Can a Broker-Dealer Firm be Sued for Failure to Supervise a Broker?

Broker-dealers, also known as brokerage firms, are routinely sued for “failure to supervise” claims. The Financial Industry Regulatory Authority (FINRA), the organization which regulates broker-dealers and their employees, has a series of rules requiring broker-dealers to establish and maintain a supervisory system to supervise its brokers and other employees, as well as to monitor all trading activity to ensure compliance with applicable securities laws and regulations. In many of our clients’ cases, the brokerage firm’s lack of supervision and failure to properly supervise a broker’s misconduct has directly and indirectly impacted our clients’ accounts, causing losses. Malecki Law’s FINRA arbitration attorneys have handled many cases against brokerage firms in New York (and across the country) for failure to supervise and have received favorable monetary awards and settlements for our clients.

A supervisory system that cannot reasonably surveil and detect trades that violate securities laws and deceptive trade practices does not meet FINRA’s minimum requirement of proper supervision. Moreover, proper supervision also requires a firm supervisor to approve a broker’s daily trades, as well as to systematically review clients’ accounts for wrongful trading activity such as recommending unsuitable investments, trading without proper authority from the customer, or charging high commissions that make it virtually impossible for the customer to make any sort of profit.

Not only are brokerage firms required to actively monitor its brokers, but its system and procedures for this must be maintained in writing and reflect applicable securities laws. The brokerage firm is then responsible for communicating its written supervisory procedures to its brokers and employees to whom such procedures are relevant, based on their activities and responsibilities. On request from FINRA regulators, the brokerage firm has to prove that it is in compliance with the supervisory rules and provisions. The brokerage firm can prove this by having written supervisory procedures and supervisor notes showing the steps it took. On the contrary, the lack of documents demonstrating proper supervision shed light on the brokerage firm’s noncompliance. Similarly, in customer disputes, the lack of documents proving compliance with FINRA’s supervisory rules evidences a firm’s failure to properly supervise its brokers.

Even when a broker improperly acts “outside” the firm, such as in a “selling away” case, a brokerage firm may still be held responsible for that activity if it was investment-related and proper supervision (e.g., such as an audit) could have stopped it. Brokerage firms must declare all outside business activity of its brokers that take place outside the firm, particularly in selling investments. This is often important in cases where the broker is running a Ponzi scheme away from the firm, which can be kept hidden without proper audits by the firm, but it is also an issue that arises in cases involving promissory notes and/or private placements, where brokers earn large commissions.

Broker-dealers are in the business of making money. They profit from the buying and selling of securities in their clients’ accounts. This could incentivize broker-dealers to turn a blind-eye on its broker’s trading activity and put its own financial gain over its regulatory and supervisory responsibilities. Where in some cases the brokerage firm will deliberately ignore the broker’s trading, other cases involve the brokerage firm’s negligence in failing to implement reasonable supervisory procedures that would detect a broker’s improper trading activity. More often than not, a brokerage firm’s failure to supervise, whether deliberate or negligent, leads to losses in its customers’ accounts. When this happens, the customer can sue the brokerage firm to recover losses sustained.

If you suspect wrongdoing by your broker or broker-dealer, New York securities fraud lawyers of Malecki law are here to help. Feel free to contact us to discuss any potential claims. For more information regarding FINRA’s supervisory rules visit FINRA.org , and for more information about claims against a broker-dealer or broker please visit our investor page.