FINRA, the U.S. financial industry's self-regulatory organization (SRO) for broker-dealers, was dealt a blow yesterday by the appellate court decision in Fiero v. FINRA that ruled it did not have the power to enforce fines against its members in court. The court based its conclusion on the lack of a specific grant of power to FINRA in the Securities and Exchange Act (Exchange Act) and FINRA's failure to properly file a proposed rule change with the Securities and Exchange Commission (SEC) in 1990.
The decision is important to the extent FINRA directly or implicitly relies on the judicial system to enforce its fines rather than on the self-interest of its members to pay any fines as a condition of not being barred from the industry. The decision is also important to the extent investors and customers rely on FINRA to be able to pursue fines against parties that no longer seek to remain in the industry. If they do rely heavily on FINRA's authority to enforce fines in court, it may make sense for FINRA to obtain the power to do so by properly filing a rule change with the SEC; that is, one that goes through the full notice and comment process.
Perhaps the most important aspect of Fiero, however, is the impact it may have on future investment adviser regulation. Pending new legislation, FINRA or some other SRO is likely to begin to oversee hedge funds and other investment advisers, consistent with the SEC's recommendation and admission that it lacks the resources to effectively oversee advisers. Whatever SRO does end up overseeing investment advisers, investors should know in advance whether the SRO has the legal authority to enforce fines against advisers in court so that they can tailor their reliance on the SRO to do so accordingly. Based on Fiero, the new adviser SRO will not be able to enforce fines in court absent a legislative or regulatory grant of power.
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