New Trouble for Regulators at High Court; Union Files Grievance After CFTC Meeting Incident; Finra Gains Support in Constitutional Challenge
Capitol Account: Free Weekly Version
Even in a week cut short by a federal holiday, there was a lot going on in financial regulation. The CFPB, for once winning plaudits from the banking industry, proposed rules that would put Silicon Valley giants that operate in the payments space under the agency’s supervision. Chair Gary Gensler hit the speaking circuit, discussing everything from the lawlessness of crypto to Treasury market reform. There was even an ESG hearing in the House, though a few lawmakers and witnesses weren’t exactly sure why they were spending so much time on the subject. We dug into several lawsuits, including one looking to overturn the new SEC private funds rule, and another at the Supreme Court that could have a big impact on bank oversight. Finra’s supporters also filed amicus briefs in a case that questions the constitutionality of its judicial system. Lastly, we continued to cover the contretemps at the CFTC over a commissioner’s treatment of staff. Suffice it to say, the workers aren’t happy.
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More SCOTUS Trouble Ahead? The Supreme Court’s docket is already full of cases that could have a deep impact on financial oversight, including challenges to the CFPB’s funding and the SEC’s in-house judges. Last week, the justices decided to hear another that, depending on how they rule, may have even broader ramifications – for bank supervision, especially. It may also hit rulemakings like Gensler’s climate disclosure plan.
National Rifle Association v. Vullo, centers on whether a New York state banking regulator violated the NRA’s First Amendment rights by encouraging banks and insurers not to do business with the group in the wake of the 2018 school shooting in Parkland, Fla. Essentially, the NRA said that it was being punished for its “disfavored speech” of advocating for gun rights. Here’s how it described the claim in its petition to the court:
“Does the First Amendment allow a government regulator to threaten regulated entities with adverse regulatory actions if they do business with a controversial speaker, as a consequence of (a) the government’s own hostility to the speaker’s viewpoint or (b) a perceived `general backlash’ against the speaker’s advocacy?”
The case has been a bit of a sleeper because freedom of speech is not a subject that often comes up in financial regulation. “A lot of people are thinking about it more as a First Amendment case, which it is, obviously, but it’s also a banking regulation case,” says Keith Noreika, who served as acting comptroller of the currency during the Trump administration. “This is not a topic that the general counsels of the agencies spend a lot of time on – but they may have to start thinking about these issues in ways they haven't before.”
To Noreika and others, the case takes direct aim at how regulators, outside the normal rulemaking process, can push policies that go after lawful businesses (or activities) they may not like. This is a theme, of course, that has caused a lot of consternation among conservatives, especially as some banks have stopped providing services to gun manufacturers and energy companies.
There have also been high-profile examples of agencies being accused of overstepping their bounds. That includes the infamous “Operation Choke Point” scandal where the FDIC allegedly leaned on banks to cut off businesses like gun dealers and payday lenders where there was risk of money laundering and other fraud.
Some think that a broad ruling backing the NRA (not totally unimaginable with the high court’s 6-3 conservative majority) could curb some of the power that bank supervisors have to make demands through non-binding guidance or use “moral suasion” (ie. wink, wink, nod, nod) to get firms to drop unfavored clients or change business practices.
“If a regulator wants to talk about climate change or community reinvestment, there are a lot of bank CEOs jumping up and saying: `How high?’” says Norieka. “There have to be some checks, and I think we’re getting to the point of seeing this.”
A March amicus brief led by the Mercatus Center at George Mason University supporting the NRA’s request for certiorari, described the situation like this: “This particular case involving the NYDFS and the NRA is not the first example of regulators potentially abusing their unique positions of power for political, rather than bona fide regulatory, purposes and – unless it is curtailed – it will certainly not be the last.”
The filing took particular issue with the ability of regulators to use “informal statements and guidance” to influence firms that are largely unwilling to challenge their overseers. Much of the supervision occurs, it pointed out, out of the public view and includes monitoring things like “reputation risk” – an ambiguous concept. “These definitions are sweeping and vague, and provide significant discretion to examiners,” the brief noted.
In an interview, Brian Knight, a senior research fellow at Mercatus who spearheaded the amicus brief, notes that it’s impossible to know how the Supreme Court will rule. Still, he points out that “the nature of bank…regulation – how it’s actually conducted in the real world – is going to be a key component of the court’s analysis.”
One hope is that the justices could warn regulators to be more careful of taking actions that could chill free speech or violate due process rights. That also could mean agencies would need to more formally describe supervisory guidance on topics like reputation risk – perhaps even in formal rules.
“This case could provide a lot of needed restraint on an area of regulation that has become very opaque and very discretionary,” Knight says.
Spinning it out a bit further, Noreika says a broad ruling could strike at all sorts of regulations – Exhibit A being the SEC’s climate disclosure rule. There could be an argument, for example, that the agency is trying to compel speech through disclosure, essentially naming and shaming companies. While the scenario is a bit different than the NRA case, Noreika notes, “you’re kind of getting to the same place – where the current administration and the people running the SEC don’t want you to do business with heavily intensive carbon businesses.” … (Friday)
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Labor Unrest: The CFTC’s union has filed a grievance over Republican Commissioner Caroline Pham’s treatment of an enforcement lawyer at a closed-door meeting. The complaint contends that the derivatives regulator has allowed Pham to repeatedly intimidate and abuse employees, a situation that “has created and fostered a hostile work environment.”
The union is demanding that Pham undergo mandatory harassment training, write an apology to everyone who attended the closed meeting and apologize to the entire agency workforce. “If the CFTC does not act immediately, it will only exacerbate the problem and empower Pham’s continued hostility,” the union wrote.
The escalation isn’t completely surprising. As Capitol Account reported late last month, the episode prompted the chapter president Malcolm Alexander-Neal to send an email to members complaining about “unprofessional conduct” that “raised concerns about the way our staff was treated.” (Alexander-Neal didn’t identify Pham by name, but the new document does.)
Pham’s office said the grievance, submitted on Oct. 31, is an act of retaliation. Here’s a statement from Harry Jung, Pham’s counselor and senior policy advisor:
“The baseless grievance was only filed after Commissioner Pham received an anonymous harassing email that was reported by CFTC management on October 30, 2023, to workforce relations as in violation of the CFTC’s anti-harassment policy and federal laws. The email was concerning enough that the incident was also reported to the CFTC’s physical security and cyber security offices. The fact that this retaliatory grievance was filed the day after the CFTC management reported the harassment of Commissioner Pham speaks for itself.”
A CFTC spokesman declined to comment.
According to the grievance, Pham spent almost 30 minutes at the Oct. 20 meeting questioning the enforcement attorney “as if they were a hostile witness being cross-examined.” It added that the commissioner repeatedly raised her voice and made “angry facial expressions,” while only allowing the lawyer to provide “yes” or “no” responses to her questions.
At one point, the document stated, Enforcement Director Ian McGinley attempted to convey that all future interactions should be “conducted with respect.” But Pham intimated that she was the person “not being treated with respect.” (It's not clear what enforcement matter the commissioners were voting on.)
The union also described another meeting, in August, where CFTC staff observed “similar misconduct by Pham.” The commissioner allegedly subjected an enforcement manager to a “lengthy (sixty-plus minutes) harangue in which she questioned the manager about the intelligence and skill of the manager’s staff.” She also referenced the general counsel’s office, suggesting its workers were “equally incompetent,” the complaint said…(Tuesday)
Supporters Speak Up: Finra, facing what it has called an “existential” federal court fight over its constitutionality, now has some allies.
Its backers, who recently filed amicus briefs in the U.S. Court of Appeals for the D.C. Circuit, include other self-regulators like stock exchanges, state securities cops and attorneys who represent investors. Even a group that sets health and safety standards for horse racing is sticking up for the front-line brokerage overseer.
The supporters – like Finra – are warning of potentially profound consequences that loom in the case.
“If this court's ruling renders Finra unable to enforce its own rules, the various risks that it manages – including fraud, cybersecurity, and broker-dealer capital and financial responsibility – will fall on the shoulders of other [self-regulatory organizations] and market participants,” noted a group of SEC-registered clearing agencies, including the Options Clearing Corp. and Depository Trust Co. Calling the suit “meritless but dangerous,” they added: “Nothing compels the court to launch this parade of horribles.”
The North American Securities Administrators Association, which also weighed in, stressed that Finra “provides essential services…that state and federal securities regulators, thousands of firms, hundreds of thousands of registered persons, and millions of American investors rely upon.”
That includes monitoring some 3,400 firms and 624,000 registered brokers. Just in 2022, NASAA said, Finra expelled seven brokerages and 228 brokers – actions that other enforcers would likely have a tough time picking up. A ruling against the self-regulator would “disrupt the essential functioning of securities regulation and the nation’s securities markets, harming the economy,” NASAA concluded.
The litigation, filed by a brokerage called Alpine Securities, has taken on extra importance after a D.C. Circuit panel granted the firm an emergency injunction to halt an enforcement proceeding. One of the three judges, wrote in a concurrence that “there may be a constitutional problem” with the self-regulator’s judicial officers because they aren’t appointed by the president.
After the order was released in July, the case quickly became much more than just a standard enforcement proceeding. It has been heralded by conservative groups who have been looking to deal a blow to the so-called administrative state by reining in the power of federal agencies. That’s an issue, too, that the Supreme Court’s 6-3 conservative majority has shown a lot of interest in.
The opponents contend that Finra has essentially become a second SEC, without having to follow any of the traditional government checks and balances. As former Attorney General William Barr, who filed a friend of the court brief in September backing Alpine, emphasized, Finra exists in what is “effectively a Constitution-free twilight zone.” He argued that not only should the self-regulator’s judges be appointed by the president (or a subordinate such as an agency head), but also its CEO and board members because they exercise sweeping governmental powers as well.
Alpine raised its constitutional objections after a Finra hearing panel kicked it out of the industry in 2022 and ordered it to pay $2.3 million in restitution to customers. The litany of wrongdoing Alpine was accused of included misusing client funds and securities, engaging in unauthorized trading and charging excess fees…(Monday)
You’ve just read some 2,100 words on financial regulation. Seems like you might enjoy this every weekday…