FINRA Authority Fight Carries Weight But May Be a ‘Hard Ask’

A newly identified paradox in the Financial Industry Regulatory Authority’s enforcement role threatens to dismantle the private regulator, but courts reviewing the issue may not have the appetite to go that far.

Alpine Securities Corp.‘s constitutional challenge at the US Court of Appeals for the D.C. Circuit fits into a broader wave of litigation against the authority of federal agencies. Once among the largest US clearing firms, Alpine is now combating banishment from FINRA—which would prevent it from operating entirely—by arguing the regulator’s structure and operation violate the separation of powers, the appointments clause, and the delegation of powers.

“There could be a reckoning for the administrative state, and this is a piece of that,” said attorney Jeff Kern of Sheppard Mullin.

Some observers say that separation of powers cases at the US Supreme Court are part of a long-term strategy by conservatives to chip away at the federal bureaucracy. FINRA itself is a financial industry self-regulatory organization, supervised by the Securities and Exchange Commission, that writes and enforces ethical rules for broker-dealer firms and brokers in the US, according to its website. It enforces its own rules, SEC rules, and federal securities laws, according to Kern.

A hearing there against Alpine led to a scathing decision that found violations of several FINRA rules and ordered its expulsion. Citing higher costs, Alpine tried to end its retail securities business, according to the FINRA decision. Alpine imposed $5,000-per-month fees on retail accounts that remained and improperly categorized some as abandoned, FINRA said.

Alpine disputes the report’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. “FINRA uses an unprecedented and untenable definition of an ‘excessive’ fee,” insisting on pass-throughs of direct costs only, she said. “That is not the proper gauge for determining the appropriateness of such fully disclosed fees in an industry in which its customers had every ability to decline to continue to conduct business with Alpine,” she said.

“Alpine also took issue with the Hearing Panel’s decision to credit the testimony of certain former employees,” she said.

Fritz says that her arguments are similar to those that resulted in the 2021 reversal by the SEC of a FINRA decision against a related firm, Scottsdale Capital Advisors Corp., Fritz said. Alpine and Scottsdale have common ownership, according to the FINRA decision against Alpine.

FINRA Is Sued

Alpine, along with Scottsdale, fought back in a lawsuit at the US District Court for the District of Columbia.

The district court rebuffed their request for a preliminary injunction. Another judge in that district, hearing a separate challenge, also denied a preliminary injunction in an opinion issued Oct. 6. The broker who sought to stop FINRA in that case, Eugene Kim, failed to show he was likely to succeed on his claims, the judge said.

In Alpine’s case, a D.C. Circuit panel imposed an injunction to stop enforcement while the appeal is pending by a 2–1 vote in July. Briefing is now underway at the appeals court, which will decide whether Alpine can remain protected when the firm returns to the lower court to litigate the rest of its challenge.

In the divided ruling on that injunction, Judge Justin R. Walker wrote a concurring opinion in which he pointed to a potential loophole “if the Constitution prohibits Congress from vesting significant executive power in an unappointed and unremovable government administrator but allows Congress to vest such power in an unappointed and unremovable private hearing officer.”

“Despite seeming to exercise the executive authority of the United States, FINRA hearing officers remain private employees,” he said.

State Actor?

“Judge Walker hit the nail on the head,” Professor Kent Barnett of the University of Georgia School of Law said in an interview. There’s a “practicality” that’s led people to accept the arrangement, but Walker identified a dichotomy: “What we require from the government, we don’t require from private entities,” he said.

Walker is convincing, said Nick Morgan, a partner at Paul Hastings LLP in Los Angeles. If FINRA is like the SEC, cases examining the SEC’s constitutionality apply, he said. The case “stands or falls” on the issue of whether FINRA, which he calls “quasi-private,” is a state actor, he said.

But even if it’s not a state actor, there are problems with the SEC’s supervision of FINRA, said Russ Ryan of the New Civil Liberties Alliance in Washington, which submitted an amicus brief supporting Alpine. The brief said the SEC’s supervisory role in enforcement matters wasn’t close or meaningful.

“FINRA is trying to have it both ways,” said Ryan, who co-authored the brief. FINRA claims that it’s a private, not state, actor independent of the SEC, but that it’s supervised by the SEC, he said.

Not the Right Horse

Alpine’s argument that the self-regulatory organization is private but functionally governmental may not fit well with current US Supreme Court jurisprudence, said Barnett. The high court looks at separation-of-powers cases in a way that’s “more formal than functional,” he said. And in the realm of financial regulation, there’s a historical exception to the public-private distinction “that even an originalist would recognize,” the professor said.

NCLA’s friend-of-the-court brief is “seductive to read,” said white-collar and securities practitioner Kern, who co-wrote an article cited in it. “But to dismantle FINRA’s disciplinary system is a hard ask,” he said.

The legislation underpinning the system, including the Maloney Act, which created FINRA’s predecessor, came after the market crash of 1929, he said. “Historically, it’s worked pretty well.”

“This is not a case of a private Star Chamber,” he said, referring to the English court abolished in 1640 after it became known for abuses of power.

Three Supreme Court justices—Clarence Thomas, Neil M. Gorsuch, and Samuel A. Alito Jr.—have been vocal in opposition to the “administrative state,” he said. “But this is not the horse you would want to ride in on,” he said.

Remedies

Even if the D.C. Circuit rules for Alpine, the remedy may be relatively small, Barnett said. There have been “small fixes” in some SEC cases: another hearing before an administrative law judge, or a change in the way a case moves through the agency, he said. Here, it might come to FINRA recommending a course of action to the SEC rather than issuing a final order, he said.

The civil liberties group’s preferred solution, according to Ryan, would be for the SEC to be more involved in FINRA’s investigation and discipline or for FINRA to get formal approval from the SEC for enforcement.

“That would reduce the constitutional issues,” he said. “But it wouldn’t resolve all our issues with the SEC” and administrative adjudication, he said.