Investor advocates call on SEC to end RIAs' use of mandatory arbitration

Investor advocates are calling on the SEC to end registered investment advisors’ use of mandatory arbitration clauses in client contracts, arguing the provisions limit the ability of harmed investors to recover losses and represent a breach of an RIA’s fiduciary duty.

The Investor Advocacy Coalition sent a letter Wednesday to SEC Chair Gary Gensler urging the commission to adopt rules that would ban the use of pre-dispute arbitration agreements in investment advisor and broker contracts. The 2010 Dodd-Frank financial reform law gave the Securities and Exchange Commission the authority to promulgate such a rule, but the agency has not acted.

In a press conference Thursday, the coalition asserted that RIA arbitration is a growing investor protection threat that must be addressed by the SEC and Congress.

An SEC study released last summer estimated that about 61 percent of RIAs force their clients to go to arbitration to settle disputes. Unlike brokers, who use the Finra arbitration system, RIAs utilize private forums that the coalition said are expensive, opaque and put claimants at a significant disadvantage.

“Investors are forced into an arbitration process that’s unfair – a process that too often leaves retirees ripped off by unscrupulous RIAs and then priced out of  justice by forced arbitration clauses inserted by folks who are fake fiduciaries,” Joe Peiffer, president of the Public Investors Advocate Bar Association, said at the National Press Club in Washington.

Micah Hauptman, director of investor protection at the Consumer Federation of America, said mandatory arbitration clauses represent a breach of the fiduciary standard of care to which RIAs are held.

“If an advisor uses forced arbitrations in ways that effectively deny a client’s ability to pursue justice and recover losses they’ve suffered, the advisor is placing their interests ahead of the client’s, in violation of the advisors’ fiduciary duty,’ Hauptman told the National Press Club audience.

Arbitration proponents assert that it is faster and less costly than the court system, which benefits both sides of a dispute. But mandatory arbitration is better for RIAs than for their clients, said Christine Hines, legislative director at the National Association of Consumer Advocates.

“We agree with our colleagues that use of forced arbitration directly conflicts with prohibitions on advisors’ self-dealing and self-serving misconduct that risks harm to investors,” Hines said at the press conference, which also included coalition members Better Markets and Public Citizen.

A report released in December by the SEC’s Office of Investor Advocate said mandatory arbitration clauses may be a breach of RIAs’ fiduciary duty, which combined with the earlier SEC report on RIA arbitration has put some wind at the back of the coalition.

“Once you understand the scope of the problem, then it really is incumbent upon the SEC to do something,” Peiffer said. “So, I do think we’ve got some momentum.”

An SEC spokesperson said the agency is listening to concerns about RIA arbitration.

“The commission takes seriously the issues raised in the Office of the Investor Advocate report and welcomes input from investor advocates,” the spokesperson said.

Gensler already has a burgeoning agenda of pending regulatory proposals, which could make it difficult to wedge in mandatory arbitration. But Hauptman said a new regulation may not be required.

“I don’t think the SEC necessarily has to engage in rulemaking to address this problem,” he said. “I think they could provide guidance and provide some fact patterns that they would view as inconsistent with an advisor’s fiduciary duty.”

The coalition also is pursuing a legislative strategy. Democratic House and Senate lawmakers re-introduced legislation Wednesday that would prohibit mandatory arbitration clauses in brokerage and advisory contracts.  In the past, the bill has not been able to overcome long political odds.

Some members of the coalition, particularly PIABA, have been criticizing the Finra arbitration system for years. Although they also want to give brokerage customers the freedom to go to court rather than Finra arbitration to settle disputes, they did point out strengths of the Firna system compared to the private arbitration forums advisors use.

For instance, Finra prohibits brokerages from forcing customers to waive their ability to bring class actions. The broker-dealer self-regulator also provides a mechanism for small-dollar claims and publishes arbitration award decisions, although those documents rarely provide the reasoning for the ruling.

“I’ve spent probably 20 years picking on Finra and their arbitration system, and I think there’s a lot of problems with Finra arbitration,” Peiffer said. “However, the RIA system is far, far worse. So, if we could get as a start, as a first baby step, that we at least have the [same] protections in Finra arbitration, that would be a step in the right direction. Would it get us all the way there? Absolutely not. But it’s better than the system we’ve got right now.”