Self-regulatory organizations

Do self-regulatory organizations like the Philippine Stock Exchange and Philippine Dealing Exchange Corp. have the power to impose monetary damages (like actual, punitive or damages) on entities or persons under their regulatory jurisdiction?

A self-regulatory organization (SRO) is an organization or association registered under the Securities Regulation Code that is empowered to make and enforce its own rules among its members or persons associated with members. It is authorized to discipline its members or any person associated with a member through the imposition of fines, suspension or expulsion of membership.

There is no judicial precedent in the Philippines for the question at hand but the fairly recent case of Fiero vs. Financial Industry Regulatory Authority, 660 F.3d 569 (2011), is instructive.

Finra is an SRO registered with the U.S. SEC. Like our SROs, it is empowered by law to initiate disciplinary proceedings against its members or their associated persons for violating any Finra rule or securities regulation.

Fiero Brothers, a broker-dealer registered with the U.S. SEC, was a member of Finra. John Fiero was the registered representative of Fiero Brothers. Finra, through its predecessor, NASD, expelled Fiero Brothers, barred Mr. Fiero from associating with any Finra-member firm, and fined the Fieros $1 million for violation of rules and securities regulations.

The Fieros refused to pay the fine. Finra filed a civil case to collect the fine with a state court in New York.

The trial court held that the case was firmly based on ordinary principles of contract law because the Fieros had “expressly agreed to comply with all NASD rules, including the imposition of fines and sanctions” when they voluntarily executed the NASD registration forms. The trial court said “New York state courts have long recognized the right of a private membership organization to impose fines on its members, when authorized to do so by statute, charter or by-laws.”

It also stated that “NASD is not `just a private club,’ but a self-regulatory organization, federally-mandated under . . . the Exchange Act to discipline its members and enforce the federal securities laws as well as its own SEC-approved rules.” It awarded the NASD a judgment of $1,329,724.54.

The Fieros questioned the authority of Finra to enforce the fine in the court.

The Federal Court of Appeals ruled against Finra. While conceding that SROs “have a statutory authority and obligation to ’appropriately discipline’ their members by expulsion, suspension, limitation of activities, functions, and operations, fine, censure, being suspended or barred from being associated with a member, or any other fitting sanction,” the law did not expressly grant them the authority to enforce the collection of fines through judicial action.

The court reasoned out that the “statutory scheme carefully particularizes an array of available remedies, including permissible actions in the federal courts.” This includes express statutory authority for the SEC to seek judicial enforcement of penalties for violation of the law and SEC rules.

However, conspicuously absent from the array of remedies is the power of SROs to enforce fines through judicial action. In the words of the Court, “[i]n contrast, there are no explicit provisions in the statute authorizing SRO’s to seek judicial enforcement of the variety of sanctions they can impose.”

The court rejected the argument that congressional intent to authorize such legal actions by Finra can be implied or inferred from the seemingly inexplicable nature of a gap in the Finra enforcement scheme: fines may be levied but not collected.

According to the court, such “significant under enforcement of the securities laws and Finra rules is hardly the inevitable result of Finra’s inability to bring fine- enforcement actions.” This is because “Finra fines are already enforced by a draconian sanction not involving court action. One cannot deal in securities with the public without being a member of Finra.

When a member fails to pay a fine levied by Finra, it can revoke the member’s registration, resulting in exclusion from the industry. Moreover, where a fine is based on a violation of the Exchange Act, the violator will also face a panoply of private and SEC remedies.”

The Fiero case has persuasive effect in our jurisdiction. Although it did not directly deal with the issue at hand, the morale of the story is that an SRO can only exercise powers as expressly granted it by law.

Unless an SRO is expressly granted the power to impose monetary damages, the answer seems to be that it is powerless to do so, and any damages it imposes on trading participants (brokers) and listed companies can certainly be questioned for having been made without or in excess of jurisdiction. This, indeed, is consistent with our legal system where the courts of law have “exclusive jurisdiction” to award damages.

(The author is former president and CEO of the Philippine Stock Exchange. He is now president of Shareholders’ Association of the Philippines and a senior partner of ACCRA Law Offices. His views in this column are strictly personal. He may be contacted at francis.ed.lim@gmail.com.)

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