ABS Market Research (June 29, 2023) - A recent report from the U.S. Securities and Exchange Commission (SEC) has raised concerns about the practice of including mandatory arbitration clauses in contracts for clients of registered investment advisers. Released by the U.S. House Committee on Appropriations, the report suggests that these clauses could significantly limit the ability of clients to seek legal remedies in the event of a dispute.
However, due to inadequate disclosure requirements, the SEC was unable to gauge the extent of this issue fully. The existing arbitration disclosure requirements prevented the SEC staff from reviewing a comprehensive data set or sample of clients involved in such proceedings. Therefore, the agency turned to eight external stakeholder groups, identified as having relevant information or having publicly expressed opinions on mandatory arbitration, for insights into how these clauses affect end consumers.
The SEC also tried to examine how unpaid arbitration awards are settled but encountered a lack of information in this area as well. The report noted that private dispute resolution forums do not track information about unpaid awards, and private arbitrators do not have authority over the parties once they issue an award. As a result, disputes over unpaid awards have to be litigated in the court system.
Hugh Berkson, President of Public Investors Advocate Bar Association (PIABA), expressed frustration over the lack of hard data on the subject. In 2021, Berkson published a report alleging that 30% of arbitration awards go unpaid. He, along with PIABA, has been advocating for SEC intervention.
The SEC report found that approximately six in 10 registered investment advisers (RIAs) include arbitration mandates in client agreement contracts. It concluded that the nature and limitations of many of these mandates could disadvantage or discourage clients seeking restitution. In some cases, the requirement was embedded in another contractual provision, and the language was often ambiguous.
The report also highlighted concerns about the arbitration forum or location of proceedings, which can result in high fees and travel expenses for clients, potentially deterring them from pursuing legal remedy.
Furthermore, the SEC found that nearly one-fifth of firm contracts with mandated arbitration also include fee-shifting provisions, requiring the losing party to pay all legal fees, hedge clauses that can limit advisor liability, and prohibitions on disclosure of settlements. Much of the language in these agreements can mislead clients into believing they are restricted from pursuing other legal remedies.
Joseph Peiffer, PIABA’s incoming President, called the findings a “double whammy for American investors.” He urged the SEC to act to end the practice of advisors slipping fine print into contracts that prevent investors from seeking justice.
The SEC agreed with stakeholder findings that RIAs are including these restrictions in advisory agreements, that such terms can increase arbitration expenses for clients, and that many are not allowed in other dispute resolution forums.
The report noted that the number of SEC-registered advisors has risen by 44% over the last decade, serving 64.7 million clients. The authors of the report suggested that this increase in advisers and clients may lead to a rise in adviser arbitrations.
The report concluded that for many advisory clients, mandatory arbitration clauses in advisory agreements mean that arbitration is the only avenue to obtain remedy for financial harm caused by their advisers. It suggested that further evaluation may be necessary to ensure that arbitration is an accessible and affordable means of dispute resolution for advisory clients.