By Rodney F. Tonkovic, J.D.
FINRA has issued a regulatory notice providing guidance on a Chief Compliance Officer's potential liability for failure to reasonably supervise. The notice serves as a reminder to member firms of the scope of FINRA Rule 3110. The responsibility to meet the supervisory obligations imposed by the rule rests with a firm's business management, and that is where FINRA will look first to determine failures to supervise. An action will not be brought against a CCO unless the firm confers supervisory responsibility upon the CCO and the CCO the failed to discharge those responsibilities, the notice says.
Rule 3110. Regulatory Notice 22-10 is intended to remind member firms of the scope of Rule 3110 in relation to the potential liability of CCO's for failure to discharge designated supervisory responsibilities. Rule 3110 sets out a firm's supervisory obligations and requires the designation of individual supervisors and the maintenance and enforcement of written supervisory procedures. Individual liability under the rule is based on the firm's express or implied delegation of supervisory responsibility to the designated individuals, and FINRA may bring an enforcement action against an individual supervisor who fails to reasonably discharge their supervisory responsibilities.
The CCO's role. FINRA recognizes that a CCO's role is advisory, not supervisory, and that compliance and supervision are separate functions. And, there is a distinction between compliance guidelines and supervisory procedures that document the system that ensures the compliance guidelines are followed. Neither Rule 3110 nor Rule 3130 (setting out the role of the CCO) attach supervisory responsibilities to a CCO, but a CCO might fall under the scope of Rule 3110 based on another position they may hold.
A CCO's liability. A CCO is subject to liability under Rule 3110 only when the firm designates them as having supervisory responsibility. This designation can occur in several ways, including being assigned in the firm's written supervisory procedures or an express or implied designation apart from the written procedures, such as on an ad hoc basis. When a CCO has supervisory responsibilities, FINRA will bring an action against the CCO only if they have failed to reasonably discharge those responsibilities. Whether the performance of these responsibilities was reasonable depends on the facts and circumstances of a particular situation.
The notice advises that not every violation of a FINRA rule results in a formal disciplinary action. Factors that weigh in favor of charging a CCO—or anyone else with supervisory responsibility—can include: awareness of, but not addressing, red flags; failing to establish or enforce written procedures; and if the supervisory failure resulted in a violation that could cause customer harm. Factors weighing against charges include: insufficient support to reasonably fulfill supervisory duties; competing functions and responsibilities that are an undue burden; or a good faith attempt to discharge the supervisory responsibilities. FINRA may also consider whether it is more appropriate to charge the firm or its president, or another party having more direct responsibility with failure to supervise instead of the CCO. Finally, first-time violators may simply receive a Cautionary Action Letter.