Thursday, October 06, 2011

Second Circuit Panel Says FINRA Cannot Bring Federal Court Action to Collect Disciplinary Fines Imposed on Members

The Exchange Act does not authorize the Financial Industry Regulatory Authority (FINRA) to bring federal court actions to collect disciplinary fines it imposed on its members, ruled a panel of the Second Circuit Court of Appeals. Congress did not intend to empower FINRA to bring judicial actions to enforce its fines, said the panel. FINRA fines are already enforced by a draconian sanction not involving court action, noted the appeals court, since FINRA can exclude a member from the industry for failure to pay a fine. FINRA is a non-profit Delaware corporation that was formed in July 2007 when the NASD consolidated with the regulatory arm of the New York Stock Exchange. Fiero v. FINRA,(CA-2, No. 09-1556, Oct. 5, 2011).

FINRA argued that it is authorized to collect fines in federal court under the Exchange Act and under a FINRA (formerly NASD) rule submitted to, and not disapproved by, the SEC in 1990. Under Section 15A(b) of the Exchange Act, noted the court, SROs like FINRA have a statutory authority and obligation to discipline their members for violation of any provision of the Exchange Act, SEC regulations or their own rules by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, being suspended or barred from being associated with a member. However, noted the panel, there is no express statutory authority for SROs to bring judicial actions to enforce the collection of fines.

Section 21(d) of the Exchange Act expressly authorizes the SEC to seek judicial enforcement of penalties, observed the panel, so Congress is fully aware of how to expressly authorize an entity to collect its monetary penalties in a federal court action. Since there are no explicit provisions in the statute authorizing SROs to seek judicial enforcement of the variety of sanctions they can impose, reasoned the appeals panel, this is significant evidence that Congress did not intend to authorize FINRA to seek judicial enforcement to collect its disciplinary fines.

Further evidence of legislative intent is that FINRA’s sanctions are appealable by an aggrieved party to the SEC and thereafter to the US Courts of Appeals. Had Congress intended judicial enforcement of FINRA’s fines, said the panel, it would surely have provided for some specific relief other than leaving FINRA to common law proceedings in state courts or in federal district courts under diversity jurisdiction.

The panel also rejected FINRA’s claim that a 1990 NASD Rule Change authorizes judicial enforcement of its fines. According to the court, the 1990 Rule Change does not even purport to be newly granted authorization from the SEC to FINRA to bring such judicial actions. Rather, it appears to assume a preexisting power and to serve only as a notice of a new policy under that power. In addition, the Rule Change was not properly promulgated under the procedures established by the Exchange Act.

Under this system, established by Congres, all new substantive rules and modification of existing rules for SROs must go through a notice and comment period and obtain SEC approval before becoming effective, except for house-keeping rules and other rules which do not substantially affect the public interest. The panel said that the rule change issued in 1990, and ``not disapproved’’ by the SEC that said the NASD would collect fines in court was a substantive rule, not the housekeeping rule the NASD said it was, and should have gone through the Exchange Act process of SEC approval after notice and public comment.

Because the NASD improperly designated the 1990 Rule Change, concluded the court, it was never properly promulgated and cannot authorize FINRA to judicially enforce the collection of its disciplinary fines. The panel emphasized that a federal court is not bound by the NASD’s own characterization as to whether the 1990 Rule Change affected the substantive rights of its members.

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