Bates Research, Compliance and Regulatory Alerts | 07-15-22
SEC Case finding CCO “Aided and Abetted” Raises New Questions; Is a Liability Framework Next?
A recent settlement in an SEC action against an investment adviser and its Chief Compliance Officer (“CCO”) is raising questions about determinations that hold CCOs personally liable, absent fraud or obstruction on their part. As described in previous Bates posts (here and here), both the SEC and FINRA have offered guidance on CCO responsibility concerning effective supervision and compliance. The recent settlement involved SEC charges against a CCO of an investment adviser firm for numerous deficiencies with respect to the adviser’s compliance program. The case is notable for drawing the attention of SEC Commissioner Hester Peirce, who responded to it by urging the SEC to adopt a "liability framework" for bringing enforcement actions against CCOs. Here’s what you need to know.
The Facts of the Matter
The case involved a CCO and principal of an investment adviser who also served as a registered representative of a broker-dealer used by the adviser. Under the adviser’s compliance program, an investment adviser representative (“IAR”) was required to disclose outside business activities (“OBAs”) to the firm. Among other things, the SEC found that the CCO (i) failed to require or review the filing of an OBA report upon notification; (ii) failed to determine whether the OBA presented any conflicts of interest; (iii) failed to take steps to ensure adequate disclosure to clients as to the OBA or related conflicts of interest; (iv) failed to conduct a review to determine the legitimacy of transactions between the adviser's client assets and the IAR’s OBA; and (v) failed to monitor the IAR’s compliance with the associate broker-dealer’s policies.
The SEC found that the CCO “willfully aided and abetted and caused [the investment adviser]” to violate rules requiring investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act. As part of the settlement, the CCO agreed not “to act in a supervisory or compliance capacity with any broker, dealer, investment adviser, municipal securities dealer, municipal advisor, transfer agent, or national recognized statistical rating organization," and to pay a civil money penalty in the amount of $15,000. The investment adviser agreed to censure, and to pay a civil money penalty in the amount of $150,000.
Commissioner Peirce’s Remarks
In a statement on the matter, Commissioner Peirce argued that the case against the CCO, who was also a principal, “merits close consideration,” and that “determinations about whether to charge a compliance officer are consequential not only for the particular compliance officer, but more generally for the profession.” She raised concerns over the impact of such cases on “attracting well-qualified people to the profession,” and how “raising fears of facing liability for someone else’s missteps can dissuade excellent candidates from seeking compliance jobs.”
On regulatory policy, Ms. Peirce reiterated her previous position that the “compliance obligation belongs to the firm, not to the CCO,” and that that distinction is necessary to “ensure that [an adviser] dedicate[s] adequate resources to, and appropriately defer[s] to the judgment of, their compliance departments. To that end, the Commissioner recommended that the SEC adopt a "liability framework" for bringing enforcement actions against CCOs. She noted such a proposal by the New York City Bar Association, which would require a number of considerations as to, for example, whether the CCO made a good faith effort to fulfill its responsibilities; whether the CCO had opportunities to resolve the compliance failure and for how long the violations persisted; whether the violation related to a discrete, specified obligation under securities law or the firm's compliance program; and whether the SEC has rules or guidance on similar violations, among others. Applying this framework, she concluded that the CCO in the immediate case “had the opportunity to improve the compliance program but did not do so despite frequently recurring reminders that the program was not working effectively to cover outside business activities.” As a result, she said, “I believe the Order lays out a sound basis for concluding that this CCO’s conduct here fell materially short.”
Finding the right balance between personal and corporate responsibility is part of a continuing debate among regulators and enforcement officials. A CCO liability framework from the SEC, of the kind Commissioner Peirce suggests, may go far toward reassuring the compliance community that CCOs will not be held to an impossible standard. As the New York City Bar Association made plain, “given the special role that CCOs play and the compliance community’s legitimate concerns, we believe that instituting a Framework of nonbinding factors will provide the compliance community with the guidance it needs balanced against regulators’ need for ultimate discretion.” Bates will continue to keep your apprised.
This article is part of a continuing series focusing on CCO liability, enforcement, and the evolving liability framework.