By MICHAEL SMALLBERG
Should a private organization that's acting with quasi-governmental authority—such as the Financial Industry Regulatory (FINRA)—enjoy the same kind of sovereign immunity that applies to government agencies, even when the organization is sued for misconduct related to its private business?
POGO signed on to an amicus brief this week asking the Supreme Court to take up this very question. We joined Public Citizen, Consumer Action, and U.S. Public Interest Research Group (PIRG) in signing on to the brief, which was written and submitted by Public Citizen’s Litigation Group.
The case in question involves a deal that led to the creation of FINRA, the self-regulatory organization (SRO) for the securities industry. FINRA was formed in 2006-2007 when the National Association of Securities Dealers (NASD) acquired the regulatory arm of the New York Stock Exchange (NYSE). The deal required an amendment to NASD’s bylaws that would increase the voting power of the organization’s larger member firms, and was therefore subject to a vote by NASD’s members. After the deal was approved, one of NASD’s smaller member firms, Standard Investment Chartered, Inc., filed a lawsuit alleging that NASD’s proxy statement seeking approval of the deal was fraudulent.
Standard’s lawsuit brings up the issue of sovereign immunity, which generally protects federal, state, and tribal governments from lawsuits that could subject them to monetary liabilities. In contrast to the immunity available to sovereign entities as a whole, certain officials are entitled to absolute immunity, but only for performing sensitive functions such as legislating, adjudicating, and prosecuting. In other words, absolute immunity is based on the specific function performed by the government official, whereas sovereign immunity applies more broadly to federal, state, and tribal governments.
Courts have historically extended absolute immunity to non-governmental individuals who perform functions such as judging and prosecuting, but only to the extent that they perform these functions. In keeping with this principle, the Fifth Circuit has extended absolute immunity to NASD and other SROs, but only in cases where they perform prosecutorial and adjudicatory functions.
Over the years, however, courts have vastly expanded SRO immunity. Some courts began to liken SRO immunity to sovereign immunity, focusing on SROs’ status as quasi-governmental regulators. Other courts granted SROs immunity even in cases when they weren’t performing strictly prosecutorial or adjudicatory functions, as long as they were acting in a quasi-governmental capacity.
For instance, the Second Circuit has granted SROs immunity in cases where the alleged misconduct involved disciplinary proceedings against members, the interpretation and application of securities rules and regulations, the referral of members to the SEC and other agencies for civil or criminal prosecution, and the public announcement of regulatory decisions. In the case of Standard’s lawsuit, the Second Circuit upheld a lower court’s ruling that immunity also applies to an SRO’s amendment of its bylaws when the amendment is “inextricable from the SRO’s role as a regulator.”
The amicus brief signed by POGO and other public interest groups states that “[t]he only rationale that appears to support these...extensions of immunity is the principle that the SRO may partake of the SEC’s sovereign immunity.” Thus, the Second Circuit’s decision in Standard’s case “reflects a theory of derivative sovereign immunity that is far broader than, and in sharp conflict with, other courts’ cautious jurisprudence regarding the extension of sovereign immunity to non-sovereign entities.”
The brief goes on to question whether NASD/FINRA should be granted the sovereign immunity that applies to the SEC and other governmental entities. Some court decisions have raised doubt about whether sovereign immunity can ever apply to private entities. Other cases have held that sovereign immunity can be extended to non-sovereign actors only in cases where a lawsuit could create a liability for the sovereign’s treasury. However, this condition should not apply in the case of SROs, which are private organizations that receive no federal or state funding.
The brief also states that
[t]he extension of sovereign immunity to SROs…produces the bizarre result that a corporate entity—which lacks the democratic accountability that legitimizes our federal and state governments—can avail itself of the same protections as actual governments subject to oversight via the democratic process.
This argument gets to the heart of our concerns about FINRA. As described on its website, FINRA “touches virtually every aspect of the securities business” with its quasi-governmental authority, and it has been given the same type of immunity enjoyed by the SEC. Unlike the SEC, however, FINRA is not subject to the Freedom of Information Act, its board meetings are closed to the public, its executives receive million-dollar compensation packages, its employees do not have to follow the ethics rules that apply to executive branch personnel, it is not overseen by anything akin to an independent inspector general, and, according to a recent decision by the Second Circuit, it may not even have the authority to enforce its own fines.
Along these lines, Standard’s petition to the Supreme Court points out that NASD/FINRA “wears two hats”:
On some occasions, it exercises regulatory authority over its members’ activities in securities markets, the kind of authority that might otherwise be exercised by a government agency. But on other occasions, it attends to its private, proprietary interests—renting facilities, hiring employees, acquiring assets, paying bonuses to its management, and dealing with questions of corporate governance….
These divergent incentives—between what is best for the private SROs as businesses and what is best for effective regulation—are playing out today amidst a period of unrivaled turmoil in the financial markets. Confidence in the integrity and soundness of our financial institutions requires effective means for holding those institutions accountable for wrongdoing.
We hope the Supreme Court takes this opportunity to clarify that SROs such as FINRA can be sued for misconduct related to their private business. Unless FINRA and other SROs are held to a higher standard of accountability, we question whether they should be granted any additional regulatory authority.
Michael Smallberg is a POGO Investigator