On Wednesday, October 5, the U.S. Court of Appeals for the Second Circuit ruled that FINRA lacks the authority to bring court actions to collect disciplinary fines it has imposed. Fiero v. FINRA, No. 09-cv-1556, slip op. (2d Cir. Oct. 5, 2011). The decision is the latest development in a case which can be traced back to 1998. Significantly, the ruling appears to extend to all "self-regulatory organizations" ("SROs"). However, the Court hints that, under Section 19(b) of the Exchange Act, an SRO can potentially address this issue by filing a proposed rule change with the SEC, who must publish notice of the proposed rule change and give interested individuals an opportunity to comment prior to either approving or disapproving the rule (something which FINRA failed to do in this situation).
FINRA is the successor to the National Association of Securities Dealers ("NASD"). It has authority to conduct investigations and commence against its member firms and their associated representatives regarding compliance with the federal securities laws and regulations.
On February 6, 1998, NASD’s Department of Enforcement initiated disciplinary proceedings against the Fiero Brothers, Inc. and its sole registered representative, John J. Fiero ("the Fieros"). On December 6, 2000, an NASD hearing panel held that the Fieros had violated Section 10(b) of the Exchange Act, Rule 10b-5, and several FINRA Conduct Rules. The panel expelled Fiero Brothers, barred Fiero from associating with any FINRA-member firm in any capacity, and fined the Fieros $1,000,000 plus costs.
After the Fieros refused to pay the fine, FINRA commenced an action in December 2003, in New York Supreme Court (the state court). On May 11, 2006, the Supreme Court awarded the NASD a judgment of $1,329,724.54. However, the New York Court of Appeals (the highest state court in New York) reversed on the ground that the state courts lacked subject matter jurisdiction – an action to enforce a liability or duty created under the Securities Exchange Act fell within the exclusive jurisdiction of the federal courts. FINRA v. Fiero, 882 N.E.2d 879, 881-82 (N.Y. 2008).
Immediately after the state court ruling, the Fieros filed suit in federal court in New York requesting a declaratory judgment that FINRA has no authority to collect fines through judicial proceedings. FINRA filed a counterclaim, alleging breach of contract and seeking to enforce the fine. On March 30, 2009, the district court dismissed the Fieros' claim, denied the Fieros' motion to dismiss FINRA's counterclaim, and instructed the clerk to enter judgment in favor of FINRA (initially, no amount was specified, but later the Court ruled that FINRA was entitled to $1,010,809.25). The Fieros appealed.
The Second Circuit Court of Appeals ruled that under Section 15A of the Exchange Act FINRA (or any SRO) has the authority to discipline its members, including imposing a fine, but, "there is no express statutory authority for SRO’s to bring judicial actions to enforce the collection of fines." The Court concluded that "Congress did not intend to empower FINRA to bring judicial actions to enforce its fines." The Court cited various provisions under which the SEC was granted authority to file enforcement actions as examples that Congress "was well aware of how to grant an agency access to the courts to seek judicial enforcement of specific sanctions including monetary penalties," as elected not to do so for FINRA and other SROs.
The Court also addressed the "seemingly inexplicable nature of a gap in the FINRA enforcement scheme: fines may be levied but not collected" by stating:
FINRA fines are already enforced by a draconian sanction not involving court action. One cannot deal in securities with the public without being a member of FINRA. When a member fails to pay a fine levied by FINRA, FINRA can revoke the member’s registration, resulting in exclusion from the industry. Moreover, where a fine is based on a violation of the Exchange Act, the violator will also face a panoply of private and SEC remedies.
The Court also considered the NASD's 1990 rule change, which provided notification that the NASD "intends to pursue other available means for the collection of fines and costs imposed … in disciplinary decisions" on or after July 1, 1990. That Court, noting that prior to 1990 "there was no existing SEC rule or statute that authorized the NASD to initiate judicial proceedings to enforce the collection of its disciplinary fines," and "the NASD had a longstanding practice of not seeking to enforce collection through judicial actions," concluded that the NASD failed to file the new rule with the SEC under 15 U.S.C. § 78s(b)(1) for publication of a notice and comment period. According to the Court, since the rule change was "never properly promulgated," it could not "authorize FINRA to judicially enforce the collection of its disciplinary fines."