[Federal Register Volume 75, Number 109 (Tuesday, June 8, 2010)]
[Notices]
[Pages 32525-32526]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-13764]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-62211; File No. SR-FINRA-2010-014]
Self-Regulatory Organizations; Financial Industry Regulatory
Authority, Inc.; Order Approving Proposed Rule Change Relating to FINRA
Rule 9554 To Eliminate Explicitly the Inability-To-Pay Defense in the
Expedited Proceedings Context
June 2, 2010.
On March 31, 2010, Financial Industry Regulatory Authority, Inc.
(``FINRA'') filed with the Securities and Exchange Commission (``SEC''
or ``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'' or ``Exchange Act'') \1\ and Rule 19b-4
thereunder,\2\ a proposed rule change to FINRA Rule 9554 to eliminate
explicitly the inability-to-pay defense in the expedited proceedings
context. The proposed rule change was published for comment in the
Federal Register on April 26, 2010.\3\ The Commission received three
comments, all of which supported the proposed rule change.\4\ This
order approves the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 61938 (Apr. 19,
2010), 75 FR 21686 (Apr. 26, 2010).
\4\ See letters from Michael T. Nommensen, dated May 14, 2010;
William A Jacobson, Esq., Associate Clinical Professor of Law,
Cornell Law School, and Director, Cornell Securities Law Clinic, and
Lennie Sliwinski, Cornell Law School class of 2011, dated May 15,
2010; and Scott R. Shewan, President, Public Investors Arbitration
Bar Association (``PIABA''), dated May 17, 2010.
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I. Description of the Proposed Rule Change
FINRA proposed to amend FINRA Rule 9554 to eliminate explicitly the
inability-to-pay defense in the expedited proceedings context when a
member or associated person fails to pay an arbitration award to a
customer.
FINRA Rule 9554 allows FINRA to bring expedited actions to address
failures to pay FINRA arbitration awards.\5\ Once a monetary award has
been issued in a FINRA arbitration proceeding, the party that must pay
the award has thirty days to do so.\6\ If the party that must pay the
award is a respondent, (i.e., a member or an associated person, FINRA
coordinates between FINRA Dispute Resolution's arbitration forum and
FINRA's enforcement program to verify whether such respondent has done
so. If the respondent has not paid, FINRA initiates an expedited
proceeding by sending a notice explaining that the respondent will be
suspended unless the respondent pays the award or requests a hearing.
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\5\ Expedited actions allow FINRA to address certain types of
misconduct quicker than would be possible using the ordinary
disciplinary process. In general, expedited actions are designed to
encourage respondents to comply with the law or take corrective
action rather than sanction them for past misconduct. Moreover, as
discussed in detail below, the Act uses a different standard of
review for expedited actions than it does for disciplinary cases.
\6\ FINRA Rule 10330(h).
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A respondent that requests a hearing may raise a number of defenses
to the suspension. One of the current defenses is establishing a bona
fide inability-to-pay. When a respondent successfully demonstrates a
bona fide inability-to-pay, it is a complete defense to the suspension.
Consequently, the inability-to-pay defense currently precludes a harmed
customer from obtaining payment of a valid arbitration award.
FINRA's expedited proceedings for failure to pay an arbitration
award use the leverage of a potential suspension to help ensure that a
member or an associated person promptly pays a valid arbitration award.
However, if a respondent demonstrates a financial inability to pay the
award--regardless of the reason--the leverage is removed. When FINRA's
efforts to suspend a respondent who has not paid an award have been
defeated, a claimant is much less likely to be paid. FINRA believes
that by eliminating the inability-to-pay defense, it will increase the
probability of customers having their awards paid, or, at a minimum, it
should prompt meaningful settlement discussions between claimants and
respondents.
The ability to work in the securities industry carries with it,
among other things, an obligation to comply with the federal securities
laws, FINRA rules, and orders imposed by the disciplinary and
arbitration processes. Allowing members or their associated persons
that fail to pay arbitration awards to remain in the securities
industry presents regulatory risks and is unfair to harmed customers.
Although FINRA proposes to eliminate the inability-to-pay defense,
a respondent would still have available the following four defenses:
The member or person paid the award in full or fully
complied with the settlement agreement;
The arbitration claimant has agreed to installment
payments or has otherwise settled the matter;
The member or person has filed a timely motion to vacate
or modify the arbitration award and such motion has not been denied;
and
The member or person has filed a petition in bankruptcy
and the bankruptcy proceeding is pending or the award or payment owed
under the settlement agreement has been discharged by the bankruptcy
court.\7\
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\7\ In its order approving changes to the predecessor to Rule
9554, the SEC noted that the issues raised in cases in which at
least one of the aforementioned defenses is raised are narrow and
generally limited to determining whether the respondent has proven
any of these four defenses or an inability-to-pay the award. See
Securities Exchange Act Release No. 40026 (May 26, 1998), 63 FR
30789 (June 5, 1998).
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Regarding the last defense, FINRA believes that a federal
bankruptcy court is the best forum for adjudicating a financial
condition defense. Bankruptcy judges are experts in evaluating whether
a debtor's obligations should be legally discharged. The bankruptcy
process and associated filings are designed to consider fully and
evaluate the financial condition of bankruptcy debtors.\8\ In addition,
bankruptcy filings, which are subject to federal perjury charges,
provide greater penalties for hiding assets.\9\ FINRA's lack of
subpoena power over banks and other third parties raises practical
concerns regarding its ability to confirm accurately the assets of the
firm or person asserting the defense.\10\
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\8\ See 4 Collier on Bankruptcy, ]] 521.01, 521.09 (15th ed.
2009).
\9\ See 18 U.S.C. 151-58 (2010). Bankruptcy fraud is punishable
by a fine, or by up to five years in prison, or both. Id.
\10\ The ability to legally discharge debts, the more thorough
and accurate verification of a bankruptcy debtor's financial
condition, and possible criminal prosecution for intentionally
inaccurate disclosures, among other aspects, distinguish bankruptcy
from inability-to-pay.
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[[Page 32526]]
The inability-to-pay defense emerged from a series of SEC decisions
that require FINRA to consider the defense in disciplinary cases (as
opposed to expedited actions), including disciplinary cases involving
failures to pay arbitration awards and restitution.\11\ The legal
underpinnings that support the inability-to-pay defense in disciplinary
cases are not, however, present in the expedited proceedings context.
The aforementioned SEC decisions largely rely on the ``excessive and
oppressive'' language in Section 19(e) of the Exchange Act in requiring
FINRA to consider inability-to-pay. Section 19(e) of the Exchange Act
provides authority to the SEC to review and affirm, modify or set aside
any final disciplinary sanctions imposed by FINRA on its members.
Section 19(e), however, does not apply to expedited proceedings.
Expedited proceedings are reviewed under Exchange Act Section 19(f),
which requires that ``the specific grounds'' on which FINRA based its
action ``exist in fact,'' that FINRA followed its rules, and that those
rules are consistent with the Act. The different focus of these two
standards and the more limited review for expedited actions are
understandable and support eliminating the inability-to-pay defense in
expedited actions.\12\ Unlike in disciplinary cases, FINRA is not
imposing a monetary sanction in these expedited actions; it is
suspending a respondent for failing to pay a previously imposed
arbitration award. There also is an explicit procedural mechanism built
into these expedited actions that allows a suspension to be lifted once
respondents satisfy any of the four defenses listed above. The main
goal is to encourage respondents to comply with the law or previously
imposed orders, not to sanction them for past misconduct.
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\11\ See Toney L. Reed, 52 S.E.C. 944 (1996), recons. denied,
Securities Exchange Act Release No. 39354 (Nov. 25, 1997); Bruce M.
Zipper, 51 S.E.C. 928 (1993). In addition, the SEC had previously
recognized that a bona fide inability-to-pay an arbitration award is
an important consideration in determining whether any sanction for
failing to pay an arbitration award is ``excessive or oppressive.''
See Securities Exchange Act Release No. 40026 (May 26, 1998), 63 FR
30789 (June 5, 1998). (Without further discussion, the order cited
the SEC's decision in Zipper, which was a disciplinary case, not an
expedited action.)
\12\ In William J. Gallagher, Securities Exchange Act Release
No. 47501 (March 14, 2003), the SEC emphasized that expedited
actions are reviewed under Section 19(f) of the Act not Section
19(e). The SEC stated, ``Gallagher misconstrues the applicable
review standard when he argues that [FINRA's] sanction is `excessive
and oppressive' and that [FINRA's] indefinite suspension order is
inconsistent with the [FINRA] Sanction Guidelines, standards
relevant in the Commission's review of [FINRA] disciplinary
proceedings under Section 19(e) of the Exchange Act.'' Id. at *6.
The SEC explained that its review is limited to analyzing whether
``the specific ground on which [FINRA] based its suspension--failure
to pay in full an arbitration award--`exists in fact[,]''' the
``SRO's determination was in accordance with its rules, and * * *
those rules are, and were applied in a manner, consistent with the
purposes of the Exchange Act.'' Id. at *5 & *7. In Gallagher, FINRA
and the SEC rejected the respondent's claim of inability-to-pay on
factual grounds. The issue of whether a respondent was permitted to
raise the defense as a matter of law was neither raised nor decided.
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In sum, members and associated persons that fail to pay arbitration
awards to customers should not be allowed to remain in the securities
industry by relying on the inability-to-pay defense in expedited
actions. This is especially true because they can avoid regulatory
action by paying the award, reaching a settlement with the customers
(which can include payment plans), moving to vacate the award, or
filing for bankruptcy. Three commenters addressed the proposed rule
change and all three urged the Commission to approve it.\13\
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\13\ In its comment, PIABA also recommended that FINRA eliminate
or restrict the bankruptcy defense in expedited proceedings. Those
suggestions are outside the scope of the current proposed rule
change.
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II. Discussion and Commission Findings
After careful review, the Commission finds the proposed rule change
to be consistent with the requirements of the Act and the rules and
regulations thereunder applicable to a national securities
association.\14\ In particular, the Commission finds that the proposed
rule change is consistent with the provisions of Section 15A(b)(6) of
the Act,\15\ which requires, among other things, that FINRA rules must
be designed to prevent fraudulent and manipulative acts and practices;
to promote just and equitable principles of trade; to remove
impediments to and perfect the mechanism of a free and open market and
a national market system; and, in general, to protect investors and the
public interest. The proposal also is consistent with Section 15A(b)(7)
of the Act,\16\ which provides that FINRA must take appropriate action
when members and associated persons violate provisions of the Act or
FINRA rules.
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\14\ In approving the proposed rule change, the Commission has
considered the rule change's impact on efficiency, competition, and
capital formation. See 15 U.S.C. 78c(f).
\15\ 15 U.S.C. 78o-3(b)(6).
\16\ 15 U.S.C. 78o-3(b)(7).
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The Commission believes that the proposed rule change will further
FINRA's investor protection mandate by promoting a fair and efficient
process for taking action to encourage members and associated persons
to pay arbitration awards to customers. The Commission also believes
that the proposed rule change will further FINRA's statutory obligation
to take appropriate action when members and associated persons violate
provisions of the Act or FINRA rules.
III. Conclusion
For the foregoing reasons, the Commission finds that the proposed
rule change is consistent with the Act and the rules and regulations
thereunder applicable to a national securities association.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change (SR-FINRA-2010-0014) be and
hereby is approved.
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\17\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. 2010-13764 Filed 6-7-10; 8:45 am]
BILLING CODE 8010-01-P