Failure to Supervise

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. The failure to supervise is a violation of self-regulatory rules and give rise to a private cause of action cognizable under the broad antifraud provisions of construction of SEC Rule 10b-5. In addition to vicarious liability under the common law, brokerage firms can be held as control persons under Section 20(a) of the Exchange Act of 1934, 15 U.S.C. 78t(a). Congress adopted Section 20(a) in an attempt to protect the investing public from representatives who were improperly supervised or controlled. It 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 a control person liability claim that plaintiff need not show day-to-day control of affairs, but only that defendants had possession of the power to influence in order to state a claim under Section 20(a). Moreover it does not matter 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.

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. As a result, 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 broker’s 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.

Many commentators and securities regulators 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. Such activity as been at the heart of recent cases, both civil and regulatory, involving these firms and their“registered representatives.

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.