There has been a lot of discussion over the past few years, including in this blog, about the growing – and troubling – trend for Chief Compliance Officers to be named as respondents in disciplinary actions.  While regulators regularly deny that they truly have it out for CCOs, as is often the case, their actions speak louder than their words.  Today, the threat of a CCO becoming a respondent is real and undeniable.  I thought I would use a recent FINRA Enforcement action to make this point clear.

In September 2011, Southridge Investment Group, LLC, a broker-dealer, withdrew its membership from FINRA. For a two-year period leading up to that withdrawal, Thaddeus North was the firm’s CCO.  Generally speaking, when a BD files a BDW, FINRA calls off its dogs…at least as far as the firm itself is concerned.  For the defunct firm’s principals, however, it is quite another story, as FINRA will absolutely, positively continue to pursue those individuals, whether they move to another firm or whether they leave the securities industry altogether.  Mr. North learned that lesson firsthand and the hard way.

While FINRA took no action against Southridge, FINRA did file an Enforcement action against Mr. North alleging a bunch of rule violations, including a couple that, in my view, would have been more appropriately targeted against Southridge, except for the unfortunate fact that the firm was not still in business. Specifically, FINRA alleged that Mr. North – as CCO, remember, not as CEO, not as owner[1] – failed to establish a reasonable supervisory system for the review of electronic correspondence, and failed to report that one of the firm’s registered representatives had a relationship with an individual who was statutorily disqualified.  The hearing panel found Mr. North personally liable for both of these violations – shocking, yes, I know – and, on appeal, the NAC concurred.[2]

Let’s start with the supervisory violation. Generally speaking, there are two broad categories of supervisory cases:  either the procedures themselves are inadequate, or there is a failure actually to supervise.  (Sometimes, a case can involve both.)  The case against Mr. North involved the former.  We all acknowledge that under NASD Rule 3010(a), every broker-dealer must “establish and maintain” a supervisory system that is reasonably designed to achieve compliance with applicable securities laws and FINRA rules, and, under NASD Rule 3010(d), firms must also establish written supervisory procedures to effectuate the supervisory system.  Clearly, these are both responsibilities of the firm.

Given that, it is typically the broker-dealer that gets named when the problem is with the supervisory procedures. Now, I am not saying there aren’t exceptions to this, as there are such cases with individual respondents.  (Indeed, as I’ve blogged about before, FINRA does routinely threaten to name individuals as respondents as part of its efforts to exact settlements from firms, and sometimes it follows through on those threats.)  But, from a strictly logical standpoint, the broker-dealer is the appropriate respondent: it is a firm responsibility to come up with a reasonable system and set of procedures.  Here, however, the hearing panel and the NAC both hung their respective hats on the fact that in Southridge’s 2008 written supervisory procedures, the firm’s “compliance officer” was designated as the person responsible for maintaining the procedures, “and the 2010 written supervisory procedures designated Mr. North, by title and name, as the person responsible for reviewing and maintaining the procedures.  The 2010 procedures also provided that the CCO was responsible for ensuring that Southridge had appropriate policies and procedures concerning electronic communication.”

My problem is that every firm’s WSPs designate someone as the person responsible for the “maintenance” of the WSPs, whatever “maintenance” means, but most of the time, FINRA is content only to go after the firm for inadequate procedures.  Here, it seems that the driving force behind FINRA’s decision to pursue Mr. North individually was simply the fact that Southridge was dead, and safe from Enforcement action.  I simply hate it when FINRA, or any regulator, acts inconsistently (and, therefore, unpredictably).  Two sets of identical facts should yield the same result.  But, that is clearly not the case when dealing with FINRA, which is wildly inconsistent and wildly unpredictable.  And that, to put it directly, is just not fair.

Regarding the latter violation, NASD Rule 3070(a)(9), effective through June 30, 2011, required a member firm to report to FINRA whenever it, or one of its associated persons, was “associated in any business or financial activity with any person who is subject to a ‘statutory disqualification’ … and the member knows or should have known of the association.” In the pertinent written supervisory procedures, Mr. North was delegated the responsibility for Southridge’s compliance with its Rule 3070 reporting requirements.  Accordingly, FINRA concluded that Mr. North was personally responsible for the firm’s failure to have made a timely report of its registered representative’s association with an SD’d individual.  But, again, in many, if not most, instances, violations of this sort are deemed to be firm violations, not individual violations.  Here, because Southridge had already withdrawn, FINRA had no firm on which to focus its Enforcement wrath, leaving only poor Mr. North.

The lesson here is not just for CCOs, but any principal at a firm that no longer exists: you need to understand that it’s not just possible that you will be named individually, but it’s much more likely than if the firm was still around and available as a respondent.  Not saying this is right or fair; it’s just an acknowledgement of the fact that FINRA wants its pound of flesh, and if the firm cannot supply it, then it will look to individuals who can.


[1] In the interest of full disclosure, it appears that Mr. North was registered as a principal and sales supervisor.  But, it is noteworthy that it is his role as CCO that is highlighted by FINRA in the decision to find him personally liable.


[2] It is also worth noting that FINRA brought an action against the firm’s CEO, too.  He submitted an Offer of Settlement, which FINRA accepted.