The SEC Urged to End Mandatory Arbitration Clauses within Investment Advisory Client Agreements

June 04, 2013

The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which was signed into law on July 21, 2010, provides the U.S. Securities and Exchange Commission (“SEC”) with the authority under the Investment Advisers Act of 1940 to prohibit or impose conditions upon the use of pre-dispute, mandatory arbitration clauses within investment advisory client agreements.

Section 921(b) of the Dodd-Frank Act:

(b) AMENDMENT TO INVESTMENT ADVISERS ACT OF 1940.—Section 205 of the Investment Advisers Act of 1940 (15 U.S.C. 80b—5) is amended by adding at the end the following new subsection:

(f) AUTHORITY TO RESTRICT MANDATORY PRE-DISPUTE ARBITRATION.—The Commission, by rule, may prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any investment adviser to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.

Pre-dispute, mandatory arbitration clauses are typically found in most new account agreements between a broker-dealer and its customers; however, such clauses are becoming more prevalent within investment advisory client agreements.

Arbitration clauses typically require the parties to an investment advisory client agreement to resolve any future disputes in an arbitration forum rather than through a trial in court.  Although the SEC has not issued any rules on the use of pre-dispute arbitration clauses by investment advisers since the enactment of Dodd-Frank Act, many lawmakers are pushing the SEC to end pre-dispute, mandatory arbitration clauses in investment advisory client agreements in efforts to provide a more fair landscape for investors. In a letter to SEC Chairman Mary Jo White, composed by U.S. Senator Al Franken and 36 additional Congressional colleagues, Sen. Franken stated on the groups behalf:

We write to express our strong belief that the Securities and Exchange Commission (the “Commission”) should promptly exercise its authority under Section 921 of the Dodd-Frank Wall Street Reform and Consumer Protection Act to prohibit the use of mandatory arbitration provisions in customer service agreements… If arbitration offers investors an efficient forum to resolve disputes, as some argue, investors may choose that option-but they should be given the choice. It is equally important that investors not be precluded from bringing class actions because of contractual fine print imposed by a mandatory waiver class action clause.

Moreover, in a speech presented on April 16, 2013, SEC Commissioner Luis A. Aguilar also voiced his concerns that the SEC should act on its authority granted under the Dodd-Frank Act to end pre-dispute, mandatory arbitration clauses within investment advisory agreements.

Investors also should have the unencumbered right to seek redress in all available forum…Currently, almost all customer agreements with brokerage firms include an arbitration clause requiring customers to arbitrate their claims in an arbitration forum – and they’re now popping-up in the investment advisory industry. By adding such provisions, brokerage and advisory firms are essentially requiring their clients to give up their legal rights before the client even knows about the nature of a dispute, and before the client has had the opportunity to consider whether giving up those rights would be in their interest. The inclusion of such provisions in brokerage and advisory contracts diminishes investor protection.

Additionally, state securities regulators are attempting to build support to end and/or restrict the use of pre-dispute, mandatory arbitration clauses within investment advisory client agreements. A recent survey conducted by the Massachusetts Securities Division Staff found that nearly half of the investment advisers surveyed have pre-dispute, mandatory arbitration clauses within their investment advisory client agreements. The Division concluded that:

While the Division recognizes that arbitration may be appropriate in selected situations, a clause binding an investor to arbitrate a dispute before its circumstances are established may not be in that client’s best interests, nor may such a requirement be consistent with the fiduciary duty owed to the client by the investment adviser. Accordingly, the Division urges that the SEC conduct an in-depth review of the use of these clauses in the advisory context and enact such rules as are necessary and appropriate for the protection of investors.

The North American Securities Administrators Association (“NASAA”) has also brought attention to the use of pre-dispute, mandatory arbitration clauses.  In a letter to the SEC, NASAA reiterated their position that mandatory arbitration clauses in advisory agreements are harmful to investors. NASAA urged the SEC to “curb” their use and encouraged the SEC to act in accordance with Section 921 of the Dodd-Frank act to prohibit or impose limitations on the use of mandatory arbitrations in advisory contracts. NASAA members in favor of the repeal of mandatory arbitration clauses contend that investors should be allowed to settle disputes in court.

Although the SEC has not yet taken a position on the use of pre-dispute, mandatory arbitration clauses by investment advisers, the opposition from state securities regulators, lawmakers and certain SEC commissioners increases the likelihood that the SEC may eventually issue a rule on this subject.

To learn more about the use of pre-dispute, mandatory arbitration clauses and the other issues related to investment advisory client agreements, please join us for a webinar on June 6, 2013 at 12:00 p.m. CDT.  During this webinar, “Key Elements that Should be Included in an Investment Advisory Client Contract – Presented by Bryan Hill Law,” there will be a review of the federal and state regulatory requirements, common mistakes and best practices for an investment adviser to consider when preparing its client agreement.  (RIA Compliance Consultants is not a law firm and does not provide legal services.)  For more information and to register for this event, please click here.

Posted by Bryan Hill
Labels: Arbitration, Client Contracts, NASAA, SEC