SEC Panel Considers Restrictions on RIA Arbitration Requirements

An SEC panel recently discussed the potential limitations on Registered Investment Advisors (RIAs) requiring private arbitration when disputes arise with clients. One securities lawyer, Adam Gana, called mandatory arbitration a “disaster” for regular investors. He argued that this system forces clients to resolve conflicts in costly, secretive forums that are often unfair to them. This conversation took place during a meeting of the Securities and Exchange Commission’s investor advisory committee.

Arbitration clauses are contracts that steer disputes away from the court system by mandating private forums like the Financial Industry Regulatory Authority (FINRA). Advocates claim that this process speeds up resolutions. However, critics argue that these forums lack consistency, are costly, and provide limited appeal options for clients. Suggestions for reform aim to make the complaint process against RIAs more affordable and practical for everyday investors.

The investor advisory committee examined mandatory arbitration in response to an SEC report that revealed these clauses are widespread in the RIA industry. About six out of 10 advisory agreements required arbitration for conflict resolution. Concerns arose about RIAs potentially breaching their fiduciary duty by not prioritizing their clients’ best interests. While the office didn’t receive immediate action on its recommendation to stop mandatory arbitration, the SEC staff continued to review the matter.

The office’s report showed that most advisor agreements specified arbitration providers and often selected the more expensive option, such as the American Arbitration Association (AAA). In contrast, FINRA, with lower filing fees, was less frequently chosen. During the committee meeting, Stephen Brey suggested that investors be given the freedom to select the forum for dispute resolution to ensure fairness.

Gana, who leads the Public Investors Advocate Bar Association, shared a story of a client facing a $25,000 fee to arbitrate a $60,000 claim, illustrating how high costs deter investors from pursuing disputes against RIAs. He highlighted the “chilling effect” where the expense of arbitration prevents clients from seeking justice effectively.

RIAs’ arbitration requirements are often compared unfavorably to FINRA’s policies, which offer more client-friendly terms. RIAs may impose stricter limits on damages, restrict class-action claims, or make the losing party cover legal fees. In contrast, FINRA rules prohibit such restrictions in disputes involving broker-dealers and ensure easier geographic access to arbitration panels.

Overall, the conversation around mandatory arbitration for RIAs involves balancing the interests of investors with the need for efficient conflict resolution mechanisms in the financial industry.