AdvisorHub (June 28th) - A Securities and Exchange Commission report to Congress on Tuesday raised concerns about registered investment advisory firms’ use of mandatory arbitration clauses in retail customer agreements and whether current disclosure requirements are adequate for investors.
The SEC staff report estimates approximately 61% of RIAs serving retail investors have mandatory arbitration clauses in their investment advisory agreements. But the report said that even determining the prevalence of arbitration clauses is difficult because of the lack of publicly available information.
Investment advisor representatives’ disclosures about arbitrations also paled in comparison to what was required of brokers registered with the Financial Industry Regulatory Authority, who must report the existence of a pending complaint as well as the outcome of hearings and existence of a settlement, according to the report.
“This report is the alarm bell that says, ‘We have a problem,’ ” Michael Edmiston, a plaintiff lawyer in Studio City, California, and former president of the Public Investors Advocate Bar Association, said. “Anybody looking to do business with an RIA should be able to get this information before turning over their hard-earned money and then trusting them with their future.”
The SEC staff issued its findings after the House Committee on Appropriations in December 2022 “expressed concerns about the proliferation of mandatory arbitration clauses,” the report said. The SEC report noted that the use of arbitration clauses by RIAs have become more prevalent as the number of such firms and clients have “increased steadily” over the past decade.
The staff concluded that “further evaluation” may be needed to ensure that arbitration is an “accessible and affordable means of dispute resolution” for their customers and to determine whether to implement uniform disclosure requirements.
The Commission itself “expressed no view regarding the analysis, findings, or conclusions,” according to the report.
Almost all of RIAs’ mandatory arbitration clauses designated a specific forum where disputes must be brought. Eighty three percent selected the American Arbitration Association; 10%, Finra’s Dispute Resolution; 6%, JAMS; and 1%, other forums. But AAA and JAMS do not track advisor arbitrations or report individual case results, so the SEC staff could not determine how frequently claims involved RIAs, according to the report.
In addition, almost all, or 97%, of the agreements designating a venue “did not consider the client’s location or place of business,” the SEC staff said. The report also raised concerns that mandatory arbitration agreements included clauses that would preclude clients’ participation in a class action, limit damages or impose other restrictive terms.
There existed unanimous agreement among the industry trade groups and regulators interviewed by the SEC staff that mandatory arbitration benefited advisers, the report said. Those advantages included: simplification of the dispute resolution process through limited discovery and no right to appeal, maximization of privacy during and after the arbitration, and increasing “both predictability and efficiency through the designation of a known venue with familiar rules,” the report said.
Proponents of mandatory arbitration “further asserted” that it bestowed the same benefits for clients, the report said.
Critics argued that because advisors selected the forum, rules and venue, mandatory arbitration likely favors the advisor at the client’s expense.
“This report highlights a double whammy for American investors. After losing their hard-earned money, advisors often slip fine print into contracts that prevent investors from seeking justice,” Joseph Peiffer, the incoming president, PIABA, said in a statement on Thursday. “The SEC must act to put an end to this.”
The report cited other criticisms, including that the “lack of uniform disclosure requirements for adviser arbitration information would allow recidivist advisers to conceal client allegations of wrongdoing from regulators and prospective clients.”
“Establishing uniform disclosure requirements for adviser arbitration information could, as some stakeholders suggested, increase public access to this information, as well as regulatory and investor insight into advisory conduct,” the report concluded.