Innovations Inc.," a hypothetical technology company. Jane, who serves as a senior executive and sits on Apex's board of directors, owns 5% of the company's outstanding shares. Despite her ownership being less than 10%, her position as an executive and a board member means she actively participates in major strategic decisions, including mergers and acquisitions, and has access to sensitive, non-public information. Due to her direct involvement in directing the management and policies of Apex Innovations, Jane would be considered a control person. If Jane wished to sell her shares, even though they are not restricted securities by initial acquisition, her status as a control person would subject her sale to the volume and manner of sale restrictions under SEC Rule 144. She would likely need to sell her shares through a broker and adhere to specific reporting requirements, unlike an ordinary investor selling their shares on the stock market.

Practical Applications

The designation of a control person has significant implications across various aspects of finance and regulation, primarily in the realm of securities regulation.

• Securities Sales: One of the most common applications is in the sale of securities. Control persons who wish to sell their company's stock in the public market must do so in compliance with SEC Rule 144.¹⁵ This rule imposes specific conditions, including holding periods (for restricted shares), volume limitations, manner of sale requirements (e.g., through brokers' transactions), and public notice filings (Form 144) for sales exceeding certain thresholds.¹³, ¹⁴ This is to prevent large, unannounced sales that could destabilize the market or be based on undisclosed material information.
• Insider Trading Prevention: Control persons often possess material non-public information. The strict rules governing their securities transactions, combined with broader anti-fraud provisions, aim to prevent them from profiting illegally from such information. The SEC Division of Corporation Finance plays a critical role in overseeing the disclosure practices of public companies, helping ensure that investors receive the necessary information to make informed decisions.¹²
• Liability: Control persons can face legal liability for violations of securities laws committed by the entities they control.¹¹ This "control person liability" is a significant mechanism for enforcement, ensuring that individuals with the power to direct a company are held accountable for its compliance with regulations.
• Corporate Governance: The concept underpins many corporate governance principles, particularly those related to the duties and responsibilities of company executives and directors. It underscores the expectation that those in control act in the best interests of the company and its shareholders.

Limitations and Criticisms

While the concept of a control person is essential for regulatory oversight, its application can present limitations and invite criticism. One primary challenge lies in the subjective nature of determining "control." The SEC's definition in Rule 405 is broad, focusing on the "power to direct or cause the direction," which is highly fact-specific and can lead to ambiguities.¹⁰ This lack of a bright-line rule can create uncertainty for individuals and companies, making it difficult to definitively know when one crosses the threshold into control person status.

Furthermore, legal interpretations of control can vary among courts, leading to inconsistent rulings on what constitutes actual power or influence.⁹ This variability can complicate compliance and enforcement efforts. Critics might argue that without clearer quantitative thresholds, the determination can be arbitrary or dependent on extensive legal analysis of a person's relationships and actions, rather than clear, objective criteria. This can impose a significant compliance burden on individuals and the legal teams responsible for advising them on securities transactions. The process of getting a restrictive legend removed from control securities by a transfer agent often requires an opinion letter from the issuer's counsel, highlighting the legal complexities involved.⁸

Control Person vs. Affiliate

The terms "control person" and "affiliate" are closely related within securities law and are often used interchangeably, but they have distinct definitions and implications.

An affiliate, as defined in SEC Rule 405 under the Securities Act of 1933, is a person who directly or indirectly controls, is controlled by, or is under common control with, a specified entity.⁶, ⁷ This means that a control person is, by definition, an affiliate of the company they control. However, the term "affiliate" also encompasses those who are controlled by, or under common control with, the entity. For example, a subsidiary company would be an affiliate of its parent company because it is controlled by the parent.

Conversely, while all control persons are affiliates, not all affiliates are necessarily control persons in the same direct sense. An individual might be considered an affiliate due to their relationship with an officer or director, even if they don't directly possess the power to direct the company's management and policies themselves. Both categories are subject to specific rules, particularly concerning the resale of unregistered or restricted securities under Rule 144, but the precise scope and application of these rules can vary based on whether the individual is primarily acting as a controlling party or as an entity under common control.

FAQs

Who is typically considered a control person?

Individuals typically considered control persons include officers, directors, and significant shareholders (often presumed to be those owning 10% or more of the voting stock). However, the actual determination relies on whether the individual or entity has the power to direct or influence the company's management and policies.⁴, ⁵

Why are there special rules for control persons?

Special rules exist for control persons to prevent the misuse of non-public information and to ensure fair and transparent capital markets. These individuals often have access to privileged information and the ability to influence company decisions, which could be exploited for personal gain without regulatory oversight.

How does being a control person affect selling shares?

Being a control person significantly impacts how you can sell company shares. Sales must generally comply with SEC Rule 144, which imposes limitations on the volume of shares that can be sold within a specific period, mandates a particular manner of sale (e.g., through a broker), and often requires filing a notice with the SEC.², ³ These rules apply even if the shares were not originally restricted securities.

Can someone be a control person without owning much stock?

Yes, it is possible to be a control person without owning a significant amount of stock. The key criterion is the power to direct or cause the direction of the management and policies, which can be achieved through various means, such as holding a key executive position, board membership, or through contractual agreements.¹

What are the consequences of not complying with control person rules?

Failure to comply with control person rules can lead to serious consequences, including civil penalties, disgorgement of profits, and even criminal charges in cases of egregious violations like insider trading. The SEC actively enforces these regulations to maintain market integrity.