Briefs flood in defending FINRA in "existential threat" case

Investor advocacy groups are out with a slew of briefs arguing that a lawsuit questioning FINRA's mere right to exist could blow open a regulatory hole that no one's in a position to fill.

Friday was the deadline for filing friend-of-the-court briefs in a legal battle pitting the brokerage and clearing firm Alpine Securities against the Financial Industry Regulatory Authority, the broker-dealer industry's self-regulator. Alpine Securities, a Salt Lake City, Utah-based firm with a spotty regulatory history, is questioning what role a private organization like FINRA can constitutionally play in overseeing the securities industry.

Among the organizations that filed briefs by the deadline Friday were the North American Securities Administrators Association, which represents state and provincial regulators in the U.S., Canada and Mexico; the Public Investors Arbitration Bar Association, which consists largely of plaintiff's lawyers in securities cases; and various stock exchanges and clearing houses. The groups uniformly insist victory for Alpine Securities would have devastating consequences for not only the oversight but also orderly operation of U.S. securities markets and leave investors dangerously exposed.

"Simply put, if FINRA's regulatory and enforcement power were taken away, there would be no government agency or SRO with regulatory and enforcement powers over the securities industry members that could readily take over FINRA's functions," wrote a pair of securities lawyers, Alan Rosca and Melinda Steuer, in PIABA's brief. "FINRA exercises oversight over the thousands of securities broker-dealer firms and hundreds of thousands of securities professionals associated with those firms."

Alpine Securities' lawsuit, filed in October 2022, argues that FINRA is an unconstitutional combination of a public state actor with police powers and a private organization that's shielded from direct control by the federal executive branch. FINRA, under authority granted it by the Securities and Exchange Commission, oversees roughly 620,000 registered representatives at nearly 3,500 brokerage firms. 

The dispute arises from FINRA's attempt in March 2022 to have Alpine expelled from the industry after finding that the firm had charged customers unreasonable fees and expenses. The case ended up in federal court in Washington, D.C., when FINRA tried to expedite the expulsion after accusing Alpine of not abiding by a cease-and-desist order related to the alleged overcharging.

Alpine and its affiliate Scottsdale Capital Advisors were initially defeated in district court but then scored a victory before a three-judge panel at the appellate level. The case now awaits a final decision from the full D.C. federal court of appeals.

Apline's lawyer, Maranda Fritz, said the firm is preparing a brief that's due for submission by Nov. 17.

"The (three-member) panel got it right when it stopped FINRA from imposing the corporate death penalty on Alpine in violation of the separation of powers," she wrote in an email. "The purported policy arguments of FINRA and its amici do not change that."

NASAA, in its brief filed on Friday, noted that FINRA doesn't just enforce securities rules for the brokerage industry. Its BrokerCheck database is the single most comprehensive resource investors can use to look up the past disciplinary records of any broker they might consider working with. 

NASAA further noted that FINRA has played a large role in assembling what's known as the Consolidated Audit Trail, a vast record of U.S. trading activity. This system, which is nearing completion, is designed to give regulators real-time data that they can use to uncover questionable transactions or activity deserving scrutiny.

"If this Court were to find that FINRA's rule writing and enforcement mechanisms were unconstitutional, this Court could disrupt the essential functioning of securities regulation and the Nation's securities markets, harming the economy," wrote Zachary Knepper, NASAA deputy general counsel. 

PIABA's brief wades more into the constitutional questions that are at the heart of Alpine's claims against FINRA. The investor advocacy group, for instance, disputed the notion that FINRA is not subject to sufficient oversight from the federal government.

PIABA noted that all FINRA rules and regulatory proposals are subject to approval by the SEC, which can also overturn the self-regulator's disciplinary decisions. Alpine affiliate Scottsdale Capital itself persuaded the SEC in September 2021 to undo a $1.5 million FINRA fine handed down over alleged sales of unregistered securities.

Because of the SEC's power of review, PIABA argues in its brief, Alpine's warnings about a "corporate death penalty" amount to a giant exaggeration.

"If the SEC disagrees with FINRA, it could simply reverse FINRA's decision, and reinstate Appellant, thereby bringing the supposed death penalty victim back to life," PIABA wrote. "The SEC's power to review and reverse FINRA's enforcement action shows that the delegation of powers to FINRA is valid because the SEC has retained final reviewing authority."

In their own brief, the New York Stock Exchange and Nasdaq, among other exchanges, noted that they are all self-regulatory organizations that, like FINRA, play important roles in the functioning of U.S. securities markets. Writing on behalf of the exchanges, attorney Kevin King of the firm Covington & Burling, contended that defeat for FINRA could be a blow against them all.

"While Alpine frames this appeal as a challenge to a single disciplinary proceeding, the consequences of a ruling in Alpine's favor could be sweeping and deeply problematic for the U.S. securities markets," King wrote. "Private self-regulatory organizations have promoted the health and integrity of securities markets for more than two centuries, and Congress has repeatedly affirmed that system."

Separately on Monday, the SEC issued a decision denying Alpine's request for a stay for the collection of margin fees by the National Securities Clearing Corporation, a self-regulatory organization that plays a counterparty role in brokerage transactions. Alpine is arguing that a volatility charge the NSCC levies on its member firms is excessive and discriminates against smaller firms. The SEC denied the requested stay after finding Alpine is unlikely to succeed in its larger challenge.