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The Financial Industry Regulatory Authority (FINRA) is usually the one handing out judgements. But just last month, the powerful self-regulatory agency (SRO) kind of got its own butt handed to it. 

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A July decision by the U.S. Court of Appeals for the D.C. Circuit could ultimately undermine the very core of FINRA’s mission. Today, we are asking a fascinating question. 

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Is FINRA unconstitutional? Trump-appointed Judge Justin R. Walker says…maybe?  

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But what if the Financial Industry Regulatory Authority was stripped of its regulatory authority? Obviously, they’d have to come up with a new name, but it actually goes a lot deeper than that. 

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So what’s actually going on here? And how likely is it that FINRA might soon be a constitutional relic like prohibition and wearing powdered wigs to hearings?

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On the surface, it seems pretty far-fetched. But…

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The FINRA Countdown?

Our guest this week on the Let’s Talk Markets podcast is former securities litigator and current UNLV Law Professor Benjamin P. Edwards. Writing last week for the Columbia Law School’s Blue Sky Blog (w/ James Fallows Tierney), Ben suggests that FINRA may actually have its hands quite full defending its continued existence. 

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In the case of Alpine Securities Corp. v. FINRA, Tierney and Edwards say that the self-regulatory organization faces a serious challenge to its constitutionality. 

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“In July,” they report, “Judge Justin R. Walker of the U.S. Court of Appeals for the D.C. Circuit issued a concurrence that signaled genuine skepticism about FINRA’s constitutional status.”

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Alpine and FINRA have locked horns frequently. FINRA’s charge is to oversee the brokerage industry. From that position, it has repeatedly taken action against Alpine. And that’s precisely where this saga begins.

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Alpine in the Ass

Let’s start with the most recent action against Alpine Securities. In March of 2022, FINRA ordered Alpine Securities Corporation to pay $2.3 million in restitution for charging unreasonable fees to its customers, and sought its expulsion from the industry for its long and continuing track record of disciplinary actions, suspensions, and alleged reporting failures. 

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In October, Alpine challenged its expulsion, calling on a federal court in Tampa to issue an injunction against FINRA’s intended action. The court denied their request.

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But on July 5th, Circuit Judge Justin Walker led the way in a 2 to 1 reversal of that decision. Not only did the recent vote grant Alpine a stay of execution, but it also gave life to a far more consequential claim. 

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Together, Scottsdale Capital Advisors and affiliate Alpine Securities Corporation (which share ownership and a checkered history with FINRA) have challenged the very constitutionality of the self-regulatory agency. The Walker opinion clears a pathway for the courts to seriously acknowledge this challenge.

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So on what grounds is FINRA unconstitutional, according to Alpine?

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Well, let’s first be clear. The court did not actually offer any opinion on the question of FINRA’s constitutionality. But Walker did give the idea a nudge of credibility. 

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While granting that Alpine is entitled to an injunction against “the corporate death penalty,” Judge Walker also noted that "“There is a serious argument that Finra hearing officers exercise significant executive power. And it is undisputed that they do not act under the President,” Walker wrote. “That may be a constitutional problem.”

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Judge Walker has effectively moved the question of FINRA’s constitutionality past the threshold of frivolousness.

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SR-On No You Didn’t! 

Formed in 2006 as a successor to the Nation Association of Securities Dealers, Inc. (NASD), FINRA is a private non-profit corporation that regulates member brokerage firms and exchange markets. FINRA is classified as a self-regulatory organization (SRO).

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By definition, an SRO is an organization with some regulatory control over its own industry that does not necessarily descend from governmental authority and, in fact, often exists in the place of governmental authority. 

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In a technical sense, the SEC is the government agency charged with oversight of the full financial industry in the U.S. But in another sense, brokerages and exchanges answer to FINRA—a private enterprise that shares their economic interests.

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It’s basically like letting baseball team owners umpire their own games.

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In fact though, SROs have been a part of the U.S. financial structure since basically the beginning of time (which, for our purposes, begins in the 1930s). From the very start, the SEC granted the NASD and NYSE authority to impose and enforce certain regulatory standards and rules within their own industry spaces. 

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In 2007, NASD and NYSE merged their respective enforcement arms, creating a massive, Voltron-like apparatus called FINRA. But given its roots, this private, non-governmental enforcement structure is actually a foundational beam in our market structure.

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We’re not here to label this as a good or bad thing…not because we have no opinion on the matter, but because our opinion on FINRA is immaterial.

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The reality is that FINRA’s authority—right, wrong, or neutral—is deeply ingrained in the regulatory structure of our markets. Its removal would not magically transform markets into a safe, well-regulated space for consumers. It would open the spigot for a flood of lawsuits against the regulator—frivolous or otherwise—from accused corporate abusers. 

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Crimes be damned, firms simply won’t stand for enforcement actions imposed by an organization that has no real constitutional authority. Even if an Alpine decision doesn’t establish precedent against FINRA, it is an open invitation to others who find themselves in the cross-hairs of enforcement action. A sympathetic judge could then theoretically be all that stands between a bad actor and total carte blanche. 

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So again, this isn’t about whether SROs are good or bad. It’s simply that they are. And as long as they are, dismantling the authority of the chief regulatory organization in the brokerage space seems a bold experiment in chaos theory. 

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We’re Not Saying It’s Great, But It’s Definitely Old

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To reiterate a point, the brokerage industry has been regulated by SROs for nearly a century. And yet, this structure has been at the root of some of our most catastrophic market failures over that duration. 

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But we still prefer holding feet to fire, in lieu of burning down the whole damn thing. 

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The reason why is pretty simple. If they blow it up, everyday investors are the ones who will get burnt.

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Take Alpine as Exhibit A. We have no idea whether or not they’re guilty of that which they are accused. But according to FINRA, they’ve misused customer funds and misrepresented data to customers. 

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In spite of Alpine’s long track record of doing that exact thing, we have no idea if the allegations are true. But if they are,, I’d sure as shit rather somebody put a stop to it. 

Alpine v. FINRA is not David v. Goliath. It’s Godzilla vs. Mothra. And we’re Tokyo. We’re the ones who get smooshed by the fallout.

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So a note to our dear friends, who we love, from the burn-the-motherfucker-down contingent—hold your fire. 

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Because let’s just say for a second that Alpine is not only successful, but that the surrounding decision actually sees FINRA stripped of its authority. 

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Is this a big deal? Well, only if you have concerns about dismantling the very fabric of our markets. 

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As Tierney and Edwards note, “a broad ruling finding industry SROs incompatible with nondelegation doctrines, for instance, could render unenforceable large swaths of the stock exchange, clearing agency, and broker-dealer laws that enable American capital markets to operate. Declaring SROs unconstitutional would unravel economic power structures. In addition, a court decision declaring a keystone SRO unconstitutional could have enormous market impacts.”

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In other words, they warn, should FINRA become an unconstitutional entity, decades of capital markets rulemaking would be in jeopardy. It would likely also undermine the very concept of SROs.

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If you’re in favor of relative anarchy, we’d advise you to temper your excitement. While the elimination of SROs might initially open the door for bad actors to delay or even evade FINRA enforcement actions, the long run would likely only see the SEC step in to pick up the slack.

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In other words, if you think Gary Gensler and company are making too many rules too quickly right now, just wait. The disappearance of SROs could very well expand the SEC’s jurisdiction, its budget, and its size. 

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So there’s that to consider.

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Could It Happen?

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Well, that's the tricky part. The truth is that recent years have seen a flurry of judicial decisions that are not particularly sympathetic to the regulatory sector. 

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As Edwards and Tierney point out:

“The challenge arrives at a time when securities regulators have struggled before the U.S. Supreme Court. In Lucia v. SEC (2018), the SEC lost an important claim about its ability to appoint its administrative law judges without regard to the Appointments Clause of the Constitution. Just this term, in Axon Enterprise v. FTC and Cochran v. SEC (2023), the court held that statutory agency review procedures do not preclude a collateral challenge to the constitutionality of SEC enforcement proceedings.  And the court granted certiorari to hear SEC v. Jarkesy, in which the Fifth Circuit had found that the SEC’s administrative proceedings raised Seventh Amendment, non-delegation, and separation of powers concerns.”

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It’s clear that Scotsdale and Alpine saw an opening here. The courts are receptive to such challenges, and if nothing else, it buys the repeat offender a bit more time. But we also can’t dismiss the possibility that the courts ultimately feed this tide of anti-administrative decisions with a bombshell against FINRA.

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If this happens, we may be looking at a baseball game without any umpires at all. 

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Let Me Be Your Sledgehammer

Look…on the surface, we recognize and have said many times that SROs are problematic. They are riddled with conflicts of interest and representative of deep seated problems in our markets. And the very notion of self-regulation is…(I’m trying to think of a better word than stupid…but it’s escaping me at the moment).

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But it's also true that current market structure is inextricable from the SRO system, for better and worse.

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As Urvin CEO Dave Lauer explained to Congress way back in 2014: 

“I am not advocating that the self-regulatory structure disappear. I agree with the CFA Institute that “[w]ith its inherent conflicts and governance challenges, the self-regulatory system is far from perfect. Such a system is needed, however, in today’s highly complex and technologically changing and evolving markets.” I believe that the framework is dated, and must undergo a transformation so that it does not continue to undermine the integrity of markets.”

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However, that transformation must be done thoughtfully, carefully, and purposefully. The courts operate with the surgical precision of a sledgehammer. If they smash it all up, you won’t like what emerges from the rubble. 

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We favor evolution over demolition. Whatever our opinion of SROs, this is not a matter to be decided by the courts.

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