[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:

    <bullet> The member or person paid the award in full or fully 

complied with the settlement agreement;

    <bullet> The arbitration claimant has agreed to installment 

payments or has otherwise settled the matter;

    <bullet> The member or person has filed a timely motion to vacate 

or modify the arbitration award and such motion has not been denied; 

and

    <bullet> 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