The SEC has provided some much-needed clarity on the issue of when broker-dealer compliance or legal personnel may be considered to be supervisors. On September 30, 2013, the Division of Trading and Markets (the “Division”) issued a set of eight FAQs providing guidance relating to potential liability of Chief Compliance Officers, and other compliance and legal personnel at broker-dealers under Sections 15(b)(4) and 15(b)(6) of the Securities Exchange Act of 1934. Broker-dealers should carefully review these FAQs to understand when their compliance or legal personnel function as “supervisors,” and thereby become potentially subject to liability for failure to supervise. Even though they do not specifically say so, the FAQs strongly suggest that they are articulating a test for finding supervisory authority to replace the test set out in the Initial Decision in the Theodore Urban administrative proceeding.
By way of background, Section 15(b)(6) authorizes the Commission to institute proceedings against a natural person associated with a broker-dealer for failure to supervise if someone under that person’s supervision violates the provisions of the federal securities laws, the Commodity Exchange Act, the rules or regulations under those statutes, or the rules of the Municipal Securities Rulemaking Board, and the supervisor fails reasonably to supervise that person with a view to preventing the particular violation.
The Exchange Act does not presume that broker-dealer compliance or legal personnel are supervisors solely by virtue of their compliance or legal functions; rather, the inquiry turns on whether compliance or legal personnel have supervisory authority over business units or other personnel outside the compliance and legal departments. While the Commission has brought many actions alleging failure to supervise against individuals with supervisory authority, it has infrequently brought actions against broker-dealer legal or compliance personnel, and typically only in the limited circumstances in which compliance and legal personnel 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.” In Sheldon v. SEC, 45 F.3d 1515, 1517 (11th Cir. 1995), the Commission stated that ultimately the responsibility for a broker-dealer’s compliance resides with its chief executive officer and senior management, and the FAQs clarify that “[a]s a general matter, the staff does not single out compliance or legal personnel,” but the staff does encourage “compliance officers and other compliance and legal personnel to take strong and vigorous action regarding indications of misconduct.”
WHEN COMPLIANCE AND LEGAL PERSONNEL ARE “SUPERVISORS”
The FAQs make clear that compliance and legal personnel are not “supervisors” of business line personnel for purposes of Sections 15(b)(4) and 15(b)(6) solely because they occupy compliance or legal positions. Rather, determining if a particular person is a supervisor comes down to whether, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.
A person’s actual responsibilities and authority, rather than his “line” or “non-line” status, determine whether he is a “supervisor” for purposes of Sections 15(b)(4) and 15(b)(6), and some of the relevant factors include whether:
- the person was clearly entrusted with, or assumed supervisory authority or responsibility for, particular business activities;
- the firm’s policies and procedures or other documentation identify the person as responsible for supervising, or for overseeing, business persons or activities;
- the person has the power to affect another’s conduct by hiring, rewarding or punishing that person;
- the person had such authority and responsibility that he could have prevented the violation from continuing, even if he did not have the authority to fire, demote or reduce the pay of the person in question;
- the person knew that he was responsible for the actions of another, and could have taken effective action to fulfill that responsibility;
- the person should have known in light of all the facts and circumstances that he had the authority or responsibility within the administrative structure to exercise control to prevent the underlying violation.
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