Daniel Nam


I. The Tension between the SEC and FINRA

Payment for Order Flow (PFOF), a compensation paid to brokers for directing customers’ orders to particular trading venues, has been a hotly debated topic in Washington recently.[1] Its potential harmful effects to the investing public, including incentivizing brokers to prioritize PFOF violating their best execution obligation,[2] and the suspicion that it contributed to the GameStop event in January 2021[3] seem to be part of the reason. Robinhood, a zero-commission brokerage firm that had more than 70% of its revenue in 2020 generated from PFOF[4], is alleged to have contributed to the GameStop event by gamifying investing and goading retail traders into trading more than what is optimal for their profitability for more PFOF.[5] In an investigative report released on October 18, 2021, the SEC designated PFOF as one of the “areas of market structure and our regulatory framework for potential study and additional consideration” among others.[6] Gary Gensler and Robert Cook, the SEC Chair and FINRA CEO, respectively, testified before the House Financial Services Committee on PFOF and other issues.

Aside from the rarity of retail investors one-upping institutional short-sellers, what was intriguing about the event was that the heads of the two regulatory bodies exhibited slightly different stances toward PFOF. Cook highlighted FINRA’s effort in assuring compliance with order handling and best execution as well as PFOF’s legitimacy provided it does not interfere with best execution and vowed to assist the SEC in improving related disclosure.[7] Gensler has, however, hinted at the possibility of banning PFOF altogether.[8] Their differing stances on PFOF suggest something larger is at play here—it is the tension between the SEC, a federal oversight agency, and the FINRA, a self-regulatory organization (SRO).

II. The Significance and Inherent Problems of FINRA as SRO

FINRA was created in 2007 as a result of a merger between the NASD and the regulatory arm of the NYSE. Currently overseeing over 624,000 brokers and recording $1,105.6 million in revenue in 2021,[9] FINRA has grown to rival the SEC, both in size and importance. But as FINRA grew bigger, the inherent problems it had grew in tandem. Even though FINRA is a non-profit organization, its members that fund its operation are not. The governance structure of FINRA, particularly its board composition,[10] also makes it hard to say that it is a completely public regulatory organization. There is an inherent conflict of interest between FINRA’s regulatory objectives, such as “foster[ing] market transparency,”[11] and private for-profit motives, such as allowing dubious practices like PFOF that can diminish price accuracy. The conflict becomes particularly poignant in the financial context because, as the issue of PFOF shows, it is often a zero-sum game between the public and the industry. Robinhood’s settlement with the SEC in December 2020 for an alleged violation of its duty of best execution with PFOF[12]and FINRA’s inaction and effective endorsement of the same behavior that caused a market distortion earlier this year illustrate the issue.

On the other side of the scale, however, are the many traditional benefits of industry self-regulation—access to superior industry expertise, stability and independence from federal funding, and the freedom to impose higher ethical standards upon members by the threat of expulsion that the federal government cannot replicate.[13] So the balancing is a difficult one, to say the least.

III. Possibility of a Constitutional Challenge Against FINRA

Aside from the complicated balancing consideration mentioned above, however, scholars have voiced concerns about numerous constitutional problems with FINRA and other SROs as well. Such problems include the nondelegation doctrine, separation of powers issue, appointment clause and state action risks.[14] With the current six-to-three conservative dominance of SCOTUS justice composition, and each of the six conservative justices having expressed their unease with the status quo of SROs,[15]there is a real danger of an unfavorable constitutional ruling by the Supreme Court that will invalidate SROs’ actions or existence altogether. Given the greater role FINRA has come to play in the federal government’s securities market regulation scene, such ruling is guaranteed to cause complete mayhem.

IV. Potential Mitigating Solutions

Therefore, regardless of whether one sees more benefit or harm in FINRA, it will be worthwhile to consider the various reform measures for FINRA suggested by some scholars—including contingency statutes that will turn over FINRA’s regulatory functions to the SEC in case of an unfavorable SCOTUS decision that will minimize the regulatory vacuum; structural changes that will either revert FINRA back to its private origin or convert it entirely to governmental agencies; increasing external oversight and etc.[16] There will not be one solution that fits all SROs, and there should be a lively discussion about what unique preventative measures may be taken with FINRA. But one thing that is certain is that it is not okay for FINRA to self-regulate as it does now.



[1] JD Supra, Stopping GameStop Games: Regulators Eye Payment for Order Flow (Sept. 20, 2021), https://www.jdsupra.com/legalnews/stopping-gamestop-games-regulators-eye-3860012/; Justin Chretien, The SEC May Soon Propose Changes to Equity Market Structure: What Traders Should Know, Traders Magazine (Nov. 5, 2021), https://www.tradersmagazine.com/am/the-sec-may-soon-propose-changes-to-equity-market-structure-what-traders-should-know/.

[2] FINRA, Securities Offering and Trading Standards and Practices R. 5310 Best Execution and Interpositioning, FINRA Rules, https://www.finra.org/rules-guidance/rulebooks/finra-rules/5310 (providing that, “[i]n any transaction for or with a customer or a customer of another broker-dealer, a member and persons associated with a member shall use reasonable diligence to ascertain the best market for the subject security and buy or sell in such market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.”)

[3] JD Supra, supra note 1.

[4] John Detrixhe, Robinhood shares have dropped as regulatory worries stack up, Quartz https://qz.com/2078712/robinhood-fell-as-sec-scrutinizes-crypto-payment-for-order-flow/.

[5] JD Supra, supra note 1.

[6] SEC. & EXCH. COMM'N, Staff Report on Equity and Options Market Structure Conditions in Early 2021, 45 (2021), available athttps://www.sec.gov/files/staff-report-equity-options-market-struction-conditions-early-2021.pdf.

[7] Robert W. Cook, Statement Before the Financial Services Committee U.S. House of Representatives (May 6, 2021), available athttps://www.finra.org/media-center/speeches-testimony/statement-financial-services-committee-us-house-representatives.

[8] Thomas Franck, SEC chief Gensler says regulator assessing future of payment for order flow, CNBC, https://www.cnbc.com/2021/10/19/sec-chief-gensler-says-regulator-assessing-payment-for-order-flow.html; Manojna Maddipatla and Sahil Shaw, SEC chairman says ban of payment for order flow 'on the table', Reuters, https://www.reuters.com/legal/litigation/sec-chairman-says-ban-payment-order-flow-on-table-barrons-2021-08-30/.

[9] FINRA, NASD and NYSE Member Regulation Combine to Form the Financial Industry Regulatory Authority – FINRA, https://www.finra.org/media-center/newsreleases/2007/nasd-and-nyse-member-regulation-combine-form-financial-industry (July 30, 2007); FINRA, FINRA 2020 Annual Financial report (2021), available at https://www.finra.org/sites/default/files/2021-06/2020-annual-financial-report.pdf; Fin. Indus. Reg. Auth., About the Financial Industry Regulatory Authority, FINRA, https://www.finra.org/about. 

[10] Susan Antilla, Finance Execs Fill ‘Public’ Board Seats at Finra, the Regulator that Promises Investor Protection: The powerful Board of Governors at Finra divvies up board seats among ‘public’ and ‘industry’ members. So why is Finra letting people from the financial world take the public seats?, The Street, https://www.thestreet.com/opinion/finance-execs-fill-public-board-seats-at-finra-the-regulator-that-promises-investor-protection-13684706 (Aug. 26, 2016); Andrew Stoltmann & Benjamin P. Edwards, Finra Governance Review: Public Governors Should Protect the Public Interest, 24 PIABA B.J. 369, 382 (2017).

[11] FINRA, About the Financial Industry Regulatory Authority, FINRA, https://www.finra.org/about/what-we-do.

[12] In the Matter of Robinhood Fin., LLC, Respondent., Securities Act Release No. 10906 & Exchange Act Release No. 90694 (Dec. 17, 2020)

[13] Benjamin P. Edwards, Supreme Risk, 85 Fla. L. Rev., Forthcoming, available at SSRN: https://ssrn.com/abstract=3907534

[14] Id.

[15] Gundy v. United States, 139 S. Ct. 2116, 2131 (2019) (Gorsuch, J., joined by Roberts, C.J. & Thomas, J., dissenting); id. at 2130-31 (Alito, J., concurring in the judgment); Paul v. United States, No. 17-8830, slip op. at 2 (U.S. Nov. 25, 2019) (statement of Kavanaugh, J.); Amy Coney Barrett, Suspension and Delegation, 99 Cornell L. Rev. 251 (2014).

[16] Edwards, supra note 13.