Financial Advisor (January 21, 2022) – The Public Investors Advocate Bar Association (PIABA) says it has begun lobbying the SEC to either do away with the forced arbitration clauses RIAs foist upon clients or require the industry to pick 80% to 90% of the tab for investors’ arbitration costs.

Right now, an investor filing an arbitration claim against an RIA would need to advance more than $30,000 to cover their anticipated private arbitration forum fees upfront, according to the PIABA.

That’s compared with an average of $2,300 in upfront fees a brokerage investor would need to pay to use the Financial Industry Regulatory Association’s (Finra’s) arbitration forum, which also allows investors to settle their fees after their arbitration claim is decided, the organization said. Moreover, Finra-registered firms are required to pay most of the cost for arbitration themselves.

Regulators should either do away with forced RIA arbitration or “firms should pay 80% to 90% of arbitration fees, like Finra firms do,” PIABA President Michael Edmiston said in an interview.

Forced arbitration “works out well for the RIA industry,” Edmiston said. “I can’t tell you how many times I’ve had to say, ‘I see you have a JAMS clause in your RIA contract so you’ll need to advance $30,000.”

The American Arbitration Association (AAA) and JAMS are the two leading national forums that most RIAs with arbitration clauses use and arbitrators set their own rates, said Edmiston, a former arbitration forum executive himself in the early 2000s.

“AAA and JAMS charge the rates they can because their bread-and-butter business is really meant to be arbitration between Fortune 500 companies, but when individual investors who have already lost money are asked to use the forums, they’re usually in no position to pay that,” Edmiston said.

The private arbitration forum arbitrators can charge $8,000 or more for a day’s work. Arbitration costs can easily exceed $64,000 for five days of hearings and three days of pre-hearing and post-hearing work. Triple that amount if there are three arbitrators hearing the dispute, he said.

“What happens is you have retiree who have lost their retirement savings because of a bad actor and they literally cannot afford to get their money back in arbitration,” he said.

“We hear ‘God, I could lose more money” or ‘Oh my God, I don’t have any money left to pay for this,’” said Edmiston, an attorney with the law firm Jonathan W. Evans & Associates in Studio City, Calif.

The veteran investor advocate attorney said he knows getting both the Securities and Exchange Commission and state regulators to change the RIA arbitration landscape will be an uphill, but necessary battle.

“It’s going to be a long project, but we had to start the process. We’re going to start pushing the SEC and NASAA [the North American Securities Administrators Association]. We have ongoing conversations with the SEC right now and we understand that this issue is a point of interest for them,” the PIABA president said.

The trade group is also “continuing to talk with NASAA senior leadership about RIA arbitration issues,” he added.

Solving the problem is not easy because of the fragmented regulatory system governing RIAs, he said. SEC regulates advisors with assets under management in excess of $100 million, while individual states regulate those with under $100 million.

There are more than 14,000 SEC-registered advisors and more than 17,000 state-registered advisors. For any uniform solution to be implemented to solve the forced arbitration problem, the SEC and the states must act in concert, Edmiston said.

At the same time, neither the SEC nor the states have a handle on any cost or outcome data for RIA arbitration, so PIABA is also asking regulators to begin to study the topic.

The need to act is critical as more assets shift from the brokerage side of the industry to the advisory side and more RIAs use forced arbitration clauses, Edmiston said. Unlike Finra cases, with RIA arbitrations the privately run forums require the expected fees to be deposited prior to the case proceeding. This means that an investor may have to deposit tens of thousands of dollars just to have their claim move forward, he added.

Edmiston and his team of attorneys at PIABA are presenting the SEC and NASAA with three possible solutions. The first involves prohibiting RIAs from using forced arbitration clauses in their account agreements, which gives harmed clients the opportunity to file a lawsuit in court.

The state of Virginia has already prohibited RIAs from using forced arbitration clauses by RIAs in a regulation that called such pricey, forced agreements “dishonest or unethical business practices.”

Second, RIAs can also be required to pay all the costs of the forum they have designated in their arbitration clause, except for a nominal filing fee. “This puts the cost burden on the more sophisticated party that forced arbitration, as opposed to the consumer or employee, who was forced to waive their right to pursue a claim in any other forum,” Edmiston said.

Finra also permits claims against RIAs to proceed in its forum, so long as both sides agree, and the firm agrees to bear a significant portion of the forum fees. However, few RIAs agree to proceed using Finra, he said.

Finally, the RIA client should be permitted to choose between court and arbitration after the dispute arises, so that the investor can make a decision that fits his or her needs best, he said.

The Investor Choice Act, which was introduced in the U.S. House by Rep. Bill Foster (D-Ill.) in 2021 with seven co-sponsors, would give investors that right.

“Without reform, a rapidly growing number of investors will not have the opportunity to purse fair and accessible right of action to pursue recovery of funds lost because of the misconduct of a trusted advisor,” Edmiston said.