If they haven’t already, financial advisors and wealth managers should take extra steps to protect themselves from client litigation. Though the violent spike in customer arbitration filings in the first quarter of this year has subsided somewhat, filings are still way up from recent years and should continue that way for a few years to come, say securities lawyers. Advisors are spending more time in arbitration, as well, due to a new FINRA rule out early this year, which severely limits attorneys’ ability to file motions to dismiss, says Jason Roberts, partner of the law firm of Reish & Reicher and co-chair of the firm’s Financial Services Practice Group. These days an advisor is likely to spend 12 to 18 months in arbitration instead of 3 to 4 months, he says.
Customer arbitration filings for 2009 year-to-date through September total 5,545, according to FINRA data, exceeding by 60 percent the total filed for all of 2008. There are obvious reasons for this. Whenever the market tanks, investors are more anxious to find fault with their financial advisors for allowing their portfolios to lose money. When markets rise, they have little to complain about. And then there are the still relatively recent high-profile cases of securities fraud: Madoff, Stanford. But there’s another reason, too: an increasing awareness of fiduciary duty, says securities attorney Fred Reish in his own October newsletter, the “Erisa Controversy Report.”
Filings for breach of fiduciary duty are up year-to-date versus prior years, accounting for the biggest proportion of all filings, or 59 percent. This is not just because fiduciary status has become a watchword in Washington, as the Obama administration seeks to make it a universal standard of care for all financial advisors.
For one thing, the number of dually registered advisors has exploded in the recent years: It is the fastest growing “channel” today, according to recent Cerulli data. Plaintiff lawyers often claim that because the advisor is wearing two hats, it’s hard to know which one he was wearing when he gave the client investment advice, says Roberts.
But plaintiffs lawyers also often claim a breach of fiduciary duty in arbitration claims whether the advisor is a registered rep. or a 40-Act Investment Adviser, in order to heighten the standard of care, and because these allow for longer discovery periods. In other words, the client can wait longer after the supposed breach occurred to file the claim, says Roberts. “You don’t file a suitability claim without also filing a fiduciary claim and failure to supervise,” he says. “Half of these breach of fiduciary duty cases should never be filed. But they are filed in every well-plead complaint. You can file under multiple reasons.”
Roberts says the number one thing he would recommend that advisors do is create a written service agreement if they do not already have one: That agreement should clearly define the scope of your services, (and what services are not provided), the compensation you will receive for your services, a statement of whether those services give rise to a fiduciary status, any conflicts of interest, and procedures to address those conflicts. “That will go a long way, even though arbitrators are wishy-washy about what law applies. It will help arbitrators understand what the party’s intent was when the services were contracted.” It can also help manage client expectations in rough markets.