The SEC’s Investor Advisory Committee met this week to discuss mandatory arbitration clauses used by registered investment advisers (RIAs) in client contracts, comparing practices in the broker-dealer and state-registered RIA worlds.

The Commission’s Office of Investor Advocate is recommending that the agency steps up requirements for disclosure and transparency around RIA firms’ use of such agreements. 

The Investor Advocate Office does not set policy but makes recommendations to the Commission on policy and potential policy changes. 

Report findings and comments

The hearing detailed findings of a year-and-a-half-old report from the SEC to Congress on that topic, which had noted that 6 in 10 RIAs use mandatory arbitration.

Further, most firms using it place limits on the forums and locations for arbitration, which investor advocates have said makes it expensive and burdensome for people to bring claims. And they often limit the damages that clients may seek  

The staff study also points out that a “notable percentage of advisory agreements with mandatory arbitration clauses also imposed requirements on the type and/or number of arbitrators — e.g., requiring a panel of three arbitrators, or requiring arbitrators to be affiliated with the securities industry.”

“The inclusion of these types of restrictive clauses … like claim limitations, damage limitations … are most likely harmful to clients,” said Stacy Puente, ombudsman at the SEC. “It’s difficult to imagine a situation where a limitation on claims or damages would be beneficial to the client.”

“If you want to make sure that nothing gets arbitrated, then ban arbitration clauses. Then everything will go court. I don’t think many folks think that is a recipe for fairness for retail investors.”

Kevin Carroll, deputy general counsel for litigation and private client at SIFMA

That means that “even RIAs as fiduciaries using mandatory arbitration would seem to violate fiduciary duties to clients”, according to Puente.

Puente’s position was supported by a state securities regulator on the panel and 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 to 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 FINRAs dispute resolution website. 

RIAs, on the other hand, 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’s forum with costs for some cases being 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.” 

But maybe don’t ban them

“It would be a terrible idea to ban arbitration clauses,” said Kevin Carroll, deputy general counsel for litigation and private client at SIFMA. “If you want to make sure that nothing gets arbitrated, then ban arbitration clauses. Then everything will go court. I don’t think many folks think that is a recipe for fairness for retail investors.”

Commissioners speak up

Commissioner Hester Peirce indicated opposition to limiting arbitration agreements in her prepared comments she delivered at the beginning of the meeting.

“A disclosure regime can morph into a prohibitory regime,” she said. “Today’s discussion, therefore, should not lose sight of the importance of allowing investors and their advisers to choose binding arbitration to resolve disputes. Freedom of contract is a bedrock principle. Submitting a dispute to arbitration is, in many instances, a cheaper and less burdensome process than litigation.”

And Commissioner Mark Uyeda said he would be interested in hearing perspectives on whether arbitrations involving investment advisers and their clients are more costly than necessary, including due to the use of multiple arbitrators when a single arbitrator would suffice.