The Securities and Exchange Commission has provided some much-needed clarification on when compliance and legal professionals at broker dealers might face potential supervisory liability under the Securities Exchange Act.

The guidance came in the form of eight “frequently asked questions” published by the Division of Trading and Markets. “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,” a Morrison & Foerster client alert advised.

Under Section 15(b)(6) of the Securities Exchange Act, the SEC has authority to bring proceedings against individuals associated with a broker-dealer 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 failed reasonably to supervise that person with a view to preventing the particular violation.

“As a general matter, the staff does not single out compliance or legal personnel,” the SEC stated. “Rather we encourage compliance officers and other compliance and legal personnel to take strong and vigorous action regarding indications of misconduct.”

Among the questions and responses offered by the SEC:

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?

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.

What does it mean to have the requisite degree of responsibility, ability or authority to affect the conduct of another employee?

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?

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?

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.

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?

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.

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?

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.

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?

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.