Financial Advisor IQ (February 2, 2024) By Glenn Koch

The newly formed Investor Advocacy Coalition is calling on the Securities and Exchange Commission to review registered investment advisors’ inclusion of forced-arbitration clauses in client agreements.

A coalition of investor-advocacy groups yesterday announced a campaign aimed at having the Securities and Exchange Commission review the practice among registered investment advisors of including forced-arbitration clauses in client agreements.

The process of forcing disputes into private arbitration “too often leaves retirees ripped off by unscrupulous RIAs and then priced out of justice by … folks who I call ‘fake fiduciaries,’” attorney Joe Peiffer, president of the Public Investors Advocate Bar Association, said during a press conference held by the newly formed Investor Advocacy Coalition at the National Press Club in Washington, D.C.

The coalition also includes the American Association for JusticeAmericans for Financial ReformBetter Markets, the Consumer Federation of America, the National Association of Consumer Advocates and Public Citizen.

A December report by the SEC’s Office of the Investor Advocate indicated that 61% of RIA firms working with retail clients use forced-arbitration clauses in their advisory agreements. The report recommended suspension of the practice of using such clauses “until further exploration of the associated costs and benefits to advisory clients is undertaken.”

Brady Williams, legal counsel at Better Markets, said yesterday that the clauses often impose “extraordinarily burdensome terms and costs,” such as filing and hearing fees, “staggering” forum costs, hedge clauses that narrow the misconduct for which the RIA can be held liable, choice-of-law clauses that impose the body of law most favorable to the RIA, and venue-selection clauses that often serve only to maximize the time and expense involved for a client to attend hearings.

Contrasting private arbitration to the public, member-funded system the Financial Industry Regulatory Authority uses for broker-dealers, Peiffer presented an example of an investor who had lost more than $250,000 and faced the prospect of having to nearly double her losses by paying about $200,000 as an up-front fee for the private arbitration proceeding mandated by the client agreement she signed with her RIA.

The coalition believes the Office of the Investor Advocate’s suggestion to pause use of forced arbitration does not go far enough.

“We recommend that mandatory arbitration clauses in advisor agreements be banned permanently,” Martha Perez-Pedemonti, civil justice and consumer rights counsel for Public Citizen, said at the conference. She announced that Public Citizen and 16 other groups requested such a ban in a letter sent Wednesday to SEC Chair Gary Gensler.

“We do not stand against the concept of arbitration. We stand against forcing investors to agree to arbitration even before a dispute arises, as a condition of using the services of a broker-dealer or investment advisor,” Perez-Pedemonti added.

Micah Hauptman, director of investor protection for the Consumer Federation of America, acknowledged that the Investor Advocacy Coalition’s proposal is one of many on a crowded regulatory agenda for the SEC but said that the proposal may not necessarily require immediate regulation.

“I think that [the SEC] could provide guidance and provide some fact patterns that they would view as inconsistent with an advisor’s fiduciary duty,” Hauptman said at the conference.

“For example, if it’s too cost-prohibitive to bring small claims, if investors are required to travel an unreasonable distance, if the rules are procedurally or substantively unfair to investors, if there is secrecy that doesn’t allow other investors to make an informed decision about who to select as an advisor, I think those factors should be deemed inconsistent with an advisor’s fiduciary duty.”

The SEC did not respond to FA-IQ's request for comment.