SEC committee recommends RIA arbitration reforms, advocates push for more

A committee that advises the Securities and Exchange Commission (SEC) has called for more disclosure and investor protections when it comes to the widely used RIA practice of mandatory arbitration.

At a meeting last week, the SEC’s Investor Advisory Committee approved recommendations that include the disclosure by RIAs of pre-dispute arbitration clauses, as well as pending and resolved arbitration claims themselves, in their public Form ADV filings. Some investor advocates backed these calls for more transparency around the process, while urging more action.

When they sign on clients, RIAs commonly require that certain disputes be heard in private arbitration forums, where proceedings are shielded from public scrutiny. An SEC staff report from June of 2023 showed that nearly two-thirds of RIAs that serve retail investors have mandatory arbitration clauses in their agreements with clients.

Investor advocacy groups like the Public Investors Advocate Bar Association (PIABA), which represents claimants in arbitration proceedings, have long criticized mandatory arbitration, with its president Adam Gana saying late last year that it has a ‘chilling effect’ on customer complaints.

Following discussion in a June 5 meeting, the Investor Advisory Committee of the SEC published recommendations on the arbitration process in a recent letter.

In addition to enhanced disclosure by RIAs, the committee suggested the SEC adopt rules similar to what the Financial Industry Regulatory Authority (Finra) has in place for the broker-dealers it oversees.

RIA firms ‘should not be permitted to include any clause that limits or contradicts the rules of any self-regulatory organization, limits the ability of a party to file any claim in arbitration… or limits the ability of arbitrators to make any award,’ the Investor Advisory Committee’s letter reads. ‘Further, investment advisors should be required to agree to a venue closest to the investor’s residence at the time of the events giving rise to the dispute.’

Noting Finra’s own searchable database of arbitration awards, the advisory committee recommended the creation of a similar database for investment advisor arbitration awards.

The SEC should also ‘develop investor education materials’ so retail investors can ask educated questions about the arbitration process in their dealings with advisory firms, the committee suggested.

While the SEC’s five-member Commission sets the agenda on regulatory priorities, the 2010 Dodd-Frank act set up the investor advisory committee to provide advice on these priorities.

Weighing in on the use of industry-wide arbitration, University of Nevada Las Vegas law professor Benjamin Edwards told Citywire that it can prevent courts from adapting the law to emerging problems, which are swept into private dispute resolution.

‘Many of the more abusive clauses you often see in arbitration agreements around venue, damages limitations, or other hedge-clauses would likely have been deemed incompatible with a fiduciary’s role by courts – if they had real opportunities to encounter these issues,’ Edwards wrote in an email. ‘Without meaningful judicial oversight, the SEC really has to stay involved and oversee these arbitration agreements because they are best positioned to protect the public.’

In a statement Wednesday, Gana welcomed the advisory committee’s move as a good first step but urged stronger action.

‘Investors should not be forced into opaque, one-sided forums with no meaningful choice or recourse,’ Gana stated. ‘These recommendations are a strong step forward—but the SEC must ensure they translate into real-world change.’

The advisory committee’s recommendations on arbitration were treated with some skepticism by Chris Stanley, founder of Beach Street Legal, a law firm that works with RIAs.

‘The prescriptive rules-based Finra regulatory regime is fundamentally different than the principles-based SEC regulatory regime, and the SEC should not catalyze the erosion of such principles or the freedom of contract in favor of Finra-style regulation,’ Stanley wrote in a Wednesday LinkedIn post.