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State Regulator Bars Arbitration Clauses in Advisor Contracts

Virginia's State Corporation Commission's ban on advisors using mandatory arbitration clauses in advisory contracts went into effect this week, but the rule is likely unenforceable.

According to an article from law firm Venable posted on legal news site, Virginia's State Corporation Commission's ban on investment advisors operating in the state from using mandatory arbitration clauses in advisory contracts went into effect this week, but is unlikely to withstand a legal challenge.

The anti-arbitration rule became binding on Monday. It was meant to combat the “growing trend of advisers including mandatory arbitration provisions in their client agreements,” said Venable's attorneys P. Randy Seybold and Andrew B. Kay, which were discovered during routine examinations of firms.

Mandatory arbitration clauses are "contrary to the fiduciary duty" that investment advisors owe to their clients, according to Virginia's state regulators. While mandatory arbitration clauses are commonly used in the financial services industry, in particular in broker/dealer contracts with clients, and have been subject to attack by consumer groups and regulators in the past, Virginia appears to be the first state to seek to limit them in financial advisor contracts.

But Seybold and Kay said that the rule “is almost certainly preempted by [the Federal Arbitration Act] and therefore unenforceable.” 

"The agency's stated rationale for the rule is that mandatory arbitration provisions in investment advisors' clients' contracts are 'inherently unfair,' the lawyers write. "But that kind of reasoning reflects the very 'hostility to arbitration agreements' that was the basis for Congress's enactment of the FAA in the first place. As a result, it should not be surprising that the Supreme Court has repeatedly rejected this type of hostility to arbitration in holding that state laws prohibiting arbitration agreements are preempted by the FAA."

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