Financial Advisor (February 2, 2024) By Tracey Longo
Seven prominent investor advocacy groups have formed a coalition to turn up the heat on the Securities and Exchange Commission and Congress to put an end to the forced arbitration clauses that investors are forced to sign by a majority of registered investment advisors.
The coalition's creation follows a January report from the SEC’s Office of the Investor Advocate that found that the mandatory arbitration system is stacked against investors and likely violates advisors’ fiduciary duty.
The coalition members include the Public Investors Advocate Bar Association (PIABA), the American Association for Justice (AAJ), Americans for Financial Reform (AFR), Better Markets, the Consumer Federation of America (CFA), the National Association of Consumer Advocates (NACA) and Public Citizen. The coalition formally announced its new campaign aimed at reforming the SEC's rules for RIAs at the National Press Club in Washington, D.C., today.
"PIABA will continue to fight forced arbitration clauses inserted into investor contracts by unscrupulous RIAs,” PIABA President Joe Peiffer said in a statement. “These fake fiduciaries use their boilerplate agreements to stack the deck against investors. It’s time that either the SEC or Congress put an end to this nonsense."
Forced arbitration clauses are used by 61% of the RIA industry and are usually tucked into client investment advisory agreements, the SEC's report found.
The PIABA called RIAs’ forced arbitration an “untenable system for aggrieved investors who seek restitution for improper investment practices by their RIA, which can often dissuade wronged investors from seeking compensatory damages for losses they’ve suffered."
“Advisers should not be able to use forced arbitration clauses to immunize themselves from accountability for their misconduct,” Micah Hauptman, director of investor protection at the CFA, said in a statement. “If an adviser uses forced arbitrations in ways that effectively deny a client’s ability to pursue justice and recover for losses they’ve suffered, the adviser is placing their interests ahead of the client’s, in violation of the adviser’s fiduciary duty. No reasonable investor would consent to the use of such a clause."
In contrast to brokerage firms, which are required to designate Finra as the arbitration forum clients use, RIAs most commonly require clients to file arbitration claims with privately run dispute resolution forums such as the American Arbitration Association or JAMS.
Unlike Finra, which sets the arbitrators’ rates, private forums like AAA or JAMS allow arbitrators to set their own fees, which in some cases can be $8,000 or more for a day’s work, according to the PIABA. Total arbitration costs can easily exceed $64,000 for five days of hearings and three days of pre-hearing and post-hearing work, or triple that amount if three arbitrators hear the dispute, the organization says.
Private forums require investors to deposit the expected fees before the case proceeding, which can mean an investor who may have already lost thousands or even millions of dollars at the hands of an unscrupulous RIA will have to deposit tens of thousands of dollars more to have their claim heard, the group says.
“Knowing the forum fees are cost-prohibitive for most clients, [some RIAs] use these types of forced arbitration clauses to shield themselves from liability for their misconduct,” the coalition said.
The group’s criticisms of RIAs’ forced arbitration echo the complaints of investment fraud victims who spoke at a July press conference held by the PIABA. The victims, who are represented by PIABA member attorneys, complained that RIAs use arbitration provisions as a shield against liability and often fail to pay awards even when they lose.
Marykay Dragovich, the conservator for her cousin, former registered nurse Rita Berardelli, who was incapacitated by two brain aneurysms, said she turned to forced arbitration to recover more than $228,000 that was lost by Berardelli’s advisor.
Dragovich learned it would cost $202,000 in up-front arbitration costs to proceed to arbitration, “so even if Berardelli got all her money back, she would have to pay as much as 90% of it to the arbitrators as prescribed by the overlooked forced arbitration clause in the agreement with her RIA,” according to the coalition.
A second investment fraud victim, Michael Phillips, said he he was awarded over $4 million in an arbitration dispute against an investment management firm but has yet to receive a penny. The investment management firm, Asia Pacific, filed for bankruptcy “to escape the financial responsibility of paying the award—a surprisingly legal evasion tactic that was also spelled out as one of the primary issues identified in the December SEC OIA report,” the coalition said.