Last month, the US Supreme Court heard arguments in Securities and Exchange Commission v. Jarkesy. The justices’ queries hinted towards the likelihood of the SEC’s in-house tribunal being declared, at least partially, unconstitutional. This case advances on the heels of the Fifth Circuit asserting that the SEC’s in-house adjudication of securities fraud claims infringes upon the Seventh Amendment. A consequence of this ruling is additional ambiguity for the Financial Industry Regulatory Authority (FINRA), which is also facing a constitutional challenge regarding its in-house tribunal structure.
Alpine Securities Corp. has brought a case against FINRA, which has spurred additional cases questioning the constitutionality of FINRA. It has been established by the courts that FINRA in general is not a government actor. However, the question still lingers: to what extent can FINRA, in its enforcement authority, be considered a state actor? To identify state action, the Court must disentangle the complicated state action doctrine that delimits when a private actor’s conduct can be attributed to the government.
Federal law mandates that FINRA enforces the federal security laws against its members, a requirement that could conceivably render FINRA a state actor under the compulsion test. This test establishes state action when the government enforces a private actor to act in a particular manner. Law enforcement is an inherently governmental function and courts have consistently affirmed this. Therefore, under the public function test, a court could interpret FINRA’s enforcement of the federal securities laws as a state action.
Other recent noteworthy cases have addressed administrative power. The Supreme Court held in Lucia v. SEC that SEC administrative law judges must be appointed in accordance with the Appointments Clause. In Axon Enterprise v. FTC, the Supreme Court ruled that district courts could hear certain constitutional challenges against an agency before the conclusion of applicable administrative review processes.
It is likely that Alpine will be appealed to the Supreme Court. Considering the latest decisions by the court, arguments in a similar vein as Alpine could be well-received by the current bench. The court’s eventual decision will undeniably give rise to numerous additional questions that will, in turn, lead to extensive litigation.
If it is found that FINRA does engage in state action when enforcing federal securities laws, but not when enforcing its own rules, the impact could be relatively limited. In such a scenario, FINRA can continue to preside over enforcement actions pertaining to its rules in its in-house tribunal without being subject to any constitution restrictions. However, if the court decrees that FINRA respondents are entitled to Fifth Amendment rights, FINRA could presumably accommodate assertions of those rights within its internal adjudication structure.
In the event that FINRA is prohibited from bringing enforcement actions under the federal securities laws in its in-house tribunal, only enforcement proceedings related to FINRA’s internal rules would be remaining for hearing officers. In such a case, consistent with the Appointments Clause, hearing officers might not require appointment.
A verdict stating that FINRA engages in state action in connection with its enforcement authority would create numerous challenging issues that litigants and courts will deliberate for the foreseeable future.