By MICHAEL SMALLBERG
POGO has long criticized the Financial Industry Regulatory Authority (FINRA), the self-regulatory group for the securities industry, for being a toothless watchdog. This week, the U.S. Court of Appeals for the Second Circuit may have knocked out another tooth by ruling that FINRA does not even have the authority to enforce its own fines.
The ruling stems from a protracted legal battle involving FINRA’s predecessor, the National Association of Securities Dealers (NASD), and Fiero Brothers, a small brokerage firm owned by John Fiero. In 1998, NASD alleged that Fiero and others drove down the price of securities underwritten by Hanover Sterling & Co. through illegal short selling. A few years later, a NASD hearing panel barred Fiero, expelled his firm, and ordered a $1 million fine.
But the firm and its owner simply refused to pay the fine, and NASD/FINRA ended up in federal court trying to collect the money. In a surprising setback for the self-regulatory group, this week’s ruling by the Second Circuit held that NASD/FINRA does not have the authority to bring judicial actions to collect fines.
FINRA argued that this authority was based in 1) federal securities law and 2) a 1990 NASD rule change. In response to the first argument, the Court held that “the issue is one of legislative intent, and we conclude that the heavy weight of evidence suggests that Congress did not intend to empower FINRA to bring court proceedings to enforce its fines.” In response to the second argument, the Court found that the 1990 rule change was “never properly promulgated,” and thus does not give FINRA the authority to judicially enforce its fines.
Securities law professor John Coffee, Jr., stated that “[t]he decision neuters Finra.” Securities lawyer Matthew Farley called it a “game changer.” The New York Times pointed out that the ruling is also slightly problematic for the Securities and Exchange Commission (SEC):
The court’s criticism will also sting a bit at the Securities and Exchange Commission. The commission oversees Finra’s rule-making, and the chairwoman and chief executive of Finra during much of the time it pursued the Fiero case in court was Mary L. Schapiro, the current head of the commission.
POGO believes the ruling demonstrates that industry self-regulation is no substitute for fully funded SEC oversight, a point we made in a recent letter to the House Financial Services Committee, which is considering legislation to authorize FINRA or another self-regulatory group to oversee registered investment advisers.
David Tittsworth, Executive Director of the Investment Adviser Association and a witness at a recent hearing to discuss the proposed legislation, provided POGO with the following statement on the Second Circuit's ruling:
I hope this court decision does not detract from an analysis of more important issues regarding FINRA. Specifically, Congress should be examining all aspects of private regulation – and FINRA’s regulatory model in particular – before considering any legislation in this important area. For example, lawmakers need to fully analyze FINRA’s lack of accountability, including the fact that its budget is not subject to SEC oversight and that it is not subject to the Administrative Procedures Act, Freedom of Information Act, and other laws that are designed to ensure accountability and full transparency.
Michael Smallberg is a POGO Investigator.
Image via Flickr user lobstar28.