As a result of the 2008 financial crisis, industry oversight and regulation by the Securities and Exchange Commission (“SEC”) has increased significantly. One aspect of this oversight has focused on a firm or individual’s duty to ensure overall compliance, which is a distinct obligation under federal securities laws. The importance of complying with FINRA and SEC rules was underscored by a recent court ruling that broadened the scope of potentially sanctionable activity to past supervisory violations.
A May 2, 2014 decision from the United States Court of Appeals for the Seventh Circuit, Carl M. Birkelbach v. SEC, No. 13-2896, affirmed a SEC ruling that failure to supervise is a ongoing violation, rather than a single violation, and that all violative conduct can be considered in determining sanctions. In this case, brokerage founder Carl Birkelbach was accused of failing to supervise one of his traders for conduct beginning in 2002. Mr. Birkelbach was initially sanctioned by the Financial Industry Regulatory Authority (“FINRA”), which imposed a limited six month suspension and fined him $25,000. He appealed the ruling to FINRA’s National Adjudicatory Council (“NAC”), which found that the sanctions were insufficient to remedy the alleged conduct. Instead, NAC issued a lifetime ban from association with any member firm in any capacity. On appeal, the SEC affirmed the ban due to Mr. Birkelbach’s “egregious” failure to supervise.
Mr. Birkelbach appealed the SEC ruling to the Seventh Circuit, claiming that the disciplinary action was barred by the five-year statute of limitations in 28 U.S.C. §2462 and that the lifetime ban was excessive. In arguing that the action was outside of the statute of limitations, Mr. Birkelbach maintained that his failure to supervise was a single, indivisible incident that occurred when the trader first took over the account in 2002. The court disagreed with this interpretation, and affirmed that a duty to supervise is a continuous duty; any violative conduct that falls within the previous five years is sanctionable, irrespective of whether or not there was additional conduct that occurred before that time. The court further held that while any prior conduct may not be the basis for the disciplinary action, it may be used by the SEC in determining the appropriate sanctions. Consequently, all of Mr. Birkelbach’s supervisory failures could be considered when crafting a sanction—even though the earlier violations would otherwise be barred by the statute of limitations. Finally, after reviewing the evidence considered by the SEC in affirming the lifetime ban, the court determined that this sanction was not excessive because Mr. Birkelbach’s conduct was “sufficiently egregious.”
This ruling makes it clear that compliance with industry rules—including the duty to supervise—is an ongoing obligation, and that past violations may influence the sanctioning phase of enforcement actions. As a result, in this aggressive enforcement climate, financial industry professionals must remain vigilant about understanding and complying with the guidelines and rules set by FINRA and SEC. Moreover, it is critical that firms institute supervisory procedures as well as mechanisms to ensure the effectiveness of these procedures.
If you have any questions regarding the Birkelbach v SEC decision, or would like specific guidance based on this or other enforcement action issues, please contact a member of Reminger’s Financial Services Professional Liability Practice Group.
This has been prepared for informational purposes only. It does not contain legal advice or legal opinion and should not be relied upon for individual situations. Nothing herein creates an attorney-client relationship between the Reader and Reminger. The information in this document is subject to change and the Reader should not rely on the statements in this document without first consulting legal counsel.
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