SEC issues guidance on supervisory liability of broker-dealer compliance and legal personnel

by DLA Piper

A difficult question continually faced by broker-dealer compliance and legal personnel is whether their roles and duties can lead to them being considered supervisors of business personnel, and thereby subject them to liability for “failure to supervise” if those business personnel engage in activities that violate applicable laws, rules and regulations.

The Securities and Exchange Commission Division of Trading and Markets recently issued a set of Frequently Asked Questions concerning the supervisory liability of broker-dealer compliance and legal personnel.i  The Division staff issued, and may periodically update, the FAQs to provide guidance relating to liability that may arise from the role and duties of a broker-dealer’s Chief Compliance Officer (CCO) and other compliance and legal personnel.ii

Acknowledging the critical role that compliance and legal personnel play in a broker-dealer’s efforts to comply with legal and regulatory requirements, the FAQs are intended to provide assistance in evaluating the facts and circumstances under which compliance and legal personnel  face potential supervisory liability.iii    According to the Staff, the Exchange Act does not presume that compliance or legal personnel are supervisors; instead, the issue centers on whether such personnel have supervisory authority over business units or personnel outside of their departments (for example, a chief executive officer acting as CCO).  Supervisory authority also can be implicitly delegated to or assumed by compliance or legal personnel, resulting in supervisory liability.

The SEC brings “failure to supervise” actions against broker-dealer compliance and legal personnel “only in limited circumstances in which these individuals have been delegated, or have assumed, supervisory responsibility for particular activities or situations, and therefore have ‘the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.’”  According to the FAQs, responsibility for a broker-dealer’s compliance resides ultimately with its chief executive officer and senior management. When the SEC brings actions for failure to supervise, the focus is on the roles and responsibilities of the relevant parties. 

Thus, the SEC encourages compliance and legal personnel “to take strong and vigorous action regarding indications of misconduct” and generally does not single out compliance or legal personnel.

The FAQs: crossing the line from advisor to supervisor

The FAQs begin by explaining that compliance and legal personnel are not “supervisors” of business personnel solely because of their positions.  Instead, whether a particular person is a supervisor depends on whether the individual in question “has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.”  In making this determination, the factors considered by the SEC include:

  • Whether the individual clearly has, or has assumed, supervisory authority or responsibility for particular business activities or situations
  • Whether the firm’s policies, procedures, and/or other documents identify the individual as having supervisory or oversight responsibilities for business personnel or activities
  • Whether the individual has the power to affect another person’s conduct, such as power to hire, fire or discipline the person, or involvement in the person’s compensation
  • Whether the individual has been given authority and responsibility that would enable him or her to prevent the violation from continuing, even without the power to discipline the person in question;
  • Whether the individual knew that he or she had responsibility for the actions of others and thus could have taken effective action and
  • Whether the individual reasonably should have known that, under the facts and circumstances surrounding the particular violation, he or she had authority or responsibility to take action to prevent it.

The FAQs explain that compliance and legal personnel play a critical role in developing and implementing a broker-dealer’s compliance system.  This includes advising and counseling business personnel and assisting in remediation efforts.  While this alone does not result in compliance and legal personnel becoming supervisors, if they assume duties and authority that extend beyond compliance and legal functions, it could result in such individuals being deemed to have the requisite responsibility, ability or authority over the conduct of business personnel to trigger additional inquiry into whether they should be considered supervisors.

Broker-dealers have a duty to build effective compliance programs that are reasonably designed to ensure compliance with applicable laws, rules and regulations. These include robust compliance monitoring systems, processes to remediate noncompliance and procedures that clearly designate supervisory responsibility to business personnel.  The Staff explains that in satisfying this duty, a firm’s management can greatly benefit from participation by compliance and legal personnel, but advises firms to:

  • clearly designate responsibility to business line personnel for supervising functions and persons
  • clearly define compliance and advisory duties and
  • clearly distinguish these duties from business-line duties in order to avoid having compliance and legal personnel deemed to be supervisors.

The Staff also notes that compliance and legal personnel can participate in management or other committees without being considered supervisors of business activities or business personnel, and that such persons play a critical role in efforts to develop and implement an effective compliance system when they do so.  But again, if a person is given the requisite degree of responsibility, ability or authority to affect employee conduct, that person may be deemed a supervisor.

Finally, the FAQs advise that once a person does take on supervisory obligations, the person must reasonably supervise with a view to preventing violations of applicable laws, rules and regulations, and must reasonably discharge those obligations or confirm that others are doing so. It is unreasonable for a supervisor to ignore possible wrongdoing, red flags or suggestions of improper conduct.  The Staff also notes that the Exchange Act provides an affirmative defense to failure to supervise liability if a firm has procedures, and systems for applying them, that can reasonably be expected to prevent and detect, insofar as practicable, a violation, and the supervisor reasonably discharges his or her supervisory duties pursuant to those procedures and that system.

i  Frequently Asked Questions about Liability of Compliance and Legal Personnel at Broker-Dealers under Sections 15(b)(4) and 15(b)(6) of the Exchange Act.

ii  The responses to the questions in the FAQs represent the views of the Division but “are not rules, regulations or statements” of the Commission itself, which “has neither approved nor disapproved these interpretive answers.” 

iii  The Staff also cautions that, irrespective of whether they are supervisors, compliance and legal personnel who violate federal securities laws, or aid, abet or cause such violations, may independently be held liable.



DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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