Finra Likely to Amend Expulsion Practices in Wake of Ruling

Finra, the financial industry’s self-regulator, is likely to avoid bringing expedited expulsion proceedings against members without SEC input after the D.C. Circuit said that doing so would probably exceed its authority.

But the ruling constraining the Financial Industry Regulatory Authority is a narrow one, considering that broker-dealer Alpine Securities Corp. attacked the private group’s enforcement power as unconstitutional, some attorneys said.

“Finra dodged a bullet,” said Adam Gana, managing partner of Gana Weinstein LLP.

The organization says it will make changes. Finra “believes it can implement measures to address the framework the court requires,” spokeswoman Rita De Ramos said in a statement. But she declined to specify what the new measures might be.

Alpine is entitled to proceed with its constitutional challenge to the regulator before facing expulsion from the industry, the US Court of Appeals for the District of Columbia Circuit said Nov. 22 in the closely watched case, sending it back to the district court where it will continue barring further review.

In the disciplinary proceeding underlying the appeal, Finra said that the penny-stock brokerage, citing higher costs, imposed $5,000-per-month fees on retail accounts and improperly categorized some accounts as abandoned.

The regulator’s enforcement arm alleged that Alpine violated Finra’s rules “by stealing more than $54.5 million from its customers through excessive fees and the unauthorized conversion of customer securities,” according to its brief. A Finra hearing panel disciplined and expelled the former clearinghouse from the organization.

Significant Holding

Alpine disputes the organization’s conclusions. Finra “is seeking to micromanage the fully disclosed fees that can be charged by a firm in a costly segment of the market,” an attorney for Alpine, Maranda Fritz, who practices in New York, said in an email at an earlier stage of the case.

The district court rebuffed Alpine’s request for a preliminary injunction, opening the door to its banishment from Finra while the court case proceeded—which would prevent it from operating entirely under a 1983 amendment to the securities laws.

The D.C. Circuit had “a very significant holding regarding Finra authority, which is that its procedure of expelling Alpine on an expedited basis was invalid,” said Marc Indeglia, co-chair of Glaser Weil Fink Howard Jordan & Shapiro LLP’s corporate department and president of the Small Public Company Coalition.

The appeals court “acknowledged the factual reality” that under the current structure, a company can only become a broker-dealer through Finra membership, said Indeglia, who wasn’t involved in the case.

“It wasn’t always that Finra was the only game in town,” he said. “It wasn’t always that they had so much power.”

The court didn’t agree that Finra’s safeguards had any meaning, because by the time the Securities and Exchange Commission had a chance to review any expedited proceeding for expulsion, “the broker-dealer would be dead, essentially,” he said.

The ruling is a narrow one because it “only requires SEC approval before barring a member,” said Gana, who represents investors in disputes with investment advisers and broker-dealers. The bigger question, he said, is if the brokerage industry “doesn’t want Finra enforcement, how is that going to work its way through the courts?”

Slowing the Process

Benjamin Edwards, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas, said the ruling, by requiring SEC review, will slow down the ability of Finra and other self-regulatory organizations “to remove bad actors.” Edwards submitted a friend of the court brief supporting Finra.

And the SEC’s involvement “may impose due process obligations on FINRA,” Edwards said in an email. “What does this mean if a FINRA member refuses to cooperate with an investigation and asserts 5th Amendment rights?”

“I would expect you would not see expulsions through expedited proceedings from Finra anymore, unless they decide to appeal to the Supreme Court” or try to justify those proceedings on a fuller record at the trial court, Indeglia said.

Fritz said in an interview that the decision implicates Finra’s expulsion procedures more broadly than the expedited proceedings. “The thrust of the decision is there should not be action without agency review,” she said. “Normal expulsion also becomes effective prior to agency review.”

De Ramos declined to say whether Finra will seek en banc review or US Supreme Court review.

Alpine is considering all options, and is waiting to see what Finra decides, Fritz said.

“This issue seems likely to reach the Supreme Court at some point,” said UNLV’s Edwards.

The case is Alpine Securities Corp. v. Fin. Ind. Regul. Auth., Inc., D.C. Cir., No. 23-5129, 11/22/24.