Analysis of Alpine Securities Corporation v. FINRA: Constitutionality of FINRA Hearing Panels in Jeopardy.

The United States Court of Appeals for the District of Columbia Circuit recently rendered a significant decision in the case of Alpine Securities Corporation v. Financial Industry Regulatory Authority, No. 23-5129, 2023 WL 4703307 (D.C. Cir. July 5, 2023). This case brings to the forefront several key legal issues about the authority of FINRA and its hearing officers and raises profound constitutional questions about the exercise of executive power within the framework of the securities industry’s self-regulatory organizations.

In this case, Alpine, a registered securities broker, was subject to an expedited enforcement action by FINRA for purportedly violating numerous FINRA rules. After losing its case before a FINRA hearing panel, Alpine responded by filing a lawsuit challenging FINRA’s authority to conduct the enforcement proceeding. Specifically, Alpine argued that FINRA's hearing officers wielded executive power in a manner that violated the Constitution, as such power could only be exercised by the President or officers directly under the President’s supervision.

Background and FINRA Investigation

The underlying FINRA investigation and subsequent disciplinary action against Alpine were extensive and allegedly revealed multiple violations of regulatory standards. FINRA accused Alpine of converting and misusing customer funds and securities, engaging in unauthorized trading, charging and paying customers unfair prices in securities transactions, charging customers unreasonable and discriminatory fees, and making an unauthorized capital withdrawal.

According to FINRA, the complaint it filed, and the Hearing Panel decision, Alpine violated FINRA rules by (i) charging an unreasonable $5,000 monthly account fee, and in a discriminatory manner, in violation of FINRA Rules 2122, (ii) converting and misusing customer funds and securities and committing unauthorized trading in connection with the $5,000 fee in violation of FINRA Rule 2150, (iii) converting and misusing customers’ securities in violation of FINRA Rules 2150 by intentionally taking without customer authorization every customer position valued at $1,500 or less, (iv) executing unauthorized transactions in violation of FINRA Rule 2010 by selling hundreds of positions improperly deemed worthless to itself for one cent per position without customer authorization, (v) charging its customers a 2.5% market-making/execution fee which, when combined with other charges, resulted in unfair and excessive prices and commissions in excess of 5%, in violation of FINRA Rules 2121, and (vi) making an unauthorized withdrawal of capital in the amount of $610,373 in violation of FINRA Rule 4110.

Key Legal Issues

The court granted Alpine’s emergency motion for an injunction pending appeal, an action that effectively halts FINRA’s enforcement proceedings against Alpine Securities until the appeal is resolved. This decision was based on the criteria established in Nken v. Holder, 556 U.S. 418, 426, 435 (2009), which requires that a party seeking an injunction must demonstrate it is likely to win on the merits, it will suffer irreparable harm without an injunction, and the equities and public interest favor the court’s intervention.

Alpine raised a substantial constitutional issue regarding the exercise of executive power by FINRA hearing officers. The court examined whether FINRA hearing officers exercised significant authority akin to that of Administrative Law Judges (ALJs) within the Securities and Exchange Commission (SEC), as delineated in the Supreme Court case Lucia v. SEC, 138 S. Ct. 2044 (2018).

Recall that in Lucia the Supreme Court ruled that Administrative Law Judges (ALJs) in the SEC are "officers" under the Constitution, meaning their appointment must comply with the Appointments Clause. U.S. Const. art. II, § 2, cl. 2. The Lucia decision invalidated the prior method of appointing ALJs through SEC staff and the Office of Personnel Management (OPM) procedures.

Following the Lucia decision, the President issued an executive order exempting ALJs from competitive service selection and examination, allowing department heads to appoint them directly. In addition, the Office of the Solicitor General released a memo extending Lucia's reasoning to all ALJs and similarly situated non-ALJ adjudicators, advising that they be appointed by the President or department heads. Agencies were instructed to ratify the appointments of current ALJs and to appoint future ALJs and similar adjudicators according to the Appointments Clause. These measures aimed to ensure greater executive control and compliance with the Appointments Clause, as interpreted by the Lucia decision.

Like the Lucia Court, the DC Circuit Court noted that FINRA hearing officers possess significant powers, including the authority to demand testimony, rule on motions, regulate the course of hearings, decide on the admissibility of evidence, and enforce compliance through contempt orders. These functions closely mirror those of SEC ALJs, who were deemed to wield significant executive power by the Supreme Court. According to the court, “FINRA’s hearing officers are near carbon copies of those ALJs.”

The court reasoned that it did not “make a difference that FINRA hearing officers are employees of a nominally private corporation.” Despite FINRA being a private corporation, its enforcement activities are substantially controlled by the government. FINRA is required by law to enforce governmental standards, its rules are subject to SEC approval, and the SEC can modify these rules at any time. This intricate relationship between FINRA and the government implies that FINRA hearing officers could be considered government actors, thereby subjecting them to the requirements of the Appointments Clause of the U.S. Constitution. This clause mandates that officers who exercise significant executive power must be appointed by appropriate government authorities, a criterion that FINRA’s hearing officers do not meet, as they are appointed by a private entity.

Furthermore, the court identified potential constitutional issues with the removal protections afforded to FINRA hearing officers. These officers are insulated from removal except for cause, and the SEC Commissioners, who themselves enjoy similar protections, oversee them. This dual layer of protection could infringe upon the President’s ability to ensure the faithful execution of the laws, thus raising significant constitutional concerns. Analogizing to the Lucia decision, the court commented that “[i]t would be odd if the Constitution prohibits Congress from vesting significant executive power in an unappointed and unremovable government administrator but allows Congress to vest such power in an unappointed and unremovable private hearing officer.”

Conclusions

The court's decision to grant an injunction pending appeal underscores the seriousness of these constitutional questions. By halting FINRA’s enforcement action, the court allows Alpine to fully litigate its case without facing immediate and potentially irreparable harm, such as being expelled from FINRA—a move that would effectively end its business operations.

Impact on the Securities Industry

The implications of this decision extend far beyond the immediate parties involved. Should the court ultimately find in favor of Alpine Securities on the constitutional issues, it could fundamentally alter the structure and operation of self-regulatory organizations within the securities industry. Self-regulatory organizations like FINRA play a crucial role in maintaining the integrity of the securities markets by enforcing compliance with securities laws and regulations. However, if their hearing officers are found to wield executive power in a manner that violates the Constitution, it could necessitate a significant overhaul of their enforcement mechanisms.

Such a ruling would impact FINRA and potentially other self-regulatory organizations that operate under similar frameworks. The decision could lead to increased scrutiny of how these organizations appoint and remove their officers, potentially requiring legislative changes to bring these practices into compliance with constitutional standards. This could result in a more direct governmental oversight of these bodies or a restructuring to ensure that their officers are properly appointed and subject to appropriate removal procedures.

Moreover, this case highlights the delicate balance between self-regulation and government oversight in the securities industry. Self-regulatory organizations are designed to leverage industry expertise while maintaining a degree of independence from direct governmental control. However, this case suggests that this independence may come into conflict with constitutional principles, particularly regarding the separation of powers and the executive’s control over the enforcement of laws.

In conclusion, the court’s decision in Alpine Securities Corporation v. FINRA raises critical constitutional issues about the exercise of executive power by private self-regulatory organizations in the securities industry. The outcome of this case could have far-reaching effects, potentially reshaping how disciplinary actions are conducted and how self-regulatory organizations operate. It underscores the necessity for a careful balance between effective self-regulation and adherence to constitutional principles, ensuring that those who enforce the law are properly appointed and accountable to the executive branch. This case serves as a pivotal moment in the ongoing evolution of regulatory practices within the securities industry, with implications that could extend to various facets of financial regulation and enforcement.