December 27, 2016
This is an update of "FINRA Wins Scottsdale Capital Advisors Motion to Dismiss" (BrokeAndBroker.com Blog, May 9, 2016)
Wall Street is regulated by the federal Securities and Exchange Commission ("SEC"), by state securities divisions, and by the self-regulatory organization ("SRO") the Financial Industry Regulatory Authority ("FINRA"). On top of that regulatory regime, we should also add the Federal Bureau of Investigation, the Department of Justice, the United States Attorneys, the states's Attorneys General, and, in some cases, local county or district attorneys. For such a prodigious tower of oversight, it's puzzling how poorly it all works -- or fails to. Feuding regulators battle over turf and precious media exposure instead of walking the beat. Competing regulators inefficiently pursue similar investigations seeking the same documents resulting in redundant charges. Adding insult to injury, public investors and industry participants frequently complain about being sent from an examiner to a supervisor to an office to a division to a department to an agency -- all of which culminates with no one able to solve a problem or willing to take responsibility. The process is endless,suffocating, and impotent.
For much of my three-plus decades on Wall Street, I have waged an often lonely but persistent battle in favor of regulatory reform. Pointedly, I have long advocated the end of SROs and a modernization of the tired policies and practices in place at the SEC. See, for example: End The Politics Of Wall Street Regulation: Decentralize FINRA And The SEC (BrokeAndBroker.com Blog, November 16, 2011). A recent case filed against FINRA in federal court raises many issues about the state of Wall Street regulation and underscores the need to bring about overdue reform.
Case In Point
On March 22, 2016, a FINRA member firm; one of the firm's founders and Director; and three registered representatives filed a Complaint against FINRA in the United States District Court for the District of Maryland ("DMD") seeking injunctive and declaratory relief. Scottsdale Capital Advisors Corporation, John J. Hurry, Timothy B. DiBlasi, and Darrell Michael Cruz, Plaintiffs, v. Financial Industry Regulatory Authority, Inc., Defendant (Complaint, 16-CV-00860, March 22, 2016). Plaintiff Scottsdale Capital Advisors Corporation ("SCA") is a broker-dealer and registered investment advisor; Plaintiff Hurry is a founder and Director of SCA; Plaintiff DiBlasi is SCA's Chief Compliance Officer; and Plaintiff Cruz was formerly SCA's President. The Complaint seeks
A. An order and judgment preliminarily and permanently enjoining FINRA from continuing disciplinary proceeding against Plaintiffs (FINRA Case No. 2014041724601).
B. An order and judgment declaring that FINRA lacks statutory authority under the Exchange Act to bring disciplinary proceedings against member firms or their associated persons premised upon alleged violations of the Securities Act.
Page 19 of the ComplaintREAD the FINRA v. Scottsdale et al Disciplinary ComplaintFINRA Disciplinary ProceedingAs more fully explained in the "Background" section of the Complaint, at the core of this dispute is an ongoing FINRA disciplinary proceeding:
26. Since SCA's formation in 2001, the firm has become a market leader in microcap securities trading.27. In 2013, Mr. Hurry organized Cayman Securities Clearing and Trading SEZC Ltd. ("CSCT") in the Special Economic Zone of the Cayman Islands to serve as an offshore broker for foreign clients. CSCT became a customer of SCA and, through its account there, deposited and liquidated penny stocks on behalf of CSCT's own customers.
28. On May 15, 2015, FINRA commenced a disciplinary proceeding against Plaintiffs. In brief, FINRA's complaint alleges that (i) certain transactions that CSCT routed through SCA on behalf of specified CSCT customers violated Section 5 of the Securities Act and (ii) Plaintiffs' supervisory processes and procedures were not reasonably designed to detect and prevent violations of Section 5. As a result of these purported Section 5 violations, the Complaint charges Plaintiffs with violating FINRA Rule 2010, which requires members to "observe high standards of commercial honor and just and equitable principles of trade."
29. In its complaint, FINRA requests that the Hearing Officer order one or more of the sanctions listed in FINRA Rule 8310. Rule 8310(a) authorizes FINRA to impose a variety of penalties on its members, including censure, fines, suspension of FINRA membership or registration, expulsion from FINRA, cancellation or revocation of FINRA membership, suspension from or bars on association with FINRA members, entry of temporary or permanent cease-and-desist orders, and "any other fitting sanction." FINRA R. 8310(a).
30. On December 11, 2015, Plaintiffs moved for summary disposition before the FINRA Hearing Officer assigned to their disciplinary proceeding. Plaintiffs' submission rested principally on the jurisdictional argument advanced in this Complaint.
31. On February 26, 2016, the Hearing Officer, a FINRA-employed attorney, denied Plaintiffs' motion, holding, in effect, that FINRA can use its general ethical rule to enforce any of the federal securities laws, notwithstanding the contrary text in FINRA's enabling legislation.Pages 10 - 11 of the Complaint
Exhaustion of Administrative Remedies
The Exhaustion of Administrative Remedies Doctrine ("Exhaustion Doctrine") is cited as keeping the machinery of regulation well-oiled. At its core, the Exhaustion Doctrine prevents a party from seeking the intervention of the courts into a given regulator's disciplinary process until such time as all the prerequisite administrative remedies have been exhausted. Advocates of the Exhaustion Doctrine argue that it supports the integrity of the regulatory process by avoiding the delays and bad-faith that arise when defendants/respondents prematurely run to a courthouse in lieu of exhausting the statutorily proscribed scheme of hearings and appeals. Cynics see the Exhaustion Doctrine as a way for the courts to cut down on their caseload by not getting involved in an agency's or organization's administrative procedures until there is some "final" decision. Historically, courts are loathe to interrupt the regulatory administrative process on a "piecemeal " basis and have opined that it is best to ensure that appeals arrive at the courts's doorsteps in a relatively ripe condition with a full record. Similarly, courts generally defer to the purported expertise of regulators when it comes to interpreting and applying the applicable regulatory rules and regulation.
Short Circuiting the Pathway
In light of the above Exhaustion Doctrine, the Scottsdale Complaint is an edgy undertaking because Plaintiffs are trying to avoid exhausting their administrative remedies via a route that entails a FINRA Office of Hearing Officers hearing and then an appeal to a FINRA National Adjudicatory Council hearing and then an appeal to the SEC and, then, and only then, an appeal to the federal courts. In Plaintiffs' federal lawsuit against FINRA, they are attempting to short-circuit that administrative-remedies pathway and bring their grievances against the SRO to a United States District Court. In justifying an exception to the Exhaustion Doctrine, Plaintiffs argue, in part, that:
[F]INRA's in-house disciplinary action against them exceeds FINRA's statutory authority under the Exchange Act, rendering the entire proceeding ultra vires. Although Plaintiffs ultimately may obtain federal appellate review of this claim after several administrative appeals this belated judicial intervention will not be meaningful, as submission to an unlawful proceeding constitutes the very harm that Plaintiffs seek to avoid.Pages 5 - 6 of the ComplaintAs set forth in the "Introduction" section of the Complaint:
1. Plaintiffs bring this action for injunctive and declaratory relief to prevent FINRA from further proceeding against them with a disciplinary action premised on claims that exceed the organization's expressly limited authority under the Securities Exchange Act of 1934 (the "Exchange Act").
2. FINRA is a registered securities association and self-regulatory organization that operates as a private regulatory body for broker-dealers. As a practical matter, any broker-dealer that desires to conduct business in the United States is required to register with FINRA.
3. Plaintiffs are a FINRA-registered broker-dealer (Scottsdale Capital Advisors Corporation ("SCA")), its founder (Mr. Hurry), and two of its officers (Mr. DiBlasi and Mr. Cruz). FINRA has initiated a disciplinary proceeding against Plaintiffs (FINRA Case No. 2014041724601), raising allegations premised on supposed violations of Section 5 of the Securities Act of 1933 (the "Securities Act"), which generally prohibits the public distribution of unregistered securities absent an applicable exemption. The Section 5 allegations are the predicate for charged violations of FINRA Rule 2010, which states that "[a] member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade." FINRA R. 2010.
4. FINRA's disciplinary authority is derived from, and governed by, Sections 15A and 19 of the Exchange Act. Together, these provisions empower the organization to discipline its members for violations of "this chapter," "the rules and regulations thereunder," and FINRA's own rules. Because the Exchange Act occupies a different chapter in the United States Code from the Securities Act, the plain and unambiguous text of FINRA's enabling legislation forecloses disciplinary actions premised upon alleged violations of the Securities Act or federal securities laws other than the Exchange Act.
5. Before seeking relief from this Court, Plaintiffs raised this jurisdictional argument to the FINRA Hearing Officer assigned to their disciplinary proceeding. On February 26, 2016, the Hearing Officer, an attorney employed by FINRA, rejected Plaintiffs' argument and adopted FINRA's view that the organization can confer upon itself jurisdiction to enforce any law it chooses, despite the explicit textual limitations in the Exchange Act, as long as the conduct it aims to regulate relates to trade. This disregard of the statutory limits on FINRA's jurisdiction renders the disciplinary proceeding ultra vires and necessitates this Court's intervention.
6. The FINRA disciplinary proceeding is scheduled for a two-week hearing commencing June 13, 2016, in Los Angeles, California. Preparation for the hearing, including the completion of witness and exhibit lists and the submission of pre-hearing briefing, will begin imminently, with deadlines approaching in mid-April.
7. Declaratory and injunctive relief is necessary to prevent Plaintiffs from being compelled to submit to an ultra vires administrative proceeding and from suffering irreparable reputational and financial harm-all without meaningful judicial review.Pages 3 -4 of the ComplaintIn amplifying their positions, Plaintiffs explain that:
18. Plaintiffs' claims are not within the particular expertise of FINRA or the SEC. FINRA's expertise concerns the liability provisions of the Exchange Act and related issues affecting broker-dealers. The SEC's expertise concerns the substantive portions of the federal securities laws. Plaintiffs here assert claims regarding the proper interpretation of the scope of FINRA's enabling legislation, a subject implicating general principles of statutory interpretation and ascertainment of congressional intent. These principles bear no relation to the substantive expertise of FINRA or the SEC; to the contrary, they are within the core competence of the federal judiciary.]Page 6 of the ComplaintExceptions to the Exhaustion Doctrine
In seeking to detour around the Exhaustion Doctrine, Plaintiffs pointedly cite to five examples of exceptions that support their approach. First, Plaintiffs argue that FINRA's disciplinary proceeding exceeds the SRO's authority under the Exchange Act. Second, that Plaintiffs are not seeking to embroil DMD in the substantive regulatory charges inherent in FINRA's pending disciplinary action but, to the contrary, are seeking injunctions and declaratory judgments that are properly within the court's authority. Further, Plaintiffs assert that they will suffer "irreparable harm" if forced to exhaust their administrative remedies by participating in FINRA hearings and appeals and, thereafter, an appeal to the SEC and, thereafter, and only thereafter, filing an appeal to a federal court. Additionally, Plaintiff's cite to an established exception to the Exhaustion Doctrine that arises when it would be "futile" to pursue the Exhaustion Doctrine. Finally, Plaintiffs assert that FINRA lacks the institutional capacity "to neutrally assess the limits of its own statutory jurisdiction."
Scottsdale Capital Advisors Corporation, John J. Hurry, Timothy B. DiBlasi, and Darrell Michael Cruz, Plaintiffs, v. Financial Industry Regulatory Authority, Inc., Defendant (Complaint, 16-CV-00860, March 22, 2016)
For more details on the background to the disputes between FINRA and SCA, READ:
UPDATE May 9, 2016
On April 26, 2016, DMD ordered that Defendant FINRA's Motion to Dismiss
be granted and that Plaintiffs' Complaint
be dismissed for lack of subject matter jurisdiction. Scottsdale Capital Advisors Corporation, John J. Hurry, Timothy B. DiBlasi, and Darrell Michael Cruz, Plaintiffs, v. Financial Industry Regulatory Authority, Inc., Defendant (Order
, DMD, 16-CV-00860, April 26, 2016)
Have we heard the end of this dispute? Hardly. On April 27, 2016, Plaintiffs filed a Notice of Appeal
with the the United States Court of Appeals for the Fourth Circuit. See, 4Cir Notice of Appeal
UPDATE December 2016
In framing the appeal before it, Scottsdale Capital Advisors Corporation, John J. Hurry, Timothy B. DiBlasi, and Darrell Michael Cruz, Plaintiffs, v. Financial Industry Regulatory Authority, Inc., Defendant (Opinion, 16-1497, December 20, 2016),
4Cir offered this [Ed: Footnotes omitted':
Pages 8 - 9 of the 4Cir Opinion
Notwithstanding the exclusive grant of jurisdiction to the courts of appeals in the Exchange Act, Scottsdale argues the district court had jurisdiction to consider its claim because FINRA lacked authority to initiate the disciplinary proceeding. Scottsdale believes it need not, as it describes it, exhaust administrative remedies before seeking review in this court for two reasons. First, Scottsdale claims the limited exception to jurisdiction-stripping recognized in Leedom v. Kyne, 358 U.S. 184 (1958), applies because FINRA is allegedly acting outside of its statutory authority. Alternatively, Scottsdale asserts its claim is not of the type Congress intended to remove from district court jurisdiction under the framework articulated in Thunder Basin . . .
In response to Scottsdale's arguments, 4Cir determined to apply the following:
Page 16 of the 4Cir Opinion
[T]his claim-specific analysis considers three factors: (1) whether "adjudication of petitioner's claims through the statutory-review provisions will violate due process by depriving petitioner of meaningful judicial review"; (2) whether the claims are "wholly collateral" to the statute's review provisions; and (3) whether the claims are "outside of the agency's expertise." Id. at 212-14. Applying each of these factors to Scottsdale's claim, we agree with the district court that the Exchange Act's "administrative structure was intended to preclude district court jurisdiction over petitioner's claims and that those claims can be meaningfully reviewed through that structure consistent with due process." Id. at 218.
In dismissing Scottsdale's complaints about the undue burden of its battle against a regulator not purportedly acting within its proscribed powers, 4Cir explained that:
Scottsdale's desire to "prevent the per se irreparable harm of being forced to submit to the orders of an organization acting beyond the limits of its statutory authority," Appellant's Br. at 28-29, conflicts with the long-standing principle that "the expense and annoyance of litigation is 'part of the social burden of living under government.'" Bennett, slip op. at 22 (quoting FTC v. Standard Oil of Cal., 449 U.S. 232, 244 (1980)). The same is true of Scottsdale's allegations of potential reputational harm. See Sampson v. Murray, 415 U.S. 61, 89 (1974).
Scottsdale's concern that it will be unable to press its claims if it prevails before FINRA also lacks merit. Federal regulations "specifically provide" mechanisms by which Scottsdale could challenge FINRA Rule 2010 outside of the disciplinary proceeding. Standard Oil, 449 U.S. at 245. Scottsdale could petition the SEC--apart from any disciplinary action--to amend or repeal FINRA Rule 2010. See 17 C.F.R. § 201.192. The SEC's decision on FINRA's rule would be final agency action of which Scottsdale could then seek review in the appropriate court of appeals . . .
Page 17 of the 4Cir Opinion
[A]s part of the SEC's oversight of FINRA, Congress vested authority in the SEC to review "a final disciplinary sanction imposed by" FINRA and determine whether its rules "were applied in a manner consistent with the purposes" of the Exchange Act. 15 U.S.C. § 78s(e)(1). Thus, Congress unambiguously channeled Scottsdale's claim--whether FINRA has exceeded its authority in charging Scottsdale--to the SEC for determination in the first instance . . .
Page 19 of the 4Cir Opinion
4Cir concluded, in pertinent part, that:
When Congress provides a comprehensive review scheme our judicial review must comport with those statutory provisions unless doing so would violate the Constitution. Congress, through the Exchange Act, intended to channel objections to FINRA's authority through the agency and the courts of appeals. In so doing, it is clear Congress sought to preclude federal district-court jurisdiction. Because Scottsdale can obtain meaningful judicial review of its claim in this court following the appeal process outlined in the Exchange Act, we hold its challenge to FINRA's authority is the type of claim Congress intended to be reviewed within the statutory scheme. Accordingly, the district court properly dismissed for lack of subject-matter jurisdiction . . .
Page 20 of the 4Cir Opinion