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US SEC building in Washington, D.C., 2008 Chip Somodevilla/Getty Images
US SEC building in Washington, D.C., 2008

PIABA Urges SEC to Suspend RIA Mandatory Arbitration Clauses

In a recent report, the SEC Investor Advocate suggested the commission "temporarily" stop RIAs from including mandatory arbitration clauses in contracts, arguing they could "mislead retail clients into not exercising their legal rights."

The Public Investor Advocate Bar Association is hoping the SEC follows the recommendation by the commission’s Investor Advocate to temporarily suspend including mandatory arbitration clauses in RIA client agreements.

PIABA President Joseph Peiffer said the association warned of the issue for a long time, but the practice increased along with the numbers of registered advisors in the past several years (estimated by the SEC to be a 44% jump in the last decade). 

Too often, these clauses seem created to “price retirees out of justice,” Peiffer told

“I’m glad the Investor Advocate has recognized that making it so that investors who lost their life savings due to fraud can’t recover money from the RIAs due to forced arbitration contracts is a big deal, and a total conflict with advisors’ fiduciary duty,” he said.

Earlier this year, an SEC study commissioned by the U.S. House Appropriations Committee found the use of mandatory arbitration clauses often left clients at a disadvantage (despite the fact the commission found it difficult to grasp the severity of the problem partly due to paltry disclosure requirements).

Nevertheless, the commission determined that about 61% of SEC-registered advisors working with retail clients included mandatory arbitration clauses into advisory agreements. Additionally, of the 60% of mandatory arbitration clauses designating a venue for the arbitration hearing, 97% designated a location “that did not consider (the) client’s location or place of business,” according to the IA report. 

“In practice, clients could be required to participate in an arbitration far from their place of residence, incurring travel and lodging expenses to attend in-person hearings,” the report read. 

According to PIABA, RIAs differ from broker/dealers who must designate FINRA as the forum for any arbitration (which has its own issues, according to PIABA and other investor advocates). 

But RIAs can require clients file arbitration claims with private dispute resolution forums like the American Arbitration Association or JAMS. In this situation, the arbitrators’ fees can run into daily costs in the thousands, and those can triple if there are multiple arbitrators on the panel.

It leads to scenarios in which a client wanting to pursue arbitration may face massive travel costs, along with hefty arbitrators’ fees that may have to be paid at the start of the proceedings. 

According to Peiffer, RIAs count on this, hoping the pricetag stops clients from pulling the trigger on arbitration. He recalled the story of Marykay Dragovich, the cousin of Rita Berardelli, a registered nurse who suffered two brain aneurysms in 2016. 

Dragovich became Berardelli’s conservator after she moved into assisted living and worked with an advisor who made allegedly risky investments, losing about $228,000. After she tried to pursue arbitration, she found she would have to pay at least $200,000, with the possibility it may cost more to enter arbitration than her cousin lost in the first place.

“If you’re tasked with looking out for investors’ best interest as an advisor, how can that possibly be in an investor’s best interest?” Peiffer asked. “It’s just not.”

After this spring’s report, the Investor Advocate determined that language in an advisory arrangement “preemptively limiting the damages available to clients in arbitration, or limiting the types of claims that clients may assert against the advisor in arbitration” could mislead retail clients into not pursuing valid claims.

Therefore, the IA recommended “temporarily suspending” the use of mandatory arbitration clauses by RIAs “until further exploration of the associated costs and benefits to advisory clients is undertaken.”

In the meantime, Peiffer said PIABA will be watching to see if the commission follows through on the IA’s recommendation, and felt the dangers of the mandatory clauses were readily apparent to anyone who learned the truth about them.

“Their jaw hits the floor, because they have no idea if their advisor rips them off, they might have to arbitrate their claims in some far-flung venue for hundreds of thousands of dollars rather than just being able to file a court case. It blows their mind,” he said. “So this issue needs sunshine. I appreciate the Investor Advocate doing its part. But now it’s the commission’s turn.”

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