Judge lets Finra proceed with enforcement action against broker, By Mark Schoeff, Jr.

InvestmentNews (October 10, 2023) - 'If Finra doesn’t have the ability to enforce its own rules and discipline its members, then chaos will reign,' says PIABA President Hugh Berkson.

Eugene H. Kim filed a lawsuit in a Washington, D.C., federal court against the Financial Industry Regulatory Authority in August challenging its enforcement authority. In July, the broker-dealer self-regulator alleged that Kim misused customer funds in connection with a private placement offering sold by the firm he worked for from 2015 until last year, National Securities Corp.

Kim sought a temporary restraining order and preliminary injunction against Finra to prevent it from pursuing the enforcement action. He argued that Finra is a “state actor” and that its enforcement efforts were unconstitutional.

U.S. District Judge Ana C. Reyes denied the injunction in an order issued last Friday. Reyes, citing much legal precedent, said Finra is not a state actor. She noted that it’s subordinate to the Securities and Exchange Commission and is not under direct control of government appointees.

“Though opportunities have abounded, no court has ever held that Finra or its relationship with the SEC is unconstitutional,” Reyes wrote in her 36-page opinion. “Because Finra is likely not a state actor, plaintiff’s [constitutional] challenges are unlikely to succeed.”

Finra recently expressed confidence that it would be able to defend itself against Kim’s charges and a similar lawsuit working its way through the court system brought by Alpine Securities Corp. Reyes’ decision gives it an initial victory.

“Finra is gratified by the court’s ruling denying Kim’s motion,” Finra spokesperson Rita De Ramos wrote in an email.

Kim did not respond to a request for comment.

Reyes walked through the history of U.S. securities regulation — from the establishment of the first stock exchange in a Philadelphia coffee house in 1790 to the advent of the SEC in the 1930s following the stock market crash of 1929 to the Maloney Act of 1938 and amendments in 1975 — to show how self-regulatory organizations like Finra came into being.

But Finra’s authority is being challenged on a couple of fronts in court. In August, the U.S. Court of Appeals for the D.C. Circuit upheld a preliminary injunction sought by Alpine Securities Corp. to prevent Finra from throwing it out of the industry.

Finra barred Alpine after finding that it misused customer funds, charged unreasonable fees and engaged in unauthorized trading and capital withdrawal. The injunction allows Alpine to operate while its lawsuit is being considered by the appeals court.

Kim cited that injunction to seek his own. But Reyes rejected his argument.

“Reading the Alpine order as effectively halting all Finra enforcement actions for now would upend Finra’s work—a result that would put investors and U.S. securities markets at risk,” Reyes wrote. “Enjoining this enforcement proceeding would interfere with Finra’s regulatory mission and ability to enforce its own rules.”

She held that allowing Finra to pursue its enforcement work is in the public interest.

“If Finra doesn’t have the ability to enforce its own rules and discipline its members, then chaos will reign,” said Hugh Berkson, president of the Public Investors Advocate Bar Association. “Finra’s primary mission is to protect investors. Allowing serial bad actors to continue to victimize investors runs afoul of Finra’s principal mission.”

Courts “have agreed across the board” that Finra, as a self-regulatory organization, is best suited to carry out its mandate, said Patrick Mahoney, a Los Angeles securities attorney. If Finra were found to be a so-called state actor, it would be subject to legal procedures that could make it impossible to function.

“I think [Reyes made] the right decision,” Mahoney said. “I think courts are going to stay consistent in ruling that Finra is a private entity capable of enforcing rules designed to protect investors and ensure market integrity.”

Finra regulates approximately 3,400 brokerages and 624,000 registered representatives. It reports to the SEC, which also has jurisdiction over investment advisors with more than $100 million in assets under management. States regulate smaller advisors.

A merits briefing on the Alpine case is scheduled to conclude by Nov. 17.