When Legal Or Compliance Personnel May Be Subject To Failure To Supervise Liability Under The Securities Laws

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...