On March 17, 2022, FINRA issued a notice to member firms about Rule 3110 as it pertains to the potential liability of Chief Compliance Officers (CCOs) for failure to discharge designated supervisory responsibilities. (Regulatory Notice 22-10, “the Notice”). The Notice provides welcome guidance, clarifying when CCOs will, and will not, be held liable for supervisory violations and explicitly acknowledging that CCOs are generally not responsible for all supervisory activity within member firms.
The Notice recognizes that a CCO’s role at a member firm is presumptively advisory, not supervisory. Under Rule 3110, the firm’s business management, not its compliance officials, has the responsibility of meeting the rule’s supervisory obligations. As such, the responsibility for implementing and maintaining an effective supervisory system is the responsibility of the firm and its president (or equivalent officer or senior business executive or individual, whether titled president or CEO) and whoever it designates as supervisors with delegated supervisory responsibility.
The Notice also recognizes the separate functions of compliance and supervision and distinguishes between written compliance guidelines and written supervisory procedures; compliance guidelines set forth the rules and policies that must be adhered to and describe prohibited practices, while supervisory procedures document the supervisory system to ensure that compliance guidelines are followed. Therefore, member firms must designate one or more registered principals as CCO to fulfill the compliance function. FINRA further acknowledges that a CCO can also hold other positions at a firm (
e.g., CEO), and in such circumstances, a CCO would likely fall within the scope of Rule 3130 because of the supervisory authority designated to them based on their non-CCO position. But when an individual’s sole position at a firm is that of CCO, FINRA will conduct a more extensive liability assessment under Rule 3110 before concluding there is liability. To determine supervisor liability for a CCO, FINRA clarified that it will (i) determine whether the member firm designated supervisory responsibility, (ii) apply the reasonableness standard and (iii) consider factors for or against charging a CCO, as explained further below:
First, a firm may designate its CCO as having supervisory responsibility either through the firm’s written supervisory procedures or otherwise. According to FINRA, this designation can occur by assigning the CCO the responsibility to establish, maintain and update written supervisory procedures (both generally as well as in specific areas) or assigning the CCO the responsibility to enforce the written supervisory procedures or other specific oversight duties usually reserved for line supervisors. Separate from written procedures, the designation can occur when the president or senior business executive expressly or impliedly designates specific supervisory responsibilities to the CCO on an ad hoc basis or when the CCO takes on specific supervisory responsibilities such as an exigencies demand (
e.g., the review of trading activity in customer accounts or oversight of associated persons).
Second, FINRA will then evaluate whether the CCO’s conduct in performing designated supervisory responsibilities was reasonable to comply with the federal securities laws, regulations, or FINRA rules. For example, if the CCO is responsible for establishing, maintaining and enforcing the firm’s written supervisory procedures, FINRA will ask whether the procedures were reasonably tailored to the firm’s business and whether they addressed the specific activities of the firm’s personnel.
Third, FINRA will determine whether formal or informal action is an appropriate response for any failure to supervise by a CCO. FINRA set out factors it will evaluate to determine whether charging the CCO under Rule 3110 in a formal disciplinary action is appropriate to address the violation. Some of the factors that would weigh in favor of a formal action against a CCO include:
Some of the factors that FINRA said would weigh against a formal action against a CCO include:
While the specific manner in which FINRA will apply this Notice will be developed over time, it provides welcome clarity given that the role of CCOs as gatekeepers has been a considerable focus for FINRA and other enforcement agencies over the last several years.
