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Sharemaster v. U.S. Securities & Exchange Commission

United States Court of Appeals, Ninth Circuit

February 2, 2017

Sharemaster, Petitioner,
v.
U.S. Securities & Exchange Commission, Respondent.

          Argued February 3, 2016

          Submitted February 2, 2017 Pasadena, California

         On Petition for Review of an Order of the Securities & Exchange Commission

         COUNSEL

          Howard Feigenbaum (argued), Hemet, California, pro se Petitioner.

          Nicholas Bronni (argued), Senior Counsel; William K. Shirey, Assistant General Counsel; Jacob H. Stillman, Solicitor; Anne K. Small, General Counsel; Securities and Exchange Commission, Washington, D.C.; for Respondent.

          Before: Consuelo M. Callahan, and N. Randy Smith, Circuit Judges, and Jed S. Rakoff, [*] District Judge.

         SUMMARY [*]

         Securities and Exchange Commission / Financial Industry Regulatory Authority

         The panel granted the pro se petition for review by Sharemaster, a registered broker dealer, and held that the Securities and Exchange Commission's decision - that a $1000 penalty that the Financial Industry Regulatory Authority ("FINRA") imposed on Sharemaster was not a "live" sanction capable of redress - was unreasonable and inconsistent with applicable law.

         FINRA rejected Sharemaster's annual report and suspended Sharemaster's FINRA membership because Sharemaster's report did not comply with the SEC's Rule 17a-5(d)'s requirement that broker-dealers annually file a balance sheet and income statement certified by a public accounting firm registered with the Public Company Accounting Oversight Board. FINRA also ordered Sharemaster to pay $1, 785 in costs. The SEC dismissed Sharemaster's application for review.

         The panel held that the SEC's interpretation of Securities Exchange Act Section 19(d)(2) to include a live-sanction requirement was entitled to deference under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). The panel further held that the SEC unreasonably decided that the disciplinary sanction imposed by FINRA on Sharemaster was no longer live. The panel concluded that the disciplinary sanction imposed by FINRA remained live based on a $1000 fine, and Sharemaster's challenge to FINRA's final disciplinary sanction was subject to review by the SEC. The panel remanded for the SEC to determine whether, if Sharemaster prevails on the merits of its argument regarding the applicability of a registered-accountant requirement, the SEC may direct FINRA to reinstate Sharemaster nunc pro tunc.

         Judge N.R. Smith dissented in part because the majority resolved the case on grounds not raised by the parties and not supported by the record. He did, however, agree with the majority's conclusion that the SEC's interpretation of Securities Exchange Act Section 19(d)(2), concerning a live-sanction requirement, was entitled to Chevron deference. Judge N.R. Smith would hold that there is substantial evidence to support the SEC's finding that no part of the $1, 785 in costs was a sanction, and he would deny the petition for review.

          OPINION

          CALLAHAN, Circuit Judge:

         Securities Exchange Act Section 19(d)(2) authorizes the Securities and Exchange Commission (the Commission) to review any "final disciplinary sanction" imposed by a registered securities industry self-regulatory organization, including the Financial Industry Regulatory Authority (FINRA). 15 U.S.C. § 78s(d)(2). This case requires us to decide whether the Commission's review authority under Section 19(d)(2) is limited to final disciplinary sanctions that remain "live." The Commission interpreted Section 19(d)(2) to include a live-sanction requirement in dismissing petitioner Sharemaster's application for review of a disciplinary sanction imposed by FINRA. We hold that Commission's interpretation of Section 19(d)(2) is entitled to deference under Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984). However, we conclude that the Commission's decision that a $1, 000 penalty that FINRA imposed on Sharemaster is not a "live" sanction capable of redress is unreasonable and inconsistent with applicable law. We therefore grant Sharemaster's pro se petition for review.

         I.

         A. FINRA and the Commission's regulatory framework

         FINRA is a securities industry self-regulatory organization (SRO) registered with the Commission under Section 15A of the Securities Exchange Act (the Exchange Act), 15 U.S.C. § 78o-3. As a condition of its registration, FINRA is required to have in place rules regulating the conduct of its broker-dealer members and other participants. Id. § 78o-3(b)(6)-(8). These rules must provide for the enforcement of federal securities laws and the Commission's rules, including the imposition of disciplinary sanctions. See id. § 78o-3(b)(7); id. 78o-3(k)(2)(C). FINRA's Rules provide for a variety of sanctions that FINRA may impose on its members and other participants for violating securities laws, including censures, fines, suspensions, expulsions, or "any other fitting sanction." FINRA Rule 8310.[1]

         Disciplinary proceedings before FINRA are placed on either an ordinary or expedited track. See FINRA Rules 9370, 9550-9559. Both tracks involve similar procedural steps, but FINRA endeavors to handle expedited disciplinary proceedings more quickly. See FINRA Rules 9559, 9290. Additionally, although most sanctions imposed in an ordinary FINRA disciplinary proceeding are automatically stayed pending the Commission's review, sanctions imposed in an expedited proceeding are not. See FINRA Rules 9370(a), 9559(r). However, an aggrieved party may request a stay from the Commission, which the Commission must decide on an expedited basis "consistent with the Commission's other responsibilities." 17 C.F.R. § 201.401(d).

         Among the provisions enforced by FINRA are Exchange Act Section 17(e)(1)(A), 15 U.S.C. § 78q(e)(1)(A), and Commission Rule 17a-5(d), 17 C.F.R. § 240.17a-5(d). The provisions, which FINRA enforced against Sharemaster here, require some registered broker-dealers to "annually file . . . a balance sheet and income statement certified by" a public accounting firm registered with the Public Company Accounting Oversight Board (PCAOB). 15 U.S.C. § 78q(e)(1)(A).

         Once FINRA's internal disciplinary process is complete, an aggrieved party may file an application for review with the Commission. Exchange Act Section 19(d)(2) authorizes the Commission to review "any final disciplinary sanction" or denial of access that, like the sanction at issue here, Section 19(d)(1) requires FINRA to report to the Commission. Id. § 78s(d)(1), (2).

         While Section 19(d) addresses what FINRA actions "shall be subject to review, " Section 19(e)-entitled "Disposition of review; cancellation, reduction, or remission of sanction"- governs the scope of the Commission's remedial authority. In deciding an application for review of a final disciplinary sanction, Section 19(e)(1) requires the Commission to declare whether FINRA correctly found a violation of applicable rules or, if not, to set aside the sanction. Id. § 78s(e)(1)(A), (B). If the Commission finds a violation, it may "affirm the sanction imposed . . ., modify the sanction . . ., or remand . . . for further proceedings." Id. § 78s(e)(1)(A). Additionally, if the Commission finds that the sanction "imposes any burden on competition not necessary or appropriate in furtherance of the purposes of this chapter or is excessive or oppressive, [the Commission] may cancel, reduce, or require the remission of such sanction." Id. § 78s(e)(2).

         Section 19(f)-entitled "Dismissal of review proceeding"-addresses the Commission's review of "denials of access" imposed by FINRA and other SROs. It directs the Commission to dismiss an unmeritorious challenge to an action denying access to FINRA or, in the case of a meritorious challenge, set aside FINRA's action and grant the access that FINRA denied. Id. § 78s(f).

         B. Background

         1. Sharemaster's business and 2009 annual report

         Sharemaster is a registered securities broker-dealer and FINRA member that is wholly owned and operated by Howard Feigenbaum. Sharemaster's alleged annual income is modest at around $10, 000. Its business is limited to acting as an agent for investment and insurance companies in the sale of mutual funds and variable insurance products. It does not hold any customer funds or securities. In preparing an annual audit report for 2009, Sharemaster learned that review of the report by a PCAOB-registered accountant may be required under 17 C.F.R. § 240.17a-5(f)(1). Sharemaster found that a PCAOB-registered accountant would charge significantly more to prepare the required annual report than the certified public accountant that Sharemaster regularly used-$2, 800 instead of the usual $585 charge. According to Sharemaster, this increased cost would inflict a significant financial hardship on its small business. After consulting with the Commission, Sharemaster learned that 17 C.F.R. § 240.17a-5(e)(1)(i)(A) provides for an exemption from the PCAOB requirement for certain securities brokers and dealers.[2] Believing that it qualified for this exemption as an agent that does not hold customer funds or securities, Sharemaster filed an annual audit report using a certified accountant who was not registered with the PCAOB.

         2. FINRA's disciplinary sanction on Sharemaster

         In May of 2010, FINRA's Department of Member Regulation rejected Sharemaster's annual report and suspended Sharemaster's FINRA membership because the report did not comply with Rule 17 a-5(d)'s PCAOB requirement. Sharemaster filed a request for a hearing before a FINRA hearing panel, which was held on June 24, 2010. On October 6, 2010, the hearing panel found that Sharemaster's report did not comply with Rule 17 a-5(d)'s PCAOB requirement and thus rejected it. The panel sanctioned Sharemaster for the violation, ordering:

Sharemaster is suspended until it files the requisite annual report. At the end of six months, the suspension will convert to an expulsion if [Sharemaster] has at that time not filed a properly audited annual report for 2009. [Sharemaster] is also ordered to pay costs of $1, 785.00, which includes an administrative fee of $750.00 and the cost of the hearing transcript.

         The $1, 785 sum that FINRA ordered Sharemaster to pay evidently included a $1, 000 penalty for not timely complying with Rule 17 a-5(d) or, in the Commission's words, a "late fee." Costs associated with the hearing amounted to $750 and the cost of the hearing transcript presumably accounts for the remaining $35.

         3. The Commission's review of FINRA's final disciplinary sanction

         On October 29, 2010, Sharemaster filed an application for Commission review of FINRA's final disciplinary sanction. Because the sanction was imposed in an expedited disciplinary proceeding, it was not automatically stayed. Sharemaster states that the absence of an automatic stay presented it with a Hobson's choice: comply immediately or risk going bankrupt waiting for the Commission to decide the motion to stay. Accordingly, three days after seeking review, Sharemaster filed an annual report reviewed by a more costly, PCAOB-registered accountant. While FINRA's order imposing the sanction stated that the suspension would be lifted upon filing of "the requisite annual report, " FINRA did not lift the suspension until January 24, 2011, almost three months later.

         The Commission then requested supplemental briefing from Sharemaster and FINRA on "what impact, if any, Sharemaster's subsequent compliance and FINRA's lifting of the suspension would have on the Commission's consideration" of Sharemaster's application for review. Both FINRA and Sharemaster asserted that Sharemaster's compliance with the PCAOB requirement and the lifting of the suspension did not foreclose the Commission's review under Section 19(d)(2). According to FINRA, "costs that had been assessed against-but not yet paid by-Sharemaster were sufficient to preserve statutory jurisdiction." In its brief, Sharemaster also argued, among other things, that the Commission had a statutory duty to review FINRA's failure to immediately lift the suspension after Sharemaster filed a compliant report, as the delay violated the terms of FINRA's sanction order and caused financial harm to Sharemaster.

         On October 14, 2011, the Commission dismissed Sharemaster's application for review, finding that it "lacked jurisdiction over this matter pursuant to Section 19(d) of the Exchange Act" because the suspension was no longer in effect. Sharemaster, Exchange Act Release No. 65570, 2011 WL 4889100 (Oct. 14, 2011). Sharemaster thereafter sought review by the Ninth Circuit. However, at the Commission's request, we remanded the matter on May 7, 2012.

         On remand, the Commission ordered additional briefing. This time, FINRA changed its position and argued that the Commission lacked review authority under Section 19(d)(2). Sharemaster renewed its argument that the Commission had authority to review FINRA's sanction, as well as FINRA's failure to timely lift the suspension upon submission of a compliant report. On August 29, 2013, the Commission withdrew its earlier order and dismissed Sharemaster's application for review. Sharemaster, Exchange Act Release No. 70290, 2013 WL 4647204 (Aug. 29, 2013). The Commission again concluded that it lacked "statutory jurisdiction" under Section 19(d) to consider ...


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