On October 6, 2011, the US Court of Appeals for the Second Circuit sharply curtailed the US Financial Industry Regulatory Authority’s ("FINRA") ability to collect fines imposed in FINRA proceedings against its members and associated registered representatives. The court invalidated a rule adopted by FINRA’s predecessor, the National Association of Securities Dealers (NASD), allowing the organization to seek judicial enforcement of fines imposed in its disciplinary proceedings. Concluding that the rule was invalidly adopted and statutorily unauthorized, the Court in Fiero v. Financial Industry Regulatory Authority has effectively shut down FINRA’s ability to take brokers or dealers to court and obtain enforceable judgments to collect unpaid fines.
The NASD, now FINRA, is a self-regulatory-organization (SRO) under Section 15A of the Securities Exchange Act of 1934. As such, it is responsible for conducting investigations and commencing disciplinary proceedings against member firms and their associated member representatives for violations of the federal securities acts. In these proceedings the Exchange Act authorizes the SRO to discipline its members by expulsion, suspension and other sanctions, including the imposition of monetary fines. In 1990, the NASD adopted a rule allowing the use of court proceedings to collect fines imposed in its disciplinary proceedings.
Fiero Brothers, Inc., a member firm and broker-dealer registered with the SEC, and John J. Fiero, the sole registered representative of the member firm, tested the validity of the rule allowing FINRA to go to court to collect fines. FINRA initiated disciplinary proceedings against the Fieros and concluded that each had violated Rule 10b-5 of the Exchange Act and the conduct rules of the SRO. The hearing panel expelled Fiero Brothers from membership, barred John Fiero from association with any member firm and imposed a fine of $1,000,000 jointly and severally against the Fieros.
The Fieros refused to pay the fine and FINRA initiated New York state court proceedings to collect the amount due. New York’s state courts concluded that they lacked subject matter jurisdiction to render judgment on the fine and dismissed FINRA’s suit. Once the state court proceeding was dismissed, the Fieros initiated a declaratory judgment action in federal court seeking a ruling that FINRA lacked the authority to collect the fines through judicial proceedings. FINRA counterclaimed, seeking to recover the fine under a breach of contract theory. The trial court dismissed the Fiero’s claims and entered judgment in favor of FINRA. The Second Circuit reversed. See Fiero v . Financial Industry Regulatory Authority, Nos. 09-1556-cv (L), 09-1863-cv (XAP) (2nd Cir. Oct. 5, 2011).
In reaching its decision, the appellate court ruled that Section 15A of the Exchange Act does not expressly allow an SRO to initiate court proceedings to recover fines. Additionally, the court examined the process by which FINRA adopted its rule allowing it to initiate court proceedings to collect the fines and concluded that the rule was invalidly adopted.
FINRA, as an SRO under the supervision of the SEC, may request that the SEC initiate court proceedings to recover fines assessed by the SRO. The SEC, in response to a GAO report in 2001 criticizing the SEC’s collection efforts, agreed to seek court orders to enforce FINRA disciplinary fines, but only in cases that it affirmed on appeal and that met other specific requirements. In light of these conditions and the otherwise severe budgetary limitations currently affecting the SEC, it is unlikely that the agency will have the resources or the desire to become FINRA’s collection agency.
Although the Second Circuit’s decision is not necessarily binding on courts outside of New York, Connecticut and Vermont, its decisions are considered highly persuasive, especially in matters related to securities law. Therefore, the practical effects of the Fiero decision are as follows:
- For those members or associated persons that are fined by FINRA but desire to remain in the securities industry, paying a FINRA fine will remain the "price to pay" to stay in the business.
- FINRA can expel a member or bar a person from association with a member for failure to pay an assessed fine.
- For the foreseeable future, FINRA members or associated persons that are fined by the SRO have the option to simply walk away from the securities industry in lieu of paying disciplinary fines imposed in SRO proceedings.