The United States Court of Appeals for the Third Circuit held that the failure by corporate directors to supervise the enforcement of compliance protocols, which might have uncovered an employee's fraudulent activities, does not establish "culpable participation" in the employee's misconduct sufficient to support controlling person liability of the directors under Section 20(a) of the Securities Exchange Act of 1934.  According to the Court, a plaintiff proceeding on such a theory of inaction must prove that a director had knowledge of a fraud and that the inaction was to further the fraud and intentionally prevent its discovery.  Here, the Court found that the directors had no knowledge of certain fraudulent employee activities (securities fraud) due to poor compliance protocols in place, and that without the requisite knowledge, culpable participation for purposes of Section 20(a) liability cannot be established.

The Court also held that a corporation's directors may not be held personally liable for the misconduct of employees under a theory of negligent supervision.  The Court explained that although negligent supervision encompasses the four elements of common law negligence (duty, breach, causation and damages), it is specifically predicated on an employer's duty to monitor employees and to refrain from placing them in situations where they will harm third parties.  The Court held that directors owe no duty to third parties to supervise employees, and while a director's fiduciary duty of loyalty to act in good faith for the benefit of the corporation may include some duty of oversight, that duty has never been found to include responsibility for daily supervision of employees.  The Court further held that there is no agency relationship between a director and an employee, but that the corporation alone is the employer of the employee and potentially liable for any of the employee's tortious acts. 

Belmont v. MB Investment Partners, Inc., No. 12-1580, 2013 WL 646344 (3d Cir. Feb. 22, 2013).