The SEC has already lost a great deal of its authority to pursue fraud cases in in-house proceedings. Now it could be FINRA's turn.
That ruling affirmed that defendants in cases seeking penalties for fraud allegations have a right to appear before a jury. Before the ruling, the Securities and Exchange Commission had been bringing some of its fraud allegations before internal tribunals known as administrative law judges.
A 6-3 majority of the high court found last month that that system had stripped former hedge fund manager George Jarkesy of his Seventh Amendment right to a jury trial when SEC internal proceedings found him guilty of fraud. Now a follow-up lawsuit accuses FINRA of the same overreach in a case it has brought against D. Allen Blankenship, a broker with
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"Without admitting to any of the allegations brought by FINRA, Mr. Blankenship asserts that all of these allegations are assertions of common law fraud, and as such the claims are legal in nature and should properly be brought before [a court]," according to the suit, which seeks an immediate halt to FINRA's enforcement action.
Case against Blankenship
Blankenship was fired by Independent Financial Group, a brokerage firm in King of Prussia, Pennsylvania, in October 2019 over allegations that he had neglected to file required documents and had failed to ensure clients were receiving certain benefits from mutual fund investments. FINRA, the broker-dealer industry's self-regulator,
Specifically, FINRA accused Blankenship of excessively trading mutual funds in 11 customer accounts and of taking steps to prevent clients from benefiting from discounts offered on their mutual fund holdings. Many of the funds Blankenship put clients into would lower their fees when the money being invested exceeded certain thresholds.
Blankenship was accused by FINRA of deliberately breaking his clients' investments into small chunks to avoid those breakpoints. By keeping the transaction values relatively small, according to the complaint, he was also able to avoid his firm's policy of scrutinizing trades over $20,000.
According to FINRA, Blankenship cost 11 customer accounts $21,158 through his excessively frequent trades in mutual funds while generating more than $16,000 in commissions for himself. He was also alleged to have taken steps to prevent customers from realizing discounts offered on certain mutual fund transactions, costing 37 accounts $21,875. FINRA's complaint seeks to have Blankenship pay back any ill-gotten gains.
Blankenship's lawsuit contends FINRA is bringing the exact same sort of fraud charges that the Supreme Court, in the Jarkesy case, has now decided must go before juries.
"This case is ultimately a case for common law fraud disguised under regulatory language as the core allegations are that Mr. Blankenship did not properly file documents, did not make suitable recommendations to his clients, and acted without proper authorization from his principal client," according to the suit.
Blankenship's lead counsel in the case, Dochtor Kennedy of AdvisorLaw in Westminster, Colorado, didn't immediately return a request for comment. FINRA declined to comment.
Regulatory rollback
In the Jarkesy ruling, the Supreme Court found that the types of fraud allegations the SEC was bringing before its in-house tribunals were akin to common law fraud cases that must go before juries. It also decided that the courts were the proper venue for disputes calling for defendants to pay punitive damages rather than just pay back ill-gotten gains.
Hugh Berkson, a partner at Cleveland-based McCarthy Lebit Crystal & Liffman and former president of the Public Investors Advocate Bar Association, said he's not surprised to see other legal challenges of regulatory watchdogs' authority following closely on the Jarkesy decision and other recent Supreme Court cases.
"I imagine you are going to see this with every agency that tries to enforce its own rules," he said. "You are going to see it with the Department of Justice, with the Department of Labor."
Beyond Jarkesy, the Supreme Court this term has handed down four other decisions that have potential to
FINRA presents a special case since it's technically an industry-supported self-regulatory organization.
There's also a question of whether the charges brought against Blankenship constitute the type of fraud allegations that the Supreme Court has now found must be heard by a jury. To be sure, nowhere in FINRA's complaint against Blankenship does the word "fraud" appear. Regulators instead accuse him of making unsuitable mutual fund transactions, circumventing his firm's procedures and mismarking trade orders.
Still, the types of violations Blankenship is charged with are much the same kind that many fraud cases are built on, Edwards noted. Brokers' fundamental promise to clients is usually to look out for their best interests and recommend only suitable investments.
FINRA's allegations, Edwards said, paint a picture of an advisor who was deliberately trying to mislead people who had placed trust in him.
"If you believe what they are supposed to be doing is giving you advice that's in your best interest and what they were actually doing is giving advice that's causing you to pay more, that's a form of fraud," Edwards said.
Existential threats
From an even bigger perspective, Blankenship's case is the latest in a series challenging the role self-regulatory organizations play in monitoring markets in the U.S. A separate lawsuit filed last October by the
Edwards said he thinks disputes like Blankenship's and Alpine's raise fundamental questions about the value of self-regulatory organizations. If Blankenship prevails in his case, Edwards said he thinks FINRA could still bring allegations through the regular court system.
But there would be losses in efficiency and timeliness, he said. FINRA, which has been showing a tendency to
Hearing officers, for instance, can bar brokers from the industry for refusing to answer questions. In court, those same defendants would have the right to shield themselves against unwanted questions by invoking their Fifth Amendment right to avoid self-incrimination.
"So if brokers gain those kinds of due-process rights, these cases become a lot more difficult for FINRA to enforce," Edwards said.
He said one benefit to FINRA's current efficiency is that it allows bad actors to be booted from the industry before they can cause more harm. If that advantage were to disappear, questions might arise about the need for an agency like FINRA in the first place, Edwards said.
He agreed that the U.S. regulatory system is undergoing a massive overhaul led by the six conservative justices, three appointed during President Donald Trump's administration, who now dominate the Supreme Court.
"The idea that FINRA wouldn't be able to enforce its own rules was once unthinkable," Edwards said. "But a lot has changed with the post-Trump Supreme Court."
