Investor advocates are cheering an attempt to place stricter limits on how RIAs can use arbitration to resolve client disputes. But amid the current atmosphere of deregulation, arbitration reform may be a long shot.
Last week, the Securities and Exchange Commission’s Investment Advisory Committee issued a recommendation seeking to overhaul the contract provisions that advisory firms often use, which keep legal actions with investors out of regular courts and put them before industry arbitrators. These mandatory arbitration clauses have long been a bête noire for securities lawyers, who argue they can deprive clients of some of the most cherished protections of the justice system.
Among other things, the SEC panel recommended that firms should no longer be able to use contract clauses to limit the size of awards investors can win through mandatory arbitration or to bar them from joining other aggrieved parties to file class-action complaints in arbitration.
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The proposed reforms also call on the SEC to publicly post arbitration decisions involving RIAs — much as the Financial Industry Regulatory Authority now does with broker-dealers — and embark on a public campaign informing investors of the nuances of arbitration. Firms would further be required to pursue arbitration in a venue near where an investor bringing a complaint lives.
Deregulatory environment
The proposal lands at a time when industry watchdogs are taking a lighter hand to overseeing everything from cryptocurrency to alternative investments like private equity and private credit. The proposed reforms would also need formal approval from the SEC itself, which is now largely controlled by regulation skeptics.
Even with the odds so stacked, Adam Gana, the president of the Public Investors Advocate Bar Association, said he still likes the proposal’s chances. For one, the recommendation was developed with contributions from industry groups like the Securities Industry and Financial Markets Association and the Financial Services Institute, which represent brokerages and other financial firms. What’s more, at least one of the conservative SEC commissioners who have held sway at the watchdog agency since President Donald Trump took over this year has expressed some openness to reform.
Mark Uyeda, a Republican who joined the SEC in 2022, said in December that he wonders if mandatory arbitration in RIA disputes is often more costly than necessary — especially if contract clauses require the use of multiple arbitrators in cases when a single one would suffice.
“I am particularly mindful of the costs associated with the use of mandatory arbitration clauses by investment advisers,” Uyeda said.
However, his comments took no stance regarding the kind of changes recommended by the SEC’s Investment Advisory Committee. Meanwhile, one of Uyeda’s conservative colleagues,Commissioner Hester Peirce, has expressed much more skepticism toward calls for overhauling the current arbitration system.
In remarks made earlier this month, she said she remains wary of proposals placing limits on how private firms draw up contracts. “Freedom of contract,” she said, “is a bedrock principle.”
She also pointed to an SEC staff report from June 2023 finding that contract provisions requiring arbitration for client disputes are common in the RIA industry. Yet the same study, Peirce noted, found that only 5% of these agreements contained clauses restricting what sorts of claims investors could bring in arbitration, and only 11% set limits on the damages that could be awarded.
“Given these statistics and the fact that some states have addressed adviser arbitration clauses, should the Commission use its limited resources to engage in a rulemaking on investment adviser arbitration?” Peirce asked.
Investors treated better in arbitration with broker-dealers?
But Gana and other investor advocates aren’t overly concerned. Gana, also the managing partner of the New York-based legal firm Gana Weinstein, said the proposal now up for consideration is far from the sweeping overhaul many opponents seem to fear. Rather, it would merely bring the arbitration rules for disputes with RIA into line with those that apply in investor complaints against broker-dealers.
The irony, Gana said, is that RIAs are under a fiduciary duty to always do what’s best for their clients and are often favorably contrasted with broker-dealers, which have more leeway to disclose conflicts of interest rather than eliminate them. But RIAs don’t give investors a better deal when it comes to mandatory arbitration, Gana said.
“Investment advisors are always touted as being better for the investor,” Gana said. “But so long as there’s no fix to how aggrieved investors can bring claims against their investment advisor, that’s just not the case.”
Like advisory firms, brokerages require investors to sign contracts that keep disputes out of court and before arbitrators. But arbitration proceedings against broker-dealers are governed by a consistent set of rules laid out by FINRA, the brokerage industry’s self-regulator.
“Everyone wants fairness,” Gana said. “They want consistency and they want transparency. These are things that FINRA provides.”
Touting the benefits of arbitration
Much of the input that industry groups provided to the SEC’s Investment Advisory Committee involved expressions of support for FINRA’s current system rather than calls for RIA arbitration reform.
In a letter submitted to the panel in December, Robin Traxler, deputy general counsel of the Financial Services Institute, wrote that, “Arbitration before FINRA has proven to be a less costly option” than courts, and that “arbitration resolves disputes significantly faster than traditional court proceedings.”
Similarly, SIFMA deputy general counsel Kevin Carroll spoke at the SEC’s Investment Advisory Committee’s meeting in December of the lower costs and other benefits of arbitration.
“Decisions are faster and final,” Carroll said. “Customers’ sensitive financial business is kept private. And all parties benefit from these qualities.”
If it ain’t broke …
Meanwhile, some remain skeptical that any change is needed. Cary Kvitka, a founder and partner of the Parsippany, New Jersey-based firm RIA Lawyers, said the SEC panel’s proposal seems like a lot of work to overhaul a system that nobody has shown is failing investors.
He said most of the contracts he helps negotiate for RIAs include arbitration clauses but nothing that limits the awards that can be handed down or the types of claims investors can bring.
“It works well, and we don’t have any experience with the current rules or lack thereof being to the detriment of clients who have valid legal claims against RIAs,” Kvitka said. “We view arbitration as a reasonable and often more efficient alternative to litigation, and any curtailment of that would be a cause of some concern to our clients.”
Regardless of what the SEC commissioners decide to do, Gana is confident that most people in the industry agree with the investment advisory panel’s reform recommendations.
“It sounds like there are individuals who may disagree with the SEC panel’s approach,” he said. “But by and large, the industry does agree with it.”
