Business Law Prof Blog (July 27, 2023) - Last month, the SEC released a report on Mandatory Arbitration Among SEC-Registered Advisers.  The report tackles a basic dispute resolution problem.  For context, investors with a problem with a financial adviser will likely have to go to arbitration.  If their financial adviser is an associated person for a FINRA-registered brokerage firm, the dispute will likely go through FINRA arbitration.  While the FINRA system isn't perfect, it's often much better than any other alternative out there.  FINRA has made improvements to its arbitration process over the years resulting in a forum that has become fairer for investors.

But many financial advisers are not brokers.  They are registered investment advisers.  They usually charge fees on an assets under management basis.  Where do disputes against these RIA firms go?  It depends on what kind of pre-dispute arbitration agreement exists between the adviser and the investor.  The SEC report details the current options available to investors.

Here's the short version, far too many RIAs have put in place arbitration agreements that effectively frustrate an investor's ability to resolve a complaint.  Most of these agreements force investors to resolve their disputes through AAA--the American Arbitration Association.  Within that forum, Advisers generally elect to apply the commercial arbitration rules.  The fees for commercial arbitration can be hefty and enough to deter many investors from even filing a claim.

PIABA, the Public Investor Advocate Bar Association, recently put out its view to follow on the SEC's report.  It allowed one investor to explain the impact of the arbitration provision on her ability to seek a recovery:

Marykay Dragovich, the conservator for her cousin Rita Berardelli, described the process of forced arbitration after their trusted RIA lost over $228,000 in principal investments, money that Berardelli had saved as a registered nurse before suffering two life-altering brain aneurisms that left her incapacitated.  When Dragovich investigated recovering the losses for her cousin, she learned it would cost up to $202,000 to pay the upfront costs of an arbitration hearing.  So even if Berardelli got all her money back, she would have to pay as much as 90% of it to the arbitrators as prescribed by the overlooked forced arbitration clause in the agreement with her RIA.

Congress or the SEC will need to act to ensure that investors, who are now locked out of courts by arbitration agreements, will not also be locked out of arbitration by excessive fees.


** Disclosure -- I am a member of PIABA.