A purported class-action lawsuit brought by a broker-dealer against the predecessor to the Financial Industry Regulatory Authority Inc., or FINRA, went out meekly this week, when the U.S. Supreme Court denied without explanation the plaintiff’s petition for the case to be heard.
The suit, Standard Investment Chartered Inc v. National Association of Securities Dealers, was first filed in the U.S. District Court for the Southern District of New York. It arose out of the 2007 merger of the National Association of Securities Dealers Inc., or NASD, with the regulatory arm of the New York Stock Exchange, or NYSE, to form FINRA, the self-regulatory organization that overseas broker-dealers and their stockbrokers.
Alleged Fraudulent Proxy Solicitation
Certain officers of the merged entities were also named as defendants. The complaint alleged that NASD and its officers sent out a fraudulent proxy solicitation in 2006 through which NASD was seeking to amend its bylaws to bring them in line with those of NYSE so the two entities could merge.
The proxy solicitation also provided for a one-time “special member payment” of $35,000, according to court documents. Standard, the plaintiff, alleged in its complaint that the defendants had falsely stated in the proxy and in other communications that $35,000 was the maximum possible payment that could be made under Internal Revenue Service rules.
District Court Grants Motion to Dismiss
In March 2010, the district court granted the defendants’ motion to dismiss for failure to state a claim upon which relief could be granted.
The district court held that self-regulatory organizations, or SROs, such as NASD are absolutely immune from private actions for damages when they are acting in a regulatory capacity. The SROs, the court said, enjoy this immunity as “quasi-governmental organizations” because their regulatory power is delegated to them by the Securities and Exchange Commission, or SEC.
2nd U.S. Circuit Court of Appeals Affirmed Dismissal
Standard appealed the case to the 2nd U.S. Circuit Court of Appeals, which affirmed the district court’s dismissal.
The 2nd Circuit accepted the district court’s reasoning that the bylaw amendments, which were the subject of the allegedly fraudulent proxy solicitation, were part of NASD’s regulatory function. The appeals court said the amendments were “a necessary prerequisite for consolidation, and amendment of the bylaws falls squarely within SRO statutory rulemaking authority as delegated by the SEC.”
The appeals court cited a whole string of recent precedent to back up this assertion, saying the immunity extends to both affirmative acts and omissions or failure to act.
Per the cases cited as precedent by the 2nd Circuit, quasi-governmental SROs have been found immune from suit when the alleged misconduct was related to: (1) disciplinary proceedings against exchange members; (2) the enforcement of rules and regulations and general oversight; (3) interpretation of the securities laws and regulations; (4) referral of members to the SEC and other government agencies for civil enforcement or criminal prosecution under the securities laws; and (5) the public announcement of regulatory decisions.
In the Standard case, the 2nd Circuit added another category to the list, stating that an SRO is immune from any suit related to amendment of its bylaws when the amendments are “inextricable from the SRO’s role as a regulator.”
As the district court noted in the decision below, the amendments were necessary for the consolidation and transfer of NASD’s regulatory function and NYSE’s regulatory function into FINRA.
The merger was to result in more streamlined regulations, resolving a situation in which many members were subject to two sets of sometimes inconsistent rules, the 2nd Circuit opinion said. Therefore, the bylaw amendments were part of the regulatory function.
The question remained, according to the 2nd Circuit, as to whether the proxy solicitation itself “constituted an exercise of NASD’s regulatory function.”
The court answered in the affirmative, because approval of the bylaw amendments was necessary for the completion of the merger, and this fact was clearly stated in the proxy.
Moreover, NASD’s authority to amend its bylaws came from federal statutes, along with all its other rulemaking authority, and the proxy solicitation was the only means available to effect the amendments, the opinion said.
In affirming the district court’s dismissal, the 2nd Circuit also found it significant that NASD could not alter its bylaws without approval from the SEC, subject to the usual the notice and comment period. This highlighted the extent to which an SRO’s bylaws are intertwined with the regulatory powers delegated by the SEC, the opinion said.
Standard Petition to the Supreme Court Denied
Standard petitioned for certiorari to the Supreme Court after the 2nd Circuit rejected its appeal in February 2011. The broker dealer asserted that lower courts have issued conflicting opinions on the subject of immunity for SROs and other state actors, according to a report in Investment News.
The Supreme Court denied the petition without explanation on Jan. 17.
Guiliano Law Group
Investors suffering losses or damages from such conduct may be able to recover their investment losses. Our practice is limited to the representation of investors in claims, for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to you unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
