Resolving Client Disputes

What happens when clients believe they have been harmed by their broker or advisor? It’s a tricky topic in the investment business because different advisors’ standards mean they are responsible for different actions under the law, and that can mean different resolutions in client disputes.

For more than two decades, the advisory and brokerage industries have been evolving along two parallel tracks, with advisors governed by a fiduciary standard and brokers subject to suitability rules. The question of how a fiduciary role should be expanded to cover all advisors and brokers, as mandated under the Dodd-Frank Act, is experiencing serious implementation problems in Washington, D.C.

Experts agree that a fiduciary standard, of which suitability rules are a subset, is a higher standard, since it demands that advisors act in the clients’ best interest. Suitability, on the other hand, requires only that an investment is appropriate given the investor’s age, risk tolerance, experience and other investments.

Most investors are clueless about the distinctions between the legal definitions. But when they think they’ve been harmed or when their investments tank, they may blame their advisor, rightly or wrongly. Those that do have a couple of avenues they can take. In some cases, they can go to the courts for redress.
Or they can go to an arbitration panel that resolves the matter for them. Frequently, they’ve been forced into the latter by the contract with a firm—when the arbitration becomes mandatory.

Arbitration isn’t new, and it’s not bound to the world of securities law. Even mandatory arbitration, first legalized by the 1925 Federal Arbitration Act, is common in consumer contracts for credit cards, cell phones, car rentals and checking accounts.

Since 1987, brokerages have been allowed to make arbitration mandatory for the resolution of consumer and employee disputes. In 2012, Finra opened up its arbitration process to RIAs—meaning RIAs can ask clients to use Finra’s process in its contracts with clients. Currently, RIAs can choose whether disputes should be argued before Finra’s panels, in other arbitration forums or in state or federal courts. Depending on which states they do business in, RIAs may or may not be able to include mandatory arbitration clauses in their customer contracts.

It’s not surprising that the rules don’t satisfy everybody.

Brokers complain that Finra’s arbitration process allows too many frivolous cases to be brought to a hearing. Often, brokerages give up and settle claims simply to save themselves the headache and legal fees, which can blow back on the individual brokers.

When RIAs go to Finra arbitrators, the judgments are not binding. Since most RIAs are not Finra members, the organization has no power to enforce arbitrators’ rulings against them.

Investor advocates, meanwhile, argue that clauses in brokerage contracts force claims to Finra arbitration, denying investors their right to stand in state and federal court. The arbitrator panels can’t help but favor brokerages, they argue, because brokerages fund Finra.
So what’s fair and what isn’t?

For at least 15 years, Harold Evensky of Evensky & Katz in Coral Gables, Fla., has served as a part-time expert witness in Finra arbitration cases. He thinks the system has imperfections, but that the outcomes are reasonable for the most part.

“My general experience is [that] it’s very fair, at least as fair as humanly possible,” he says. “But to the extent that it errs on one side or the other, my experience has been that it errs on the side of the plaintiff, not the brokers.”

Most of the cases Evensky has testified in concern the suitability standard of the brokerage business rather than the fiduciary standard, and the outcomes could have been different if a strict fiduciary standard, which he supports, were used.

And the gap between these two standards can be dramatic. He recalls a claimant who lost a case more than a decade ago. The man had put $250,000 into four separate accounts with a brokerage because his wealthy friend had succeeded with the same stock pickers. When the tech bubble burst, the plaintiff lost more than 50% of his investment.