FINRA’s Sky Isn’t Falling (Just Yet)

Is FINRA constitutional? Two cases currently playing out in D.C. federal courts, Alpine Securities Corp. v. FINRA and Kim v. FINRA, tee up that question. But the Financial Industry Regulatory Authority is an unusual target for constitutional challenge, because it is not a government agency. As securities lawyers know, FINRA is a private Delaware corporation registered as a self-regulatory organization (SRO). As an SRO, FINRA (among other things) writes and enforces conduct rules for registered broker-dealer firms, monitors firms’ compliance, administers broker qualification exams, and refers fraud and insider-trading investigations to the SEC.

As law students studying for the bar are advised, a private actor generally cannot violate the U.S. Constitution. So Alpine and Kim largely turn on whether FINRA acts as a private entity or as an arm of the government when it enforces conduct rules and securities laws.

In Alpine, the district court refused to enjoin FINRA’s expedited proceeding against a broker-dealer. The court found that FINRA is not a state actor for constitutional purposes, emphasizing that: the government does not fund FINRA or select its board or officers; FINRA performs other functions (like administering exams) that the SEC does not share; and FINRA alone determines which of its member firms to investigate and discipline. FINRA’s SRO role also did not violate the constitutional doctrine that limits the delegation of congressional powers to private parties, because FINRA’s activities are statutorily subject to SEC oversight.

The broker-dealer in Alpine had a bit more luck before the D.C. Circuit, at least temporarily. In a barebones, per curiam order, a motion panel (2–1) temporarily enjoined FINRA’s expedited proceeding. Judge Walker wrote a solo concurrence articulating his view that FINRA’s activities violate Article II of the Constitution because FINRA wields executive power but is not subject to presidential control. FINRA hearing officers, he thought, were functionally identical to the SEC’s administrative law judges, and so suffer from the same constitutional infirmity that the U.S. Supreme Court found in Lucia v. SEC. And Judge Walker brushed aside the notion that FINRA is “a nominally private corporation,” characterizing its activities as controlled by the government “[f]rom start to finish” “with little to no room for private control.”

A few months later, though, another D.C. district court judge, in Kim, refused to enjoin a different FINRA proceeding before one of its hearing officers. To begin with, the opinion in Kim declined to read the appellate court’s order in Alpine “as effectively halting all FINRA enforcement actions.” Rather, the court in Kim reached the same conclusion that the district court had reached in Alpine, and for somewhat similar reasons. Namely, FINRA’s board is not appointed by public officials, it relies entirely on its own funding, and neither the SEC nor any other agency compels FINRA to take any action. That FINRA has a role alongside the SEC in regulating the securities market, Kim reasoned, did not necessarily mean the two act “jointly.” And it would be a mistake to characterize SRO activities as functions traditionally reserved to the government for another reason: “securities industry self-regulation has a long tradition” in the U.S. stretching back to 1790. Judge Walker’s concurrence in Alpine went astray, in the district court’s view, because it didn’t adequately address the threshold question for applying Lucia: whether FINRA is a state actor at all.

So two federal district court judges have expressed the view that FINRA likely acts as a private party in its SRO role, and at least one federal appellate judge believes FINRA wields government power. Both Alpine and Kim remain pending in the D.C. Circuit, with Kim held in abeyance until Alpine is resolved. In February, the Alpine merits panel (Judges Srinivasan, Millett, and Walker) held oral argument, followed by several rounds of supplemental briefing.

Regardless of who carries the day in the D.C. Circuit, the Supreme Court may be interested. Then again, maybe not: Jarkesy v. SEC presented similar nondelegation and Article II arguments this past term and the Supreme Court shied away. Instead, six justices avoided those complicated issues and opted to resolve Jarkesy on a Seventh Amendment point (right to jury trial) that, as it happens, offers little guidance for Alpine and Kim. So, although the sky hasn’t fallen for FINRA, some dark clouds loom on the horizon.