More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- The Need for Thorough and Effective Policies and Procedures Whethere an advisor is SEC or state-registered, RIAs must revise their policies and procedures to address significant compliance problems occurring during the year, changes in business arrangements, and regulatory developments.
SEC Commissioner Daniel Gallagher said Friday that the question of what makes a legal or compliance officer a supervisor remains “disturbingly murky,” and signaled that he’d like the securities regulator to develop “clearer guidance” on the issue.
Gallagher, speaking at the SEC Speaks conference in Washington, held by the Practising Law Institute, said the “old issue” of “failure to supervise” has become very relevant again.
As Gallagher explained, broker-dealers and investment advisors employ legal and compliance personnel to provide advice and guidance to firms and their employees regarding the application of laws and regulations to their businesses. Almost by definition, he said, “legal and compliance personnel work outside the direct chain of supervision for business activities, and few, if any, would think of themselves as ‘supervising’ day-to-day activity.”
A key question, therefore, he continued “is at what point can legal and compliance personnel be reasonably deemed ‘supervisors’ as they carry out their responsibility to prevent and, if necessary, address violations of laws or regulations by firm employees and to provide advice and guidance to management?” Over the course of the past three decades, he said, “this question has been raised in a series of commission broker-dealer enforcement cases, but it has never been answered in the clear and definitive manner such a weighty issue deserves.”
The Securities and Exchange Commission’s failure-to-supervise precedent provides limited guidance for determining whether a given member of a firm’s legal or compliance staff is a “supervisor” for the purposes of Exchange Act and Advisers Act liability, Gallagher explained. The clearest guidance, he said, was set forth in the Gutfreund Section 21(A) report issued by the SEC in 1992 in connection with an administrative proceeding involving the general counsel of a broker-dealer.
In that report, Gallagher said, “the commission noted that legal and compliance personnel do not become ‘supervisors’ for purposes of [the Exchange Act] ... solely because they occupy those positions.” The commission explained, however, he said, “that an in-house lawyer can be deemed a supervisor when other members of senior management ‘involve him as part of management’s collective response to the problem.’”
What Gutfreund and similar proceedings make clear, Gallagher said, “is that once a person becomes involved in formulating management’s response to a problem, he or she is obligated to take affirmative steps to ensure that appropriate action is taken.
Brian Rubin, a partner in the law firm Sutherland in Washington, says that chief compliance officers and in-house counsel “must be careful that when they are involved in decisions such as disciplining a rep, a member of the business team must ultimately be responsible.”
In searching for clarity on what makes a legal and compliance officer a supervisor, Gallagher said the SEC “must be mindful of the importance of the legal and compliance role and, critically, the ability of legal and compliance personnel to carry out their responsibilities.”
Rubin says he and his colleagues "frequently hear criticism of the SEC (and FINRA) for rulemaking by enforcement." Gallagher's remarks seem "to be a recognition of that criticism."
Rubin says, however, that the definition of “supervisor” is “hard to pin down both because of firms’ business models and because when bad things happen at firms, they take different twists and turns.” General guidance on supervision has been provided through other cases, Rubin says, “but the Commission needs to think more about how to provide guidance to compliance officers and in-house counsel.”
Rubin notes that while the SEC has “regularly been bringing cases against CCOs and a few times against in-house counsel, they are usually not for failing to supervise representatives.” If
However, a recent case against Theodore Urban, the former general counsel of a U.S. registered broker-dealer relating to his purported failure to supervise Stephen Glantz, a registered rep, “scared” a lot of compliance officers and in-house counsel, Rubin says, “because there was such a disconnect between the facts of that case and traditional failure to supervise cases.”
While the SEC dismissed the proceedings against Urban, unresolved questions remain regarding when and if a broker-dealer’s in-house legal counsel and compliance personnel have supervisory responsibilities with respect to registered reps and other personnel, and what constitutes reasonable supervision of such persons.
In closing his remarks, Gallagher said that the SEC’s ability “to impose sanctions for failures to supervise is a powerful tool to compel a broker-dealer or investment advisor’s managers and executives to proactively monitor subordinate employees’ compliance with laws and regulations. Those high-level personnel clearly fall within the ambit of the commission’s failure-to-supervise authority, a fact of which such high-level personnel are well aware.”
Failure-to-supervise liability, he continued, “can therefore act as a key incentive for a firm’s management to carry out their responsibilities properly. We must strive to ensure, however, that the fear of failure-to-supervise liability never deters legal and compliance personnel from carrying out their own critical responsibilities.”