United States: Legal And Compliance Officers Left In Doubt About Their Personal Liability

On October 19, 2009, the SEC instituted an administrative proceeding against Theodore Urban, the former general counsel of a broker-dealer, alleging that he had "failed to supervise" a registered representative of the firm. Urban was alleged to have been alerted to possible wrongdoing by a registered representative of the firm, to have tried to investigate and to stop any misconduct, but to have done too little to stop this misconduct. On first glance, it is difficult to identify a theory of liability under which Urban could be charged. He did not commit illegal acts, did not aid and abet or cause others to commit illegal acts, and was not the line supervisor of any wrongdoer. Nonetheless, the SEC asserted a theory of liability first articulated two decades ago under which a legal or compliance officer holding a senior position within the firm can be held liable for a failure to take affirmative action to investigate and to prevent misconduct that such officer had reason to suspect was taking place. Application of this failure to supervise theory is of particular concern to those within the legal and compliance community because, under such a theory of secondary liability, once a person is found to be a supervisor of a wrongdoer, the supervisor is subject to liability, with the burden shifting to the supervisor to prove the defense that supervision had in fact been adequate. Although the Urban case involved claims brought against the general counsel of a registered broker-dealer, the case potentially has important implications for a broader group of legal and compliance personnel, including chief compliance officers of registered broker-dealers and registered investment advisers.

The Urban case has a somewhat unusual procedural history. The SEC's claims were initially tried before an administrative law judge, who accepted the theory of supervisory liability but found that Urban met his burden of proving he had adequately supervised the wrongdoer. A year ago, the SEC Commissioners denied summary affirmance of this decision. Just a few weeks ago, the SEC Commissioners scheduled, then cancelled, oral argument on the appeal of this decision. On January 26, 2012, the case was finally resolved, but without in any way clarifying the theory under which legal and compliance officers can be held liable. Instead, the SEC dismissed the case because all but two of the Commissioners had recused themselves from the case, and the two remaining Commissioners were split in their views of the case. Urban has now been vindicated, but with legal and compliance officers left with no clear guidance as to the standard of liability that applies to their conduct in carrying out their duties and responsibilities.

Background on Supervisory Liability of Legal and Compliance Officers

The theory of liability under which Urban was charged was first asserted in In re John Gutfreund, 51 S.E.C. 93, Release No. 34-31554, 1992 WL 362753, *15-16 (1992), where the SEC stated in dictum that a firm's chief legal counsel, who directly supervised the firm's CCO, could be disciplined for a failure to supervise based on the misconduct of employees for whom he was not the direct supervisor but where the CLO/CCO had knowledge of possible misconduct and the authority to intervene to prevent it. Gutfreund represents an expansion of traditional failure to supervise claims to non-line supervisors. This theory was most clearly and forcefully advocated in a 1993 speech by then SEC Commissioner Mary Schapiro, who said "the facts and circumstances which may make you 'become' a supervisor vis-a-vis a particular employee, when formerly you were not, are (1) your knowledge and awareness of allegedly improper conduct, and (2), being so situated within a firm that you have some ability to affect the conduct at issue." Mary L. Schapiro, Commissioner, U.S. Securities and Exchange Commission, SIA Compliance and Legal Seminar: Broker-Dealer Failure to Supervise: Determining Who is a "Supervisor", at 15 (Mar. 24, 1993).

According to the SEC, under this theory of supervisory liability, two obligations are imposed on legal and compliance professionals when they learn of possible wrongdoing – a duty to investigate and a duty to prevent misconduct:

"The 'supervisory obligations imposed by the federal securities laws require a vigorous response even to indications of wrongdoing.' In re John H. Gutfreund, Exchange Act Release No. 31554, 1992 SEC LEXIS 2939, at *34 (Dec. 3, 1992). Thus, supervisors must respond not only when they are 'explicitly informed of an illegal act,' but also when they are 'aware only of 'red flags' or 'suggestions' of irregularity.' See id. at *34-35. In addition, '[e]ven where the knowledge of supervisors is limited to 'red flags' or 'suggestions' of irregularity, they cannot discharge their supervisory obligations simply by relying on the unverified representations of employees.' Id. at *35. 'Red flags and suggestions of irregularities demand inquiry as well as adequate follow-up and review.' In re Edwin Kantor, Exchange Act Release No. 32341, 1993 SEC LEXIS 1240, at *16 (May 20, 1993)." In the Matter of George M. Lintz, Exchange Act Rel. 43961 (Feb. 14, 2001).

"Once a person in [the general counsel's] position becomes involved in formulating management's response to the problem, he or she is obligated to take affirmative steps to ensure that appropriate action is taken to address the misconduct. For example, such a person could direct or monitor an investigation of the conduct at issue, make appropriate recommendations for limiting the activities of the employee or for the institution of appropriate procedures, reasonably designed to prevent and detect future misconduct, and verify that his or her recommendations, or acceptable alternatives, are implemented. If such a person takes appropriate steps but management fails to act and that person knows or has reason to know of that failure, he or she should consider what additional steps are appropriate to address the matter. These steps may include disclosure of the matter to the entity's board of directors, resignation from the firm, or disclosure to regulatory authorities." In re John Gutfreund, 51 S.E.C. 93, Release No. 34-31554, 1992 WL 362753, *15-16 (1992) (emphasis added).

Decisions in the Urban Litigation

In the Urban case, an administrative law judge held that Urban should be deemed the supervisor of a registered representative (Glantz) under the Gutfreund standard, although the judge found that the general counsel had acted reasonably in response to indications of misconduct. In re Urban, File No. 13835 (Sept. 8, 2010).

On December 7, 2010, the SEC Commissioners refused to grant summary affirmance of the administrative law judge's decision and indicated that the Commissioners would consider many important issues in reviewing this appeal: "the proceeding raises important legal and policy issues, including whether Urban acted reasonably in supervising Glantz and responded reasonably to indications of his misconduct, whether securities professionals like Urban are, or should be, legally required to 'report up,' and whether Urban's professional status as an attorney and the role he played as FBW's general counsel affect his liability for supervisory failure." Exchange Act Rel. 63456. It is interesting that Chairman Shapiro and Commissioner Walter did not recuse themselves from this decision since their participation in this decision would seem to be inconsistent with their recent recusal from this matter. On November 29, 2011, the Commissioners announced that they would hear oral argument on the Urban appeal on December 6, 2011, although they quickly cancelled that oral argument. Again, there was no indication Chairman Shapiro or Commissioner Walter would recuse themselves.

On January 26, 2012, without ever holding oral argument, the Commission dismissed the Urban case because only two Commissioners, Paredes and Aguilar, had not recused themselves from the case and they were divided in their views on how to decide the appeal.

Lessons for Legal and Compliance Officers

The SEC's resolution of the Urban case leaves legal and compliance officers with great uncertainty as to their responsibilities and potential liability. Legal and compliance officers will continue to operate with the risk that they could be liable under a failure to supervise theory, which imposes on them liability with the burden of proving the defense of adequate supervision. To meet this burden they would have to prove that they (1) reasonably investigated allegations of possible misconduct and (2) took effective action to prevent the misconduct, including the possibility that they must resign or report to the SEC if their efforts, however vigorous, are not supported by senior management.

An alternative theory of liability for legal and compliance officers would be that they are liable only if they participate in misconduct, aid and abet such misconduct, or fail to supervise persons who report directly to them. Although this view of the liability of legal and compliance officers would impose sensible limitations on such liability, the SEC's resolution of the Urban case leaves serious questions about whether it recognizes such sensible limitations.


The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions