On March 17, 2022, FINRA issued Regulatory Notice 22-10 on the liability of chief compliance officers (CCOs) at broker-dealers. The notice represents a significant step for FINRA in clarifying to its membership when CCOs will and will not be held liable for supervisory violations in enforcement actions.
FINRA first acknowledges an important point: CCOs are not, simply by virtue of their positions, supervisors responsible for the adequacy of the firm’s policies and procedures under FINRA Rule 3110. Rather, the responsibility for implementing and maintaining an effective supervisory system is the responsibility of the firm’s senior business executive (whether titled president, CEO, or something else) and whomever the senior business executive delegates supervisory responsibility, including the registered principals responsible for each business line. But FINRA states that if a CCO has other business responsibilities (such as at firms where the CEO also serves as CCO), the CCO can be held liable for failure to supervise in his or her business line capacity, notwithstanding the CCO title.
More significantly, FINRA states that it will follow a firm’s designations of supervisory responsibility in its written supervisory procedures. Thus, if a firm designates the CCO as responsible for a particular set of supervisory procedures, then the CCO becomes the supervisor for those procedures and is responsible for performing those functions reasonably. Some firms’ written supervisory procedures (WSPs) designate the CCO or others in compliance as being responsible for many WSPs. CCOs should consider whether this is appropriate; the FINRA notice suggests that the better approach is to have a business-side supervisor responsible for carrying out WSPs, with compliance in the second-level defense role of monitoring and testing the business’ performance of its responsibilities.
FINRA also explains that a CCO can become a supervisor if the firm, through a senior business manager, expressly or impliedly designates the CCO as having specific supervisory responsibilities on an ad hoc basis. Supervisor status may attach if CCO is asked to take on specific supervisory responsibilities, such as the review of trading activity in customer accounts or oversight of associated persons. CCOs should be careful to document their roles, so that if the firm is responding to a red flag, the respective roles and responsibilities of the CCO and the business-line supervisors are clear, and the CCO does not inadvertently become a supervisor with respect to a specific situation.
FINRA also explains that even when a CCO is acting as a supervisor, the test for liability is still whether they behaved reasonably under the circumstances. Helpfully, FINRA set out factors leaning toward or against whether a CCO’s responses were reasonable. FINRA states that factors counseling toward charging a CCO could include these:
- if the CCO was aware of multiple red flags or actual misconduct he or she did not address
- if the CCO failed to establish, maintain, or enforce the firm’s written procedures
- if the CCO’s supervisory failure resulted in a violation (FINRA’s example is a CCO tasked for due diligence failing to do so reasonably on a private offering, so that the firm did not have a reasonable basis to recommend the offering)
- if the violations caused or created a high likelihood of customer harm
Factors counseling against charging a CCO could include these:
- if the CCO was given insufficient support in terms of staffing, budget, training, or otherwise to fulfill the supervisory duties
- if the CCO was unduly burdened in light of competing functions and duties
- if the CCO’s supervisory responsibilities were poorly defined or shared by others in a confusing or overlapping way
- if the firm merged with another firm, adopted a new business line, or made new hires, such that it would be appropriate to allow the CCO a reasonable time to update the firm’s systems and procedures
- if the CCO attempted in good faith to discharge the supervisory responsibilities by, among other things, escalating issues to firm leadership
FINRA’s guidance provides a helpful roadmap to CCOs. Well-designed WSPs and delegations of supervisory authority, clear documentation of duties, and prompt escalation of concerns should help prevent CCOs from being deemed supervisors or from being deemed not to have acted reasonably.
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