Over the last few years, broker dealers and financial advisors have filed a flurry of legal actions seeking both: (1) to strip the Financial Industry Regulatory Authority (FINRA) of its power to adjudicate customer and industry disputes through FINRA’s arbitration process, and (2) to limit its authority to police, and punish, and broker-dealers for misbehavior.
Thrivent Files Suit to Bypass FINRA Arbitration
Just last month, the financial firm Thrivent Financial for Lutherans (Thrivent) and its subsidiary Thrivent Investment Management Inc. (TIMI) filed a petition with the D.C. Circuit Court of Appeals asking the Court to abrogate FINRA rules that, according to Thrivent, prohibit parties from entering or enforcing agreements that call for individual arbitration outside the FINRA arbitration forum. Thrivent Financial for Lutherans, et al. v. United States Securities and Exchange Commission, No. 25-1047, United States Court of Appeals for the District of Columbia Circuit. In short, Thrivent claims the SEC, which reviews and approves FINRA’s rules, does not have statutory authority to limit parties’ ability to agree to arbitration according to the parties’ own choice of forum and rules.
Conflict Between Thrivent’s Policies and FINRA Rules
Thrivent, a fraternal benefit society, and FINRA member, offers variable insurance products through its wholly owned subsidiary TIMI. Thrivent is required to be a FINRA member because FINRA regulates the market for these variable insurance products. Thrivent had adopted a dispute resolution process agreed to by its members that did not involve FINRA. However, Thrivent’s dispute resolution process conflicts with FINRA Rules 12200, 12204(d), 2268, which require that members arbitrate any customer or employee dispute directly with FINRA. Thrivent characterizes these rules as unlawfully restricting parties’ freedom to agree to arbitrate disputes individually in a forum of their choice.
In their suit, Thrivent and TIMI chiefly argue that by requiring FINRA arbitration, the SEC went beyond its statutory authority under the Exchange Act because the SEC cannot foreclose private arbitrations. In short, they argue that (i) “regulators may only limit private arbitration rights with express congressional authorization … and neither the Exchange Act nor the Securities Act give the SEC or FINRA such authority.” This case is in its infancy and the SEC has not yet responded to the petition.
Blankenship Challenges FINRA Disciplinary Authority
In yet another attack on FINRA’s authority, last year an investment advisor named D. Allen Blankenship filed a lawsuit against FINRA seeking an injunction prohibiting FINRA from proceeding with a disciplinary hearing (before FINRA) against him. Blankenship argued that the Supreme Court’s then recent decision in SEC v. Jarkesy, 603 U.S. 109 (2024) prohibits direct FINRA disciplinary proceedings which seek civil penalties, because they run afoul of the Seventh Amendment’s right to a jury trial.
In Jarkesy, the SEC itself initiated an enforcement action for civil penalties against an investment advisor and his firm for alleged violations of the anti-fraud provisions contained in the federal securities laws. The SEC brought the disciplinary proceeding under its internal hearing mechanism and levied a civil penalty after it determined that the defendants had committed securities violations. The defendant asserted that the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud. The Supreme Court agreed and held that when the SEC seeks civil penalties against a defendant for securities fraud, the Seventh Amendment entitles the defendant to a jury trial. Therefore, the disciplinary finding and fine were overturned.
In the Blankenship case, the financial advisor argued that FINRA likewise could not seek civil penalties against him because FINRA gets its authority from the SEC and he was entitled to a jury trial under the Seventh Amendment. The District Court, however, dismissed the case on procedural grounds and did not reach the merits of Blankenship’s Seventh Amendment argument. Consequently, the issue of whether Jarkesy applies to FINRA internal disciplinary proceedings seeking civil penalties remains up in the air.
Nguyen v. Wells Fargo
Likewise, another financial advisor, Tommy Nguyen, sued Wells Fargo, his former firm, last year in federal court claiming that Wells Fargo had misled him into signing a forgivable loan in the form of a bonus. Wells Fargo moved to compel arbitration with FINRA because Nguyen was registered with FINRA and he had executed a Form U-4 requiring him to “arbitrate any dispute, claim or controversy that may arise between me and my firm.” Similar to Blankenship, Nguyen argued that under Jarkesy he cannot be compelled to arbitrate his civil claims for damages. The District Court did not agree with that argument and compelled FINRA arbitration. The District Court explained:
But the Supreme Court had no occasion in Jarkesy to consider whether private parties – such as Nguyen and Wells Fargo – could be compelled to honor their agreements to arbitrate civil claims for damages. Instead, the “case posed a straightforward question: whether the Seventh Amendment entitles a defendant to a jury trial when the SEC seeks civil penalties against him for securities fraud.” The answer to that question was, “Yes.” But the SEC is not involved in this case, which does not concern enforcement proceedings, civil penalties, or securities fraud. The Jarkesy Court did not consider agreements to arbitrate between private parties, and its pronouncement that “common law claims must be heard by a jury” cannot be construed as the “Get Out of Arbitration Free” card that Nguyen wishes it were. And whatever the SEC can (or, more accurately, cannot) do in the context of civil enforcement proceedings has no bearing on what private parties can (or in this case, must) do in the context of agreeing to arbitrate their private disputes. Jarkesy does not obviate Nguyen’s obligation to arbitrate his disputes with Wells Fargo in this case.
What’s at Stake for FINRA?
The issue of FINRA’s authority to force arbitrations or disciplinary actions before it is clearly being challenged. It may very well be that a court in the near future holds that, like the SEC, FINRA cannot seek to impose civil penalties against registered advisors and broker dealers through FINRA’s internal disciplinary process because the defendants are entitled to a jury under the Seventh Amendment. Further, FINRA’s ability to require members to adjudicate all customer disputes through FINRA arbitration process may hang in the balance of the Thrivent case. KJK will continue to monitor developments and provide updates as they occur.
