Securities Litigation

For years, self-regulatory agencies (like FINRA or the Exchanges) have wielded the statutory authority granted them by Congress - and backed by the SEC - exercising governmental power to compel testimony, impose fines and punishments, and even bar a person or firm from an entire industry.

At the same time, they declaim that they're just membership organizations, so don't owe anyone Constitutional protections (like Fifth Amendment Due Process) and aren't subject to Equal Access to Justice Act claims for your litigation expenses when they lose.

So SROs essentially are the government - except when they're not.

The latest in this double-speak arrived last week from the IRS. The Wall St. Journal (June 6, 2016) reports a memo by the IRS Associate Chief Counsel's Office concluding that fines and penalties paid to FINRA are not deductible because FINRA "is effectively a government agency when it enforces securities regulations."

IRS Chief Counsel Advice Memorandum No. 201623006 (IRS May 2, 2016, released June 3, 2016) concluded "FINRA is a corporation serving as an agency or instrumentality of the government of the United States for purposes of section 1.162-21(a)(3) when it is performing its federally-mandated duties under the Securities Exchange Act of 1934… of conducting enforcement and disciplinary proceedings…."

Its author (Chief, Branch 3, Office of Associate Chief Counsel - Income Tax and Accounting) blithely dismissed the IRS's prior concession to the contrary in Rothner v. Commissioner, T.C. Memo 1996-442 (affirming deductibility of a Chicago Mercantile Exchange fine). He also rejected taxpayer arguments pointing out that SROs themselves claim they are not government instrumentalities and are not subject to Fifth Amendment Due Process constraints. The IRS concludes: "This does not undermine our conclusion, because an entity can be an agency or instrumentality of government for one purpose but not another."

Put another way: SROs are the government when it suits them, but not when it suits you.

And consistency in the law, apparently, is just foolish - the hobgoblin of little minds.

I argued this before: 'Entwinement' and NASD Enforcement Proceedings: Reexamining NASD's State-Actor Status in the Post-Brentwood Era, 39 Sec. Reg. L. Rep. 1111 (BNA July 16, 2007).

Finally, don't think this IRS position will be of any use to you. The memo says "This advice may not be used or cited as precedent." (So, then, what's it purpose?)

Thomas K. Potter, III (tpotter@burr.com) is a partner in the Securities Litigation Practice Group at Burr & Forman, LLP. Tom is licensed in Tennessee, Texas and Louisiana. He has over 30 years' experience representing financial institutions in litigation, regulatory and compliance matters. See attorney profile.