On August 20, 2019, the Securities and Exchange Commission (“SEC”) charged Mosaic Capital, LLC, formerly known as AOC Securities, LLC (“AOC”), and its CEO with failing to adequately supervise an employee who engaged in securities fraud.  Pursuant to the SEC Orders, AOC and its CEO were ordered to pay penalties of $250,000 and $40,000, respectively.  The SEC’s actions serve as a reminder to broker-dealers—and members of firm management—of the potential for liability based on the actions of a self-dealing employee, and the need to guard against such activities.

The employee was a registered broker associated with AOC from May 2015 until he pleaded guilty to a host of criminal counts, including securities fraud, in April 2017.  The employee was charged with engaging in a fraudulent scheme, whereby he provided inflated price quotes on mortgage-backed securities to a New York-based investment advisor. In exchange, the advisor promised to send securities trades to AOC.  While AOC and its CEO did not admit to knowing about this fraudulent scheme (an element not required for supervisor liability) the SEC ultimately determined that they “failed to establish policies or procedures reasonably designed to prevent and detect [the employee’s] misconduct.”

Section 15(b) of the Securities and Exchange Act of 1934, as amended, makes broker-dealers and individuals associated with broker-dealers liable for failing to reasonably supervise an individual who violates federal securities laws.  However, under the same Section, broker-dealers and supervisors can avoid liability if: (1) the broker-dealer has established procedures that would “reasonably be expected to prevent and detect” violations of the securities laws by an individual; and (2) the individual’s supervisor “has reasonably discharged the duties and obligations” pursuant to those procedures.

Determining who is a “supervisor” under Section 15(b) is a fact-intensive exercise, but ultimately depends on whether the person in question has the requisite degree of responsibility or authority to affect the conduct of the employee alleged to have violated federal securities laws.  In a September 30, 2013 guidance document, the SEC’s Division of Trading and Markets provided the following non-exhaustive list of factors to consider in determining supervisory status:

• Has the person clearly been given, or otherwise assumed, supervisory authority or responsibility for particular business activities or situations?

• Do the firm’s policies and procedures, or other documents, identify the person as responsible for supervising, or for overseeing, one or more business persons or activities?

• Did the person have the power to affect another’s conduct? Did the person, for example, have the ability to hire, reward or punish that person?

• Did the person otherwise have authority and responsibility such that he or she could have prevented the violation from continuing, even if he or she did not have the power to fire, demote or reduce the pay of the person in question?

• Did the person know that he or she was responsible for the actions of another, and that he or she could have taken effective action to fulfill that responsibility?

• Should the person nonetheless reasonably have known in light of all the facts and circumstances that he or she had the authority or responsibility within the administrative structure to exercise control to prevent the underlying violation?

When considered a “supervisor,” an individual must reasonably supervise employees with an eye towards preventing federal securities violations.  The SEC’s sanctions against AOC and its CEO highlight the wisdom in establishing robust, written policies and procedures for detecting and preventing federal securities violations, including unmistakable delegations of supervisory authority and practices designed to ensure that supervisors are fulfilling their duties under those policies and procedures.