By Thomas C. White, Esq. and A.J. Monaco, Esq
As any financial industry professional knows, any financial services dispute involving Financial Industry Regulatory Authority (“FINRA”) members and/or associated persons are required to submit to FINRA’s arbitration process. This procedural requirement, while well-established, has been increasingly viewed as controversial in recent years. While federal legislators have proposed reforms in recent years, none have managed to be signed into law.[1] However, a pending case before the D.C. Circuit Court of Appeals has presented possibly industry-altering questions.
Earlier this year, Thrivent Financial for Lutherans (“TFL”) and its subsidiary Thrivent Investment Management Inc. (“TIMI” and, together with TFL, “Thrivent”) filed a petition with the D.C. Circuit Court of Appeals[2] challenging the Securities and Exchange Commission’s (“SEC”) adoption of three specific FINRA rules that Thrivent says interfere with a party’s right to private arbitration agreements.
In its brief filed in July, Thrivent highlighted three specific FINRA rules for which it sought SEC review—FINRA Rule 12200, FINRA Rule 2268(d), and FINRA Rule 12204(d). Summarizing these rules, Thrivent contended that “Rule 12200 gives customers a right to demand FINRA arbitration; Rule 2268(d)(1) prohibits arbitration agreements that limit or contradict that right; and Rule 12204(d) prohibits parties from agreeing to pursue claims through individual arbitration, rather than a judicial class action.”
Thrivent, an IRS-designated religious non-profit organization, provides financial services and offers related products to its members, all of whom are bonded under their shared Christian faith. In their petition before the D.C. Circuit, Thrivent argued strongly that the FINRA rules inhibited its abilities to self-govern its members. In its petition, Thrivent specifically pointed to its internal bylaws and stressed that the organization placed a high value on treating all of its members in a uniform and equal manner. In furtherance of this goal, Thrivent adopted a “Member Dispute Resolution Program” (“MDRP”). The MDRP, as outlined in Thrivent’s bylaws, is a multi-step process that culminates in a mandatory individual arbitration in a non-FINRA forum. Thrivent touts the MDRP, which has been in place for around 25 years, as an efficient system that allows for each arbitration to be individually tailored to each Thrivent member’s particular needs in a given case.
Presently, TFL’s insurance product offerings are able to be arbitrated in accordance with the terms and procedures set forth in the MDRP. TIMI, on the other hand, sells variable annuities and variable life insurance products, thereby falling under the SEC’s jurisdiction. As such, whenever a controversy involving one of TIMI’s variable products arises, SEC rules require FINRA arbitration—with no exceptions. Ultimately, these separate arbitration paths for TFL and TIMI lead to inconsistent treatment of Thrivent customers. Thrivent argues that mandatory FINRA arbitration for TIMI customers hinders the organization’s principal focus of uniform, equal treatment of members, all of whom are united in their common religious mission/ideals.
In its reply brief, the SEC defended its rulemaking processes and authority. In defense of empowering FINRA, the SEC wrote, “[Self-regulatory organizations have] maintained private arbitration forums for more than a century, predating the federal securities laws.” Here, the SEC echoes a long-standing defense of the decisions made by administrative agencies. For decades, policymakers and courts alike have consistently deferred to agency rules and regulations on the basis that these agencies, as subject-matter experts in their respective fields, are better positioned than legislators or judges to make important, nuanced policy decisions.
The SEC emphasized the organization’s clear, broad authority as demonstrated by decades of federal administrative law jurisprudence. For instance, in response to Thrivent’s contention that the SEC provided no explanation for its support of the three challenged FINRA rules, the SEC claimed that it offered sufficient justification for its decision-making process. Although Thrivent argued that the SEC’s one page explanation was insufficient and unsatisfactory, the SEC countered that, under the Administrative Procedure Act, it was not required to do anything other than provide a brief explanation.
Notably, the authorities the SEC cited in defense of its position, Massachusetts v. EPA[3], UAW v. Chao[4], and WildEarth Guardians v. EPA[5],were reviewed and, ultimately decided, during the era of “Chevron Deference” to administrative agency decisions.
The landmark 1984 decision in Chevron v. Natural Resources Defense Council[6] granted broad authority to federal agencies—holding that, if Congress has not directly addressed a particular issue, the agency’s interpretation of the statute at issue is given great deference. Massachusetts v. EPA, one of the cases cited by the SEC in its reply brief, explicitly applied Chevron in its holding, stating, “As we have repeated time and time again, an agency has broad discretion to choose how best to marshal its limited resources and personnel to carry out its delegated responsibilities.”
Last summer, however, in Loper Bright Enterprises v. Raimondo[7], the Supreme Court overruled Chevron, holding that courts are responsible for analyzing agency actions and, as part of their deliberation, are not permitted to defer to agency interpretations of statutes. However, following the Supreme Court’s decision to overturn Chevron last summer, it is unclear how authoritative the cases relied on by the SEC are today. While the aforementioned SEC citations (Massachusetts, UAW, and WildEarth Guardians) have not been explicitly overruled, it is unclear whether they still constitute binding precedent.
In light of the uncertainty surrounding federal administrative law, it is difficult to state with any certainty how the D.C. Circuit may rule on Thrivent’s petition. Amidst that backdrop, it would not be surprising to see the D.C. Circuit attempt to curtail FINRA’s jurisdiction. At the very least, the D.C. Circuit may not be the last court to rule on this matter, as the Supreme Court could weigh in and attempt to clarify the post-Chevron landscape.
Complicating matters further, the issue of mandatory arbitrations may potentially run afoul of certain Trump Administration policy preferences. Thus far, the Trump Administration has consistently demonstrated strong support for religious liberties and religious organizations who brush up against the powers of the federal government. It is also worth noting that SEC Commissioner Caroline Crenshaw, who was first appointed to her position by President Trump in 2020, is also a vocal critic of mandatory arbitration. In fact, earlier this month, on September 17th, she argued that the process “stack[s] the deck against investors.”[8]
If FINRA were to be limited in any way, there could be an industry-wide flood of parties flocking to independent dispute resolution bodies like JAMS or AAA. Another trend to look out for would be state regulators “filling the gap.” Historically, when federal regulators pull back their enforcement efforts in a specific industry, states respond by increasing their own regulatory efforts. It is entirely possible, then, that a weakened FINRA could lead to the rise of state-level FINRA replacement agencies.
Barton will continue to monitor this case for any future developments. If you or your business have any questions about the regulatory landscape facing financial advisors, broker-dealers, or other financial industry queries, please contact Thomas White, A.J. Monaco, and James Heavey.
James E. Heavey
A.J. Monaco
Thomas C. White