Publications

11 Oct 2011

FINRA lacks authority to bring court actions to collect disciplinary fines

Securities Litigation Alert

Rajiv Dharnidharka

In a ruling in a case of first impression, the Second Circuit Court of Appeals has found that the Financial Industry Regulatory Authority, Inc. (FINRA) lacks authority to bring court actions to collect disciplinary fines, reversing a decision of the United States District Court for the Southern District of New York. Fiero v. Financial Industry Regulatory Authority, Inc., Nos. 09-1556-cv, 09-1863-cv (2nd Cir. Oct. 5, 2011).

Early this month, the Second Circuit found that while FINRA can discipline member companies and even expel companies from membership in FINRA, Congress gave only the Securities and Exchange Commission, not FINRA, the authority to seek judicial enforcement of penalties. As a practical matter, because all securities firms dealing with the public must be members of FINRA, FINRA can still bar securities firms from practicing, but it cannot enforce its monetary penalties in court.

The court rejected FINRA’s argument that it had the implicit authority to enforce penalties in federal court. The court also found that FINRA's predecessor (NASD) had not properly promulgated under the Exchange Act a rule for enforcement of penalties in federal court – NASD’s 1990 Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to the Collection of Fines and Costs in Disciplinary Proceedings – which FINRA claimed was a "house-keeping" rule exempt from the notice and comment and SEC approval requirements of Section 19(b) of the Exchange Act.

To gain authority to enforce its penalties in court in the future, FINRA will need new legislation from Congress granting it such authority. FINRA might also be able to do so by issuing the rule in accordance with the rulemaking mechanisms under Section 19(b) of the Exchange Act, although under the language of the court's decision and focus on the lack of authority under the Exchange Act, it is not clear that even a properly promulgated rule would allow FINRA to sue in federal court to enforce disciplinary fines. Section 19(b) requires FINRA to propose a rule change with the SEC and provide a concise general statement of the purposed rule change. The SEC then publishes notice of the proposed rule change and provides interested parties with an opportunity to comment, after which the SEC may approve FINRA’s proposed rule.

The Fiero decision likely will have little or no impact on FINRA's ability to supervise members and to enforce FINRA rules on members because, as mentioned above, all securities firms dealing with the public must be FINRA members and FINRA's ability to bar securities firms remains intact. Moreover, to the extent that FINRA imposes fines on its members, its expulsion power should continue to provide a strong incentive for FINRA members to pay FINRA-imposed fines (without court recourse).

For this reason, the direct impact of Fiero will be felt on FINRA members who no longer are or wish to be FINRA members. The bigger issue, however, is whether securities firms will review and challenge other so-called "house-keeping" rules issued by FINRA without the notice and comment procedures and SEC approval required by Section 19(b) of the Exchange Act.

For more information about this decision, please contact:

Rajiv Dharnidharka