A broker facing FINRA disciplinary charges is citing last month's Supreme Court decision that weakened the SEC's enforcement powers to challenge the validity of the brokerage regulator's enforcement arm.
D. Allen Blankenship filed suit in federal court in Pennsylvania against FINRA, seeking a temporary restraining order to stop the regulator from pursuing disciplinary hearings.
Blankenship claims the proceedings will be “conducted in an improper forum, before an arbitrator whose selection was made in flagrant violation and disregard of Mr. Blankenship's Seventh Amendment right to a trial by jury in a court of law of Article III.”
To support his case, Blankenship cited SEC v. Jarkesy, in which the Supreme Court held that the SEC's use of in-house judges for certain enforcement proceedings violated defendants' constitutional rights, despite arguments that those judges have specialized expertise and have helped the commission and defendants avoid costly and lengthy jury trials.
FINRA charged Blankenship with allegedly “improper mutual fund trading” between 2016 and 2019 when he was with Independent Financial Group, a brokerage firm based in San Diego. (Blankenship lives and works in Pennsylvania.)
According to FINRA, Blankenship recommended multiple short-term holdings in Class A mutual funds designed to be long-term investments. The representative allegedly advised nine IFG clients to make 27 trades to sell shares in the funds after less than a year, incurring multiple mutual fund sales charges. (Clients incurred more than $21,150 in “unnecessary” upfront fees, with Blankenship racking up more than $16,000 in commissions as a result of the trades, according to FINRA.)
These mutual funds often offered “breakpoint” discounts, which entitled clients to reduced sales charges when purchases exceeded certain financial limits (ie, fees would be lower for more significant investments). However, Blankenship allegedly split clients' investments into multiple purchases for the same fund so that those purchases would avoid IFG's mandated reviews of each purchase over $20,000. Blankenship made 578 purchases in 59 customer accounts over two to five business days, each of less than $20,000. Those trades allegedly left 37 customer accounts incurring nearly $21,900 in excess sales fees because they missed out on threshold discounts offered by the funds, according to FINRA.
IFG fired Blankenship for violating the firm's policy “regarding the filing of documents required for certain mutual fund transactions and failing to ensure that clients were receiving benefits (as) from mutual fund breakpoints.” according to FINRA BrokerCheck data. Blankenship claimed FINRA began investigating the firing in late 2019 before ultimately filing a disciplinary complaint in December.
In his complaint, Blankenship describes how FINRA “exclusively” brings enforcement actions through an internal arbitration forum, “including cases that would traditionally be common law actions” in a jury trial. However, Blankenship argued that the Jarkesy decision found that such suits were subject to a constitutional right to a jury trial, and Congress did not establish a “public right” in which administrative courts could decide them. Blankenship argued that his case qualified, so FINRA's disciplinary proceeding was unconstitutional.
Blankenship can appeal a decision by the hearing officers to FINRA's National Judicial Council, which can then be appealed to an internal SEC court for review. However, according to his appeal, he argued that even that decision would not be constitutional without a jury trial.
FINRA declined to comment for this story.
Ben Edwards, a professor at the William S. Boyd School of Law at the University of Nevada, Las Vegas, said he wasn't surprised the mediators would try that angle, though he anticipated some obstacles with the case. In this case, the court would have to regard FINRA hearing officers as sufficiently similar to SEC administrative law judges, even though FINRA employees are not nominally part of the government. If the court views FINRA as something akin to a private club, an action to expel a broker like Blankenship should not trigger the same constitutional protections, Edwards surmised.
“Of course, the law also requires all brokerage firms to be members of a club like FINRA,” he said. “And FINRA is the only club in existence that operates under the supervision of the SEC,” he said.
According to securities attorneys interviewed by WealthManagement.comThe Jarkesy decision was unlikely to have a dramatic short-term effect on SEC enforcement, as it had moved civil penalty cases away from administrative judges over the past several years (in other words, it is likely that cases involving fraud and potential monetary penalties already going to federal court if not settled).
However, others, including Supreme Court Justice Sonia Sotomayor, in a dissenting opinion on the ruling, predicted it could have disastrous effects on other government agencies with structures similar to the SEC. Others speculated that it could affect FINRA's operations even though it is not a government agency.
Edwards worried that the court's skepticism about agency enforcement through internal justice could filter down to self-regulatory organizations like FINRA, calling the decision “not a good sign” for regulators.
Other FINRA opponents are catching on. The agency is facing a lawsuit by registrar Alpine Securities in the appeals court in Washington, DC, questioning the constitutionality of its arbitration panels. Alpine argues that they are essentially judges and, therefore, unconstitutional.
In Alpine's latest response to the court this week, its lawyers cited the Jarkesi High Court decision as part of its defence.
Edwards, who said he had long warned of FINRA's vulnerability in this regard, said the regulator operated in a “border space” between being a private organization and a government entity. FINRA may find it difficult to oscillate between the two poles.
“The more independence you give FINRA and the more it leans toward a private club, the less accountable and democratic it is,” he said. “It's challenging to maintain her authority, but also her distance from the government.”
Although FINRA has been successful in many court challenges so far, Edwards noted that the Supreme Court's conservative turn with new members and a federal judiciary reshuffled by appointments during the Trump administration could make it more vulnerable. “You can tell the wind blows differently now than it used to,” he said.