Failure to Supervise
Securities Brokerage firms have a duty to supervise their brokers and the sales practices of their brokers, and to review customer statements for, among other things, evidence of suitability, unauthorized trading, or excessive activity.
Conduct Rule 3010, specifically provides that:
Each member shall establish and maintain a system to supervise the activities of each registered representative and associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with the Rules of this Association. Final responsibility for proper supervision shall rest with the member.
Many courts, including the United States Supreme Court, have recognized a private cause of action for violation of NASD and NYSE Rules. See, e.g., Cook v. Goildman Sachs & Co., 726 F. Supp. 151, 156 (S.D. Tex. 1989)(private right of action under exchange rules if claim is for misrepresentation or deception); Noland v. Gurley, 566 F. Supp. 210 (D. Colo. 1983)(same); Bateman Eichler Hill & Richards v. Berner, 472 U.S. 299, n.9 (1985)(private cause of action under Section 17); Laing v. Dean Witter & Co., Inc., 540 F.2d 1107; Fed. Sec. L. Rep. (CCH) ¶95,646 (D.C. Cir. 1976)(noncompliance with SEC Rules provides the basis for a private cause of action); Dale v. Prudential-Bache Securities, Inc., 719 F. Supp. 1164; Fed. Sec. L. Rep. (CCH) ¶94,991; Emmon v. Merril Lynch, Pierce Fenner & Smith, Inc., 532 F. Supp. 480, 484 (W.D. Ohio 1982); Fed. Sec. L. Rep. (CCH) ¶98,657.
Specifically, with respect to the "failure to supervise," courts will impose civil liability, unless the broker-dealer can establish a "good faith" defense that it maintained, and enforced an adequate system of supervision. See, e.g., Smith v. Christie [1981] Fed. Sec. L. Rep. (CCH) ¶ 97,828 (N.D. Cal. 1980)(defendants meet burden of proving good faith by proving to the court’s satisfaction the adequacy of their supervision and compliance system set out in some detail); Trustman v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 1984-1985 Fed. Sec. L. Rep. (CCH) ¶91,936 (C.D.) Cal. 1985). In addition, failure to comply with one’s own rules may be basis for primary liability. Thropp v. Bache Halsey Stuart Shields, Inc., 650 F. 2d. 817, 820 (6th Cir. 1981) (court relied on defendant’s failure to enforce diligently its own rules in finding defendant negligent).
But for the performance of these duties, most cases of securities fraud may be reasonably prevented. The failure to supervise is a violation of self-regulatory rules. Courts have recognized a cause of action for the negligent failure to supervise, and brokerage firms are liable for the acts of their registered representatives under the common law doctrine of respondeat superior, and as control persons under Section 20(a) of the Exchange Act. The failure to supervise is a form of stockbroker misconduct and is actionable under the federal securities laws.
