Tag: Urban

Are you a Supervisor?

As a compliance officer, how far do you need to go in dealing with a problem employee? The Urban case was trying to address this question, but got twisted up in procedural machinations. In dropping the case, the two SEC commissioners didn’t explain when a compliance officer or in-house counsel at a broker-dealer or investment adviser becomes a supervisor liable for an employee’s actions.

The case began with suspicious trading at Ferris, Baker Watts, Inc. by Stephen Glantz, a top-performing broker. In 2007, the U.S. attorney in Cleveland accused Glantz and an accomplice of scheming to artificially increase the stock price of Innotrac Corp., a company that provides e-commerce fulfillment services. Glantz pleaded guilty in September 2007 to one count of stock fraud and one count of making a false statement. He was sentenced to 33 months in prison.

The SEC moved up the chain and began investigating Theodore W. Urban, Ferris, Baker Watts, Inc.’s, General Counsel, Executive Vice President, and a voting member of the Board of Directors, the Executive Committee of the Board, and the Credit Committee. The SEC’s claim was that Urban was a supervisor of Glantz and that he failed to properly supervise him.

Urban had a hearing before the SEC’s chief administrative law judge in March 2010. The judge decided that that although Urban was, under the law, the broker’s supervisor, he “performed his responsibilities in a cautious, objective, thorough and reasonable manner.” As a result, “Urban did not fail to supervise.”

Apparently, the SEC was not happy with losing that case, so the Enforcement Division petitioned the commission for a review of the decision. On Jan. 26, the SEC dismissed the case, leaving compliance officers and in-house counsel with no guidance on when you are a supervisor.

SEC Chairman Mary Schapiro, Elisse Walter and Daniel Gallagher recused themselves for unexplained reason. The remaining two, Parades and Aguilar, couldn’t agree.

Commissioner Gallagher to address the topic in his speech at The SEC Speaks in 2012:

Once again, I want to stress that firms and investors are best served when legal and compliance personnel feel confident in stepping forward and engaging on real issues. An overbroad interpretation of “supervision” risks tacitly deputizing as a supervisor, with concomitant liability, anyone who becomes actively involved in assisting management in dealing with problems. Deterring such active involvement will erode investor confidence in firms, to the detriment of all.

Looking at the Enforcement Division’s view of a supervisor:

Gutfreund 51 S.E.C. 93 (1992): the person was not a line supervisor and others shared supervisory responsibility; still, he was a supervisor because he had the requisite degree of responsibility, ability, or authority to affect the person’s conduct when senior management informed him of the misconduct to obtain his advice and guidance and to involve him as part of management’s collective response to the problem.

Kirk Montgomery, 55 S.E.C. 485, 500 (2001): a chief compliance officer is a supervisor because it was sufficient if the person plays a significant, even if shared, role in the firm’s supervisory structure and that his authority was subject to countermand at a higher level.

Urban was required to take concerns about Glantz’s conduct to the Ferris Board or Executive Committee, and, if they did not act, he was required to resign and report the matter to regulatory authorities.

That is a very harsh standard for compliance officer or general counsel when dealing with an employee that he or she does not directly supervise. The final decision by the SEC leaves it murky as to whether that position by the Enforcement Division is the position of the Commissioners.

If you can’t get a compliance problem fixed what should you do?

Sources:

Chief Compliance Officer and General Counsel Supervisory Responsibility and Liability Brian L. Rubin, Partner

ACA Compliance sponsored this webinar on Thursday. Brian L. Rubin, Partner, Sutherland Asbill & Brennan LLP was the presenter. These are my notes.

Section 203(e) of the Advisers Act:

If an investment adviser fails to reasonably supervise an employee or any other person subject to the adviser’s supervision, and that person violates the federal securities laws, then the SEC may take action against such investment adviser

In the Matter of Pegasus Investment Management, LLC, Peter Bortel, and Douglas Saksa (.pdf) (June 15, 2011) Pegasus VP Peter Bortel, under the supervision of President and CCO Douglas Saksa, allegedly did not disclose the arrangement to their fund investors and retained retained broker rebates for Pegasus, rather than passing it along to the investors. The SEC stated that Saksa failed to reasonably supervise Bortel within the meaning of Section 203(e)(6)

Direct Liability

CCO has direct liability for:

–Aiding and abetting, and causing firm violations such as:

•Responding to regulatory inquiries
•Responding to deficiency letters
•Adopt/implement policies and procedures
•Failing to file

– Permitting unregistered individuals to act

As an example the they cited In the Matter of the Buckingham Research Group, Inc., Buckingham Capital Management, Inc., and Lloyd R. Karp (.pdf) (November 17, 2010). The CCO allegedly represented in deficiency letter response that certain corrective action would occur (new policies/monitoring). The SEC claimed CCO was liable because he was responsible for establishing and administering the policies at issue and he “was aware of the compliance weaknesses and failures and either failed to act or failed to correct them”

Are you a supervisor?

Some factors are whether you have the ability to hire, fire, discipline, affect compensation. You would have the requisite degree of “responsibility, ability or authority” to “affect” the conduct of the employee whose behavior is at issue.

You can still be held liable as the SEC if you are overruled by superiors. (Scary!!)

In the Matter of Theodore W. Urban (.pdf), Adm. Proc. File No. 3-13655, Initial Decision (Sept. 8, 2010) Urban was General Counsel and headed Compliance, HR and Int. Audit. Urban had no authority to hire or fire employees outside of these departments, but he served on the board of directors and the firm’s credit and risk committee as a full voting member. SEC alleged that Urban was bad rep’s supervisor because of the role he played in monitoring bad rep’s actions. SEC also alleged that Urban failed to follow up on numerous red flags and took inadequate action regarding other red flags. As General Counsel, his opinions on legal/compliance matters were “viewed as authoritative and his recommendations were generally followed” by all business units.

The Administrative Law Judge found that Urban was a bad rep’s supervisor, but he had not failed to supervise because he performed his supervisory responsibilities “in a cautious, objective, thorough and reasonable manner”. The decision has been appealed to the SEC. So this ruling may change.

Combination/Separation of Legal and Compliance Functions

Some advantages to combining the roles:

  • Federal Sentencing Guidelines call for adoption of a compliance program overseen by senior personnel
  • Compliance is represented at senior management level
  • GC is actively involved in strategic business decisions, offering exposure to potential compliance issues
  • May be better positioned to push the firm toward appropriate actions/conclusions
  • Direct or tangential experience with regulations
  • “Noisy Withdrawal” trigger
  • Reduced headcount
  • GC is generally consulted on key compliance matters by senior management

Why separate the roles?

  • Respects the differing goals of legal versus compliance (legal protects the firm; compliance prevents and detects violations
  • Allows firms to acquire necessary skill set in each area
  • Avoids misplaced privilege claims
  • Creates necessary bandwidth to execute each role fully
  • Allows each person to serve appropriate stakeholders
  • Avoids conflicts at the board level/recusals
  • Compliance gets same standing as legal in organization charts

Reporting

How about the CCO Reporting to GC?

  • Centralizes legal and compliance in a single functional area. There is overlap.
  • Matters identified can be more quickly resolved due to combination of functions
  • GC may be in a good position to muster resources or provide a platform
  • Gives clout to the compliance function. To the extent legal has clout.

How about an Independent CCO

  • Highest degree of independence
  • Decisions to report matters up to senior management or to regulators not subject to approval by GC
  • CCO does not have to go outside reporting structure to raise matters to senior management
  • GC does not need to create time to supervise the CCO
  • Consistent with ICA 38a-1 and FINRA Rule 3130

As a case study, they used the Wunderlich case.

Avoiding Supervisory Responsibility

  • Document with written supervisory policies and procedures
  • Identify the direct supervisors of all employees
  • Specifically state that compliance personnel are limited to offering advice and recommendations and do not have the responsibility, ability or authority to affect the conduct of employees outside of their departments
  • Where misconduct is addressed, document which business-line supervisor is handling the issue and how
  • Make it clear that the role on committees and boards is only advisory in nature