SEC Has No Way to Track RIA Arbitration Stats, Unpaid Awards

SEC Has No Way to Track RIA Arbitration Stats, Unpaid Awards

The Securities and Exchange Commission has no way to track the number of registered investment advisor arbitrations or unpaid arbitration awards, according to a just-released report.

Last year, the House Appropriations Committee expressed concerns about the proliferation of mandatory arbitration clauses among SEC-registered investment advisors and directed the SEC to study the issue.

In its just-released report, the commission estimates that 61% of RIAs that serve retail investors incorporate mandatory arbitration clauses into their investment advisory agreements.

According to the report, ”due to the lack of publicly available information about SEC-registered adviser arbitration, [SEC] 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.’”

Instead, as a proxy for the perspectives of advisory clients, the SEC report states that its staff “interviewed eight external stakeholder groups identified as having information relevant to the issue of mandatory arbitration, and/or as having publicly expressed opinion” on the issue of mandatory arbitration.

As the report notes, unlike brokers, RIAs “are not required to register with an SRO and do not have a dedicated forum for dispute resolution.”

Further, an RIA “may designate the dispute resolution forum of their choosing in a mandatory arbitration clause, and may invoke the application of specific forum rules.”

Broker arbitration disputes, on the other hand, are heard via the Financial Industry Regulatory Authority’s Dispute Resolution Forum. Brokers are also required to file a Form U4 with FINRA that includes information about arbitrations. This info is then made public via BrokerCheck.

The commission, according to the report, “previously considered whether to require advisers to disclose arbitration information in their Forms ADV, but determined not to require disclosure, as arbitration settlements or awards may not actually reflect a finding that the adviser violated the law, and disclosure might cause unwarranted reputational harm to the adviser.”

Hugh Berkson, president of the Public Investors Advocate Bar Association, or PIABA, said Thursday in a statement that “while we appreciate the SEC’s attempt to address the problem of investment advisors failing to pay investors after losing their money, we find it frustrating that the SEC ran into the same problem we did: there is no source of hard data on the subject.” 

American investors, Berkson continued, “would have benefited if the SEC, which regulates these advisers, had stated an intent to start with a requirement that those advisors report the exact same information brokers must, followed by a mandate that financial professionals carry insurance.”

Berkson told ThinkAdvisor Thursday in an email that the “SEC’s estimation that 61% of SEC-registered investment advisors include mandatory pre-dispute arbitration clauses is surprising: we thought the number would be higher.”

However, ”the fact that the SEC is presently unable to track arbitration result information is not surprising, since the SEC doesn’t mandate that IAs report the same information brokers must,” Berkson continued.

“What IS surprising is that the SEC made a conscious decision to allow RIAs to decline to provide that information for fear that they would suffer the same sort of reputational harm brokers are required to face,” Berkson said. “It’s also surprising that the SEC tells investors they should research their advisors’ backgrounds, but knows that’s impossible since arbitration results are unavailable.”

Micah Hauptman, director of investor protection for the Consumer Federation of America, told ThinkAdvisor Thursday in an email that the SEC report “provides a good start to examining investment advisers’ use of forced arbitration clauses and the potential limitations on investors’ ability to seek redress when they are harmed by advisers who use forced arbitration clauses.”

That said, “as the report makes clear, there is still a lack of publicly available information about advisers’ use of forced arbitration clauses and the effects such clauses have on investors that are harmed by advisers,” Hauptman continued. “It is therefore incumbent on the SEC to collect more information, including through examinations, to better understand how these clauses affect investors.”

Joseph Peiffer, PIABA’s incoming president, added in the statement that the report “highlights a double whammy for American investors. After losing their hard-earned money, advisors often slip fine print into contracts that prevent investors from seeking justice. The SEC must act to put an end to this.”

Informational ‘Black Hole’

Former PIABA president Michael Edmiston, an attorney with Jonathan W. Evans & Associates, told ThinkAdvisor in another email that the SEC report “revealed an informational black hole” around RIAs’ ”use of forced arbitration, its exorbitant costs, the improper and illegal limitations of claims and remedies, and outcomes.”

Edmiston said the report “is an alarm for regulators and legislatures to more closely regulate an ever-growing segment of the financial services industry to protect investors from predatory practices of investment advisors placing their interests ahead of their clients.”

The SEC report, however, “exposed how RIAs use private arbitration providers’ fees as a shield from viable, compensable claims. RIAs are fiduciaries for their clients,” Edmiston said. “They should never consider such an anti-customer tactic. The abuse of forced arbitration indicates RIAs are in need of much more thorough regulation to be sure they are held to their fiduciary obligations.”

Source: thinkadvisor.com, Melanie Waddell

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