After Lucia Another Domino Falls: Constitutionality of FINRA’s Disciplinary Proceedings in Question

Introduction

FINRA investigates potential securities violations and can also bring formal disciplinary actions against member firms and their associated persons before FINRA hearing officers. On July 5, 2023, a D.C. Circuit panel voted 2-1 to enjoin FINRA from continuing an enforcement action against Alpine Securities that sought to bar Alpine from selling securities because Alpine had allegedly violated a prior cease and desist order.² While the panel majority did not issue an opinion to accompany its order, Judge Walker issued a detailed concurring statement. In this statement, Judge Walker reasoned that the similarity of FINRA’s hearing officers to the SEC’s ALJs in Lucia v. SEC called the constitutionality of these hearing officers into question.³ The decision to enjoin FINRA suggests that some members of the D.C. Circuit are willing to use the door opened in Axon Enterprise, Inc. v. FTC and SEC v. Cochran to entertain challenges to FINRA’s enforcement authority⁴ following the Supreme Court’s decision to limit the SEC’s enforcement in Lucia and the Fifth Circuit’s decision in Jarkesy v. SEC.⁵

Background

In March 2022, following a FINRA investigation and the filing of a disciplinary proceeding, a panel of FINRA hearing officers found that Alpine Securities (“Alpine”) had committed a variety of securities violations including misusing customer funds, unauthorized trading, and charging customers “unreasonable” fees.⁶ The FINRA panel revoked Alpine’s FINRA membership.⁷

Alpine subsequently filed suit in Florida challenging FINRA’s constitutionality.⁸ After FINRA sought to expedite Alpine’s expulsion, Alpine requested emergency relief to enjoin FINRA from continuing enforcement proceedings pending a resolution of its constitutional challenges.⁹ The Florida court transferred that request to the U.S. District Court for the District of Columbia, which denied the request.¹⁰ Alpine appealed the denial to the U.S. Court of Appeals for the District of Columbia Circuit.¹¹

FINRA’s structure is central to Alpine’s constitutional challenge. As a private corporation that serves as the SRO for broker-dealers, FINRA is governed by a member-appointed Board of Governors. The SEC exercises some oversight authority over FINRA, including by approving proposed FINRA rules, ensuring FINRA’s compliance with SEC regulations, and reviewing FINRA decisions. FINRA, however, wields considerable authority.¹² FINRA may commence investigations, file complaints, and adjudicate them before its own in-house hearing officers.¹³ These hearing officers can impose financial sanctions and can bar individuals from the securities industry.¹⁴ However, such decisions are subject to review by the SEC.

D.C. Circuit Order

On Alpine’s motion for an injunction of the FINRA proceeding pending appeal, a majority of the D.C. Circuit panel granted Alpine’s emergency request without comment.¹⁵ In a concurring statement, Judge Walker explained that Alpine had a high likelihood of prevailing on its challenges.¹⁶ Judge Walker further stated that the Constitution vests the executive authority in the President alone, and that those who exercise “significant executive power” must be an accountable “Officer of the United States,” who under the Constitution must be appointed and subject to removal by the President or by the head of an executive agency.¹⁷

Judge Walker opined that FINRA adjudications were very similar to the SEC’s administrative courts, which the Supreme Court had addressed in Lucia v. SEC.¹⁸ There, the Court held that the SEC’s ALJs exercised “significant [executive] authority” and thus qualified as Officers of the United States because, among other things, they had discretion in enforcing the nations laws, the power to regulate hearings, the authority to decide the admissibility of evidence, rule on motions, demand testimony, and punish contempt.¹⁹ Since FINRA’s hearing officers have the same authority, Judge Walker reasoned that they too likely exercise significant executive authority and therefore count as Officers of the United States.²⁰

Under the Constitution, FINRA’s hearing officers therefore must be appointed pursuant to the Appointments Clause and subject to supervision and removal by the President or the head of an agency.²¹ Yet the SEC may only remove FINRA hearing officers for cause, and the SEC’s commissioners have themselves been viewed as subject to removal only for cause. Moreover, the Supreme Court has held that such double for-cause removal protection is constitutionally impermissible.²² Judge Walker also stated that no FINRA hearing officer is appointed by any government body, let alone one that can permissibly appoint Officers of the United States under the Appointments Clause. Thus, to the extent FINRA’s hearing officers do exercise significant executive authority, Judge Walker thought that exercise of authority likely to be unconstitutional.²³

Judge Walker acknowledged that unlike the SEC in Lucia, FINRA is a private corporation. He nevertheless concluded that it is unlikely that Congress can permissibly create a “constitutional loophole” and avoid the constitutional infirmities identified in Lucia by relying on private corporations that exist outside of the executive branch.²⁴

Conclusion

Although not a decision on the merits, the D.C. Circuit’s decision to grant a preliminary injunction reflects Alpine’s successful effort to mount a pre-adjudication challenge to FINRA’s structure. Judge Walker’s statement also suggests that the D.C. Circuit panel may well limit FINRA’s ability to rely on their in-house hearing officers to adjudicate and enforce securities laws. This litigation, which will continue to unfold in the coming months, illustrates the new options available to targets of agency enforcement actions following the Supreme Court’s decision in Axon Enterprise and Cochran and follows the recent trend of federal courts looking skeptically at the reliance on in-house hearing officers at government agencies with enforcement authority. This trend, which began with the Supreme Court’s decision in Lucia, may well continue when the Court hears a case challenging the constitutionality of the SEC’s in-house adjudications next term.²⁵