Judicial Limitations on Investor Protection: Fiero v. FINRA (Part 5)

We are examining Fiero v. Financial Industry Regulatory Authority, 2011 U.S. App. LEXIS 20173 (2^nd Cir. Sept. 29, 2011), the recent decision by the 2nd Circuit that concluded FINRA lacked the authority to file an action to collect fines imposed on members.

Is there a right answer to this question?  Congress clearly contemplated the imposition of fines.  The fines were to be part of the rules and regulations of the SRO.  The House and Senate Reports on the Maloney Act do not provide much additional insight.  See HR Report No. 2307, 75th Cong., 3d Sess. (MAY 6, 1938); Senate Report No. 1455, 75th Cong., 3d Sess. (Jan. 5, 1938). The argument that fines are meaningless if they cannot be collected seems to create a strong argument for the implicit authority to bring an action. 

Moreover, since members prior to 1983 did not have to join an SRO, the threat of expulsion for nonpayment arguably had little meaning.  It merely meant that the brokers would become subject to SEC oversight, rather than the oversight of the NASD.  Moreover, the comparison to the authority given to the SEC to bring actions is inapposite.  In addition to the fact that the authority to impose penalties (and bring actions for nonpayment) came long after the adoptin of the Maloney Act, a federal agency is a very different animal than an SRO.  Government agencies are entirely a matter of statute and can have no authority except what is in the statute.

An SRO is different.  Depending upon the business form used (a for profit company in the case of the exchanges, a non-profit in the case of the NASD/FINRA), the entity has certain types of legal authority that does not need to be granted by Congress.  Thus, for example, the rights of a non-profit are largely determined by state statutes, not Congress. 

All of this suggests that Congress did not consider the authority to impose fines a matter that required much thought.  At the same time, however, it suggests that Congress did not view the authority as superflous, something that would be the case if a broker could simply exit the NASD.  Most likely, Congress intended any registering organization to have whatever authority to enforce that it would have as is typical of that type of entity.  FINRA, as a non-profit, brought an action againt the member for collection of an amount under a theory of breach of contract.  A non-profit has status to maintain an action for breach.  In those circumstances, it would appear FINRA has the right to bring an action for nonpayment. 

Moreover, the determination of the New York court that the action had to be brought in federal court prevents one of the concerns raised by the Second Circuit from occuring.  Resolution of the issue, to the extent requiring an interpretation of the securities laws, will be undertaken by a federal court which has the expertise to do so.

The consequence of the decision is that the court has essentially eliminated fines as a mechanism by FINRA for enforcing the securities laws.  Since fines can only be enforced by revocation of membership, FINRA can only enforce the securities law by threatening to put the broker out of business.  This is not unlike the situation with the exchanges that can only suspend or delist companies (in addition to letters of admonition in some cases) in the case of violations of listing standards. 

In effect, therefore, the SROs have only a nuclear weapon as a penalty.  The SROs are unlikely to impose such a draconian remedy for modest violations.  One way of doing so is to reduce the willingness to find such a violation and to enforce the securities laws.   

In any event, whatever the outcome of the decision, the reasoning used by the Second Circuit panel was unpersuasive.  It will be of considerable interest to see whether FINRA challenges the decision.  To the extent it does not and it declines to seek recovery of fines, it will raise questions about whether FINRA is the appropriate regulator to ensure the protection of investors.

Comments

[Anon]

An important issue, which does not seem to be addressed in this series of posts, is whether the Second Circuit had the authority to strike down a FINRA rule on the theory that it was wrongly characterized as nonsubstantive. The statute seems to contemplate that such rule filings become effective automatically and that it is the SEC that has the authority to abrogate the change. Section 19(b)(3)(iii) of the 1934 Act also provides that the SEC's action shall be nonreviewable.

[Brian Graifman]

I applaud author J. Robert Brown for his probing analysis but believe he is missing the full picture that was addressed in our underlying appellate briefs for the Fieros in Fiero v. FINRA. In my view, our briefs were more persuassive than the Second Circuit opinion itself, and raised issues not even discussed in the opinion. One may want to read them and then reconsider the analysis here.