Liability of Compliance and Legal Personnel at U.S. Broker-Dealers for Failure to Supervise

The SEC’s Division of Trading and Markets has recently issued guidance on the liability of compliance and legal personnel at broker-dealers under sections 15(b)(4) and (6) (the “failure to supervise” sections) of the U.S. Securities Exchange Act of 1934 (the Act).

Under the Act, the SEC may institute proceedings against a broker-dealer “supervisor” of business line personnel if someone under that person’s supervision violates securities laws and the supervisor failed reasonably to supervise that person with a view to preventing the particular violation. 

Most SEC enforcement actions for failure to supervise involve business line personnel rather than compliance or legal personnel. However, a person’s “line” status alone does not determine whether they are a “supervisor”. Supervisory authority can be implicitly delegated to or assumed by compliance or legal personnel.

Whether an individual is a “supervisor” of business line personnel involves a factual assessment of various factors including:

  • whether the person has clearly been given, or otherwise assumed, supervisory authority or responsibility for particular business activities or situations
  • whether the firm’s policies and procedures, or other documents, identify the person as responsible for supervising or overseeing business persons or activities
  • whether the person has the power to affect the conduct of others by hiring, rewarding or punishing
  • whether the person had authority and responsibility to be able to prevent the violation from continuing even if they did not have the power to fire, demote or reduce the pay of the individual in question
  • whether the person knew that they were responsible for the actions of another and that they could have taken effective action to fulfill that responsibility
  • whether the person reasonably should have known on the facts that they had the authority or responsibility within the administrative structure to exercise control to prevent the violation.

Compliance and legal personnel are not “supervisors” of business line personnel:

  • solely because of their compliance or legal positions
  • solely because they have provided advice or counsel concerning compliance or legal issues to business line personnel, or assisted in the remediation of an issue
  • solely because a broker-dealer established and implemented a robust compliance program
  • solely because they participate in, provide advice to, or consult with senior management or a management or other committee.

A person that is found to be a “supervisor”:

  • must reasonably supervise with a view to preventing violations of securities laws
  • must reasonably discharge supervisory obligations or know that others are taking appropriate action
  • cannot r be a mere bystander to events that occurred, or ignore wrongdoing or “red flags” or other suggestions of irregularity.

The recent guidance also touches on some of the responsibilities of compliance and legal personnel of U.S. broker-dealers, which include:

  • providing advice and counsel to senior management
  • keeping management informed about:
    • the state of compliance at the broker-dealer
    • major regulatory developments
    • external events that may have an impact on the broker-dealer
  • informing direct supervisors of business line employees about conduct that raises red flags
  • continuing to follow up to help ensure that a proper response is implemented by business line supervisors to address possible misconduct
  • escalating situations to persons of higher authority if concerns have not been addressed.

As we discussed in an earlier post, Canadian regulators also released guidance late last year on the compliance and supervision responsibilities of IIROC-regulated personnel.

broker-dealer compliance failure to supervise legal personnel SEC supervisor

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