The mandatory arbitration clauses that 61% of the nation’s 15,000 registered investment advisor firms require clients to sign benefit advisors over investors, SEC staff said in a new report sent to Congress yesterday.
Because of a lack of RIA disclosure and a lack of data collection at arbitration forums, SEC staff said they cannot tell lawmakers how many aggrieved RIA clients sought to recover losses for fraud or other claims in arbitration against RIAs over the past 10 years, what the investor “win” rate is or how many advisors did not pay their arbitration awards.
The lack of data “prevented Staff from measuring the frequency of adviser arbitration or unpaid awards. While investment adviser representatives must disclose certain arbitration information, the opaque nature of adviser arbitration and difficulty accessing adviser arbitration information raises questions about the ability of regulators to evaluate adviser conduct in the context of client disputes,” the SEC said in the report.
The report was requested in January by the House Committee on Appropriations, which controls the SEC’s annual funding.
“Due to the lack of publicly available information about SEC-registered adviser arbitration, Staff could neither review adviser arbitration data nor identify a representative sample of advisory clients to determine the ‘effect such contracts with mandatory arbitration clauses have on investors that are harmed by the conduct of advisers,’” SEC staff said.
In lieu of data and as a proxy for the perspectives of advisory clients, staff interviewed eight external stakeholder groups identified as having information relevant to the issue of mandatory arbitration including Finra, the Financial Services Institute, Inc. (FSI); Investment Adviser Association (IAA); North American Securities Administrators Association (NASAA); Public Investors Advocate Bar Association (PIABA); and Securities Industry and Financial Markets Association (SIFMA).
“Their views, while anecdotal, provided insight into the potential harms and benefits of mandatory arbitration clauses for advisory clients,” SEC staff said.
The agency also reached out to what it said was a geographically diverse group of RIAs from different sized firms to collect 579 advisory agreements and sifted through the data at RIA-selected arbitration forums such as AAA to reach their anecdotal findings.
Stakeholders who were critical of RIA mandatory arbitration cited numerous problems that impact aggrieved investors, including the exorbitant price of private arbitration.
Right now, an investor filing an arbitration claim against an RIA in a private forum would need to advance more than $30,000 to cover their anticipated private arbitration forum fees upfront, before attorney fees, the report said. That is compared to $2,300 in upfront fees a brokerage investor pays to use Finra’s Dispute Resolution Forum, which brokers, registered reps and their firms are required to use.
In some cases, RIA mandated arbitration clauses also designated venues for arbitration hearings that “disregarded the client’s location, limited the types of claims that investors can bring and waived investor rights to seek a class action," SEC staff.
PIABA one of the stakeholders the SEC interviewed and a leading opponent of mandatory RIA arbitration clauses, began lobbying the SEC last January to either do away with the forced arbitration clauses and give investors a choice of legal redress or require the industry to pick up 80% to 90% of the tab for investors' arbitration costs.
Forced arbitration “works out well for the RIA industry,” former PIABA President Michael Edmiston, who spearhead mandatory arbitration reforms throughout his 2022 term, said. “I can’t tell you how many times I’ve had to say to investors, ‘I see you have a clause mandating you use JAMS [the Judicial Arbitration and Mediation Services forum] in your RIA contract, so you’ll need to advance $30,000."
The private arbitration forum arbitrators can charge $8,000 or more for a day’s work., Edmiston said.
Arbitration costs can easily exceed $64,000 for five days of hearings and three days of pre-hearing and post-hearing work. Triple that amount if there are three arbitrators hearing the dispute, he said.
“What happens is you have retirees who have lost their retirement savings because of a bad actor and they literally cannot afford to get their money back in arbitration,” he said.
“We hear ‘God, I could lose more money” or ‘Oh my God, I don’t have any money left to pay for this,’” said Edmiston, an attorney with the law firm Jonathan W. Evans & Associates in Studio City, Calif.
The need to act is “critical” as more assets shift from the brokerage side of the industry to the advisory side and more RIAs use forced arbitration clauses, Edmiston said.
"I’m glad see the SEC acknowledge that they have problems. That’s the first step in fixing it," he added.
The SEC said that more study and RIA disclosure of their arbitrations may be needed to protect investors. Currently advisors are only required to disclose arbitration results or claims that they deem “material.”