FINRA Has No Authority to Bring Court Actions to Collect Disciplinary Fines
The Financial Industry Regulatory Authority, Inc. (FINRA) lacks the authority to bring court actions to collect disciplinary fines it has imposed, the U.S. Court of Appeals for the Second Circuit determined.
Background on FINRA
FINRA is a self-regulatory organization (SRO), responsible for investigating and disciplining FINRA member firms and their associated member representatives, “relating to their compliance with the federal securities laws and regulations.” FINRA is the successor to the National Association of Securities Dealers (NASD), and, for all intents and purposes, all securities firms dealing with the general public must be members of FINRA.
— FINRA Procedures
Disciplinary proceedings are governed by FINRA’s Code of Procedure, which has been approved by the Securities and Exchange Commission (SEC) under Section 19 of the Securities Exchange Act of 1934 (Exchange Act). Disciplinary actions are brought by FINRA’s Department of Enforcement or Department of Market Regulation, after approval from FINRA’s Regulation Board or FINRA Board. A hearing council adjudicates matters initiated by complaint, and council decisions are appealable to the FINRA National Adjudicatory Council (NAC). Pursuant to Section 19, NAC decisions may be appealed to the SEC and, from there, to the U.S. Court of Appeals.
Enforcement Action Against the Fieros
In December 2000, an NASD hearing panel determined that John Fiero and Fiero Brothers, Inc. (together, Fieros) violated Section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and NASD Conduct Rules 2110, 2120, and 3370. The panel expelled Fiero Brothers, Inc. and barred John Fiero from associating with any FINRA-member firm in any capacity and fined the Fieros $1,000,000 plus costs, jointly and severally. The NAC’s decision was affirmed on appeal, but the Fieros did not appeal to the SEC.
— State Court Proceedings
When the Fieros refused to pay the fine, NASD commenced an action in New York Supreme Court. The court determined that the Fieros were bound by contract—their express agreement to comply with all FINRA/NASD rules—and, as an SRO, NASD had the authority to enforce its rules. The First Department of the New York Appellate Division affirmed the Supreme Court’s decision. The New York Court of Appeals reversed, however, when it found that the NASD action was intended to enforce a liability created under the Exchange Act, and thus it fell within the exclusive jurisdiction of the federal courts.
— Federal Court Action
After the Court of Appeals decision, the Fieros filed a declaratory judgment action seeking a ruling that FINRA has no authority to collect fines through a judicial proceeding. FINRA counterclaimed to enforce the judgment against the Fieros. The district court dismissed the declaratory judgment and ordered entry of a judgment in favor of FINRA in the amount of $1,010,809.25. The Fieros appealed.
Authority Under the Exchange Act
The Second Circuit held that FINRA does not have the authority to bring judicial actions to collect monetary sanctions. First, there is no statutory authority for SROs to bring judicial actions, and Congress never provided such statutory authority. As the Second Circuit explained, “there are no explicit provisions in the [Exchange Act] authorizing SRO’s to seek judicial enforcement of the variety of sanctions they can impose.” Moreover, if Congress had intended to permit judicial enforcement, it would have “provided for some specific relief other than leaving SRO’s to commonlaw proceedings in state courts or in federal district courts under diversity jurisdiction.”
— Conflict Between Contract Actions and Exclusive Federal Jurisdiction
FINRA’s authority to bring judicial actions would run up against powers granted under the Exchange Act. Because federal courts have exclusive jurisdiction to enforce the Exchange Act, “FINRA contract enforcement actions may bristle with Exchange Act legal issues because the most serious fines levied by FINRA will be for member violations of the Act.” Thus, in the case of the Fieros, the state contract action necessarily would have involved judicial interpretation of Exchange Act provisions, even though federal courts have exclusive jurisdiction.
— Fines Levied but Not Collected?
The Second Circuit rejected the notion that congressional intent to allow FINRA to bring judicial actions could be inferred because otherwise a gap in FINRA’s enforcement powers would result. Instead, there was no concern about under-enforcement of the securities laws and FINRA rules because “FINRA fines are already enforced by a draconian sanction not involving court action.” FINRA’s ability to revoke registration and bar a member from dealing with the public counteract the concern that FINRA’s inability to bring judicial actions renders it all but impotent. Additionally, when fines are based on a violation of the Exchange Act, private and SEC remedies will be available.
Further support for the Second Circuit’s finding was FINRA’s long-standing practice of relying exclusively on its powers to revoke registration, deny re-entry into the industry, or punish noncompliant members. It was not until 1990 that FINRA even sought to enforce fines through judicial actions, after NASD proposed a rule that notified members of its intent to bring court actions to collect fines. Moreover, according to the Second Circuit, the case against the Fieros was the first attempt by FINRA to bring court action under that rule. “Such a longstanding practice supports an inference that NASD believed that it lacked judicial enforcement power.”
The 1990 notice noted that the NASD intended to pursue “other available means” for collecting fines and costs in disciplinary decisions on or after July 1, 1990. This, FINRA argued, gave it the authority to initiate judicial action to enforce its fines. Yet this interpretation is “something of an exaggeration,” according to the Second Circuit. The notice assumes a pre-existing power which never actually existed. In order for FINRA to have obtained authority under the 1990 notice, it would have to have been promulgated under the procedures required by the Exchange Act—notably a notice and comment period, as well as formal SEC approval. Even though the notice was characterized by the NASD itself as a mere “house keeping” rule that did not require formal notice and comment under the Exchange Act, the Second Circuit was not convinced and explained that “[w]e, however, are not bound by the NASD’s characterization as to whether the 1990 Rule Change affected the substantive rights of members.” Because the notice was intended to create a substantive right for the NASD to bring judicial actions to enforce fines, it was not merely a policy change that could bypass the formal requirements for rulemaking. Rather, “it was a substantive rule that affected the rights of barred and suspended members to stay out of the industry and not pay the fines imposed on them in prior disciplinary proceedings.”
This document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. Bloomberg Finance L.P. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.
©2011 Bloomberg Finance L.P. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of Bloomberg Finance L.P.