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 a suit in Pennsylvania federal court against FINRA, requesting a temporary restraining order to stop the regulator from following through on disciplinary hearings.
Blankenship claims the proceedings will “take place in an improper forum, before an arbitrator whose selection was made in blatant violation and disregard of Mr. Blankenship’s Seventh Amendment right to a trial before a jury in an Article III court.”
To support his case, Blankenship cited SEC v. Jarkesy, in which the Supreme Court ruled that the SEC’s use of in-house judges for certain enforcement proceedings violated defendants’ constitutional rights, despite arguments that those justices have specialized expertise and helped the commission and defendants avoid costly, lengthy jury trials.
FINRA charged Blankenship with alleged “unsuitable mutual fund trading” between 2016 and 2019 when he was with Independent Financial Group, a San Diego-based brokerage firm. (Blankenship lives and works in Pennsylvania.)
According to FINRA, Blankenship recommended numerous short-term holds on Class A mutual funds designed to be long-term investments. The rep allegedly advised nine IFG clients to make 27 trades to sell stakes in the funds after less than a year, incurring numerous mutual fund sales charges. (Clients incurred more than $21,150 in “unnecessary” upfront charges, with Blankenship pocketing more than $16,000 in commissions as a result of the trades, according to FINRA.)
Those mutual funds often offered “breakpoint” discounts, which entitled clients to reduced sales charged when the purchases exceeded certain financial thresholds (i.e., the charges would be lower for more significant investments). However, Blankenship allegedly divided clients’ investments into multiple purchases for the same fund so that those purchases would evade mandated IFG reviews of any purchases over $20,000. Blankenship made 578 purchases across 59 client accounts over two to five business days, each amounting to less than $20,000. These trades allegedly left 37 client accounts incurring nearly $21,900 in excess sales charges because they missed the threshold discounts offered by the funds, according to FINRA.
IFG fired Blankenship for breaking firm policy “with regard to submission of required documents for certain mutual fund transactions and failure to ensure clients were receiving (sic) benefit of mutual fund breakpoints,” according to FINRA BrokerCheck records. Blankenship claimed FINRA began inquiring about the firing in late 2019 before finally filing a disciplinary complaint in December.
In his complaint, Blankenship describes how FINRA “exclusively” brings enforcement actions via an in-house arbitration forum, “including cases which would traditionally be actions brought at common law” in a jury trial. However, Blankenship argued the Jarkesy decision found such suits to be 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 could appeal a decision by the hearing officers to FINRA’s National Adjudicatory Council, which could then be appealed to an SEC in-house justice for review. However, according to his complaint, 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 brokers would try this angle, though he foresaw some hurdles with the case. In this instance, the court would need to deem FINRA’s hearing officers as being similar enough to the 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 shouldn’t 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 existing club operating under the SEC’s supervision,” he said.
According to securities attorneys interviewed by WealthManagement.com, the Jarkesy decision was unlikely to have a striking short-term effect on SEC enforcement, as it had been moving cases with civil penalties away from administrative judges during the past several years (in other words, cases involving fraud and potential monetary penalties are likely already going to federal court if they aren’t settled).
However, others, including Supreme Court Justice Sonia Sotomayor, in a dissenting opinion on the ruling, predicted it could have disastrous effects on other governmental agencies with similar set-ups to the SEC. Others speculated it could impact FINRA’s operations even though it is not a governmental agency.
Edwards worried the court’s skepticism about agency enforcement through in-house justice could filter into self-regulatory organizations like FINRA, calling the ruling “not a good sign” for regulators.
Other adversaries of FINRA are catching on. The agency is facing a lawsuit from registrant Alpine Securities in the Washington, D.C. appeals court, questioning the constitutionality of its arbitration panels. Alpine argues they are essentially judges and, therefore, unconstitutional.
In Alpine’s most recent response to the court this week, its attorneys cited the Supreme Court’s Jarkesy ruling as a part of its defense.
Edwards, who said he’d long warned about FINRA’s vulnerability in this regard, said the regulator operated in a “liminal space” between being a private organization and a governmental entity. FINRA could find it tricky to vacillate between the two poles.
“The more independence you give FINRA and the more it tends towards a private club, the less accountable and democratic it is,” he said. “It’s challenging to maintain its authority but also its distance from government.”
Though FINRA has been successful in many court challenges thus far, Edwards noted that the Supreme Court’s conservative turn with new members and a federal judiciary changed by appointments during the Trump administration may leave it more vulnerable. “You can recognize the wind blows differently now than it used to,” he said.