The Securities and Exchange Commission’s Office of Investor Advocate is recommending that the federal agency steps up requirements for disclosure and transparency around registered investment advisory firms’ use of mandatory arbitration agreements.

The recommendations came during a panel discussion on Tuesday following a 2023 study by the investor advocate division, which found that RIAs often include strict arbitration terms such as “hedge” clauses limiting damages that clients may seek. RIAs also have fewer reporting requirements related to arbitration than their broker counterparts overseen by the Financial Industry Regulatory Authority, the panel found.

“There are few issues that are more important to investor justice than this one,” said Stacy Puente, ombuds and assistant director of the SEC’s OIA.

Puente added that the restrictive terms in client agreements could be considered a violation of RIA’s fiduciary obligation to act in their customers’ best interest and pointed to a recent SEC enforcement action over a hedge clause.

The SEC investor advocate does not set policy but makes recommendations to the Commission for policy.

Puente’s position was backed by a state securities regulator on the panel as well as plaintiff lawyers. Representatives from two prominent industry trade groups for broker-dealers also suggested they were in favor of arbitration as long as it was presented clearly and fairly for investors.

At a minimum, Puente said that RIAs should be required to make more fulsome disclosures about their arbitration usage. Finra arbitrations, for example, appear on brokers’ public BrokerCheck records, and decisions can be easily accessed through Finra’s dispute resolution website.

RIAs often require investors to submit to private forums where complaints and awards are not disclosed and it is difficult to track when an advisor has been named in a case. Peunte also said that there needs to be a way for investors to appeal an unjust decision.

Adam Gana, a partner in the law firm Gana Weinstein and president of the Public Investors Advocate Bar Association, also pointed out that the forums required by RIAs were often more costly than Finra. Costs for some cases have risen as high as $65,000, he said.

“We all agree that currently, RIA arbitration is a disaster for investors,” Gana said. “It is too expensive and too inconsistent.”

Michigan securities regulator Stephen Brey, who is co-chair of the North American Securities Administrators Association, supported a broader ban on mandatory arbitration. NASAA, which includes state securities regulators, “has long supported legislative efforts to empower investors by giving them the choice when it comes to resolving disputes,” Brey said.

The SEC is in a position, based on the Dodd-Frank statute, to restrict mandatory arbitration use, if federal securities laws are part of the disputes, Brey noted.

A senior lawyer with the brokerage industry’s largest trade group, the Securities Industry and Financial Markets Association, was quick to push back on outlawing mandatory arbitration entirely.

“A balance needs to be struck,” said Kevin Carroll, a deputy general counsel at SIFMA. Any proposal to ban mandatory arbitration clauses would be “terrible,” he added.