The Financial Industry Regulatory Authority (“FINRA”) is now facing a second litigation challenging the constitutionality of its use of disciplinary tribunals to impose sanctions on FINRA members. A broker filed a complaint in federal court in Pennsylvania on the heels of the Supreme Court’s landmark ruling in SEC v. Jarkesy, 144 S.Ct. 2117 (2024). The case, Blankenship v. Financial Industry Regulatory Authority, Docket No. 2:24-cv-03003 (E.D. Pa. Jul 10, 2024), seeks both preliminary and permanent injunctions to halt disciplinary proceedings brought against him by FINRA’s Department of Enforcement. FINRA had previously charged the broker with allegedly engaging in unsuitable mutual fund trading practices including, among other things, recommending short-term holds for Class A mutual funds designed to be long-term investments which allegedly resulted in unnecessary charges to customers and excess commissions to the broker.

The broker argues that the precedent from the recent Jarkesy decision—affirming the Fifth Circuit’s ruling that the SEC’s in-house administrative proceedings, when used to impose civil penalties for securities fraud, violate the Seventh Amendment right to a jury in an Article III court—requires FINRA’s claims against him to be adjudicated in a court, not through FINRA’s Office of Hearing Officers (“OHO”), which serves as the regulator’s in-house trial forum. The Court in Jarkesy found last month that the SEC’s approach was at odds with the Seventh Amendment’s right to a jury trial given that the allegations, which concerned securities fraud, were “legal in nature” and closely resembled common law fraud. This resemblance, together with the punitive nature of the civil penalties sought, led the Court to conclude that Jarkesy was entitled to a jury trial.

The broker’s complaint asserts that the charges against him are a “common law fraud disguised under regulatory language” and must be brought before an Article III court in line with the Jarkesy holding. It further alleges that the FINRA Rule 2111 claim against him is viewed by the SEC as a securities fraud claim under the Securities and Exchange Act of 1934. The broker argues that under Jarkesy, FINRA’s pursuit of disgorgement and restitution qualifies as legal relief, necessitating a jury trial. 

The Jarkesy decision is expected to have limited direct implications for the SEC’s current enforcement program, given that the SEC has in recent years consistently filed contested fraud actions in federal court, rather than as administrative proceedings; but this case, if successful, would suggest that the implications may actually be larger for other regulators and membership organizations acting under delegated authority as self-regulatory bodies. Before Jarkesy, FINRA was already defending an existential constitutional challenge to certain aspects of its program in Alpine Securities Corporation, et al v. Financial Industry Regulatory Authority, Inc., 1:23-cv-01506-BAH (July 5, 2023). In that case, a broker-dealer claimed that FINRA Hearing Officers are improperly delegated executive power, in violation of the Appointments Clause. We analyzed that case in July of last year, when a divided D.C. Circuit panel granted an emergency injunction temporarily barring FINRA from expelling the broker-dealer’s securities business because the broker-dealer had demonstrated a substantial likelihood of success on the merits. Together with the Blankenship matter, these cases create substantial uncertainty for FINRA’s enforcement program.

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