Finra Faces Constitutional Challenges After Appeal Ducks Issues

The self-regulatory organization responsible for member broker-dealers under federal law, the Financial Industry Regulatory Authority, is facing a number of constitutional challenges in the lower court following a federal appeals court decision in Washington late last year.

The US Court of Appeals for the District of Columbia issued the first successful blow to Finra’s enforcement power in Alpine Securities Corp. v. FINRA. A 2-1 panel agreed Nov. 22 with member firm Alpine Securities Corp. that Finra’s expedited proceeding against the broker-dealer—which would allow “FINRA to expel Alpine with no opportunity for SEC review”—likely violates the private nondelegation doctrine. That doctrine requires that a private actor that Congress gives a regulatory role must be supervised by a government actor.

In issuing this narrow decision, which applies only to Finra expedited proceedings, the court declined to address many of Alpine’s broader and more consequential constitutional arguments. These open issues will now be litigated in the lower court and, if successful, could severely limit Finra’s securities enforcement authority.

Finra is a nominally private organization that regulates the securities industry alongside the SEC. Finra oversees US broker-dealers and their personnel, including individuals who recommend or sell securities products to the public. If a challenge to its broad enforcement powers is successful, it could significantly undermine Finra’s ability to pursue violations of the federal securities laws in its internal tribunal structure.

Unless the US Supreme Court takes up an appeal and the case is stayed further, the case will return on remand to the district court. The district court will have to grapple with Finra’s motion to dismiss Alpine’s operative complaint, which attacks Finra’s authority on numerous constitutional grounds.

If the district court permits any of Alpine’s claims to proceed, the court’s decision would lead to an unprecedented scenario: discovery relating to Finra’s constitutionality. The most notable issues left open by the D.C. Circuit’s opinion are discussed below.

State Action

Whether Finra—a nominally private actor—in fact operates as a state actor is a threshold question underlying nearly all of Alpine’s claims. If the court holds that Finra does operate as a state actor, Finra must abide by the many safeguards set forth in the Constitution in connection with its enforcement activities.

The D.C. Circuit was careful to distinguish between Finra proceedings involving enforcement of only Finra rules and Finra proceedings involving enforcement of the federal securities laws. In so doing, the court signaled that Finra’s enforcement of the federal securities laws could pose a bigger constitutional problem than Finra’s enforcement of its own rules.

Notably, in arguing against the broader injunction called for by the dissent, the opinion twice implored the dissenting judge to remember “that FINRA is not enforcing any federal law or SEC regulation against Alpine in the underlying proceeding.” That is because the underlying proceeding that was the subject of the D.C. Circuit’s decision—Finra’s expedited proceeding against Alpine—involves only Finra’s enforcement of its own rules against Alpine. For that reason, Alpine focused only on Finra’s enforcement of its rules in its appeal to the D.C. Circuit. Alpine’s operative complaint is broader, however—that complaint does challenge Finra’s enforcement of the federal securities laws. Consequently, the proceedings in the district court will likely address this distinction.

Seventh Amendment

Alpine argues that Finra’s enforcement structure, which involves an evidentiary hearing before a Finra tribunal composed of Finra-employed hearing officers, violates the Seventh Amendment right to a trial by jury. If the court were to agree and find that Finra engages in state action when it enforces federal securities laws, but not when it enforces its own rules, Finra conceivably could continue to adjudicate enforcement actions involving its internal rules through its in-house tribunal structure. But for claims arising under the federal securities laws, Finra wouldn’t be able to bring those cases in its internal structure. Because Finra has no private right of action under the federal securities laws, it likely would have to refer those cases to the SEC.

This claim may be aided by the recent decision of the Supreme Court in SEC v. Jarkesy, in which it held that the SEC’s in-house adjudication of securities fraud claims violates the Seventh Amendment. Indeed, if the issue ends up before the Supreme Court, which is likely, given Jarkesy and the high court’s other recent decisions, Alpine-like arguments may have a receptive audience before the current bench.

Members Versus Individuals

Although the limited scope of the D.C. Circuit’s decision technically applies only to Alpine, other Finra member firms would be free to analogize the court’s holding to their own factual circumstances. Finra-registered individuals, however, wouldn’t be so fortunate. The court implied that Finra’s expulsion of individuals may not rise to a nondelegation violation, as it stated in a footnote: “Such a bar may be meaningfully different from expulsion of a Finra member firm since a person barred from trading securities can pursue other work while appealing to the SEC, while a firm organized for the purpose of trading securities cannot.”

But if the district court were to rule that Finra is a state actor and therefore subject to constitutional restrictions, the court’s logic, if not the court’s ruling itself, could apply to individuals in addition to member firms. Indeed, in the wake of Alpine’s suit, several Finra-registered securities brokers brought similar suits against Finra alleging constitutional violations, and at least two such suits remain pending in federal courts.

In one case currently before the Western District of North Carolina, an individual is challenging Finra’s authority under the Appointments Clause, the private nondelegation doctrine, Article III, the Seventh Amendment, and the Fifth Amendment.

Another individual has raised claims in the Eastern District of Pennsylvania under the Seventh Amendment. That case is currently on appeal to the Third Circuit following the lower court’s dismissal for lack of subject matter jurisdiction. And more challenges to Finra’s authority by individuals may well be in store.

In taking up the Alpine appeal, the D.C. Circuit seemed poised to address key questions about Finra’s constitutional status. While significant, the court’s opinion ultimately fell short of providing the far-reaching answers for which observers were hoping. But these issues are now ripe for the lower courts to tackle.

The case is Scottsdale Cap. Advisors Corp. v. FINRA, D.D.C., No. 1:23-cv-1506.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rachel Mechanic and Daniel Zinman are litigation partners in Perkins Coie’s New York office.‌ They are attorneys for the plaintiff in Lebental v. FINRA, in which the plaintiff also raises questions about Finra’s constitutionality.

Emily Drinkwater and Ben Estes contributed to this article.

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