According to FINRA and the SEC, Scottsdale knowingly engages in fraudulent business practices.
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The U.S. Securities and Exchange Commission on Wednesday told the Fourth Circuit that Scottsdale Capital Advisors Corp. must first face a Financial Industry Regulatory Authority disciplinary action and appeal to the SEC before it can bring a challenge of FINRA's authority before an appellate court.
Scottsdale must initially raise its challenge of FINRA's authority to bring charges against members over violations of the Securities Act as a defense during a disciplinary proceeding about the firm's allegedly unethical trades, the SEC said. Scottsdale can appeal FINRA's decision to the SEC itself and even bring its case to a federal appellate court if the SEC's decision is not in its favor.
"Plaintiffs' suit seeks to upend that statutory scheme by barring FINRA from continuing the disciplinary proceeding it has initiated against them," the SEC said in the brief.
In May 2015 FINRA initiated a disciplinary proceeding claiming that Arizona-based Scottsdale, its principals John Hurry and Timothy DiBlasi, and its former president, Darrel Cruz, liquidated 74 million shares of three penny stocks that were not registered with the SEC or exempt from registration and sold them in violation of FINRA's rules through a Cayman Islands broker-dealer controlled by Hurry.
FINRA said the trades violated the Securities Act and thus broke its rules
But in March Scottsdale filed a suit in Maryland federal court seeking to stop FINRA's administrative proceedings, arguing that the regulator lacks authority to enforce the Securities Act. The SEC had filed an amicus brief in that case as well.
In April U.S. District Judge Deborah K. Chasanow dismissed the suit after hearing arguments on FINRA's bid to toss the case, saying the Securities Exchange Act gives the brokerage ample opportunity to defend itself against the allegations.
Appealing to the Fourth Circuit, Scottsdale has argued that FINRA has taken on "a general police power" to enforce laws outside its congressional mandate and the brokerage should be able to immediately seek judicial remedies since the regulator "violated an unambiguous limitation on its statutory authority."
FINRA, meanwhile, has countered that its authority is not limited to the four corners of the Exchange Act as Scottsdale claims and the broker can't bring its claims in federal court before going through the administrative process.
The SEC's Wednesday brief declined to weigh in on the merits of Scottsdale's claims but agreed with FINRA that the broker can not circumvent an administrative process that's clearly laid out in the Exchange Act.
Scottsdale will be able to receive a meaningful review of FINRA's final decision, the SEC said, because it always takes into account whether FINRA has properly applied its rules and brought enforcement actions in a manner consistent with the Exchange Act.
The agency backed up its argument by citing a series of recent appellate court decisions in the Second, Seventh, Eleventh and District of Columbia Circuits in cases claiming that the SEC's in-house court is unconstitutional because its administrative law judges are not appointed. The appellate courts ruled in these cases that the would-be challengers must first bring their claims before the SEC and face the disciplinary actions brought against them before appealing to a federal appellate court. The Supreme Court declined petitions to review the Seventh and D.C. Circuit rulings.
On one point this week the SEC did differ slightly with FINRA. While FINRA has argued that Scottsdale failed to exhaust its administrative remedies, the SEC said the district court would lack jurisdiction to rule on the merits of Scottsdale's challenge even if the firm first goes through the agencies' procedures because the Exchange Act vests exclusive jurisdiction over administrative claims in the federal appellate courts.
The appeal is Scottsdale Capital Advisors Corp. et al. v. Financial Industry Regulatory Authority, case number 16-1497, in the U.S. Court of Appeals for the Fourth Circuit.
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