Corporate & Securities Law

By Jim Hamilton

Federal Court Rejects Challenge to Creation of FINRA Citing Absolute Immunity of SROs

A federal judge (SD NY) dismissed a challenge to the consolidation of the NASD and the NYSE regulatory arm that created FINRA as the sole regulator of member firms. The Exchange Act authorizes the SEC to delegate regulatory functions to self-regulatory organizations, said the court, and as a result SROs are considered quasi-governmental bodies. As such, SROs and their officers were entitled to absolute immune from private damage suits challenging official conduct performed within the scope of their regulatory function. Standard Investment Chartered, Inc. v. NASD; 07 Civ 2014 (JSR); Benchmark Financial Services, Inc. v. FINRA, 08 Civ 11193 (JSR), (SD NY), March 1, 2010.

The consolidation that formed FINRA was challenged by NASD members alleging misrepresentations in the proxy statements that solicited NASD shareholder votes in favor of by-law amendments that were a necessary prerequisite to the consolidation. Specifically, they alleged that the proxy falsely asserted that $35,000 was the maximum amount that the NASD was authorized by the IRS to pay members in connection with the merger.

Rejecting the private challenge, the court said that SRO sovereign immunity, being absolute, turns on whether specific acts and forbearances were incident to the exercise of regulatory power and not on the propriety of those actions or inactions. The court held that the consolidation that transferred the NASD and NYSE regulatory powers to FINRA was patently on its face an exercise of the SROs? delegated regulatory functions and thus entitled to absolute immunity.

The court also rejected the argument that the actions being challenged, namely the proxy misrepresentations, pertained solely to the SROs? proprietary functions to which absolute immunity does not apply. The members particularly argued that the misstatement about limiting the payment to $35,000 related to SRO finances not their regulatory functions.

The court rejected as "artificial and unconvincing" this attempt to parse the proxy to separate financially-related statements from regulatory-related statements. Although the shareholder vote for which the proxy was issued was not a vote on the regulatory consolidation itself, said the court, the approval of the by-law changes was a necessary prerequisite to the completion of the consolidation and was promoted as such in the proxy.

Moreover, the amendment to the by-laws fell within the parameters of the NASD?s statutory rulemaking authority. To focus on the fact that the amendment to the by-laws also encompassed a financial component would be to miss the entire purpose of the reorganization, reasoned the court, which was a regulatory purpose to which immunity applies.

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Full post as published by Jim Hamilton's World of Securities Regulation on March 02, 2010 (boomark / email).