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Power of “Failure to Supervise” Affirmed by Federal Appeals Court

When one person is wronged by another—in the securities context or otherwise—fault can sometimes be placed at the feet of more than just the person who actively committed the wrong. For example, the courts and the regulatory agencies overseeing the financial markets (including FINRA and the SEC) have long recognized “failure to supervise” as a means to hold a supervisor liable for harms caused by a broker.

Investors or agency enforcers, while pursuing a broker who violated duties toward his or her clients, may also look to the broker’s employer or supervisor. The employer or supervisor may be at fault for failing to terminate or censure the employee before the damage was done. Or, in other cases, the employer or supervisor may be at fault for hiring the broker in the first place, considering the broker’s previous record.

However, because of the secondary nature of these types of wrongs, there has been some lack of clarity regarding how they should be punished.

The Consequences of Failing to Supervise

FINRA publishes guidelines to help its adjudicators decide how best to enforce the rules on supervision. It encourages the person making the decision to consider the “nature, extent, size and character of the underlying misconduct”; to assess the “quality and degree” of the supervisor’s adherence to company policies; and to determine whether the supervisor ignored obvious “red flags,” or even actively concealed the employee’s conduct.

With these factors in mind, FINRA recommends monetary sanctions of between $5,000 and $50,000, as well as short-term suspensions of supervisory capacity. And in so-called “egregious cases,” FINRA advises the adjudicator to consider harsher consequences. But the regulatory body does not explicitly recommend one sanction that was the subject of a recent federal appeals court case—and that was upheld despite its severity: A lifetime ban of the supervisor from the profession.

The Birkelbach Case

On May 2, 2014, the United States Court of Appeals for the Seventh Circuit decided the case of Birkelbach v. SEC. In Birkelbach, FINRA (affirmed by the SEC) imposed this extreme sanction on the president of a securities brokerage. The supervisor admitted that he breached his responsibilities in failing to investigate numerous red flags associated with a broker who made unsuitable recommendations to a client, engaged in excessive and unauthorized trading, churned accounts to drum up fees, and made misleading communications.

He argued, however, that barring him for life from the industry was excessive.

He cited several FINRA cases in which something less than a lifetime ban was imposed. And he asserted that this blanket punishment was not “tailored to the offense.” However, the Seventh Circuit disagreed with the supervisor’s framing of the law. Previous sanction history did not mean that either FINRA or the SEC were bound to limits in more egregious cases. And, though both entities had repeatedly emphasized that punishments should connect to the conduct being punished, there could be a point at which a lifetime ban was appropriate.

If you think that you have been defrauded or otherwise harmed by a securities professional or his or her supervisor, please contact attorney Gregory Tendrich, P.A. today.

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