A court decision last week could make it easier for violators in the securities industry to keep ill-gotten gains, assuming they leave the business for good.
A federal appeals court ruled last Wednesday that the Financial Industry Regulatory Authority Inc. has no right to collect fines through court judgments.
Finra usually doesn't pursue barred individuals for unpaid fines, but it does have a policy of seeking payment for investor restitution and disgorgement of funds amassed by fraud.
The appeals court case stems from a 1998 enforcement action that Finra, then known as NASD Regulation Inc., brought against John Fiero, founder of Fiero Brothers Inc.
The regulator alleged that Mr. Fiero engaged in illegal short selling and coercion in mounting bear raids against stocks underwritten by the now-defunct penny stock firm Hanover Sterling & Co. NASD claimed that Mr. Fiero made at least $550,000 on his short sales. A hearing panel later expelled Mr. Fiero and fined him $1 million. Mr. Fiero refused to pay and fought off Finra's collection efforts in court battles for 10 years.
That battle ended last week when the 2nd U.S. Circuit Court of Appeals in New York ruled in Mr. Fiero's favor. The three-judge panel said Congress “did not intend to empower Finra to bring court proceedings to enforce its fines.”
Legal observers said the decision would have minimal impact on Finra's collection of fines overall, since violators must pay up or lose their licenses.
Finra has filed for only five court judgments since 2000, the Fiero case being one of them, according to Finra spokeswoman Nancy Condon. But the case could affect Finra's ability to chase down some miscreants who leave the industry.
LITTLE LEVERAGE
“The potential was always there [for a court judgment], and that in itself might have been an incentive for people to pay their fines,” said Linda Riefberg, special-counsel resident at Fried Frank Harris Shriver & Jacobson LLP and formerly chief counsel in Finra's enforcement department. The court's decision has “really taken away that little bit of leverage they had.”
What's more, Finra could be hamstrung in getting restitution for investors, said Brian Rubin, a partner at Sutherland Asbill & Brennan LLP.
“Finra's top priority is often remediation [for victims], not just ill-gotten gains,” Mr. Rubin said. “The case doesn't raise that issue, but it wouldn't surprise me if respondents [now] litigate that.”
Mr. Fiero's attorney, Marty Kaplan, a partner at Gusrae Kaplan Bruno Nusbaum PLLC, thinks any type of collection effort by Finra could be affected.
“Say you were barred, thrown out and fined $50,000,” he said. “Can you get that 50 grand back, plus damages?”
The decision addressed only court judgments, but Mr. Kaplan said the case made clear that Finra is limited to suspending or barring respondents who don't pay.
Ms. Riefberg disagreed, saying nothing in the decision would stop Finra from pursuing, and getting, payment without a court judgment.TAKING IT TO CONGRESS
The case has a big enough impact that Finra might have to go to Congress to get the problem fixed, observers said. Finra also could appeal the case to the Supreme Court.
“We will continue to review the ruling and weigh our options,” Ms. Condon said. The decision will not affect Finra's ability to enforce its rules, she added.
Asking Congress for more power is tricky, observers said, especially as Finra angles to get jurisdiction over investment advisers.
Finra “may need to address how they plan to use this power in a more effective and consistent fashion,” said Sylvia Scott, a partner at Freeman Freeman & Smiley LLP.
In a rule change effective in 1990, NASD began using debt collectors and court judgments to bring in unpaid fines.
The appeals court last week chastised Finra for failing to publish that rule change for notice and comment. Instead, NASD submitted the rule to the Securities and Exchange Commission as a “housekeeping” item, the court said, which made the rule effective upon filing.
“I am glad that the court recognized the need to go through the formal rule-making process,” said Alan Wolper, a partner at Locke Lord LLP.
“My clients are often frustrated when Finra announces a new standard for something but does so in a [regulatory notice] or, worse, an enforcement decision,” he said.
The appeals court decision suggested that Finra might be able to remedy the rule by putting it out for comment and getting SEC approval.
Unless it's appealed, the appeals court decision concludes a long-running saga that began in 1995 when Mr. Fiero's and others' short-selling schemes led to the failure of Hanover Sterling and the collapse of its clearing firm, Adler Coleman Clearing Corp.
Mr. Fiero argued at his disciplinary hearing that he helped bring down Hanover, a well-known bucket shop.
Indeed, one former Hanover official, Robert Catoggio, testified in Mr. Fiero's case that Hanover's capital position had been seriously threatened as a result of the short-selling pressure.
In 2000, Mr. Catoggio and another Hanover official, Roy Ageloff, pleaded guilty to racketeering charges for their role in Hanover's stock fraud scheme.
But the NASD disciplinary panel didn't exactly see Mr. Fiero as one of the good guys. He was evasive to NASD investigators about his short-selling strategy, the panel said in its December 2000 decision, but “at the hearing, Fiero recalled many more self-serving facts than he had during his investigative testimony.”
djamieson@investmentnews.com
