Supervision Is Among A Brokerage Firm’s Business Activities
“A dispute that arises from a firm’s lack of supervision over its brokers arises in connection with its business activities.” Vestax Securities Corp. v. McWood, 280 F.3d 1078, 1082 (6th Cir. 2002)(quoting John Hancock, 254 F.3d at 58-59 (Therefore, having determined that the current dispute (i) is between customers and persons associated with Vestax, and (ii) arises in connection with Vestax’s alleged negligent supervision of its registered agents); John Hancock, 254 F.3d at 58-59 (same); MONY Secs. Corp. v. Bornstein, 250 F. Supp. 2d 1352, 1357 (M.D. Fla. 2003) (same); Hornor, Townsend & Kent, Inc. v. Hamilton, 218 F. Supp. 2d 1369, 1384 (N.D. Ga. 2002) (same); First Montauk Secs. Corp. v. Four Mile Ranch Dev. Co., Inc., 65 F. Supp. 2d 1371, 1379 (S.D. Fla. 1999) (same)(quoting, Thomas H. Oehmke, Commercial Arbitration § 28:14 (2003) (“A dispute that arises from a securities brokerage firm’s lack of supervision over its brokers arises in connection with its business”); Spear, Leeds & Kellogg v. Central Life Assurance Co., 85 F.3d 21, 29 (2d Cir.)(because Defendants’ claims arise in connection with the supervision of two of those representatives, they arise in connection with Plaintiff’s business)(applying analogous New York Stock Exchange rules), cert. denied, 519 U.S. 1040 (1996).
Business activities include the supervision of its registered representatives and the activities conducted at branch offices. Royal Alliance Associates, Inc. v. Wischmeyer, 897 F. Supp. 783 (S.D.N.Y. 1995); Royal Alliance Assoc. v. Davis, 897 F. Supp. 783, 788 (S.D.N.Y. 1995)(A dispute that arises from a firm’s lack of supervision over its brokers “arises in connection with its business activities”).
In May 1998, the NASD issues Notice to Members 98-39, reminding members of their Supervisory And Inspection Obligations, and suggesting that “Members should note the Royal Alliance” decision, which among other things “emphasized the need for close attention to supervision of small, dispersed offices.” NASD Notice to Members 98-38 at 274 (May 1998).
NASD 98-38 also stated that:
The purpose of this Notice is to remind members of their supervisory and inspection obligations for all of their associated persons and offices. Member firms must supervise all of their associated persons—regardless of location, compensation or employment arrangement, or registration status—in accordance with the NASD By-Laws and Rules. The fact that an associated person conducts business at an unregistered office or is compensated as an independent contractor does not alter the obligations of the individual and the firm to comply fully with all applicable securities
regulatory requirements.
NASD Notice to Members 98-38 at 273 (May 1998).
In June 1999, the NASD issued Notice to Members 99-45, offering specific guidance as to the types of activities a member must review that occur at each of its offices, and again recognizing that:
Some associated persons working in these unregistered offices may be involved in other business enterprises, such as insurance, real estate sales, accounting, tax planning, or investment advisory services, and consequently may be classified for compensation purposes as part-time employees or independent contractors. Some unregistered offices also operate as separate business entities under
names other than those of the members.
While the NASD does not encourage or discourage such arrangements, a large number of geographically diverse offices presents the potential that sales practice problems will not be as quickly identified as in larger, centralized branch offices. This increased potential must be taken into account when drafting supervisory procedures.
NASD issued Notice to Members 99-45 at 296 (June 1999)(Appendix “H”); See also, Sarah B. Estes, Supervision of Independent Broker Dealers: From Royal Alliance to NTM 99-45, North American Securities Administrator Assoc., Enforcement Law Reporter (2000)(supervision of non-traditional broker-dealer network offices).
Similarly, in March 2004, the SEC issued Staff Legal Bulletin No. 17, concerning: Remote Office Supervision (and again referencing the Royal Alliance decision in a footnote), and
expressing the Staff’s concern that:
Some broker-dealer firms have geographically dispersed offices staffed by only a few people, and many are not subject to onsite supervision. Their distance from compliance and supervisory personnel can make it easier for registered representatives (representatives) and other employees in these offices to carry out and conceal violations of the securities laws. Staff Legal Bulletin No 17. (March 19, 2004).
As at least one commentator has suggested, 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 selling away cases. In fact, the United States Securities Exchange Commission has found that the “mere existence of a remote office where a registered representative is engaging in outside business activity constitutes a red flag where, by nature of the business, the representative creates a potential vehicle by which he may carry out or conceal violations of the securities laws.”
Accordingly, a dispute that arises from a firm’s lack of supervision over its brokers arises in connection with its business, and these claims, pursuant to FINRA Rules are required to be submitted to arbitration.
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