Recently, the SEC’s Division of Trading and Markets provided guidance on the potential liability of compliance and legal personnel at registered broker-dealers through a series of answers to eight Frequently Asked Questions (FAQs). Following the recent and controversial Urban case and public comments made by SEC Commissioners since, then there have been many questions in the industry about when a Chief Compliance Officer (“CCO”) becomes a “supervisor” for purposes of liability under Sections 15(b)(4) and 15(b)(6) of the Exchange Act. These Compliance FAQs aim to address some of those industry concerns. Although these FAQ’s deal with compliance officers at registered broker-dealers, I think they can provide some insight into how the SEC views a CCO in an anti-corruption compliance context. I site to the SEC’s FAQ in full, although the end notes have been removed.
Question 1.
Is a chief compliance officer or any other compliance or legal personnel a supervisor of broker-dealer business personnel solely by virtue of the compliance or legal position?
Answer: No. Compliance and legal personnel are not “supervisors” of business line personnel for purposes of Exchange Act Sections 15(b)(4) and 15(b)(6) solely because they occupy compliance or legal positions. Determining if a particular person is a supervisor depends on whether, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.
Question 2.
What does it mean to have the requisite degree of responsibility, ability or authority to affect the conduct of another employee?
Answer:
A person’s actual responsibilities and authority, rather than, for example, his or her “line” or “non-line” status, determine whether he or she is a “supervisor” for purposes of Exchange Act Sections 15(b)(4) and 15(b)(6). Among the questions to consider in this regard:
Has the person clearly been given, or otherwise assumed, supervisory authority or responsibility for particular business activities or situations?
Do the firm’s policies and procedures, or other documents, identify the person as responsible for supervising, or for overseeing, one or more business persons or activities?
Did the person have the power to affect another’s conduct? Did the person, for example, have the ability to hire, reward or punish that person?
Did the person otherwise have authority and responsibility such that he or she could have prevented the violation from continuing, even if he or she did not have the power to fire, demote or reduce the pay of the person in question?
Did the person know that he or she was responsible for the actions of another, and that he or she could have taken effective action to fulfill that responsibility?
Should the person nonetheless reasonably have known in light of all the facts and circumstances that he or she had the authority or responsibility within the administrative structure to exercise control to prevent the underlying violation?
Question 3.
Can compliance and legal personnel provide advice and counsel to business line personnel without being considered supervisors of the business line personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by providing advice and counsel to business line personnel. Compliance and legal personnel do not become “supervisors” 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. If their responsibilities or authorities extend beyond compliance and legal functions such that they have the requisite degree of responsibility, ability or authority to affect the conduct of business line personnel, additional inquiry may be necessary to determine if they could be considered supervisors of the business line personnel.
Question 4.
Can a broker-dealer establish and implement a robust compliance program without its compliance and legal personnel being considered to be supervisors for purposes of the Exchange Act?
Answer: Yes. Broker-dealers have a duty to build effective compliance programs that are reasonably designed to ensure compliance with applicable laws and regulations. Among the things that firms should consider including in their programs are robust compliance monitoring systems, processes to escalate identified instances of noncompliance to business line personnel for remediation, and procedures that clearly designate responsibility to business line personnel for supervision of functions and persons.
Broker-dealers should consider clearly defining compliance and advisory duties and distinguishing those duties from business line duties in order for persons who perform only compliance and legal functions to avoid becoming supervisors of business line employees. Management at broker-dealers can greatly benefit from the participation and input of compliance and legal personnel.
Question 5.
Can compliance or legal personnel participate in a management or other committee without being considered supervisors of business activities or business personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by participating in management and other committees. Compliance and legal personnel do not become “supervisors” solely because they participate in, provide advice to, or consult with a management or other committee. As explained above, the determination whether a particular person is a supervisor depends on whether, under the facts and circumstances of a particular case, that person has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.
Question 6.
Can compliance or legal personnel provide advice to, or consult with, senior management without being considered supervisors of business activities or business personnel for purposes of the Exchange Act?
Answer: Yes. Compliance and legal personnel play a critical role in efforts by broker-dealers to develop and implement an effective compliance system throughout their organizations, including by providing advice and counsel to senior management. Compliance and legal personnel do not become “supervisors” solely because they provide advice to, or consult with, senior management. In fact, compliance and legal personnel play a key role in providing advice and counsel to senior management, including keeping management informed about the state of compliance at the broker-dealer, major regulatory developments, and external events that may have an impact on the broker-dealer. In this regard, compliance and legal personnel should inform direct supervisors of business line employees about conduct that raises red flags and continue to follow up in situations where misconduct may have occurred to help ensure that a proper response to an issue is implemented by business line supervisors. Compliance and legal personnel may need to escalate situations to persons of higher authority if they determine that concerns have not been addressed.
Question 7.
What is the status of the initial decision in the Theodore W. Urban matter?
Answer: Under the Commission’s rules of practice, if a majority of the Commissioners do not agree on the merits (as was the case in Urban), the initial decision “shall be of no effect.”
Question 8.
What responsibilities does a person working in a compliance or legal capacity have if he or she is a supervisor for purposes of the Exchange Act?
Answer: Once a person has supervisory obligations, he or she must reasonably supervise with a view to preventing violations 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. That person must reasonably discharge those obligations or know that others are taking appropriate action. It is not reasonable for a person with supervisory obligations to be a mere bystander to events that occurred, or to ignore wrongdoing or “red flags” or other suggestions of irregularity.
Exchange Act Section 15(b)(4)(E) provides an affirmative defense to potential liability for failure to supervise if a firm has established procedures and a system for applying those procedures that would reasonably be expected to prevent and detect, insofar as practicable, a violation, and the supervisor has reasonably discharged his or her duties pursuant to the procedures and system, without reasonable cause to believe that the procedures and system were not being complied with.
As noted in a Sydley and Austin client alert, “the Compliance FAQs address the question of what a person working in a compliance or legal capacity should do if he or she is also a supervisor for purposes of the Exchange Act. According to the staff, once a person has supervisory obligations, he or she must “reasonably supervise with a view to preventing violations of the federal securities laws…. It is not reasonable for a person with supervisory obligations to be a mere bystander to events that occurred, or to ignore wrongdoing or ‘red flags.’” The existence of an effective compliance program is essential for protecting compliance and legal personnel from liability once they act in a supervisory capacity. As the Compliance FAQs point out, an affirmative defense to potential liability for failure to supervise exists, but only if the firm “has established procedures and a system for applying those procedures that would reasonably be expected to prevent and detect…a violation, and the supervisor has reasonably discharged his or her duties pursuant to the procedures and system.
Compliance officers need to sit up and take notice of these FAQs.
