The SEC Investor Advocate has recommended that the agency temporarily ban mandatory arbitration clauses in advisor-client contracts on the grounds that the clauses may be harming investors.
The clauses, which are common in the financial services industry, force clients to settle disputes through arbitration rather than lawsuits.
“We are concerned that a number of characteristics of these clauses in advisory agreements are not in the best interest of retail investors,” SEC Investor Advocate Cristina Begona Martin Firvida said in the report.
“We recommend that the Commission consider temporarily suspending the use of mandatory arbitration clauses in advisory agreements until further exploration of the associated costs and benefits to advisory clients is undertaken,’ Firvida added.
The authority to suspend or ban such practices was granted to the SEC in the Dodd-Frank Act, she noted.
The investor advocate said she was troubled by advisors' use of contract provisions that limit investors rights, including damage limitations and class action waivers. She also contended that advisors use pricey, opague forums, which make it impossible for the SEC to track arbitration outcomes for investors or the number of unpaid claims advisors may have.
The new report, which Firvida said was prompted by “troubling anecdotal information about investor experiences with their advisors in mandatory arbitration,” found that about 61% of SEC-registered advisors use mandatory arbitration clauses. About 6% included class action waivers, 5% limited the types of claims that could be asserted and 11% limited the types of damages that a client may seek in arbitration, the report said.
In contrast, Finra regulation on the brokerage side of the industry prohibits usage of class action waivers, prohibits language that limits a party’s ability to file “any claim” in arbitration, and prohibits language that limits the ability of arbitrators to make awards, Firvida said.
Advisors who use mandatory arbitration clauses with such limitations are likely violating their fiduciary requirement to put client interests first, she noted.
“It is the view of the Office of the Investor Advocate that if an adviser includes language in an advisory agreement preemptively limiting the types or dollar amount of damages available to clients ... or limiting the types of claims that clients may assert against the adviser in an arbitration ... it would constitute a breach of the adviser’s fiduciary duty in violation of the antifraud provisions of the Advisers Act,’ Firvida said.