FINRA member firms take note: 

The 4th Circuit recently shot down an appeal by a member firm who challenged FINRA’s authority to bring charges against it under Section 5 of the Securities Act (for allegedly selling unregistered securities). The firm sought a federal court injunction against FINRA, contending that FINRA was acting outside its statutory authority—which is provided by and derived from the Exchange Act—by seeking to prosecute claims under Section 5 of the Securities Act. The Court disagreed and dismissed the action. 

The firm argued that numerous references in the Exchange Act limit the authority of FINRA to discipline members for violations of “this chapter,” that is, the Exchange Act. FINRA countered that the Exchange Act authorizes FINRA to enact its own rules and enforce compliance. Thus, according to FINRA, grounding violations of the Securities Act in FINRA rules (i.e., Rule 2010) is an exercise of FINRA’s statutory authority to “promote just and equitable principles of trade [and] foster cooperation and coordination with persons engaged in regulating, clearing, settling . . . and facilitating transactions in securities.” The Fourth Circuit found FINRA’s interpretation plausible.

In affirming the District Court, the Fourth Circuit held that the member firm “does not identify a congressionally authorized right of action” and “has ultimate recourse to the federal courts through 15 U.S.C. § 78y.” As the SEC noted in its Amicus brief (filed in favor of FINRA), “[t]he Exchange Act provides an exclusive avenue for review that plaintiffs may not bypass by filing suit in district court.” The Court noted that FINRA, though not an agency of the federal government, is subject to “close supervision” by the SEC. 

The Court held that Congress has provided “a comprehensive review scheme . . . through the Exchange Act, intended to channel objections to FINRA’s authority through the [SEC] and court of appeals.” Because the member firm “can obtain meaningful judicial review of its claim in this court following the appeal process outlined in the Exchange Act,” the Court held that “its challenge to FINRA’s authority is the type of claim Congress intended to be reviewed within the statutory scheme.”

The bottom line is that federal courts are courts of limited jurisdiction and there is no mechanism that allows a party to invoke their jurisdiction to mount a “collateral” challenge to FINRA’s authority to prosecute the federal securities laws. One is left to wonder what would have been the result had the firm sought injunctive relief in state court?

Nonetheless, the Court’s opinion includes a nice summary of the statutory and regulatory procedures invoked by FINRA when commencing and prosecuting a disciplinary proceeding, and is suggested reading for firms facing the specter of a disciplinary proceeding. 

The case is Scottsdale Capital Advisors v. Financial Industry Regulatory Authority, Case No. 16-1497 (4th Cir.), decided on December 20, 2016.

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