FINRA Cannot Collect Fines Against Barred Members through Court

No Comment

On October 5, 2011, the Second Circuit in Fiero v. Financial Industry Regulatory Authority, Inc. held that FINRA was not authorized under the Securities Exchange Act of 1934 to enforce disciplinary fines through judicial enforcement.

Facts

Apellants, Fiero Brothers, Inc., was a FINRA member firm and broker-dealer registered with the SEC and John J. Fiero was the sole registered representative of Fiero Brothers, and both were subject to FINRA, and its predecessor, the NASD.

In 1998, the Department of Enforcement initiated disciplinary proceedings against Appellants with a hearing panel holding that Appellants violated Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder, and FINRA Conduct rules 2110, 2120 and 3370 and as a result, barred Fiero from association with any member firm and issued a fine of $1 million, jointly and severally. FINRA National Adjudicatory Council (“NAC”) affirmed the decision in its entirety.

Procedural History

Appellants refused to pay the fine and FINRA instituted an action in New York Supreme Court. NY Supreme Court upheld the fines based on ordinary principles of contract law recognizing the right of a private membership organization to impose fines on its members, when authorized to do by statute, charter or by-laws.

Appellate courts in New York initially upheld the Superior Court decision, but granted leave to appeal, and in February 2008, reversed the decision on the ground that state courts lacked jurisdiction – the FINRA complaint constituted an action to enforce a liability or duty created under the Exchange Act, and therefore, fell within the exclusive jurisdiction of the federal courts pursuant to 15 U.S.C. § 78aa.

The United States District Court for the Southern District of New York entered judgment for FINRA based on applicable state contract law.

Holding

The Exchange Act does not provide FINRA with the necessary authority

While Section 15A(b) of the Exchange Act, FINRA and other self-regulatory organizations (SROs) have a statutory authority and obligation to appropriately discipline members for violations, there is no express authority or Congressional intent for SRO’s to bring judicial actions to enforce the collection of fines.

1990 Rule Filing does not provide FINRA with authority

FINRA filed a rule proposal with the SEC pursuant to Section 19(b)(1) of the Exchange Act NASD stated its intent “to pursue other available means for the collection of fines and costs imposed…in disciplinary decisions.” The NASD reiterated the policy Notice to Members 90-21.

However, the court determined that for “FINRA to have obtained authority [thereunder], the rule must have been properly promulgated under the procedures established by the Exchange Act [and it] was not.” Section 19(b) of the Exchange Act requires SRO’s must file any proposed rule change with the SEC, with a general statement of the basis and purpose, and then the SEC is required to publish notice and give interested individuals an opportunity to comment prior to either approving or disapproving the rule.

While FINRA (then NASD) defined such rule as “House-Keeping,” whereby FINRA was just stating a current policy of an existing rule, the Court determined that this was not “simply a stated policy change…that could bypass the required notice and comment period of Section 19(b)[, but rather,] it was a new substantive rule.” Therefore, the rule was never properly promulgated and “cannot authorize to judicially enforce the collection of its disciplinary fines.”

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