Global financial stability depends on steady capital markets. At present, US markets represent about 38% of global equity and fixed income markets. US markets themselves rely on quasi-governmental self-regulatory organizations (SROs) such as stock exchanges, derivatives exchanges, futures and brokerage organizations, and clearing houses. These all face an unappreciated risk: that the post-Trump era US Supreme Court may render a market-destabilizing decision in the foreseeable future. Little thought has been devoted to a response should American courts cause capital markets to freeze up from legal uncertainty. If corporations and municipalities cannot secure expected financing as bonds come due in the ordinary course, stalled capital markets may trigger waves of defaults and massive insurance pay-outs. Interest rates will rise, and lending will slow, driving consequences throughout the global economy.
For many years, these types of scenarios would have been entirely implausible. After all, American SROs have supported markets for generations. Many courts have found that they operate as private-sector organizations. Yet both SROs and the American Supreme Court have changed in ways that make the possibility that a Supreme Court decision will invalidate or interfere with SROs much more likely.
Consider how SROs have matured from their private-club origins. In the aftermath of the Great Depression, Congress struck a political compromise with the New York Stock Exchange and other exchanges, subjecting them to supervision by the Securities and Exchange Commission (SEC). To regulate off-exchange trading, Congress later mandated that brokerages be members of an SRO, and the Financial Industry Regulatory Authority (FINRA) is the one they joined. In the 1970s, reliance on the SRO model expanded again with a series of changes to the federal securities laws. Other SROs, such as the National Futures Association, have come into being. SRO responsibilities have also changed, with Congress adding requirements that SROs enforce federal securities laws. The SEC also gained the power to amend an SRO’s rules under its own authority. At present, SROs enforce federal law, and the SEC has the power to amend SRO rules to effectively compel SRO compliance.
The American Supreme Court has also changed in significant ways that implicate constitutional interpretation. With conservative justices ascendant, changing constitutional doctrines may place SROs on the wrong side of constitutional boundaries. For example, a majority of the Supreme Court has signalled an interest in reconsidering or extending the nondelegation doctrine. Although enormous controversy exists over the existence and scope of the doctrine, it is best understood as drawing the line between regulators merely implementing what Congress directed the executive to do and impermissibly legislating. Supreme Court decisions cutting back on congressional delegation may ripple down to SROs’ exercise of delegated governmental power. SROs could also face disruption if the Supreme Court takes a renewed interest in its private nondelegation doctrine.
Similarly, recent Supreme Court decisions on Separation of Powers and Appointments Clause doctrines also pose a significant risk to SROs. In both areas, the Supreme Court has invalidated regulatory structures that it saw as impermissibly insulating regulatory authority from presidential control. These decisions pose a real danger to SROs because their governance structures often insulate SRO leadership and significant officials from political influence. These structures undoubtedly limit a president’s ability to control personnel and ensure the faithful execution of the laws. That they also limit political interference may be beside the point.
Some of these dangers have been recognized before. Others have raised questions about the constitutionality of FINRA or the Municipal Securities Rulemaking Board. Much of the existing analysis begins with Free Enterprise Fund, a critical Supreme Court case where Chief Justice Roberts declared for-cause removal protections for members of the Public Company Accounting Oversight Board (PCAOB) unconstitutional. The court has changed significantly since then, and new decisions have extended its reasoning. For example, last June, in Collins v. Yellin, the Supreme Court invalidated removal protections for the head of the Federal Housing Finance Agency (FHFA). In the majority opinion, Justice Alito rejected a string of attempts to distinguish the FHFA from the PCAOB, including a proposed distinction pointing out how the FHFA operates as a private entity when it acts as a receiver. Justice Alito rejected the proposed distinction because the FHFA must still interpret and apply federal law. As SROs now enforce and necessarily interpret and apply federal law, they may be increasingly vulnerable to challenge.
Of course, the PCAOB and the FHFA differ from most SROs because their leaders are appointed by public officials. That SRO leaders are not government-appointed may not suffice to shield SROs from a court concerned with protecting the president’s duty to ensure the faithful execution of the laws.
My point here is not to take a side in the constitutional debates over these doctrines. Rather, my aim is focus attention on the possible second- and third-order consequences flowing from changing Supreme Court doctrine. The Supreme Court might never tangle with SROs. It might shy away from extending its emerging doctrines to invalidate SROs. SROs and regulators should still plan for the possibility. It would not be wise to play chicken with a possible financial crisis in the balance.
SROs, financial institutions, regulators, and legislators must begin to monitor this risk and consider ways to mitigate the dangers. Prudential changes to SRO structures and responsibilities might substantially reduce risk. These changes could run in either direction by consolidating SROs within the federal hierarchy or by returning them to their roots as private clubs. Congress might also craft contingency statutes to allow regulators to nationalize SROs or SRO responsibilities in the event of an adverse judicial decision.
Benjamin P Edwards is Associate Professor at the University of Las Vegas, William S Boyd School of Law. This post is based on his recent article, ‘Supreme Risk,’ available here. A version of this post was previously featured on the Columbia Blue Sky Blog.