ISSUEWhether the Financial Industry Regulatory Authority (FINRA) is a "corporation or other entity serving as an agency or instrumentality" of the government of the United States for purposes of section 1.162-21(a)(3) of the Income Tax Regulations.CONCLUSIONFINRA is a corporation serving as an agency or instrumentality of the government of the United States for purposes of section 1.162-21(a)(3) when it is performing its federally mandated duties under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., of conducting enforcement and disciplinary proceedings relating to compliance with federal securities laws, regulations, and FINRA rules promulgated pursuant to that statutory and regulatory authority.LAW AND ANALYSISSection 162(f)Section 162(f) of the Code provides that no deduction shall be allowed under section 162(a) for any fine or similar penalty paid to a government for the violation of any law. Section 1.162-21(a) of the Income Tax Regulations provides that no deduction shall be allowed under section 162(a) for any fine or similar penalty paid to:(1) The government of the United States, a State, a territory or possession of the United States, the District of Columbia, or the Commonwealth of Puerto Rico;(2) The government of a foreign country; or(3) A political subdivision of, or corporation or other entity serving as an agency or instrumentality of, any of the above.
FINRA is an Agency or Instrumentality Under the Guardian Industries TestFINRA's restated certificate of incorporation, the delegation to FINRA Regulation, Inc., and the applicable federal securities laws and regulations all clearly show FINRA's role as an SRO conducting federally-mandated enforcement and disciplinary proceedings relating to the federal securities laws and regulations. FINRA enforces compliance with the Securities Exchange Act, SEC regulations, and FINRA's own rules. FINRA does so by bringing disciplinary proceedings to adjudicate violations, which are subject to review by the SEC. Saad v. SEC, 718 F.3d 904, 907 (D.C. Cir. 2013). "[W]here FINRA enforces statutory or administrative rules, or enforces its own rules promulgated pursuant to statutory or administrative authority, it is exercising the powers granted to it under the Exchange Act. Indeed, FINRA's powers in that regard are subject to divestment by the SEC under Section 19(g)(2) of that Act." Fiero, 660 F.3d at 575-576. The court in Fiero held that Congress did not empower FINRA to bring judicial actions to enforce its own fines; however, as the court noted, the SEC asserts the authority to issue an order affirming sanctions, including fines, imposed by FINRA, and to bring an action in a federal district court to enforce that order. See id. at 575 n.7.The SEC reviews sanctions imposed by FINRA to determine whether they impose any burden on competition not necessary or appropriate, or are excessive or oppressive. Saad, 718 F.3d at 910. The court reviews the SEC's conclusions regarding sanctions to determine whether those conclusions are arbitrary, capricious, or an abuse of discretion. Id.; Siegel v. SEC, 592 F.3d 147,155 (D.C. Cir. 2010), cert. denied, 560 U.S. 926 (2010). Although the SEC has express statutory authority to seek judicial enforcement of penalties and to seek monetary penalties for violations of the federal securities laws, the SEC is prohibited from bringing an action against any person for violation of, or to command compliance with, the rules of a SRO unless it appears that (1) such SRO is unable or unwilling to take appropriate action against such person in the public interest and for the protection of investors, or (2) such action is otherwise necessary or appropriate in the public interest or for the protection of investors. Fiero, 660 F.3d at 574-575.If a fine is imposed on a taxpayer for violation of the securities laws and regulations, the deductibility of the fine should not depend on whether the same type of bad conduct is being punished by the SRO or directly by the SEC. Otherwise, there would be inconsistent treatment of similarly situated taxpayers. Furthermore, deductibility of the fine should not depend on whether the taxpayer pays a fine to the SRO without contesting it or whether the taxpayer eventually pays the fine after exhausting all levels of review.FINRA has been delegated the right to exercise part of the sovereign power of a government, it performs an important governmental function, and it has the authority to act with the sanction of government behind it. Moreover, FINRA has absolute immunity with respect to actions taken in furtherance of its regulatory duties. Lobaito v. Fin. Indus. Regulatory Auth., Inc., 599 Fed. Appx. 400 (2d Cir. 2015), cert. denied, 193 L. Ed. 2d 445 (2015); Santos-Buch v. Fin. Indus. Regulatory Auth., Inc., 591 Fed. Appx. 32 (2d Cir. 2015), cert. denied, 136 S. Ct. 43 (2015). Therefore, under the Guardian Industries test, FINRA is a corporation serving as an agency or instrumentality of the government of the United States for purposes of section 1.162-21(a)(3) when it is performing its federally-mandated duties under the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq., of conducting enforcement and disciplinary proceedings relating to compliance with federal securities laws, regulations, and FINRA rules promulgated pursuant to that statutory and regulatory authority. We note that section 162(f) would not apply to a fine paid to FINRA solely for a violation of a "house-keeping" rule that is a matter of private contract between FINRA in its capacity as a professional association and its members.
Also read:The Fiero Case: FINRA Loses Landmark Federal Appeals Case On Collection Of Fines (BrokeAndBroker.com Blog,October 7, 2011)
[F]INRA is a corporation serving as an agency or instrumentality of the government of the United States for purposes of section 1.162-21(a)(3) when it is performing its federally-mandated duties under the Securities Exchange Act of 1934 . . .
No person shall be held to answer for a capital, or otherwise infamous crime, unless on a presentment or indictment of a Grand Jury, except in cases arising in the land or naval forces, or in the Militia, when in actual service in time of War or public danger; nor shall any person be subject for the same offense to be twice put in jeopardy of life or limb; nor shall be compelled in any criminal case to be a witness against himself, nor be deprived of life, liberty, or property, without due process of law; nor shall private property be taken for public use, without just compensation.
Most of the provisions of the Fifth Amendment, in which the self-incrimination clause is embedded, are incapable of violation by anyone except government in the narrowest sense. No private body, however close its affiliations with the government, can hold a person 'to answer for a capital or otherwise infamous crime' without an indictment . . ."
[F]ifth Amendment claim was meritless; that FINRA was not a governmental agency and did not recognize the Fifth Amendment; and that if he refused to answer questions by asserting this privilege, he may be subject to disciplinary action, including a bar. Additionally, Market Regulation denied that it was coordinating its investigation with the SEC, and represented that its inquiry was independent 21 of, and separate from, any existing governmental inquiry relating to his conduct. Market Regulation then asked Lubetsky a few additional questions, including where he worked before joining Lek, but Lubetsky declined to answer these questions, relying on the Fifth Amendment. Market Regulation again reminded Lubetsky that his refusal to answer questions could lead to disciplinary action, including a bar. Lubetsky reaffirmed his decision not to answer any more questions, and Market Regulation terminated the OTR.
McGinn, Smith & Co., Inc. v. FINRA, 786 F. Supp. 2d 139 (D.C. 2011)Financial Industry Regulatory Authority, Inc. ("FINRA") is a private not-for-profit corporation and a self-regulatory organization that is registered with the Securities and Exchange Commission ("SEC") as a national securities association pursuant to § 15A of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78o-3. Nat'l Ass'n of Sec. Dealers, Inc. v. SEC, 431 F.3d 803, 804 (D.C.Cir.2005). "By virtue of its statutory authority, [FINRA] wears two institutional hats: it serves as a professional association, promoting the interests of its members, and it servers as a quasi-governmental agency, with express statutory authority to adjudicate actions against members who are accused of illegal securities practices and to sanction members found to have violated the Exchange Act or ... [SEC] regulations issued pursuant thereto." Id. (internal citations omitted); 15 U.S.C. § 78o-3(b)(7). Disciplinary actions brought by FINRA's Department of Enforcement may be adjudicated before a FINRA Hearing Panel and appealed to the FINRA National Adjudicatory Council. 431 F.3d at 804. FINRA must notify the SEC of any final disciplinary action taken against a member. 15 U.S.C. § 78s(d)(1). The SEC may review FINRA's decision de novo pursuant to a petition from the aggrieved member; the SEC may also review the action sua sponte. Id. § 78s(d)-(e); 431 F.3d at 804. A person aggrieved by a final order of the SEC may obtain judicial review by filing a petition with the United States Court of Appeals for the District of Columbia Circuit or for the circuit in which he resides or has his principal place of business. 15 U.S.C. § 78y(a)(1). This *142 statutory system authorizing self-regulatory organizations to act as quasi-governmental agencies in disciplining members for federal securities law violations has existed for over 70 years. See Nat'l Ass'n of Sec. Dealers v. SEC, 431 F.3d at 804.
As held in Solomon, SROs have historically been viewed as private, non-governmental organizations. As clearly expressed in Graman v. NASD 3, a 1998 decision of the United States District Court for the District of Columbia:Every court that has considered the question has concluded that NASD is not a governmental actor. See First Jersey Secs., Inc. v. Bergen, 605 F.2d 690, 698, 699 n. 5 (3d Cir.1979); Shrader v. NASD, Inc., 855 F. Supp. 122, 124 (E.D.N.C.1994), aff'd, 54 F.3d 774 (4th Cir.1995); Cremin v. Merrill Lynch Pierce Fenner & Smith, Inc., 957 F.Supp. 1460, 1468 (N.D.Ill.1997); Datek Secs. Corp. v. NASD, Inc., 875 F.Supp. 230, 234 (S.D.N.Y.1995); First Heritage Corp. v. NASD, Inc., 795 F.Supp. 1250, 1251 (E.D.Mich.1992); Bahr v. NASD, Inc., 763 F.Supp. 584, 589 (S.D.Fla.1991); United States v. Bloom, 450 F.Supp. 323, 330 (E.D.Pa.1978).[Ed: emphasis supplied]In recent years entities and individuals are finding themselves increasingly under investigation by both an SRO and a criminal prosecutor; whereas previously, parallel investigations were more likely conducted by an SRO and the SEC. Older cases considered the issue of whether an SRO was acting as the agent of the SEC --- and then questioned whether the SEC's role as a government agency was sufficient to infect federal prosecutors under whose aegis federal criminal charges were brought. More recently we are finding SROs accused of directly acting in concert with or at the behest of state or federal prosecutors, with less emphasis on attempting to establish the SEC as a disqualifying intermediary. More dramatically, the SROs themselves are now being characterized as quasi-governmental in nature.In Marchiano v. NASD4 , the United States District Court for the District of Columbia recently visited the issue of the NASD's role as a "private entity". In Marchiano an NASD member firm's former president sought to enjoin the SRO from pursuing a disciplinary proceeding against him. The Plaintiff alleged that the NASD acted in concert with state prosecutors (who had charged him in a pending 240 count indictment alleging stock manipulation and fraud) and that the SRO was impermissibly planning to provide its disciplinary proceeding materials to the state prosecutors. The NASD argued that it was a private entity, not a state actor. Marchiano countered that the NASD was a quasi-governmental agency acting in concert with the state prosecutors and seeking to coerce him into surrendering his privilege against self-incrimination by threatening him with permanent banishment from the securities industry for failure to testify during the SRO's investigation. In dismissing the complaint against the NASD, the Court cited to Graman as "rejecting the argument that NASD is a 'quasi governmental authority' because of its regulatory duties," and further noted, inter alia:[T]he court is aware of no case --- and Marchiano has presented none --- in which NASD Defendants were found to be state actors either because of their regulatory responsibilities or because of any alleged collusion with criminal prosecutors.