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Failure To Supervise

The Failure to supervise is a violation of FINRA Rules.  The violation of these Rules while not independently giving rise to a private right or cause of action are cognizable under the broad construction of the antifraud provisions of SEC Rule 10b-5 as an "omission" in the failure to disclose that the broker was unsupervised.

In addition, a brokerage firm's liability for the conduct of its registered representatives, not only arises from its lack of effective supervision but also from the familiar principles of an employer's vicarious liability. In addition to vicarious liability under the common law, Section 20(a) of the Exchange Act of 1934, 15 U.S.C. 78t(a) provides that:

every person who directly or indirectly controls a person liable under any provision of this chapter or any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the acts or acts constituting the violation or cause of action.

15 U.S.C. 78t(a) .

In order to establish liability under Section 20(a), a plaintiff need only allege that the controlling person had knowledge, or at least a duty to know, of the alleged wrongful activity, and the power or ability to control or influence the affairs of the controlled persons.

Many "independent" brokerage firms have hundreds, if not thousands, of financial advisors operating "franchises" under assumed, and often catchy, trade names, in branch offices across the United States." These offices, typically are comprised of one or two sales persons and a clerical assistant, and the brokers, in exchange for a high percentage payout of their commissions, generally pay their own operating expenses.

However, these "franchise" offices have no independent on-site supervision as do most traditional brokerage firms, and as such, the brokerage firm, is substantially unable to directly supervise the sales practices or activities conducted at these geographically dispersed, independent and remote offices.

We believe that this business model is flawed and the securities regulators appear to agree. The structure of non-traditional firms has made it inherently difficult for such broker-dealers to properly design, implement, and maintain a supervisory structure capable of preventing fraud of the type complained of here. See, In the Matter of Prospera Financial Services, Inc., 73 S.E.C. 935 at 6 (Sept. 26, 2000). Such activity as been at the heart of recent cases, both civil and regulatory, involving these firms and their "registered representatives."

"In recent years," as one commentator has observed, "a growing number of securities brokers are discarding the notion of working for a large wire house in favor of working for a non-traditional brokerage firm in a small satellite office. These non-traditional firms typically employ these representatives as independent contractors in geographically dispersed offices containing anywhere from one to four brokers, and offer up to a 80 or 90 percent commission pay out, may be double what a broker can earn at a conventional firm."

If you believe that you may have been the victim of the your brokerage firm's failure to supervise its broker, contact us for a free evaluation of your claim.

Sources / Additional Reading:

See, e.g. Klock v. Lehman Brothers Kuhn Loeb Inc., 585 F. Supp. 210, 216 (S.D.N.Y. 1984)(failure to disclose to the broker's termination may be actionable as an omission under the broad construction of SEC Rule 10b-5).

See Carras v. Burns, 516 F. 2d 251, 288 (4th Cir. 1975); Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 198 1 ), cert. denied, 455 U.S. 938 ( 1982). The doctrine of respondeat superior imposes vicarious liability on the brokerage firm for its broker's misdeeds (vicarious liability may be based on respondent superior and Section 20(a)); Denten v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 88 F. Supp. 176, 1 77 (N.D. Ill.1995)(brokerage firm liable under doctrine of respondent superior).

See also, Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1573 (9th Cir. 1990)("Congress adopted Section 20(a) in an attempt to protect the investing public from representatives who were improperly supervised or controlled")

Arthur Children's Trust v. Keim, 994 F.2d 1390, 1398 (9th Cir. 1993);

Powers v. Eichen, 977 F. Supp. 1031, 1044-45 (N.D. Cal. 1997) ("plaintiff need not show day-to-day control of affairs, only that defendants had possession of the power to influence in order to state a claim under Section 20(a)"). Hollinger, 914 F.2d at 1572 n.16 (same);

Safeway Portland Employees' Fed. Credit Union v. C.H. Wagner & Co., 501 F.2d 1120 (9th Cir. 1974) (same).

See, e.g., In re Royal Alliance Associates, Inc., 63 S.E.C. Docket 1601 (Jan. 15, 1997)(inadequate system of effective supervision over geographically dispersed brokers); See also, In re Consolidated Investment Services, 58 S.E.C. 699 (Dec. 12, 1994);

In the Matter of Prospera Financial Services, Inc., 73 S.E.C. 935 at 6 (Sept. 26, 2000);

In re New York Life Securities, Inc., 68 S.E.C. 102 (Sept. 23, 1998).

P. Michaels, Arbitration of Trading Away Cases Against Non-Traditional Broker-Dealers, Securities Arbitration 2002 (PLI), Volume I at 621. Traditional firms generally have large, centralized branch offices where the majority of registered representatives are full-time employees of the broker-dealer.




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