Investment News (November 7, 2023) By Mark Schoeff Jr.

‘Finra provides essential services … thousands of firms, hundreds of thousands of registered persons, and millions of American investors rely upon,’ the North American Securities Administrators Association says in a brief.

Two groups sometimes at odds with Finra over how best to protect investors are backing the regulator against a lawsuit that questions its constitutionality.

The Financial Industry Regulatory Authority Inc. is defending itself against a claim brought by Alpine Securities Corp., a firm Finra expelled in March 2022 for misusing customer funds, charging unreasonable fees and making unauthorized trades and capital withdrawals.

In its lawsuit, Alpine argues Finra violates the Constitution because its disciplinary hearing officers aren’t properly appointed by the executive branch. The firm also claims Finra operates inappropriately as a state actor.

In July, the U.S. Court of Appeals for the D.C. Circuit upheld a preliminary injunction against Finra that allows Alpine to continue to conduct business while it appeals Finra’s bar.

If Alpine wins the case, it could threaten Finra’s existence. Last Friday, state securities regulators and arbitration lawyers came to the defense of the brokerage industry self-regulator.

The North American Securities Administrators Association, the membership organization for state regulators, said Finra plays a critical regulatory role. In an amicus brief filed with the D.C. Court of Appeals, NASAA said Finra sets and enforces standards for approximately 3,400 brokerage firms and 624,000 registered representatives, maintains critical databases, such as the Central Registration Depository and the Investment Adviser Registration Depository, and performs market surveillance.

“Finra provides essential services like these that state and federal securities regulators, thousands of firms, hundreds of thousands of registered persons, and millions of American investors rely upon,” NASAA counsel Zachary Knepper wrote in a Nov. 3 amicus brief. “If this Court were to find that Finra’s rule writing and enforcement mechanisms were unconstitutional, this Court could disrupt the essential functioning of securities regulation and the Nation’s securities markets, harming the economy.”

The Public Investors Advocate Bar Association also said Finra “serves a critically important and necessary function” in regulating the conduct of its broker-dealer members. It carries out those tasks while reporting to the Securities and Exchange Commission, rather than operating unfettered, the group said.

“Congress’s delegation of such powers to Finra does not violate the Constitution’s nondelegation doctrine because Finra’s authority is subordinate to the SEC, which exercises extensive authority and surveillance over all aspects of Finra’s relevant operations and activities,” Alan Rosca and Melinda Steuer, counsel for PIABA, wrote in a Nov. 3 amicus brief.

In its own brief, filed Oct. 27, Finra argued that it operates within the historical context of Congress delegating governmental responsibilities to private corporations without requiring presidential appointment and removal of their directors.

Finra also said that it’s not engaged in state action when it carries out its self-regulatory responsibilities.

“As centuries of self-regulation in the securities industry confirm, those responsibilities have traditionally been private, not governmental,” Amir Tayrani, Alex Gesch and Max Schulman, counsel for Finra, wrote in the amicus brief. “Moreover, Alpine’s attempt to cast the Finra expedited proceeding as enforcing federal law ignores that the proceeding involves Alpine’s violations of a Finra cease-and-desist order barring further violations of Finra rules—not violations of any statute.”

Both NASAA and PIABA recently have resisted Finra’s proposal to allow brokerages to conduct remote branch office inspections on a permanent basis. But when it comes to a legal challenge to Finra’s right to exist, they’re on the self-regulator’s side.

PIABA noted that Finra was trying to prevent Alpine from harming investors when it expelled the firm from the industry.

“Instead of accepting responsibility for its misconduct, Alpine now seeks to have Finra declared unconstitutional in its entirety, and to shut down Finra’s ability to regulate brokers and broker-dealers and police their conduct,” PIABA wrote in its amicus brief. “The result that Alpine envisions would create market chaos and eviscerate meaningful protections for the investing public.”

Finra recently achieved a win in court in a separate challenge to its authority from a broker whom it had disciplined. U.S. District Judge Ana C. Reyes denied the broker’s request for a preliminary injunction against Finra to stop the enforcement proceeding. She held that Finra is not a state actor and is subordinate to the SEC.