Sixth Circuit Upholds FINRA Jurisdiction Over Unregistered Broker-Dealer Controllers

The Sixth Circuit has affirmed FINRA’s authority to discipline the controlling owner of a registered broker-dealer who never personally registered with the self-regulatory organization – while simultaneously acknowledging that the disciplinary process may have violated his right to a jury trial, a right the court said it could not address on procedural grounds.

In an amended opinion issued this week in Smith v. Securities and Exchange Commission and FINRA, a three-judge panel denied the petition for review filed by Eric S. Smith, founder and chief executive officer of Consulting Services Support Corp., a financial services holding company whose subsidiary operated as a FINRA-registered broker-dealer. The panel left intact a FINRA bar and $130,000 restitution order stemming from misleading disclosures in a 2015 debt offering that caused four investors to lose a combined $130,000.

The ruling carries practical implications for senior executives at alternative investment firms with affiliated broker-dealer entities who hold management roles without maintaining personal FINRA registration.

FINRA’s Reach Over Non-Registered Controllers

Smith argued that FINRA lacked authority over him because he had never personally registered as a broker or dealer. The panel disagreed, relying on the Securities Exchange Act’s definition of persons “associated with” a member firm, a category that expressly includes anyone who “directly or indirectly controls” a FINRA member.

The court found that Smith, who served as chairman and chief executive officer of the parent entity and took an increasingly active role managing the broker-dealer’s debt offerings between 2010 and 2015, qualified as an associated person regardless of his personal registration status. The holding confirms that executives who exercise control over registered entities are subject to FINRA’s disciplinary authority even without individual registration.

The Constitutional Question the Court Declined to Answer

More consequential than the jurisdictional ruling is what the panel said it could not decide. Smith argued that FINRA’s in-house disciplinary proceeding violated his Seventh Amendment right to a jury trial, a right the Supreme Court recognized in SEC v. Jarkesy for fraud-based monetary sanctions imposed through administrative proceedings.

The panel declined to reach the argument. Under the Securities Exchange Act, petitioners must raise issues before the SEC before a reviewing court can consider them, and Smith had not pressed the jury trial argument in the proceedings below.

But the majority did not leave the issue unexamined. Writing for the panel, Judge Chad Readler said Smith’s case is “difficult to distinguish” from Jarkesy and that Smith “may well have been entitled to a jury trial” had he raised the constitutional argument before the agency. The observation carries no binding force – it is dicta – but it signals the Sixth Circuit’s view that FINRA’s disciplinary process faces unresolved constitutional exposure in Jarkesy’s wake.

Judge Rachel Bloomekatz wrote separately to object to the majority examining constitutional questions on a procedurally barred claim at all.

Judge Eric Murphy wrote a separate concurrence raising a deeper issue: the “unconstitutional conditions” doctrine. Even accepting that Congress can condition participation in the securities markets on submitting to FINRA’s disciplinary jurisdiction, Murphy asked, can it constitutionally require that submission to also extinguish jury trial rights that the Seventh Amendment otherwise guarantees?

NCLA’s Rehearing Challenge

The New Civil Liberties Alliance, which represents Smith, filed a petition for panel or en banc rehearing on June 10 – before the amended opinion was issued – arguing that the panel’s approach to the issue-exhaustion requirement creates a structural constitutional problem.

The NCLA’s central argument: constitutional challenges to agency adjudication, particularly those rooted in Article III and the Seventh Amendment, should not have to be raised first before the very agency the challenger contends is operating unconstitutionally. The SEC and FINRA, as executive and self-regulatory entities, lack authority to adjudicate structural constitutional claims; requiring a litigant to raise such claims before them serves no functional purpose and forces enforcement targets into a procedural trap.

The NCLA also points to the SEC’s conduct after Jarkesy as evidence of futility. The agency took nearly four years to decide Smith’s administrative appeal, issuing 11 delay orders along the way, and has continued to take the position that no jury trial right attaches in FINRA disciplinary proceedings even after the Supreme Court’s ruling.

The amended opinion addressed a separate objection in the petition – the original opinion’s comparison of Smith to Jordan Belfort, the subject of the film “The Wolf of Wall Street” – by amending the language to note the comparison held “for entirely different reasons.” The substantive holdings were unchanged.

“Agencies enforce the law while Article III courts interpret our Constitution and laws,” said Russ Ryan, senior litigation counsel at the NCLA. “Targets of SEC law enforcement should not have to beg their prosecutors for a nonbinding advisory opinion about their constitutional rights before seeking Article III judicial relief to protect those rights.”

Industry Watch

The constitutional questions in Smith are not confined to its facts. Multiple pending FINRA disciplinary matters have raised similar Jarkesy-based challenges, and whether the Exchange Act’s exhaustion requirement can serve as a procedural bar to constitutional claims is likely to be litigated further across circuits.

For the alternatives distribution industry, the jurisdictional holding has immediate relevance. Controlling shareholders, parent company officers, and holding company executives who exercise operational oversight of FINRA-registered subsidiaries may be subject to FINRA’s disciplinary authority regardless of personal registration status. The Smith rehearing petition remains pending before the Sixth Circuit.

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