Financial Advisor IQ (July 26, 2023) - An organization of plaintiffs’ lawyers urged the SEC to increase investor choice regarding where to settle claims and to require RIAs to disclose information around claims and their resolutions.

Industry watchers highlighted the faults of mandatory arbitration clauses used by registered investment advisors and called on the Securities and Exchange Commission to increase regulation around the practice during a webinar hosted by Public Investors Advocate Bar Association.

Lawyers speaking during Tuesday’s webinar asserted that the widespread use of mandatory arbitration clauses can cause investors to get priced out of justice or left without awarded funds, referencing the SEC’s June report regarding the practice. The report estimated that about 61% of SEC-registered advisors that serve retail investors incorporate mandatory arbitration clauses into their investment advisory agreements. The SEC noted that it was unable to determine the “effect such contracts with mandatory arbitration clauses have on investors that are harmed by the conduct of advisers,” and, because of a lack of centralized reporting of claims against RIAs, could not quantify the number of unpaid awards.

“The SEC report highlighted the irony of RIA fiduciaries being allowed to treat their aggrieved customers far worse than brokers who claim they are not fiduciaries are allowed to do,” said Joseph Peiffer, lawyer at Peiffer Wolf Carr Kane Conway & Wise and an incoming president at Piaba.

Affected investors and their representatives also spoke out Tuesday against the unregulated practice and relayed stories about the high costs and uncertainty inherent in the arbitration process.

Marykay Dragovich, a conservator of a victim of misconduct by an unidentified RIA, described the costly process of seeking justice after an advisor placed her cousin's money into risky investments that were expected to “time the market” but ultimately resulted in $228,167.67 in principal losses. The process was initially expected to cost Dragovich between 40% and 90% of the losses to pay for the arbitrators. After negotiating with Judicial Arbitration & Mediation Services to only use one arbitrator, Dragovich was able to reduce her costs but was still expected to pay a bill of $32,000 plus an additional 13% JAMS case management fee to proceed with the case.

“We were shocked and completely dumbfounded that this is how the system actually works,” said Dragovich. “It really makes you wonder how many investors can afford to pay thousands of dollars out of pocket right after getting hit with huge life-saving losses. Where is the justice?”

Michael Phillips, a former client of Asia Pacific Financial Management Group, an RIA and broker-dealer based in Guam, also took the stage to discuss his fight to receive his arbitration award after, he claims, the firm filed for bankruptcy to avoid paying the award. During his time as a client, the firm bought and sold large volumes of high-risk equities without receiving his approval, he said. The firm also changed paperwork indicating that Phillips was a moderate risk investor with no investor experience to match the risky trading and as a result of its actions, he lost all his retirement savings, he added.

Phillips initiated arbitration claims against the firm in October 2021. After a lengthy process, a panel of Financial Industry Regulatory Authority arbitrators ordered Asia Pacific to pay about $1.5 million in compensatory damages and an additional $1.5 million in punitive damages plus interest in February of this year. However, just a month later the firm sought a motion to vacate the arbitrators' decision before filing for bankruptcy the following month.

“It's now obvious the Asia Pacific had no intention to abide by, or even litigate or honor, the arbitration award in the Superior Court of Guam,” said Phillips.

The association said it would like to see investors who experience misconduct have a greater choice as to where to settle claims as a possible solution moving forward.

Unlike brokerage firms, which must designate Finra as the arbitration forum, RIAs typically require clients to file arbitration claims with privately run dispute-resolution forums such as the American Arbitration Association or Jams, where arbitrators set their own fees. In the Finra forum, by contrast, Finra sets the arbitrators’ rates.

“Let the investor choose whether arbitration or court is the best forum,” said Piaba President Hugh Berkson. “It happens pretty much everywhere else except the financial services industry.”

Berkson added that the SEC should mandate that RIAs disclose the existence and resolution of claims in the same way that broker-dealers are required and prohibit class-action waivers.

The organization said it plans to continue to speak with wronged investors and other parties in the coming weeks to produce specific solutions to address the shortcomings in current regulation and warned that it’s willing to take matters beyond the SEC if needed.

“If the SEC will not move forward on its own accord, we will use all other efforts with Congress to encourage that,” said Berkson.