SEC ALJ Issues Important Decision on the Duty of Supervision of General Counsel and Compliance Personnel

September 12, 2010

In a case that has been watched closely in the industry, the SEC’s Chief Administrative Law Judge recently cleared the former General Counsel of Ferris Baker Watts of charges that he failed to supervise a rogue broker at the firm. In re Theodore Urban, Case No. 3-13665 (September 8, 2010) (Initial Decision). The decision is important in helping to clarify the supervisory obligations of the general counsel, other internal counsel and compliance personnel at broker-dealers and investment advisers. The decision stems from an October 2009 administrative proceeding initiated by the SEC’s Division of Enforcement against Urban alleging that he failed reasonably to supervise the broker by failing to adequately respond to “red flags” indicating that the broker’s conduct was illegal. (The broker in question pled guilty in 2007 to charges including securities fraud and lying to investigators.)

After determining that Urban “did not have any of the traditional powers associated with a person supervising brokers” (such as the authority to hire and fire), the ALJ nevertheless concluded that Urban was a supervisor of the rogue broker because: (1) as General Counsel, his opinions were viewed as authoritative and his recommendations generally followed by people in the firm’s business units; and (2) he acted to affect the broker’s conduct in his capacity as a member of the firm’s Credit Committee. The ALJ agreed with the experts in the case that the language in John H. Gutfreund, 51 S.E.C. 93 (1992), “taken literally, would result in [the broker] having many supervisors because many people at [the firm] had acted to affect [the broker’s] conduct in a variety of different ways.”

The ALJ, however, rejected the Division’s contention that Urban failed to respond adequately to indications that the broker was engaged in illegal conduct and instead found Urban’s actions reasonable. The ALJ identified the key issue as whether Urban’s response to “red flags” of misconduct was adequate under Gutfreund, which requires “adequate follow-up and review” by non-line personnel upon detection of irregularities or unusual trading activity. The ALJ rejected the Division’s argument that going to the CEO, the Board, or the Executive Committee was a reasonable alternative to the actions Urban took, which included recommending the firing of the broker and multiple follow-up conversations with the broker’s direct supervisors. The ALJ stressed its finding that Urban had been lied to by virtually all the business leaders at the firm 2 and found that Urban’s “numerous good faith attempts to deal with [the broker’s] supervision” met the requirements under Gutfreund. In rejecting the Division’s allegation that Urban failed to elevate his termination recommendation to the CEO and ultimately the Board or Executive Committee, the ALJ credited Urban’s contention that both courses of action would have been futile.

The ALJ’s decision contains a lengthy and detailed factual discussion and application of Gutfreund and many of its particulars not discussed here warrant careful consideration by legal and compliance personnel at broker-dealers and investment advisors. (You will find a link to the text of the initial decision here:

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Joseph Goldstein and other attorneys at Murphy & McGonigle represented multiple individuals in Urban and related matters. In addition, the Gutfreund case was brought and settled under Joe Goldstein’s supervision during his tenure as the Associate Director of the Division of Enforcement. For more information concerning our broker-dealer and investment adviser enforcement and compliance practice, please contact any of the lawyers listed below: Joseph Goldstein 202.661.7013

Thomas McGonigle 202.661.7010

Paul Merolla 212.792.4043

William Donnelly 202.661.7011

Jerry Isenberg 202.661.7012

Joseph Lombard 202.661.7028

Robert Howard 202.661.7015

Adriaen Morse 202.661.7014

Thomas Hershenson 202.661.7016