On December 3, 2024, a federal lawsuit filed in the U.S. District Court for the District of Arizona challenges the authority of the Securities and Exchange Commission (SEC) to regulate outside business activities of employees through its oversight of Financial Industry Regulatory Authority (FINRA) rules. The case, Preston v. SEC, No. 2:24-cv-03396, raises significant constitutional and administrative law questions.
The Plaintiff's Claims
Joshua Matthew Preston, a JPMorgan employee, filed the suit pro se, asserting that FINRA Rule 3270—which governs employees' outside business activities—constitutes an unconstitutional delegation of regulatory authority. Specifically, Preston alleges that the rule improperly allows FINRA member firms, such as JPMorgan, to exercise overly broad oversight over employees' external engagements. According to Preston, this delegation violates:
- The First Amendment: By infringing on employees' rights to engage in lawful outside activities without undue restriction.
- The Fifth Amendment: Through depriving employees of due process rights when firms impose prohibitions or penalties.
- The Administrative Procedure Act (APA): By delegating rulemaking and enforcement authority without proper statutory authorization or oversight.
- The Ultra Vires Doctrine: As an action beyond the scope of SEC's statutory authority.
- Common Law Tort Principles: Arguing that the rule enables tortious interference with employees' lawful pursuits.
FINRA Rule 3270 and Its Implications
FINRA Rule 3270 requires registered individuals to notify their firms of any outside business activities and to receive firm approval before engaging in them. The rule's intent is to ensure that outside engagements do not create conflicts of interest or undermine the integrity of the financial industry. However, Preston contends that this framework allows firms to act as de facto regulators, wielding discretionary power that can stifle employees' professional and personal pursuits.
Constitutional and Regulatory Questions
Preston's case underscores broader debates about the delegation of regulatory authority within the U.S. administrative system. Key issues include:
- Delegation Doctrine: Can the SEC delegate enforcement of its rules to private entities like FINRA and its member firms? The nondelegation doctrine prohibits Congress from transferring legislative powers to private parties without clear guidelines.
- First Amendment Implications: By requiring pre-approval for outside activities, Rule 3270 could restrict employees' freedom of association and expression.
- Due Process Concerns: Firms' authority to deny outside activity requests or impose disciplinary actions may lack procedural safeguards, raising Fifth Amendment issues.
- Scope of SEC's Authority: Does the SEC's endorsement of FINRA rules overreach its statutory mandate under the Securities Exchange Act of 1934?
Potential Industry Impact
If Preston's claims succeed, the decision could ripple across the financial services industry, potentially curtailing firms' ability to enforce outside activity restrictions. This could prompt regulatory reforms to balance employee rights with firms' compliance and risk management objectives. Conversely, if the court upholds Rule 3270, it may reinforce the SEC and FINRA's approach to preserving market integrity through stringent oversight.
Looking Ahead
The court's resolution of Preston v. SEC could establish critical precedents on regulatory delegation and employees' constitutional rights. Stakeholders in the financial and legal sectors will closely monitor developments in this case as it progresses through the judiciary.
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