Financial Advisor (July 26, 2023) – On Tuesday, the Public Investors Advocate Bar Association hosted a press conference in which investors defrauded by registered investment advisors discussed the ways unregulated and costly mandatory RIA arbitration has failed them.

One of the victims, Marykay Dragovich, was the conservator of a disabled nurse who lost $208,000 to fraud by an advisor and has been forced to deposit more than $36,000 to cover costs on pending private arbitration mandated to fight the fraud. Another speaker, Michael Phillips, is an attorney who was swindled out of $4 million by an advisory firm, only to see the RIA file for bankruptcy to avoid paying his $3 million arbitration award.

Joseph Peiffer, the incoming president of the PIABA, said the association is urging the Securities and Exchange Commission to solve the multiple mandatory RIA arbitration issues that the agency itself outlined in a July report.

“We won’t stop,” Peiffer said, “until we achieve some sort of fair process for wronged investors like Mr. Phillips and Ms. Berardelli who fall victim to RIA misconduct. If the SEC won’t act, then we’ll turn to Congress. It’s a broken system. Let’s fix it.”

Among the problems cited by victims and their attorneys (and echoed in the SEC report) is the price tag: Before it can begin, arbitration in private forums provided by organizations such as the American Arbitration Association or JAMS can require hundreds of thousands of dollars in up-front deposits.

An estimated 61% of RIAs serving retail clients use mandatory arbitration clauses in their advisory agreements that sometimes include restrictive terms, impose higher costs and enforce provisions that are “impermissible in agreements between brokers and their customers,” the Securities and Exchange Commission said in June 27 Congressional report.

Dragovich is the conservator for her cousin Rita Berardelli, a former nurse who is now in an assisted living facility after suffering two stokes. She said Berardelli’s registered investment advisor lost more than $228,000—but that first shock turned into a second one after she learned it could cost as much as $202,000 to pay the required up-front cost for mandated private arbitration.

Berardelli’s attorney, Michael Edmiston, said that even if Berardelli got all her money back, she would have to pay as much as 90% of it to the arbitrators according to the agreement with the RIA firm. Edmiston, who is himself a past president of the PIABA, said he was able to reduce the price by negotiating for a single arbitrator after the forum assigned three. The arbitration hearing is scheduled for 2024, he said.

As a conservator, Dragovich was required to front the money herself.

“It’s obvious that the RIA and advisor were counting on [my cousin] not having enough money to file a claim in the first place,” she said. We were shocked and completely dumbfounded that this is how the system actually works.”

There was also fine print in the forced arbitration agreement that prohibits the claimant from seeking punitive damages or going to court, which Pfeiffer said is always cheaper because “you don’t have to pay the judge or the jury or the court stenographer.”

Another regulatory body, the Financial Industry Regulatory Authority, collects statistics that clearly show the numbers of arbitration and investor “win” rates. These must be disclosed to investors on brokers’ public records. But there are no such data collection or disclosure requirements at the SEC or among private forums for advisor arbitrations.

“I found it truly remarkable that the SEC said in its report that they did not require such disclosures because they were worried that it would hurt advisors’ business,” said Hugh Berkson, the PIABA’s current president.

Michael Phillips, one of the victims who spoke Tuesday, recounted what he described as a “cruel lesson” after he was awarded more than $4 million in an arbitration dispute against his former advisory firm, Asia Pacific Financial Management Group. This arbitration involved Finra, but the firm declared bankruptcy.

“While acting as my fiduciary, Asia Pacific’s advisor exercised unauthorized control over my accounts and engaged in a pattern and practice of trading that I did not approve and was not suitable for me, including wildly speculative bets and risky margin trading,” Phillips said.

“There are tens of thousands of victims just like Marykay and Michael out there,” Peiffer said. “The least I want to see is for advisors’ clients to be treated at least as well as brokerage clients in arbitration.”

“We’ve been fighting this fight for three years now, and even if it takes 10 more, we’ll keep fighting,” Peiffer added. “We would love to work with the SEC to fix this, but if we can’t, we’ll go to Congress,” where he said there was “surprising” bipartisan interest to help defrauded investors.

The SEC did not immediately respond to a request for comment.