Wealth Advisor (February 6, 2024)

Legislators are intensifying their calls for the reform of arbitration processes involving disputes between clients and wealth advisors. This marks a significant push towards altering the prevalent arbitration clauses in service agreements, which have been a point of contention for advocates of investor rights.

The proposed Investor Choice Act, supported by members of the Democratic Party in both the House of Representatives and the Senate, seeks to eliminate the mandatory use of arbitration forums for the resolution of client grievances against brokers, registered investment advisors (RIAs), and other financial service professionals. Furthermore, this legislation aims to eliminate clauses that prevent clients from initiating class-action lawsuits against their financial advisors.

Representative Bill Foster (D., Illinois), who introduced the bill in the House, emphasized that individuals should not have to forfeit their legal rights as a condition of receiving financial planning or investment services. He asserts that the legislation is a crucial step towards rectifying a system that, in its current form, disproportionately benefits advisors by allowing them to select arbitration venues and set the rules of engagement, often to the detriment of the client.

One of the main criticisms of the existing arbitration system is its limitation on the discovery process, as governed by the brokerage industry’s self-regulatory body, Finra. This limitation restricts clients’ access to vital information that could support their case, effectively creating a system that the authors of the bill describe as biased against consumers.

Senator Jeff Merkley (D., Oregon), the leading proponent of the bill in the Senate, highlighted the inherent conflict of interest in a system where the advisor or broker not only selects but also compensates the arbitrator, potentially promising future business. This, according to Senator Merkley, undermines the fairness and impartiality of the dispute resolution process.

The Consumer Federation of America and the Public Investor Advocate Bar Association, among others, have voiced their support for the Investor Choice Act, pointing out the significant costs associated with arbitration and questioning the fairness of the process.

On the other hand, industry groups have defended arbitration as a more expedient alternative to court litigation. However, the debate has taken on a partisan character, with divisions emerging along party lines concerning the preservation of mandatory arbitration clauses and the allowance of class-action litigation.

The Securities and Exchange Commission (SEC), following directives from a 2022 funding bill, has been examining arbitration practices within the RIA sector. Unlike brokers, who typically resolve disputes through Finra, RIAs often engage private arbiters, predominantly from the American Arbitration Association, for dispute resolution.

The SEC’s findings reveal that a significant portion of advisors incorporate mandatory arbitration clauses in their service agreements, with a large majority opting for the American Arbitration Association as their preferred arbitration forum. However, the lack of transparency and public accessibility to arbitration outcomes and the accountability of advisors in fulfilling arbitration awards have been noted as areas of concern.

The SEC’s Office of the Investor Advocate recently issued a report critiquing forced-arbitration provisions and suggested that such practices could potentially breach the fiduciary duties of advisors by imposing undue costs and inconveniences on clients.

A newly formed coalition, supported by the backers of the Investor Choice Act, is actively campaigning for the abolition of forced arbitration, branding it as an unfair practice that benefits advisors at the expense of investors. Joe Peiffer, president of the Piaba, underscored the urgency of regulatory or legislative action to eliminate these practices, which he characterized as manipulative and detrimental to investor interests.