Failure To Supervise

Financial and securities brokerage firms have a legal duty to supervise their brokers and their brokers’ recommendations to clients to ensure compliance with the rules of the securities industry. When an individual broker is negligent or acts in an unlawful manner against the interests of the client and that client suffers damages, the firm may be held liable for the investor’s losses.

Below is a summary of a recent case that illustrates a failure to supervise claim:

A client recently came into a lawyer’s office and complained that his accounts had suffered losses and that his adviser would not return his calls. The attorney reviewed his monthly account statements and noticed that a large portion of his investment losses occurred in “penny stocks.” Historically, a penny stock was defined as a stock valued at less than $1 per share. The SEC modified that definition to include shares valued at less than $5 per share. Penny stocks are typically issued by small startup companies with limited resources and cash. These companies issue penny stocks to raise money for their operations. Penny stocks are thinly traded, meaning that they are not traded in high volumes, which makes it difficult for investors to sell their shares. Penny stocks are extremely risky investments, and most brokerage firms have written compliance procedures that expressly prohibit their representatives from selling them.

Knowing these facts, the lawyer requested that the client provide her with all trade confirmations that he received from the brokerage firm. A trade confirmation is a written document that brokerage firms are required to send to the customer after the transaction is completed. Importantly, trade confirmations are marked as either “solicited” (i.e., the broker made the recommendation) or “unsolicited” (i.e., the customer instructed that the brokerage firm purchase or sell an investment). The client kept good records and provided the attorney with a stack of trade confirmations. All of the confirmations pertaining to the penny stocks were marked “unsolicited,” which could mean either that the client actually recommended the trades or that the broker was intentionally mislabeling the trades to avoid the firm’s compliance department.

Without explaining to the client the significance of the “unsolicited” language, the attorney asked the client whether he had ever contacted the broker and instructed him to purchase any of the penny stocks. The client stated that he had never even heard of the penny stock companies, much less instructed the broker to purchase them. This confirmed the attorney’s suspicion that the broker had been mislabeling the trades to avoid detection by the brokerage firm’s compliance department.

The attorney then obtained a copy of the broker’s Central Registration Depository (CRD) report. FINRA, as well as state and federal securities regulators, requires that brokers and their firms provide certain information about the broker and broker- age firms (e.g., customer complaints, broker employer information, facts relating to broker termination, etc.). This information is compiled by regulators and a CRD report is generated. The CRD report is public information and is extremely helpful to consumers who are aware that such reports exist. CRD reports can be obtained from the FINRA website,, under the term “Broker Check report” or from state securities regulators.

In this case, the CRD report stated that the broker had been terminated the month before for “violating firm policy by recommending penny stocks to customers.” The CRD report also listed several complaints from other customers about sustaining losses in penny stocks.


New York Stock Exchange Rule 405(b) requires that a brokerage firm “[s]upervise diligently all accounts handled by registered representatives of the organization.” Proper supervision in the securities industry is mandatory. Firms must create, maintain, and enforce a plan that will supervise the day-to-day activities of their workforce. Addition- ally, FINRA Conduct Rule 3010 provides, in part, that “[e]ach member shall establish and maintain a system to supervise the activities of each registered representative, registered principal, and other associated person that is reasonably designed to achieve compliance with applicable securities laws and regulations, and with applicable NASD Rules. Final responsibility for proper supervision shall rest with the member. . . .”

A brokerage firm may also be responsible for its brokers’ conduct under the concept of vicarious liability. In the context of an employer/employee relationship, a firm’s vicarious liability stems from the common law doctrine of agency or respondeat superior. Under this doctrine, the employer (or superior) is responsible for the negligent or wrongful acts of its employee (subordinate). That is to say, the employer is charged with a legal responsibility for the employee because the employee is acting as the agent of the employer or principal.

Finally, firms may have to accept responsibility for the wrongful conduct of their broker employees under the theory of “control person liability.” This theory of liability is set out in section 20(a) of the Exchange Act of 1934, 15 U.S.C. 78t(a). That section provides:

Every person who directly or indirectly controls a person liable under any provision of this chapter or any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.


Stockbrokers are supervised by branch managers or branch office managers (BOMs). BOMs are obligated to make sure that the brokers they oversee comply with regulatory rules and sales practices. They do this in a number of ways. BOMs may conduct prehire screening or evaluation of broker candidates. Once a broker is hired by a firm, BOMs may review broker-client communications, order tickets, account opening documents, account holdings, and customer complaints. The BOM may also review account activity in the client accounts for which a broker is responsible. To do this, the BOM may use exception reports that are created upon certain types of account activity, such as high-volume orders, high-dollar-value orders, concentrated positions (too much of one stock in a single account), excessive use of margin, or unusual or excessive commissions.

If a BOM determines that a broker has acted negligently or fraudulently, the BOM must take action and create a written record of the broker’s conduct. This written record is often helpful in proving a case against the broker or firm. Another source of information about a broker’s past conduct is the CRD. A copy of a broker’s CRD information can be obtained by contacting the state securities regulator in the state in which the broker is or should be licensed or by visiting FINRA’s broker check website at Calculators/BrokerCheck.

If you have experienced investment losses involving failure to supervise, call The Doss Firm for a free consultation at (770) 578-1314.