The Financial Industry Regulatory Authority (FINRA) recently scored a legal victory after a federal judge in Philadelphia dismissed a broker's challenge to a FINRA disciplinary proceeding, which was based on the U.S. Supreme Court's Jarkesy decision. This decision provides some relief for both FINRA and the Securities and Exchange Commission (SEC), as they face increased scrutiny following the Supreme Court's ruling on administrative law judges.
Background: The Jarkesy Decision and Its Fallout
In June 2024, the U.S. Supreme Court ruled in SEC v. Jarkesy that the Seventh Amendment right to a jury trial precludes the SEC from using its administrative law judges (ALJs) to oversee enforcement actions seeking civil penalties. This ruling sent shockwaves through regulatory agencies, as it limited their ability to use in-house ALJs for disciplinary proceedings. The SEC has already dismissed several cases to avoid potential constitutional challenges.
Following Jarkesy, other federal agencies have faced challenges to their in-house proceedings. For example, Comcast recently filed a lawsuit against the U.S. Department of Labor, and Perdue Farms followed with a similar case. Both actions argue that Jarkesy prevents administrative law judges from overseeing certain cases.
The Challenge to FINRA's Disciplinary Authority
In July 2024, Pennsylvania broker Allen Blankenship filed a complaint in federal court, seeking to block a FINRA disciplinary hearing. Blankenship, who lost his job in 2019, was accused of engaging in unsuitable mutual fund trading to generate commissions for himself. His lawyers, inspired by the Jarkesy ruling, argued that FINRA's disciplinary process violated his Seventh Amendment right to a jury trial. They claimed that FINRA's allegations were similar to common-law fraud, entitling Blankenship to a jury trial rather than an administrative hearing.
Additionally, Blankenship's legal team pointed to the Supreme Court's decision in Axon v. FTC, arguing that he should be able to challenge FINRA's authority before enduring the entire disciplinary process. Axon allowed certain constitutional challenges to administrative proceedings before those proceedings concluded, giving hope to Blankenship's team that they could halt the hearing.
FINRA's Response and the Court's Ruling
FINRA, represented by outside counsel from Gibson, Dunn & Crutcher, countered that Blankenship's challenge was premature under the Supreme Court's 1994 ruling in Thunder Basin Coal Co. v. Reich. In Thunder Basin, the Court held that when Congress provides a comprehensive structure for agency enforcement, defendants generally must wait until the agency reaches a final decision before challenging the proceeding in court.
FINRA argued that Axon applied only to challenges that threatened the agency's very structure or existence, which was not the case with Blankenship. Additionally, FINRA maintained that it is not a federal agency but a private organization with congressional authority to regulate its members. Therefore, Blankenship had waived his right to challenge FINRA's procedures by agreeing to its rules when he registered as a broker.
In a brief opinion, U.S. District Judge John Murphy sided with FINRA, ruling that Blankenship could not challenge the hearing until he had exhausted his administrative remedies. Judge Murphy emphasized that Blankenship still had meaningful avenues for review, as he could appeal any adverse ruling to FINRA's appellate council and ultimately to the SEC.
What This Means for FINRA and Brokers
The court's ruling in favor of FINRA is significant, as it shields the organization from immediate challenges that could threaten its disciplinary process in the wake of the Jarkesy decision. The decision reinforces the need for brokers to follow established procedures before seeking judicial intervention.
For brokers facing disciplinary actions, this case highlights the difficulty of challenging FINRA's authority before completing the administrative process. While Jarkesy has raised constitutional questions about in-house enforcement proceedings, those issues may not apply as readily to FINRA, which operates as a private regulator.
Conclusion
FINRA's win in this case underscores its ability to maintain its disciplinary process despite the potential implications of Jarkesy. For brokers, this decision reaffirms that challenges to FINRA's procedures must wait until the administrative process has played out fully. As regulatory scrutiny continues to evolve, firms and brokers should stay informed about their rights and obligations under FINRA's rules and seek expert legal counsel when facing disciplinary proceedings.
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