On October 5th, the United States Court of Appeals for the Second Circuit ruled that the Financial Industry Regulatory Authority (FINRA) does not have authority to bring lawsuits to collect fines imposed in disciplinary proceedings. According to Diana B. Henriques of the New York Times, “The surprise decision curbs the power of [FINRA] … at a time when it has been under pressure to impose greater accountability on its licensed brokers and brokerage firms.” The impact of the ruling, however, will be less sweeping than it appears.
In John J. Fiero and Fiero Brothers, Inc. v. FINRA, the Second Circuit held that neither the federal securities laws nor the FINRA rules empower the regulator to bring court actions to collect disciplinary fines. Leading to the dispute in Fiero Brothers, FINRA initiated disciplinary proceedings against Fiero Brothers, Inc., a penny-stock brokerage firm, and its owner John J. Fiero, both FINRA members, alleging that the brokerage firm engaged in manipulative and fraudulent selling practices. As a result of the disciplinary proceedings, FINRA expelled Fiero Brothers, barred Fiero from associating with any FINRA-member firm, and imposed a $1 million fine against the firm and its principal, jointly and severally. When Fiero Bros. and Fiero refused to pay the sanction, FINRA successfully sued to collect the unpaid fine.
On appeal to the Second Circuit, the court ruled that FINRA lacked authority to bring lawsuits against regulated brokers and brokerage firms to collect monetary sanctions levied in enforcement actions. The Court reasoned that while the Securities Exchange Act of 1934 and FINRA’s rules and bylaws grant the organization certain disciplinary powers over its membership – including the ability to impose sanctions – FINRA has “no authority to bring judicial actions to collect monetary sanctions.” According to the Court, “the statutory scheme carefully particularizes an array of available remedies,” but does not include express authority “to seek judicial enforcement of the variety of sanctions [FINRA] can impose.”
As Ms. Henriques reports, FINRA’s General Counsel, T. Grant Callery, says the organization will “continue to review the ruling and weigh our options.” As a practical matter, two “options” emerge. First, FINRA could seek to appeal the ruling to the Supreme Court of the United States. This, however, is a time consuming proposition that is not guaranteed to end in a favorable decision. A second option – and one that is eminently more likely to have the desired effect – would be for FINRA to change its rules according to the procedures set out in the Exchange Act. In the Fiero Bros. opinion, the Second Circuit noted that “Section 19(b) of the Exchange Act establishes the mechanism by which SRO’s can change their governing rules.” Through a rule “properly promulgated under [those] procedures,” FINRA might obtain authority to “enforce the collection of its disciplinary fines through judicial proceedings.”
The decision has led many to believe FINRA will be powerless to effectively discipline its members, with a number of commenters concluding that the organization now has “no teeth.” However, this conclusion is considerably overstated. The facts presented in Fiero Bros. are strikingly narrow in the context of typical FINRA disciplinary proceedings. FINRA does not usually impose a fine when expelling a firm or barring an individual. In fact, the Fiero Bros. case is the only time FINRA has sought to collect a disciplinary fine through judicial proceedings.
As a practical matter, FINRA’s regulatory powers are not substantially eroded by the Fiero Bros. ruling. Indeed, FINRA’s General Counsel is confident that the decision will not impact the regulator’s “ability to enforce FINRA rules and securities laws, to discipline firms or protect investors.” Even without the authority to hale a member into court, FINRA indisputably retains its two most potent regulatory powers: the authority to promulgate and enforce rules governing its members; and the power to indefinitely suspend or expel brokerage firms and bar brokers from the financial industry. Through the threat of suspension, expulsion or debarment, FINRA will be able to continue enforcing the rules governing its members.
We will continue to track the Fiero Bros. case, and any related action undertaken by FINRA. Stay tuned: There may be more developments ahead.