Broker-dealer compliance and legal staff are a robust line of defense protecting registered reps from making costly mistakes or worse, engaging in bad behavior. However, compliance staff could potentially find themselves in hot water with the SEC if a problem arises with one of their brokers.
A stark example of this involved Theodore Urban, who was the General Counsel and Head of Compliance at a registered broker-dealer. A broker who worked at Urban’s firm was accused of committing fraud. The SEC charged the broker but also charged Urban with a failure to supervise. At the time, Urban was in charge of all compliance, human resources and internal audits at his firm, and the broker involved did not work in any of those departments. An administrative law judge initially determined that Urban failed to “reasonably” supervise the broker. On appeal, a judge ruled that, in fact, Urban exercised reasonable supervision, and the SEC subsequently dismissed the action.
Even though Urban was exonerated, the Commission’s charges gave rise to several liability questions for compliance staff. Can compliance staff be liable for the conduct of every employee of a broker-dealer? Does it matter whether an employee is in a firm’s compliance line versus their business line? When does the liability for compliance failures end?
In order to provide some clarity on the liability issue, the SEC released a set of Frequently Asked Questions last month on the liability of compliance officers and legal staff at broker dealers. The FAQs focused on situations where compliance and legal personnel are face with issues involving individuals or employees who work outside their departments and/or report to a business line.
A few important takeaways include the following:
- Compliance and legal staff provide valuable counsel and advice to all employees at their broker-dealers. They do not become supervisors of every employee to whom they provide advice to or counsel. What matters is the responsibilities and authority that a given compliance person has over an employee.
- The Commission determines liability for a failure to supervise on a “facts and circumstances determination.” Therefore, there is no bright line rule for determining liability.
- The Securities and Exchange Act does not presume that legal and compliance staff are supervisors simply by virtue of the fact that they are involved in compliance or legal functions. The SEC lists several considerations including: compliance staff responsibilities; influence over the conduct of the employee in question; the ability of the compliance staff to hire or fire the broker; and whether the compliance staff actually knew or should have known they had responsibility over the broker in question.
- The FAQs point out that “most” of the enforcement actions brought by the Commission for a failure to supervise have been against business line personnel and not compliance personnel but the Commission will bring failure to supervise actions against compliance staff that have been delegated or assumed the supervisory responsibilities for a particular activity. The Commission believes that this assumption of responsibility by a compliance employee gives them “the requisite degree of responsibility” or authority to affect the conduct of the employee outside of their department.
- When determining if a person has the “requisite degree of responsibility,” the Commission says that the most important factor is a person’s actual responsibilities. When determining a person’s responsibilities, the Commission lists several factors, including:
- Has the compliance staff assumed or been granted authority for certain activities?
- Does the compliance staff have the power to affect a person’s conduct?
- Does the compliance staff have the authority of responsibility to prevent the unlawful activity from continuing?
- Did the compliance person know they had this responsibility?
- Should the compliance person have known they had such a responsibility?
- The FAQs also explain that compliance and legal personnel do not become supervisors of business line employees by simply providing advice or counsel to them. The actual responsibilities of the compliance staff and their ability to affect the conduct of the business line employee’s conduct are the most important considerations.
Perhaps most importantly, the SEC says that firms should consider clearly defining the duties of its compliance and advisory staff in order to distinguish them from business line employees as a way to avoid compliance staff being confused with supervisors of business line employees.