Doing The Right Thing” Finally Pays Off for General Counsel of Broker-Dealer: SEC Dismisses Failure to Supervise” Enforcement Proceeding

Kelley Drye Client Advisory

As recently as 2009, few in the securities industry would have suspected that a senior legal or compliance officer’s reporting of potential misconduct by a broker to senior business managers and recommendation to fire the broker would result in an enforcement action against the legal or compliance officer.  But that is exactly where Theodore W. Urban, former general counsel of Ferris, Baker Watts, Inc. (“FBW”), found himself in October 2009.1

Fortunately, reason ultimately prevailed on January 26, 2012 when the Securities and Exchange Commission (the Commission”) dismissed the Division of Enforcement’s proceeding against Urban.2  Representing a significant development for legal and compliance professionals at securities firms, the dismissal of the proceedings, by an evenly divided Commission, rendered of no effect” a prior administrative law judge (“ALJ”) decision that alarmed legal and compliance professionals because of its broad interpretation of the circumstances under which a legal or compliance professional could be deemed a supervisor” in the world of broker-dealers.

In the Commission’s Order Instituting Proceedings, dated October 19, 2009 (the OIP”), the Division of Enforcement alleged that Urban had been the supervisor of a FBW employee, Stephen Glantz, who purportedly engaged in violations of the securities laws.3  The OIP also alleged that Urban had failed reasonably to supervise” Glantz under both Section 15(b) of the Securities Exchange Act of 1934 and Section 203(f) of the Investment Advisers Act of 1940.  In the Initial Decision relating to the matter, the Commission’s chief administrative law judge found that Urban was Glantz’s supervisor,” though Glantz did not report to Urban.4  The ALJ ultimately dismissed the Division’s petition on the grounds that Urban had reasonably discharged his duties as a supervisor, but more importantly, left the industry to grapple with an expansive interpretation of when a legal or compliance officer could be deemed a supervisor” under the federal securities laws.

In her decision, the ALJ relied on the Commission’s Section 21(a) Report in John H. Gutfreund.1  According to Gutfreund, one is a supervisor if one has the requisite degree of responsibility, ability or authority to affect the conduct of the employee whose behavior is at issue.” (emphasis added).6  In this regard, Gutfreund cites to a significant concurring opinion in In re Huff, which provides that a supervisor is someone who has the power to hire or fire, and to reward or punish” or, if the purported supervisor does not have these powers, then he knew or should have known that he had the authority and responsibility within the administrative structure . . . to exercise such control . . . that he could have prevented [the employee’s] violations.”7

While the ALJ acknowledged in her decision that Urban did not have any of the traditional powers associated with a person supervising brokers and the facts and circumstances of his situation are very different than in Gutfreund and its progeny,” she nonetheless reasoned that “[a]s General Counsel, Urban’s opinions on legal and compliance issues were viewed as authoritative and his recommendations were generally followed by people in FBW’s business units, but not by [the unit in which Glantz worked]. Urban did not direct FBW’s response to dealing with Glantz, however, he was a member of the Credit Committee, and dealt with Glantz on behalf of the committee.”8  The ALJ apparently recognized the logical extension of her theory, stating that the language in Gutfreund, taken literally, would result in Glantz having many supervisors because many people at FBW acted to affect Glantz’s conduct in a variety of different ways.”9

The Commission ultimately reviewed the Initial Decision on cross appeals by the parties and after briefs were filed in the appeal by several amici curiae. As noted above, the Commission was evenly divided on the matter, thereby dismissing the proceedings against Urban and rendering the Initial Decision of no effect” under Commission Rule of Practice 411(f). 10

While the dismissal of the Initial Decision eliminates potentially adverse precedent in this area, it nonetheless leaves unsettled many questions regarding when legal and compliance professionals cross the threshold into the perilous world of supervision, even where those purportedly supervised are outside of their departments.

1 Urban also served as an Executive Vice President and member of the Board of Directors of FBW.

2 Admin Proc. File No. 3-13655; Rel. No. 34-66259 (Jan. 26, 2012), available at http://​www​.sec​.gov/​n​e​w​s​/​d​i​g​e​s​t​/​2​0​1​2​/​d​i​g​0​1​2​6​1​2.htm.

3 Admin Proc. File No. 3-13655, Rel. No. 34-60837 (Oct. 19, 2009), available at http://​www​.sec​.gov/​l​i​t​i​g​a​t​i​o​n​/​a​d​m​i​n​/​2​0​0​9​/​3​4​-​6​0​8​3​7.pdf.

4 Admin. Proc. File No. 3-13655, Initial Decision Rel. No. 402 (Sept. 8, 2010), available at http://​www​.sec​.gov/​l​i​t​i​g​a​t​i​o​n​/​a​l​j​d​e​c​/​2​0​1​0​/​i​d​4​0​2​b​p​m.pdf.

5 Exchange Act Release No. 31554, 52 SEC Docket 2849, 1992 WL 362753 (Dec. 3, 1992).

6 Id. at 113.

7 50 S.E.C. 524 (1991).

8 See Initial Decision Release, supra note 4 at 52.

9 Id.

10 17 C.F.R. § 201.411(f). (“In the event a majority of participating Commissioners do not agree to a disposition on the merits, the initial decision shall be of no effect, and an order will be issued in accordance with this result.”)