Financial Advisor (May 19, 2022) - A coalition of investor advocates are urging the SEC to investigate registered investment advisors' use of predispute arbitration clauses that allegedly force investors with complaints into pricey, private-forum arbitration where a five-day arbitration can cost them $64,000,
The coalition requested the investigation in a letter to SEC Chairman Gary Gensler yesterday because “RIAs are not adequately disclosing their use of predispute arbitration clauses, and may be disadvantaging investors by designating expensive forums and otherwise limiting investors’ rights to pursue their claims,” said the group, which includes the Consumer Federation of America (CFA), Public Citizen and the Public Investors Advocate Bar Association (PIABA).
Like the brokerage industry, RIAs now regularly include forced predispute arbitration clauses in their account agreements. But unlike brokerage firms, RIAs don't have to include Finra Dispute Resolution Services as an available forum.
Instead, RIAs designate private dispute resolution forums such as the American Arbitration Association or JAMS in their clauses. These forums are significantly more expensive than Finra arbitration, where an investor’s filing fee is based on a graduated scale depending on the size of the damages claim, and ranges from $50 to $2,300.
In forced RIA arbitration “it is not uncommon for a single arbitrator in JAMS (where arbitrators set their own fees in addition to what the forum charges for its administrative fees) to charge $8,000 or more for a single day’s work,” the coalition members said in their letter to Gensler.
The arbitrator’s fees alone can easily exceed $64,000 for five days of hearings and pre- and post-hearing work and investors are required to deposit half, the group said.
“Imagine being required to front $32,000 for the opportunity to try to recover your losses. If there are three arbitrators hearing the dispute, the fees can be triple that amount,” the coalition said.
Currently, there are more than 31,000 federal- and state-registered RIAs, compared with 3,400 brokerage firms regulated by Finra.
RIA forums “are far more expensive than the Finra forum and require the investor to make a sizable deposit to proceed with their claims,” the coalition wrote.
Such “exorbitant expenses are often far too much for retail investors who have already lost much of their savings,” the group said.
According to PIABA President Michael Edmiston, when an RIA intentionally names an expensive private dispute resolution provider in an arbitration agreement “to act as a shield against client claims, that is the RIA putting its interests ahead of its client. That is a breach of the RIA's fiduciary duty.
“An RIA should have the courage to disclose the client's share of cost of an arbitration may range between $20,000 and $40,000. The duty to disclose extends to the RIA's efforts to inappropriately shield itself from claims. The fiduciary obligations owed by an RIA to a client remain in good times and bad,” Edmiston said.
If an RIA names an expensive dispute resolution provider, uses an “illegal hedge clause to limit claims and damages” and picks a hearing location far from the investors' residence, the RIA is acting solely in the best interest of the RIA, Edmiston added.
Right now, no regulator compiles or analyzes RIA arbitration statistics. To combat that, the coalition urged the SEC to compile public data, track investor complaints and their outcomes and create a uniform disclosure to be used regarding RIA arbitration clauses.
“This lack of transparency is particularly troubling in the context of recent trends in the securities industry, which show mass migration of assets from Finra-registered broker-dealers to SEC- and state-registered RIAs,” the coalition wrote.
Gensler has said in congressional hearings he supports limiting the use of forced arbitration by broker-dealers. The SEC did not respond to a request for comment on the coalition’s push for an SEC investigation.