“Supervision” is one of those compliance buzzwords that gets tossed around without much explanation, like its meaning is taken for granted and assumed to be obvious. I submit to you that it is not, especially when it comes to demonstrating that adequate supervision of a person, process, product or policy has occurred. But why should RIAs care about supervision at all?
The concept of supervision is sprinkled throughout the regulatory sandbox that the SEC has built for RIAs to play within. The foundation of this sandbox is the Investment Advisers Act of 1940, which introduces the definition of both a “supervised person” and the “failure to reasonably supervise.” In short: Supervised persons of a registered investment adviser need to be supervised, and the failure to reasonably do so can result in an adviser being censured or its registration being limited, suspended or revoked. Or said another way, a supervisor that’s asleep at the wheel may unwittingly be held liable for violations committed by others he was supposed to be overseeing.
A “supervised person” is defined to include any partner, officer, director (or other person occupying a similar status or performing similar functions), or employee of an investment adviser, or other person who provides investment advice on behalf of the investment adviser and is subject to the supervision and control of the investment adviser.
This is a very broad definition, and is designed to encompass the vast majority of most advisers’ personnel. It is also specifically designed to encompass all “access persons” — the folks that must report their personal securities transactions and holdings for code of ethics purposes. All access persons are supervised persons, but not all supervised persons are access persons.
As is not uncommon in principles-based regulation, a “failure to supervise” is not defined by what it is, but is instead defined by what it is not. To cite section 203(e)(6) of the Advisers Act itself, no person shall be deemed to have failed reasonably to supervise any person, if:
- There have been established procedures, and a system for applying such procedures, which would reasonably be expected to prevent and detect, insofar as practicable, any such violation by such other person, and
- Such person has reasonably discharged the duties and obligations incumbent upon him by reason of such procedures and system without reasonable cause to believe that such procedures and system were not being complied with.
Step 1: Establish supervisory procedures. Step 2: Follow said procedures. I’m intentionally oversimplifying to underscore just how important written procedures are to an adviser’s compliance program and as a means of refuting a “failure to reasonably supervise” allegation.