Second Circuit Rules FINRA Has No Power to Enforce Disciplinary Fines in Court

October 06, 2011

On October 5, 2011, the United States Court of Appeals for the Second Circuit issued an opinion in Fiero v. FINRA, holding that FINRA lacks authority to bring court actions to collect disciplinary fines that it has imposed on its members. Specifically, the Second Circuit conducted a de novo review of the district court’s dismissal of a broker-dealer’s complaint seeking a declaratory judgment that FINRA has no authority to collect fines through judicial proceedings, and held that neither the Exchange Act nor NASD’s 1990 Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to the Collection of Fines and Costs in Disciplinary Proceedings (the “1990 Rule Change”) provided FINRA with the necessary authority to do so. As described in more detail below, the court concluded that (1) the statutory scheme of the Exchange Act indicated that Congress did not intend to empower FINRA to bring court proceedings to enforce its fines, and (2) the 1990 Rule Change did not provide FINRA with the authority to do so because it was not properly promulgated under the procedures established by the Exchange Act. Although the result prohibiting fine collection through judicial proceedings will have greater significance for certain categories of individuals than for member firms, the court’s analysis and rejection of the 1990 Rule Change could have significant and far-reaching implications. Specifically, the Second Circuit’s ruling could open the door to a re-evaluation of the efficacy and validity of a variety of other SRO rules or rule modifications that were implemented as “House-Keeping” rules, thereby bypassing the notice and comment requirements associated with more substantive rules. It also could make it much harder for FINRA and other SROs, going forward, to implement new rules or rule changes without a lengthy notice and comment period.

FINRA’s Authority Under the Exchange Act

The Second Circuit held that the Exchange Act does not provide FINRA with the necessary authority to bring judicial actions to collect monetary sanctions. The court noted that Section 15A(b) of the Exchange Act, which provides SROs with statutory authority and obligation to “appropriately discipline” their members, provides no express statutory authority for SROs to bring judicial actions to enforce the collection of fines. The court determined that this omission constitutes significant evidence that Congress did not intend to authorize FINRA to seek judicial enforcement to collect its disciplinary fines because the statutory scheme “carefully particularizes an array of available remedies,” including permissible actions in the federal courts such as actions by private parties for damages, and because Section 21(d) of the Exchange Act provides express statutory authority for the SEC to seek judicial enforcement of penalties.

Additionally, the court noted that its conclusion regarding congressional intent against authorizing FINRA fine-enforcement actions was further supported by the existing sanction enforcement options available to FINRA as well as by FINRA’s longstanding practices. The court noted that FINRA fines are already enforced by the “draconian sanction” of revoking a FINRA member’s registration, resulting in exclusion from the industry. Furthermore, the court determined that FINRA’s longstanding practice of exclusive reliance on its powers to revoke registration or deny re-entry into the industry to punish members who do not comply with its monetary sanctions supports an inference that FINRA believed that it lacked judicial enforcement power, and that Congress was aware of this reliance on other enforcement methods and left that reliance unaltered.

FINRA’s Authority Under the 1990 Rule Change

The Second Circuit rejected FINRA’s claim that the 1990 Rule Change constituted authority for judicial enforcement of its fines because the court concluded that the 1990 Rule Change was not properly promulgated under the Exchange Act. NASD filed the 1990 Rule Change with the SEC to provide notification that, should “its own internal efforts for the collection of fines…fail‚” it may refer a matter “to external collection agencies and in appropriate situations,…seek to reduce such fines to a judgment.” Along with the SEC filing, NASD issued a notice to its members informing them of the new policy and outlining how the policy would be implemented. In proposing the 1990 Rule Change, NASD had designated it as a “House-Keeping” rule‚ “one constituting a stated policy with respect to the enforcement of an existing rule of the NASD‚” which falls under the exception to the notice and comment requirement of Section 19(b) of the Exchange Act for new substantive rules and modification of existing rules for SROs. Accordingly, the rule was to become effective upon the SEC’s receipt of the filing.

In Fiero v. FINRA, the Second Circuit held that it was not bound by FINRA’s characterization of the 1990 Rule Change as a “House-Keeping” rule and furthermore determined that this characterization was erroneous. The court based this conclusion on the fact that prior to the 1990 Rule Change, there was no existing SEC rule or statute that authorized FINRA to initiate judicial proceedings to enforce the collection of its disciplinary fines, and on the fact that FINRA had a longstanding practice of not seeking to enforce collection through judicial actions. Accordingly, the court held that the 1990 Rule Change was not simply a stated policy change that could bypass the required notice and comment period of Section 19(b), but was rather “a new substantive rule that affected the rights of barred and suspended members to stay out of the industry and not pay the fines imposed on them in prior disciplinary proceedings.” The court held that the 1990 Rule Change was never properly promulgated as a new substantive rule because it was not filed with the SEC for publication for a notice and comment period. As a result, the court further held that the 1990 Rule Change “cannot authorize FINRA to judicially enforce the collection of its disciplinary fines.” In a footnote, the court noted that it expressed no opinion as to the validity of a properly promulgated rule authorizing fine collection through judicial proceedings.

Implications of Decision

The inability of FINRA to bring judicial actions to collect disciplinary fines will not have a significant impact on member firms because the prospect of expulsion from the industry provides sufficient incentive to pay monetary penalties imposed by FINRA. This decision will likely be most important to individuals who receive significant penalties and who can afford to walk away from the industry as an alternative to paying the fine. Of course, the most egregious violators should understand that they are still subject to the jurisdiction of the SEC, and the SEC may pursue an action against them in federal district court to enforce any order it issues that affirms sanctions, including fines, imposed by FINRA.1

But the court’s analysis of the 1990 Rule Change may have wide-reaching implications for FINRA’s characterization of new rules or rule changes as “House-Keeping,” or otherwise having no substantial effect on the public interest or the protection of investors. The Second Circuit’s disagreement with FINRA’s designation of the 1990 Rule Change as a “House-Keeping” rule may incentivize FINRA and other SROs to more closely scrutinize which future rules or rule changes require notice and comment under the Exchange Act. Additionally, the Second Circuit’s approach to FINRA’s characterization of the 1990 Rule Change as a “House-Keeping” rule may provide incentive for members to consider what other “House-Keeping” rules might be second-guessed if brought to a judicial body for consideration. Furthermore, the Second Circuit’s analysis may provide a basis for a review of the validity and efficacy of existing SRO rules that bypassed the notice and comment process.

Finally, because the court stated that it expressed no opinion as to the validity of a properly promulgated rule authorizing FINRA to collect fines through judicial proceedings, this decision potentially leaves the door open for FINRA to seek such authorization through the notice and comment rule-making process. However, given the court’s clear statements on the lack of statutory authority and the clear congressional intent, it seems unlikely that even a properly promulgated rule would withstand judicial scrutiny.


For additional information concerning this alert, please contact the following lawyers:

David Boch, Partner, Broker-Dealer Group, 617.951.8485

Amy Kroll, Partner, Broker-Dealer Group, 202.373.6118

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Tim Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1 The Fiero decision was not appealed to the SEC.

This article was originally published by Bingham McCutchen LLP.