Failure To Supervise

A FINRA examiner asks Ravensmere Securities to demonstrate that a principal actually reviewed the mutual fund transactions its representatives entered last month. Written supervisory procedures alone will not satisfy the examiner because the firm must also:

1. A.Evidence the review, for example by documenting who reviewed each transaction and when.Correct. FINRA requires the review to be evidenced, so the firm can show the reviewer and the date for each item.
2. B.File the reviewed transaction reports with FINRA each month.There is no monthly filing of reviewed transactions. The evidence is kept at the firm and produced on request.
3. C.Obtain the customer's written acknowledgement that a principal reviewed the transaction.Supervisory review is an internal obligation; no customer acknowledgement is involved.
4. D.Have the reviewing principal re-approve each transaction annually for the life of the account.Review attaches to the transaction when it occurs; there is no annual re-approval requirement.

Why: Supervision is tested by evidence, not by intention. FINRA requires a member to have procedures for the review of transactions and to evidence that review, so that the firm can show who reviewed what and when. Initialling or electronically flagging the reviewed items, or generating a dated exception report the reviewer signs off, is how the obligation is met in practice.

Over eight months agent Corentin Bazile sold unregistered promissory notes to eleven customers away from his firm. His branch manager never reviewed his correspondence, never questioned an outside bank account he had listed on his annual attestation, and the firm had no written procedures for detecting outside business activity. Regarding the firm and the branch manager, which statement is correct?

1. A.Both may be sanctioned for failure to supervise, because neither established nor enforced reasonable supervisory procedures, so the reasonable-discharge defense is unavailable.Correct. Firms and individual supervisors both face failure-to-supervise liability where reasonable procedures were absent.
2. B.The firm may be sanctioned but the branch manager may not, because supervisory liability attaches only to entities.Incorrect. Individual supervisors are regularly charged with failure to supervise.
3. C.Both are automatically liable for the customer losses whatever procedures they had, because supervisory liability is strict.Incorrect. A supervisor who adopted and reasonably discharged adequate procedures has a recognized defense.
4. D.Neither may be sanctioned, because the agent concealed the activity and the firm never authorized it.Incorrect. Concealment is the reason supervision exists; it is not a defense when nothing was in place to detect it.

Why: Selling away is the agent violation, but it rarely stops there. Both a firm and the individuals responsible for supervision can be sanctioned for failure to supervise when they did not establish and enforce a reasonable supervisory system designed to detect and prevent violations. There is a defense: a supervisor who established reasonable procedures and reasonably discharged the duties those procedures imposed is not liable merely because a violation occurred. On these facts, with no procedures, no correspondence review and an unexplained outside bank account, that defense is unavailable.